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CME > SEC Filings for CME > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for CME GROUP INC.

Form 10-Q for CME GROUP INC.


8-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is provided as a supplement to, and should be read in conjunction with, the accompanying unaudited consolidated financial statements and notes in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2011.
References in this discussion and analysis to "we," "us" and "our" are to CME Group and its consolidated subsidiaries, collectively. References to "exchange" are to Chicago Mercantile Exchange Inc. (CME), Board of Trade of the City of Chicago, Inc. (CBOT), and New York Mercantile Exchange, Inc. (NYMEX), collectively.

RESULTS OF OPERATIONS
Financial Highlights
The following summarizes significant changes in our financial performance for
the periods presented.
                                   Quarter Ended                         Nine Months Ended
                                   September 30,                           September 30,
(dollars in millions,
except per share data)           2012         2011        Change        2012          2011         Change
Total revenues                $  683.2     $  874.2         (22 )%   $ 2,253.7     $ 2,544.1         (11 )%
Total expenses                   287.2        302.1          (5 )        937.3         913.4           3
Operating margin                    58 %         65 %                       58 %          64 %
Non-operating income
(expense)                     $   (0.2 )   $  (26.2 )       (99 )    $    23.5     $   (63.9 )      (137 )
Effective tax rate                  45 %         42 %                       45 %          32 %
Net income attributable to
CME Group                     $  218.0     $  316.1         (31 )    $   729.5     $ 1,066.4         (32 )
Diluted earnings per common
share attributable to CME
Group                             0.66         0.95         (31 )         2.20          3.19         (31 )
Cash flows from operating
activities                                                               897.2         999.8         (10 )

In the third quarter and first nine months of 2012, when compared with the same periods in 2011, the decreases in total revenues were attributable largely to declines in clearing and transaction fees revenue resulting from lower contract volumes.

Total expenses decreased in the third quarter of 2012 when compared with the same period in 2011 due to a decrease in amortization of purchased intangibles as a result of the contribution of certain Dow Jones Index assets and liabilities (the DJI asset group) to a new venture with The McGraw Hill Companies Inc. (McGraw) and to the sale of Credit Market Analysis Ltd (CMA). There was also a decline in compensation and benefits expense due to lower accrued bonuses and a decrease in average headcount. The decrease in average headcount was attributable to the contribution of the DJI asset group and the sale of CMA. The declines in bonus expense and average headcount were partially offset by annual salary increases and rising healthcare costs. The increase in total expenses in the first nine months of 2012 compared with the same period in 2011 was due to higher compensation and benefits expense resulting from additional stock-based compensation and employee separation costs, partially offset by a decline in accrued bonus expense. Expenses associated with S&P/Dow Jones Indices LLC (the McGraw venture), our new venture with McGraw, also contributed to the rise in total year-to-date expenses. The impact of these increases on total year-to-date expenses was partially offset by a decrease in expense from the amortization of purchased intangibles.

We recognized a gain of $59.9 million resulting from the contribution of the DJI asset group to the McGraw venture and the sale of CMA, and a gain relating to a recovery of an impairment loss on a corporate debt security, which resulted in an increase in non-operating income (expense) in the first nine months of 2012 when compared with the same period in 2011.

In the third quarter of 2012 when compared with the same period in 2011, the increase in the effective tax rate was attributable to adjustments to the deferred tax liabilities associated with the McGraw venture. The increase in the effective tax rate in the first nine months of 2012 was due to the establishment of deferred tax liabilities associated with the McGraw venture. The increase was partially offset by non-recurring reductions to tax expense related to the McGraw venture and the sale of CMA in the first nine months of 2012 as well as a change in the state tax apportionment in the first nine months of 2011.


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Revenues
                                   Quarter Ended                         Nine Months Ended
                                   September 30,                           September 30,
(dollars in millions)            2012         2011        Change        2012          2011         Change
Clearing and transaction
fees                          $  562.2     $  732.7         (23 )%   $ 1,826.9     $ 2,111.8         (13 )%
Market data and information
services                          82.8        107.0         (23 )        307.8         321.9          (4 )%
Access and communication
fees                              23.2         12.0          93           65.5          34.8          88  %
Other                             15.0         22.5         (33 )         53.5          75.6         (29 )%
Total Revenues                $  683.2     $  874.2         (22 )    $ 2,253.7     $ 2,544.1         (11 )%

Clearing and Transaction Fees
The following table summarizes our total contract volume, revenue and average
rate per contract. Total contract volume includes contracts that are traded on
our exchange and cleared through our clearing house. Contract volume also
includes cleared-only CME ClearPort contracts. Volume is measured in round
turns, which is considered a completed transaction that involves a purchase and
an offsetting sale of a contract. Average rate per contract is determined by
dividing total clearing and transaction fee revenues by total contract volume.
All amounts exclude our TRAKRS, credit default swap, interest rate swap and CME
Clearing Europe contracts.
                                   Quarter Ended                         Nine Months Ended
                                   September 30,                           September 30,
                                 2012         2011        Change        2012          2011         Change
Total contract volume (in
millions)                        682.8        940.9         (27 )%     2,238.1       2,648.4         (16 )%
Clearing and transaction
fees (in millions)            $  561.3     $  732.7         (23 )    $ 1,823.9     $ 2,111.8         (14 )%
Average rate per contract     $  0.822     $  0.779           6      $   0.815     $   0.797           2

We estimate the following decreases in clearing and transaction fees based on change in total contract volume and change in average rate per contract during the third quarter and first nine months of 2012 when compared with the same periods in 2011.

                                                                                   Nine Months
(in millions)                                                     Quarter Ended       Ended
Decrease due to change in total contract volume                  $      (212.1 )   $   (334.4 )
Increase due to change in average rate per contract                       40.7           46.5
Net decrease in clearing and transaction fees                    $      (171.4 )   $   (287.9 )

Average rate per contract is impacted by our rate structure, including volume-based incentives; product mix; trading venue, and the percentage of volume executed by customers who are members compared with non-member customers. Due to the relationship between average rate per contract and volume, the change in revenues attributable to changes in each is only an approximation.


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Contract Volume
The following table summarizes average daily contract volume. Contract volume
can be influenced by many factors, including political and economic factors, the
regulatory environment and market competition.
                                 Quarter Ended                        Nine Months Ended
                                 September 30,                          September 30,
(amounts in thousands)         2012        2011        Change         2012           2011       Change
Average Daily Volume by
Product Line:
Interest rate                  4,514       6,518         (31 )%      5,085           6,464        (21 )%
Equity                         2,391       4,040         (41 )       2,569           3,269        (21 )
Foreign exchange                 846         988         (14 )         871             956         (9 )
Agricultural commodity         1,171       1,029          14         1,194           1,111          7
Energy                         1,590       1,673          (5 )       1,761           1,801         (2 )
Metal                            327         454         (28 )         361             412        (12 )
Aggregate average daily
volume                        10,839      14,702         (26 )      11,841          14,013        (15 )
Average Daily Volume by
Venue:
Electronic                     9,293      12,462         (25 )      10,024          11,845        (15 )
Open outcry                      979       1,557         (37 )       1,144           1,473        (22 )
Privately negotiated             209         257         (19 )         225             241         (7 )
Total exchange-traded
volume                        10,481      14,276         (27 )      11,393          13,559        (16 )
Total CME ClearPort              358         426         (16 )         448             454         (1 )
Aggregate average daily
volume                        10,839      14,702         (26 )      11,841          14,013        (15 )

Interest Rate Products
The following table summarizes average daily contract volume for our key
interest rate products. Eurodollar front 8 contracts include contracts expiring
within two years. Eurodollar back 32 contracts include contracts expiring within
three to ten years.
                                  Quarter Ended                          Nine Months Ended
                                  September 30,                            September 30,
(amounts in thousands)           2012        2011        Change          2012           2011        Change
Eurodollar futures and
options:
Front 8 futures                 1,020        1,686         (40 )%      1,187            1,892         (37 )%
Back 32 futures                   554          598          (7 )         592              539          10
Options                           364          908         (60 )         453              810         (44 )
U.S. Treasury futures and
options:
10-Year                         1,156        1,603         (28 )       1,308            1,544         (15 )
5-Year                            529          773         (32 )         575              762         (25 )
Treasury bond                     404          475         (15 )         436              426           2
2-Year                            243          297         (18 )         235              328         (28 )

Overall interest rate contract volume decreased in the third quarter and first nine months of 2012 when compared with the same periods in 2011 due to low interest rate volatility as a result of the Federal Reserve's continued intent to maintain its zero interest rate policy through mid-2015. The increase in volume in the long-term interest rate products, including the Eurodollar back 32 futures and the Treasury bond futures and options contracts, in the first nine months of 2012 when compared with the same period in 2011 was attributable to periods of higher long-term interest rate volatility in early 2012. The Federal Reserve's announcement in January 2012 to extend its zero interest rate policy shifted market expectations regarding long-term interest rates, which resulted in periods of higher volatility in early 2012.


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Equity Products
The following table summarizes average daily contract volume for our key equity
products.
                                  Quarter Ended                          Nine Months Ended
                                  September 30,                            September 30,
(amounts in thousands)           2012        2011        Change          2012           2011        Change
E-mini S&P futures and
options                         1,887        3,284         (43 )%      2,036            2,621         (22 )%
E-mini NASDAQ futures and
options                           231          351         (34 )         249              309         (19 )

In the third quarter and first nine months of 2012, when compared with the same periods in 2011, the decreases in equity contract volume were due to declines in equity market volatility, as measured by the CBOE Volatility Index. The declines in volatility in the third quarter and first nine months of 2012, when compared with the same periods in 2011, were the result of unchanged economic conditions within the United States and European markets. In addition, we experienced periods of high volatility within the equity markets during 2011, which we believe were attributable to events in Asia and the Middle East as well as the downgrade of the United States credit rating.
The overall decrease in volume for the first nine months of 2012 when compared with the same period in 2011 was partially offset by an increase in equity contract volume in the second quarter of 2012 due primarily to financial and political uncertainty in the European Union. Foreign Exchange Products
The following table summarizes average daily contract volume for our key foreign exchange products.

                             Quarter Ended                      Nine Months Ended
                             September 30,                        September 30,
(amounts in thousands)       2012        2011    Change           2012           2011    Change
Euro                        283           387     (27 )%        303               369     (18 )%
Australian dollar           139           141      (1 )         141               122      16
British pound               110           116      (5 )         108               123     (12 )
Canadian dollar              99           107      (7 )          99                95       4
Japanese yen                 89           116     (24 )          94               129     (27 )

The overall decreases in foreign exchange contract volume in the third quarter and first nine months of 2012, when compared with the same periods in 2011, were primarily attributable to declines in euro contract volume. We believe trading activity in euro contracts has been impacted by the lack of a directional trend due to uncertainty related to the health of the European Union and concern over the possibility that the Federal Reserve will provide additional economic stimulus in the United States. The lack of a trend has reduced trading in euro contracts among customers who trade based on medium- to long-term expectations. We believe that intervention by the Japanese central bank to control the yen foreign exchange rate beginning in mid-2011 caused market participants to reduce their trading in Japanese yen contracts and to focus on higher yielding currencies, such as the Australian and Canadian dollars. We believe the decline in the British pound contract volume was due to lower volatility in the third quarter and first nine months of 2012 when compared with the same periods in 2011.
Agricultural Commodity Products
The following table summarizes average daily contract volume for our key agricultural commodity products.

                             Quarter Ended                      Nine Months Ended
                             September 30,                        September 30,
(amounts in thousands)       2012        2011    Change           2012           2011    Change
Corn                        396           399     (1 )%         421               444     (5 )%
Soybean                     301           219     37            287               228     26
Wheat                       125           101     24            135               122     10
Soybean oil                 115            96     20            117               106     10

The increases in agricultural commodity contract volume in the third quarter and first nine months of 2012 when compared with the same periods in 2011 were attributable to higher volatility resulting from severe drought conditions in the Midwest in the second and third quarters of 2012. We believe the increased volatility was the result of supply constraint concerns for soybean and wheat supplies. Corn volumes remained relatively flat in the third quarter and first nine months of 2012 when compared with the same periods in 2011. Early market expectations of excess supply in 2012 dampened corn price volatility in early 2012, which kept trading volumes relatively flat compared with 2011.


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Energy Products
The following table summarizes average daily contract volume for our key energy
products.
                             Quarter Ended                      Nine Months Ended
                             September 30,                        September 30,
(amounts in thousands)       2012        2011    Change           2012           2011    Change
Crude oil                   699           849     (18 )%        761               932     (18 )%
Natural gas                 547           492      11           635               530      20
Refined products            306           265      15           319               271      18

Energy contract volume decreased slightly in the third quarter and first nine months of 2012 when compared with the same periods in 2011. Declines in crude oil contract volume contributed to overall decreases in energy products volume. We believe the declines in crude oil contract volume were attributable to lower price volatility in 2012 compared with 2011. Political unrest in the Middle East in the first quarter of 2011 resulted in changes in global supply, which contributed to higher price volatility in early 2011. Additionally, lower crude oil contract volume was attributable to oversupply in Cushing, Oklahoma. We believe that these supply constraints have eased due to the reversal of the Seaway Pipeline in the second quarter of 2012, which is expected to increase in the coming months. However, uncertainty remains over the impact it will have on the overall crude oil market. The decreases in crude oil contract volume were partially offset by increases in natural gas contract volume. The increases in natural gas contract volume were attributable to higher volatility resulting from weather-related events, which caused rising natural gas consumption. Metal Products
The following table summarizes average daily volume for our key metal products.

                             Quarter Ended                      Nine Months Ended
                             September 30,                        September 30,
(amounts in thousands)       2012        2011    Change           2012           2011    Change
Gold                        194           310     (37 )%        218               252     (14 )%
Copper                       59            50      17            67                49      38
Silver                       56            79     (29 )          61                98     (38 )

The overall decreases in metal products volume in the third quarter and first nine months of 2012 when compared with the same periods in 2011 were attributable to lower volatility in the precious metals markets in 2012 when compared with 2011. We believe the August 2011 announcement of the Federal Reserve's intent to maintain its zero interest rate policy and deepening Eurozone worries, which caused high volatility within other financial markets, resulted in an increased interest in precious metals as an asset class. This increased interest resulted in relative decreases in gold and silver contract volume in the third quarter and first nine months of 2012 when compared with the same periods in 2011. This decrease was partially offset by an increase in volume for copper contracts as a result of economic growth in Asia as well as global supply constraints.
Average Rate per Contract
The average rate per contract increased in the third quarter and the first nine months of 2012 when compared with the same periods in 2011 due to a shift in the relative mix of product volume. In the third quarter of 2012, agricultural commodity and energy product volumes, when measured as a percentage of total volume, increased by 4% and 3%, respectively, while interest rate and equity product volumes decreased by 3% and 5%, respectively. In the first nine months of 2012, agricultural commodity and energy product volumes both increased by 2% while interest rate and equity product volumes decreased 3% and 2%, respectively. Agricultural commodity and energy products have higher fees compared with interest rate and equity products. Concentration of Revenue
We bill a substantial portion of our clearing and transaction fees to our clearing firms. The majority of clearing and transaction fees received from clearing firms represent charges for trades executed and cleared on behalf of their customers. Two firms each represented 12% of our clearing and transaction fees revenue in the first nine months of 2012. Should a clearing firm withdraw, we believe that the customer portion of the firm's trading activity would likely transfer to another clearing firm of the exchange. Therefore, we do not believe we are exposed to significant risk from the ongoing loss of revenue received from or through a particular clearing firm. Other Sources of Revenue
The decreases in market data and information services revenue in the third quarter and first nine months of 2012, when


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compared with the same periods in 2011, were attributable to decreases in market data and information services revenue from Index Services. In the second quarter of 2012, the DJI asset group, including assets which generated market data and information services revenue, was contributed to the McGraw venture. In addition, the decreases in revenue were due to declines in basic device counts in the third quarter and first nine months of 2012 due to cost-cutting initiatives at customer firms. The decreases in market data and information services were partially offset by an increase in our basic device service fee from $61 per month to $70 per month for each device effective January 2012. The two largest resellers of our market data represented approximately 45% of our market data and information services revenue in the first nine months of 2012. Despite this concentration, we consider exposure to significant risk of revenue loss to be minimal. In the event that one of these vendors no longer subscribes to our market data, we believe the majority of that vendor's customers would likely subscribe to our market data through another reseller. Additionally, several of our largest institutional customers that utilize services from our two largest resellers report usage and remit payment of their fees directly to us.
We launched our co-location program in the first quarter of 2012, which generated $14.0 million and $37.6 million of access and communication revenue in the third quarter and first nine months of 2012, respectively. These increases in revenue were partially offset by decreases in revenue generated from other network connections due to the migration of customers to the co-location program.
In April 2012, we sold two buildings in Chicago, which resulted in decreases in rental income of $6.1 million and $10.6 million in the third quarter and first nine months of 2012, respectively, when compared with the same periods in 2011. In addition, the initial phase to develop a new multi-asset class electronic platform for BM&FBOVESPA S.A. (BM&FBOVESPA) was completed in the third quarter of 2011, which resulted in decreases in other revenues in the third quarter and first nine months of 2012 when compared with the same periods in 2011. This agreement with BM&FBOVESPA generated $1.9 million and $6.1 million in the third quarter and first nine months of 2011, respectively. Additional revenue related to the development of the electronic platform will not be recognized until future phases are delivered. In the second quarter of 2011, we recognized a $9.8 million gain on the sale of certain Index Services assets related to one of its service offerings, which contributed to a decrease in other revenues in the first nine months of 2012 when compared with the same period in 2011. The decreases in other revenues were partially offset by increases of $1.6 million and $4.5 million in processing services revenue generated from various strategic relationships in the third quarter and first nine months of 2012, respectively, when compared with the same periods in 2011.

Expenses
                                   Quarter Ended                          Nine Months Ended
                                   September 30,                            September 30,
(dollars in millions)            2012         2011        Change          2012            2011        Change
Compensation and benefits     $  117.5     $  119.9          (2 )%   $    383.7        $  359.7           7  %
Communications                     9.8         11.0         (10 )          30.8            31.7          (3 )
Technology support services       11.8         13.3         (12 )          36.7            38.7          (5 )
Professional fees and
outside services                  26.7         29.0          (8 )          99.2            90.4          10
Amortization of purchased
intangibles                       26.2         33.0         (21 )          90.3            99.2          (9 )
Depreciation and
amortization                      34.5         32.4           6           103.0            95.1           8
Occupancy and building
operations                        18.8         18.5           1            57.8            56.9           2
Licensing and other fee
agreements                        19.2         22.6         (15 )          63.2            64.7          (2 )
Other                             22.7         22.4           2            72.6            77.0          (6 )
Total Expenses                $  287.2     $  302.1          (5 )    $    937.3        $  913.4           3


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Operating expenses decreased by $14.9 million in the third quarter of 2012, while increasing $23.9 million in the first nine months of 2012 when compared . . .

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