The CME Group is one of the world's largest options exchanges and the largest futures exchange in the world, based in Chicago in the state of Illinois, the company was formed on July 12, 2007 through the merger of the Chicago Board of Trade and Chicago Mercantile Exchange.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended June 30, 2011
- OR -
For the transition period from to
Commission file number 001-31553
CME GROUP INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
(312) 930-1000
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of each of the registrant’s classes of common stock as of July 20, 2011 was as follows: 66,862,797 shares of Class A common stock, $0.01 par value; 625 shares of Class B common stock, Class B-1, $0.01 par value; 813 shares of Class B common stock, Class B-2, $0.01 par value; 1,287 shares of Class B common stock, Class B-3, $0.01 par value; and 413 shares of Class B common stock, Class B-4, $0.01 par value.
INDEX
PART I. FINANCIAL INFORMATION
Item 1.
Item 2.
Item 3.
Item 4.
PART II. OTHER INFORMATION
Item 1A.
Item 6.
SIGNATURES
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PART I: FINANCIAL INFORMATION
Certain Terms
All references to “options” or “options contracts” in the text of this document refer to options on futures contracts.
Unless otherwise indicated, references to CME Group Inc. (CME Group) products include references to products on one of its regulated exchanges: Chicago Mercantile Exchange Inc. (CME), Board of Trade of the City of Chicago, Inc. (CBOT), New York Mercantile Exchange, Inc. (NYMEX) and Commodity Exchange, Inc. (COMEX). Products listed on these exchanges are subject to the rules and regulations of the particular exchange and the applicable rulebook should be consulted. Unless otherwise indicated, references to NYMEX include its subsidiary, COMEX.
Further information about CME Group and its products can be found at http://www.cmegroup.com. Information made available on our Web site does not constitute a part of this Quarterly Report on Form 10-Q.
Information about Trading Volume and Average Rate per Contract
Disclosed amounts of trading volume and average rate per contract exclude our TRAKRS, credit default swaps and interest rate swaps.
Trademark Information
CME Group is a trademark of CME Group Inc. The Globe logo, CME, Chicago Mercantile Exchange, Globex and E-mini are trademarks of Chicago Mercantile Exchange Inc. CBOT and Chicago Board of Trade are trademarks of Board of Trade of the City of Chicago, Inc. NYMEX, New York Mercantile Exchange and ClearPort are trademarks of New York Mercantile Exchange, Inc. Dow Jones and Dow Jones Indexes are service marks of Dow Jones Trademark Holdings, LLC, and have been licensed to CME Index Services LLC. All other trademarks are the property of their respective owners.
Forward-looking Statements
From time to time, in this Quarterly Report on Form 10-Q as well as in other written reports and verbal statements, we discuss our expectations regarding future performance. These forward-looking statements are identified by their use of terms and phrases such as “believe,” “anticipate,” “could,” “estimate,” “intend,” “may,” “plan,” “expect” and similar expressions, including references to assumptions. These forward-looking statements are based on currently available competitive, financial and economic data, current expectations, estimates, forecasts and projections about the industries in which we operate and management’s beliefs and assumptions. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. We want to caution you not to place undue reliance on any forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. Among the factors that might affect our performance are:
increasing competition by foreign and domestic entities, including increased competition from new entrants into our markets and consolidation of existing entities;
our ability to keep pace with rapid technological developments, including our ability to complete the development, implementation and maintenance of the enhanced functionality required by our customers;
our ability to continue introducing competitive new products and services on a timely, cost-effective basis, including through our electronic trading capabilities, and our ability to maintain the competitiveness of our existing products and services, including our ability to provide effective services to the over-the-counter market;
our ability to adjust our fixed costs and expenses if our revenues decline;
our ability to generate revenues from our processing services;
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our ability to maintain existing customers, develop strategic relationships and attract new customers;
our ability to expand and offer our products outside the United States;
changes in domestic and non-U.S. regulations;
changes in government policy, including policies relating to common or directed clearing and changes as a result of legislation stemming from the implementation of the Dodd-Frank Act;
the costs associated with protecting our intellectual property rights and our ability to operate our business without violating the intellectual property rights of others;
our ability to generate revenue from our market data that may be reduced or eliminated by the growth of electronic trading, the state of the overall economy or declines in subscriptions;
changes in our rate per contract due to shifts in the mix of the products traded, the trading venue and the mix of customers (whether the customer receives member or non-member fees or participates in one of our various incentive programs) and the impact of our tiered pricing structure;
the ability of our financial safeguards package to adequately protect us from the credit risks of clearing members;
the ability of our compliance and risk management methods to effectively monitor and manage our risks, including our ability to prevent errors and misconduct;
changes in price levels and volatility in the derivatives markets and in underlying fixed income, equity, foreign exchange, interest rate and commodities markets;
economic, political and market conditions, including the volatility of the capital and credit markets and the impact of economic conditions on the trading activity of our current and potential customers stemming from the financial crisis that began in 2008 and any other future crises;
our ability to accommodate increases in trading volume and order transaction traffic without failure or degradation of the performance of our trading and clearing systems;
our ability to execute our growth strategy and maintain our growth effectively;
our ability to manage the risks and control the costs associated with our acquisition, investment and alliance strategy;
our ability to continue to generate funds and/or manage our indebtedness to allow us to continue to invest in our business;
industry and customer consolidation;
decreases in trading and clearing activity;
the imposition of a transaction tax or user fee on futures and options on futures transactions and/or repeal of the 60/40 tax treatment of such transactions;
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the unfavorable resolution of material legal proceedings; and
the seasonality of the futures business.
For a detailed discussion of these and other factors that might affect our performance, see Item 1A. of our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on February 28, 2011 and Item 1A of this Report.
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CME GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in millions, except per share data; shares in thousands)
(unaudited)
Assets
Current Assets:
Cash and cash equivalents
Marketable securities
Accounts receivable, net of allowance of $1.3 and $1.6
Other current assets (includes $40.0 and $0 in restricted cash)
Cash performance bonds and guaranty fund contributions
Total current assets
Property, net of accumulated depreciation and amortization of $556.5 and $512.9
Intangible assets – trading products
Intangible assets – other, net
Goodwill
Other assets (includes $20.0 and $0 in restricted cash)
Total Assets
Liabilities and Shareholders’ Equity
Current Liabilities:
Accounts payable
Short-term debt
Other current liabilities
Total current liabilities
Long-term debt
Deferred tax liabilities, net
Other liabilities
Total Liabilities
Redeemable non-controlling interest
Shareholders’ Equity:
Preferred stock, $0.01 par value, 9,860 shares authorized, none issued or outstanding
Series A junior participating preferred stock, $0.01 par value, 140 shares authorized, none issued or outstanding
Class A common stock, $0.01 par value, 1,000,000 shares authorized, 66,667 and 66,847 shares issued and outstanding as of June 30, 2011 and December 31, 2010, respectively
Class B common stock, $0.01 par value, 3 shares authorized, issued and outstanding
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss)
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
See accompanying notes to unaudited consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
Revenues
Clearing and transaction fees
Market data and information services
Access and communication fees
Other
Total Revenues
Expenses
Compensation and benefits
Communications
Technology support services
Professional fees and outside services
Amortization of purchased intangibles
Depreciation and amortization
Occupancy and building operations
Licensing and other fee agreements
Total Expenses
Operating Income
Non-Operating Income (Expense)
Investment income
Gains (losses) on derivative investments
Interest and other borrowing costs
Equity in net losses of unconsolidated subsidiaries
Total Non-Operating
Income before Income Taxes
Income tax provision
Net Income
Less: net income attributable to redeemable non-controlling Interest
Net Income Attributable to CME Group
Earnings per Common Share Attributable to CME Group:
Basic
Diluted
Weighted Average Number of Common Shares:
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Balance at December 31, 2010
Comprehensive income attributable to CME Group:
Net income attributable to CME Group
Change in net unrealized gain on securities, net of tax of $82.6
Change in net actuarial loss on defined benefit plans, net of tax of $1.0
Net change in derivative instruments, net of tax of $0.2
Change in foreign currency translation adjustment, net of tax of $14.3
Total comprehensive income attributable to CME Group
Dividends on common stock of $2.80 per share
Repurchase of Class A common stock
Exercise of stock options
Excess tax benefits from option exercises and restricted stock vesting
Vesting of issued restricted class A common stock
Shares issued to Board of Directors
Shares issued under Employee Stock
Purchase Plan
Stock-based compensation
Balance at June 30, 2011
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (continued)
Balance at December 31, 2009
Change in net unrealized gain on securities, net of tax $4.1
Change in net actuarial loss on defined benefit plans, net of tax of $0.8
Net change in derivative instruments, net of tax of $1.6
Change in foreign currency translation adjustment, net of tax of $2.2
Dividends on common stock of $2.30 per share
Vesting of issued restricted Class A common stock
Shares issued under Employee Stock Purchase Plan
Balance at June 30, 2010
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Credit Market Analysis Limited impairment
Net accretion of discounts and amortization of debt financing costs
Gain on sale of Index Services assets
Deferred income taxes
Change in assets and liabilities:
Accounts receivable
Other current assets
Other assets
Income tax payable
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities
Proceeds from maturities of available-for-sale marketable securities
Purchases of available-for-sale marketable securities
Purchases of property, net
Cash acquired from Index Services
Proceeds from sale of Index Services assets
Proceeds from Chicago Board Options Exchange exercise right privileges
Net Cash Used in Investing Activities
Cash Flows from Financing Activities
Proceeds (repayments) of commercial paper, net
Proceeds from other borrowings, net of issuance costs
Repayment of other borrowings
Cash dividends
Repurchase of Class A common stock, including costs
Proceeds from exercise of stock options
Distribution paid to non-controlling interest
Excess tax benefits related to employee option exercises and restricted stock vesting
Net Cash Used in Financing Activities
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CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Net change in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and Cash Equivalents, End of Period
Supplemental Disclosure of Cash Flow Information
Income taxes paid
Interest paid
Non-cash investing activities:
Change in net unrealized securities gains (losses)
Change in net unrealized derivatives gains (losses)
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The consolidated financial statements consist of CME Group Inc. (CME Group) and its subsidiaries (collectively, the company), including Chicago Mercantile Exchange Inc. (CME), the Board of Trade of the City of Chicago, Inc. (CBOT), New York Mercantile Exchange, Inc. (NYMEX) and their respective subsidiaries (collectively, the exchange). On March 18, 2010, CBOT acquired a 90% ownership interest in CME Group Index Holdings LLC, which owns CME Group Index Services LLC (Index Services), a joint venture with Dow Jones & Company (Dow Jones). The financial statements and accompanying notes presented in this report include the financial results of Index Services beginning on March 19, 2010.
The accompanying interim consolidated financial statements have been prepared by CME Group without audit. Certain notes and other information normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. In the opinion of management, the accompanying consolidated financial statements include all normal recurring adjustments considered necessary to present fairly the financial position of the company at June 30, 2011 and December 31, 2010 and the results of operations and cash flows for the periods indicated. Quarterly results are not necessarily indicative of results for any subsequent period.
The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto in CME Group’s Annual Report on Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange Commission (SEC) on February 28, 2011. Certain reclassifications have been made to the 2010 financial statements to conform to the presentation in 2011.
2. Intangible Assets and Goodwill
Intangible assets consisted of the following at June 30, 2011 and December 31, 2010:
Amortizable Intangible Assets:
Clearing firm, market data and other customer relationships (1)
Lease-related intangibles
Technology-related intellectual property
Other(2)
Foreign currency translation adjustments
Total amortizable intangible assets
Indefinite-Lived Intangible Assets:
Trade names
Total intangible assets – other, net
Trading products (3)
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Total amortization expense for intangible assets was $33.0 million and $32.3 million for the quarters ended June 30, 2011 and 2010, respectively. Total amortization expense for intangible assets was $66.2 million and $63.1 million for the first six months of 2011 and 2010, respectively. As of June 30, 2011, the future estimated amortization expense related to amortizable intangible assets is expected to be:
Remainder of 2011
2012
2013
2014
2015
2016
Thereafter
Goodwill activity consisted of the following for the six months ended June 30, 2011 and the year ended December 31, 2010:
CBOT Holdings, Inc.
NYMEX Holdings, Inc.
Index Services
Total Goodwill
During the second quarter of 2010, the company recorded a $19.8 million impairment charge to reduce the carrying amount of Credit Market Analysis, Ltd. (CMA) goodwill to its estimated fair value.
3. Debt
Short-term debt consisted of the following at June 30, 2011 and December 31, 2010:
Term loan due 2011, interest equal to 3-month LIBOR plus 1.00%, reset quarterly(1)
Total short-term debt
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Long-term debt consisted of the following at June 30, 2011 and December 31, 2010:
$750.0 million fixed rate notes due August 2013, interest equal to 5.40%
$750.0 million fixed rate notes due February 2014, interest equal to 5.75%
$612.5 million fixed rate notes due March 2018, interest equal to 4.40%(2)
Total long-term debt
Commercial paper notes with an aggregate par value of $1.0 billion and maturities ranging from 1 to 33 days were issued during the first six months of 2011. There was no commercial paper outstanding at December 31, 2010 or June 30, 2011. During the first six months of 2011 and 2010, the weighted average balance, at par value, of commercial paper outstanding was $61.8 million and $168.2 million, respectively. In the first six months of 2011, the maximum month-end balance for commercial paper was $200.0 million in January. In the first six months of 2010, the maximum month-end balance was $300.0 million in February and March.
Long-term debt maturities, at par value, were as follows as of June 30, 2011:
The fair values of the fixed rate notes due 2013 and 2014 were estimated using quoted market prices. The fair value of the fixed rate notes due 2018 was derived using a standard valuation model with market-based observable inputs including U.S. Treasury yields and interest rate spreads. At June 30, 2011, the fair values of the fixed rate notes by maturity date were as follows.
$750.0 million fixed rate notes due August 2013
$750.0 million fixed rate notes due February 2014
$612.5 million fixed rate notes due March 2018
4. Income Taxes
The company’s effective tax rate decreased to 26.3% in the first six months of 2011 from 41.8% in the first six months of 2010. The effective tax rate decreased by 11.6% due to a tax benefit of $118.1 million resulting from a change in state tax apportionment in the first quarter of 2011. This change resulted in a reduction in the income tax provision primarily due to a revaluation of existing deferred tax liabilities. The effective tax rate also decreased by 4.8% due to a $48.8 million reduction in valuation allowances on unrealized capital losses previously reserved. The company began marking-to-market its investment in BM&FBOVESPA S.A. (BM&FBOVESPA) in the first quarter of 2011 which resulted in the reversal of these unrelated valuation allowances.
Also, the company reversed a valuation allowance of $64.3 million related to its investment in BM&FBOVESPA, which increased accumulated other comprehensive income (loss) in the first quarter of 2011. The valuation allowance was reversed because the company began marking-to-market its investment in BM&FBOVEPA in the first quarter of 2011.
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5. Contingencies
Legal Matters. In 2008, Fifth Market filed a complaint against CME Group and CME seeking a permanent injunction against CME’s Globex system and unquantified enhanced damages for what the plaintiff alleges is willful infringement of two U.S. patents, in addition to costs, expenses and attorneys’ fees. The matter has been stayed pending the outcome of a reexamination of one of the patents at issue by the U.S. Patent and Trademark Office (USPTO). Based on its investigation to date and advice from legal counsel, the company believes this suit is without merit and intends to defend itself vigorously against these charges.
In 2009, CME and CBOT filed a complaint against Howard Garber seeking a declaratory judgment that neither CME nor CBOT infringed Mr. Garber’s patent and that his patent is invalid and unenforceable. In 2009, Technology Research Group LLC, the current owner of the patent at issue, filed counterclaims alleging that CME and CBOT willingly infringe or induce or contribute to the infringement of its patent. Technology Research is seeking damages in the amount no less than a reasonable royalty. Trial was originally set for June 2011. The matter has been dismissed without prejudice with right to reinstate pending reexamination of the patent at issue by the USPTO and all settlement possibilities are evaluated. Based on its investigation to date and advice from legal counsel, the company believes this suit is without merit and intends to defend itself vigorously against these charges.
In 2009, Realtime Data LLC filed a complaint against CME Group and other exchanges alleging willful infringement of four patents which, was later amended to add CBOT and NYMEX as defendants. Subsequently, two additional lawsuits have been filed each adding a claim for the infringement of an additional patent. Both of these lawsuits have been consolidated with the original action. Realtime Data is seeking a permanent injunction, unquantified enhanced damages, attorneys’ fees and costs. Discovery in this matter is in the early stages. The Court of Appeals for the Federal Circuit has ordered that the case be transferred to the Southern District of New York. Realtime has requested reconsideration of the transfer. The case is currently stayed pending the Federal Circuits decision on the request for reconsideration. Based on its investigation to date and advice from legal counsel, the company believes this suit is without merit and intends to defend itself vigorously against these charges.
The foregoing legal matters involve alleged infringements of intellectual property, which due to their nature involve potential liability that is uncertain, difficult to quantify and involve a wide range of potential outcomes. The company believes that the matters are without merit and intends to defend itself vigorously against the claims. We expect the reexaminations by the USPTO in the Fifth Market and Garber matters to result in a determination of the validity of the patents at issue which we expect will have an impact on the merits of the matters. Given the uncertainty of the potential outcome of the reexaminations, at this time the company is unable to estimate the reasonably possible loss or range of reasonably possible loss in the unlikely event it were found to be liable at trial in these matters. In the Realtime matter, no estimate of our reasonably possible loss or range of reasonably possible loss may be made at this time because the damages sought in the proceeding have not been quantified or substantiated and the discovery phase of the matter is in the early stages.
In addition, the company is a defendant in, and has potential for, various other legal proceedings arising from its regular business activities. While the ultimate results of such proceedings against the company cannot be predicted with certainty, the company believes that the resolution of any of these matters on an individual basis or in the aggregate will not have a material impact on its consolidated financial position or results of operations.
Regulatory Matters. In the normal course of business, the company discusses matters with its regulators raised during regulatory examinations or otherwise subject to their inquiry and oversight. These matters could result in censures, fines, penalties or other sanctions. Management believes the outcome of any resulting actions will not have a material impact on its consolidated financial position or results of operations. However, the company is unable to predict the outcome or the timing of the ultimate resolution of these matters, or the potential fines, penalties or injunctive or other equitable relief, if any, that may result from these matters.
Intellectual Property Indemnifications. Certain agreements with customers and other third parties related to accessing the CME Globex platform, the CME ClearPort platform, and/or the Clearing 21 platform; utilizing market data services; licensing CME SPAN software; and calculating indexes as a service provider and licensing indexes as the basis of financial products may contain indemnifications from intellectual property claims that may be made against them as a result of their use of the applicable products and/or services. The potential future claims relating to these indemnifications cannot be estimated and, therefore, no liability has been recorded.
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6. Guarantees
CME Clearing Contract Settlement. CME marks-to-market open positions for most products at least twice a day, and requires payment from clearing firms whose positions have lost value and makes payments to clearing firms whose positions have gained value. For select cleared-only markets, positions are marked-to-market once daily, with the capability to mark-to-market more frequently as market conditions warrant. Under the extremely unlikely scenario of simultaneous default by every clearing firm who has open positions with unrealized losses, the maximum exposure related to CME’s guarantee would be one half day of changes in fair value of all open positions, before considering CME’s ability to access defaulting clearing firms’ performance bond and guaranty fund balances as well as other available resources. During the first six months of 2011, CME transferred an average of approximately $2.8 billion a day through its clearing system for settlement from clearing firms whose positions had lost value to clearing firms whose positions had gained value. CME reduces its guarantee exposure through initial and maintenance performance bond requirements and mandatory guaranty fund contributions. The company believes that its guarantee liability is immaterial and therefore has not recorded any liability at June 30, 2011.
Mutual Offset Agreement. CME and Singapore Exchange Limited (SGX) have a mutual offset agreement with a current term through October 2011. The term of the agreement will automatically renew for a one-year period unless either party provides advance notice of their intent to terminate. CME can maintain collateral in the form of U.S. Treasury securities or irrevocable letters of credit. At June 30, 2011, CME was contingently liable to SGX on irrevocable letters of credit totaling $83.0 million. Regardless of the collateral, CME guarantees all cleared transactions submitted through SGX and would initiate procedures designed to satisfy these financial obligations in the event of a default, such as the use of performance bonds and guaranty fund contributions of the defaulting clearing firm.
Cross-Margin Agreements. CME and The Options Clearing Corporation (OCC) have a cross-margin arrangement, whereby a common clearing firm may maintain a cross-margin account in which the clearing firm’s positions in certain CME futures and options on futures contracts are combined with certain positions cleared by OCC for purposes of calculating performance bond requirements. The performance bond deposits are held jointly by CME and OCC. If a participating firm defaults, the gain or loss on the liquidation of the firm’s open position and the proceeds from the liquidation of the cross-margin account would be allocated 50% each to CME and OCC.
Cross-margin agreements exist with CME and Fixed Income Clearing Corp (FICC) whereby the clearing firms’ offsetting positions with CME are subject to reduced margin requirements. Clearing firms maintain separate performance bond deposits with each clearing house, but depending on the net offsetting positions between CME and FICC, each clearing house may reduce the firm’s performance bond requirement. In the event of a firm default, the total liquidation net gain or loss on the firm’s offsetting open positions and the proceeds from the liquidation of the performance bond collateral held by each clearing house’s supporting offsetting positions would be divided evenly between CME and FICC. Additionally, if, after liquidation of all the positions and collateral of the defaulting firm at each respective clearing organization, and taking into account any cross-margining loss sharing payments, any of the participating clearing organizations has a remaining liquidating surplus, and any other participating clearing organization has a remaining liquidating deficit, any additional surplus from the liquidation would be shared with the other clearing house to the extent that it has a remaining liquidating deficit. Any remaining surplus funds would be passed to the bankruptcy trustee.
GFX Corporation Letter of Credit. CME guarantees a $15.0 million standby letter of credit for GFX Corporation (GFX). The beneficiary of the letter of credit is the clearing firm that is used by GFX to execute and maintain its futures positions. Based on exchange requirements, GFX is required to place performance bond deposits with its clearing firm. The letter of credit, utilized as a performance bond, would be drawn on in the event that GFX defaults in meeting requirements to its clearing firm. In the unlikely event of a payment default by GFX, if GFX’s performance bond is not sufficient to cover the deficit, CME would guarantee the remaining deficit, if any.
7. Stock-Based Payments
Total expense for stock-based payments, including shares issued to the board of directors, was $25.6 million and $20.1 million for the six months ended June 30, 2011 and 2010, respectively. The total income tax benefit recognized in the consolidated statements of income for stock-based payment arrangements was $10.1 million and $8.0 million for the six months ended June 30, 2011 and 2010, respectively.
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In the first six months of 2011, the company granted employees stock options totaling 6,172 shares under the CME Group Omnibus Stock Plan. The options have a ten-year term with exercise prices ranging from $271 to $286 per share, the closing market price on the dates of grant. The fair value of these options totaled $0.6 million, measured at the grant dates using the Black-Scholes valuation model, which is recognized as compensation expense on an accelerated basis over the vesting period of four years. The Black-Scholes fair values of the option grants were calculated using the following assumptions: dividend yields ranging from 2.0% to 2.1%; expected volatility ranging from 41% to 42%; risk-free interest rates ranging from 2.0% to 2.4% and an expected life of 6.3 years. The grant date weighted average fair value of options granted during the first six months of 2011 was $100 per share.
In the first six months of 2011, the company granted 8,521 shares of restricted Class A common stock which generally have a vesting period of two to four years. The fair value of these grants was $2.4 million, which is recognized as compensation expense on an accelerated basis over the vesting period. In the first six months of 2011, the company granted 5,542 performance shares. The vesting of these shares is contingent on meeting stated goals over a performance period, beginning in June 2011 and ending in December 2014.
8. Accumulated Other Comprehensive Income (Loss)
In December 2008, an unrealized loss of $81.7 million, net of tax, resulting from changes in foreign currency exchange rates, was recorded in accumulated other comprehensive income (loss) upon recognizing impairment on the company’s investment in BM&FBOVESPA. Prior to February 2011, this investment was recorded at cost due to restrictions on the sale of the stock. The company began marking-to-market its investment in BM&FBOVESPA in February 2011 because these restrictions will lapse in February 2012, with changes in unrealized gains (losses) recorded in accumulated other comprehensive income (loss). During the first six months, the company recognized an unrealized gain on securities of $227.3 million, net of tax, and reversed the unrealized loss of $81.7 million, net of tax, attributable to currency translation adjustments recorded in December 2008.
9. Fair Value Measurements
The company uses a three-level classification hierarchy of fair value measurements for disclosure purposes.
Level 1 inputs, which are considered the most reliable evidence of fair value, consist of quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 inputs consist of observable market data, other than level 1 inputs, such as quoted prices for similar assets and liabilities in active markets or inputs other than quoted prices that are directly observable.
Level 3 inputs consist of unobservable inputs which are derived and cannot be corroborated by market data or other entity-specific inputs.
In general, the company uses quoted prices in active markets for identical assets to determine the fair value of marketable securities and equity investments. Level 1 assets generally include U.S. Treasury securities, exchange-traded mutual funds and publicly-traded equity securities. If quoted prices are not available to determine fair value, the company uses other inputs that are observable either directly or indirectly. Assets included in level 2 generally consist of U.S. Government agency securities, municipal bonds, asset-backed securities and certain corporate bonds. The level 2 marketable securities were measured at fair value based on matrix pricing using prices of similar securities with similar inputs such as maturity dates, interest rates and credit ratings. There were no level 3 assets that were valued on a recurring basis as of June 30, 2011. In addition, there were no liabilities valued at fair value on a recurring basis.
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Financial assets recorded in the consolidated balance sheet as of June 30, 2011 were classified in their entirety based on the lowest level of input that was significant to each asset’s fair value measurement.
Financial Instruments Measured at Fair Value on a Recurring Basis:
Assets at Fair Value:
Marketable securities:
U.S. Treasury securities
Mutual funds
Corporate bonds
Municipal bonds
Asset-backed securities
U.S. Government agency securities
Total
Equity investments
Total Assets at Fair Value
At June 30, 2011, equity investments included our investment in BM&FBOVESPA, which has been recorded at fair value using the quoted market price beginning in February 2011. The fair value of our investment in BM&FBOVESPA was $665.7 million at June 30, 2011. Until February 2011, this investment was recorded at cost due to restrictions on sale of the stock that exceeded a one year time period. Equity investments are included in other assets in the consolidated balance sheets.
There were no transfers of assets between level 1 and level 2 during the first six months of 2011. Additionally, there were no assets or liabilities valued at fair value on a recurring or non-recurring basis using significant unobservable inputs during the first six months of 2011.
10. Earnings Per Share
Basic earnings per share is computed by dividing net income attributable to CME Group by the weighted average number of shares of all classes of common stock outstanding for each reporting period. Diluted earnings per share reflects the increase in shares using the treasury stock method to reflect the impact of an equivalent number of shares of common stock if stock options were exercised and restricted stock awards were converted into common stock. Outstanding stock options of approximately 687,000 were anti-dilutive for the quarter and six months ended June 30, 2011, respectively. Outstanding stock options of approximately 605,000 were anti-dilutive for the quarter and six months ended June 30, 2010. There were no anti-dilutive restricted stock awards for the quarters and six months ended June 30, 2011 and 2010.
(in millions, except shares and per share data)
Weighted Average Number of Common Shares (in thousands):
Effect of stock options
Effect of restricted stock awards
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11. Subsequent Events
The company has evaluated subsequent events through the date the financial statements were issued and has determined that there are no subsequent events that require disclosure.
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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 Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2010.
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.
Total revenues
Total expenses
Operating margin
Non-operating income (expense)
Effective tax rate
Diluted earnings per common share attributable to CME Group
Cash flows from operating activities
In the second quarter of 2011 when compared with the same period of 2010, revenues increased due to an increase in average rate per contract and a gain recognized on the sale of certain Index Service assets. The increase was partially offset by a decrease in volumes attributable to one less trading day in the second quarter of 2011 when compared with the same period in 2010. In the first six months of 2011 when compared with the same period of 2010, the overall increase in trading volume contributed to an increase in clearing and transaction fees revenue.
An increase in overall expenses in the second quarter and first six months of 2011 was attributable to a rise in compensation and benefits expense due to increases in salaries and health care costs as well as accrued bonus expense. The increase in overall expenses in the first six months of 2011 when compared with the same period in 2010 was also due to the additional employees related to the formation of CME Group Index Services LLC (Index Services) in March 2010.
The decrease in the effective tax rate in the second quarter of 2011 when compared with the same period in 2010 was due to a full valuation allowance that we established in 2010 for the tax benefit associated with Credit Market Analysis, Ltd.’s (CMA) goodwill and trade name impairment. A change in state tax apportionment and a reduction in valuation allowances on other unrealized capital losses previously reserved contributed to a decline in the effective tax rate for the first six months of 2011 when compared with the same period of 2010.
Cash flows from operations decreased due to an increase in other current assets resulting from an increase in restricted cash.
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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 which 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 swaps and interest rate swaps.
Total volume (in millions)
Clearing and transaction fees (in millions)
Average rate per contract
We estimate the following increases (decreases) in clearing and transaction fees based on change in total contract volume and change in average rate per contract during the second quarter of 2011 when compared with the same period in 2010 and the first six months of 2011 when compared with the same period in 2010.
Quarter
Ended
Six Months
Increase (decrease) due to change in total contract volume
Increase due to change in average rate per contract
Net increase in clearing and transaction fees
The decrease in revenue due to total contract volume in the second quarter of 2011 when compared with the same period of 2010 was attributed to one less trading day in the second quarter of 2011 when compared with the second quarter of 2010.
Average rate per contract is impacted by our rate structure, which includes 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.
Average Daily Volume by Product Line:
Interest rate
Equity
Foreign exchange
Agricultural commodity
Energy
Metal
Aggregate average daily volume
Average Daily Volume by Venue:
Electronic
Open outcry
Privately negotiated
Total exchange-traded volume
Total CME ClearPort
Electronic Volume as a Percentage of Total Volume
Interest Rate Products
The following table summarizes average daily volume for our key interest rate products. Eurodollar front 8 futures contracts include contracts expiring within two years. Eurodollar back 32 contracts include futures contracts expiring within three to ten years.
Eurodollar front 8 futures
Eurodollar back 32 futures
Eurodollar options
U.S. Treasury futures and options:
10-Year
5-Year
Treasury bond
2-Year
Overall interest rate contract volume increased in the second quarter and first six months of 2011 when compared with the same periods in 2010 due to an increase in mid-term interest rate contract volume, which includes Eurodollar back 32 futures and 5-Year U.S. Treasury futures and options, resulting from the uncertainty surrounding short-term and long-term interest rates. We experienced slower growth in short-term interest rate futures and options volume, which we believe resulted from the continued zero interest rate policy in the United States.
Interest rate contract volume also increased in the first six months of 2011 when compared with the same period of 2010 due to changing market expectations about future interest rate increases in early 2011.
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Equity Products
The following table summarizes average daily volume for our key equity futures and options products.
E-mini S&P futures and options
E-mini NASDAQ futures and options
The decrease in equity contract volume for the second quarter and first six months of 2011 when compared with the same periods in 2010 was attributable to an overall decrease in volatility, as measured by the CBOE Volatility Index. Volatility was lower in the second quarter of 2011 when compared with the same period of 2010. We experienced periods of high volatility within the equity markets during May 2010, which we believe was attributable to the sovereign debt crisis in Europe. However, there were short periods of high volatility in the first quarter of 2011 caused by events in Asia and the Middle East, which generated additional E-mini S&P futures and options contract volume in the first quarter of 2011.
Foreign Exchange Products
The following table summarizes average daily volume for our key foreign exchange futures and options products.
Euro
Japanese yen
British pound
Australian dollar
Canadian dollar
The overall decrease in foreign exchange contract volume for the second quarter and first six months of 2011 when compared with the same periods in 2010 was due to a decline in foreign currency rate volatility, particularly in the second quarter of 2011. We believe the higher volume in 2010 was attributable to the sovereign debt crisis in Europe.
In the first six months of 2011, the overall decline in volatility with the Japanese yen was partially offset by periods of higher volatility due to the uncertainty surrounding the Japanese economy following the earthquake and tsunami in the first quarter of 2011.
Agricultural Commodity Products
The following table summarizes average daily volume for our key agricultural commodity products.
Corn
Soybean
Wheat
We believe that the increase in contract volume for the second quarter and first six months of 2011 when compared with the same periods of 2010 was attributable to changes in supply due to flooding and other weather events in the spring of 2011, which resulted in increased volatility and higher grain prices. We also believe the increase in volume resulted from increased demand for feedgrains caused by increased demand for cattle and other proteins in emerging markets.
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Energy Products
The following table summarizes average daily volume for our key energy products.
Crude oil
Natural gas
Refined products
The decrease in contract volume in the second quarter of 2011 when compared with the same period of 2010 was attributable to lower price volatility within the energy market.
We believe the increase in contract volume in the first six months of 2011 when compared with the same period of 2010 was due to increased price volatility within the energy market during the first quarter of 2011. We believe that the increase in crude oil volume was due to increased volatility caused by changes in global supply and demand resulting from political unrest in the Middle East in the first quarter of 2011. We also believe that increased volatility caused by weather-related events led to an increase in natural gas contract volume.
Metal Products
The following table summarizes average daily volume for our key metal products.
Gold
Silver
The overall increase in metal contract volume is attributable to the increased investment in precious metals as an asset class, particularly in periods with higher expectations of inflation or uncertainty in currency values. We believe that there has been an increase in silver contract volume due to the greater use of silver as an alternative investment.
Average Rate per Contract
The average rate per contract increased in the second quarter and first six months of 2011 when compared with the same periods in 2010 due to a higher portion of agricultural commodity and metal products as a percentage of total volume compared with equity products. As a percentage of volume, agricultural commodity product volume increased by 2% in the second quarter and first six months of 2011 while equity products decreased by 5% and 4%, respectively. Agricultural commodity products have higher fees compared with equity products. The overall increase in average rate per contract was partially offset by an increase in interest rate product volume as a percentage of total volume, which has a lower rate per contract. In addition, the average rate per contract decreased due to incremental volume in energy and interest rate products which triggered higher-tiered discount levels.
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 six months of 2011. 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 loss of revenue received from a particular clearing firm.
Other Sources of Revenue
Revenue from Index Services contributed to an increase in market data and information services revenue in the second quarter and first six months of 2011 when compared with the same periods in 2010. Revenues from Index Services, which include revenue from market data and licensing, increased in the second quarter of 2011 when compared with the same period of 2010 due to growth in assets under management, which was driven by new offerings based on our indexes and underlying index market performance. The increase in the first six months of 2011 when compared with the same period in 2010 was attributable to the formation of Index Services in March 2010.
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The two largest resellers of our market data represented approximately 40% of our market data and information services revenue in the first six months of 2011. 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.
In the second quarter of 2011, we recognized a $9.8 million gain on sale of certain Index Services assets related to one of its service offerings, which was included in other revenues. Other revenues also increased in the second quarter and first six months of 2011 when compared with the same periods of 2010 due to $1.3 million and $2.8 million, respectively, in incremental processing services revenue generated from various strategic relationships. In addition, the increase in the second quarter and first six months was attributable to $0.8 million and $4.2 million, respectively, of revenues generated from our agreement with BM&FBOVESPA S.A. (BM&FBOVESPA) to develop a new multi-asset class electronic trading platform.
Operating expenses increased by $5.0 million and $34.0 million in the second quarter and first six months of 2011, respectively, when compared with the same periods in 2010. The following table shows the estimated impact of key factors resulting in the increase (decrease) in operating expenses:
Salaries, benefits and employer taxes
Litigation matters and associated legal fees
Marketing expenses
Stock based compensation
Bonus
Expense related to Index Service asset sale
Professional fees related to Index Services
CMA goodwill and trade name impairment
Other expenses, net
Total increase
The rise in salaries, benefits and employer taxes was due to salary increases and rising healthcare costs. An increase in average headcount primarily due to the formation of Index Services also contributed to an increase in expense in the first six months of 2011.
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An increase in litigation matters and associated legal fees also contributed to an increase in expenses.
Marketing expenses increased in the second quarter and first six months of 2011 due primarily to new advertising initiatives.
Stock based compensation increased in the second quarter and first six months of 2011 due to the expense impact related to the September 2010 grant.
The decrease in bonus expense in the second quarter of 2011 was due to a decline in performance relative to our 2011 cash earnings target compared with the second quarter of 2010 relative to our 2010 cash earnings target. The increase in our bonus expense in the first six months of 2011 was due to improved performance relative to our 2011 cash earnings target compared with 2010 relative to our 2010 cash earnings target.
In the second quarter of 2011, we recognized additional expense related to the sale of certain assets associated with the Index Services’ service offerings.
The overall increase in expense in the first six months of 2011 was partially offset by a decrease in professional fees relating to the formation and integration of Index Services, which occurred in the first quarter of 2010.
In addition, impairment charges recorded in the second quarter of 2010 on goodwill and trade name related to our CMA operations partially offset the overall increase in expense in the second quarter and first six months of 2011.
Data center assets related to the initial phase of our co-location initiative were placed into service in the second quarter of 2011. Approximately $52.0 million of assets were placed into service with useful lives ranging from 10 to 39 years. As a result, we expect depreciation to increase for the remainder of the year relative to the prior year.
(dollars in millions)
Investment Income
Equity in losses of unconsolidated subsidiaries
The increase in investment income during the first six months of 2011 when compared with the same period in 2010 was due to an increase in dividend income from our investment in BM&FBOVESPA. Total dividend income was $20.3 million in the first six months of 2011 compared with $15.9 million for the same period in 2010.
In March 2010, we recognized a $6.0 million gain on derivative investments as a result of a settlement from the Lehman Brothers Holdings Inc. (Lehman) bankruptcy proceedings. The settlement related to an unsecured claim against Lehman as counterparty to an over-the-counter put option contract we purchased to hedge our risk of changes in the fair value of BM&FBOVESPA stock resulting from foreign currency exchange rate fluctuations between the U.S. dollar and the Brazilian real.
In the second quarter and first six months of 2011 when compared with the same periods in 2010, interest expense decreased due to the repayment of the $420.5 million term loan in January 2011 and the maturity of the $300.0 million floating rate notes in August 2010. The decrease in interest expense in the second quarter and first six months of 2011 was partially offset by the issuance of $612.5 million of 4.40% fixed rate notes due 2018 in March 2010.
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Weighted average borrowings outstanding (in millions)
Weighted average effective yield
Total cost of borrowings (1)
Income Tax Provision
The following table summarizes the effective tax rate for the periods presented:
Quarter ended June 30
Six months ended June 30
In the second quarter of 2011 when compared with the same period in 2010, the effective tax rate decreased because we established a full valuation allowance for the tax benefit associated with CMA’s goodwill and trade name impairment in the second quarter of 2010.
In the first six months of 2011 when compared with the same period of 2010, the decrease in our effective tax rate was primarily attributable to a change in state tax apportionment recorded in the first quarter of 2011. This change resulted in a reduction in our income tax provision of $118.1 million due largely to a revaluation of our existing deferred tax liabilities. Additionally, in the first quarter of 2011, we began marking to market our investment in BM&FBOVESPA which resulted in a $48.8 million reduction in valuation allowances on other unrealized capital losses previously reserved.
Liquidity and Capital Resources
Sources and Uses of Cash. Net cash provided by operating activities was $576.1 million for the first six months of 2011 compared with $649.1 million for the same period in 2010. The decrease in net cash provided by operating activities was due to an increase in other current assets resulting from an increase in restricted cash of $40.0 million. The decrease in net cash provided by operating activities was also due to an increase in accounts receivable in the second quarter of 2011 compared with the same period in 2010. Accounts receivable in any period result primarily from the clearing and transaction fees billed in the last month of the reporting period. We experienced higher trading volumes in June 2011 compared with June 2010, which resulted in a higher accounts receivable balance in June 2011. In the first six months of 2011, net cash provided by operating activities was $176.6 million lower than net income. This decrease was primarily the result of a decrease in deferred income tax liabilities of $151.7 million due to the revaluation of our existing deferred tax liabilities and a reduction in deferred tax valuation allowances. Also contributing to the overall decrease in cash was an increase in accounts receivable of $88.0 million.
Cash used in investing activities was $70.2 million in the first six months of 2011 compared with cash used in investing activities of $7.7 million in the first six months of 2010. The increase in cash used was largely attributable to an increase in purchases of property in the first six months of 2011 when compared with the same period in 2010. We also recognized proceeds from Chicago Board Options Exchange exercise priviledges in 2010.
Cash used in financing activities was $667.5 million in the first six months of 2011 compared with $538.4 million for the same period in 2010. The increase was primarily attributable to the repayment of the $420.5 million term loan in January 2011. The increase was partially offset by a decrease in share repurchases of $230.9 million in the first six months of 2011 when compared with the same period in 2010.
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Debt Instruments. The following table summarizes our debt outstanding as of June 30, 2011:
Fixed rate notes due August 2013, interest equal to 5.40%
Fixed rate notes due February 2014, interest equal to 5.75%
Fixed rate notes due March 2018, interest equal to 4.40% (1)
Effective January 11, 2011, we entered into a new $1.0 billion multi-currency revolving senior credit facility with various financial institutions. The proceeds from the revolving senior credit facility can be used for general corporate purposes, which includes providing liquidity for our clearing house. As long as we are not in default under the new senior credit facility, we have the option to increase the facility to $1.8 billion with the consent of the agent and lenders providing the additional funds. The new senior credit facility matures in January 2014 and is voluntarily prepayable from time to time without premium or penalty. Under our new credit facility, we are required to remain in compliance with a consolidated net worth test, which is defined as our consolidated shareholders’ equity as of September 30, 2010, giving effect to share repurchases made and special dividends paid during the term of the agreement (and in no event greater than $2.0 billion in aggregate), multiplied by 0.65. We currently do not have any borrowings under this credit facility.
We maintain a 364-day fully secured, committed line of credit with a consortium of domestic and international banks to be used in certain situations by our clearing house. We may use the proceeds to provide temporary liquidity in the unlikely event of a clearing firm default, in the event of a liquidity constraint or default by a depositary (custodian for our collateral), or in the event of a temporary disruption with the domestic payments system that would delay payment of settlement variation between us and our clearing firms. Clearing firm guaranty fund contributions received in the form of U.S. Treasury securities, Government agency securities or money market mutual fund as well as the performance bond assets of a defaulting firm can be used to collateralize the facility. The line of credit provides for borrowings of up to $1.0 billion. At June 30, 2011, guaranty fund collateral available was $3.3 billion. We have the option to request an increase in the line from $1.0 billion to $2.0 billion. In addition to the 364-day fully secured, committed line of credit, we also have the option to use the new $1.0 billion multi-currency revolving senior credit facility to provide liquidity for our clearing house in the unlikely event of default.
In addition, our 364-day fully secured, committed revolving line of credit contains a requirement that CME remain in compliance with a consolidated tangible net worth test, defined as CME consolidated shareholder’s equity less intangible assets (as defined in the agreement), of not less than $125.0 million. In the event that CME elects to increase the facility, the minimum consolidated tangible net worth test would increase ratably up to $187.5 million.
The indentures governing our fixed rate notes, our 364-day fully secured, committed revolving line of credit for $1.0 billion and our $1.0 billion multi-currency revolving senior credit facility do not contain specific covenants that restrict the ability to pay dividends. These documents, however, do contain other customary financial and operating covenants that place restrictions on the operations of the company, which could indirectly affect the ability to pay dividends.
At June 30, 2011, we have excess borrowing capacity for general corporate purposes of approximately $1.0 billion.
As of June 30, 2011, we were in compliance with the various covenant requirements of all our debt facilities.
CME Group, as a holding company, has no operations of its own. Instead, it relies on dividends declared and paid to it by its subsidiaries in order to provide a portion of the funds which it uses to pay dividends to its shareholders.
To satisfy our performance bond obligation with Singapore Exchange Limited, we may pledge CME-owned U.S. Treasury securities in lieu of, or in combination with, irrevocable letters of credit. At June 30, 2011, the letters of credit totaled $83.0 million. CME also guarantees a $15.0 million standby letter of credit for GFX. The beneficiary of this letter of credit is the clearing firm that is used by GFX to execute and maintain its futures position. The letter of credit would be utilized in the event that GFX defaults in meeting performance bond requirements to its clearing firm.
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The following table summarizes our credit ratings as of June 30, 2011:
Rating Agency
Standard & Poor’s
Moody’s Investors Service
During June 2011, Standard & Poor’s Ratings Services affirmed its ratings for CME Group as AA with a negative outlook. In August 2011, Moody’s Investors Service affirmed its ratings for CME Group as Aa3 with a stable outlook.
Given our ability to pay down debt levels and refinance existing debt facilities if necessary, we expect to maintain an investment grade rating. If our ratings are downgraded due to a change in control which results in a downgrade below investment grade, we are required to make an offer to repurchase our fixed rate notes at a price equal to 101% of the principal amount, plus accrued and unpaid interest.
Liquidity and Cash Management. Cash and cash equivalents totaled $693.6 million at June 30, 2011 and $855.2 million at December 31, 2010. The balance retained in cash and cash equivalents is a function of anticipated or possible short-term cash needs, prevailing interest rates, our investment policy and alternative investment choices. A majority of our cash and cash equivalents balance is invested in money market mutual funds that invest only in U.S. Treasury securities or U.S. government agency securities. Our exposure to risk is minimal given the nature of the investments.
In June 2011, we announced that we are pursuing a sale and partial leaseback of the north and south buildings of the CBOT. A lease agreement will allow us to maintain the agricultural commodities trading floor and certain office space of the north and south buildings. Ownership of the east building, which houses the financial trading floor and office space, will be retained by us.
Net current deferred tax assets of $19.9 million and $18.3 million are included in other current assets at June 30, 2011 and December 31, 2010, respectively. Total net current deferred tax assets include unrealized losses, stock-based compensation and accrued expenses.
Net long-term deferred tax liabilities were $7.8 billion at June 30, 2011 and December 31, 2010, respectively. Net deferred tax liabilities are principally the result of purchase accounting for intangible assets in our various mergers including CBOT Holdings and NYMEX Holdings.
Net long-term deferred tax assets include a $20.0 million deferred tax asset for foreign net operating losses related to Swapstream. Our assessment at June 30, 2011 was that we did not currently meet the more-likely-than-not threshold that would allow us to realize the value of acquired and accumulated foreign net operating losses in the future. As a result, the $20.0 million deferred tax assets arising from these net operating losses have been fully reserved. In addition, valuation allowances of $0.3 million have also been provided for other foreign net operating losses in various other jurisdictions for which we do not believe that we currently meet the more-likely-than-not-threshold for recognition.
We also have a long-term deferred tax asset related to Brazilian taxes of $7.0 million for an unrealized capital loss incurred related to our investment in BM&FBOVESPA. A full valuation allowance of $7.0 million has been provided because we do not believe that we currently meet the more-likely-than-not threshold that would allow us to realize the value of the unrealized capital loss in Brazil in the future.
Recent Accounting Pronouncements
In May 2011, Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) for Fair Value Measurement. The ASU provides fair value measurement and disclosure requirements, and is effective for interim and annual periods beginning after December 15, 2011, with no early adoption permitted. We will adopt the disclosure requirements once the guidance becomes effective.
In June 2011, FASB issued an ASU for Presentation of Comprehensive Income. The ASU requires entities to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. The ASU is effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. We will adopt the disclosure requirements once the guidance becomes effective.
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We are subject to various market risks, including those caused by changes in interest rates, credit, foreign currency exchange rates and equity prices. There have not been material changes in our exposure to market risk since December 31, 2010. Refer to Item 7A. of CME Group’s Annual Report on Form 10-K for the year ended December 31, 2010 for additional information.
(a) Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective.
b) Changes in Internal Control Over Financial Reporting. As required by Rule 13a-15(d) under the Exchange Act, the company’s management, including the company’s Chief Executive Officer and Chief Financial Officer, have evaluated the company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) to determine whether any changes occurred during the quarter covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting. There were no changes in the company’s internal control over financial reporting during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
See “Legal Matters” in Note 5. Contingencies to the Consolidated Financial Statements beginning on page 15 for updates to CME Group’s legal proceedings disclosure which is incorporated herein by reference.
Other than as described below, there have been no material updates to the Risk Factors as set forth in Item 1A. of our Annual Report on Form 10-K, filed with the SEC on February 28, 2011. In addition to the other information contained in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in our Annual Report on Form 10-K, which are the risks that we believe are material at this time. These risks could materially and adversely affect our business, financial condition and results of operations. These risks and uncertainties are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business in the future.
The ongoing uncertainty and volatility in the markets stemming from the U.S. budget deficit, the European debt crisis, and the status of the U.S. economic recovery may negatively impact our business.
Investors have grown increasingly concerned due to the issues related to the U.S. budget deficit, solvency problems in several European countries and the slowdown of the U.S. economic recovery. The U.S. government recently approved an increase to the debt ceiling and approved spending cuts to reduce the deficit. However, the government will need to continue to monitor its deficit including the implementation of the approved spending cuts. The rating agencies have indicated that they will continue to review the government’s fiscal policy and its implementation of the proposed spending cuts. Weakening in fiscal discipline in the future may result in a downgrade from the rating agencies, which could create additional volatility in the treasury market. To the extent the global markets continue to experience uncertainty, our business may be negatively impacted:
We generate revenues primarily from our clearing and transaction fees. Declines in trading volumes and market liquidity stemming from this market uncertainty would adversely affect our business and financial condition.
The required capital and posted collateral of our clearing firms may lose value given the volatility of the market. To become a clearing member, a firm must meet certain minimum capital requirements and must deposit a certain amount of funds to meet performance bond and guaranty fund requirements with our clearing house as collateral for their trading activity. We accept a variety of collateral to satisfy these requirements, including U.S. Treasury securities, U.S. Government Agency securities and foreign sovereign debt. Given the level of market volatility, there is no guarantee that these investments will continue to maintain their value. To the extent a clearing firm is not in compliance with our collateral requirements, it would be required to acquire additional funds, decrease its proprietary trading activity and/or transfer customer accounts to another clearing firm. These actions could result in a decrease in trading activity in our products.
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(c) Issuer Purchases of Equity Securities
(a) Total Number of
Class A
Shares Purchased (1)
(b) Average Price
Paid Per Share
(c) Total Number of
Shares Purchased as
Part of Publicly
Announced
Plans or Programs
(d) Approximate
Dollar Value
of Shares
that
May Yet Be
Purchased
Under
the Plans or
Programs
(in millions) (2)
April 1 to April 30
May 1 to May 31
June 1 to June 30
31
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CME Group Inc.
(Registrant)
/S/ JAMES E. PARISI
Chief Financial Officer & Managing
Director Finance
and Corporate Development
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