Home » CME Group Q3 2013 Earnings Conference Call Transcript

CME Group Q3 2013 Earnings Conference Call Transcript

In addition, if you look at the CFTC commitment of traders report on our website, it shows a noticeable increase in asset manager participation within Eurodollars increasing from 11% of the open interest to more than 15%.

Lastly, our deliverable swap futures activity continues to grow. We had the strongest roll month in September. Building on that, in October, we had the strongest non-roll month to date. During the turbulence of October, we performed relatively well, despite the market uncertainty related to the debt ceiling and the government shutdown. During several weeks, economic data was not readily available, and in some cases the market adopted a wait-and-see approach as the situation developed. Nonetheless, we did what we do best, which is to continue to provide an avenue for our clients to manage risk and express their views.

In October, our total average daily volume was up 12%, with rates up as well as equities, which benefitted from heightened volatility during an interesting month. I am very excited about the growth trajectory of the company and our entire employee base has done a tremendous job focusing on execution in the midst of a challenging macro backdrop and low interest rate environment.

Now, I will turn the call over to Jamie to discuss the financials.

Jamie Parisi – CFO

Thank you, Gill, and good morning everyone. Q3 was a solid quarter in many respects. Average daily volume was up 11% compared to the third quarter last year, outperforming our major peers. Adjusted EPS came in at $0.75, excluding FX related benefits and several tax impacts. We have seen a drop in our overall tax rate this quarter, and the benefit will be ongoing, which I’ll touch on later.

Now let’s get into some of the details; starting with revenue. The rate per contract for the third quarter was $0.762, up from $0.748 last quarter. The main driver was strong non-member participation during Q3, relative to Q2, particularly in interest rates and energy. OTC swaps revenue for the quarter was up almost $5 million sequentially, to $11.5 million, driven by a 100% jump in interest rate swap clearing activity. In addition to our success in attracting real-money clients, we have also been successful in executing our strategy to attract high-turnover clients, primarily large hedge funds, which on a sequential basis led to a contraction in the average rate per million. I want to clarify that although the rate we capture has declined due to an increase in the mix of higher turnover participants, we have been able to substantially grow the higher paying customer base as well, which includes asset managers and insurance companies.

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During the third quarter, the total notional amount cleared by this customer segment was up 115% sequentially, with revenue up 94%. In comparison, during the same timeframe, the total notional amount cleared by the high turnover participant base was up 138% and revenue was up 125%. Overall, as Gill noted, we are pleased to see IRS dealer-to-client market share jump from 5% in Q1 to 33% so far in Q4.

Our Q3 interest rate product line revenue was up 32% to $181 million, and if you add the incremental interest rate swap revenue, the total rates related revenue was up 40%. That is how we’re thinking about this business — the OTC clearing business is strengthening our overall interest rate franchise.

Moving on, total third-quarter operating expense was $314 million, which included a foreign exchange benefit of $12 million, reversing the Q1 FX expense of the same amount. Excluding the FX benefit, as well as other items noted in the reconciliation, expenses would have been $325 million. As you recall, I guided to a higher expense level for the second half, and that is playing out.

A couple different areas impacted us this quarter. The primary contributor to the sequential increase was in professional fees, which tends to have more variability than other expense lines from quarter to quarter. This was up $7.7 million versus prior quarter due to an increase in IT and legal consulting fees, higher market studies expense, and higher public relations and brand consulting fees.

Within the compensation line, we had $3.2 million of deferred comp expense based on the strength of the equity market during the quarter. Keep in mind that this expense is offset 100% in the interest income line. Lastly, in Q3, license fees did not fall as much as would be expected from the seasonal decrease in equity volumes, as we are now recording our OTC revenue share expense in this line item.

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Turning to non-operating income, the main thing to point out is interest expense dropped from $39 million to $35 million based on the pay down of $750 million of debt in August. We expect that to increase back to $40 million in Q4, based on the full quarter impact of the debt we took on in early September, and an increase in our clearing house credit facility. The total interest expense and borrowing costs line is expected to drop by $30 million in 2014 to approximately $123 million from $153 million this year.

We had put in place an interest rate lock in August of 2012, which generated $128 million, which is included in our current cash balance, and which also reduces the all-in accounting effective rate on our recent 30 year bond issuance by 50 basis points to 4.8% per year.

With respect to taxes, excluding the FX impact and non-cash deferred tax items, as well as other prior year tax benefits, the effective tax rate was 35.6% this quarter.

Turning to the balance sheet, we had almost $1.4 billion of cash and marketable securities along with an additional $750 million held in cash for the February 2014 debt paydown. During the third quarter, capital expenditures net of leasehold improvement allowances totaled $36 million, bringing us to $91 million so far this year.

In terms of guidance, I said last quarter we expected 2013 expenses to range from $1.25 billion to $1.26 billion, and I anticipate that expenses in Q4 will be close to $325 million, which means we expect to be near $1.26 billion, including $6 million of deferred compensation expense year-to-date. In terms of CapEx, I expect between $130 million and $140 million for the year, which is down from my prior estimate.

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