|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
|
You should read the following discussions together with the consolidated financial statements and related notes. Except for the historical information and discussions contained herein, statements contained in this
Form 10-Q may constitute “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these statements by the fact that they do not relate strictly to historical or current
facts. They use words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” plan,” “believe,” “will,” and other words and terms of similar meaning in connection
with any discussion of future operating or financial performance. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including market and general economic conditions in
the U.S. and elsewhere in the world, growth of our market share, our ability to keep up with rapid technological change, our business strategy, our offering of new products including index options and market data products, consolidation in our
exchange member base and within our industry and legislative and regulatory changes relating to our business and operations or activities, and other risks, uncertainties and factors discussed elsewhere in this Form 10-Q, in the Company’s other
filings with the U.S. Securities and Exchange Commission (“SEC”) or in materials incorporated therein by reference.
References in this
discussion and analysis to “we” and “our” are to the International Securities Exchange Holdings, Inc. and its consolidated subsidiaries (collectively, the “Company”).
OVERVIEW
We operate a family of innovative securities markets. We
were founded on the principle that technology and competition create better, more efficient markets for investors. We continually enhance our trading system and develop new products to provide investors with the best marketplace and investment tools
to trade smarter.
Our gross margin (total revenues less cost of revenues) has grown 36.1% from $131.1 million in the first nine months of 2006 to $178.4
million for the same period in 2007 primarily due to increased trading volumes. Our net income has grown 27.5% from $40.1 million to $51.1 million over the same period. Included in our results for 2007 are accelerated stock-based compensation
charges of $11.2 million and merger related expenses of $2.4 million. These costs were incurred in connection with our pending merger with Eurex (see “Our Pending Merger with Eurex”). Excluding these charges and the related tax effect (a
non-GAAP measurement), our net income grew 47.8% to $59.7 million (see “Non-GAAP Financial Measures”).
Segments
Beginning in the first quarter of 2007, our management began evaluating the Company’s financial performance based on two operating segments -an options exchange and
a stock exchange. In order to provide a meaningful comparison, we have presented historical financial information using the current methodology.
|
|
•
|
|
Our options exchange business segment
- We operate the largest U.S. equity options exchange and are among the leading options exchanges in the world.
We developed a unique market structure for advanced screen- based trading systems and in May 2000 launched the first fully-electronic U.S. options exchange. Our exchange provides a trading platform in listed equity and index options and related
services that are designed to improve the market for options and the speed and quality of trade execution for our exchange members.
|
Also included in this segment is our alternative markets platform which consists of an events market trading platform known as Longitude. Longitude’s patented and proprietary technology provides a unique
parimutuel structure for derivatives auctions which results in greater trading and pricing flexibility for market participants.
Lastly,
this segment includes corporate overhead costs related to public company matters as well as corporate wide strategic initiatives.
|
|
•
|
|
Our stock exchange business segment
-
In 2006, we expanded our business into the trading of cash equities with the launch of ISE Stock Exchange
in partnership with key strategic investors. The ISE Stock Exchange currently operates the only dual structure platform that integrates a non-displayed market, MidPoint Match (“MPM”), with a fully displayed stock market. Traders have
complete order protection and continuous price improvement.
|
Pursuant to the terms of our agreement with the strategic
investors of the ISE Stock Exchange and in accordance with U.S. GAAP, we are the primary beneficiary of the ISE Stock Exchange and consolidate its financial results. We exercise a majority of the voting interest of the ISE Stock Exchange; however,
all losses are allocated solely to the minority owners. Consolidation of the ISE Stock Exchange does not currently have any effect on our net results of operations and will not until it generates net profits. Therefore, consolidation increases our
revenues and expenses to reflect 100% of the ISE Stock Exchange’s results; however, these revenues and expenses are offset dollar-for-dollar by minority interest since we are not required to recognize any of its losses. Prior to our agreement
with the strategic investors in April 2006, we recognized all the losses related to ISE Stock Exchange.
Summary operating results for our two segments and
their effect on our consolidated results are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2007
|
|
|
Three Months Ended September 30, 2006
|
|
|
|
Options
Exchange
|
|
Stock
Exchange
|
|
|
Elimination
|
|
|
ISE
Holdings
|
|
|
Options
Exchange
|
|
Stock
Exchange
|
|
|
Elimination
|
|
|
ISE
Holdings
|
|
Total revenues
|
|
$
|
72,170
|
|
13,706
|
|
|
(320
|
)
|
|
$
|
85,556
|
|
|
$
|
50,081
|
|
11
|
|
|
(11
|
)
|
|
$
|
50,081
|
|
Gross margin
|
|
|
68,313
|
|
4,145
|
|
|
(320
|
)
|
|
|
72,138
|
|
|
|
44,450
|
|
11
|
|
|
(11
|
)
|
|
|
44,450
|
|
Total expenses
|
|
|
38,672
|
|
4,302
|
|
|
(320
|
)
|
|
|
42,654
|
|
|
|
22,476
|
|
2,986
|
|
|
(2,986
|
)
|
|
|
22,476
|
|
Minority interest
|
|
|
—
|
|
(250
|
)
|
|
—
|
|
|
|
(250
|
)
|
|
|
223
|
|
—
|
|
|
—
|
|
|
|
223
|
|
Income before provision for income taxes
|
|
|
32,754
|
|
—
|
|
|
—
|
|
|
|
32,754
|
|
|
|
24,478
|
|
(2,448
|
)
|
|
2,448
|
|
|
|
24,478
|
|
Net income
|
|
|
18,517
|
|
—
|
|
|
—
|
|
|
|
18,517
|
|
|
|
13,958
|
|
(2,448
|
)
|
|
2,448
|
|
|
|
13,958
|
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2007
|
|
Nine Months Ended September 30, 2006
|
|
|
|
Options
Exchange
|
|
Stock
Exchange
|
|
Elimination
|
|
|
ISE
Holdings
|
|
Options
Exchange
|
|
Stock
Exchange
|
|
|
Elimination
|
|
|
ISE
Holdings
|
|
Total revenues
|
|
$
|
186,070
|
|
15,945
|
|
(891
|
)
|
|
201,124
|
|
$
|
148,732
|
|
11
|
|
|
(11
|
)
|
|
$
|
148,732
|
|
Gross margin
|
|
|
173,894
|
|
5,421
|
|
(891
|
)
|
|
178,424
|
|
|
131,104
|
|
11
|
|
|
(11
|
)
|
|
|
131,104
|
|
Total expenses
|
|
|
90,847
|
|
12,227
|
|
(891
|
)
|
|
102,183
|
|
|
64,838
|
|
5,362
|
|
|
(4,344
|
)
|
|
|
65,856
|
|
Minority interest
|
|
|
—
|
|
5,504
|
|
—
|
|
|
5,504
|
|
|
495
|
|
—
|
|
|
—
|
|
|
|
495
|
|
Income before provision for income taxes
|
|
|
91,992
|
|
—
|
|
—
|
|
|
91,992
|
|
|
72,188
|
|
(4,753
|
)
|
|
3,735
|
|
|
|
71,170
|
|
Net income
|
|
|
51,084
|
|
—
|
|
—
|
|
|
51,084
|
|
|
40,639
|
|
(4,295
|
)
|
|
3,735
|
|
|
|
40,079
|
Business Environment
Our business is affected by macroeconomic factors impacting the U.S. economy as well as factors specific to the securities industry, and in particular,
the equities markets. The equities markets ended the first nine months of 2007 above the levels of prior periods with all the major equities indices—the Dow Jones Industrial Average, S&P 500 Index and NASDAQ composite index—increasing
approximately 11%, 11% and 6%, respectively, since the beginning of the year. Average daily volume of U.S. equity-listed securities increased approximately 23% in the first nine months of 2007 compared to the comparable period in the prior year.
The options industry continues to operate in an increasingly competitive environment while at the same time experiencing continued robust
growth and expansion. Industry average daily equity options volume increased 36% from 7.2 million contracts during the first nine months of 2006 to 9.7 million contracts during the first nine months of 2007, and industry average daily
index option volume increased from 722,000 to 1,067,000 over the same period. Our average daily equity options volume increased 29% from 2.3 million to 3.0 million over the same period; however, our market share decreased to 30.5% from
32.2%. Our average daily index option volume was 59,000 during the first nine months of 2007 compared to 32,000 during the same period last year.
During the third quarter, the equities and options markets experienced significant volatility as a result of economic news including concerns over the U.S. housing markets, sub-prime lending and tightening of the credit markets. Also during
the quarter, the U.S. Federal Reserve reduced its key interest rate 50 basis points. As a result of the significant volatility, we, as well as the options industry, experienced record trading volumes. For example, on August 16, 2007, the
options industry traded a record 23.7 million contracts and we traded a record 6.5 million contracts. In addition, on October 2, 2007, the options industry passed the annual volume record set in 2006 with nearly a full quarter of
trading left for the year.
Our record results, excluding merger related costs and the effect of accelerated stock-based compensation
charges, reflects a key aspect of our business model and operating leverage to increase profits without a significant increase in related expenses.
Our Pending Merger with Eurex
On April 30, 2007, we signed a definitive agreement with Eurex, a
derivatives exchange jointly owned by Deutsche Börse AG and SWX Swiss Exchange, under which Eurex will acquire us for approximately $2.8 billion in cash, or $67.50 per share. The combination will create the leading transatlantic derivatives
marketplace with significant U.S. dollar and Euro product coverage and with significant operations and revenues in both the U.S. and Europe. We will continue to operate as a separate entity under SEC regulation as a U.S. exchange in our current
governance structure and under the ISE brand. On July 27, 2007, our stockholders voted to approve our merger agreement with Eurex and this affirmative stockholder vote satisfies a condition of the closing our merger; however, the transaction
also requires SEC approval. We expect the transaction to close in the fourth quarter of 2007 and are currently planning the forthcoming integration efforts. In connection with the merger, we incurred expenses of $2.4 million for the nine months
ended September 30, 2007 related to various advisory costs and expect to incur additional costs until our transaction closes.
Accelerated Stock-Based Compensation Charge
As a result of our stockholder approval of our merger with
Eurex on July 27, 2007, all of our awards of restricted stock and options to our employees as part of their long-term incentive compensation, which typically vest equally over a three year period from the grant date, became immediately vested
under the change in control provisions in our stock plan. Certain employees waived such right to vest in their restricted stock until the earlier of closing of the merger or December 31, 2007. We incurred a stock-based compensation charge,
which is included in compensation and benefits expense, of $11.2 million in the third quarter of 2007 related to this acceleration. We accelerated the stock-based compensation for the unvested restricted stock over the shortened requisite service
period.
Penny Pilot
On January 26, 2007, at the request of the SEC, all of the options exchanges initiated a pilot program to quote 13 options in pennies. The pilot
program is being conducted with trading increments of one-cent for options trading up to $3.00 and in five-cent increments for options trading above $3.00 for 12 of the pilot options. All options on one ETF, the QQQQ, are being quoted in one-cent
increments. On September 28, 2007, the penny pilot expanded to cover classes representing the top 35% of industry trading volume. The additional names are quoted in pennies for options under $3.00 and nickels for options above $3.00. QQQQ will
continue to be quoted in pennies for all series. This phase will continue for six months. On March 28, 2008, we anticipate that the pilot will expand to a total of 63 options again trading in pennies only for options priced under $3.00. The SEC
staff anticipates that the pilot will remain at this level for at least one year, through March 2009.
We have carefully planned and
implemented several hardware and software upgrades to prepare for the penny pilot. However, in certain options we experienced a doubling, and in one option a tripling, of quote traffic. We are currently planning our future capacity needs and expect
to incur additional costs for computer equipment as the penny pilot expands. Also, we noted that issues trading in the pilot generally did not keep pace with the overall growth experienced in the options industry. Lastly, we noted a narrowing of
market spreads and a reduction in quoted size.
In order to better compete for trading volume, NYSE Arca and the Boston Options Exchange
charge “maker-taker” pricing for options in the penny pilot where they will rebate market makers and other market participants for posting liquidity and charge for taking liquidity. Nasdaq also announced it would adopt a maker-taker
pricing model when it launches its options marketplace. These exchanges believe that providing a rebate will encourage market makers to aggressively quote in a penny environment; thereby increasing volumes on their exchange.
16
We continue to monitor the impact of the penny pilot and will adjust our operations and pricing as needed
in order to maintain our competitive position in the options marketplace.
Change in Control of OMX
On May 25, 2007, Nasdaq and OMX announced they had entered into a definitive agreement to combine the two companies. Our options trading system is an
enhanced version of OMX’s standard trading software modified to include functionality we designed. In addition, Nasdaq has announced plans to directly compete with us and introduce an options market. Subsequent to the Nasdaq merger
announcement, Bourse Dubai, the government controlled holding company for its two exchanges, announced it had purchased an equity interest in OMX and options to increase its ownership percentage in order to prevent Nasdaq’s acquisition.
Subsequent to this announcement, the Qatar Investment Authority, the government controlled fund of Qatar, announced it accumulated an equity interest in OMX for strategic purposes. Recently, Nasdaq and Bourse Dubai announced an agreement to allow
Nasdaq to proceed with its merger with OMX; however, no agreement has been announced with Qatar.
A change in control of OMX may create a
complex relationship where we are dependent on a competitor to provide us with software and related support services for a large component of our Options Trading System (“OTS”).
While a merger with OMX would give its owner access to OMX’s electronic systems, a change in control would not cancel or modify any of the terms of
our current agreements with OMX, including the “exclusivity” provision, which governs OMX’s ability to deliver another options trading system in competition with our U.S. offering. In addition, while the licensed OMX software
serves as the foundation of our OTS, our options platform is customized and unique to us as a result of detailed functional specifications and significant enhancements to the OMX software, including a number of patented components that are
integrated with the OMX software to create our OTS. Moreover, our agreement with OMX for Genium provides for the creation of an information barrier between OMX’s technology team and their exchange business to protect proprietary information.
While we have the protections described above, we cannot be assured that we will be adequately protected through these safeguards, and we
are continuing to examine various alternatives.
Nasdaq’s Acquisition of the Boston Stock Exchange
On October 2, 2007, Nasdaq announced it had entered into a definitive agreement to acquire the Boston Stock Exchange and certain of its affiliates
(“BSE”) for approximately $61.0 million. Nasdaq did not acquire BSE’s interest in the Boston Options Exchange, a competitor to us, in this transaction. Consolidation of our competitors into larger, well capitalized organizations may
create substantial or increased competition to us through cost reductions or other efficiencies.
Market Outage
On the morning of October 12, 2007, we experienced a power disruption at our primary data center site which resulted in the temporary suspension of
trading in both our options and stock exchanges for approximately one hour and forty five minutes. We have completed a thorough review, including determining the resiliency of our back-up power systems, and have mitigated the cause of the issue. We
are undergoing all necessary steps to prevent a recurrence including further strengthening the resiliency of our power infrastructure. This outage did not have a material effect on our operating results.
Our Market Share and Dividend Trade Activity
Our average daily volume of equity options has grown significantly; however, we have experienced seasonal fluctuations on a quarterly basis. While our trading volumes have generally been increasing, over the same period our market share has
fluctuated. The following chart reflects our equity options ADV and market share since 2006 on a quarterly basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Q1-06
|
|
|
Q2-06
|
|
|
Q3-06
|
|
|
Q4-06
|
|
|
Q1-07
|
|
|
Q2-07
|
|
|
Q3-07
|
|
|
Our Equity Options ADV
|
|
2,356
|
|
|
2,372
|
|
|
2,194
|
|
|
2,381
|
|
|
2,728
|
|
|
2,858
|
|
|
3,321
|
|
|
Equity Options Market Share
|
|
32.7
|
%
|
|
31.8
|
%
|
|
32.2
|
%
|
|
30.1
|
%
|
|
30.2
|
%
|
|
30.7
|
%
|
|
30.5
|
%
|
While we do monitor our market share, we do not believe it is the primary indicator of the health
of our business relative to absolute volume growth, which is what drives our revenues.
In particular, we believe our market share
statistics have been negatively impacted by the execution of large crossing transactions commonly referred to as “dividend trades.” The industry has experienced increased activity in this type of trading activity. Dividend trades are
options transactions in which very large quantities of “in-the-money” calls are purchased and exercised simultaneously in order to establish ownership in the stock just prior to the ex-dividend date. The exchanges that facilitate these
transactions have instituted fee caps which encourage market makers to enter extremely large size orders and engage in this activity. We believe that these transactions serve to distort volume and market share statistics for the industry as well as
disadvantage certain customers and therefore, do not encourage or engage in this activity.
Index Court Action
On November 2, 2006, we filed a complaint in the U.S. District Court for the Southern District of New York seeking to end the exclusive listing of
certain index options (the “ISE NY Action”). We asked the District Court to issue a declaratory judgment ordering that we do not need a license to list index options on the DJIA and S&P 500 Index. Currently, these two actively-traded
index options trade exclusively on CBOE pursuant to licensing agreements between CBOE, Dow Jones, and McGraw-Hill. On November 15, 2006, Dow Jones, McGraw-Hill, and CBOE filed a complaint against us and OCC in the Circuit Court of Cook County,
Illinois, asking the Circuit Court to issue a declaratory judgment ordering, among other things, that we may not list index options on the DJIA and S&P 500 Index without a license from Dow Jones and McGraw-Hill (the “Defendants’
Action”). On December 22, 2006, Dow Jones and McGraw-Hill filed a motion to dismiss or stay the ISE NY Action pending a decision in the Defendants’ Action. On March 8, 2007, we filed a motion to dismiss or stay the
Defendants’ Action pending a decision in the ISE NY Action. On May 15, 2007, our motion to dismiss or stay the Defendants’ Action was denied. On June 4, 2007, we filed a motion with the Illinois Appellate Court seeking to stay
the Illinois Circuit Court proceedings pending a decision on our appeal. This motion was denied on June 18, 2007. On July 25, 2007, the U.S. District Court for the Southern District of New York stayed the ISE NY Action pending
determination of the Defendants’ Action in the Illinois Circuit Court. On September 25, 2007, we filed in the United States Court of Appeals for the Second Circuit an appeal to vacate the stay order of the District Court and to
reinstate our declaratory judgment action.
17
Stock Exchange Segment
Our stock exchange segment is still in the early stages of its operations. Recently, we have seen an increase in volume resulting from new functionality, new members, as well as an increase in industry volumes. For
example, on September 19, 2007 we traded a record 115.7 million shares. We expect to make further progress in the development of this business.
BUSINESS TRENDS AND DRIVERS
Options Exchange Segment
The financial results from our options exchange segment account for the vast majority of our revenues and expenses. The following discusses the options exchange segment’s business trends and drivers.
Revenues
Transaction Fees
Transaction fees have accounted for, and continue to account for, a majority of our revenues and are
primarily driven by trading volumes, pricing changes and the proportion of non-broker-dealer customer volume in the trading mix. We have three general fee categories on our options exchange—market maker, firm proprietary and non-broker-dealer
customers.
As a result of competitive pressures, we generally do not charge our options exchange members for executing non-broker-dealer
customer orders on our exchange with the exception of premium products and our Second Market. Generally, an increase in our non-broker-dealer customer orders reduces our average revenue per side. As a percent of our total sides, non-broker-dealer
customer sides have been increasing, reaching a high of 43.1% during the first quarter of 2006. However, it has decreased to 40.5% during the third quarter of 2007. We have also experienced an increase in firm proprietary trading as a percent of our
overall trading mix from 10.9% in the first quarter of 2006 to 15.2% in the third quarter of 2007. We believe this increase is an indicator of increased institutional use of our trading platform. Also included in transaction fees are fees we charge
exchange members for canceling orders.
Also included in transaction fees are activity remittance fees we pay to the SEC as well as license
fees we pay for our exchange members to trade licensed products. GAAP requires us to record these fees on a gross basis.
We continually
examine our fee structure in light of competitive changes in the marketplace. Most recently, we increased our fees for non-ISE market makers trading on our exchange from $0.19 per contract to $0.40 per contract effective June 2007. This change
resulted in significant additional revenue, although we expect this trend to moderate as our members adjust their trading patterns. Additionally, as a result of reaching certain overall volume levels on our exchange, our market maker fee decreased
in August 2007 from $0.17 per contract to $0.16 per contract. Our transaction fee for market makers will change when our monthly ADV reaches the following thresholds:
|
|
|
|
|
|
Monthly ADV
(in thousands)
|
|
Transaction
Fee
|
|
1,045 - 1,343
|
|
$
|
0.19
|
|
1,343 - 1,880
|
|
$
|
0.18
|
|
1,880 - 3,133
|
|
$
|
0.17
|
|
3,133 - 9,400
|
|
$
|
0.16
|
|
Greater than 9,400
|
|
$
|
0.15
|
Member Fees and Other
Member fees and other are primarily driven by (a) the number of participants that become members of our exchange; (b) capacity requirements that
are dictated by the number of quotes or orders submitted to our trading system as well as the communication method chosen by the member; and(c) revenue from the sale of CMM trading rights. In 2002, we created 60 CMM trading rights to sell for
$1.5 million each. Each CMM trading right grants the holder the right to trade as a CMM on our options exchange. We currently recognize revenue from the sale of these CMM trading rights over an estimated useful life of 14 years on a straight line
basis. As of September 30, 2007, we have 10 remaining CMM trading rights to sell. We seek appropriate buyers for these CMM trading rights based on their ability to provide significant liquidity to our markets. The proceeds we receive from the
sales, less taxes and bonuses we pay on those sales, have been distributed to our stockholders. Unsold CMM trading rights do not generate revenue for us. Accordingly, based on requests by potential exchange members, we decided in 2006 to offer to
lease the unsold CMM trading rights for one year periods, for $150,000 per year. We anticipate leasing or selling all of the remaining unsold CMM trading rights and may affect such sales at anytime. However, we have no present agreements with any
entity to purchase or lease the remaining CMM trading rights and we cannot assure such sale or lease will take place. As of September 30, 2007, we sold 50 CMM trading rights. Other fees represent revenues from our subsidiary, Longitude, which
we do not expect to be material to our 2007 results due to the suspension of its auctions as discussed above.
Market Data Fees
Market data
revenues are primarily driven by the proportional number of trades executed on our exchange as well as the OPRA profits. We expect our market data revenues to continue to fluctuate based upon our market share of trades and OPRA’s
profitability. Our market share of trades is partly driven by our trade size or our average contracts per trade. We have generally been experiencing an increasing number of contracts per trade. We believe the increase in number of contracts per
trade is an indicator of increased trading by institutional investors, who generally trade in larger size than retail investors. To the extent we are successful in our efforts to increase trading by institutional investors, we may experience a
decrease in our market data revenues; however, this decrease would be more than offset by increased transaction fee revenues due to the increased trading. Also, to the extent the SEC expands the number of options included in the penny pilot, we
would expect OPRA to have increased costs for upgrading the capacity of its systems which may reduce our market data revenues. Additionally, beginning in the second quarter of 2006, we began to record revenues from our own options market data
offering. We do not expect the revenues generated from this offering to be material to our 2007 results.
18
Cost of Revenues
We record direct costs associated with our revenues as “Cost of revenues” on our consolidated statement of income. These costs are comprised of:
|
|
•
|
|
Activity remittance fees we pay to the SEC pursuant to Section 31 of the Exchange Act. These fees are designed to recover costs to the government for the
supervision and regulation of securities markets and securities professionals. This expense is wholly offset by activity assessment fees we charge our exchange members which is included in transaction fees.
|
|
|
•
|
|
License fees we pay for our exchange members to trade licensed products, primarily options on certain ETFs and indexes. This expense is offset by surcharges we
charge our exchange members for trading these products which is included in transaction fees. We expect these fees to decrease as we no longer pay such fees on certain ETFs, including in October 2006 license fees on the QQQQ’s and beginning
January 2007 Russell ETF’s including IWM.
|
Expenses
Compensation and Benefits
Employee
compensation and benefits expense is primarily driven by changes in our headcount and levels of incentive compensation. We may continue to increase our headcount to support our business initiatives which will lead to higher compensation and benefits
expense. We also may experience fluctuations in our incentive compensation as a portion of that expense is based on our profitability. We may also incur costs for a success bonus, in the form of cash and/or stock, payable to our executive officers
and certain directors if and when we sell our remaining 10 CMM trading rights. Pursuant to change in control provisions contained within our Omnibus Stock Plan, all of our unvested stock grants become immediately vested as a result of our
stockholders affirmative vote of our merger with Eurex, unless an employee waived such right until the earlier of closing of the merger or December 31, 2007. Accordingly, we accelerated all remaining stock based compensation charges.
Technology and Communications
Technology and communication expense is primarily driven by costs associated with our trading system and generally fluctuates based upon long-term trends in our business activity. Certain elements of this expense, which we incur in
anticipation of certain transaction volume levels, have both a fixed and variable nature. Once we incur these expenses initially, we may not incur them going forward on a recurring, annual basis. As a result of the importance of our systems to the
viability of our business, we continue to invest heavily in areas such as system capacity and reliability, increased functionality and performance and security and expect the costs to increase in 2007. We also must modify our systems from time to
time to comply with various regulatory requirements and competitive responses. The expenses we incur for these modifications may vary substantially from period to period. We anticipate technology and communication expense to fluctuate with increases
in volumes and trading system enhancements as well as technology changes in the industry. In addition, we will incur additional costs to upgrade our systems as a result of the penny quoting pilot.
Occupancy
Occupancy expense is
primarily driven by our facility needs due to headcount or system needs as well as back-up facilities. We anticipate higher occupancy costs in the future to support our growth, computer operations and disaster recovery needs.
Professional Fees
Professional fees
are generally discretionary in nature, however there are non-discretionary components, such as accounting, audit and regulatory fees. As a SRO, we are required to regulate our exchange members and as such, we employ the services of the NASD to
perform certain of these functions on our behalf. Certain expenses, such as those related to new business initiatives or litigation may fluctuate from year to year.
Marketing and Business Development
Marketing and business development expense is generally
discretionary in nature and is primarily driven by our public relations and product promotion campaigns.
Depreciation and Amortization
Depreciation and amortization expense is primarily driven by purchases of software licenses, leasehold improvements and intangible
assets we purchase and capitalize. We expect to incur additional software amortization expense related to enhancements to our trading system in order to remain competitive. In addition, our leasehold improvements amortization may increase as we
review our office space requirements, computer operations and disaster recovery needs.
Other Expenses
Other expenses include Board of Director expenses, travel and entertainment related
costs, general office expenses and liability insurance premiums. We expect other expenses to increase to support our overall growth.
Merger Related Costs
Merger related costs consist primarily of advisory fees incurred in connection with our contemplated
merger with Eurex. We expect to incur additional costs until our transaction closes.
Interest and Investment Income
Interest and investment income is primarily driven by our available cash balances.
Provision for Income Taxes
Provision
for income taxes is based on the application of prevailing federal, state and local tax rates. The difference between our effective tax rate and the statutory tax rate may vary from period to period, but primarily results from state and local taxes
and the effect of certain non-deductible expenses. We expect our effective tax rate to range from approximately 43% to 44% in 2007 before the impact of non-deductible merger related costs.
19
Stock Exchange Segment
Our stock exchange segment is still in the early stages of its operations. The revenues in this segment will not be material until such time as we can attract significant amounts of trading volume. There are many ways
to attract trading volume, including pricing, system performance and functionality. Our profitability will be affected by how we position this business to be competitive in these areas.
Seasonality
In the securities trading industry, quarterly revenue fluctuations are common and are
due primarily to variations in trading volumes. We believe we experience increased levels of trading activity in the first and fourth quarters, and decreased levels of trading activity in the second and third quarters. However, we believe the
increased volatility in the third quarter of this year offset the historic seasonality. As a result of this and other factors described elsewhere herein, period-to-period comparisons of our revenues and operating results are not necessarily
meaningful, and the results of any quarter are not necessarily indicative of results of any future period.
Fixed and Variable Expenses
Our expense structure is predominantly fixed. However, there are some variable components that fluctuate with volumes. We may incur certain costs in
anticipation of certain transaction volume levels and make significant expenditures related to technological innovations over long periods of time, so that our operating margins and profitability could be adversely affected. In addition, a component
of our incentive compensation is dependent upon our operating results. If demand for our services should decline suddenly and we are unable to adjust our fixed cost base on a timely basis, it could have a material adverse effect on our operating
results and financial condition.
NON-GAAP FINANCIAL MEASURES
In an effort to provide additional information regarding our results as determined by GAAP, we also disclose certain non-GAAP information which we believe provides useful and meaningful information. Our management
reviews this non-GAAP financial measurement when evaluating our financial performance and results of operations; therefore, we believe it is useful to provide information with respect to these non-GAAP measurements so as to share this perspective of
management. Non-GAAP measurements do not have any standardized meaning and are therefore unlikely to be comparable to similar measures presented by other companies. These non-GAAP financial measures should be considered in the context with our GAAP
results.
We have disclosed non-GAAP financial measures using our net transaction fees which we define as our transaction fees less
activity remittance fees and ETF and index license fees. Under GAAP, activity remittance fees and ETF and index license fees are required to be recorded on a gross basis. Since activity remittance fee and ETF and index license fees are wholly offset
by corresponding amounts in transaction fees, management believes presenting net transaction fees provides a clearer measure of our transaction related performance.
The following table reflects the calculation of our net transaction fees for our options exchange:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
|
|
(in thousands, except per side amounts)
|
|
|
(in thousands, except per side amounts)
|
|
|
Transaction fees
|
|
$
|
71,222
|
|
|
$
|
38,778
|
|
|
$
|
163,258
|
|
|
$
|
116,327
|
|
|
Less cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Activity remittance fees
|
|
|
4,567
|
|
|
|
3,525
|
|
|
|
11,179
|
|
|
|
11,576
|
|
|
ETF and index license fees
|
|
|
8,851
|
|
|
|
2,106
|
|
|
|
11,521
|
|
|
|
6,052
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
|
13,418
|
|
|
|
5,631
|
|
|
|
22,700
|
|
|
|
17,628
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net transaction fees
|
|
$
|
57,804
|
|
|
$
|
33,147
|
|
|
$
|
140,558
|
|
|
$
|
98,699
|
|
|
Total sides
|
|
|
429,281
|
|
|
|
280,540
|
|
|
|
1,134,152
|
|
|
|
879,581
|
|
|
Average transaction fee per side
|
|
$
|
0.140
|
|
|
$
|
0.138
|
|
|
$
|
0.133
|
|
|
$
|
0.132
|
|
|
Average cost of revenues per side
|
|
|
(0.009
|
)
|
|
|
(0.020
|
)
|
|
|
(0.011
|
)
|
|
|
(0.020
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average net transaction fee per side
|
|
$
|
0.131
|
|
|
$
|
0.118
|
|
|
$
|
0.122
|
|
|
$
|
0.112
|
|
20
We have also disclosed our results excluding certain non-operating charges. These non-operating charges
relate to advisory expenses incurred in connection with our pending merger with Eurex, the net accelerated charge for stock-based compensation resulting from our stockholders approving our merger with Eurex, and legal fees incurred to reorganize
into a holding company in 2006. Management excludes these costs when measuring our financial performance as they do not relate to our core business of operating a multi-asset class exchange. Management believes presenting our results excluding these
costs provides a clearer measure of our results and performance.
The following table reflects the calculation of our non-operating charges
on our consolidated results:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated Results
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
GAAP Income before provision for income taxes, as reported
|
|
$
|
32,754
|
|
$
|
24,478
|
|
$
|
91,992
|
|
$
|
71,170
|
|
Less Accelerated stock based compensation
|
|
|
11,200
|
|
|
—
|
|
|
11,200
|
|
|
—
|
|
Less Merger related costs
|
|
|
235
|
|
|
—
|
|
|
2,384
|
|
|
—
|
|
Less Reorganization
|
|
|
—
|
|
|
197
|
|
|
—
|
|
|
326
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before provision for income taxes, proforma
|
|
$
|
44,189
|
|
$
|
24,675
|
|
$
|
105,576
|
|
$
|
71,496
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP Net income, as reported
|
|
$
|
18,517
|
|
$
|
13,958
|
|
$
|
51,084
|
|
$
|
40,079
|
|
Less Accelerated stock based compensation, net of tax
|
|
|
6,272
|
|
|
—
|
|
|
6,272
|
|
|
—
|
|
Less Merger related costs, net of tax
|
|
|
235
|
|
|
—
|
|
|
2,352
|
|
|
—
|
|
Less Reorganization, net of tax
|
|
|
—
|
|
|
197
|
|
|
—
|
|
|
326
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income, proforma
|
|
$
|
25,024
|
|
$
|
14,155
|
|
$
|
59,708
|
|
$
|
40,405
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table reflects the calculation of our non-operating charges for our options
exchange:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Segment
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
GAAP Income before provision for income taxes, as reported
|
|
$
|
32,754
|
|
$
|
24,478
|
|
$
|
91,992
|
|
$
|
72,188
|
|
Less Accelerated stock based compensation
|
|
|
11,200
|
|
|
|
|
|
11,200
|
|
|
—
|
|
Less Merger related costs
|
|
|
235
|
|
|
—
|
|
|
2,384
|
|
|
—
|
|
Less Reorganization
|
|
|
—
|
|
|
197
|
|
|
—
|
|
|
326
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before provision for income taxes, proforma
|
|
$
|
44,189
|
|
$
|
24,675
|
|
$
|
105,576
|
|
$
|
72,514
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP Net income, as reported
|
|
$
|
18,517
|
|
$
|
13,958
|
|
$
|
51,084
|
|
$
|
40,639
|
|
Less Accelerated stock based compensation, net of tax
|
|
|
6,272
|
|
|
|
|
|
6,272
|
|
|
—
|
|
Less Merger related costs, net of tax
|
|
|
235
|
|
|
—
|
|
|
2,352
|
|
|
—
|
|
Less Reorganization, net of tax
|
|
|
—
|
|
|
197
|
|
|
—
|
|
|
326
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income, proforma
|
|
$
|
25,024
|
|
$
|
14,155
|
|
$
|
59,708
|
|
$
|
40,965
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CRITICAL ACCOUNTING POLICIES
Our accounting policy related to our revenue recognition from the sale of CMM trading rights on our options exchange is our most critical accounting policy that requires management to make estimates and judgments that
could affect our results.
As of September 30, 2007, we have sold 50 trading rights. The trading rights were each sold pursuant to a
purchase agreement for $1.5 million each. Certain trading rights were paid in full on the purchase date, while others are payable in annual installments; however, the purchase agreement grants immediate membership upon execution of the purchase
agreement.
The trading rights are transferable and have no contractual term. We have an implied performance obligation to maintain our
marketplace over the life of the membership, and therefore recognize the revenue from the sale of the trading rights over the estimated life of the trading right, as the implied performance obligation is fulfilled. We have estimated the life of the
trading right at 14 years, and recognize revenue over this period on a straight-line basis.
In order to determine the estimated service
life of the trading right, we identified three broad factors affecting the securities industry that have a significant impact on our operations, and therefore, the estimated service life of the trading rights – the securities industry’s
challenging operating environment, regulatory changes and technology innovations. We identified specific historical events in the options industry and the broader securities industry for each of these factors, assigned an appropriate time horizon
for each event, and calculated an average time horizon for each factor. Based on this analysis, we used the average across all factors, 14 years, as an estimate for the service life of the trading rights.
21
The occurrence of each historical event considered in the analysis has necessitated significant changes
in the business models of the securities exchanges and market participants. Each of the factors identified have had a significant impact on the options industry or broader securities industry, and will have a significant impact on our trading
rights.
On a periodic basis, or if certain circumstances come to our attention, we review the original factors or assumptions used in
determining the estimated service period to ascertain the effect, if any, current events may have on those factors and assumptions. If the current facts warrant a change in the estimated service period, we will adjust the remaining revenue to be
recognized in accordance with the new estimated service life using the prospective method. The service period may increase or decrease from our current estimate of 14 years based upon the facts and circumstances, and therefore, these revenues may
fluctuate in the future.
We recognized revenue of $1.3 million and $1.2 million during the three months ended September 30, 2007 and
2006, respectively and $3.8 million and $3.6 million during the nine months ended September 30, 2007 and 2006, respectively, from the sale of CMM trading rights.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
None
22
KEY STATISTICAL INFORMATION
In evaluating the performance of our options exchange business, management closely monitors these key statistics for ISE:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Trading Days
|
|
|
63
|
|
|
|
63
|
|
|
|
187
|
|
|
|
188
|
|
|
Average daily trading volume (1) (2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity and Index Options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total U.S. industry equity and index options traded (in thousands)
|
|
|
12,119
|
|
|
|
7,524
|
|
|
|
10,817
|
|
|
|
7,881
|
|
|
Our equity and index options traded (in thousands)
|
|
|
3,407
|
|
|
|
2,227
|
|
|
|
3,032
|
|
|
|
2,339
|
|
|
Our market share of equity and index options traded
|
|
|
28.1
|
%
|
|
|
29.6
|
%
|
|
|
28.0
|
%
|
|
|
29.7
|
%
|
|
Equity Options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total U.S. industry equity options traded (in thousands)
|
|
|
10,872
|
|
|
|
6,815
|
|
|
|
9,745
|
|
|
|
7,159
|
|
|
Our equity options traded (in thousands)
|
|
|
3,321
|
|
|
|
2,194
|
|
|
|
2,972
|
|
|
|
2,307
|
|
|
Our market share of equity options traded
|
|
|
30.5
|
%
|
|
|
32.2
|
%
|
|
|
30.5
|
%
|
|
|
32.2
|
%
|
|
Index Options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total U.S. industry index options traded (in thousands)
|
|
|
1,237
|
|
|
|
709
|
|
|
|
1,067
|
|
|
|
722
|
|
|
Our index options traded (in thousands)
|
|
|
82
|
|
|
|
33
|
|
|
|
59
|
|
|
|
32
|
|
|
Our market share of index options traded
|
|
|
6.6
|
%
|
|
|
4.6
|
%
|
|
|
5.5
|
%
|
|
|
4.4
|
%
|
|
Our member total trading volume (sides, in thousands): (3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Account type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
|
|
|
173,666
|
|
|
|
112,429
|
|
|
|
467,934
|
|
|
|
364,217
|
|
|
Firm proprietary
|
|
|
65,155
|
|
|
|
36,402
|
|
|
|
165,753
|
|
|
|
108,998
|
|
|
Market maker
|
|
|
190,460
|
|
|
|
131,710
|
|
|
|
500,465
|
|
|
|
406,366
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Sides
|
|
|
429,281
|
|
|
|
280,540
|
|
|
|
1,134,152
|
|
|
|
879,581
|
|
|
Our market share of total industry trading: (4)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
|
|
|
28.5
|
%
|
|
|
29.3
|
%
|
|
|
29.1
|
%
|
|
|
30.2
|
%
|
|
Firm proprietary
|
|
|
27.8
|
%
|
|
|
25.8
|
%
|
|
|
26.2
|
%
|
|
|
25.7
|
%
|
|
Market maker
|
|
|
27.9
|
%
|
|
|
31.2
|
%
|
|
|
27.8
|
%
|
|
|
30.5
|
%
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average transaction fee per side (5)
|
|
$
|
0.140
|
|
|
$
|
0.138
|
|
|
$
|
0.133
|
|
|
$
|
0.132
|
|
|
Average cost of transaction fee per side (6)
|
|
$
|
(0.009
|
)
|
|
$
|
(0.020
|
)
|
|
$
|
(0.011
|
)
|
|
$
|
(0.020
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average net transaction fee per side (6)
|
|
$
|
0.131
|
|
|
$
|
0.118
|
|
|
$
|
0.122
|
|
|
$
|
0.112
|
|
|
Average transaction fee per revenue side (7)
|
|
$
|
0.200
|
|
|
$
|
0.176
|
|
|
$
|
0.187
|
|
|
$
|
0.176
|
|
|
Our trades: (8)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average contracts per trade
|
|
|
18.1
|
|
|
|
18.0
|
|
|
|
18.1
|
|
|
|
17.6
|
|
|
Average trades per day (in thousands)
|
|
|
188.1
|
|
|
|
123.4
|
|
|
|
167.6
|
|
|
|
133.0
|
|
|
Total trades (in thousands)
|
|
|
11,853
|
|
|
|
7,774
|
|
|
|
31,332
|
|
|
|
24,999
|
|
|
Our market share of industry trade volume
|
|
|
31.3
|
%
|
|
|
32.5
|
%
|
|
|
31.6
|
%
|
|
|
32.3
|
%
|
|
Our listed issues: (9)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average number of issues traded during the period
|
|
|
1,778
|
|
|
|
931
|
|
|
|
1,719
|
|
|
|
891
|
|
|
Our Members (average number trading during period) (10)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PMMs
|
|
|
10
|
|
|
|
10
|
|
|
|
10
|
|
|
|
10
|
|
|
CMMs
|
|
|
143
|
|
|
|
148
|
|
|
|
144
|
|
|
|
145
|
|
|
EAMs
|
|
|
108
|
|
|
|
99
|
|
|
|
109
|
|
|
|
101
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
261
|
|
|
|
257
|
|
|
|
263
|
|
|
|
256
|
|
|
Employees (period average)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Full-time equivalent (11)
|
|
|
196
|
|
|
|
178
|
|
|
|
188
|
|
|
|
181
|
|
|
(1)
|
Represents single counted contract volume. For example, a transaction of 500 contracts on our exchange is counted as a single 500 contract transaction for purposes of calculating
our volumes, even though we may receive transaction fees from parties on both sides of the transaction, one side of a transaction, or in some cases, neither side of a transaction.
|
|
(2)
|
Our market share is calculated based on the number of contracts executed on our exchange as a percentage of total industry contract volume.
|
|
(3)
|
Represents each side of a buy or sell transaction. For example, a transaction of 500 contracts on our exchange is counted as two sides of 500 contracts, representing a buy and a
sell transaction. We generally do not charge our members for executing non-broker-dealer customer orders on our exchange except for options on our premium products as well as options for listings in our Second Market.
|
|
(4)
|
Represents our market share of total U.S. industry equity and index trading for members trading on our exchange based on contract trading volume.
|
23
|
(5)
|
Average transaction fee per side is calculated by dividing our transaction fees by the total number of sides executed on our exchange. We generally do not charge our members for
executing non-broker-dealer customer orders on our exchange except for options on our premium products as well as options for listings in our Second Market. Comparing our average transaction fee per side to our average transaction fee per revenue
side reflects the negative effect of our fee waivers or reductions on our revenues, on a per side basis.
|
|
(6)
|
Average cost of transaction fee per side is calculated by subtracting cost of revenues from transaction fees, which we refer to as net transaction fees, and dividing the result by
the total number of sides executed on our exchange.
|
|
(7)
|
Our average transaction fee per revenue side reflects the transaction fee we charge to our market participants per our publicly available pricing schedules. These schedules were
part of rule proposals that became effective upon filing pursuant to Section 19(b)(3)(A) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Securities and Exchange Commission may abrogate such rule proposals
within 60 days of filing if it determines that such action is necessary or appropriate in the public interest, for the protection of investors or otherwise in furtherance of the purposes of the Exchange Act.
|
|
(8)
|
Members can have several contracts per trade. Trades represent the number of trades cleared through The Option Clearing Corporation, or the OCC. Market data revenue is generated on
a per trade basis, not on a contract basis.
|
|
(9)
|
By “issues” we mean the number of securities underlying our options. We trade multiple options series on each underlying security.
|
|
(10)
|
Excludes PMM’s and CMM’s in our Second and FX Markets.
|
|
(11)
|
Excludes full-time equivalent employees of ISE Stock Exchange, LLC, beginning April 2006.
|
We derive our data from our own records and data for the markets in which we compete from information published by or prepared for OCC and OPRA.
24
Results of Operations
THREE MONTHS ENDED SEPTEMBER 30, 2007 VERSUS SEPTEMBER 30, 2006
Options Exchange Segment
Overview
Net income increased 32.7% to $18.5 million
during the three months ended September 30, 2007 from $14.0 million during the comparable period in 2006, primarily due to increased trading volumes on our options exchange. Our expenses increased 72.1% to $38.7 million during the three months
ended September 30, 2007 from $22.5 million during the comparable period in 2006, primarily due to increased stock based compensation. Included in our results for the three months ended September 30, 2007 are accelerated stock based
compensation costs of $11.2 million.
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
2007
|
|
2006
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
(in millions)
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
Transaction fees
|
|
60.0
|
|
38.8
|
|
21.3
|
|
|
54.8
|
%
|
|
Member fees and other
|
|
7.5
|
|
6.9
|
|
0.6
|
|
|
8.4
|
%
|
|
Market data
|
|
4.6
|
|
4.4
|
|
0.2
|
|
|
5.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
72.2
|
|
50.1
|
|
22.1
|
|
|
44.1
|
%
|
|
Cost of revenues
|
|
|
|
|
|
|
|
|
|
|
|
Activity remittance fees
|
|
2.7
|
|
3.5
|
|
(0.8
|
)
|
|
-23.0
|
%
|
|
License fees
|
|
1.1
|
|
2.1
|
|
(1.0
|
)
|
|
-45.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
3.9
|
|
5.6
|
|
(1.8
|
)
|
|
-31.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
68.3
|
|
44.5
|
|
23.9
|
|
|
53.7
|
%
|
Transaction Fees
Transaction fee revenues increased 54.8% to $60.0 million during the three months ended September 30, 2007 from $38.8 million during the comparable period in 2006, primarily due to increased trading volumes on
our options exchange resulting from increased volatility. This volume growth was due to several factors, including the following:
|
|
•
|
|
Industry ADV for equity options during the three months ended September 30, 2007 increased 59.5% from the comparable period in 2006.
|
|
|
•
|
|
Our ADV increased 51.4% over the same period; however our market share decreased to 30.5% from 32.2%.
|
|
|
•
|
|
Our ADV in index options was 82,000 during the three months ended September 30, 2007 compared to 33,000 during the comparable period in 2006.
|
Our average transaction fee per side increased to $0.140 during the three months ended September 30, 2007 from
$0.138 during the comparable period in 2006. Over the same period our average net transaction fee per side, a measure we use to evaluate our revenues which excludes activity remittance fees and ETF and index license fees, increased to $0.131
from $0.118. An increase in our fees to non-ISE market makers beginning June 2007 drove this change. Additionally, we recorded higher cancellation fee revenues due to increases in the amount we charge for this activity. Partly offsetting these
increases was a decrease in the per contract fee we charge market makers based on our exchange reaching certain volume levels.
Member Fees and Other
Member fees and other increased 8.4% to $7.5 million during the three months ended September 30, 2007 from $6.9 million during
the comparable period in 2006. The increase was primarily driven by an increase in connectivity fees due to a pricing change. In April 2006, we changed our exchange member connectivity fees to be based on an exchange member’s quote capacity
usage versus login activity. Quote traffic increased significantly due to the Penny Pilot as well as increased volatility.
Market Data
Market data revenues increased 5.7% to $4.6 million during the three months ended September 30, 2007 from $4.4 million in 2006
primarily due to increased profitability of OPRA which more than offset our decline in trade market share. We accounted for 31.3% of total industry trades during the three months ended September 30, 2007 and 32.5% during the comparable period
in 2006.
25
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
2007
|
|
2006
|
|
$ Change
|
|
% Change
|
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
Compensation and benefits
|
|
26.1
|
|
11.9
|
|
14.2
|
|
119.9
|
%
|
|
Technology and communications
|
|
4.3
|
|
4.1
|
|
0.2
|
|
4.2
|
%
|
|
Occupancy
|
|
1.3
|
|
1.3
|
|
0.0
|
|
-0.7
|
%
|
|
Professional fees
|
|
2.8
|
|
1.4
|
|
1.4
|
|
97.7
|
%
|
|
Marketing and business development
|
|
0.7
|
|
0.8
|
|
0.0
|
|
-6.4
|
%
|
|
Depreciation and amortization
|
|
1.7
|
|
1.7
|
|
-0.1
|
|
-3.6
|
%
|
|
Other
|
|
1.6
|
|
1.1
|
|
0.5
|
|
43.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
Total direct expenses
|
|
38.4
|
|
22.3
|
|
16.2
|
|
72.5
|
%
|
|
Merger Related
|
|
0.2
|
|
0.0
|
|
0.2
|
|
N/M
|
|
|
Reorganization
|
|
0.0
|
|
0.2
|
|
-0.2
|
|
N/M
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
38.7
|
|
22.5
|
|
16.2
|
|
72.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and Benefits
Compensation and benefits expense increased 119.9% to $26.1 million during the three months ended September 30, 2007 from $11.9 million during the
comparable period in 2006. The increase was primarily due to accelerated stock based compensation resulting from stockholder approval of our merger agreement with Eurex. We also recorded higher incentive compensation as a result of our higher
profitability.
Technology and Communication
Technology and communication expense increased 4.2% to $4.3 million during the three months ended September 30, 2007 from $4.1 million during the comparable period in 2006 primarily due to spending on capacity
and enhancements to our options trading system.
Professional Fees
Professional fees increased 97.7% to $2.8 million during the three months ended September 30, 2007 from $1.4 million during the comparable period in
2006 primarily due to higher legal expenses related to our litigation concerning the exclusive listing of index options and patent enforcement, as well as other advisory fees relating to possible new business initiatives.
Marketing and Business Development
Marketing
and business development expenses decreased 6.4% to $0.7 million during the three months ended September 30, 2007 from $0.8 million during the comparable period in 2006, due to lower levels of spending on marketing and advertising material
primarily due to timing of marketing programs.
Depreciation and Amortization
Depreciation and amortization expenses decreased 3.6% to $1.7 million during the three months ended September 30, 2007 from $1.7 million during the
comparable period in 2006.
Other Expenses
Other expenses increased 43.9% to $1.6 million during the three months ended September 30, 2007 from $1.1 million during the comparable period in 2006. The increase was attributable to payments relating to
trading disruptions as well as increased travel and other general expenses to support our overall growth.
Merger related Costs
We incurred $0.2 million of merger related costs during the three months ended September 30, 2007. These fees consist primarily of advisory fees
incurred in connection with our contemplated merger with Eurex.
Interest and Investment Income
Interest and investment income increased to $3.1 million during the three months ended September 30, 2007 from $2.3 million during the comparable
period in 2006 as a result of higher average cash balances.
Provision for Income Taxes
Our tax provision increased to $14.2 million during the three months ended September 30, 2007 from $10.5 million during the comparable period in
2006. Over the same period our effective tax rate increased to 43.5% from 43.0%.
26
NINE MONTHS ENDED SEPTEMBER 30, 2007 VERSUS SEPTEMBER 30, 2006
Options Exchange Segment
Overview
Net income increased 25.7% to $51.1 million during the nine months ended September 30, 2007 from $40.6 million during the comparable period in 2006,
primarily due to increased trading volumes on our options exchange. Our expenses increased 40.1% to $90.8 million during the nine months ended September 30, 2007 from $64.8 million during the comparable period in 2006, primarily due to
increased stock based compensation. Included in our results for the quarter are accelerated stock based compensation costs of $11.2 million.
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
2007
|
|
2006
|
|
$ Change
|
|
|
% Change
|
|
|
|
|
(in millions)
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
Transaction fees
|
|
150.3
|
|
116.3
|
|
34.0
|
|
|
29.2
|
%
|
|
Member fees and other
|
|
22.0
|
|
18.9
|
|
3.1
|
|
|
16.2
|
%
|
|
Market data
|
|
13.8
|
|
13.5
|
|
0.3
|
|
|
2.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
186.1
|
|
148.7
|
|
37.3
|
|
|
25.1
|
%
|
|
Cost of revenues
|
|
|
|
|
|
|
|
|
|
|
|
Activity remittance fees
|
|
8.9
|
|
11.6
|
|
(2.7
|
)
|
|
-23.3
|
%
|
|
License fees
|
|
3.3
|
|
6.1
|
|
(2.8
|
)
|
|
-45.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
12.2
|
|
17.6
|
|
(5.5
|
)
|
|
-30.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
173.9
|
|
131.1
|
|
42.8
|
|
|
32.6
|
%
|
Transaction Fees
Transaction fee revenues increased 29.2% to $150.3 million during the nine months ended September 30, 2007 from $116.3 million during the comparable period in 2006, primarily due to increased trading volumes on
our options exchange. This volume growth was due to several factors, including the following:
|
|
•
|
|
Industry ADV for equity options during the nine months ended September 30, 2007 increased 36.1% from the comparable period in 2006.
|
|
|
•
|
|
Our ADV increased 28.8% over the same period; however our market share decreased to 30.5% from 32.2%.
|
|
|
•
|
|
Our ADV in index options was 59,000 during the nine months ended September 30, 2007 compared to 32,000 during the comparable period in 2006.
|
Our average transaction fee per side increased to $0.133 during the nine months ended September 30, 2007 from
$0.132 during the comparable period in 2006. Over the same period our average net transaction fee per side, a measure we use to evaluate our revenues which excludes activity remittance fees and ETF and index license fees, increased to $0.122
from $0.112. An increase in our fees to non-ISE market makers beginning June 2007 drove this change. Additionally, we recorded higher cancellation fee revenues due to increases in the amount we charge for this activity. Partly offsetting these
increases was a decrease in the per contract fee we charge market makers based on our exchange reaching certain volume levels.
Member Fees and Other
Member fees and other increased 16.2% to $22.0 million during the nine months ended September 30, 2007 from $18.9 million
during the comparable period in 2006. The increase was primarily driven by an increase in connectivity fees due to a pricing change. In April 2006, we changed our exchange member connectivity fees to be based on an exchange member’s quote
capacity usage versus login activity. Quote traffic increased significantly due to the Penny Pilot as well as increased volatility.
Market Data
Market data revenues increased 2.0% to $13.8 million during the nine months ended September 30, 2007 from $13.5 million in
2006 as an increase in OPRA profitability was partly offset by our lower market share of trades. We accounted for 31.6% of total industry trades during the nine months ended September 30, 2007 and 32.3% during the comparable period in 2006.
27
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
2007
|
|
2006
|
|
$ Change
|
|
% Change
|
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
Compensation and benefits
|
|
52.6
|
|
34.2
|
|
18.4
|
|
53.9
|
%
|
|
Technology and communications
|
|
12.9
|
|
11.3
|
|
1.6
|
|
14.0
|
%
|
|
Occupancy
|
|
3.8
|
|
3.9
|
|
-0.1
|
|
-3.0
|
%
|
|
Professional fees
|
|
6.4
|
|
4.1
|
|
2.2
|
|
54.5
|
%
|
|
Marketing and business development
|
|
1.9
|
|
2.2
|
|
-0.3
|
|
-15.0
|
%
|
|
Depreciation and amortization
|
|
6.1
|
|
5.1
|
|
1.0
|
|
19.9
|
%
|
|
Other
|
|
4.8
|
|
3.7
|
|
1.1
|
|
30.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
Total direct expenses
|
|
88.5
|
|
64.5
|
|
24.0
|
|
37.1
|
%
|
|
Merger related costs
|
|
2.4
|
|
0.0
|
|
2.4
|
|
N/M
|
|
|
Reorganization
|
|
0.0
|
|
0.3
|
|
-0.3
|
|
N/M
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
90.8
|
|
64.8
|
|
26.0
|
|
40.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and Benefits
Compensation and benefits expense increased 53.9% to $52.6 million during the nine months ended September 30, 2007 from $34.2 million during the
comparable period in 2006. The increase was primarily due to accelerated stock based compensation resulting from stockholder approval of our merger agreement with Eurex. We also recorded higher incentive compensation as a result of our higher
profitability.
Technology and Communication
Technology and communication expense increased 14.0% to $12.9 million during the nine months ended September 30, 2007 from $11.3 million during the comparable period in 2006 primarily due to an increase in
spending on equipment and software in order to handle the increased quoting on our trading system. In addition, costs related to OMX increased $0.7 million for enhancements to our options trading system.
Professional Fees
Professional fees increased
54.5% to $6.4 million during the nine months ended September 30, 2007 from $4.1 million during the comparable period in 2006 primarily due to higher legal expenses related to our litigation concerning the exclusive listing of index options and
patent enforcement. Partly offsetting this increase, was consulting fees incurred in the year ago period related to us preparing for compliance with the Sarbanes Oxley Act of 2002.
Marketing and Business Development
Marketing and business development expenses decreased
15.0% to $1.9 million during the nine months ended September 30, 2007 from $2.2 million during the comparable period in 2006 due to lower levels of spending on branding campaigns primarily due to timing of marketing programs.
Depreciation and Amortization
Depreciation
and amortization expenses increased 19.9% to $6.1 million during the nine months ended September 30, 2007 from $5.1 million during the comparable period in 2006 primarily due to an impairment charge of $0.9 million relating to Longitude
intellectual property.
Other Expenses
Other expenses increased 30.6% to $4.8 million during the nine months ended September 30, 2007 from $3.7 million during the comparable period in 2006. The increase was attributable to payments relating to trading disruptions,
settlement of a state tax audit and an increase in other general expenses to support our overall growth.
Merger related costs
We incurred $2.4 million of merger related costs during the nine months ended September 30, 2007. These fees consist primarily of advisory fees
incurred in connection with our contemplated merger with Eurex.
Interest and Investment Income
Interest and investment income increased to $8.9 million during the nine months ended September 30, 2007 from $5.4 million during the comparable
period in 2006 as a result of higher average cash balances.
Provision for Income Taxes
Our tax provision increased to $40.9 million during the nine months ended September 30, 2007 from $31.5 million during the comparable period in 2006.
Over the same period our effective tax rate increased to 44.5% from 43.7%, primarily as a result of non-deductible merger related costs.
28
Stock Exchange Segment
Our stock exchange segment is still in its early stages of operations. For the three months ended September 30, 2007, this segment recorded gross margin of $4.1 million resulting from transaction fees and market
data. We use a maker-taker pricing method for our displayed market and waived fees for our MPM platform through May 1, 2007. Total expenses increased to $4.3 million during the three months ended September 30, 2007 from $3.0 million during
the comparable period in 2006 primarily due to higher compensation and benefits expense reflecting higher staffing levels required to launch and operate the stock exchange.
For the nine months ended September 30, 2007, this segment recorded gross margin of $5.4 million primarily as a result of the launch of our
displayed market in December 2006. Total expenses increased to $12.2 million during the nine months ended September 30, 2007 from $5.4 million during the comparable period in 2006 primarily due to higher compensation and benefits expense
reflecting higher staffing levels required to launch and operate the stock exchange.
As discussed above, see “Overview – Our
stock exchange business segment”, we do not recognize any losses from ISE Stock Exchange on a consolidated basis beginning April 2006.
Liquidity
and Capital Resources
We presently finance our options exchange business primarily through cash generated by our operating activities.
We believe that cash flows generated by our operating activities should be sufficient for us to fund our current operations. In addition, we have access to an uncommitted $10.0 million credit facility and may have the ability to raise capital
through issuance of debt or equity to new or existing investors through private and public capital markets transactions, if necessary. We finance our stock exchange business through the cash initially raised from its strategic investors.
The following table sets forth our consolidated net cash flows from operating activities, investing activities and financing activities for the
periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Net cash provided by operating activities
|
|
$
|
51,538
|
|
|
$
|
49,108
|
|
|
Net cash (used in)/provided by investing activities
|
|
|
24,428
|
|
|
|
(36,862
|
)
|
|
Net cash provided by/(used in) financing activities
|
|
|
(4,305
|
)
|
|
|
5,662
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase/(decrease) in cash and cash equivalents
|
|
|
71,661
|
|
|
|
17,908
|
|
|
Cash and cash equivalents at beginning of period
|
|
|
200,015
|
|
|
|
170,927
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period
|
|
$
|
271,676
|
|
|
$
|
188,835
|
|
|
|
|
|
|
|
|
|
|
|
Our cash and cash equivalents are primarily comprised of investments in money market accounts and
highly liquid investments with maturities of less than 90 days. Assets readily convertible into cash consists of amounts due from our members for transactions executed on our options and stock exchange, which are principally reflected in our current
accounts receivable, less cash we hold in connection with our payment for order flow program which is discussed below. We charge members for their transactions on a monthly basis and collect these fees within five business days after the end of each
month pursuant to a standing agreement with OCC for options transactions and DTCC for stock transactions, where we have the ability to withdraw our non-contested fees from members’ security clearing accounts. Also included in amounts readily
convertible into cash are investments of our excess cash in U.S. Treasuries and municipal bonds, which are included in securities owned. Cash and cash equivalents, together with assets readily convertible into cash, accounted for 76.9% of our total
assets as of September 30, 2007, and 77.5% as of December 31, 2006.
Cash and cash equivalents increased to $271.7 million as of
September 30, 2007 from $200.0 million as of December 31, 2006:
|
|
•
|
|
Our net cash provided by operating activities was $51.5 million during the nine months ended September 30, 2007 primarily due to increased trading volumes on
our options exchange.
|
|
|
•
|
|
Our net cash provided in investing activities was $24.4 million during the nine months ended September 30, 2007. We had $53.7 million in maturities of
available for sale securities, primarily municipal debt instruments, partly offset by $10.7 million in purchases. We contributed $11.9 million to DEX, our previously announced joint venture with TSX Group. We purchased fixed assets of $6.6 million
primarily for leasehold improvements relating to expansion of our data center in order to support our overall growth as well as software for our options exchange.
|
|
|
•
|
|
Our net cash used by financing activities was $4.3 million during the nine months ended September 30, 2007. We repurchased $12.3 million of our common stock
tendered by our employees to satisfy tax withholding obligations in connection with the vesting of restricted stock awards. We repurchased these shares based on their fair market value on the vesting date. We paid dividends of $5.8 million for the
nine months ended September 30, 2007. Partly offsetting these decreases was a tax benefit of $12.5 million related to options exercised by our employees. Our taxes are reduced by the after tax effect of the difference between the fair market
value and strike price of the options our employees exercised.
|
As of September 30, 2007 and December 31, 2006
included in cash and cash equivalents is $0.8 million and $0.6 million, respectively, for our payment for order flow program. Under this program we pay our EAMs on behalf of our market makers for order flow sent to the exchange. We assess fees
to our market makers, PMMs and CMMs, and distribute those funds to our EAMs. Each PMM has full discretion regarding the payment, and we administer the payments. Accordingly, we reflect the assessments and payments on a net basis with no impact on
revenues or expenses. When fees are assessed, we record an asset with a corresponding liability.
As of September 30, 2007 and
December 31, 2006, included in cash and cash equivalents is $30.5 and $37.8 million held for the exclusive use of ISE Stock Exchange.
As of September 30, 2007 and December 31, 2006, we had a letter of credit agreement totaling $0.4 million to satisfy lease commitments and administrative obligations.
29
Financial Condition
Our total assets increased to $446.9 million as of September 30, 2007 from $396.4 million as of December 31, 2006. This increase was primarily
due to operating cash proceeds resulting from higher transaction volumes as well as higher income tax receivables as a result of exercise of stock options.
Our total liabilities decreased to $92.9 million as of September 30, 2007 from $101.8 million as of December 31, 2006. This decrease was primarily due to a lower levels of trade payables.
We recorded $30.8 million of minority interest representing minority stockholder’s interest in ISE Stock Exchange as of September 30, 2007.
Contractual Obligations
The following
table summarizes our future cash payments associated with contractual obligations as of September 30, 2007, which are primarily operating leases for office space and equipment and contractual agreements for trading software license technology
enhancements and support of our core trading system from OMX:
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments due by
Period
|
|
|
|
Total
|
|
<1
Years
|
|
1 to 3
Years
|
|
3 to 5
Years
|
|
5+
Years
|
|
Operating Leases
|
|
25,852
|
|
6,740
|
|
9,313
|
|
4,031
|
|
5,768
|
|
OMX
|
|
16,520
|
|
7,305
|
|
8,193
|
|
1,022
|
|
—
|
|
Other
|
|
1,153
|
|
1,003
|
|
150
|
|
—
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
43,525
|
|
15,048
|
|
17,656
|
|
5,053
|
|
5,768
|
|
|
|
|
|
|
|
|
|
|
|
|
Our operating lease commitments primarily relate to obligations under operating leases with
initial non-cancelable terms in excess of one year for office space and computer equipment. OMX purchase obligations relate to contractual agreements for trading software licenses, technology enhancements and support of our core trading system from
OMX. Other purchase obligations relate to minimum license fees for certain index options.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.