CBOE Holdings' CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: CBOE Holdings (CBOE)

CBOE Holdings, Inc. (NASDAQ:CBOE)

Q4 2012 Earnings Conference Call

February 8, 20123 08:30 AM ET

Executives

Deborah Koopman - Vice President of Investor Relations

William Brodsky - Chairman and Chief Executive Officer

Alan Dean - Executive Vice President, Chief Financial Officer and Treasurer

Edward Tilly - President and Chief Operating Officer

Edward Provost - Executive Vice President and Chief Business Development Officer

Analysts

Richard Repetto - Sandler O'Neill

Jillian Miller - BMO Capital Markets

Alexander Blostein - Goldman Sachs

Kenneth Worthington - J.P. Morgan

Patrick O'Shaughnessy - Raymond James

Chris Harris - Wells Fargo

Roger Freeman - Barclays

Niamh Alexander - KBW

Howard Chen - Credit Suisse

Ken Leon - S&P Capital IQ

Akhil Bhatia - Rosenblatt Securities

Gaston Ceron - Morningstar Equity Research

Operator

Good day, ladies and gentlemen, and welcome to the CBOE Holdings
Fourth Quarter 2012 Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now turn the conference over to your host Debbie Koopman, please go ahead.

Deborah Koopman

Thank you. Good morning, and thank you for joining us for our fourth quarter conference call. On the call today, Bill Brodsky, our Chairman and CEO, will discuss the quarter and our strategic initiatives for 2013; then Alan Dean, our Executive Vice President and CFO, will detail our fourth quarter 2012 financial results. Following their comments, we will open the call to Q&A. Also joining us for Q&A will be our President and COO, Ed Tilly; and our Executive Vice President and Chief Business Development Officer, Ed Provost.

In addition, I would like to point out that this presentation will include the use of several slides. We will be showing the slides and providing commentary on each. A downloadable copy of the slide presentation is available on the Investor Relations portion of our website.

As a preliminary note, you should be aware that this presentation contains forward-looking statements, which represent our current judgment on what the future may hold. And while we believe these judgments are reasonable, these forward-looking statements are not guarantees of future performance and involve certain assumptions, risks and uncertainties. Actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements.

Please refer to our filings with the SEC for a full discussion of the factors that may affect 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, after this conference call.

Now, I would like to turn the call over to Bill Brodsky.

William Brodsky

Thanks, Debbie. Good morning, and thank you for joining us today. I am pleased to report that CBOE Holdings posted record fourth quarter financial results, capping of a record setting performance for 2012, despite the year’s well known macro challenges.

CBOE’s total options volume for 2012 was down 8% compared to volume declines of 12% in the US options industry, 14% in the US futures trading, and 19% in the US stock market. Our total options and futures average daily volume in the fourth quarter declined 4% from the same period in 2011, offset by 11% increase in average revenue per contract, driven by higher growth rates in our proprietary product lines.

Our ability to leverage our higher margin products and to effectively manage our resources enabled CBOE to continue to invest in future growth initiatives and to return increased value to stockholders in 2012.

I am pleased to report that our total stockholder return for 2012 was 19%, up from 15% in 2011. Moreover, we began 2013 well positioned to continue to grow and shape the options and volatility space.

Alan will take you through the numbers, so the balance of my remarks will focus on how we intend to lead the industry’s secular growth and to further expand opportunities that are unique to CBOE.

More than anything, a singular focus on options and volatility trading is what has enabled CBOE to continue to lead and define the industry it created 40 years ago this April. We remain at the forefront by providing investors with innovative solutions to meet their evolving investment needs.

Helping customers to execute success is more than a tagline. It is a company-wide vision and mission that translates into customer and stockholder value through a sustained investment in three key areas, product development, trading technology, and investor education.

Turning first to product innovation. There are several developments to note with regard to our proprietary product lines, options and futures on the CBOE volatility index and the CBOE

S&P 500 options complex. The growth story of VIX options and futures in 2012 was made more remarkable given the backdrop of historically low volatility and low trading volumes throughout the world’s markets. Average daily volume in VIX options rose 53% in the final quarter of 2012 and 14% for the year, posting a sixth consecutive record volume year. VIX futures more than tripled the fourth quarter and rose 99% for the year posting a third consecutive volume year. We are of course thrilled with the volume, but even more gratified to see that it is increasingly driven by a broader user base.

Historically, growth in VIX futures and options parallel the growth in exchange traded products, or ETPs, tied to the VIX. While ETPs continue to be a meaningful driver of volume, customer research confirms significant growth in both the number and types of participants using our VIX products. Specifically, we now see significant activity among proprietary trading firms, hedge funds, CTAs, pensions, endowments, and registered investment advisors. We believe that the growth of VIX user base from a core group of early adopters to a broader more diverse customer base that we see today is due in large measure to CBOE’s ongoing commitment to investor education.

CBOE’s options institute has greatly increased its VIX related curricula to keep up with customer demand and our annual risk management conference which will be held next month in Carlsbad, California continues to showcase the evolving state-of-the-art in VIX trading.

In our last call, we touched on other fronts to expand our VIX customer base, including plans to launch a London hub. I am pleased to say that the hub was launched on February 1st, providing our European customers with an economic and efficient connection to the CBOE’s futures exchange trade matching engine. Pending regulatory approval, we plan to begin rolling out expanded trading hours in VIX futures in May, which will allow European customers to access a longer trading session in their local time zone and we will also meet the demand from US customers for expanded trading hours.

Moving on now to our S&P 500 product line, which includes our flagship SPX contract, SPX Weeklys, and SPXpm. Each offers a unique way to trade options on the S&P 500 and each carries our highest options rate per contract. Although trading in our SPX complex was down 7% for 2012, SPX Weeklys continue to shine brightly as one of our fastest growing products up nearly 70% over 2011’s record performance. We look forward to moving SPXpm from C2s all electronic environment to CBOE’s hybrid model on February 19th, which will expose Xpm to a broader base of likely users, including our very active SPX trading crowd on the floor of the CBOE. The migration also unifies all our S&P 500 products on a single exchange, making it more straightforward to access our entire S&P product line and easy to execute spreads between and among those products.

On December 10, 2012, the CBOE futures exchange launched an S&P 500 variance futures contract, which is based on realized or actual variance of the S&P 500 index and mirrors the quoting conventions and economic performance of the over the counter variance swaps. Much isn’t written about the futurization of the swaps market and our S&P 500 variance product which was customized to meet the needs of OTC variance swap market users. The S&P 500 variance trading is a major focus for CBOE in 2013. Not only is there great opportunity for an exchange traded S&P 500 variance product but we believe that the CBOE is a natural home given the close relationship between variance, volatility, and SPX trading. We are working closely with customers to ensure the specifications of our variance futures are aligned with the OTC variance market. We are encouraged to see some trading and even as we continue to fine tune the product.

Moving on now to multiply-listed options. As you know, competition in this space is fierce and fast changing. CBOE’s total market share for the year, excluding dividend trades was up 1.6 percentage points over 2011, reflecting positive customer response to the volume incentive program we introduced in 2012. However, market share declined in the fourth quarter to 26.5% from 29.3% in the third quarter, and 26.7% in the fourth quarter of 2011.

We know we can never rest on yesterday’s winning strategy in this hyper competitive environment and made numerous adjustments to our VIP program to counter the erosion in market share. I am pleased to report that we began to see an increase in market share following the implementation of our most recent changes made on February 1st. We are determined to lead the daily battle for market share by leveraging our strengths, our unique product line, competing in complimentary market products and innovative pricing programs.

In addition to our recent changes to VIP, we made even more radical changes to our C2 options exchange. C2’s growth was hampered in recent quarters largely due to the resurgence in popularity of traditional payment for order flow models over maker-taker models. We elected to retool C2 entirely, not merely just as another payment for order flow model, but as an innovative alternative that provides a pricing plan unlike anything else in the options industry. C2’s new DPM centric model launched on February 1st features a unique spread based pricing plan, in which fees and rebates are based primarily on C2’s market width at the time of the trade. Tighter spreads are rewarded with lower fees and rebates are also based on the width of the spread. Although feedback from C2 participants is very positive, we are not expecting to see immediate results. Unlike a simple fee change, C2 offers an entirely new approach to pricing, consequently it takes a bit more time on the front end for firms to fully acclimate to the new C2. Ultimately, we believe spread pricing in combination with C2’s new DPM model will provide the maximum incentive for order flow providers to route orders to C2. We look forward to reporting on the results of these changes made to both our options exchanges going forward in 2013.

Long term secular trends, independent studies and our own customer research consistently point towards strong ongoing growth and options in volatility trading. Volume in the first month of January was encouraging. Industry wide trading volume rose 8% over 2012 and equity options trading rose 4% and Index options volume driven primarily by CBOE’s products was up 53% from the previous January. VIX options and futures both soured to new monthly volume records in January. VIX futures’ average daily volume was up 241% and VIX options’ average daily volume was 85% over a year ago. While we are hesitant to read too much into a single month of trading, we believe that 2013 holds great growth opportunities for our company, given greater retail participation in the market and continued migration of many forms of OTC trading to exchange markets, the futurization of swaps and increased globalization. Moreover, we believe CBOE is uniquely positioned to benefit from the realization of these major growth drivers. We are thrilled with the opportunities before us in 2013, which in many ways is a momentous year for CBOE.

As I mentioned earlier, this April marks the 40th anniversary of CBOE and the options industry. Shortly thereafter, Ed Tilly will assume his new role as CBOE’s CEO, Ed Provost will take over as CBOE’s President and COO, and I will move into my new role as Executive Chairman.

We are in the midst of what I would call a very deliberate and measured transition process, which, I am happy to say is going smoothly as planned. Ed Tilly, Ed Provost and I continue to work very closely together to insure that when the transition is completed our company leadership is well positioned to begin the next great chapter in CBOE’s history.

Thank you for your attention. I will now turn it over to Alan.

Alan Dean

Thanks Bill. Good morning everyone and thank you for joining us. This morning I will take you through our fourth quarter results, as well as provide guidance on certain financial metrics for 2013.

We ended 2012 on a strong note, posting record fourth quarter financial results. Our operating revenue for the fourth quarter was $130.1 million, up 8% compared with last year’s fourth quarter. Adjusted operating income was $64.9 million, representing a 49.9% of operating revenue, a 300 basis point improvement in operating margin. Adjusted net income allocated to common stockholders was $38.9 million, up 17% compared with the fourth quarter of 2011, which translates to adjusted diluted earnings per share of $0.45.

Before I continue, let me point out that our GAAP results reported for the fourth quarter of 2012 and 2011 include certain unusual items that impact the comparison of our operating performance. These items are detailed in our non-GAAP information provided in the press release and in the appendix of our slide deck.

Turning to the details of the quarter, as shown on this chart, the growth in operating revenue was driven by increases in transaction fees, exchange services, and other fees and regulatory fees, offset somewhat by lower access fees. Transaction fees increased $3.8 million, or 4% from last year’s fourth quarter, due to an 11% increase in average revenue per contract, or RPC, compared with last year’s fourth quarter, offset somewhat by a 6% decline in trading volume. If you recall, we lost two trading days in the fourth quarter when all US exchanges closed due to Hurricane Sandy. While total trading volume declined for the quarter, volume in our index options and VIX futures contracts increased, which had a favorable impact on RPC and transaction fees for the quarter.

Our blended RPC, including options and futures, increased to $0.355, primarily reflecting a shift in product mix towards our higher margin index options and futures contracts, as well as an increase in the revenue per contract generated from these products. The RPC in our options business increased 3% to $0.322 compared with $0.312 in last year’s fourth quarter. The increase was a result of index options accounting for a higher percentage of total options volume, as well as a 6% increase in revenue per contract for index options to $0.67. At the same time, the contribution from CFE, our futures exchange, has become more meaningful and we are realizing the benefit of the higher RPC it generates. For the fourth quarter, the RPC for futures contracts was $1.44, a 9% increase compared with last year’s fourth quarter.

As this slide depicts, index options accounted for 31.4% of all contracts traded in the fourth quarter of 2012, in comparison with 28% in last year’s fourth quarter. Futures contracts accounted for 3% of total volume, up significantly versus its contribution of just less than 1% in last year’s fourth quarter. Converting the volume to transaction fees, index options accounted for 59% of transaction fees and futures contracts accounted for 12%, up from 55% and 4%, respectively, in the fourth quarter of 2011.

Exchange services and other fees increased by $3.6 million versus last year’s fourth quarter, as a result of fee changes we implemented at the beginning of 2012. The $2.3 million increase in regulatory fees resulted from CBOE raising its options regulatory fee and C2’s implementation of an options regulatory fee in August of 2012. Keep in mind, revenue derived from regulatory fees, as well as fines can only be used for regulatory purposes. We increased these fees in response to higher expenses we are incurring to carry out our obligations as a self-regulatory organization and also to account for lower trading volume.

Continuing down the income statement, this next slide details total adjusted operating expense of $65.2 million for the quarter, which was up $1.4 million or 2%, compared with last year’s fourth quarter, primarily due to higher costs for outside services. Adjusted operating expense for the fourth quarter of 2012 excludes $5 million accrued for an estimated liability related to the resolution of a previously disclosed SEC investigation. We are engaged in ongoing settlement discussions with the SEC staff on the resolution of this matter, however no agreement has been reached.

Core operating expense was $46.3 million, an increase of $4.8 million or 11% compared with the fourth quarter of 2011, reflecting increases in outside services and employee costs, offset somewhat by lower travel and promotional expenses. Outside services were up primarily due to higher legal expenses pertaining to litigation activity. The increase in employee costs was due to a higher accrual adjustment for incentive compensation compared with 2011’s fourth quarter. The decrease in travel and promotional expense was driven by lower costs incurred for advertising.

Volume-based expense, which includes royalty fees and trading volume incentives, was $12.7 million for the quarter, a decrease of $2.1 million, or 14%, versus last year’s fourth quarter, representing decreases of $700,000 of royalty fees and $1.4 million in trading volume incentives. The decline in royalty fees was due to the impact of higher expenses recognized in the fourth quarter of 2011 to adjust for another accrual of expenses. Trading volume incentives were down due to lower trading volume in multiply-listed options contracts and changes in the criteria for contracts that qualify for the quantity-based fee waivers.

Our GAAP effective tax rate for the quarter of 33.1% was down significantly from last year’s effective tax rate of 39.2%, primarily as a result of tax benefits recognized during the quarter. The effective rate for the current quarter includes the benefit of significant discrete items relating to prior years totaling $5.4 million, or $0.06 per share as well as the recognition of other discrete items. Last year’s fourth quarter included the impact of an increase in the Illinois tax rate effective January 1, 2011. This slide gives you the details of the tax adjustments to GAAP results.

In 2012, our strong cash flow generation enabled us to repurchase shares of nearly $53 million and return more than $114 million to stockholders through dividends which included the payment of a special dividend of $0.75 per share, or $66 million in the fourth quarter. There were no share repurchases made under our share authorization in the fourth quarter of 2012 or to date this year. Thus, we have $103.3 million remaining on our existing share authorization. A few days ago, we announced that we declared a dividend of $0.15 per share over the first quarter of 2013.

Our capital position remains strong. We ended 2012 with cash and cash equivalents of $135.6 million and a debt-free balance sheet. Our capital deployment strategy and priorities remain unchanged. Our first priority is to fund the growth of our business. Then we will look to repurchase shares to enhance our EPS growth and stockholder returns. Finally, we will look to show steady consistent growth in our annual dividend payout.

Let’s now move to our 2013 guidance for certain financial metrics. For 2013, we expect core expenses to be in the range of $189 million to $194 million. The increase versus 2012 primarily reflects higher expenses for stock-based compensation and regulatory services. In our ongoing effort to maintain the highest standards for regulation and compliance we have increased resources devoted to regulatory services, primarily additions to staff and enhancements to our regulatory systems. At the same time, effective January 2nd of this year, we increased the options regulatory fee, which is designed to cover these costs. We expect the additional revenue generated from regulatory fees to offset the incremental costs with no impact to our bottom line.

Turning to stock-based compensation. This year we are granting additional shares of restricted stock. In the first quarter of this year we expect to record approximately $3.2 million of accelerated stock-based compensation to recognize the expense for certain executives due to provisions contained in agreements regarding their employment. Accelerated stock-based compensation is not included in core expenses and will be reconciled as a non-GAAP item. Excluding continuing stock-based compensation of approximately $18 million, core expenses are expected to increase 2% to 5% compared with 2012’s comparable expense of $167 million.

Since stock-based compensation will fluctuate a bit quarter-to-quarter due to the timing of stock grants, the appendix includes a slide that provides guidance by quarter. In 2013, capital spending is expected to be between $35 million to $40 million, up versus the $30 million we spent in 2012. This increase primarily reflects additional capital spending to enhance our systems and software for regulatory services.

In conclusion, as we enter 2013, CBOE Holdings is strongly positioned in terms of our innovative products and services, operational performance, and financial condition to accomplish our strategic objectives. While we are investing to further strengthen our business, we see opportunity to continue to gain long-term margin improvement. Our financial strength affords us the flexibility to invest in growing our businesses and pursue new opportunities, while we continue to deliver value to our stockholders.

With that, I will turn the call over to Debbie so we can take your questions. Thank you.

Deborah Koopman

At this point, we would be happy to take questions. We ask that you please limit your questions to one per person to allow time to get to everyone. Feel free to get back in the queue and if time permits we will take a second question.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Richard Repetto from Sandler O'Neill, your line is open.

Richard Repetto - Sandler O'Neill

Yes, good morning Bill, good morning Alan.

William Brodsky

Good morning, Richard.

Alan Dean

Good morning, Richard.

Richard Repetto - Sandler O'Neill

Congrats. I think this is the 10th straight quarter to be here but – if we are keeping track correctly.

William Brodsky

We weren’t keeping track, but it’s nice to hear.

Richard Repetto - Sandler O'Neill

Alan, well – I will leave at that. My question is on – you did a good job, Bill, of outlining the changes in markets, what you are doing to respond to that. I guess, I just wanted to understand on Slide 12 a little bit more, this designated primary market maker model, how it differs and the spread-based pricing, how it differs from what – is that C2 and what’s that CBOE as well?

William Brodsky

Yes. It’s really quite innovative. As I said, we are working with the industry to educate them. We had a big meeting with them last week and it was very well received. But I’ll ask Ed Tilly to give you a little bit more detail on that.

Edward Tilly

Hi, Rich. Good morning.

Richard Repetto - Sandler O'Neill

Good morning.

Edward Tilly

So, let me dive in to C2 and it is a different story. Just to remind you from our last earnings call that we told you we weren’t really happy with the C2 market share. Remind you that, we developed C2 as an alternative model. So, what you are seeing is completely new to the industry and I will give you a little bit of a highlights. As you pointed out, we saw the share moving from the – paying the liquidity provider to post, that maker-taker model, back to the traditional model that pays for flow. So, we had a choice. We could have got into the race VIP, that is just to continue to make payments from the exchange for orders or come up with something completely different, which is at the end of the day what we did.

So we are trying to reward liquidity providers with lower fees for posting tighter markets and tying customer rebates to the width of the spread. So, that’s different than CBOE. So if a customer trades at a very tight market the liquidity provider pays very little deposit and the rebate is small. But if a customer trades in a light quote, we raise the rebate and raise the fee of the liquidity providers. And as Bill pointed out in the prepared comments, this is new to the industry, it’s going to take a little bit of time to get used to. But we think providing fee incentives for tighter markets we would reward either competitive quoting that aligns us with liquidity providers and customers. We didn’t want to continue to participate in the race of just purely paying for flow without offering incentive to tighter markets.

Richard Repetto - Sandler O'Neill

Got it. And C2 was a maker-taker, if I got it correctly?

Edward Tilly

It was, Richard, you are right, and it continues to be in EPF classes. We do actually quite well on C2 and maker-taker spider for example on IWM, this is really for the multi-list single name classes where we put in the industry’s leading liquidity providers as DPMs to lead the way.

Richard Repetto - Sandler O'Neill

Great. That’s very helpful, thank you.

Operator

Our next question comes from Jillian Miller from BMO Capital Markets, your line is open.

Jillian Miller - BMO Capital Markets

Thanks, good morning everyone.

William Brodsky

Good morning, Jillian.

Alan Dean

Good morning, Jillian.

Jillian Miller - BMO Capital Markets

I just wanted to get a little bit more detail hopefully on the pricing change that you made February 1st. Like what exactly did you change? I know in the past you guys have lowered multi-list fees and then kind of set that with higher index fees and that were kind of neutral in terms RPCs. I am not sure if that’s kind of what happened again this year. Any guidance on the 2013 rate per contract would be helpful?

Edward Tilly

Jillian, on February 1st, we modified our VIP rebate, increased the rebate and also modified a customer fee that we had in place for certain exchange traded products and for certain order sizes. That was February 1st. The way I am looking at RPC for the year, for 2013, is if volume is similar in the multi-list products for 2013 compared to 2012, I would expect RPC to be similar relative to two years. What if multi-list volume increases, I would expect RPC in those multi-list products to decline and if multi-list volume declines, I would expect RPC in those products to increase.

CBOE is uniquely positioned with more than 70% of our transaction fees generated by our proprietary products. However, we must and we will remain competitive pricing on those multi-listed products. So the fee changes that we made on February 2nd were changes that we thought we had to make an order to remain competitive and defend our market share and also to defend other fee categories in our P&Ls, such as access fees, exchange services and other fees, and of course market data revenue was driven by market share. So, that gives you a recap of how I am looking at RPC and the changes we made on February 1st.

Jillian Miller - BMO Capital Markets

Okay. Just to clarify one thing. So there weren’t any direct changes made to the index category, it was all associated with the equity and ETF?

Edward Tilly

That is true.

Jillian Miller - BMO Capital Markets

Okay. Thank you.

Edward Tilly

On February 1st, yes.

Jillian Miller - BMO Capital Markets

Got it.

Operator

Our next question comes from Alex Blostein from Goldman Sachs, your line is open.

Alexander Blostein - Goldman Sachs

Great. Thanks good morning, everybody.

William Brodsky

Good morning.

Alexander Blostein - Goldman Sachs

I was wondering if you guys could give us a little bit more color on the, obviously very significant volume growth you are seeing in VIX futures? You highlighted a number, I guess, new adapters and just kind of going through different users that are picking up the product. Maybe you could spend a little bit of time on kind of giving us more sense on who – which one of these, I guess, maybe, is driving the incremental market share and the outlook there?

William Brodsky

Alex, this is Bill Brodsky. We are seeing, as I said, new users coming in. VIX has become the bench for volatility of equity markets globally. So, we are seeing business coming in from Europe. We are seeing business coming in from pension funds, from institutional investors in the US. We are seeing it coming in from CTAs. We have a team of people in our futures exchange that are geared to educating a whole variety of different types of users. As I said in my prepared remarks, we have our – I think it’s our 29th or 30th Annual Risk Management conference next month in California, and we will have a tremendous emphasis on the whole volatility line at that time.

Alexander Blostein - Goldman Sachs

Got you. But no specific category there you highlighted pretty broadly?

William Brodsky

I would tell you, it’s a variety, but it’s institutional. When I say institutional, it’s a lot of professional type investors and I think Ed Tilly is going to add another aspect to this.

Edward Tilly

Yes, I think, Alex, what we have seen I think is most significant is the volume that we have shown you over the last couple of years, really starting about two years ago, introducing – when Barclays introduced the first ETP into the marketplace, a lot of the futures volume and a lot of the layoff business into the VIX options was really driven by the incredible growth in assets under management in that category. That’s no longer as in pass vote to the growth that we see on the CFE today. And as Bill points out, asset managers, hedge funds, everyone looking for any volatility exposure, the pure play, moving away from ETP is in our futures exchange. We have got retail traders coming into VIX futures and VIX options. It’s really an incredible story. ETP still play a very very important role but less and less a percent of our overall volume and less and less of a growth story in the recent last 6 months to 12 months.

Alexander Blostein - Goldman Sachs

Got it, yes, that’s helpful. That’s what I was trying to get to. On the fee side of the equation, it looks like the RPC ticked down sequentially, I think down about 10%. Is this just a function of volumes or there is something else going on, or I guess, how should we think about the rate per contract and the overall category volumes continue to creep higher?

Edward Tilly

Well, you are referring to RPC in 2012 compared to 2011?

Alexander Blostein - Goldman Sachs

No, just CFE for the fourth quarter.

Alan Dean

CFE.

Edward Tilly

Oh, CFE. Alan, thank you. That had to do with certain aspects of our fees schedule in CFE related to day trading and also to CBOE permit holders who receive different rates than non-CBOE permit holders when they traded CFE. So, we saw higher activity in those two areas which had the effect of slightly lowering RPC in the futures exchange.

Alexander Blostein - Goldman Sachs

Got it. So the fourth quarter is a decent run rate you would say, actually when volume stay as robust as they have been.

Edward Tilly

I would say that would be a pretty good place to begin. Although if you look at our history of RPC and CFE, it’s been a little bit on lower demand. So, it is hard to predict, but not a bad place to start off.

Alexander Blostein - Goldman Sachs

Got you. The last from me, it’s just on capital. You obviously talked about back in the fourth quarter to make the special, still (inaudible) $35 million of cash. I think in the past you talked about $50 million working capital needs, is that still the number and I guess should we expect you guys to resume buyback in the first quarter?

Alan Dean

Yes. What I said in the past is $40 million to $60 million of working capital is kind of our minimum, so that $50 million is right in the middle of that. Our share reauthorization of $103.3 million stands and we will – our approach towards that with share repurchase hasn’t changed. We are opportunistic and when the time is right we will resume.

William Brodsky

Alex, you got a lot out of that one question.

Alexander Blostein - Goldman Sachs

Thanks, guys.

Alan Dean

Okay.

Operator

Our next question comes from Ken Worthington from J.P. Morgan, your line is open.

Kenneth Worthington - J.P. Morgan

Hi, good morning. I have got one question with ten different parts.

William Brodsky

Is it the golden times J.P. Morgan kind of thing going on here?

Kenneth Worthington - J.P. Morgan

Just on, really C2, I thought that the SPXpm product was kind of the flagship product. I may have misinterpreted that, but how does pulling that product kind of impact engagement on C2? I see the retooling and it’s innovative. But if the retooling doesn’t work, what are the levers do you have to pull to kind of jump start C2?

Edward Tilly

Let me just restate. SPXpm and C2 is actually perfect timing. We were looking for an electronic version of the S&P 500, the big macro $1,500 underlying product and we launched C2 in and around the same time when we were trying to compete with (inaudible) pricing model which is relatively new to the marketplace. So, it was more of a perfect storm than a flagship. The index complex here is our key driver, whether it’s on CBOE or C2. For our shareholders, it’s the same. So, what can we attract, how do we attract users to C2 if this big product moves to CBOE and are successful in the hybrid trading environment as we anticipate it will be. Well, we changed the market model. The anchor tenants now are our new DPMs and as I repeat, the biggest liquidity providers in the industry, that’s our new draw to C2, coupled with unique pricing that returns the incentive to liquidity providers for posting tight markets and still pays our customers when they interact with that flow. So, I don’t think I would over play the move of SPX for us, for CBOE, for Alan as he is looking to see how we doing. That’s going to be in our complex, rather it’s the importance that we place on naming these five big liquidity providers to our new pricing model on C2. And if it doesn’t work, to follow-up and answer your – or to complete the question, we will come up with something new and completely innovative just as we have done with this pricing scheme and we will keep you posted.

Kenneth Worthington - J.P. Morgan

Awesome. Thank you very much.

Operator

Our next question comes from Patrick O'Shaughnessy from Raymond James, your line is open.

Patrick O'Shaughnessy - Raymond James

Hi, good morning, guys.

William Brodsky

Good morning, Patrick.

Patrick O'Shaughnessy - Raymond James

Alan, a question for you. I feel like every quarter you kind of have a separate view of where exchange services and other fees are going to go and they keep kind of staying in there really really strongly. Do you have a view on kind of some of the non-transaction fees in 2013, what’s the outlook for those?

Alan Dean

Well, we gave as much guidance as we could. Last year, we gave you guidance on exchange services and other fees because we dramatically changed the fees that we had in place for those items in 2012 compared to 2011 and I was conservative in my guidance and fortunately it turned out to be a lot better than we expected. There were no significant changes in exchange services and other fees in ’13 relative to ’12, so we didn’t give you any guidance. So, the only thing that can change there is utilization and that’s very difficult to predict.

Other non-transactional revenue items, I think you need to focus on looking at our regulatory fees and I talked about that in my prepared remarks. If you look at our history of the options regulatory fee, it’s up dramatically from where it was a year ago and we implemented a options regulatory fee for C2, and that fee both of those fees, and every customer contract and every U.S. options exchange, so on a matter of word’s rate. So, that’s a significant change and we did that because our regulatory expenses are increasing, I talked about that in our core operating expenses as well as our CapEx is going up as well, we are capitalizing more software related to the enhancement of our regulatory systems. So, I think that’s an area that you should look at and focus, but it’s volume-based, you know, the regulatory fees. I can’t predict where that fee would be for 2013.

Those are the two main items in the non-transaction. Access fees, we didn’t give you guidance on access fees. We didn’t make any fee changes at all to access fees for 2013, for 2012, so just like exchange services and others, that can only go up or down based on usage utilization. Utilization of access fees held pretty steady in 2012. I can’t predict, I don’t know how it will be for 2013. We hope it will be stable to grow, maintaining market share, certainly a foundation for that fee, and I have talked about that many times. And so, I think those are the material non-transactional line items on the revenue side. Hope that helps.

Patrick O'Shaughnessy - Raymond James

All right, very helpful, thank you.

Operator

Our next question comes from Chris Harris from Wells Fargo. Your line is open.

Chris Harris - Wells Fargo

Good morning everybody and, Bill, congratulations on your retirement from the CEO post.

William Brodsky

Thank you, Chris.

Chris Harris - Wells Fargo

I want to follow-up here on the VIX, the institutional update that you guys kind of referenced here. Curious to get your perspective on what the appeal would be for an institutional investor to use the VIX as opposed to say hedging with S&P 500 puts, and then along that line, can growth in VIX here actually cannibalize your S&P 500 volumes overtime.

William Brodsky

I am talking a shot at the first one. The guy that I look to in this business is really one of the leaders, Larry McMillan who wrote the foundation piece on this. I think there is a view by those who understand how to hedge macro portfolios, but you can hedge a portfolio much less expensively with VIX than you can with SPX puts. And so, this is part of the whole learning process that we are going through in terms of how you ensure if you're long, a large portfolio of equities and you want to protect it. You configure whether you are better off with out-of-the-money put or VIX. And this is part of the excitement of what we are doing in this product and that is that people are learning as they go along. And Larry wrote a very interesting comment there. I can't tell you exactly when it was specifically on that point.

Edward Tilly

And then, I would add from a traders’ perspective, the VIX, the future specifically eliminates some of the Greek exposure that traders may or may not want in their portfolio. The daily – the game of managing a position in SPX, if it’s just a pure volatility exposure, the VIX future is that, but then to your cannibalization issue, for us, at the end of the day, our professional traders know that VIX is driven by the strip of options in the S&P 500.

So as they are trading and their portfolio includes SPX and VIX and VIX options, at the end of the day, they own or are assured the components that make up this strip and the pricing in the SPX and they drive the volume back and forth into from one complex to the other. Think of it just like the biggest customer in the CME futures contract and the S&P 500, other traders on the CBOE is not cannibalizing, that's their underlying. So, the same way the strip of options in SPX provides the pricing for the VIX futures and the VIX futures provides the pricing for VIX options.

Chris Harris - Wells Fargo

Got it, okay. Thank you, guys.

Operator

Our next question comes from Roger Freeman from Barclays. Your line is open.

Roger Freeman - Barclays

Hi, good morning. Just what would you say was the biggest obstacle that you face in getting the SPXpm to really take off on C2 and then let you to add it on the CBOE? And then, just quickly on VIP 2.0, can you clarify what the sort of adjustment is versus 1.0 that has gotten you some share than trailed off a bit? Is there a customer segment that you are targeting there?

William Brodsky

So, Roger, let me start off on the first part, and Alan will do the second. The interesting thing about SPXpm is that we had decided to put it on C2 for a whole variety of reasons, but what was really happening parallel to this is we are waiting for the SEC to approve C2 weeklies, which we came up with the concept of trading a weekly option. We did it on the Hybrid system in CBOE and it took off bigger than anything we expected. So, a lot of the interest that might have been in SPXpm really started with the weeklies, and by the time we brought out SPXpm, the weeklies already had become a very popular thing. So, it's just more almost the accident of the sequencing of these events more than anything else. And we are very enthusiastic by the way, we are saying February 19th is when we are going to cut over and have SPXpm on CBOE. I think that will make a big difference.

Edward Provost

Let me add a little bit Roger to what we see in the difference in how SPX is traded versus SPXpm, and compare that perhaps to a single name equity class. Very, very few of the orders that we see in SPX are single-line, meaning one strike at a time. Complex orders, orders that involve more than one strike or spreads are really the way in which people trade, customers trade SPX, the institutions trade SPX.

Also, our customers reference the futures prices over at the CME and get engaged in these multi-leg strategies, very difficult to replicate on a screen, on SPX, on C2. So, we think by adding liquidity that's found in SPX on the trading floor, surrounding that contract in a hybrid form, meaning brokers can interact with the market makers who are also streaming quotes into the complex really gives us the best opportunity to test and to realize the demand for SPXpm. And then I think you had a VIP question –

William Brodsky

The biggest change that we made on February 1st related to VIP that I think has the most effect and in the highest cost is that the prior version of what we did is when a firm reached a customer volume threshold, then they would begin earning a credit from that contract on, that was the old version. And the change we made on February 1st was a response to our competition.

We said once the firm reaches the volumes threshold, we will give them that credit for that customer – for all the customer contracts not only after that, but the contract won during the month. But that change, which is a direct response to our competition, I think will have the biggest and is having the biggest impact in helping us recapture that lost market share.

Roger Freeman - Barclays

Okay, thanks a lot.

Operator

Our next question comes from Niamh Alexander from KBW. Your line is open.

Niamh Alexander – KBW

Hi, thanks for taking my question and for updating on the VIP 2.0. You made it clear that you don't like to see the declining market share, but also maybe that you want to be number one. Is that something that you still want to be? And then, just help me understand, when we have seen the publicly traded competitors, they have gained share, but their effective fees have actually been increasing, not decreasing. So, is it that it's a different customer that they seem to reporting away from you or help me better understand what is going on that they can kind of take share and raise fees as far you are kind of losing share and now you are, it seems like you are cutting fees a little bit.

William Brodsky

Yes, this is a little bit of speculation, but I think while you might have seen the revenue per contract increase as they gain market share is because they switch from a maker-taker structure in which the spread that they were collecting was lower than their traditional structure. That’s I think was probably a catalyst and why an exchange would have switched from maker-taker to traditional, because they could drive an increase in RPC. And that's some speculation, but that's what I believe now.

As far as staying number one in a multi-list side, I think it is important for CBOE to stay a leader in all options products categories. It’s a foundation – being number one is a foundation not only for transaction fees, but for all those other revenue items, line items that I talked about. And so, I think it is important for CBOE and it expands our leverage, the more contracts that we can pump through our trade engine lowers the per cost of that and of operating the system, the per contract cost. And so, yes, I still believe that, and that's our goal.

Niamh Alexander – KBW

Will this new pricing will be effectively the lowest price in the market?

William Brodsky

No. The way we are looking at is about equal with our competition.

Niamh Alexander – KBW

Okay, thanks for taking question.

Operator

Our next question comes from Howard Chen from Credit Suisse. Your line is open.

Howard Chen - Credit Suisse

Hi, good morning everyone. Bill, I guess I will throw out a boarding one that has been asked yet. This merger announcement between ICE and New York Stock Exchange Euronext, you have been all at this for a very long time, but from a competitive position, do you view this good or bad for you? And second, how does this impact you and the boards just participate in industry consolidation more in the near-term than the longer-term? Thanks,

Edward Tilly

As to your third find, I do not view the potential consolidation is having any major impact on us. We compete with MISC, two operations AMEX and Arca and I see that as basically no change.. I think you have to keep in mind that ICE's main motivation in the transaction was to get a hold of the life. That was their goal. So, we look at NYSE as a very vibrant competitor and we will continue to compete with them. What was the other question?

Howard Chen - Credit Suisse

Your desire to participate in industry consolidations, just generally we have seen a couple of these deals in the industry come in clusters.

William Brodsky

Sure. First of all I, think the general view is that we continue to outperform in our space by a variety of metrics, including total shareholder returned last year if you ignore the 30% premium that put on top of the NYSE's price on December 20th. But we are certainly always conscious of the fact that our size relative to our peers causes this kind of speculation. But there are always compelling reasons for consolidation. Our goal is to enhance shareholder value, but we also are very bullish in our own opportunity for organic growth and I think we continue to show that our organic growth continues to outstrip our peers.

Howard Chen - Credit Suisse

Great, thanks for the thoughts.

Operator

Our next question comes from Ken Leon from S&P Capital IQ.

Ken Leon - S&P Capital IQ

Thank you, and my question here is when you look at transaction fee revenue, particularly the fourth quarter year-over-year, your share of fee revenues coming from equity and ETPs have gone from 41% down to roughly 28%. So there's a lot of good positive things happening in the other products and the institutional market. But what does this speak to in terms of either your position, let's say, in ETPs or something about the retail market that impacts equity, where is it positioned possibly for future growth or we are seeing CBOE make a concerted transformation really with products more for institutional markets?

William Brodsky

A lot of comments and a lot of questions there. I will give you my reaction to that shift in transaction fees. It used to be that 25% of our volume was indexes and it represented 50% of our transaction fee revenue and, of course, that metric has changed dramatically in the fourth quarter.

And along with CFE, the VIX contract really growing incredibly. And some that's a function of two things. First of all, VIX both the future and the option growing incredibly, still on this hockey stick type growth curve, continued increasing interest from multiple users driving that volume. So, that has the impact of increasing the revenue from that category and that's good. On the other hand, if you look at revenue per contract in the multi-list category over the years and in our previous charts, we have a historical chart of our own RPC in a multi-list category, it's been a slow decline in RPC, and I think that will continue in the future because competition is so fierce in that category. And so, the combination of a lower RPC on a negative side, and on a positive side, the tremendous growth in VIX and a strong year on SPX really is the driver of that change.

So, let me add on I think part of the question was how does CBOE position itself? Is this a deliberate move to move our mix from the multi-list classes into the proprietary complex? And I think we haven't spent any time this morning -- Ed Provost is here, if you want more detail, but our move to – eventually trade 24x5 to open up a hub in Slough, England to attract users outside of the U.S. trading hours is really directed right at that VIX futures volume, and it allows us to expand other proprietary products if we decide to do so in the future.

But it is with that mix in mind and shifting being reliant so much on competitive products into what we do best and that is the institutional hedging exchange with the SPX complex and the volatility complex. But I just offer that, that this is the driving force behind increasing to 24x5 in the London hub.

Ken Leon - S&P Capital IQ

Fairly understand. Thanks.

Operator

Our next question comes from Akhil Bhatia from Rosenblatt Securities. Your line is open.

Akhil Bhatia - Rosenblatt Securities

Hi, good morning, do you guys, I know it’s early days, but do you have any color on the early adoption in the London hub and how it's being received?

Edward Provost

Ed Provost here. So the London hub is up and ready for connectivity. We are engaged in discussions with a number of potential users. No one has established connectivity up to this point, but then again we've only been up and running for the last several days. So we are very optimistic given the enquiries we've received that we will see same connectivity in the very near future. We are very optimistic about it.

Akhil Bhatia - Rosenblatt Securities

Okay, great, and just a last one, it looks like the BOX Exchange is trying to launch a S&P related linked contract. Any thoughts upon how that might violate your exclusive with S&P?

William Brodsky

This is Bill Brodsky, we are looking at that as it relates to the site of products. We and S&P are always looking at whether there is a violation of the contract, but at this point, I am not going to get into it. It's a pending filing and we will decide whether we will comment on it or not.

Edward Provost

I think we are more interested in the BOX filing from the investors' perspective and further fragmentation of liquidity in Spiders. As you know, the minis are going to start. That takes some time to get used to from an investor's perspective, changing the multipliers. We would prefer certainly to see how the retail community adjusts to trading minis before BOX launches a larger multiplier on their contract. We are very mindful of the slow and steady education process that's required around the minis, before we contemplate going to a large contract. So that's what we would prefer. As Bill says, we will be commenting, but in regard to S&P, it is a different issue. We are more concerned with the customers and their confusion and fragmentation of liquidity among different contracts representing the same exposure to S&P 500.

Akhil Bhatia - Rosenblatt Securities

Okay, thanks you.

Operator

Our next question comes from Gaston Ceron from Morningstar Equity Research. Your line is open.

Gaston Ceron - Morningstar Equity Research

Hi, good morning. Hi, thanks for taking my question. Just real quick here, I know you spoke about the dividend policy a little bit at the beginning of the call. I am not sure if I missed there, or if you didn't mention this, but I was wondering, now that you have paid the special dividend last year, how will you think about that going forward, whether special dividends will remain part of the capital playbook or if it's something that you will review annually or if this was strictly a one-off?

William Brodsky

It's certainly the tax issues that were in play at year-end. It was a key driver on the part of our Board in deciding to do what they will do. I cannot predict if we will do a special dividend every year or never again. But what I can tell you is that our stated policy for dividends, for returning capital to shareholders, what our Board has told me is that they want steady, sustainable regular dividends growth in that annual dividend, supplemented by stock repurchases and don't hang to cash unless we can communicate to shareholders why we are hanging on to that cash. So that fundamental belief policy hasn't changed.

Gaston Ceron - Morningstar Equity Research

And then, just very quickly. Just following up on the C2 questions. I was wondering, from now, going forward, what would be your approach to product launches on C2, I mean, how will you sort of use or market there. How as kind of your experience with SPXpm kind of altered and how any future products might deal on C2?

William Brodsky

I think as just to kind of restate, C2 really provides us an opportunity to test different models and pricing. We get the broadest liquidity base really relying on the established CBOE. So, I at this point, don't see an exclusive launch for new products on the C2. The liquidity base and the liquidity providers in the penetration in the marketplace and all the major institutions on CBOE and a Hybrid trading model, which allows the interaction with brokers, their ability to query for debt outside of electronic markets, really are a better incubator for new products because of the interaction, the human factor with brokers able to provide liquidity in excess of what's found on the stream. So I don't look for us to launch exclusive on C2.

Gaston Ceron - Morningstar Equity Research

Okay, great. Good to know, thanks.

Operator

Our next question comes from Ed Ditmire from Macquarie. Your line is open. Hi, good morning. My question is some of the larger exchanges over the last couple of years, to build out big data centers and today have a lot of excess capacity, does an exchange like CBOE have any opportunities to kind of leverage some of those investments and take advantage of that. I know you guys in general are more of a (ramp or a spy) when it comes to things like data centers,
any thoughts?

Alan Dean

Ed Alan here. While in a way we, capturing some of that revenue and the exchange services and other fees line item. And so, that's part of the same kind of similar revenue that building a big data center would generate courses on a much smaller scale than what you're seeing in New York or I believe in NASDAQ.

I think the difference is that the underlying — the reason for building those data centers is you want to place your computers close to the computers of the host exchange that has the underlying security being traded. And that value we haven’t identified as a big potential for us, although I won't close it out in the future you never know. And yes, you're right we have tended to rent versus buy in our move of our data center off to the East Coast. And but if we have talked about that whole issue here in the past, haven't identified a big opportunity other than what we did in that revenue line item so far.

Gaston Ceron - Morningstar Equity Research

Okay, thank you.

Operator

Our next question is a follow-up Jillian Miller from BMO Capital Markets, your line is open.

Jillian Miller - BMO Capital Markets

In January, we've seen index volume very strong and ETF volume has been weaker like the S&P options up over 30% year-over-year and Spiders down 23%. Maybe you can just give us an insight into what's driving that market dynamic and whether that mix of business is sustainable longer-term because that kind of have a does kind of have a significant impact on your overall rate per contract?

William Brodsky

Jillian, I don't know if we know of any certainty, but my guess is that we have in some respects, different user groups. The Spider tends to be much more retail. The SPX, as Ed Tilly, said is not only institutional, but it's very sophisticated where most of the trades are not single strike trades, but multiple legs and related to VIX and other things. So, I think we like to watch it over time, but again I think that there are just different user groups that use these things.

Jillian Miller - BMO Capital Markets

Okay, thanks.

William Brodsky

Okay, thanks.

Operator

I am showing no further questions at this time. I will now turn the call back over the management for closing remarks.

Deborah Koopman

Thank you. That completes our call this morning. We appreciate your time and continued interest in our company, and we look forward to speaking with you in the future. Thank you.

Operator

Thank you, ladies and gentlemen, it does conclude today’s conference. You may all disconnect and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!