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CBOE Holdings (NASDAQ:CBOE)

Q4 2011 Earnings Call

February 9, 2012, 8:30 a.m. ET

Executives

Debbie Koopman – VP IR

William Brodsky – Chairman, CEO

Alan J. Dean - CFO, EVP of Finance & Administration and Treasurer

Edward T. Tilly – President, COO

Edward L. Provost – EVP, Chief Business Development Officer

Analysts

Richard H. Repetto - Sandler O'Neill

Michael Carrier - Deutsche Bank AG

Jillian Miller - BMO Capital Markets U.S.

Christopher J. Allen - Evercore Partners Inc.

Kenneth B. Worthington - JP Morgan Chase & Co.

Niamh Alexander - KBW

Patrick O’Shaughnessy– Raymond James

Alex Kramm - UBS Investment Bank

Justin Schack – Rosenblatt Securities

Gaston F. Ceron - Morningstar Inc.

Matthew Heinz – Stifel Nicolaus

Rob Brostrom – CLSA

Dan Fannon – Jefferies & Co.

Christopher Harris - Wells Fargo Securities, LLC.

Operator

Good day everyone and welcome to today's CBOE Holdings Fourth Quarter 2011 Earnings Conference Call. At this time, all participants are on a listen-only mode. Later we’ll conduct a question and answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today’s call is being recorded. At this time, for opening introductions, I would like to turn the call over to Debbie Koopman, Director of Investor Relations.

Debbie Koopman

Thank you. Good afternoon and thank you for joining us on our fourth quarter conference call. On the call today, Bill Brotsky, our Chairman and CEO, will discuss the quarter and our strategic initiative for 2012, then Alan Dean, our Executive Vice President and CFO will detail our fourth quarter 2011 financial results. Following their comments, we will open the call to Q&A. Also, joining us for Q&A today is our President and Chief Operating Officer, Ed Tilly; and our Executive Vice President of Business Development Officer, Ed Provost.

In addition, I'd 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 present 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'd like to turn the call over to Bill Brotsky.

William J. Brodsky

Thank you Debbie and good morning, and thank you for joining us today. 2011 was a banner year for CBOE Holdings, with new records across key financial metrics, including revenues, earnings, and operating margins. We returned nearly $92 million in capital to stockholders in 2011 through our share repurchase program and quarterly dividends, which we increased by 20% during the second half of the year.

We achieved record trading volume as well. Fueled by record trading levels and SPX and volatility options and futures, CBOE Holdings reached an all-time high of 4.8 million contracts per day, an increase of 8% over 2010.

2011 also saw the continued expansion of our volatility product line. The addition of SPXpm to our S&P 500 complex and enhancements to C2. I’m particularly pleased to note the outstanding performance of our trade engine, CBOEdirect, which supports multiple exchanges and hybrid trading with low latency, which was virtually flawless throughout a busy and tumultuous trading year.

Solid fourth quarter results capped an outstanding year. Despite slower than usual trading in November and December, we reached a fourth quarter record high in adjusted revenues and earnings, posting adjusted diluted earnings per-share of $0.37 on revenues of $120.2 million.

Alan will discuss our quarterly results in more detail, so I’ll move ahead now with a look at what’s on the horizon for CBOE Holdings.

Our core mission is to create value for stockholders by generating industry leading profit margins and growth rates to a diversified portfolio mix of risk management products and services. Strategic initiatives in 2012 voted three main categories, developing new products, optimizing revenue and commoditized products, and broadening our customer base, all while maintaining the highest standards in market regulations. I will spend a few moments discussing each strategic initiative.

Product development most clearly distinguishes CBOE from the competition, and is the centerpiece of our mission going forward. We are keenly focused on developing exclusive products that generate premium fees and superior profit margins.

Three main product areas a slated for expansion in 2012, our SPX – our S&P 500 complex, our volatility product line, and new future products on CFE. CBOEs exclusive S&P 500 options complex includes our flagship S&P, SPX contact, SPX weekly, and the newly launched SPXpm on C2. Each offers a unique way to trade options on the S&P 500.

S&P is the premier U.S. Index option – I’m sorry, SPX is the premier U.S. Index option for institutions trading large and complex orders. These customers prefer the tremendous liquidity provided by some 270 SPX market makers and brokers on CBOE trading floor.

SPX reached a record total of nearly 200 million contracts last year, up 13% over 2010. SPX weekly options bring an added dimension to SPX by trading – by allowing traders to more specifically target opportunities tied to market events, such as earnings and government reports.

Early in 2011, we made SPX weekly available electronically through our hybrid system. Volume subsequently jumped to 69,000 contracts a day, up 283% over the previous year when they traded an open outcry.

SPXpm our new electronic S&P 500 option product was launched in October. Customers wanted a cost efficient user friendly alternative to other electronically based S&P 500 option products, mainly spider options. Our pm products is designed to provide them with greater efficiency, more control, and lower cost.

The early traction we saw after the October launch of SPXpm has continued, despite the press volumes overall in November and December, a new products ability to maintain its protectory against significant market headwinds is telling. We believe that SPXpm is establishing the foundation needed to grow, even in challenging markets, and to flourish when conditions are more favorable.

We’re working closely to early adopters to monitor their experience. Customer remain very positive on the utility of the product and the overall concept. The number of market makers on C2 has doubled since SPXpm began trading, and we believe it’s a matter of time before they become more comfortable trading SPXpm and incorporating it in their strategies.

To that end, a comprehensive marketing and educational program begun last year, is now being expanded. Indeed, increased awareness and understand of the benefits of SPXpm is a major focus for 2012.

Turning now to our volatility product line, VIX volatility options volume in 2011, rose 57% over the previous year for a record daily total of nearly 100 million contracts. Even more impressive, trading in VIX volatility index futures, increased 174% over 2010 for a record total of 12 million contracts.

It’s important to note that VIXs futures are ten times the size of VIX options. Despite the tremendous growth in both products, we believe we are still in the early chapters of our volatility story, and that education is the key to its further development. We are committed to retaining our status as the world’s go-to source for volatility education and we continually expand our roster of tools to help investors understand, calculate and trade volatility.

In addition to the fear gauge, CBOE Holdings now offers more than two dozen VIX related benchmarks and strategies, many of which were added in 2011. These benchmarks use real time option prices, to provide investors with a true snapshot of how market views – how the market views expected volatility across various asset classes. They’re among the many value adds that keep customers coming back to CBOE, to our website, to our CBOE options institute and to our trading facilities.

We are rolling out several new volatility benchmarks and tradable products in 2012, including sector ETF and single stock VIX products. The first of these, futures on the CBOE emerging markets ETF volatility index was launched on January 9. I’m pleased to note that trading a EEM volatility futures are off to a nice start, and EEM volatility option was sequentially launched on January 31.

We also listed a non-volatility product on CFE last week, in the form of futures on the radar logic, 25 metropolitan statistical area composite index. The opportunity offer futures on the index intrigued us given the size of the market and because it is the only futures contract that links comprehensive real estate, residential real estate values with daily pricing.

In addition to our focus on high margin premium product, we are also – remain highly competitive on the multi-list front, optimizing revenue and market share in commoditized products is an on-going strategic initiative.

To that end, we introduce C2 a little over a year ago to provide our customers with an all-electronic [inaudible] model that complements our traditional hybrid model. Our goal is to attract order flow to the CBOE market place by offering two distinct models. We met our initial target of achieving 1 to 2%, options market share in C2s first year, and we continue to enhance our C2 model.

We also made a number of fee changes in CBOE and introduced a new volume incentive program called VIP on January 3. VIP pays credits to permit holders for executing certain types and levels in business in CBOE. Alan will discuss all of our fee changes in more detail, but I am pleased to report we are already seeing positive traction from VIP. For January, our market share and multi-list equities and ETF increased by 3.7 percentage points to 22.3% from 18.6% in December.

The final initiative I will touch on today is the expansion of our user base, through targeted business development programs. These efforts will target customer segments where we see the greatest potential for growth, which is current users of the OTC market, institutional investors and volatility traders. Despite on-going Dodd-Frank delays, we already seeing some OTC type trade coming to CBOE as a result of the continued post-crisis focus on septemic risk management.

FLEX trading, CBOEs proprietary product grew 21% in 2011. We saw large FLEX trade transacted at the end of 2011, originating from [inaudible] banks facilitating customer orders. Order flow that historically has been executed in the OTC market. Our feedback suggest that other customers such as insurance company and the created structured products are also using FLEX options in lue of OTC trading.

CBOEs FLEX market share was 47.6% in 2011 and we are rolling out new technology to better serve this growing market. CFLEX will be implemented within CBOEdirect, enabling users to conveniently access FLEX options with the same interface that they use for regular options trading, built entirely in-house, the new FLEX technology will also feature CBOEs automated improvement mechanism functionality, which is a particular appeal to the dealer community.

Use of options by institutional investors continue to trend upward. This is a significant opportunity for CBOE Holdings, given that we are for many proprietary products tailored to this market. We are devoting significant resources to growing this customer segment in 2012, including hiring of additional sales support to specifically target asset managers, pension funds, insurance companies, and financial advisors. We are stepping efforts to expand our European customer base as well.

This September will mark the first CBOE risk management conference in Europe. Our annual risk management conference in the U.S., which takes place next month, is now in its 28th year. It continues to grow in popularity and attract the industry’s most sophisticated practitioners. Our attendees are likely to be earlier doctors of our new products, such as SPXpm, new services such as our volatility calculations, and new technologies such as CFLEX 2.0.

We are confident that the European conference will provide us a similar networking opportunities with overseas users. Last, we continue to focus our efforts and resources on expanding the universe of potential customers for VIX options and futures.

As mentioned, we are working closely with the issuers and ETNs pegged to the VIX. There are now 42 structured products tied to VIX, 20 of them were added in 2011 alone with $2.8 billion in assets under management. All of these products generate license and revenues to CBOE, and their issuers hedge their exposure by trading a highest margin products, VIX futures, VIX options, and SPX options.

We’re also optimistic about our plans aimed specifically at expanding VIX futures trading. CTAs and hedge funds in particular have proven to be natural users of that volatility futures. We have established a good level of penetration within these communities here in the U.S. and Europe. Last year we began a similar outreach in Asia and Australia, and we will intensify those initiatives in 2012.

To summarize, we see considerable opportunities on the options landscape and in the volatility space in 2012. We view the recent volume slowdown in part as a natural cause of the marketplace, as the marketplace regroups for a long period of [inaudible] volume and high volatility.

Meanwhile, our staff continues to sow the seeds for our company’s future growth, with programs aimed at developing new products, optimizing our market share and commoditized products, and expanding our user base. And we continue to capitalize on the favorable operating leverage inherent in our business through disciplined expense management and prudent allocation of capital.

On that note, I will turn this over to Alan Dean, to report on our financials.

Alan Dean

Thank you, Bill, and good morning everyone. As Bill mentioned, we established a number of records in 2011, setting new highs for trading volume, revenues, earnings, margins, and cash generation.

For the final quarter 2011, CBOE Holdings increased adjusted operating revenues by 6% to $120, $22 million, and adjusted operating income by 14% to $56.4 million. Our adjusted diluted earnings per-share rose 19% to $0.37 per-share. We closed out the year with almost $135 million in cash and cash equivalence, and we returned nearly $92 million to stockholders through dividends and share repurchases.

Our GAAP results reported for the fourth quarter includes 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. I will touch on those items later.

Turning to the details of the quarter, let me begin with our revenue drivers. As shown on this slide, total adjusted operating revenues increased by $7.2 million or 6% in the fourth quarter. This improvement was primarily driven by higher revenue from transaction fees and exchange services, offset somewhat by a decline in access fees.

Turning to the next slide, you see that the $7.2 million or 9% increase in transaction fees was primarily driven by a 10% increase in the average revenue per contract, or RPC, offset slightly by a 1% in trading volume. Our RPC increased to $0.32.1 compared with $0.29.3 in the fourth quarter of 2010, reflecting a shift in the product mix towards higher margin, index options and futures contracts. Sequentially, RPC rose 3% due to a decline in volume discounts, resulting from lower trading volume.

Looking at the mix of contracts traded, as shown on this slide, index options accounted for 27.9% of total contracts traded in the fourth quarter of this year, in comparison with 23.1% last year. Futures contracts, our highest margin product, accounted for nearly 1% of our total volume, versus last year’s fourth quarter when it was seven tenth of 1%. These results reflect our efforts to grow our highest margin products.

Access fees in the fourth quarter were down year-over-year, but up slightly compared with the third quarter of 2011, as the number of trading permits held steady going in to the final quarter of 2011, and we saw a lift in new users on C2, following the launch of SPXpm.

The year-over-year change reflects market makers taking advantage of the sliding fee scale, which lowered access fees compared with last year’s fourth quarter.

This next slide details our adjusted operating expenses of $63.8 million, which were about flat compared with last year’s fourth quarter. Adjusted operating expenses this year exclude severance of $3.7 million paid out under the terms of Ed Joyce’s employment agreement, and for the fourth quarter of 2010, $2 million of accelerated stock based compensation.

Breaking this number down further it shows that core operating expenses increased 4% to $41.5 million from $40 million in the fourth quarter of 2010, driven by a $1.7 million increase in travel and promotional expense, and a $700,000 increase in employee cost, offset somewhat by a $700,000 decrease in data processing.

The increase in travel and promotional expenses reflects our advertising campaign for fixed products, and the launch of SPXpm. Employee cost were up due to higher benefit expenses. The decline in data processing resulted from lower cost related to equipment, maintenance, and external data fees.

Volume base expenses, which include royalty fees and trading volume incentives were $14.8 million, a decline of about $600,000 compared with the fourth quarter of 2010. This decline reflects a $3.2 million decrease in trading volume incentives, offset by a $2.6 million increase in royalty fees, related to the higher trading volume in our licensed index products.

The decrease in trading volume incentives resulted from changes in the criteria for contracts qualifying for quantity based fee waivers. Adjusted operating income for the quarter was $56.4 million resulting in an operating margin of 46.9%, up 310 basis points compared with a adjusted margin of 43.8% in last year’s fourth quarter. [inaudible] posting our sixth consecutive quarter of year-over-year margin improvement.

On a GAAP basis, we reported an effective tax rate of 39.2% versus 37.2% in last year’s fourth quarter. Tax rate increase reflects the net effect of the increase in the Illinois tax rate, effective January 1, 2011, offset somewhat by tax benefits resulting from the recognition of tax credits and adjustments to deferred tax positions.

Our adjusted effective tax rate for the quarter was 39.8%, which excludes the tax benefit of $322,000 for tax credits related to prior years. As shown on this slide, we ended the quarter with cash and cash equivalence of $134.9 million, compared with $53.8 million at the end of 2010. We remain debt free and our cash generation remains strong.

Cash flow from operations for 2011 was $203.1 million, exceeding last year by $68.2 million or 51%. Capital expenditures for the year were $29 million, slightly under our guidance of $30 to $35 million, due to the rollover of some projects in to 2012. We continue to return excess cash to stockholders through dividends and share repurchases.

During the fourth quarter, we acquired 1.2 million shares under the share repurchase program, at an added price of $25.97 totalling $32 million. For the year, we purchased 1.8 million shares at an average price of $25.59 bringing the total investment to $47 million.

At year-end 2011, we had $53 million available under our $100 million share repurchase program that was authorized in early August of 2011. Our focus on the creation and delivery of long-term value for our stockholders guides our capital allocation priorities. Our strong cash flow has allowed us to simultaneously invest in the growth of our business, while we’re turning value directly to stockholders. Since our IPO in June 2010, we returned more than $525 million to stockholders through share repurchases, tender offers and dividend payments.

Let’s now move to our 2012 objectives and targets. Effective January 3, 2012, we implemented a number of fee changes designed to drive incremental volume to our exchanges, leverage the strength of our proprietary products, and maintain competitive pricing across all of our service areas. We expect these fee changes to generate incremental revenue and increase CBOE market share in multiply listed options. There were a number of changes, the most significant, which are summarized on this slide.

We revamped our liquidity provider sliding scale to exclude proprietary and exclusive products, implemented a new volume incentive program for certain customer orders and multiply listed options, modified the firm fee cap criteria on multiply listed options, increased fees at CFE, our futures exchange, and increased fees for certain exchange services.

While we do not provide guidance on trading volume or RPC, I know you are looking for a gauge on the impact of the fee changes on RPC. Based on our analysis, we expect all of the fee changes we made to decrease the RPC and equity options, increase the RPC for index options, end result in little or no change in the RPC for ETF options.

In addition, we expect the RPC for CFE where we trade VIX futures to increase as a result of adjustments made to their fee schedule. Our expectations for fee changes in RPC and transaction fees are based on full-year 2011 RPC and transaction mix. Again, RPC is influenced by many factors that could cause actual results to differ significantly from our outlook.

We expect the fee changes we made and exchange services to increase revenue and to be in the range of $24 million to $26 million in 2012, compared with $18 million in 2011. This increase primarily reflects higher fees related to connectivity charges, registration fees, and co-location fees.

On access fees, we lowered the monthly fee and sliding scale for CBOE trading permits, while increasing some other permit fees. As a result, total access fees are expected to be in the range of $64 million to $67 million in 2012 compared with $67.8 million for 2011.

Turning to expenses for 2012, we expect core expenses to be between $173 million to $178 million reflecting a return to a more normalized level of spending. Early in 2011, we took aggressive actions to trim or cut discretionary spending in response to a market downturn, with core operating expense increasing only 1% compared with 2010.

We will continue to focus on matching spending levels with trading volumes, and would expect core operating expenses for 2012 to be at the lower end of our guidance range, the volume is flat to up 4%, and at the higher end of the guidance range the volume growth is 5% or higher.

Having said that, our goal is to continue to grow our operating margin in 2012, through the revenue potential we expect to derive from our fee changes and other organic growth opportunities that Bill outlined.

Finally, let me comment on our expected tax rate. As we saw this year, taxes can move around for a number of reasons. However, based on what we know now, we expect our tax rate for the full-year 2012 to go down to a range of 41.2% to 41.7% reflecting the projected benefit from the new tax apportionment enacted by Illinois. And our tax rate should go down further in 2013 to around 40%, once the new Illinois tax apportionment rules are fully implemented.

Entering 2012, our primary objectives remain focused on expanding our business while continuing to strengthen our overall financial profile. We will invest in growth opportunities while still carefully managing expenses with a pristine balance sheet and a strong cash position, we have the necessary resources to successfully execute on our strategic objectives, and in turn deliver long-term value for our stockholders.

With that I will hand the call over to Debbie, so we can get started taking your questions. Thank you, very much.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from Rich Repetto with Sandler O’Neill. You may begin.

Richard H. Repetto - Sandler O'Neill

Yes, good morning, guys.

William Brodsky

Good morning, Rich.

Richard H. Repetto - Sandler O'Neill

First, I want to congratulate Ed Provost. It seems like every quarter, someone named Ed gets promoted at the CBOE.

Edward Provost

Thanks, Rich.

Richard H. Repetto - Sandler O'Neill

Anyway, the question is, and I think all eyes have focused on this, is the progress of SPXpm. And Bill, I found it, you know, helpful in the way you positioned it and I'm just trying to see, you know, when you look at – it grew relative to the SPX product, you know, the open outcry product in November and December, but if you look in January and February, you know, it looks like the open outcry product is outpacing the growth.

You know, are there things, you know, what’s the catalyst to get it, you know, grown at a greater rate again, and you know, any more detail that you’re looking at to sort of judge the progress of SPXpm?

William Brodsky

Yes, thank, Rich. I think what’s important to recognize is that the target audience for SPXpm was not the SPX current users, and we said that from the very, very beginning. So we’re positive on that. I think one of the other things you’ve got to look at is that we also, during 2011, put the weekly, the SPX weekly on the Hybrid system, which gave another dimension to electronic trading of the SPX product line.

We’re looking at SPXpm has having potential, but we’ve learned over the years that these things don’t happen just because you throw the switch, you have to educate people as to the differences in the product. We’re going after the Spider user more than anything else in SPXpm and it takes time.

Ed Provost, by the way, is very much involved with the educational effort on the SPXpm and I’m going to ask him to make a couple of comments too.

Edward Provost

Sure, Rich, and I hope most of you have seen some of the campaigns that we’ve been running, both in print and online. In addition to those, we are continuing to reach out to both the current users and potential users, making them aware of the attributes of the product, the uniqueness of the market model. We received really health, good feedback and are basically told be patient, it’s going to be a great product.

So we’re very optimist and we are continuing to spend great resources on increasing the awareness of the product.

Richard H. Repetto - Sandler O'Neill

Okay, thank you.

Operator

Thank you. Our next question comes from Michael Carrier with Deutsche Bank. You may begin.

Michael Carrier - Deutsche Bank AG

Thanks, guys. I think just a little clarification on some of the guidance. So you know, when I look at the guidance on the Access, you know, fees and the exchange service fees, and then some of the commentary on the rate per contract, I just wanted to kind of flush out what’s related to the change in pricing with WIP versus other changes that you’ve implemented that can drive different revenue movements? I just want to make sure we get that clear.

William Brodsky

Sure. Let me take your question, hopefully in the order that you asked it. Access fees, we implemented a revised sliding scale for permits for access fees in 2012. It reduced it slightly and the tradeoff is that permit users get slightly lower fees. We get certainty about fees going forward.

We also increased exchange services in other fees, that’s the line item on our P&L, some of them dramatically and that’s causing the increase in the guidance there. You can almost look at that line item as another form of access because it’s mostly connectivity fees, log-in fees that we increased and we’re realizing – we expect to realize significant new revenue in 2012 over 2011. So it’s almost access fees on another form.

Now, related to RPC, we did a number of things in – related to the transaction fees on January third, 2012. I went through them and they’re on the slide deck and you can go to our circular that’s on our website. But in addition to VIP, which pays credit to big participants of – big spenders of customer volume and multi-listed options, we also adjusted our firm fee cap, we also dramatically modified our sliding scale for liquidity providers. In the past, this discount cut across all product lines and now we’re focusing the discount on the multi-list category .

In total, that led me to give a guidance on how I see our PC going forward into 2012.

Michael Carrier - Deutsche Bank AG

Okay, thanks, guys.

Operator

Thank you. Our next question comes from Jillian Miller with BMO Capital Markets. You may begin.

Jillian Miller - BMO Capital Markets U.S.

Thanks. Good morning, everyone.

William Brodsky

Good morning.

Jillian Miller - BMO Capital Markets U.S.

I just wanted to get, I guess, a little more detail on your plans or your strategies for C2, the multi-listed products in 2012. And the market share in the multi-listed contracts seems to be relatively stable and I know you guys changed the matching algorithm and raised the rebate recently, but I haven’t seen a real meaningful increase in market share so I just wanted to get an idea for whether you think that the changes are having an impact and begin looking for whether you think some other tweaks might be necessary.

William Brodsky

Yes. First of all, this is Bill Brodsky. Let me give a beginning to that and then ask Ed Tilly to follow up on it.

Just to remind you, our goal of C2 was to try to receive a target of between 1 and 2% of option market share in the first year, and we achieved that last year; it was 1.3%. What we’ve seen, which was very positive, is significant growth in two of the most active products in the whole industry. One is in the triple Qs where we were at 2.7% of industry volume in January and 3.2% in the Spider volume in January, both up significantly from the fourth quarter.

So these are areas we’re targeting certain products where we make the greatest penetration. Let me as Ed Tilly if he wants to make some additional comments on C2.

Edward Tilly

Thanks, Bill. Good question. The flexibility, I think, was another aspect that we really tried to drive home when we launched C2 is being able to offer multiple market volumes because there’s great flexibility as the marketplace changes and there are more demands on changes in algorithms, changes in fee schedules. What we’ve seen that traction in Spiders and Qs lately, we have days where C2 will trade 5% of the Spider volume. That coupled with not losing market share because of the VIP program on CBOE, and CBOE Holdings is a terrific advantage with pricings on C2.

So the traction in January, as Bill points out in Qs and Spiders, will really provide the roadmap and the direction we’ll follow as we expand into other less active classes on C2 throughout 2012.

Jillian Miller - BMO Capital Markets U.S.

Thanks.

Operator

Thank you. Our next question comes from Chris Allen with Evercore. You may begin.

Christopher J. Allen - Evercore Partners Inc.

Good morning, guys.

William Brodsky

Good morning, Chris.

Christopher J. Allen - Evercore Partners Inc.

Good morning, guys.

William Brodsky

Good morning, Chris.

Christopher J. Allen - Evercore Partners Inc.

I just wanted to touch on capital returns. Obviously, there’s been a big focus on dividends this year in some of your competitors have raised dividends to pretty great fanfare at the end of the day. And just looking at your capital generation, the cash and the balance sheet and the dividend payout ratio of about 30%, I’m just wonder if you have any thoughts around potential for increasing a dividend, how you view that relative to buybacks going forward.

William Brodsky

Chris, I’ll give a thought to that and if I need any help, Alan will join in. But I think what’s most important is recognize that as of December 31, we were a public company for barely a year and a half. During that period, we returned over a half a billion dollars to stockholders, we increased our dividend last year by 20% and our Board of Director is acutely aware that it’s not our goal to retain cash if we have no corporate need for it.

So we look at this every Board meeting and the combination of the amount that’s been returned to shareholders, the amount that we’ve been paying dividends, plus the 20% increase, plus the stock buyback program that we’re midway through, I think shows that we are very, very conscious that we’re not going to be sitting here and just sitting on cash.

Alan Dean

And I would add, so just to expand on that, we’re not ruling anything out in terms of what we might do in the future. Our goal is to return value to shareholders and that’s what we intend to do.

Christopher J. Allen - Evercore Partners Inc.

Thanks, guys.

Operator

Thank you. Our next question comes from Ken Worthington with JPMorgan. You may begin.

Kenneth B. Worthington - JPMorgan Chase & Co.

Hi. This is Rajo speaking for Ken Worthington. Our question is on the competitive landscape. Can you talk about the competitive landscape? Can you explain what our competitors are doing to seem to be getting traction?

Edward Tilly

Sure. This is Ed Tilly. The competition in, I think, pricing, we saw a lot of changes [inaudible]. as you know, the SEC allows competition to copy other’s order types in the marketplace. So that distinction has been picked up by all the competition in the marketplace. So order types tend to conserve, there’s very little distinction by exchanges. Really, right now, the game is being competitive on price, services and that’s where CBOE is the leader.

Alan Dean

I’ll add, this is Alan Dean, that the way I look at it, there’s three pricing models in our industry. There’s traditional pricing, like CBOE has where customers pay nothing, liquidity providers and others pay fees. Then there’s maker takers, so if you’re a maker of market, you get a credit and if you’re a taker, you pay a fee and the exchange keeps that. And then finally, the AMEX model, which allows for equity participation in the value of the exchange. So everybody is trying to target segment the market differently, fighting in different ways, all trying to provide the best value and services that they can and we are as well.

Kenneth B. Worthington - JPMorgan Chase & Co.

Thank you.

Operator

Thank you. Our next question come from Niamh Alexander with KBW. You may begin.

Niamh Alexander - KBW

Hi. Thanks for taking my questions. I appreciate the guidance on the detail. This is a significant move in the exchange services and other fees and I know you were kind of saying think of it maybe as part of the access fees as well. But you know, help me understand, is this something that you think you’d be able to put into effect every year? Like is this a big magnitude increase in that price – that group?

Alan Dean

Hi, Niamh, Alan. I wish I could do that every year. All I’m willing to say is the guidance that I gave for 2012, which I think was 24 to 26 million in exchange services and other fees for 2012. And we did that because we thought we saw room in where we were on pricing and where the market was, and that’s why we implemented. So I can’t guarantee it, but I’m fairly confident about the guidance I’m giving you for 2012.

Niamh Alexander - KBW

Okay, fair enough. I’ll get back in line. Thanks.

Operator

Thank you. Our next question comes from Patrick O’Shaughnessy with Raymond James. You may begin.

Patrick O’Shaughnessy– Raymond James

Good morning.

William Brodsky

Hi, Pat.

Patrick O’Shaughnessy– Raymond James

So my question is around your volitility products, and your VIX options as well as your VIX futures. You started off 2011 really, really strong in the market volitility health and then towards the end of the year and early 2012, the volume growth fell off. So in January of 2012, VIX options were down 7% year over year on the ADB basis and I think the futures were up about 4%. The question is, what – can you remind me what are the drivers for your VIX trading volumes, both options and futures, and how confident are you that your initiatives that you have going right now can really reaccelerate the growth of this franchise?

William Brodsky

This is Bill, Pat. I’ll just start off. The VIX product is a whole new concept in the investment world. It’s a new asset class. I think you have to look at the fundamental building blocks of VIX and one of them, as I said, was education. The other is the use of TTNs, which are created by the major firms, so the customers have structured products that don’t have to deal directly in a VIX future or a VIX option. I don’t think we can look at it on a month-by-month basis and say is VIX growing. I think you have to look at it year by year as it’s growing and the more we talk to people, the more the people are starting to understand that volitility is a very important factor that they can now trade.

So I don’t look at this as, you know, that January fell off a bit, I actually look at it and say, as we’ve developed products overtime, I’ve got to look at it certainly on a year-by-year basis, not a monthly-by-month basis.

And Ed Tilly is going to just add to this a little bit.

Edward Tilly

Yes, a lot of the work we do in rolling out non-tradable index products, for example, just the benchmarking, we’ve mentioned one late last year on our call was really the CBOE Tail Hedge Strategy Index, which really uses the 30 delta call and options, for example. And as volitility levels change, you’re exposure into that 30 delta call line is, we prescribe to increase or decrease. Well, we’re now at a level of historic volitility in the high-teens, low-20s that is instructing our users, go back in, reload if you will, add to your portfolio that exposure to VIX options. And lately, last week or so, we have seen a pickup in the VIX complex. And we’ve seen growth in VIX in low times of volitility as well as high times of volitility.

But if we go back to these benchmarks, the white pages, the information we put out, this is the time we see investors coming back into the VIX complex and following some of the strategies and index – or benchmarking index products that we put out.

Edward Provost

And let me just add a little bit. This is Ed Provost. It continues to be the primary focus of our educational initiatives and in particular, at the RMC Conference where many of our educational seminars focus on the use of VIX and trading volitility, starting from both elementary strategies, introducing institutional users as to how to use the product to the opposite end of the spectrum where the sophistication of the presentation’s beyond may people’s understanding, but which provides a great advanced knowledge.

So it is really a product that is in its infancy and we see greater and greater adaptation by people who have not previously tried volitility.

Patrick O’Shaughnessy– Raymond James

That’s helpful. Thank you.

Operator

Thank you. Our next question comes from Alex Kramm with UBS. You may begin.

Alex Kramm - UBS Investment Bank

Hey, good morning.

William Brodsky

Good morning, Alex.

Alex Kramm - UBS Investment Bank

Just hoping that you could come back to the SPXpm and maybe the timing a little bit more when it comes to customer adoption, marketing and what you’re doing. I think specifically, on the retail side, you know, talking to some of the ebrokers, I think that the feedback is pretty good and I think there’s at least one out there that said they really want to market this aggressively because of economics with them. So maybe can you just talk a little bit about when you think this is going to happen in terms of them actually presenting it on the website and [inaudible] with you.

And then, just real quick as a follow up to that, any other changes to the order types that you need to do, or is this all done in terms of SPXpm and making markets? Can you give us some starting points?

Edward Provost.

Alex, Ed Provost. I’ll take that question. As to the market model, we feel comfortable that what we have in place works. We never rule out the possibility of making modifications adding new order types, but at least as of now, we feel good about the market model.

You were right in pointing out the early adopters have been more retail, self-directed, active users of options and our focus this year will be very heavily in the hedge fund community that we’ll call the sophisticated institutional users who often use the point-and-click kind of market products as opposed to some of the traditional money managers who are moving substantial blocks, they have huge portfolios.

So the major focus this year will be in the hedge fund community. The active retail is a very sophisticated group that is quite in tune with the product already. One of our new hires in New York, in our institutional marketing area is very well connected with a lot of the hedge fund community and that will be one of our great focuses. But we’re very, very optimistic that the product is going to grow and particularly, that hedge fund area.

Alex Kramm - UBS Investment Bank

Very cool. Thanks.

Operator

Thank you. Our next question comes from Justin Schack with Rosenblatt Securities. You may begin.

Justin Schack – Rosenblatt Securities

Good morning, guys.

William Brodsky

Hey, Justin.

Justin Schack – Rosenblatt Securities

I'm wondering, I appreciate the additional color on migration of PC toward list environment. Can you guys comment at all on what you see happening with the [inaudible] of the OTC S&P 500 options? I know you guys benefited from that and – excuse me, just trying to get a sense of the timing, whether people are using OTC for those yet and to what level that might grow over time.

William Brodsky

We’re seeing – this is Bill. We’re seeing a significant progress there with the option clearing cooperation of getting authority to move forward with OTC clearing. And as I said in my remarks, we’re seeing a migration of institutional users to try to use flex-side products to access the Option Clearing Corp for clearing. So despite of the fact that it there has been no definitive resolution at the – in the Dodd-Frank implementation, we’re seeing these things happen. So these thing are in place with OCC in addition to be able to clear S&P 500 options. In fact, OTC is right now waiting for SEC approval, but the fact is they’re ready, they’re operationally ready and as we talked in prior conference calls, we know have a contractual agreement with S&P – an S&P 500 option [inaudible] and OCC and being traded on CBOE, we’re going to get revenue on that. So this is something that we’re looking very positively about.

Ed Tilly is going to add one more point too.

Edward Tilly

Justin, I think the way we look at it here is being prepared at a basically three-prong approach to migrating OTC trade to the list of market, or ultimately to central counter party clearnings. So we prepared ourselves for the most obvious, that is to take exchange look-a-like products and offer a solution on our listed exchange. Well, if that’s open, I’ll try traditional negotiated trade at CBOE. But it is the convention in the OTC market, TM subtled contract, we have SPXpm obviously at the ready at C2. Our flex capability, we just – we’re going to begin to roll out our new Flex 2.0 a flex system that allows for customized options to be traded on the same trade engine, CBOE [inaudible] is our listed option, so we’ll be ready for the customization of options those OTC contracts moving to the exchange.

And then as you pointed out, obviously the third is that is directly accepting OTC trades into the OTC clearing and benefitting from that.

So we’re really ready at any level and any degree of that regulation dictates certain exposure and we really find ourselves prepared.

Justin Schack – Rosenblatt Securities

All right. Thanks, guys.

Operator

Thank you. Our next question comes from Gaston Ceron with Morningstar. You may begin.

Gaston F. Ceron - Morningstar Inc.

Hello. Good morning.

William Brodsky

Good morning.

Gaston F. Ceron - Morningstar Inc.

Just a quick question. I wonder if you have any update on any talks with S&P regarding the, you know, sort of any longer term contract renewals, you know, obviously we have the – they have the [inaudible] with [inaudible] coming up. I was just wondering if there are any updates on your talks regarding long-term regulatory of the S&P venture.

William Brodsky

I appreciate the question. I guess I would just reiterate what we’ve said on this subject in the past, and that is that we have had several contract extensions over the many years of our relationship and [inaudible] is now very neutrally beneficial relationship with them. And we have not, nor will we comment on the timing of any renewals of the contract. We haven’t in the past on that, we’re not going to do it in the future. But I would tell you that our relations is very strong and I think it’s also very important as you look at the growth of the VIX product line, is that this is something that it makes the relationship more symbiotic than it’s ever been before.

Gaston F. Ceron - Morningstar Inc.

Great. Thank you.

Operator

Thank you. Our next question comes from Matthew Heinz with Stifel Nicolaus. You may begin.

Matthew Heinz – Stifel Nicolaus

Hi, good morning, guys.

William Brodsky

Hi, Matt. Good morning.

Matthew Heinz – Stifel Nicolaus

We’ve clearly seen a nice uptick on the non-exclusive side in the market share since you implemented the pricing changes on Jan 1. And it seems to be coming mostly at the expense of [inaudible] share. I'm just wondering if you can comment at all on the kind of type of order flow that you’re seeing come over. You know, whether it’s – there’s some dividend capture in there, if it’s mostly on the equity side, ETF side? Just any color there would be great.

William Brodsky

I’m going to ask Ed Provost, he’ll handle that question.

Edwards Provost

Thanks. No, it definitely does not include dividend plays. In fact, very few, if any dividend plays for CBOE. It is mostly retail, in fact, it’s almost exclusively retail and I think most of you understand that most of the order flow in the options business comes through wholesalers. So it’s the wholesalers who are the people who are entering the orders into the system and they are the firms that are eligible to get the payment.

So order flow has been concentrating on some of the larger consolidators and mostly retail order flow. And indeed, a significant portion of that has come to CBOE and based upon our analysis, although we don’t have full transparency into it, it’s does appear to be coming to us mostly from the Philadelphia area.

Matthew Heinz – Stifel Nicolaus

Okay. That’s helpful. Thank you.

Operator

Thank you. Our next question comes from Rob Brostrom with CLSA. You may begin.

Rob Brostrom – CLSA

Hey, good morning, everybody. I just had a bigger picture question. You know, over the past several years, we’ve seen big growth in the maker/taker model relative to the traditional model. What’s your view going forward? Is that transition done or should we expect to see more growth in maker/taker relative to traditional? And what would be some of the factors that will drive that?

William Brodsky

Ed Tilly will take that, Rob.

Edward Tilly

I think we’ve seen that migration for the time being. I think what you see now, the fight for market share is, you know, continues to be in the directed space where there is a preferred recipient. It’s really now a market model, an allocation model rather than the pricing model driving the touch – driving the flows. So as Ed points out, the upticks we’ve seen in share has come from retailers and it’s very, very important that the model that is winning here, if I can say winning, is the ability still for those consolidators of swell to be able to direct those orders to the market makers that they choose and that traditional allocation method is really the model that we see winning out.

The pricing model versus traditional is very, very interesting, but again, right now we see the terrific movement to CBOE really because of the ability to touch the flow from the consolidator and aggressive the VIP program that we just instituted in January.

William Brodsky

And I’ll just add just one more point. We often argue with respect to the rule files in Washington that the options market operates much differently than the cash equity markets, which have largely transitioned to the maker/taker model. As Ed points out, the traditional pricing model is very, very strong component to the overall market structure option. And we certainly see both markets prevailing and surviving.

Rob Brostrom – CLSA

Thank you.

Operator

Thank you. Our next question comes from Dan Fannon with Jefferies. You may begin.

Dan Fannon – Jefferies & Co.

Hi. This is [inaudible] calling in for Dan Fannon. I just wanted to speak about one of the strategies you had about building out new products or introducing new products. Do you have any color on perhaps the number of new products launched in 2011 and maybe some of the incremental revenues they produced or expectations?

William Brodsky

In 2011, I think we’ve had our greatest influence in the benchmark category and that is the action that occurs in the open market as a result of following or replicating benchmark strategy. So [inaudible] the overwrite strategy, buy right index for example, whether or not we have tradable BMX strategies out in the ETS world. Importantly, to replicate the success of a year like 2011 and basic overwrite strategy, tracking our BXM is extremely important to us. There’re trigger points, there’s prescribed action in the marketplace to replicate those benchmarks. Those benchmarks truly drive much of the success we’ve seen in SPX for example, as I pick on BXM.

I mentioned one earlier, the Tail Hedge strategy, really now, and [inaudible] Complex launched last year, very important, again, prescribes action is [inaudible] change in the marketplace as we go into the low-teens, mid-20s, up to 30, the exposure in the 30 delta calls and VIX options derive action in the volitility complex. So we’ve seen a great deal – very hard to measure though, great deal of traction in following these various benchmarks.

In 2012, the effort will be on more tradable products. So we’ll go over to the BFE, we’ve recently launched VIX futures contract – volitility futures contracts based on EEM, just recently launched options on those EEM volitility contracts and that will be a driving force for our futures exchange in 2012.

So similarly, we will roll out additional single name or ETF name volitility tradable products for our futures exchange that our CBOE options complex in 2012.

Edward Tilly

I’ll just add one more point. While that speaks to the volitility suite, we are very good [inaudible] new products in areas away from volitility and the RPX futures, which [inaudible] the futures contract tied to the real estate market is an example of different kinds of space were looking both in terms of products.

So we’re very optimistic, we have a lot of products in the product pipeline and we’ve said it before, it’s in our DNA to create new products. We’re very good at it. Not everyone is successful, but we think we have a great number of them that are going to becoming out in the next year.

Dan Fannon – Jefferies & Co.

Okay. And then related to that, I guess, in terms of just looking back at 2011, do you guys have any estimates or numbers around the incremental revenues that some of the new products produced or – what are the kind of expectations? Like if we introduce X number of new products, we think we should be able to capture let’s say Y percentage of incremental revenues?

William Brodsky

I think, as Ed Tilly said, some of the things that we create don’t necessarily mean they have a new product that drives the volume, and I’ll go back to this BXM, the buy right index. We’ve had tremendous success with that in terms of new institutional users, so it’s driving volume into the [inaudible] or SPX contract, it’s not a new product but the index is now being adopted by institutions and it’s driving volumes. So in some respects, we’re neutral in terms of whether it’s a new tradable product or benchmark that creates new volume in existing products.

Edward Tilly

Let me add. I don’t mean to be dodging the answer directly. I’ll give you an example on a VIX settlement. So VIX options, VIX futures, right, we settled VIX futures 30 days out of the next month, it’s applied volitility index. So on the Wednesday of expiration week, for example, the opening in the SPX complex to settle the VIX futures contract will trade 300 or 400,000 contract in SPX.

Now, can I point to the VIX futures contract as incremental revenue in the VIX future side? No, that’s actually revenue driven into the SPX complex or the CBOE side. So it’s difficult to track, but know that the product design is a conscious effort to drive more and more volume back into the complex whether it’s on future side or the option side.

Dan Fannon – Jefferies & Co.

Okay, thank you, gentlemen. I appreciate the clarity. Thank you.

Operator

Thank you. Our next question comes from Chris Harris with Wells Fargo Securities. You may begin.

Christopher Harris - Wells Fargo Securities, LLC.

Thanks. Good morning, everyone. So I wanted to flush out a little bit about the initiatives here to expand your customer base particularly in Europe. I’m just curious, do you all have any granularity on how large that customer base is relative to your customer base in the U.S.? And then maybe how large could that potential be and maybe anything around the timing on actually penetrating the market there, is it something that will take multiple years or is it something that maybe could be pretty influential over the next couple of years?

Edward Provost

So it’s very difficult for us to reach down to the customer level of understandings of what geographic area orders are coming from since we don’t, as a futures side of the world, which control the [inaudible] corporation might have greater granularity as to where the customer is. We’re not blessed with that kind of information.

That being said, we have an international and institutional marketing group that spends a good amount of time overseas. They speak to the customers, they speak to the users. We know there’s a high level of sophisticated that exists there. Indeed, we mentioned earlier the conference we’ll be doing in Europe this year, which we’ve already received significant interest in.

We believe that the potential is great for growing the use of our product overseas both in the EU and in areas of Asia and other parts of the world. So again, we are there, troops on the ground speaking to the users and every bit of information we have suggests that here’s great potential to grow product overseas.

Christopher Harris - Wells Fargo Securities, LLC.

Thank you.

Operator

Thank you. We have a follow up question from Richard Repetto with Sandler O’Neill. You may begin.

Richard H. Repetto - Sandler O'Neill

Hi, guys. I’m hoping this is quick. I think the discussion on competition has been very helpful and I guess my one question, Ed, you know, we’ve gone from the competition on the [inaudible] types, models to order types and now to pricing and it seems like we’re on the edge of, you know, where it’s really is about like what you said, directing it to your own market maker versus an open market model. And I guess the question is, when does the SEC, do you think we are getting close to that, and what do you think the SEC – I know they push back on some models and order types, where – what role do they play or what’s their position in this?

Edward Tilly

From what we know and what we’ve seen, the SEC remains pretty firm on the 40% guaranteed participation right as well as protecting the exposure on straight order types history into the marketplace. So we see no budging on that. We do see timers, that is the amount of required exposure in order to affect the cross being turned down a bit, but with the increase in efficiency in electronics, we think that the competitive quarters are able to keep pace with the technological changes.

But we really are – applaud the SEC in maintaining that exposure that they required since the options markets have begun. We don’t see that budging anytime soon but certainly, we will be keeping you up to date if we see any moment on that front. But we’re fully behind the SEC’s desire for a transparent dedicated liquidity provider and what they add to the marketplace.

William Brodsky

And I would punctuate that, Rich, by saying that the SEC has been very consumed with Dodd-Frank rule making and ultimately implementation. But one of the issues that they haven’t had time really to get back to is the whole flash crash review and my guess is that what Ed said is not only correct, but the SEC recognizes after the flash crash, the critical need for market makers. So I think that that’s where the option model is very different than the equity model and only to our benefit.

Richard H. Repetto - Sandler O'Neill

Got it. Very helpful. Thanks.

Operator

Thank you. Our next follow-up question comes from Chis Allen with Evercore. You may begin.

Christopher J. Allen - Evercore Partners Inc.

Hey, guys. I just wanted to – maybe I missed this. Just on the tax rate guidance, when I look at your adjusted 2011 results tax rate about 40.3% and the guidance is implying up from there, and then you have the tax break coming from Illinois, so I’m just wondering how to think about that, what’s like driving that?

William Brodsky

Yes, Chris, our GAAP tax rate for 2011 was 41.9% and we had a number of things happen in 2011 and that’s causing the 2012 rate to be maybe not as low as you would like. First of all, you know, we had the New York issue come to us in the middle of the year. We had the Illinois tax rate went up on January of 2011. And the Illinois – new Illinois apportionment factor is being phased in. Part of it, a smaller part is happening in 2012 and the larger part is happening in 2013. So I said in my prepared remarks that I thought 2013 we’d see a lower tax rate around 40%. So I hope that helps.

Christopher J. Allen - Evercore Partners Inc.

Thanks.

Operator

Thank you. Our next follow-up question come from Patrick O’Shaughnessy with Raymond James. You may begin.

Patrick O’Shaughnessy– Raymond James

Hey, guys. Bigger picture question for you. So for the last few months, we’ve see relatively soft volumes in monthly listed options, equities, a lot of other asset classes. And so my question for you guys is, to what extent are mostly listed options still a secular growth story and to what extent are they more of a cyclical growth story driven by market volitility and a few other factors like that?

William Brodsky

Pat, predicting this is always very hard. But what we have seen particularly in the low interest rate environment is that financial advisors in particular are very much increasing the use of option. We’ve had some wonderful studies that have confirmed that.

So I think that that you have to look at it and say are options growing generally and depending on the customer, you know, the customer is going to be trading individual stocks are going to more likely use individual equity options. We’re seeing institutions more likely to use index products So I think it varies. But what I would say is that I still think it’s part of the secular growth story of our industry that’s aided by the low interest rate environment, but it’s also aided by people just finding ways to use options in very compelling ways that they can be used properly.

And so, I look at it and say it’s been a very [inaudible] period for investors both institutional and individuals. But the professionals who guide these people, be it the portfolio manager on the institutional side or the financial advisors, they are increasing these options and that has a compounding effect. It’s just nothing you can measure on a day-by-day basis.

Patrick O’Shaughnessy– Raymond James

Thank you.

Operator

Thank you. I’m showing no further questions at this time. I would now like to turn the call back over for closing remarks.

Debbie Koopman

Thank ou. This completes our call this morning. We appreciate your time and continued interest in our company. Thanks a lot.

Operator

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day.

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