IntercontinentalExchange Q3 Earnings Call Transcript

IntercontinentalExchange, Inc. (ICE)

Q3 2007 Earnings Call

October 25, 2007 8:30 am ET

Executives

Kelly Loeffler - IR

Jeffrey Sprecher - Chairman and CEO

Scott Hill - Chief Financial Officer

Charles Vice - Chief Operating Officer

Analysts

Daniel Harris - Goldman Sachs

Howard Chen - Credit Suisse

Rob Rutschow - Deutsche Bank

Rich Repetto - Sandler O’Neill

Ken Worthington – JP Morgan

Mark Lane - William Blair

Jonathan Casteleyn - Wachovia Securities

Edward Ditmire - Fox-Pitt Kelton

Mike Vinciquerra - BMO Capital Markets

Presentation

Operator

  Good day everyone and welcome to the IntercontinentalExchange third quarter earnings results conference call.  Today’s call is being recorded.  At this time for opening remarks and introductions, I will turn the call over to Ms. Kelly Loeffler, Vice President of Investor Relations and Corporate Communications. Kelly, please go ahead.

Kelly Loeffler

Good morning. To obtain a copy of the company’s third quarter earnings release and presentation, please visit the investor relations section of our website at theICE.com. These items will be archived and available for replay.

Please be aware that our comments may contain forward-looking statements. These statements represent our current judgments and are subject to various risks, assumptions, and uncertainties as outlined in the company’s filings with the SEC. Actual results may differ materially from those that are expressed or implied in any forward-looking statements.

With us on the call today are Jeff Sprecher, Chairman and CEO; Scott Hill, Chief Financial Officer; and Chuck Vice, Chief Operating Officer.  We’ll follow the same format as on our last call where Scott will begin with a review of ICE’s financial performance and Jeff will provide an update of our growth initiatives.  At the end of the prepared remarks we will take your questions.

I’d now like to turn the call over to Scott.

Scott Hill

Thank you, Kelly, and thanks to everyone for joining us today.  I’ll begin by highlighting ICE’s key financial and operating metrics for the third quarter, and then we’ll discuss a few of our key initiatives.  Let’s start on slide 4 with an overview of ICE’s third quarter results. 

I’m pleased to report that we delivered another solid quarter including record consolidated revenues of $152 million, up 60% year over year.  Our operating income increased 54% to $101 million during the quarter.  Our operating margin was 66%. 

Net income for the quarter was $67 million, an increase of 53%.  Earnings per diluted share were $0.93.

By virtually any measure, ICE remains a leader within the rapidly growing exchange sector.  We ended the quarter with $193 million in cash and short-term investments and $231 million in debt.  Our debt level remains low, we have full access to our $250 million line of credit and we continue to generate strong growth in operating cash flow.  All of this gives us the financial flexibility to be opportunistic within a dynamic industry.  We’ve included a summary balance sheet in the appendix of the earnings presentation.

Next on slide 5, you’ll see a breakdown of consolidated revenues.  Transaction revenues comprise our European and two North American regulated futures exchanges and our global OTC segment.  Transaction revenues totaled $131 million, up 56% year to year.  These revenues accounted for 87% of our consolidated revenues in the quarter. Consolidated market data revenues increased 77% to $17 million and accounted for 11% of consolidated revenues.

Moving on to slide 6, third quarter consolidated operating expenses were $51 million, up 74% compared to last year’s third quarter.  As in prior quarters this year, the largest driver of the increase was expense associated with the addition of ICE Futures U.S. to our consolidated results. 

We remain on target to achieve the increased synergies announced in the second quarter and we continue to identify additional cost savings opportunity in our U.S. Futures business.  As a result, we expect further margin improvement over the next couple of quarters.

Operating expenses also reflect the investments we’re making to expand our clearing operations.  During the first three quarters of 2007, we’ve incurred approximately $2.6 million in clearing-related expenses.  This includes $1.2 million recorded in the third quarter, and we remain on track to open our European clearinghouse in July of next year. 

Our third quarter expenses also include $1.5 million related to the Russell licensing agreement, which I’ll detail in a few minutes.

Finally, I want to mention that during the quarter as part of a multi-phase enhancement plan, we completed an upgrade of our technology platform.  Jeff will expand on our technology initiative later in the presentation.

Now let’s turn to slide 7, which highlights some of the key drivers of our performance.  In the third quarter of 2007, ICE’s daily volume was a combined 1.5 million contracts for our futures and OTC market.  Volume growth in our core energy products remain strong as a result of new customers, increased electronic trading options and new products. We continue to make progress in ramping our electronic, agricultural, foreign exchange and index market as they transition to the ICE platform.

Now, if you’ll flip to slide 8, you can see that the average daily volume of contracts at ICE Futures Europe was 553,000 an increase of 34% over last year.  Transaction revenues were $46 million, up 25% over last year’s third quarter and accounted for 35% of quarterly consolidated transaction revenue. 

Growth in our European Energy Futures segment was driven by record gas oil volume in September, along with continued strength in our Brent and WTI crude futures markets. During the month of September, our ICE Brent and gas oil futures contract set new average daily volume records.  The ICE WTI contract recorded its second-highest ADV ever.  Rate per contract, or RPC, for ICE Futures Europe was $1.29 during the quarter, which was equal to the second quarter of this year.

Looking at ICE Futures U.S. and Winnipeg performance on slide 9, ADV rose to 221,000 contracts per day, up 31% year to year.  Transaction revenues were $27 million. North American Futures businesses accounted for 21% of third quarter consolidated transaction revenue. 

During the quarter, we established new volume records for coffee, tea, cocoa, cotton, the U.S. dollar index and a number of other contracts. In the third quarter RPC for agricultural commodities futures averaged $2.07 compared to $1.85 in the second quarter. September RPC was $2.18.  We’re very pleased with the progress we’ve made in our agricultural commodity market.  We see the excellent growth potential for these and our financial products such as the Russell indices and foreign exchange contracts.

I’m sometimes asked about the growth rates we’re experiencing at ICE Futures U.S.. As most of you know, a primary driver of volume growth in a contract is the volatility of the underlying commodity.  Despite uncharacteristically low volatility during the quarter in sugar prices, which is the largest contract in this segment, we’ve seen healthy volume growth year-to-date.  In fact, since we introduced electronic trading at our U.S. Futures business just eight months ago, we’ve seen a 26% increase in average daily volume.  This compares to a 21% increase in ADV at ICE Futures Europe during its first eight months of fully electronic trading.  We’re pleased with our progress to date and with the potential for growth that lies ahead.

Another key initiative underway at ICE is the migration of the Russell index futures contract onto our platform.  In June of this year, we took an unprecedented step when we made a long-term and meaningful commitment to entering a new asset class.  As I mentioned, our third quarter results include $1.5 million of expense related to the Russell contract.  We anticipate similar amounts in each of the next three quarters. 

The exclusivity period of this arrangement begins in the third quarter of 2008.  We expect volumes to ramp during the first half of 2008, culminating in the completion of the transition to ICE in the third quarter.  The level of expense associated with the contract will also increase in the second half of 2008. 

We remain confident that this deal will yield a strong return over the long term and will help us more rapidly expand into the equity index business.  Please see our press release issued this morning or the appendix of this presentation for additional details.

Moving on to the OTC business on slide 10, you can see that this segment delivered record transaction revenues of $58 million, up 24% year to year.  OTC revenues accounted for 44% of our third quarter consolidated transaction revenues.  Cleared contracts grew to a record 38 million contracts in the quarter, representing 84% of our OTC business. 

For the third quarter, average daily commissions rose 21% to a record $890,000 per day.  Despite the absence of volatile conditions traditionally associated with the typical hurricane season, we saw greater trading and hedging activity and increased liquidity during the quarter, while our commercial customers -- including gas and power utilities, distribution companies and global energy majors -- continue to increase their participation in these markets; so too do financial institutions and liquidity providers. 

As we’ve said before, we believe that we’re early in the adoption of the energy commodities as a traded asset class and our results demonstrate the growing demand for access to this segment of the market.

Finally, you’ll find some additional financial guidance in today’s earnings release as well as in the appendix of this presentation.  Please refer to that material for more information. 

With that, I’d like to turn the call over to Jeff.

Jeffrey Sprecher

Thank you, Scott.  Now that you have the numbers, I’ll update you on the strategy we’re pursuing to ensure that ICE remains a growth leader.  We’ve been aggressively pursuing both organic growth and expansion through mergers and acquisitions since our inception seven years ago and we intend to continue to pursue both types of growth in the future. 

We’ve spent much of the past couple of years putting in place a diverse and unique product offering, as well as establishing a leading-edge technology infrastructure to serve a global customer base. Today, we operate three futures exchanges, two clearinghouses with a third one under construction, our own technology infrastructure, a global over the counter marketplace, and a rapidly growing market data and trade confirmation business. 

We’re constantly seeking ways to increase our reach, our products, and our value for customers and shareholders.  This focus on growth is evidenced by the fact that year-to-date ICE has remained a leader in terms of growth in revenue, EPS and volume.

Importantly, we’re working to sustain and build on this performance.  Year-to-date, we’ve completed five transactions and a number of strategic partnerships.  The first acquisition was NYBOT, which is now called ICE Futures U.S. and that closed in January.  The second was our acquisition of the Winnipeg Commodity Exchange, which closed in August.  Our OTC and market data businesses have been augmented by acquisitions of ChemConnect, Chatham Energy, and Commoditrack and we have quickly and smoothly integrated these operations and are leveraging their unique assets together with our own strengths.

ICE Futures U.S. is well on-track to achieve expense and revenue synergies that we anticipate, and we continue to evaluate opportunities to increase operational efficiencies and identify additional synergies. 

Most recently, in addition to expanding its clearing operations, we’ve begun to enhance the equity index and foreign exchange complexes that until very recently have only traded on the open outcry trading floor.

In November, we’ll roll out the first tranche of currency pairs on the ICE platform.  This is a very interesting market for us and it’s one in which we believe we can unlock significant value, despite the fact that it has been historically relatively small for ICE Futures.  We look forward to rolling out more products to serve this market in the future.

In the next few quarters, our exclusive license for the U.S. Russell index futures will take us into a very large addressable market for equity index futures.  We introduced the Russell 2000 electronically in mid-August and the Russell 1000 in June.  In addition to developing cross-margining agreements and other incentive programs, we’re building relationships with many of the key users who rely on Russell benchmarks.  We believe these users are eager for a transition to take place and that there’s a great deal of loyalty to the Russell benchmarks. 

The liquidity in traded Russell products has never been greater than it is today. Year-to-date, the futures based on U.S. Russell index products have exceeded 50 million contracts across both futures and options. Given the growth of Russell as a benchmark relative to other indices, we believe the potential for ICE to grow the franchise is excellent.  Our agreement recognizes the value of the Russell indices and represents an important, long-term commitment to expanding our presence in the equity index business and in growing Russell volumes from their current levels.

We also demonstrated our appreciation for the value of other key indices by licensing -- and many times on an exclusive basis -- the right to several important commodity indices including those of NGI and Platts with whom we cooperated conducting a Platts window on ICE. 

Earlier this year, we announced a cross-licensing agreement with the Natural Gas Exchange of Canada, or NGX, and in December will complete the transition of NGX products onto the ICE platform.  Under this arrangement, we’ve secured preferred access to the most widely used natural gas benchmarks in Canada for the purpose of clearing and settling key natural gas products.  In turn, NGX will provide contract delivery assurance and settlement for physical transactions through a physical clearing facility that is unique within the energy industry.

Finally from a strategic investment perspective, earlier this year we acquired an 8% stake in the National Commodity and Derivatives Exchange of India, or NCDEX.  Recently, I accepted NCDEX’s invitation, and I will join their strategy committee.  This is a special appointment which demonstrates our mutual belief in the long-term, strategic value of our alliance.  We think that there are key benefits from participating with local exchanges in emerging derivatives markets, expanding our reach in the markets where regulatory or structural issues may prevent us from operating on a standalone basis.

On the technology front, as Scott mentioned, during the third quarter we completed one of the final stages of a multi-year development project to enhance our technology platform.  Roundtrip trades can now be executed in as few as 7 milliseconds in our Energy Futures business and 12 milliseconds on a blended exchange-wide basis.  To my knowledge, no other futures trading platform matches that speed today.

In December, we’ll finish another critical phase of enhancement to our technology platform to ensure that we stay ahead of the curve.  As a result of these and other enhancements, as well as the growing investor interest in the commodity asset class as a whole, we continue to see increased participation by funds, proprietary traders and algorithmic trading firms.  This is in addition to the commercial commodity market participants who already provide the market with deep liquidity.

In January, we expect to complete the move of our primary data center to Chicago to expand the size and the scale of our physical technology site.  This move will help accommodate an expanding range of market participants, including high-velocity traders who wish to co-locate with us.

Another area where we expect to see growth is through the expansion of our clearing business.  In September, Tom Hammond joined ICE Clear U.S. as our President, and his wealth of experience at the former Chicago Board of Trade and the Board of Trade Clearing Corporation will be invaluable to us.  We’ve already made great progress in implementing our global clearing strategy as we moved into the next phase of ICE Clear’s development in Europe.

Customers have shown a demand for more cleared products to support growth in their businesses while ensuring efficient and secure risk management, whether it be in futures or over-the-counter markets.  We’re working to bring efficiency improvements in clearing while introducing many new products to meet customer needs.  We’re working with the FCM community to ensure that ICE Clear meets their needs in terms of the financial safeguards, operational processes, and quality of services.

We’re on-track to meet the key milestones for the formation of ICE Clear Europe.  We’ve submitted our clearing applications to the FSA on July 31st, and we’re engaged in the process of regulatory approvals.  We’ve commenced the process of gaining U.S. regulatory approvals as well as a multilateral clearing organization with the CFTC.

Earlier this month, we named JP Morgan as our consolidation bank for ICE Clear Europe to provide transaction processing, investment management, and safe custody services.  Earlier this month in London, we held the first meeting of the Technology and Operations Group where we provided an update to clearing firms on the technical and operational progress of the clearinghouse.  The first meeting of the Chairman’s Clearing Transition Advisory Group for ICE Clear Europe will take place on the first of November.  In both cases, the meetings have had solid representation from the FCM community. In addition, we’re conducting meetings with customers and FCMs on a regular basis. 

We are very eager to launch this new business and we anticipate moving our clearing in-house for all of our business segments in the third quarter of next year, as previously announced. 

It’s not only our new business ventures that show potential.  We remain the fastest-growing major derivatives marketplace on a year-to-date basis.  We continue to see significant growth ahead in the energy futures and in over-the-counter markets, which were the roots of ICE’s formation.

It’s been virtually impossible for anyone, anywhere, to ignore recent news regarding record-breaking oil prices.  Geopolitical events, a weakening dollar and growth in the BRIC countries have driven oil prices to all-time highs.  While high oil prices may not always translate into increased trading volumes, we’ve experienced the positive impact as a result of strong volatility in these markets over the quarter and continuing into October. 

Particularly in this environment, our offering of both futures and over-the-counter markets on a single platform is valuable to customers seeking risk management capabilities and product diversity.

As Scott mentioned, we set records in our futures business and over-the-counter segment due to both increased participation and the need to hedge energy prices.  Today, nearly half of world’s crude oil futures are traded by ICE Futures, and recently we’ve seen consistent anecdotal evidence of continuing hiring and expansion within the commodity desks at banks and funds.  We think that this point may help address any concerns that there could be disinvestment in commodities due to the issues in credit markets.

On an adjacent topic, I’d like to take a moment to offer our perspective on the ongoing discussions regarding U.S. regulation of the over-the-counter markets.  We believe that there is a near-term opportunity to resolve this complex issue.  We’ve worked for more than a year with a range of policy makers, regulators and industry participants to develop a plan for regulation of the over-the-counter markets.  Our goal has been to help shape effective regulation without eliminating the significant economic and utility benefits that are provided by liquid and transparent markets that ICE has brought to the industry. 

Our innovation in these very large and global markets may have enabled increased hedging and risk-management capabilities for commercial players, and they’ve drawn a host of new industry participants to ICE and to other exchanges.

Therefore, given the complexities inherent in the vast and varied over-the-counter markets, we believe the CFTC’s announcement yesterday is an important step toward resolving the debate and providing regulatory certainty for trading platforms like ours and for our customers.

Over the last few months, I’ve spent time in Washington and I’ve testified before various government entities expressing our support for many of the principles espoused yesterday by the commission.  The dialogue with all the parties has been very productive in identifying the key components for regulation.  Much of what we discussed is already in process. 

Incidentally, it was one year ago this month that we began reporting positions on a daily basis to the CFTC, and during this one-year period we have experienced tremendous trading growth. I’d like to note that contrary to how this issue has been portrayed by some, regulation is not a negative for ICE.  In fact, today we operate three regulated futures exchanges under the purview of three different regulatory authorities.  Regulation in our over-the-counter markets would give us authority that we need to enforce key market principles and increase confidence in our markets for both market participants and consumers. 

As is true in futures markets, the presence of regulation does not impede the market growth or drive business models. Turning to what we do think drives growth in business models, many of you have asked us about new product launches, and this year there have been many. 

Today, we offer five asset classes on the ICE platform, four of which we’ve added just this year.  These include soft commodities and agricultural products, foreign exchange, equity indices, and chemicals.  This is a dramatic increase in the addressable markets compared to our product suite when we began this year. 

Within our existing businesses, we continued to dive deeper.  We’re extending the reach of our over-the-counter markets from natural gas and power into the refined oil products markets with our launch of the Platts Window on ICE.  As mentioned at the end of the year, we’ll add Canadian markets for both energy and agricultural products through our NGX partnership and our Winnipeg Exchange acquisition.

Therefore, by the end of 2007, we’ll offer an additional 60 products on our platform compared to the beginning of this year.  These products range from cleared physical gas to canola and coffee, Russell indices and currency pairs, as well as sugar, crude oil, and options on natural gas. 

This is on top of the growth that we’re seeing in the dozens of products that we launched in 2006, including West Texas Intermediate crude oil and several cleared OTC energy contracts. 

Today, the breadth and depth of our product lines speak for our ability to scale our markets and gives us a competitive advantage.  We continue to see growth in each of our markets, and we believe that each represents significant value creating opportunities for ICE.

As always, I’d like to thank the ICE employees and our strong customer base for a very good quarter. As you can see, we continue to set an ambitious agenda that centers on the evolving needs and the opportunities that exist in the derivatives markets. 

This concludes our prepared remarks. With that, we’d be glad to take your questions.

Question-and-Answer Session

Operator

Your first question comes from Daniel Harris - Goldman Sachs.

Daniel Harris - Goldman Sachs

Over the past couple of weeks, there were a couple of reports out indicating that there may or may not be a review of things that you guys are going to be doing down at the NYBOT in terms of the pits and keeping them open. 

While clearly a lot of the volumes have certainly trended to the electronic screen, I’m just wondering if you can update us on your thoughts regarding that?  I know a lot of this has to go through the board and be approved by member vote, but I just want to hear what you’re thinking at this point.

Jeffrey Sprecher

I think generally speaking today, about 85% of the volume of the NYBOT Futures complex is electronic and about 15% remains on the floor.  That does not include options, which is still largely floor-based. 

The reason that these press reports have come out is that our management has been out talking to the marketplace to ask the market about the efficacy of the 15% that remains on the floor and whether or not it’s an important component to the market. 

More importantly, since we’ve acquired the NYBOT, we’ve rolled out a lot of new technology, technology in addition to the obvious electronic trading platform, that allows some of the kinds of things that were done on the floor to be taken upstairs.

As a result of these conversations that our colleagues are having with the marketplace, we’re trying to gather information and we’re going to take the results of that to the board of the NYBOT and see what kind of decisions come out of that. 

Generally speaking, there is a dialogue going on right now with the trade, and this includes people on the floor and brokers that are supporting floor operations about their needs and wants and desires for continued floor-based trading. 

We don’t have an exact answer as to what’s going to happen now because we’re still in that dialogue, but the fact that we’ve hit this 15% level has really stimulated a pretty broad dialogue within the industry about whether or not the rest of the business should move upstairs.

Scott Hill

One thing I’d add, Daniel, and it is important to keep in mind, is this has not gotten in the way at all of the cost synergies.  As I mentioned in my remarks, we’re on track to the increased synergies we talked about in the second quarter. 

As we looked at the results in the third quarter, that business actually has doubled its operating margin and doubled its operating profit on a year-over-year basis, so we continue to make good progress there.

Daniel Harris - Goldman Sachs

Jeff, can you help me think about how your traders -- both institutional, financial and the underlying -- have changed their trading strategy in this type of oil pricing environment?  As oil really spikes up here, how do people think about hedging, or taking advantage of that in both the near and near term and sort of further out in the curve? 

Jeffrey Sprecher

I think one thing that you tend to see in trading of oil generally, but particularly so in times of high volatility, is that people are not necessarily trying to make a bet on the absolute price of oil because it is so volatile. As all of us know, something could happen elsewhere in the world while we’re asleep at night that could dramatically affect the price of oil.  People tend to play oil trading with spreading and they tend to look at differences between months or differences between products so that they effectively build in a hedge.

One of the things that is emerging around oil trading today that did not exist very much let’s say at the time we started ICE, is the increased use of options as another way of building a hedging strategy around the price of oil.  That’s why we have acquired Chatham Energy to try to get more options expertise in the company, and we’ve been pretty open about the fact that we’ve been building for quite some time an enhanced options trading platform that we’re going to be rolling out here in the near future.

 That’s an area where we want to address.  That options market in energy is still a very interpersonal market.  It’s done largely over the telephone and even to the extent that other futures exchanges have electronic options capability, a lot of that business is arranged upstairs through dialogue before it hits the electronic system. So we’re looking for ways to build efficiency into that so that we can capture part of that business.

Operator

Your next question comes from Howard Chen - Credit Suisse.

Howard Chen - Credit Suisse

Jeff, it appears that there continues to be widening gap between your over-the-counter revenues and that of your primary competitor.  I guess in your mind, what’s driving that widening gap and apparent growth in the over-the-counter market share for ICE?

Jeffrey Sprecher

A couple of things.  One is, we really do believe in this idea of having futures and OTC on one screen and cross-selling products. and so we have the benefit of ICE Futures Europe and their oil platform that’s being distributed globally.  We’re able to expose these over-the-counter markets on ICE, which traditionally have been very U.S.-centric to a global audience, and so that gives us a bit of an edge.

Secondly, we have started to move into the options business where we didn’t have a presence before, so there was really a lack of competition in part of the space. I think we intend to make good progress there. It’s obviously an area where management’s been putting a lot of attention.

I think we have been engaging the clearing community through the conversations about trying to build a global clearing strategy and to the extent that a clearer can bias a customer trade, I think increasingly you see it coming our way. I do think that some of the concepts that we’re trying to put in place will ultimately be very beneficial for the clearing community.

So I don’t think it’s any one thing, it’s just a combination of going out every day and trying to address needs and problems and the sum total of that seems to be doing well for us.

Howard Chen - Credit Suisse

Scott, a quick one on the numbers. Market data revenues continue to trend higher, can you parse out the drivers of that strength? Is it more users, the impact of some fill-in acquisitions like ChemConnect, are there fee schedule adjustments that you did?

Scott Hill

The biggest driver of the year-over-year growth, as you are aware, is the addition of the New York Board of Trade, now the ICE Futures U.S. business. We continue to see trends also in our ICE data business, which does come from additional users that we have. I may have the numbers a little off, but I think we’re now above 7,000 connections overall and we started the year at roughly about 6,000. So those increases will also help drive our data fees.

Howard Chen - Credit Suisse

On the sequential quarter strength in particular, anything to speak of there?

Scott Hill

It’s really the same two drivers. As I stare at the data and look back over, frankly, the last six quarters, it really has been the increased ICE data fees and the introduction or the inclusion of the ICE Futures U.S. business.

Operator

Our next question is from Rob Rutschow - Deutsche Bank.

Rob Rutschow - Deutsche Bank

I’m wondering if you might be able to give us a little more detail on the clearing build out in terms of how many employees you’ll have when you launch in the third quarter? How much head count growth will you have related to increased regulatory requirements?

Charles Vice

We are in the midst right now of recruiting and hiring out that organization. We’ve got a target somewhere between 12 and 16 employees, those are all London-based employees, and that ICE Clear Europe will have primary outsourcing arrangement with ICE, Inc., the parent.

Part of the integration with NYBOT has been integrating the IT resources, the clearing IT recourses, both the systems and the people in New York with those we have in Atlanta to support the ICE Clear Europe business unit, which as Jeff gave some details on in his remarks, is on schedule for a July launch next year.

Scott Hill

The only thing I’d add to that is we do have a few resources on board. We’ve said previously that there would be about $7 million to $10 million of transition expenses. We’re still in that range. On an ongoing basis, we had guided previously that we expected about $9 million to $14 million of ongoing operational costs, and what Chuck just talked about is an element of that guidance.

Rob Rutschow - Deutsche Bank

You mentioned the data center relocation to Chicago. I’m wondering if you’re going to have any additional costs related to that in the first quarter, and whether or not there’s going to be any change in the tax rate if you’re transitioning revenues out of Georgia and into Illinois?

Scott Hill

I didn’t get the second part of your question. Could you repeat it?

Rob Rutschow - Deutsche Bank

The first part was any additional costs associated with the relocation, and the second part was any change in the tax rate due to a change in venue?

Scott Hill

We’ve looked at both. In terms of cost, we basically have been making the capital investments throughout this year to get that data center up and running. It’s actually acting now as a backup facility for us while the primary center is here in Atlanta. There won’t be a lot of incremental costs because that capital has come in and has started to depreciate into the income statement. You shouldn’t expect as you go into first quarter, second quarter of next year to see any kind of spike in the expense due to that.

In terms of the tax rate, we did do a lot of work looking at that, and actually there is an immaterial impact in terms of overall taxes from that action.

Rob Rutschow - Deutsche Bank

You have interest from algorithmic traders at this point that you think moving will benefit you there?

Charles Vice

Absolutely, We have a much larger co-location suite, actually a separate suite there in that facility in Chicago. In fact one of the reasons we chose it is that it’s so heavily occupied by the trading firms themselves already. So they’re actually already there and it’s a simple matter of just cross-connecting to our suite, our cage there where our computers are.

Operator

Your next question comes from Rich Repetto - Sandler O’Neill.

Rich Repetto - Sandler O’Neill

On the over-the-counter segment, I know you did answer one question already, but I’m just trying to see a little bit more color where the volume -- I’m looking through the slides and volume was up 4%, but you still saw a nice 21% increase in the average daily commissions, even with a lack of major, major  hurricane volatility.

Is there anything that is primarily driven by natural gas -- it still doesn’t seems like an answer or a summary on this, or how to understand this; more the growth, I guess. Are the options being more reflected in the average daily commission?

Scott Hill

As we looked at it, there are a couple of drivers.  Number one is we saw a good strength in the power business and the mix in that business and the rates associated with that business are good relative to some of the other products.  So to the extent we see strength there, we see stronger revenues relative to simple volume. 

We continue to see increases in the oil area, particularly as the agreement with Platts comes online. Frankly, that’s something that we think will stay with us.  Also just in terms of overall rates management -- and I don’t recall in which quarter it occurred -- but there was an adjustment in the clearing fee previously where we held our rates.  So to some extent, you’ve started to see some of the transition of that revenue to our company.

Those three things combined helped drive the revenue strength relative to the volumes at 4%.

Rich Repetto - Sandler O’Neill

Jeff, more of a broader exchange question. You saw the Middle East players get active in the exchange space this past quarter; very helpful to NASDAQ.  You’ve got to believe that they would be interested in energy. I think you were right in predicating the failure of these solid crude contracts. 

Is there any activity or conversations going on with the players out there that have these balance sheets that are starting to impact the exchange landscape globally?

Scott Hill

I’ll avoid giving any specifics about current conversations, but I will try to be somewhat responsive.  We, at the time of our IPO which was in 2005, had thought that maybe some of these Middle East sovereign funds might be interested in our stock.  We did, as part of our road show, reach out to them.  At that time, there was not really much interest.  I think they were curious but there wasn’t specific interest in exchange investment. 

You’ve obviously seen through the actions around NASDAQ, OM, LSE  that view has been changing.  The one backdrop that I take away is that I think this phenomena of sovereign investment is probably something that’s relatively recent.  But there is clearly a large pool of capital that is coming out of many emerging nations that are looking to buy infrastructure. 

One of the unique things about exchanges it that they still have symbolic importance to many countries, symbolizing that they are a financial center and that capital formation can happen in their country.  So one can imagine that this may be the beginning of a trend, given the volume of capital that’s being accumulated by many emerging countries.

Rich Repetto - Sandler O’Neill

It just seems like there’s more agreements, with the CME yesterday. But you got to believe that they’d be very, very interested in your help growing something over there? 

Jeffrey Sprecher

You used up your follow-up.

Rich Repetto - Sandler O’Neill

Fair.  Thanks.

Operator

Your next question comes from Ken Worthington – JP Morgan.

Ken Worthington – JP Morgan

My question goes to the liquidity provider stats that you provide in the Qs and Ks.  What is the process that algorithmic, black box, the liquidity providers, what process do they need to go through to begin trading on ICE?  How long does this process take?  Is it different for futures than OTC? 

Given the new technology would you expect their participation or their portion of your volume growth to be bigger?  I think those stats have been stuck around 30% for a while.  Should that be a bigger part of your business? 

Scott Hill

You have a couple of questions there.  Let me do my best.  First, to the extent that we’re talking about liquidity programs around our European Futures business, the FSA has some very strong views of how order flow is accumulated and so we put together very formal programs for liquidity providers. 

They tend to be limited as to the number of liquidity providers, so they tend to be somewhere around three, four, five or six liquidity providers.  You have to apply to become a member.  They tend to have a short duration so that it allows new applicants to apply and current participants to reapply so that the mix of individual companies may change.  They don’t necessarily allow payment for order flows so these things tend to be volume metric commission discounts, largely.

In our over-the-counter business, to the extent that we tend to look at targeted programs, we tend to look at our markets with a critical eye and try to figure out where we could use some liquidity and it may be in a specific product, or it may actually be in a specific part of the forward pricing curve on our product.  There we, just through market conversation, try to find market participants that will help interject liquidity. Again, those tend to take the shape of some kind of volumetric commission discount, and it’s a bit more ad hoc.

In Winnipeg, which we just acquired, they have had a longstanding program with a handful of liquidity providers;  I think it’s about five. We just renewed that program to go through the month of February of next year.  The Winnipeg Exchange is going electronic in December of this year, so we’ll have an opportunity to look at the electronic market-making capabilities around Winnipeg.

With respect to ICE Futures U.S. or the former NYBOT, we have liquidity programs for various products. Again, they tend to be ad hoc and the ag liquidity programs are slightly different than what you use for foreign exchange and equity indices, given the different nature of trade participants. 

But anyway, when you step back and look at all that, there’s nothing particularly exotic.  It tends to be relatively limited in what we do. At the heart of your question is, what is the percentage that one can expect of those kinds of participants?  What we’ve seen is that they’ve been around 25% to 30% of our market. That has come from this broad pool of hedge funds, algorithmic traders and non-traditional players. 

But we’re growing so fast that the absolute volume that these participants are putting into our market is actually growing even though their market share is not.  One of the neat things that we see about this is that as we’ve injected this additional liquidity in these markets, the amount of commercial user interest in the market has grown proportionately to keep the market share the same. We find that to be a very, very healthy trend. 

It allows us in our conversations with you to continue to reinforce the fact that there’s a lot of commercial hedging use going on in our markets and that historically has been where we have had strength.  I think it’s an important part of the market, because if you have the commercial users there, it’s pretty easy to attract liquidity providers.  If you only have liquidity providers, it’s not necessarily easy to attract the commercials.

Ken Worthington – JP Morgan

The question was poorly asked but well answered, so thank you. Picking on Russell a little bit, can you just expand a little bit more about what you are doing and maybe other programs or things you plan to do over the next couple of quarters to migrate that volume away from the competition to ICE?

Jeffrey Sprecher

Sure.  First of all, we are getting the products out there, getting them listed and getting them distributed, which is a whole new infrastructure for us. 

The second thing -- and it’s an important part of what we’ve been trying to do -- is we’re in negotiations with the Options Clearing Corp., the OCC, to put in a cross-margining agreement that would allow equity options on Russell products to have economic offset, if you will, against futures.  A lot of the people that trade equity options on the numerous equity options exchanges hedge their position using futures. So that’s an important relationship.  That, I think, will be wound up relatively quickly.  We’re well along in that negotiation.

And then really it is just marketing. We’ve been out talking to people and trying to build interest as to exactly when this transition will take place in bulk.  A couple noteworthy facts is that obviously the last few months there has been tremendous volatility in the equity markets and trying to move something in the middle of a chaotic market is difficult.  So, we’re actually hoping for a little less volatility. It does seem and feel like we’re certainly in a less volatile period this month than we were late summer.   So, we’ll hope for a continued period where we can target that.

The Russell actually reconstitutes the index; I think it’s during the summer.  We want to try to avoid movement during that period because, again, there will be a bit of chaos, if you will, or uncertainty about the reconstituted index. 

So I think what Scott’s prepared remarks had suggested that sometime next year in the first to second quarter we’re going to make a concerted push to try to build liquidity on that product so that it happens in advance of the reconstituted index, and it also happens in advance of the loss of the license by the current competitor that has Russell trading.

Operator

Your next question comes from Mark Lane - William Blair.

Mark Lane - William Blair

First on the over-the-counter business, following up on Rich’s question, you both threw out a number of reasons for the growth and the apparent market share gains, new products, new users, and higher rates, et cetera, et cetera.  Can you put any detail around that just to give us any more transparency into that?  It seems there is like a mosaic theory at this point.

Jeffrey Sprecher

Yes. I think it actually is.  It’s not necessarily that easy to find any one driver, but one thing that has happened as you’re quite aware of is that our competitor has taken their floor-based products onto the screen and so there’s now the ability to arbitrage and lever electronically off of each others’ markets, which historically, we’ve found has driven growth in both venues. I think that’s a driver.  We’ve been bringing in these algorithmic traders into the OTC markets; that’s a driver.

As Scott mentioned, there’s been a mix shift around the OTC products that have traded.  There is definitely more oil trading and power trading going on as we get deeper into new markets. 

There was a small price increase, it would effectively be, as we internalized some of the clearing savings that have gone on.  All of that together is what has driven the performance, and all of those things, I think, continue.  Those were not one-time things.  We haven’t seen any of those trends that we’re talking about be abated.

Mark Lane - William Blair

A follow up on the regulatory question, the way that you positioned it was that increased regulation is not a negative, but can it be a big positive?  I mean, given the fact that so much of the over-the-counter market is opaque? If there’s any part of the market that’s transparent, it all would be electronic format?

Jeffrey Sprecher

Yes. I’m an optimistic person generally and as a company, we look for opportunities when there’s change. We’ve been really net beneficiaries of being at the center of a lot of change. When you really step back and think about what’s been going on, I’ve said repeatedly that I think as these markets become bigger and more transparent and broader, they’re going to naturally attract more oversight. What’s going on in the debate in Washington is just a dialog about what that means.

Given that for the last year we’ve given the bulk of our OTC trades in real time to the CFTC the real debate is now, if there is a problem in these markets, who is going to take action and what should the action be?  That’s a natural extension of the fact that the data is being provided broadly to government and there is more oversight.

What you’re going to see and what we’ve said that we would embrace is that if the government wants us to take on more oversight responsibility, we’re happy to do that.  If the government wants to keep it itself, we’re also happy to cooperate with them. But given that we have three regulated futures exchanges, we certainly have the infrastructure here and the knowledge and the understanding and the platform is designed to produce the kind of reports that one would look for.

We’ve looked at our own markets with a critical eye over the last year and we think that they are very, very properly functioning markets that are growing not because of some kind of regulatory arbitrage, but they’re growing because of the need for hedging and the increased investment that’s going on in commodities.

Having a more regulated market will do a couple of things for us. One is I’m hoping that it will bring more confidence to the smaller commercial user. These would be municipal utilities and gas and power utilities that are really the people that are concerned that there may be hedge funds that are overly dominating the markets. Getting their confidence and moving them into the over-the-counter markets will be a net positive for us. They traditionally avoid OTC markets and to the extent they’ve been hedging have been doing it on regulated futures.

The second thing is -- and I’ve been open about this with government -- is that this kind of regulation is going to increase the barriers to entry for other market participants that are seeking to organize up electronic markets. I don’t necessarily think it is a good thing for the United States, but as the CEO of ICE, I do believe it will create a bigger barrier for those that are thinking of entering this market, which is probably a good thing for us from a competitive standpoint.

One of the good things, Mark, that’s happened and the reason we came out publicly around the report that the CFTC put together and published yesterday, was their involvement of the President’s Working Group. The President’s Working Group is comprised of the Acting Chairman of the CFTC, Chairman Cox of the SEC, Chairman Bernanke and Treasury Secretary Paulson.

Those individuals are looking at these markets from a global competitive standpoint. They are wanting to make sure that we don’t have regulation that’s going to drive business offshore and what have you. Their voice entering this debate has really been helpful and I think will bring confidence to legislation that will move forward to put the right kinds of things in place that will not drive business overseas.

Again, we have many overseas businesses and we could adapt if that where the case. But as an American citizen, I personally am hoping that their influence will continue to keep balance here.

Lastly just to add, I think that it’s going to be hard to get something past this year, but I’m optimistic. I was in Washington all day yesterday. There is a movement to try to get a consensus piece of legislation together and to possibly try to move it quickly.   I think ICE is getting behind it and NYMEX potentially is getting behind a piece of legislation along with the CFTC, it could go a long way. So we’re all dialoguing and trying to see if we can develop a consensus view that would help move this along.

My interest in having it move along is simply that I don’t really want the market to be overly concerned about our position in the market, and I also don’t want our customers to be concerned about regulatory uncertainty.

Scott Hill

Mark, just to go back to your first question to give you and Rich a data point for the mosaic. Underneath the 4% OTC ADV growth, it’s about 6% for total volume and power would be 20% underneath that. So that’s some of the mix shift that you see.

Operator

Your next question comes from Jonathan Casteleyn - Wachovia Securities.

Jonathan Casteleyn - Wachovia Securities

Jeff, I really always appreciate your detailed and historical perspective on your strategy. I’m just trying to boil it down to your top three growth initiatives. Is there any way you can just rank and file those for me?

Jeffrey Sprecher

First is clearing, it probably won’t be an immediate benefit but I think structurally, my view is that this part of the market is going to become increasingly more important. So it is an expense that we’re incurring ahead of revenues.

Secondly, I think moving into equity indices and foreign exchange, given that we’re coming on from almost a zero base in those markets will be very, very important. As you know, those are very big markets. Foreign exchange had a lot of electronification already and is sort of a disjointed market so I think there’s room for new entrants into that market as opposed to many other asset classes.

Lastly, I do think that the over-the-counter markets, as we move into this more regulated type environment, will attract new market participants. When you couple that with the fact that we’re doing this Canadian deal with NGX and that we’re doing a global oil deal with Platts, and we have ChemConnect, so I think while none of those individually is revolutionary, together I think they continue to be evolutionary and I do think you will continue to see growth in the OTC part of our business.

Jonathan Casteleyn - Wachovia Securities

Scott, $193 million in cash, what’s the amount of cash or liquidity needed to run the business to support working capital and also provide a potential backstop for the clearinghouse as you get in there in the back half of ‘08?

Scott Hill

We’re still doing the analysis on what will be required in terms of liquidity as you go into the ICE Clear Europe. But I’d tell you, as I’ve looked at it, I think $75 million to $100 million is a comfortable cash and short-term investment balance in terms of running the day to day business.  I think given the strong cash generation of this business, you could dip down below that for a while because you come back fast.  

Just to give you a sense, we’re sitting with $193 million of cash right now, which is only down slightly from a year ago and that’s after $164 million spent on the New York Board of Trade, it’s after $50 million spent on Russell, it’s after nearly $50 million spent on Winnipeg. 

So I don’t think you need a large cash balance in order to run the business. I think what we do have, though, with $193 million in cash with full access to the line of credit, is we’ve got tremendous flexibility to act opportunistically as we see right investment opportunities which will help us grow the business.

Operator

Your next question comes from Chris Allen - Banc of America Securities.

Chris Allen - Banc of America Securities

I just wanted to ask quickly about your take on the CME and the BM&F transactions, given CME’s ag business and then BM&F’s, just the Brazilian economy, the focus on sugar; do you regard this as somewhat of a competitive threat or do you see it as potentially additive to the future pies as we’ve seen with other products?

Jeffrey Sprecher

Generally speaking, I think, we have the Andy Grove view around here that only the paranoid survive so we view everything as a competitive threat. But I will say that I think it was a very good investment for the CME and I did reach out yesterday and called Chairman Duffy to congratulate him because I think that is a very unique asset and an opportunity to work together. 

So in terms of direct competition, I guess we’ve always been the underdog and so we don’t shy away from that. Maybe more importantly, I think that when you have multiple venues that trade, you create trading opportunities and actually drive growth. We’ve seen that with our West Texas intermediate crude oil contract and what have you. 

I think that it’s possible that over time Brazil could get more drivers coming out of sugar, maybe ethanol, given their economy.  I think those will be symbiotic with what we’re doing at NYBOT and together the two will drive growth.  So, the paranoia has not reached the level that we feel that we have to do something really novel.

Operator

Your next question comes from Edward Ditmire - Fox-Pitt Kelton.

Edward Ditmire - Fox-Pitt Kelton

The Russell expense guidance that you gave in the release for the second half of ‘08, the $6.3 million to $7.8 million per quarter, the difference between that and the current rates and what you guys talked about on the last call, is that all volume related?

Scott Hill

No. I am going to try and make this an easy answer, but it’s a fairly complicated topic so I apologize going in.

Fundamentally, what we’ve done is we have created the $50 million upfront payment and the present value of the future minimum payment that we’ve agreed to. We’ll begin the process of amortizing that into our income statement started this quarter. What we’ve done is we’ve looked at this as if it were two assets. One is a non-exclusive asset over the first year, and the second is an exclusive asset over the subsequent six years.

As you would imagine, the value of the non-exclusive element is de minimus. The value of the exclusive element is the most significant portion. When you do this, when you take the present value, the difference between that and the expected payment is an imputed interest.

So you are going to see two components.  When you look at our income statement this quarter and for the next three quarters, the $1.5 million I’ve talked about is all going to look like interest expense. So there will be very little left in the depreciation and amortization line.

As you get into the third quarter of next year and then for every quarter for the following six years, you will see about $6.2 million, give or take, of amortization and then a slowly dwindling amount of interest expense as that asset comes into the income statement.

Edward Ditmire - Fox-Pitt Kelton

Can I just ask a simple question? I know that the Russell has strategic implications and what not, but on a standalone basis, what kind of volumes do you guys think you need to breakeven on this thing?

Scott Hill

I haven’t really looked at it. This is a rare circumstance where we know the types of volumes that occur today. We can look at the volumes that are trading and I don’t know what the latest figures are, but it’s somewhere in the 220,000 to 250,000 contract per day range. That’s how we’ve looked at it.

Our expectation is, as Jeff and I talked about a little bit in our prepared remarks, that we’ll start to see some of that volume move in the first and second quarter of next year. It will all have moved by the time we get to the third quarter of next year. We are working with customers and working with Russell to take today’s volume and grow it.

The way I’ve looked at this, and we did look at it as a business case is, when we get the volume that we have seen historically to our platform and when we take the actions necessary to grow it, what does that look like in terms of the financial return, just as if it was M&A? And it’s a very attractive return.

In the near term, as you saw this quarter, we had very little Russell-related revenue. It will probably be modest to minimal in the fourth quarter as well, but we’ll have this bit of expense.  Our expectation is the volume and the expense will start to ramp in the back half of next year.

Operator

Your next question comes from Mike Vinciquerra - BMO Capital Markets.

Mike Vinciquerra - BMO Capital Markets

Jeff, can I follow up on this thing on the Russell?  You had mentioned you had discussions with the OCC and looking for cross-margining; that goes to the bigger question about portfolio margining, in general. Is that topic being broached in your discussions as well, or do you see this being more of a product by product discussion, because equity futures connect more fully with options on the same equity?

Jeffrey Sprecher

We definitely are having broader discussions. One of the things that’s gone on around here is we’ve brought in two really topnotch clearing experts in Tom Hammond in the U.S. and Paul Swann in Europe. 

I’ve asked them to think outside the box, and let’s be a leader in driving change around clearing which is kind of an oxymoron, because obviously clearing is managing risk and so it needs to be dealt with very, very delicately and with a lot of thought and foresight.  

I think the kinds of broad, sweeping changes that may come through clearing are things that are going to be evolutionary, not revolutionary and they are going to take time because you are dealing with risk and you are dealing with the infrastructure of our industry as you broach these things. 

We definitely have a pretty broad mindset here. We have the license to do that as being the younger company entering this business and looking for opportunities.

Mike Vinciquerra - BMO Capital Markets

You made it sound as though the timeframe might be relatively soon on this. Is that the next couple of quarters? Is it even sooner than that?

Jeffrey Sprecher

I don’t want to give you any guidance in that regard because there are all kinds of discussions and conversations going on with lots of various parties.  They may or may not be fruitful and they may or may not be meritorious when you boil it all down. I think it’s fair to say that we’re looking at what can we do to improve the business? Improve it for our customers, improve it for the clearing community, and improve it, ultimately, for our shareholders. 

I think clearing has been an under-invested asset in our industry, and maybe the most important asset in our industry. So it’s with that kind of mindset that we’re looking at these things.  Beyond that, I don’t want to give you anything specifically.

Mike Vinciquerra - BMO Capital Markets

No. That’s fine.  Thank you, Jeff.  On the RPC in the U.S. Futures I think, Scott, you mentioned it was $2.18 in September and continues to expand.  Is this just a mix shift?  Is there something in particular that will allow that rate potentially to stay at those levels or even go higher?

Scott Hill

Clearly there is mix at play.  If you look at the trends over the last couple of quarters, we had $1.85 in the second quarter that was up from $1.59 in the first quarter and at $2.07 for this quarter.  You may recall that we had the fee increase that we introduced June 1, I believe, is when we put that fee increase in place which helped with the Q2 rates, helped with the Q3 rates.  Clearly, from a month-to-month standpoint, mix can impact the rates. 

What we’ve looked at and what we’re going to talk about as we move forward is really the three months rolling average.  That’s the $2.07 for the quarter. I think that’s the way you ought to think about rates.

Jeffrey Sprecher

I will say that we’re so early in the electronic migration of that business that just the power of electronification is bringing new customers into the business.  At some point, I’m sure as management, we’ll sit down and look at the rate structure there and look at do we need more aggressive market maker programs or do we need to look at the mix and put new things in there?

It’s just so new and so young and there’s still so much going on with the migration of trading that we haven’t really played around so much with that.  So in terms of what does the long-term rate structure look like, it may change but if it does, it will probably be because management believes that we can increase revenue by putting our mix change in there. 

Obviously, we’ll signal that to you if we ultimately do put some programs in place.

Scott Hill

The thing I’ve found really remarkable about the performance for this business in the quarter, if you set the rate aside, is we had 23% growth in ICE Futures U.S. ADV and that was in a world where we had the lowest volatility that we’ve seen in sugar in about a year-and-a-half with a product that represents 45% to 50% of our total contract volume, with slow to minimal growth, we grew the overall volumes about 23%.  I think that’s a good news story for the quarter.

Operator

Having no other questions in queue, Mr. Sprecher, I’ll turn it back to you for closing remarks.

Jeffrey Sprecher

Thank you all again for your attention and for following us. I appreciate the provocative questions.  We look forward to talking to you again next quarter.

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