Cboe Global Markets, Inc. (CBOE) Q1 2017 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the CBOE Holdings first quarter 2017 financial results conference call. All participants will be in listen only mode. [Operator Instructions] And please do note this event is being recorded. I would now like to turn the conference over to Debbie Koopman, Vice President of Investor Relations. Please go ahead.

Thank you. Good morning, and thank you for joining us for our first quarter conference call. On the call today, Ed Tilly, our CEO, will discuss the quarter and our strategic initiatives for 2017. Then Alan Dean, our Executive Vice President and CFO, will detail our first quarter 2017 financial results and provide updated guidance on certain financial metrics for 2017. Following their comments, we will open the call to Q&A. Also joining us for Q&A will be our President and COO, Chris Concannon; and our Chief Strategy Officer, John Deters. 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. During our remarks, we will make some forward-looking statements which represent our current judgment on what the future may hold. And while we believe these judgments are reasonable, these forward-looking statements are not guarantees of future performance and involve certain assumptions, risks and uncertainties. Actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. Please refer to our filings with the SEC for a full discussion of the factors that may affect any forward-looking statements. We undertake no obligation to publicly update any forward-looking statements whether as a result of new information, future events or otherwise after this conference call. During the course of the call this morning, we will be referring to non-GAAP measures that are defined and reconciled in our earnings materials. We also will refer to pro forma results which are also reconciled in our earnings materials. As you know, we completed our acquisition of Bats Global Markets on February 28, 2017. The pro forma results for the information regarding the combined operations as to the Bats acquisition had occurred at the beginning of 2016, in order to provide a more meaningful discussion of our results. Now I'd like to turn the call over to Ed Tilly.

Thank you, Debbie, and good morning and thank you for joining us today. Before we begin our formal remarks, I would like to welcome Chris Concannon, our new President and COO, to his first CBOE quarterly earnings call. Many of you already know Chris and the talents he brings to the CBOE leadership team. Turning to the quarter, I'm pleased to report on a strong first quarter 2017 at CBOE Holdings, with adjusted earnings per share of $0.78, a net revenue of $193.4 million. Our first quarter performance built on last year's solid financial results and continued growth in index trading, led by record trading in SPX options. Our big news for the quarter, of course, was the completion of the acquisition of Bats Global Markets on February 28. I'll have more on that in a moment, but first we'll note that we continue to focus on our core business and maintain strong organic growth in the period leading up to and after the close. Our options volume during the first quarter was up 9% over the previous year, and our proprietary products continued to outperform the industry. We saw record trading in SPX options, which increased 15% over the first quarter 2016. VIX futures trading had its third busiest quarter to-date, and increased 18% year-over-year. We saw similar trends in April in our proprietary products. In our new lines of business from the Bats transaction, we saw first quarter market share in U.S. equities decrease by 2 percentage points against the prior year's first quarter, reflecting lower volatility this year and a record quarter last year. European equities market share was down by about 2 percentage points from the first quarter last year. And while overall global FX volume was down in the first quarter, our market share grew to a record high 12.9% compared to 11.8% a year ago. Moving on now to our integration with Bats. Getting this integration right is our greatest opportunity to benefit our shareholders, customers and employees. I'll use the remainder of my time here to discuss our vision, progress to-date and next steps for fully leveraging our Bats investment. I'll begin by reiterating the four major areas of benefit we expect to see for this deal. First, it grows our company and allows us to scale up, enabling us to increase our profit margins and strategic optionality. The acquisition also increases our recurring non-transaction revenue and further enhances our strong growth and margin profile. Second, it significantly diversifies our product line into new asset classes and geographies, creates new revenue sources, attracts new users to our marketplace, and enables us to efficiently provide packaged offerings, particularly for our large customers. Third, it enhances innovation at CBOE by giving us the opportunity to shape and capture revenue from every aspect of the product development trading cycle. With the addition of Bats' Global ETF listing and trading venues, we can now design new indexes, list them, educate more customers on how to trade them and generate and package market data to deliver incremental revenue and create new products. The new asset classes and geographies brought to us by Bats are building blocks for innovation. We plan, for instance, to leverage CBOE's derivative expertise and Bats' European and FX footprint to create unique products and apply our existing -- and apply our indexing expertise to Bats growing European index business. I'll mention here that Bats rolled out the Bats Brexit 50/50 indexes in March, 10 benchmark indexes on European markets in April, and plans to launch a Pan-European index later this quarter. Fourth, the acquisition grows our customer base and immediately affords us the opportunity to cross-sell additional products and services to more customers. Now an early progress report on integration. We began on day 1 to execute a detailed plan developed well ahead of the close in order to immediately begin to realize the benefits of joining our two companies. We reconfigured our business development and sales operation to leverage our newly expanded product line and geographic reach. Bats brings a much greater physical presence in New York and Europe to CBOE, enabling us to significantly increase boots on the ground in those locations as we begin cross-promoting a broader product line globally. We consolidated offices in locations where there was overlap, and are integrating our expanded global sales force to more efficiently reach customers and improve their experience. While Bats extends our global reach, CBOE brings a robust marketing and educational offering to the combined company. This gives us the opportunity to efficiently raise the profile and understanding of Bats products and markets, which are already being incorporated into our customer-facing efforts. Our annual U.S. Risk Management Conference in March, for instance, was our first as a combined company, and we will showcase our expanded product line later this year at our European and Asian RMC events. We are similarly expanding The CBOE Options Institute curriculum to include educational content on Bats' products, while significantly expanding our educational breadth and reach with the addition of ETF.com. We have greatly expanded and reconfigured our R&D area to comprehensively approach the tremendous opportunity we see for increased innovation. Our newly launched multi-asset solutions division was structured to apply CBOE's innovation expertise to a much broader array of products and services. The new division incorporates product development, market research and information solutions, which includes indexing, data and analytics and execution services. This integrated approach positions our team to innovate across product lines and geographies, and to collaborate with market participants such as index providers and customers and new partners such as ETP issuers. I should note here that in light of our growing index business, CBOE recently joined the Index Industry Association, IIA, which includes leading global index providers such as our partners S&P Dow Jones Indices, FTSE Russell and MSCI. Going forward, our expanded products and services offering will ultimately be powered by Bats' leading proprietary trading technology. Migrating our trading technology onto Bats' proven platform underpins the scale and efficiency we expect to gain from the CBOE-Bats combination. We are laser-focused on working closely with our customers to ensure a seamless technical and operational integration. On March 29, we hosted the first in a series of customer conference calls on technology integration and a migration of CBOE's exchanges onto the Bats' trading platform. CIO, Chris Isaacson, provided a detailed roadmap for CFE's migration, which we expect to complete in February 2018, followed by C2 and then CBOE. Our next systems integration customer call, scheduled for June 6, will provide additional information on the C2 migration time line. In other technology news, we also held a customer conference call last Thursday, to introduce the new complex order book functionality being offered by the Bats' EDGX Options Exchange expected to launch in October. In closing, I would like to thank the entire combined CBOE team. Our ability to hit the ground running on day 1 is a credit to the sustained efforts of the legacy CBOE and Bats teams and our intensive integration planning and preparation prior to the close. These are the very early days of two dynamic and innovative companies coming together. A shared competitive spirit has inspired our teams to bring forth the best of each culture and to make our combined company the best it can be. We could not be more excited about the opportunities that lie ahead now that we are operating as one company and one team. With that, I thank you for your time, and now I'll turn over to Alan.

Thank you, Ed, and good morning. Before I get into the details of our first quarter results, let me point out that our GAAP or reported first quarter 2017 results include Bats for the month of March. Therefore, the year-over-year variances on a GAAP basis were largely due to the addition of Bats on March 1. To provide a more meaningful review of our business, I will speak to the combined results of CBOE and Bats for the full quarter. So my remarks today will primarily focus on our pro forma non-GAAP results, which present financial results to reflect the Bats transaction, as if it had occurred on January 1, 2016. On that basis for the combined company, we saw strong results for the quarter despite weaker trading and activity across U.S. and European equities and derivatives markets overall. Our results were primarily fueled by the strength of our proprietary index products and growth in our non-transaction revenue which offset weaker trading activity in U.S. and European equities, and we're off to a strong start on our cost synergy targets. Summarizing our pro forma adjusted results, net revenue was $265.3 million, up 4% above last year's first quarter. Operating expenses were $106.3 million, up 4%, and the operating margin increased 10 basis points versus last year's first quarter. Diluted earnings per share of $0.86 was up 25% over the prior year period. Looking at our results further, starting with net revenue, we reported increases in transaction fees, exchange services and other fees, market data fees and other revenue. Generally, we saw a mixed performance by business segment with futures achieving the largest revenue increase followed by options. U.S. and European equities were relatively flat to down as those segments faced a more challenging trading environment this year and difficult comparisons against record results posted in last year's first quarter. However, strong growth in non-transaction revenue in these segments offset shortfalls in net transaction fees. I'll get into this in more detail later when I review each business segment. Non-transaction revenue accounted for 42.9% of total revenue in the first quarter of 2017, up 160 basis points from 41.3% in 2016's first quarter. As a result of the acquisition and related organizational changes, we are now reporting on five business segments: Options, U.S. Equities, Futures, European Equities and Global FX. Results for fiscal periods prior to first quarter 2017 are presented to conform to the new segments. Looking at the revenue contribution by segment, pro forma net revenue from options accounted for 51% of total net revenue and was up $2.9 million or 2% compared with the first quarter of 2016. The increase was primarily driven by higher revenue from net transaction fees, exchange services and other fees, market data fees and other revenue, offset somewhat by an increase in royalty fees versus last year's first quarter. Net transaction fees for options was up $1.5 million in the first quarter with higher revenue from index options, offset somewhat by a decline in multiply listed options. Transaction fees from our higher RPC index options were $85 million, up $5 million or 6%. This increase was due to a 7% increase in average daily volume over the last year's first quarter, led by a record quarterly average daily volume of $1.1 million contracts for SPX options, offset somewhat by a 2% decrease in revenue per contract. Transaction fees from multiply listed options of $18 million was down $4 million or 18%, reflecting a 9% increase in average daily volume, offset by a 27% decrease in revenue per contract, resulting from higher volume-related incentives achieved by trading participants. The increase in options market data fees was primarily due to gains in our share of U.S. options transactions this quarter compared to last year's first quarter. Total market share for CBOE Holdings was 41.4% for the first quarter of 2017, up from 36.8% in the first quarter of 2016. Furthermore, Bats BZX and Bats EDGX Exchanges achieved record market share of 11.5% for the quarter, up from 10.2% in last year's first quarter. Moving to Futures. Our fastest-growing and highest RPC business segment posted strong first quarter net revenue of $28.8 million, up 37%. This increase resulted from higher transaction fees driven by an 18%, an average daily volume per CFE, and a 10% increase in revenue per contract. Futures revenue per contract reached a new quarterly high of $1.81, up from $1.64 in last year's first quarter, reflecting the impact of fee changes implemented in January 2017. Looking at CBOE's organic growth from Options and Futures, excluding the Bats revenue contribution, you can see that we had strong organic growth of 8%, driven by the strength of our proprietary products, particularly VIX futures and SPX options. In the first quarter, proprietary products accounted for 88.9% of legacy CBOE's net transaction fees, up from 85.8% in the first quarter of 2016. On a pro forma basis, proprietary products accounted for 65.9% of net transaction fees in the first quarter of 2017, compared to 59.9% in the first quarter of 2016. Turning to U.S. Equities. Net operating revenue was essentially flat, reflecting a 21% decline in market volumes and a 2.1 percentage point decrease in market share, offset by a 21% increase in net capture, reflecting difficult comparisons against last year's record market share and trading activity. Generally, during periods of low volatility, such as we experienced in the first quarter of 2017, overall equities volumes decline and a higher percentage of shares are traded off-exchange. However, we were pleased that the strong contribution from our non-transaction revenue, including exchange services and other fees and market data fees, offset the decline in net transaction fees. Faced with a similar environment, net revenue for European equities declined 4%. However, the decrease was primarily due to the stronger dollar relative to the pound sterling. In local currency, net revenue grew 11% to £14.4 million in the first quarter of 2017, from £13 million in the first quarter of 2016, primarily due to growth in non-transaction revenue. Net transaction fees also increased, although to a lesser degree, despite a 15% decline in overall market average daily notional value and difficult market conditions, which was offset by an 18% increase in net revenue capture. For the first quarter of 2017, Bats retained its position as the largest European stock exchange with 21.5% market share. Net revenues for Global FX rose 4% to $10.8 million in the first quarter of 2017. This increase was due to access fees implemented in the third quarter of 2016. In addition, market share reached a new high of 12.9% for the first quarter. During the first quarter of 2017, nearly $29 billion of average daily notional value traded on the Hotspot FX platform, down slightly from just over $29 billion in last year's first quarter. Turning to expenses. This next slide details total adjusted pro forma operating expenses of $106.3 million for the quarter, up $3.7 million compared with last year's first quarter. Looking at the expenses in detail, you can see higher costs for compensation and benefits offset by lower costs for depreciation and amortization. The increase in compensation and benefits largely reflects higher incentive-based compensation which is aligned with our financial performance. Looking at our progress on cost synergies we expect to achieve from the Bats acquisition as we discussed previously, we expect to achieve $50 million in annualized expense synergies by year three and $65 million by year five. As Ed noted, we hit the ground running day 1. And while it's still in early days, we are making solid progress executing on our integration plans and as a result, the realization of synergies is ahead of plan. As this slide shows, we now expect to end the year with $20 million in GAAP run rate synergies for 2017, as we anticipate realizing some of the synergies earlier than previously expected, to arrive at the $50 million run rate in year three. For the first quarter, we realized $2.4 million pretax in expense synergies, primarily in compensation and benefits and professional services. On a cash basis, the run rate synergies for 2017 are about $5 million higher or $25 million, primarily reflecting lower expenditures for capitalized software. We think these targets are highly achievable and we'll update you as we make further progress in the integration process. Turning to guidance, the following information details our expectations for certain financial metrics for the full year 2017, taking into account our acquisition of Bats. Starting with expenses, we now expect total operating expenses to be in the range of $415 million to $423 million. This guidance excludes acquisition-related expenses, accelerated stock-based compensation and amortization of acquired intangible assets that will be included in our non-GAAP reconciliation. In 2016, CBOE and Bats combined had adjusted operating expenses of $417 million. So our 2017 guidance for operating expenses represents a change of up 1% to down 1%. Our guidance for 2017 primarily reflects higher expenses for compensation and benefits and lower depreciation and amortization expense. The increase in compensation and benefits primarily reflects merit increases, higher incentive-based compensation and a ramp-up in hiring to appropriately staff the maintenance and operations of our two trading platforms as well as to execute on the multiyear migration to the Bats technology platform. The decrease in depreciation and amortization is primarily due to the roll-off of fully depreciated assets. Depreciation and amortization expense which is included in our total expense guidance, is expected to be between $52 million to $54 million, excluding amortization of acquired intangible assets of about $169 million, which will be excluded from our non-GAAP results. On a combined basis, CBOE and Bats incurred G&A expenses of $57 million in 2016, excluding the amortization of acquired intangible assets. We expect our effective tax rate for 2017 to be in the range of 35% to 37%. For 2016, CBOE's effective tax rate was 39.4%, and Bats' was 39%. The effective tax rate outlook includes the adoption of new accounting guidance by CBOE in 2017 that requires the excess cash benefit or expense relating to the exercise of stock options and vesting on restricted stock to be reported in income tax expense versus through equity under previous guidance. This change in accounting guidance may have a favorable or unfavorable impact on our tax rate going forward, depending upon the future stock -- our future stock price and the concentration of stock awards vesting. Additionally, the tax rate reflects the benefit of recharacterizing our European operations from U.S. tax perspective. Moving on, capital spending in 2017 is expected to be between $55 million to $60 million, which includes spending to migrate the CBOE exchanges onto the proprietary Bats technology, while continuing to invest in systems to support CBOE's current trading technology. In 2016, CBOE's capital spending was $44 million and Bats' was $9 million. Let me touch on interest expense and debt. To fund the cash portion of the Bats acquisition as well as the repayment of Bats' existing indebtedness and certain transaction costs, we obtained borrowings of $1.65 billion, including a $1 billion, five-year term loan and a $655 million in 3.65% senior notes. The interest and fees for the senior notes are expected to result in interest expense of about $24.2 million for the full year 2017, a little over $6 million each quarter. The $1 billion term loan has an initial interest rate of 2.304% based on 3-month LIBOR plus 1.25% per annum. This rate is subject to change based on credit rating in a range from 1% to 1.75%. Before I wrap up, let me touch on our capital management objectives. First and foremost, we plan to continue to invest in the growth of our business, return capital through dividends and utilize excess cash to pay down the five-year term loan as quickly as possible. We ended the first quarter with cash of $153 million and a strong cash flow position that enabled us to reduce our debt by $150 million. While I do plan to continue to utilize cash to pay down debt, I wouldn't use the first quarter payment as a quarterly run rate since our cash needs vary from quarter-to-quarter. Our debt-to-EBITDA ratio based on trailing 12 months, adjusted pro forma EBITDA at quarter end was 2.4x, which is down from 2.6x on the date of the Bats acquisition. And while we don't have a specific leverage ratio target, we are managing to. We will look to continue to reduce our debt to enhance our balance sheet flexibility. While we are not currently active on our share repurchase program, we continue to take an opportunistic approach and may make opportunistic share repurchases, depending on the circumstances. To summarize, we're off to a strong start this year. Our first quarter results demonstrate the strength of our proprietary index products, generating strong organic growth; diversifying and stabilizing our revenue streams with our increased mix of non-transaction revenues; disciplined expense management, leveraging the scale of our business model, producing higher operating margins and an integration plan on track with a strong start to cost-synergy realization; ongoing focus on capital allocation, reducing debt by $150 million. Overall, we remain focused on positioning the company for long-term success by delivering profitable growth while managing costs effectively. We are well positioned to build on our strong foundation, and look forward to updating you on our progress. With that, we thank you for your time this morning. I will turn it back over to Debbie for instructions on the Q&A portion of our call.

Thanks. At this point, we'd be happy to take questions. Operator?

[Operator Instructions] And it looks like our first questioner for today is going to be Richard Repetto with Sandler O'Neill.

So I guess my one question would be around the subject of volatility. Ed, the proprietary products, the VIX futures, the VIX options, they did extremely well in a period of very low volatility in the first quarter. So I was wondering if you could, again, go through sort of the explanation for that. And also, you've got the Wall Street Journal talking about low volatility. Can you give us any more insights on the outlook for the volatility situation here, low volatility situation?

Sure, Rich. Really let's take a look, bring it up a level kind of the characteristics of this market, there's some similarities that we've seen in other low volatility environments and a couple differences, which has really been the key to driving the volume in VIX this quarter compared to quarters past on SPX. So first, yes, low volatility, not new. We've had other periods that we would characterize as low vol. Highlighting by several spikes occurring really across the globe, again, not new. Upward sloping volatility surface starting at a very low level, almost single digit, up to about 17 or 18. So the surface of volatility over time is not new, but the steepness is. A couple of the differences that have been driving the different utilities out of our proprietary products, SKU is very high. Really the market telling us that while in this current environment, I'm not worried or uncertain. I am from day-to-day, but I am uncertain that there will be an event that significantly moves the market, hence the high SKU. Correlation very low. In an upward market, correlations tend to be lower than they are in downward sloping market. But this is really unusually highly low correlation. Premium harvesting strategies that we've seen people in the past employ, very aggressive now. The steepness of the volatility surface really lends itself to profitable volatility harvesting strategies. So it's really now when we looked at, we talked in the past, we've got these two products that depending on the market, our customers find great utility. So right now, it's more expensive to hedge a running market with S&P 500 puts. It takes a lot of rebalancing, the strike of the S&P 500 is changing. You've seen it. We're at all-time highs. That means there's a constant roll on out of the money puts in the S&P 500, making S&P 500 puts a little more expensive. What's changed and where you've seen the volume and the uptake is using the hedge on this high SKU and this uncertainty looking forward, really the utility of out-of-the-money calls in VIX. You know, VIX cannot go to 0. So really, the utility and hedging with out of the money calls, it's a lot of bang for your buck. VIX also is not S&P 500 level specific in its hedge, meaning a $0.50 option hedge in a VIX call provides great utility not dependent on the level of the S&P 500. So you see our existing customers trading much, much larger in VIX options and VIX futures. So that's kind of the difference. But again, we expect this to continue for some time before policy becomes really put into motion. Right now, lot of talk, there's a lot of uncertainty in elections over the summer time. So we think low vol highlighted for us in the volatility space by some spikes in volatility. But anticipate what the market is telling us that this pattern will continue, at least for the immediate future. And that as I started earlier, the surface volatility going higher over time, the market not as certain as we look out over the calendar. So what we're seeing is just a growing sophistication from our user group as they learn to use these products in different environments. It's a long answer, Rich, but it’s [ph] in the marketplace.

No, that's very helpful. I'm wondering whether this steepness isn't a structural difference now in the VIX term structure. But anyway, that's very helpful.

Our next questioner today is Chris Allen with Buckingham.

Just wondering if we can dig into the expense guidance a bit. The $415 million to $423 million, if we take out your first quarter results, that kind of equates to $112 million to $115 million per quarter over the rest of '17 versus $106 million on a pro forma basis. So I was just wondering, what's going to drive the sequential increase there? And then if we kind of look at it relative to 2016 and adjust for the [indiscernible] it kind of implies 4.5% to 6.5% growth. So I'm just trying to reconcile all that and think about what's going to drive the sequential expense growth from here.

Well, primarily, it's the ramp-up in our -- the resources that we need to handle the migration from the CBOE platform to the Bats platform. And our target has always been 3% to 5% on expense growth year-over-year, and so we're in that range. The range for expenses of $415 million to $423 million is intentionally a bit wide. So in the first quarter pro forma represents a time when the -- we weren't fully combined. Well, for one month, we were. So the expenses in the first quarter really can't -- aren't indicative of what we'll see the rest of the year. So we're happy with the $415 million to $423 million. It's consistent with our targets previously and we think it'll allow us to realize the operating leverage that these exchanges have enjoyed for years.

Can you give any color, though? You're saying the sequential increase may be due to preparing for the integration, but I think the synergies you talk about, Europe and headcount, you're reducing professional fees. So I'm just wondering where that spending is going to occur.

Well, I'll give you an example. So some of the headcount reduction that we experienced in the first quarter were people on the CBOE side that worked -- were working on Vector. So that's cash savings, but it really didn't impact the P&L because all the work they were doing was being capitalized. On the Bats side, as we backfill for some of the people that left CBOE or we transferred down to Kansas City, their expenses are being -- their salaries with compensation are being expensed right off the bat, so to speak and then will be later capitalized as they ramp up and are able to work on the migration of the CBOE platforms onto -- the CBOE exchanges onto the Bats platform.

Our next questioner today is by Ken Worthington with JP Morgan.

When thinking about the first stages of the integration, I think you indicated that the Bats technology for CFE switches over in February, but traders can begin requesting connectivity as early as July. So I guess, maybe from the announcement date, it's an 11-month integration. So one, why so long? Given the connectivity as early as July, would you expect to see any visible benefits from the integration in the second half of this year? And as we think about the other integrations, you mentioned that you would maybe discuss this later on. But how should we think about the laddering or the staggering of the rest of what you're going to do on the technology side?

So Ken, it's Chris. I'll be happy to answer that. Obviously, we have a model that we've used in the past quite effectively around integration of platforms starting with, obviously, the Chi-X migration and then the Direct Edge migration. What we've learned is a long lead time for clients to connect and to test is a critical part of a perfect migration. So we're using that same model of very long lead times. It also allows us to test not in production, the code that we'll launch in the new platform. So it's a tried and true model that we're going to stick to. We will be announcing a date for the C2 migration shortly. So you'll see kind of the pattern of technology migration. I think it's important to point out that the announcement around the delivery of a complex order book onto EDGX options is our down payment of integration. That complex order book is a key component that will have certain attributes you'll see in the CFE as well as in the C2 migration. So we are attempting to derisk our migration to the new technology by putting into production certain features and functionality in our other platforms on that. So as you will see, we will stick to a long lead time while we allow clients to test quite aggressively during that window. But you will see a pattern of our migration with the subsequent announcements on the migrations of not only CFE but C2, which will be announced in June.

And the next questioner is going to be Michael Carrier with Bank of America Merrill Lynch.

Hey good morning guys. This is Nimruk Rohan [ph] for Mike Carrier. Thanks for taking my questions. A quick question for Chris. You guys announced the alternative to the closing option. Just wondering if you can give us some additional details on how much volume you think is up for grabs. How are you looking to price the service? What kind of discount are you looking to provide maybe relative to your two biggest peers? And finally, maybe just provide some color on how this is going to affect Bats on the market data side? And I have lots of questions…

Sure. We’ll put you back in the queue to answer the other five. So let me just start. I think it's important to point out that this announcement is a reflection of what this combined company intends to do. We intend to continue to be aggressive, competitive and solve client needs. And this one, in particular, is a client need that we have heard about over the last couple years. And in the last month, we have talked to our clients extensively about how we can solve what has been a growing cost for them with regard to the primary markets and their closing cross auction. Now obviously, investors are using the closing cross as an important price forming moment of the day. And some of our competitors have priced their service aggressively to take advantage of that investors' needs at the close. Our design of this closing cross auction is very targeted to avoid disrupting price formation at the close. If you look at closely at what we're doing, is we're matching market on close orders only prior to the cutoff for the primary markets close. So to the extent we don't achieve a match for your market on close, you will still participate in the closing cross on the primary. We are not targeting limit on close orders which are really the price forming elements of the closing cross. We have not announced pricing for this, but you can assume in traditional aggressive competitive fashion, we will be quite aggressive on the price of our closing cross match. So we -- obviously, if you look at the numbers, the closing cross on the primary markets is close to just over 9% of the ADV. So it's a sizable part of the day that is not subject to the competitive dynamic that Bats brings to the intraday market of competing on price. So this is the first time we're stepping into that part of the market. We're doing it, I think, very appropriately by targeting only market on close orders and not limit on close orders. So we don't want to disrupt price formation at the close, which is an important element and an important goal that our clients have asked us to ensure.

And the next questioner is going to be Alex Kramm with UBS.

Just coming back to the expenses for a second, in particular, synergies. I think everybody is talking very positively about the traction that you're getting, the progress you're making and what you've been doing so far. But I think there was some expectation that perhaps, the ultimate size of synergies may be higher, and I don't think you talked about this yet. But where -- why are you not -- I guess, why are you holding back? Are you not comfortable enough yet? Are you not seeing enough yet? And I guess, asking differently, what would it take for you to have a comfort level to say, hey, there's $5 million, $10 million, $20 million extra? Like, what's the bar?

Well, Alex, the nature of the foundation of most of the synergies lies in the migration of the three CBOE exchanges onto the Bats platform. And the first one will be completed in early 2018. We haven't announced C2 or CBOE yet, but they're after that. And so there's -- before I can be comfortable in saying the $50 million is now $65 million or whatever, some number higher than $50 million or the $65 million, the 5-year number is some higher number, we need to get further into this migration process because things could go wrong. As you know, this is a very complex process. It could be that we underestimated the time that we need to migrate C2 and CBOE. It could be that the time is right but the resources are wrong, that we need more resources. And that would cause the synergy number to be different than we expected. So I need, we need, CBOE, Ed and Chris Concannon and I, we need to get further into this program, not just 1.5 months or 2 months and gain more confidence in our model that we built last fall that projected synergies before we can update them. It just -- it's premature to do something now. Now with that being said, the $15 million number that we have been public about, saying we thought we'd hit a $15 million run rate in 2017. And now we're at -- we're saying, we think it's going to be $20 million, haven't changed to $50 million yet because we see some of the incremental, the difference of $15 million versus $20 million really coming from savings that we thought would be in 2018. So gosh, I hope you're right, Alex. I hope that we can move those numbers up, but it's just -- it's premature right now. It would be extremely aggressive to do that right now given where we're at in the migration process.

Our next questioner is Alex Blostein with Goldman Sachs.

Was hoping you could provide a little bit of color on non-transaction side of the business. So Chris, I guess, specifically, for kind of legacy Bats products, you guys have done a lot over the last couple years just moving further along on, whether FX side or the options side. So maybe an update on where we stand there, kind of the outlook for growth within that area, and any opportunities you guys see to better monetize CBOE's legacy data now as combined two companies.

Sure, Alex. First, I think as a combined company, we look at the level of mix of non-transaction revenue as an important element of the future of the business from market data to access fees, how people connect and membership fees from all of our platforms, FX to options to equities to equities in Europe. So it's an important component of the mix. And if you look at a quarter like we just had where volumes were somewhat muted in equities, both in Europe and the U.S. They are offset by growth in non-transaction revenue or just the stability of that non-transaction revenue. So we look to grow it, we look to grow it year-over-year. The interesting element of that growth and our excitement of that around the growth of non-transaction revenue is that a good portion of it has come from new sales as opposed to adjusting price on an annual basis. So as I look at our new sales, it's about 25% of the growth in our non-transaction revenue. Our market data revenue in the first quarter came from new sales similar to like batch 1, which has been -- has great success among retail firms and we're seeing a success in Europe as well as clients look to achieve a lower cost of their market data because it is price competitive compared to some of the competition. So we're seeing new sales in both our batch 1 and our top-of-book market data offering. But we are excited about growing that non-transaction revenue across the entire company. When I look at our CFE, our options business and the footprint that we have with not only the multi-listed, but the proprietary products, there's wonderful opportunities over the coming years to grow non-transaction revenue as a percent of our total revenue.

And our next questioner today is going to be Kyle Voigt with KBW.

I just need to get a follow-up on the expense guidance. So the guidance was $415 million to $423 million, but that was pro forma, right? So you posted $106 million in 1Q, which tells me you're guiding to around $103 million to $106 million per quarter for the remainder of the year. I just want to make sure I'm thinking about that correct. And – sorry Alan, if you want to –

Yes. No, that's right, Kyle. You nailed it. Yes. The guidance, the $415 million to $423 million is pro forma, full year as if the acquisition occurred Jan 1, yes.

And then I just need to squeeze in one more housekeeping one on the tax rate. The guidance was a bit lower than we expected for 2017. Can you just help us understand if that range is a good range to think about heading into 2018 and beyond? Because I know the synergies are coming from the U.S. where the higher – I think the synergies are coming from the U.S. where the tax rate's a bit higher. So does that create any headwind and you might expect the tax rate to tick up a bit in 2018 and 2019? Or is that a pretty good range?

Well, first of all, the 35% to 37% is kind of a wide range. So I think it gives us some flexibility. I feel comfortable with -- certainly with the range for 2017. For looking forward, I am trying to -- in my head, trying to roll through things that might change that could affect that tax rate. Certainly, the biggest impact on that tax rate would be coming from Congress, if that happens. So it's also possible that if our operations in Europe relative to our total business change in size, so that's one of the sources of the reduction in the effective tax rate is our foreign operations. And so that could impact the tax rate going forward as well. So if it grows, I hope it grows, then the tax rate drops, if it's -- even if it grows, but the rest of our business grows even more, then its impact is -- will be felt less. And it's kind of dangerous for me to talk about taxes right now. So I hope that helps.

And our next questioner is Chris Harris with Wells Fargo.

You guys reiterated the benefits of the merger, and some of these benefits are revenue opportunities. And so as you guys think about the outlook for the combined company in the next couple years, what maybe one or two things are you guys most excited about or you think has the most impact to really drive incremental revenue for the pro forma company?

Yes, let me -- thanks, Chris, good question. Let me kind of tee up. First, it was really formalizing from CBOE and recognizing the talent that has come into CBOE and the infrastructure around a division, where in my prepared remarks, multi-asset solutions division, and that really is our ability to focus the institution, indexing data analytics and execution services. And John Deters is here who heads up that division. So I think what I'd like him to do is just kind of outline the early stage in building his group and then what some of the first couple targets on revenue synergies, and I'd invite Chris to jump in as well.

Yes, thanks, Ed. This is John Deters. So I'll give a little perspective on multi-asset solutions. As Ed said in his earlier remarks, the creation of that unit is designed to capture opportunities using the legacy CBOE innovation processes, capture those opportunities across our full span of platforms, full span of geographies and asset classes. And where we see those opportunities really arising, first, in the information solution silo with the multi-asset solutions. That's indexes, data and analytics and execution services. All of these are product sets or things that we at CBOE and at Bats have quite a bit of experience with but we see a tremendous amount of upside in combining asset classes and geographic exposures to create new products. And then in the research and product development silos, we see really kind of an accelerated ability to produce new proprietary product. Again, by combining the exposures we get from our span of markets and in channeling those exposures back into the appropriate trading venues, we think we've got tremendous opportunity for new proprietary products there. I'm going to also say, just part of the question was, where do we see the, potentially the greatest opportunity as a combined business. And we've talked about this before and it certainly merits highlighting is the opportunity internationally to channel our proprietary products to new customers. How does that get realized? Well, it starts with replatforming of our futures market. And we've always said that we think there's tremendous opportunity there. It's a very global product, our VIX futures, in particular. And it's today, a 24x5 marketplace by having the latest cutting edge technology that the futures market globally expects to have. We will see, I think, a really impressive growth in our futures product. And then in the sales effort, just knocking on doors, using the strong sales force that the Bats team has in London, to communicate and educate around our proprietary products and describe how access is achieved from non-U. S. locations. We think those are tremendous opportunities for us and we think we've already seen really great execution by the team in just a couple months since we've closed the deal.

Yes, let me chime in, I think, a little bit on that sales effort and the coordination. Immediately, with the operation in London and being able to leverage what Mark Hemsley has built there. Early days really led to some terrific leads. I think we're going to see that show up in SPX options and VIX options and the ETH sessions. And those were a direct result of the coordinated effort, both from the New York business development team and Mark Hemsley and his group. So those are probably -- that's the lowest hanging fruit. And then the infrastructure in place that John alluded to in being able to execute on indexing ideas, investment ideas, product rollout, education, data, enhanced market data and continuing that loop, that's really what we talked about in our early days right around the announcement. So kind of give you some idea of what we see going forward.

And the next questioner is going to be Vincent Hung with Autonomous.

So you continue to enjoy strong growth in the FX option complex. Can you provide some more detail around the structural growth you're experiencing there in terms of maybe new users or new use cases? And how much of the success of SPX is linked to the success of VIX?

So first, really the growth in SPX is – you first have to look across, what is it that we're offering in a listed market which is really unique to allow an investor to pinpoint their needs? And I think no greater example than the SPX complex. So of course, we have the third Friday AM-settled contract, really the flagship, that's the original SPX contract. And we offer PM-settled now weekly SPX options with Monday, Wednesday and Friday expire. We offer SPX options that expire last business day of the month, and of course, customized FLEX options. But really, the growth and the utility in this market, in this low vol market, has really been the SPX Weeklys. And which now, in first quarter, account for about 43%, 44% of total SPX options traded, up from about 34% a year ago. So it really is in this low vol, back to that premium harvesting strategy, short dated options, the ability to roll three days a week in the listed marketplace. That flexibility, that ability to pinpoint specific dates has found great utility. So that's really the SPX story. Again, it's weekly, it's access, it's multiple expirations and all in a listed marketplace, a concentration of liquidity, liquidity formation here at CBOE, unlike any other broad-based index in the country.

And our next questioner today is going to be Richard Repetto with Sandler O'Neill.

Yes, just got a follow-up on the Bats market close order for Chris. So you sort of educated us when you're at Bats on the auctions, the open and the close and how much the volume and the pricing. But I guess, the question is anyway, what's the breakout between market and limited orders on the close? And then, what's to prevent if you are successful other exchanges from copying sort of this pre-auction mechanism?

Great question. Obviously, Rich, the mix of limit on close and market on close does change during times of the year and certainly, key moments. But right now, the market on close is not the biggest portion of the close, limit on close is a larger size. And it goes to our point that we aren't disrupting price formation. We're lowering the cost of the close to our clients. When I look at the competitive response here, if folks want to compete with our closing cross on our listed products which have been growing quite aggressively, they're free to compete because ours is not priced too high. So we already price our closing cross with our flank in mind of people trying to compete with our close. Today, brokers, many brokers offer a match in market on close. So we're not doing anything unique in the marketplace. I think our offering is going to be a broader set of clients, obviously, than a single broker offering to match market on close orders at a lower cost to their clients. But so this is not something new to the market. I think the magnitude of it and the reach and breadth of it to all of our clients is unique in terms of matching market on close prior to the cutoff for the closing cross on the primary market.

So if you were successful, the impact would be -- do you think the impact would be felt more by the brokers then than sort of the closing dominant exchanges?

No. In fact, the impact will be felt by the primary markets and the level of market on closes that they receive. So it is not designed to compete with brokers. Brokers are free to continue to match of their own clients' market on close orders without sending them to the close as they do today. But this gives the industry, obviously, an alternative on their market on close orders to check to see if they can get a match, save a great deal of money and then forward those orders onto the close if they don't receive a match. So it is targeted to compete with the primary markets. We're comfortable with our position on our own closing cross given how cheap we offer it to the industry today.

And our next questioner today is Vincent Hung with Autonomous.

Just a follow-up. There's been a lot of discussion in the press about this large trading VIX calls. Is there anything you can say about this and anything around fiscal customer concentration?

Sorry, the question was on the large trader index calls?

Yes, the one that they call $0.50.

Well, I referenced the premium-specific hedging that we're seeing now. And I think rather than to speculate on the strategy, depending on the exposure of that customer, if you look at really, the most, right now, efficient way to hedge exposure in the 500 is an out of the money VIX call. Again, because it's not strike-specific of the S&P 500. $0.50 premium, not the $0.50 trader, the $0.50 premium calls having great utility, if your fear is reflected in the SKU, meaning how expensive out of the money puts are relative to at the money or calls for that instance. And this is really an efficient hedge. So it's premium -- think about the hedge as premium-specific, not strike-specific. You have a contract VIX, what I said earlier, cannot go to 0. So even if we're in single digit realized volatility, you can just look at a premium level, find a call that's roughly $0.50. You know your risk, you get bang for your buck, the entire exposure, entire term of that contract. So it's an incredibly powerful hedging tool. And I think the person you're referring to is finding great utility in a very inexpensive means to hedge exposure in the 500. So that's the -- what we're picking up from The Street, we're seeing that pattern, we're seeing those rolls. And that again, it is premium-specific, not strike-specific. I don't know if that helps, but that's really the way I look at VIX compared to out of the money put hedging in the S&P 500, which requires rolling and strike adjustment. That's a really, really big difference.

And I'd say -- this is John Deters. A key here, just a very baseline principle is that there's a high adverse correlation between the S&P 500 and VIX. So the insurance policy that I described that a market participant derives from purchasing VIX calls, it's a very effective hedge for downward changes in the S&P 500.

And our next questioner today is Alex Kramm with UBS.

Just wanted to follow-up with Chris again on the whole closing cross thing. I know you've said a lot already, but just one more. Now I think over the last couple of years, you've also been trying very much so to build the listings business and been trying to do some very attractive deals with ETF providers. And I think part of that idea was to actually get the premium business on the close. And I would say, maybe to some degree, you've had limited success, so now you're turning around, you're being aggressive on the close and trying to steal the business away from the others. So just my question, how is that not talking out of both sides of your mouth? I know you said some things to Rich already with that regard, but just wanted to see like what the strategy is like. Are you an aggressor or not, considering that you've also tried to get premium business in the past?

So Alex, great question. I'm going to focus on your term “limited success” because I can't help myself. It is astounding success that we've had in ETF listings. As a company, a standalone company called Bats and now, as CBOE, we think our success is going to accelerate. Conversations that we're having with the ETF issuers has been extraordinary before the close and now, after the close, the offerings that we can offer them. So our listing business is what I call explosive at this point. We're now over 30% of the new issues in this year alone and that's been accelerating. So certainly, our success is something to be impressive -- is impressive and we plan to continue that success. Now if you look at how the closing cross works in single name corporates versus ETFs, obviously, the single name corporates are much larger. They produce a much larger closing cross than typically ETFs will. Now there's some very high-volume ETFs that have very large closing crosses. But comparison, a corporate versus ETF, the closing cross is much larger on the corporates. So we are not only aggressively listing a product and having successful closing crosses on our own platform, we have also priced our closing cross to be very competitive and assume that someone can compete with us just as we are going to compete with the other primary markets. But again, we're competing with a much larger cross in the corporate closing cross and we will continue to be aggressive on both fronts, our listing front as well as competing with the corporate listings and their closing crosses. So hopefully that answers your question that we are having great success in our listing business. We're certainly -- this is not indicative of us throwing our arms up and saying, we're going to now compete with the closing cross. This is really client demand. Our clients have demanded of us to offer a competing product. We limited that product because of our concern around price formation and the close. We refused to disrupt price formation and the close on the primary market, but we can reduce our clients' costs of participation at the close by this offering. So again, not limited success, wild success on our ETF offering and very bullish about the closing cross that we offer at, what I call, competitive rate. And we are very bullish on our closing cross offering competing against the primary markets, mostly because of the client demand for the product. End of Q&A

This concludes our question-and-answer session. I would like to turn the conference back over to Deb Koopman for any closing remarks.

Thank you. Thank you, everybody. That concludes the call. Thank you everybody for your interest, and we look forward to updating you as we move forward.

The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines.