Interactive Brokers Group Inc (IBKR) 2012 Q1 法說會逐字稿

Good day, everyone, and welcome to the Interactive Brokers first-quarter 2012 earnings results conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Ms. Deborah Liston, Director of Investor Relations. Please go ahead.

Thanks, operator. Welcome, everyone, and thanks for joining us today. Just after the close of regular trading, we released our first-quarter financial results. We'll begin the call today with some prepared remarks on our performance that complements the material included in the Press Release, and allocate the remaining time to Q&A. Our speakers are Thomas Peterffy, our Chairman and CEO, and Paul Brody, Group CFO.

I just want to remind everybody, today's discussion might include Forward-looking statements. These statements represent the Company's beliefs regarding future events, that by their nature, are not certain and outside of the Company's control. The Company's actual results and financial conditions may differ possibly materially from what's indicated in these statements. For discussion of some of the risks and factors that can affect our future results, please see a description of the risk factors in our filings made with the SEC, and I would also direct you to read the forward-looking disclaimers in our quarterly earnings release. With that, I'll turn the call over to Thomas Peterffy.

Good afternoon, everyone. 2012 is off to a slow start compared to the results we posted last year. Exchange rate and stock and options volumes continued to decrease early into the first quarter, and stabilized only towards the end of the period. (technical difficulties) This affected our customer saving activities, along with market making, which also became subject to other pressures that I will elaborate on during the segment discussion. Despite these cyclical factors, our brokerage business continues to dominate the competition in areas of customer account growth and trading technology. As a testament to the latter, Interactive Brokers has been rated number one in several categories by the Wall Street Letter and Barron's, for best options broker, best use of technology in the industry, best for international investors, best for portfolio analysis and reports, and best for trading experience and technology.

Most importantly, we remain recognized as the least-expensive broker. I'm still waiting for a reviewer who ranks brokers by what I think should be the most important criteria, which is execution quality. Traders and investors often pay more in inferior execution prices than in commissions, but this remains a hidden charge that is often overlooked, even by some of the most sophisticated market participants. Our distinction as being the broker of choice for financial professionals is driving strong growth in this business, with the number of customer accounts approaching 200,000 and the equity they hold just shy of $30 billion. We also maintain our position as the largest E-broker by number of trades, thanks to our highly-active base of customer traders, and base of sophisticated traders and investors.

Before I review the performance of our business segments, I'll briefly mention the results of our currency hedging strategy. As you know, we maintain our equity in a self-defined basket of 16 currencies that we call The Global, in order to minimize our exposure to currency fluctuations. As a globally diversified company doing business in 27 countries, we have found this to be a prudent approach to reducing our currency risk. The value of The Global as expressed in US dollars ticked up slightly during the quarter by nearly 1%. This had a positive impact on our comprehensive earnings to the tune of about $34 million. Paul will describe in detail how this flowed through to our financials.

Market volumes and exchange rate options have remained flat in the US and decreased 1% globally from the fourth quarter. This compares to our firm's total option volume, which decreased 11% during the same period. As a result, our market share during the first quarter decreased from 10.6% to 9.5% globally and from 14.8% to 13.3% in the US. In the market-making segment, our option volume decreased 13% during the first quarter, driving our market share and debt segment from 7.1% to 6.2% globally, and from 8.7% to 7.7% in the US. The diminution in market share is mostly due to exchange volumes, concentrating in certain underlinings, such as Apple and SPDR EPS. We are generally unable to maintain significant share in very high-volume products. As a reminder, market share is not directly correlated to our profits. We provide it as an illustration as to how our performance in the exchange rate options markets move over time.

Now, I'll turn my attention to the brokerage segment. As I mentioned, we have been busy rolling out new tools that complement our sophisticated trading platform in order to continue to enhance the for our existing customers, and to provide a compelling reason for new customers to move their accounts to Interactive Brokers. We are particularly excited about our new trading interface that we have recently unveiled, called Mosaic. It is a very intuitive and user-friendly platform that offers the same basic and advanced functionality as our trader workstation, but in an easy-to-use layout that can be used straight out of the box, or customized however one pleases. Mosaic can be used alone or in conjunction with our extensive suite of trading tools. And customers that subscribe to the Interactive Brokers Information System, or IBIS, have access to premium news wires and analyst research reports from Tier 1 providers like Reuters, Dow Jones, Morningstar and Fly On the Wall, at a fraction of the cost of some other providers. We are planning to add more content in the coming future.

We also redesigned our account management system to provide customers with a fresh, streamlined Interface, where they can easily manage important account-related functions. Last month, we introduced the tax optimizer tool, which allows customers to optimize the allocation of their gains and losses for tax purposes, by manually matching specific lots on a daily basis and running real-time what-if scenarios to pick the best methodology in terms of tax impact to their portfolio. Alternatively, they may activate and automate a search mechanism to find the optimal match for a desired outcome by income category. We are seeing slowly increasing participation in our online hedge fund investing program, which was introduced last summer and allows customers to research and invest in these funds directly through their IB accounts. To date, we have 11 registered hedge fund participant in the program and we expect this number to continue to grow.

As I mentioned on past calls, we have been devoting much of our efforts to developing tools specifically for financial advisors, one of our fastest growing customer segments. One of our recent innovations allows these advisors, who act as wealth managers, to designate multiple money managers to execute and allocate trades among designated client accounts. We also introduced high water marking in our billing options for advisors that use percent of P&L as the basis for their client fees. Additionally, we have now opened access to our no queue and hold time block trading desk that was previously only available to hedge fund clients. Our advisor clients can now have instant access to the live trading desk to help work large orders. Our highly-automated business model and low cost structure helped us achieve a 52% pretax profit margin this quarter, down slightly from the 55% in the year-ago quarter.

Now, a brief overview of our market-making performance. As I mentioned, the conditions for market-making were not ideal this quarter. Bid offers have remained stable, which indicates that competition has more or less remained steady as well, but lower volatility levels and weaker volumes on global exchanges created a drag on our trading gains. The weeks averaged 18 during the quarter, which was on par with the year-ago quarter, but down from 30 in the previous quarter. The issue of actual to implied volatility was probably the biggest culprit this quarter. This ratio, as you know, is an important driver for our market-making business, with a higher ratio driving higher trading gains. This is because implied volatility determines our cost of hedging, while actual volatility measures the price movement of underlying products over time, and is directly related to our trading gains. This ratio fell to a multi-year low of 52%, which had a strong negative effect on our trading results.

Despite these conditions, pre-tax profit margins in market-making was 46%. As we set out in our dividend strategy, which was initiated last year, we paid $0.10 a share per quarter dividends from our market-making subsidiary, which dictates whether we accumulate or distribute capital from this segment. This quarter, we dipped into our market-making capital, since we earned 8.9% returns on the capital employed in this segment, instead of the 10% that would have been needed to pay $0.10 after taxes.

Looking ahead, our focus is aimed at expanding our brokerage business and strengthening our brand. Our dedication to providing our customers access to best-in-class trading technology and superior executions for the lowest possible cost, is evidenced by our robust 16% year-over-year growth in customer accounts, which continues to outpace other large E-brokers. While much of this growth comes from word of mouth referrals, we continue to focus our marketing effort to channels where we are most likely to reach out to our target customers, that being savvy financial professionals that understand the value of our offering. And now, for more detailed review of our performance, here is Paul Brody.

Thank you, Thomas. Welcome, everyone, to the call. And as usual, I'll review first the summary results, and then give segment highlights before we take questions. Although there were bright spots, earnings were lower in both brokerage and market-making segments this quarter, impacted primarily by lower trading volumes, which the industry in general has experienced, and also markedly by lower currency translation results. Net revenues were affected by decreases in brokerage commissions and trading gains. However, net interest income held relatively steady this quarter and was up from the year-ago quarter, largely on the strength of customer cash balances.

As we discussed in prior quarterly calls, our financial statements include the new GAAP accounting presentation known as comprehensive income. Comprehensive income reports all currency translation gains and losses, including those that reflect changes in the US dollar value of the Company's non-US subsidiaries, which is known as other comprehensive income, or OCI. These are reported in a statement of comprehensive income, which replaces the traditional income statement. Previously, OCI was reported only in the balance sheet.

Beginning with the first quarter of 2012, this presentation is now required, although we adopt it early, beginning our reporting in the second quarter of 2011. You can expect to see a similar presentation in the financial statements of all US companies with foreign subsidiaries. You will also notice that we have changed the order of presenting these income measures in our earnings release, placing comprehensive income first. We feel that it is appropriate, as it represents the full measure of the change in our capital. In light of the weakening of the US dollar against a number of other currencies, adding OCI to net income increases our reported earnings per share by $0.06 for the quarter.

Overall operating metrics for the latest quarter were mixed. Average overall daily trading volume was 926,000 trades per day, up 1% from the first quarter of 2011. Electronic brokerage metrics showed healthy increases in the number of customer accounts and customer equity. Total and cleared customer DARTs were both up from the year-ago quarter, though down sequentially. Orders from cleared customers who clear and carry their positions in cash with us and contribute more revenue, continues to account for over 90% of total DARTs.

Market-making trade volume was up 4% from the prior-year quarter, though mixed across product types. Options contract volumes were up 21%, while futures contracts and stock shares volumes were down 18% and 19% respectively. That higher options volume was driven largely by our decision to tighten our bid offer spreads, which may have increased volume, while reducing per contract gains. The reduction in stock volume in part reflects our actions over the past year, to pare back trading of certain instruments and in certain markets that we determine to be less profitable. Net revenues were $304 million for the first quarter, down 17% from the year-ago quarter.

Trading gains were $137 million for the quarter. While trading gains compared to the year-ago quarter decreased by 31%, that quarter included large currency translation gains, without which trading gains would have been just 5% shy of the year-ago results. Commissions and execution fees were $101 million, down 8%. Net interest income was $47 million, up 16% from the first quarter of 2011, and brokerage produced $42 million, with market-making coming in at $5 million. Other income was $18 million, up 5%. Non-interest expenses were $154 million, up 6% from the year-ago quarter. Within the non-interest expense category, execution and clearing expenses, which declined 2% from the year-ago quarter on lower trading volumes, totaled $65 million. Compensation expenses were $63 million, a 20% increase from the year-ago quarter. This increase has two primary components.

The first is the revised method for recognizing expenses related to our employee stock incentive plan, which was disclosed last quarter. While total expense over the lifecycle of these grants is unchanged, this treatment accelerates the recognition of the related compensation expense to earlier years, and decreases expense recognition in subsequent years. Second, from January 2012, we made a special one-time grant to all employees, except the Chairman, to provide them with a greater stake in the success of our business. This bonus is weighted in favor of employees toward the lower end of the pay scale. Together, these factors accounted for about 70% of the increase in compensation expenses over the year-ago quarter.

At March 31, our total head count was 885, an increase of 3% over the year-ago quarter, and 1% over the prior year-end count. As a percentage of net revenues, total non-interest expenses were 51% and out of this number, execution and clearing expense accounted for 21%, and compensation expense also accounted for 21%. Our fixed expenses were 30% of net revenues. Pre-tax income was $150 million, down 33% from the same quarter last year, and for the quarter, brokerage represented 56% of pre-tax income and market-making, 44%. For the first quarter, our overall pretax profit margin was 49% as compared to 60% in the first quarter of 2011. Brokerage pretax profit margin was 52%, down from 55% a year ago, and market-making pretax profit margin was 46%, down from 67% in the year-ago quarter. Comprehensive diluted earnings per share were $0.30 for the quarter as compared to $0.41 for the first quarter of 2011, and on a non-comprehensive basis, which excludes the effect of the changes of US dollar on the Company's non-US subsidiaries, diluted earnings per share on net income, were $0.24 for the quarter as compared to $0.38 for the same period in 2011.

Turning to the balance sheet, it remains highly liquid, with low leverage. We actively manage our excess liquidity and we maintain significant borrowing facilities through securities lending markets and with banks. As a general practice, we hold an amount of cash on hand that provides us with a buffer, should we need immediately-available funds for any reason. We also continue to maintain over $2 billion in excess regulatory capital in our broker-dealer companies around the world. Long-term debt to capitalization at March 31st was 0.6%, which was down from 2.1% at year-end 2011, due to the gradual winding down of our senior notes program. We expect this debt to be entirely retired by June 2012. Our consolidated equity capital at March 31st, 2012, was $4.82 billion.

The segment operating results are summarized in the earnings release and will be more fully-detailed in our quarterly 10-Q report, so I'll just highlight the noteworthy items. In electronic brokerage, customer trade volumes were down, in line with industry proxies. Cleared customer options and futures contract volume and stock share volume were down 1%, 8%, and 19% respectively, from the year-ago quarter. Stock volume dropped in part in low-priced stock, after we raised margin rates last year to better protect against sudden price moves on low cap companies. Customer accounts grew by 16% over the total of March 31, 2011, and by 3% in the latest quarter. Total customer DARTs were 428,000, up 1% from the year-ago quarter, and down 4% from the fourth quarter of 2011. Our cleared customer DARTs, which generate direct revenue for the brokerage business, were 391,000, up 1% on the year-ago quarter, and down 5% sequentially. The average number of DARTs per account on an annualized basis was 511, down 14% from the 2011 period, and 8% sequentially.

The lower volume and commission revenue on a stable number of DARTs is explained by smaller average order sizes in options, futures, and stocks. In line with these decreases, average commission per DART fell 8% from the year-ago quarter to $4.01. Customer equity grew to $28.9 billion, up 17% from March 31, 2011, and 15% sequentially. These increases took place during periods in which the S&P 500 Index rose 6% and 12% respectively. The source of this growth continues to be a steady inflow of new accounts and customer deposits. In addition, our favorable financing rates have allowed us to return customer margin borrowings to approximately their year-ago level, despite the drop during the market turmoil of 2011's third quarter. Increased customer credit balances are the primary driver behind the 14% increase over the year-ago quarter, in net interest income, which now accounted for 27% of net revenues in brokerage.

Lower trade volumes resulted in top line revenue from commissions and execution fees of $101 million, a decrease of 8% from the year-ago quarter, and 8% sequentially. These revenues are spread mainly across options, futures and stocks, but revenue from FX brokerage continues to build steadily. Execution and clearing fees expenses decreased to $31 million for the quarter, down 13% from the year-ago quarter, and 14% sequentially, directly impacted by lower trading volume. This demonstrates why our low fixed cost business model works well. The reduction in these direct expenses, which account for 40% of total non-interest expenses, substantially soften the impact of lower commission revenues in a period when trading volumes decline. Fixed expenses increased to $45 million, up 18% on the year-ago quarter, primarily due to higher employee compensation expenses related to the stock incentive plan, as I mentioned earlier. Pre-tax income from electronic brokerage was $83 million for the first quarter, down 7% on the year-ago quarter, and down 3% sequentially.

Now, turning to market-making, trading gains from market-making for the first quarter of 2012 were $137 million, down 31% on the year-ago quarter. This resulted in pretax income from market-making of $66 million, down 51% from the year-ago quarter. Currency translation effects negatively impacted the first quarter's reported earnings by only about $1 million, but the real driver here is that the year-ago quarter's reported earnings were boosted by $54 million. That is, currency translation accounted for about 80% of the drop in pre-tax income. Our overall equity, as measured in US dollars, was increased by the general weakening of the US dollar. More specifically, we measure the overall gains from our strategy of carrying our equity in proportion to the basket of currencies we call The Global, to be about $35 million for the quarter. Because about $36 million of gains is reported pursuant to GAAP as other comprehensive income, this leads the loss of $1 million to be included in reported non-comprehensive earnings.

Note that even under the new guidance, OCI is only reflected in earnings per share on comprehensive income, and not in pre-tax income itself. To summarize this, if we eliminated all currency effects, pretax income from market-making would be about $67 million this quarter. Execution and clearing fees expenses increased to $35 million for the quarter, up 9% on the year-ago quarter, driven by higher options trading volume. Fixed expenses increased to $42 million, up 16% on the year-ago quarter, and as in the brokerage segment, the increase was primarily due to higher employee compensation expenses related to the stock incentive plan.

Now, I would like to turn the call back over to the moderator and we will take some questions.

(Operator Instructions)

Our first question comes from the line of Rich Repetto from Sandler O'Neill. Your question, please?

Good evening, Thomas and Paul. I guess the question is on the broker -- it continues to out-perform. On the margin loan balances, just trying to see what the average gross yield. The competitors have seen drops in the first quarter. I'm just trying to see whether -- I know yours is well below theirs, but whether yours has been steady, given the spread you're trying to maintain?

Ours is smaller, you're right; and it has been relatively steady, because effectively, interest rates have been at zero for a long time.

The question as to what it is, I think it's something like 1.3%, right?

That is a blended rate, that it's probably a little less than that.

Less than that.

Okay. And then, on the market-maker, Thomas -- you know, we've talked a lot about the competition from HFT prior. Seems like the exchange is doing a little bit -- I don't know whether they are doing a lot or not -- but putting in some rules to limit the quotes. I'm just trying to see -- do you see that as having any real impact on, constraining, or having any impact on the HFT? Or are the exchanges just not done -- have they not done enough, I guess?

Well, I think that HFT competition has been fairly stable, and it's been the same as last quarter, or even the quarter before. So it's stable, and it's intense.

And the impact that this, limiting the quotes, is that meaningful do you think? Or is it just -- have they said it enough where it might have some impact on the HFT?

I don't think it has had much impact at all.

Okay. And then the very last question is just on your capital, Thomas and Paul. Could you give out on the split between -- I know it's around $2.8 billion at the market-maker, but could you give how you segment out your capital between the broker and the market-maker?

You're close. Maybe the market-making is a little bit higher, but the brokerage has about --

Between $1.7 billion and change and $2.9 billion and change.

Yes, exactly, about that.

Got it. Okay. Thank you. That's helpful. That's all I have.

Thank you. Our next question comes from the line of Niamh Alexander from KBW. Your question, please?

Thomas, I saw something on the tape here from an interview, being quoted that you were talking about maybe retiring in the next couple of years. Can you expand a little bit on that? I don't know what interview it was quoting there, but this is the first time we've heard you talk about retiring in the next few years. Can you expand a little bit more in this context with this audience?

It didn't say in the next two years. They asked me if I ever think about retiring, and I said sure, I, I think about my future all the time. And then they said, so how do you see this? And I said it would be a gradual process, and as the years go by, I intend to become less and less involved, and hand more and more of my duties over to the capable hands around me.

But we shouldn't expect any change in the next two years?

Look, as I've said, the changes are gradual and they have been going on for a year or two already.

Okay. Well, I guess we're not familiar with the succession planning within the organization or who it is that you're looking to follow you on. So it would be helpful for us to kind of understand a little bit more about that process. And I guess the interview also did ask you about your -- indicate your interest in continuing to own the Company if you're no longer running it. But I understand that you're still very much interested in remaining a big shareholder.

That's exactly what I said. The interview is written correctly.

Okay.

It says what I said to him.

Fair enough, Thomas. All right.

And can I just -- a few things -- and the special grant to the employees -- you said it was a special grant. Does that mean it's going to be a first quarter every year, or is it a one-off? And then second--

No, it's a one-off.

It's a one-off.

Yes.

And then, Paul, is this going to be accrued every quarter, or are we done in the first quarter?

It goes in as a normal grant would, which means it's accrued over a long period of time, because it's subject to the same six-year vesting schedule that all of our other grants are.

But it's front-loaded now.

The recognition method is more front loaded than it used to be, but it's still fully recognized over six years.

Okay. So should we expect the comp level to be more elevated than it has been? It has been very steadily increasing or almost flat. What's a good run rate to think about going forward?

Well, the answer to that is, where are you in the cycle of grants? And what grants do we put out every year? So, hypothetically, if we were to put out the same number of grants every year, and we had started this in 2007, we would be five years through a six-year grant cycle. Which means that it would be fairly stable going forward, if we were to continue to grant the same amount of number of shares every year.

Now, we tend to grant more shares as our staff maybe grows, and so forth. And to some extent, they are more front-loaded in terms of expense recognition. So you will see some increase; but over time, it should be relatively stable.

I think you could say that this increase that we just have seen this quarter is unusually high.

Because of the one-time grant.

Yes.

Yes.

So I don't think that you should expect the same level in the coming quarter. It's going to be less.

No, it will be, it will be -- it accrued over this first year, rateably; so the effect of this special grant will take place -- it will have the same effect on each quarter of this year.

Okay.

But that's only a piece of the total comp expense -- just from the special grant.

That is correct, for the special grant. But given that we had to revamp--

Yes. The effect of this special grant is about $3 million a quarter.

Okay. Fair enough. Thank you very much. And then just lastly, if I could real quick -- the brokerage fee, you did mention, sorry, what was driving that lower? There weren't any explicit changes; it was more contract sizes or something, was it?

We didn't make any changes, no.

Okay. All right. Thank you.

Thank you. Our next question comes from the line of Matt Heinz from Stifel Nicolaus. Your question, please?

I just had a question about your comment about the market share and options. You said that, given the high concentration in a couple of tickers, Apple and SPY that you don't make markets in, that was one of the drivers behind your share losses this quarter?

I didn't say that we do not make markets in it; but I said that if a large percentage of the overall volume gets bunched up in one underlying security, we usually have difficulty maintaining our market share of the same level as we have in other products.

Okay.

In other words, visualize this -- that instead of 10 market-makers in a product, there are suddenly a hundred market-makers in the product, right? That's what happens. And therefore, we get diluted.

I see, okay. Thanks.

And then -- sorry, just one more time on the revenue capture in brokerage? You said you didn't make any changes to the pricing there. But was it more just mix that drove the rate down?

Well, it was the -- we had a fewer number of trades and the trades were smaller in size, and I think that we also had some changes in the futures business, where we picked up some larger traders from MF who quickly reached the lower tiers in commissions, because we have a tiered commission rate. And so it goes down, it starts at something like $1.40 a contract and goes down to as low as $0.25.

Okay. So it looks like your cleared, your cleared futures volume is up about 10% or 11% year-over-year. Was that mainly just due to that -- I mean, industry volume was down closer to 10%. There's either pretty significant share gain in there, or some new accounts that are adding to that?

I think we got some of the MF Global customers.

Okay. So do you think that impact on the revenue capture should be similar, going forward?

If we are not increased the same way as it has at this time; but you must be aware that in futures brokerage, while we charge, say, $1.70 for a high-volume trader, $1.45 of that goes to the exchange in fees, and we only get to keep the $0.25. But our brokerage charge reflects what we sent to the exchange.

Okay. Thanks for the explanation.

(Operator Instructions)

Our next question comes from the line of Ed Ditmire from Macquarie. Your question, please?

Good afternoon. From November through February, you had relatively lower net account adds than what you are used to seeing. And of course, in January you talked about the pressures on the account list that were caused by the MF Global fiasco and how customers were worried about the safety of their funds. And then in March, it looks like you guys had a very healthy net account add number. Has there been a change? Are we getting past that period? And has anything really changed that all of a sudden the net account number became much more healthy?

We find that when we do small changes to our marketing program, that there is always a positive response, whatever we do. And then it gets tired and it slows down and then we have to come up with something new.

Maybe as a follow-on -- at the last conference call, you talked about having to address client concerns over the safety of their funds. Has that pressure alleviated?

That alleviated, but if something disastrous happens to somebody in the industry again, then we will be facing the same issues.

Okay. Thank you.

Thank you. This does conclude the question-and-answer session of today's program. I would like to turn the program back to management for any further remarks.

Thanks, Operator. We would just like to thank everyone for participating today, and there's a reminder, this call will be available for replay on our website. Thanks again, and have a good evening.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.