Interactive Brokers Group, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also provides fourth-quarter results. IBG, Inc. is a holding company that consolidates IBG LLC, but owned approximately 17.4% of it at year-end; most consolidated earnings are attributable to noncontrolling interests.
Business context and reporting period
Interactive Brokers operates a global electronic brokerage business and was winding down its options market-making business. It served approximately 483,000 customer accounts across more than 200 countries and territories, with access to over 120 exchanges and market centers. Brokerage was the principal growth and earnings driver.
Financial performance and position
| Metric | 2017 | 2016 |
|---|---|---|
| Total net revenues | $1.702 billion | $1.396 billion |
| Income before income taxes | $1.049 billion | $761 million |
| Net income | $793 million | $699 million |
| Net income available to common stockholders | $76 million | $84 million |
| Diluted EPS | $1.07 | $1.25 |
| Operating cash flow | $142 million | $544 million |
| Cash and cash equivalents at year-end | $1.732 billion | $1.925 billion |
| Total assets / total liabilities | $61.162 billion / $54.729 billion | $54.673 billion / $48.853 billion |
- Pre-tax margin increased to 62% from 55%. Net income available to common stockholders fell despite higher consolidated net income, primarily reflecting the Tax Act’s effect on taxes and the company’s ownership structure.
- Electronic brokerage net revenues rose 13% to $1.405 billion; segment pre-tax income grew 14% to $860 million, with a 61% pre-tax margin. Market-making net revenues fell to $86 million, and the segment recorded a $27 million pre-tax loss.
- Net interest income increased materially as rates and customer balances rose. The MD&A cites approximately $683 million, while a filing table reports $688 million; investors should reconcile this difference. Brokerage customer accounts grew 25%, customer equity 46%, and total DARTs 4% for the year.
- Cash, cash equivalents and short-term investments totaled $23.999 billion, including customer-related and segregated balances. The company classified approximately 99.3% of assets as liquid. These figures should not be read as unrestricted corporate cash.
- Year-end short-term borrowings were $15 million; the company reported no variable-rate debt outstanding. Aggregate excess regulatory capital was approximately $4.5 billion, and regulated operating companies were compliant with their capital requirements.
Material changes versus the prior comparable period
- Net revenues increased 22% and pre-tax income increased 38%, driven mainly by higher net interest income, commissions and other income. Trading gains declined 75% to $40 million as options market making was curtailed and volatility was lower.
- Net interest income rose about 30% according to MD&A. Commissions increased 6%; other income rose to $332 million from $94 million, including a $110 million currency-diversification gain and a $93 million gain from remeasuring the Tax Receivable Agreement liability.
- Income tax expense rose to $256 million from $62 million. The Tax Act reduced 2017 earnings by approximately $84 million net: a $62 million transition tax and $115 million deferred-tax remeasurement expense, partly offset by the $93 million Tax Receivable Agreement gain.
- Operating cash flow decreased to $142 million from $544 million, while cash and cash equivalents declined by $193 million during 2017. Cash-flow changes were substantially affected by customer balances and trading-related assets and liabilities.
Fourth-quarter results
Fourth-quarter 2017 net revenues were $515 million and pre-tax income was $364 million. Income tax expense was $200 million, leaving a $2 million loss available to common stockholders and diluted EPS of negative $0.02. The quarter’s tax charge reflects the Tax Act effects; quarterly results also show increasing net revenues through the year.
Outlook, risks, contingencies and unusual items
- Business transition: The company completed the transfer of its U.S. options market-making operations to Two Sigma Securities on September 29, 2017 and continued winding down remaining options operations. It expected approximately $40 million of annual net expenses to shift to electronic brokerage; approximately 82% of related resources had transferred by year-end. It also may receive contingent earn-out payments under the Two Sigma agreement.
- Outlook and capital return: The filing gives no formal earnings or revenue guidance. Management said operating cash flows, available cash and borrowings should cover liquidity needs for more than 12 months. The company intended to continue quarterly dividends of $0.10 per share, subject to board discretion.
- Tax and related-party structure: Holdings owned 82.6% of IBG LLC, and the founder and affiliates controlled the voting power. Under the Tax Receivable Agreement, 85% of qualifying realized tax savings are payable to Holdings. The estimated liability was $187 million at year-end.
- Market and operational risks: Results depend on trading activity, customer balances, interest rates, volatility, currency movements and competition. The company also highlights customer margin and counterparty credit exposure, technology and cybersecurity incidents, service interruptions, third-party dependencies, and extensive regulatory requirements. It does not have fully redundant systems for all global operations.
- Legal and other contingencies: The patent dispute with Trading Technologies remained pending, with appeals concerning two patents; a dismissed customer class action was on appeal. Management said litigation reserves were not material and did not expect a material effect on business or financial condition, while noting outcomes are uncertain. Regulatory inquiries continued, and the company expected ongoing regulatory fines but could not estimate their amount or timing.
- Unusual and legacy items: Options wind-down costs were approximately $25 million, including a $21 million write-down of exchange trading rights; these were partly offset by $13 million of recovered transition-related costs. The company also reported cumulative net losses of approximately $116 million from the 2015 Swiss franc event and continued collection efforts.
Key facts for investors to verify
- Reconcile the filing’s $683 million versus $688 million net-interest-income figures and distinguish consolidated earnings from the much smaller amount attributable to IBG, Inc. common stockholders.
- Assess how sustainable 2017 earnings are after separating the Tax Act effects, currency-diversification gains, the Tax Receivable Agreement remeasurement gain and market-making exit items.
- Review the quality and availability of liquidity: much of the reported cash and assets relates to customer balances, regulatory segregation or collateralized financing.
- Track completion costs and expense transfers from the options-market-making wind-down, as well as any earn-out proceeds from Two Sigma.
- Monitor the founder’s voting control, potential future share issuance for IBG LLC interest redemptions, and payments under the Tax Receivable Agreement.
- Follow the Swiss franc customer debt recovery, pending litigation and regulatory inquiries, and technology and business-continuity risks.