Interactive Brokers Group, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Comparative 2011 results are restated. Unless stated otherwise, amounts are in U.S. dollars; financial figures below are in millions.
Business context
Interactive Brokers is a global electronic broker and market maker operating across more than 100 exchanges and trading venues. It reports electronic brokerage and market making segments. The public company is a holding company that owned approximately 11.9% of IBG LLC at June 30, 2012 and consolidates the LLC; the remaining interests are reported as noncontrolling interests.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total net revenues | $260.9 | $296.9 | $564.8 | $664.8 |
| Income before taxes | $108.5 | $149.1 | $258.2 | $371.1 |
| Net income | $97.5 | $136.6 | $238.5 | $339.9 |
| Net income attributable to common stockholders | $8.0 | $9.6 | $19.1 | $25.8 |
| Diluted EPS | $0.17 | $0.22 | $0.43 | $0.61 |
| Comprehensive diluted EPS | $0.09 | $0.31 | $0.41 | $0.73 |
- Q2 trading gains fell 30% to $85.0; commissions and execution fees rose 2% to $108.1; net interest income fell 4% to $52.5. Six-month trading gains declined 31% to $222.3, commissions fell 3% to $209.0, and net interest income increased 4% to $99.9.
- Pre-tax margin declined to 42% from 50% in Q2 and to 46% from 56% for the first half. Employee compensation and benefits rose 14% in Q2 and 17% for the first half, partly due to a January stock award and revised stock-plan expense recognition.
- Electronic brokerage pre-tax income was $90.2 in Q2, up from $89.0, and $173.6 for the first half, down from $179.1. Market-making pre-tax income fell to $24.0 from $59.3 in Q2 and to $90.0 from $193.9 for the first half.
- Management attributed most of the earnings decline to currency translation: Q2 included a $41.2 market-making translation loss versus a $6.5 loss a year earlier; the first half included a $42.1 loss versus a $47.5 gain. Comprehensive EPS includes foreign-currency translation effects; management also cited non-comprehensive diluted EPS of $0.17 for Q2 and $0.43 for the first half.
- At June 30, cash and cash equivalents were $2.00 billion, segregated cash and securities were $11.03 billion, and total assets were $32.38 billion. Total equity was $5.00 billion, including $4.38 billion of noncontrolling interests. These balances include substantial customer-related assets and liabilities.
- Six-month operating cash flow was $519.6, investing cash outflow $30.2, and financing cash outflow $174.3; cash increased $308.0. Operating cash flow reflects large movements in customer balances and trading-related assets and liabilities.
- Senior notes were fully redeemed by June 30; none were outstanding. The new three-year revolving credit facility has a $100 million commitment and no borrowings outstanding. Short-term borrowings were $13.3 million. Excess regulatory capital was approximately $2.66 billion, and regulated operating companies were in compliance.
Material changes, outlook, and risks
- Restatement and accounting change: The company concluded its prior treatment of cash-redemption provisions for Holdings’ LLC interests was incorrect. Earlier statements were restated to classify those interests as redeemable noncontrolling interests outside permanent equity; the June 6, 2012 Exchange Agreement amendment eliminated the cash-redemption alternative, after which the interests were reported in permanent equity. The error did not affect reported net income attributable to common stockholders or cash flows, but affected equity classification and EPS. Prior annual statements and the March 2012 quarter were declared no longer reliable. Other previously identified stock-compensation errors were also corrected.
- Controls: Management identified a material weakness in controls over review and interpretation of complex accounting issues, specifically redeemable noncontrolling interests and stock-based compensation. Remediation measures include enhanced CFO/Chief Accounting Officer reviews, Audit Committee review, and use of independent accounting specialists where appropriate. Management cautioned that unremediated deficiencies could cause further material misstatements.
- Operating conditions: Management cited weak global trading activity and investor confidence, although Q2 customer DARTs rose 5%, brokerage accounts grew 14% to about 200,000, and customer equity increased 11% to $28.6 billion year over year. Market-making performance is sensitive to volatility, spreads, trading participation, and currency movements.
- Liquidity outlook: Management expected operating cash flow, available cash, and the undrawn revolving facility to meet liquidity needs for more than 12 months. It anticipated 2012 capital expenditures to be broadly level with prior years, while longer-term technology infrastructure investment could increase. No earnings or revenue guidance was provided.
- Risks and contingencies: The company cited market, foreign-exchange, interest-rate, counterparty, customer-margin, and regulatory risks. Customer margin loans were approximately $8.5 billion; losses from customer defaults or illiquid collateral could exceed amounts recorded. Futures activity can create off-balance-sheet exposure. Pending litigation included a patent infringement suit; management said litigation reserves were not material and did not expect pending matters to materially affect financial condition, though a period’s results could be affected. Clearing-member guarantees may be unquantifiable, but management considered payment risk remote.
Important facts for investors to verify
- Review the amended 2011 Form 10-K and March 2012 Form 10-Q, plus Note 17, for the full restatement impacts and comparable EPS figures.
- Track remediation and independent testing of the material weakness, and whether the company reports any further accounting corrections.
- Separate currency translation and OCI effects from underlying segment performance; monitor the company’s GLOBAL currency strategy and market-making results.
- Assess the drivers and quality of operating cash flow, customer-balance movements, margin lending exposure, and the availability of regulatory capital for use by the parent.
- Monitor customer activity and monetization trends, including DARTs, commissions per DART, stock volumes, and employee stock-compensation expense.