Interactive Brokers Group, Inc. quarterly report, Q1 FY2015

Interactive Brokers Group, Inc. — Q1 2015 Form 10-Q

Reporting period: Three months ended March 31, 2015; unaudited. Comparisons are with Q1 2014 unless otherwise stated. Interactive Brokers is a global electronic broker and market maker operating across more than 100 exchanges and trading venues. IBG, Inc. consolidates IBG LLC, but held approximately 14.5% of its membership interests at quarter-end; the remaining 85.5% was held by IBG Holdings LLC.

Financial results and key metrics

Metric	Q1 2015	Q1 2014
Total net revenues	$172 million	$355 million
Income (loss) before taxes	$(111) million	$218 million
Net income (loss)	$(109) million	$201 million
Net income (loss) available to common stockholders	$(13) million	$19 million
Diluted EPS	$(0.22)	$0.34
Operating cash flow	$(220) million	$(259) million

• Revenue mix: Trading gains were $62 million, down 41%; commissions and execution fees were $149 million, up 9%; interest income was $108 million, up 24%; and other income was a loss of $132 million, versus income of $40 million. Interest expense was $15 million, making net interest income $93 million, up 27%.
• Expenses and margins: Non-interest expenses rose to $283 million from $137 million, primarily reflecting $139 million of customer bad-debt expense versus $1 million. Consolidated pretax margin was negative 65%, compared with 61%. Excluding the Swiss-franc customer losses and currency-diversification effects, management reported net revenues of $341 million, expenses of $144 million, pretax income of $197 million, and a 58% pretax margin; these are management-presented adjusted figures, not reported GAAP results.
• Segments: Electronic brokerage reported $290 million net revenues and $51 million pretax income, versus $224 million and $135 million. Market making reported $67 million net revenues and $27 million pretax income, versus $111 million and $66 million. Corporate and eliminations recorded a $189 million pretax loss, compared with $17 million income, largely reflecting currency-diversification losses.
• Balance sheet at March 31: Assets were $43.294 billion and liabilities $38.256 billion. Total equity was $5.038 billion, including $4.290 billion of noncontrolling interests. Cash and cash equivalents were $990 million, down from $1.269 billion at year-end 2014. Customer receivables were $17.437 billion; customer payables were $32.225 billion. These customer-related balances are part of the broker-dealer balance sheet and should not be read as unrestricted corporate liquidity.
• Debt and liquidity: Short-term borrowings were $29 million, and the company reported no variable-rate debt outstanding. Management stated that approximately 99% of assets were liquid and that cash, operating cash flows, and available borrowings were expected to meet needs for more than 12 months. Aggregate excess regulatory capital was $3.393 billion; all regulated operating companies were in compliance.
• Cash flows: Investing activities used $4 million and financing activities used $45 million; cash declined $279 million during the quarter. The filing notes that operating cash flows are affected by trading positions and changes in customer cash and margin balances.

Material changes versus the prior period

• Reported net revenues fell 52%, and pretax results shifted from income of $218 million to a loss of $111 million. The main exceptional drivers were Swiss-franc-related customer losses and losses on the company’s currency-diversification strategy.
• On January 15, 2015, a sudden Swiss franc move left several customers with losses exceeding their deposits. The company recorded $139 million of customer bad-debt expense and estimated unsecured receivables, net of hedging, at approximately $121 million. It was pursuing collection; ultimate recovery and financial impact remained uncertain.
• The U.S. dollar value of the company’s 16-currency GLOBAL basket declined about 3.8% during the quarter. Management said the currency-diversification strategy reduced comprehensive earnings by $197 million. The filing presents related translation effects in other income and other comprehensive income; this amount should not be added to individual statement line items without reconciling the presentation.
• Core brokerage indicators improved: customer accounts rose 17% to 296,000, customer equity increased 25% to $61.2 billion, and total customer DARTs increased 11% to 648,000. Customer margin balances reached approximately $17.3 billion. Market-making results weakened amid competition and low volatility.
• Management changed the presentation of currency-diversification gains and losses in late 2014, moving nearly all such amounts from trading gains to other income and from market making to corporate. Prior periods were reclassified; the change did not affect total consolidated revenue or net income.

Outlook, commentary, risks, and unusual items

• No numerical earnings or revenue guidance was provided. Management described favorable brokerage trends but noted that trading activity is seasonal and unpredictable, and that market-making results face competition, market-structure changes, and sensitivity to volatility and bid-offer spreads.
• Interest-rate, foreign-exchange, equity-price, customer-credit, and liquidity risks are material to the business. Management cautioned that VaR is based on historical data and may understate extreme or illiquid-market losses. Customer margin and short-sale exposure can exceed collateral in adverse conditions; the company uses automated margin monitoring and liquidation, but acknowledges this may not work in all circumstances.
• The company reported no material change to the risk factors in its 2014 Form 10-K. It noted ongoing regulatory discussions that could result in sanctions, while management did not expect them to materially affect financial condition, results, or cash flows.
• Pending litigation includes a patent-infringement case brought by Trading Technologies; the outcome and potential loss could not be estimated, and the company intends to defend the case. Litigation reserves were not material. Clearing-house guarantees may be unquantifiable, although management considered payment under them remote.
• After quarter-end, the company agreed to acquire Covestor, an online investing marketplace and registered investment adviser. The filing describes the transaction’s strategic intent but does not provide a purchase price. A $0.10-per-share dividend was declared April 21, payable June 12, 2015 to holders of record June 1.

Important facts for investors to verify

• Recovery prospects and final losses on the approximately $121 million of Swiss-franc-related unsecured customer receivables, including the effects of hedges and collections.
• The reconciliation of the $197 million comprehensive-earnings impact from currency diversification with the reported other-income loss and other comprehensive income.
• Whether brokerage account, customer-equity, DART, and margin-balance growth continues, and how much of the earnings improvement is offset by credit, funding, and operating costs.
• Liquidity and capital available to the parent versus regulated subsidiaries, including the restricted or customer-related nature of substantial balance-sheet assets and cash held overseas.
• Developments in the Trading Technologies litigation, regulatory inquiries, and the Covestor acquisition, including any subsequently disclosed financial terms or integration costs.