Interactive Brokers Group, Inc. — 2012 Form 10-K Summary
Reporting period: Year ended December 31, 2012. The filing also provides unaudited fourth-quarter results. IBG, Inc. is a holding company that consolidates IBG LLC, which operates global electronic brokerage and market-making businesses. IBG, Inc. owned approximately 11.9% of IBG LLC at year-end; most consolidated earnings therefore belonged to noncontrolling interests.
Business context and results
The company provides automated brokerage, execution and clearing services, and makes markets in exchange-listed products. It operated across more than 100 trading venues, served about 210,000 customer accounts and had 891 employees at year-end.
| Metric | 2012 | 2011 |
|---|---|---|
| Total revenues | $1,192.5 million | $1,444.6 million |
| Net revenues, after interest expense | $1,130.5 million | $1,358.3 million |
| Income before income taxes | $527.0 million | $741.1 million |
| Net income | $497.0 million | $687.2 million |
| Net income attributable to common stockholders | $40.7 million | $61.9 million |
| Diluted EPS | $0.89 | $1.37 |
| Pre-tax margin on net revenues | 47% | 55% |
| Cash from operating activities | $558.4 million | $1,085.9 million |
Revenue, segment performance and changes
- Net revenues fell 17%. Trading gains declined 35% to $435.1 million, commissions and execution fees fell 10% to $412.6 million, while net interest income rose 6% to $206.4 million. Other income increased to $76.4 million, partly because 2011 included losses on non-market-making investments.
- Electronic brokerage: Net revenues were $670.4 million, down 3%; pre-tax income was $341.7 million, down 8%, and segment pre-tax margin declined to 51% from 54%. Customer accounts grew 11% to about 210,000 and customer equity rose 31% to $32.9 billion, but total DARTs fell 7% to about 413,000.
- Market making: Net revenues were $459.6 million, down 34%; pre-tax income fell 54% to $188.6 million and segment pre-tax margin was 41%, versus 59%. Management cited lower volatility and trading activity, an unfavorable currency-translation swing, and a decline in the actual-to-implied volatility ratio to 69% from 85%. Wider option spreads partly offset these pressures.
- Consolidated non-interest expenses decreased 2% to $603.5 million, but rose to 53% of net revenues from 45%. Employee compensation increased 13%, including an $18.4 million special restricted-stock grant; lower execution and clearing costs and general and administrative expenses partly offset the increase.
- For fourth-quarter 2012, net revenues were $247.1 million, pre-tax income was $96.2 million and diluted EPS was $0.19. Fourth-quarter revenue was lower than in each of the first three quarters.
Cash, liquidity, debt and capital
- Year-end cash and cash equivalents were $1.615 billion, down from $1.695 billion. Operating cash flow was $558.4 million; investing activities used $52.4 million and financing activities used $591.0 million, primarily reflecting dividends and senior-note repayments. Operating cash flow is affected substantially by customer balances and trading positions.
- Total assets were $33.20 billion; the filing states that 98.7% were considered liquid, chiefly cash, marketable securities and collateralized receivables. Much of the balance sheet relates to customer and brokerage activity, including $12.48 billion of cash and securities segregated for regulatory purposes and $21.42 billion payable to customers.
- Short-term borrowings were $110.4 million at year-end; no senior secured revolving-credit borrowings were outstanding under the $100 million facility. The company discontinued its senior-notes program and redeemed $101.4 million of notes during 2012. Management stated that available cash, operating cash flow and facility capacity should meet liquidity needs for more than 12 months.
- Operating companies had $2.56 billion of excess regulatory capital and were in compliance with applicable requirements. Customer margin loans were $9.85 billion, up from $7.02 billion; the company uses real-time margin monitoring and automatic liquidation, but disclosed that customer and market exposures can exceed collateral in stressed or illiquid conditions.
Outlook, risks and unusual items
- Management gave no quantified earnings or revenue guidance. It expected 2013 gross capital expenditures to be lower than 2012 as data-center and backup-facility expansion was completed; ongoing technology investment and quarterly dividends of $0.10 per share were planned. A $1.00-per-share special dividend was paid in December 2012.
- Management attributed weaker 2012 conditions to economic and political uncertainty, lower investor participation, declining exchange volumes and low volatility. Brokerage results also depend on customer activity, account and asset growth, and interest rates; market-making earnings are described as inherently unpredictable.
- Foreign-currency effects were significant: trading gains included a $38.6 million currency-translation loss in 2012 versus an $11.2 million gain in 2011. The filing says the U.S.-dollar value of the company’s 16-currency GLOBAL basket declined 0.4% during 2012.
- Reported diluted EPS of $0.89 excludes no adjustment for the ordinary reported result; comprehensive-income EPS was $1.13 and included a $0.20 benefit from reversing $9.2 million of deferred taxes previously provided in error on other comprehensive income. The filing also says 2012 tax benefits related to prior years increased EPS by $0.07.
- A material weakness in review and interpretation of complex accounting issues—particularly redeemable noncontrolling interests and stock compensation—remained at December 31, 2012. Management and the auditor concluded internal control over financial reporting was ineffective; Deloitte issued an adverse opinion on internal controls but an unqualified opinion on the financial statements. Management reported remediation progress, but had not completed remediation.
- The company had restated prior financial statements, principally concerning accounting for redeemable noncontrolling interests. The filing identifies pending patent litigation alleging infringement of 12 patents; damages sought were unspecified, and the outcome could not be predicted. Regulatory inquiries were ongoing, with no formal enforcement actions disclosed other than matters specifically identified in the filing.
- Other material risks include trading losses, model or technology failures, cyber and third-party outages, intense competition and spread compression, regulatory changes, customer defaults, clearinghouse assessments, concentrated voting control, and potential dilution from future share issuances. The filing notes that backup services were limited, particularly outside the U.S.
Investor facts to verify
- Whether the accounting-control weakness has been remediated and whether subsequent filings report effective controls.
- How sustainable brokerage activity, customer growth, net interest income and market-making profitability are under differing volume and volatility conditions.
- The normalized earnings impact of currency translation, the OCI tax reversal, prior-year tax benefits and the 2012 employee stock award.
- The composition and availability of reported liquidity, regulatory capital, customer-related balances and the $9.85 billion of margin loans.
- Potential cash payments under the tax receivable agreement, the outcome of patent litigation and regulatory inquiries, and the extent of future equity issuance and dilution.