Interactive Brokers Group, Inc. — Q1 2018 Form 10-Q
Business context and reporting period. Unaudited results cover the three months ended March 31, 2018, compared with Q1 2017. Interactive Brokers is a global electronic broker operating on more than 120 exchanges and market centers. It also retained reduced market-making operations while winding down its options market-making business. The public company owns approximately 17.4% of IBG LLC; the remaining 82.6% is reported as noncontrolling interests.
Key financial results
- Revenue: Total revenues were $621 million, up 52%; after $94 million of interest expense, net revenues were $527 million, up 41% from $374 million. Commissions rose 43% to $220 million, and interest income rose to $311 million from $177 million.
- Profit and margins: Pretax income increased 60% to $340 million from $213 million; net income was $319 million versus $195 million. Net income attributable to noncontrolling interests was $273 million, leaving $46 million available to common stockholders, compared with $24 million. Diluted EPS was $0.63 versus $0.34. Consolidated pretax margin was 65% versus 57%; electronic brokerage’s margin was 63% versus 59%.
- Interest and operating drivers: Management reported net interest income of $217 million, up 53%, driven by higher benchmark rates and customer balances. The MD&A’s net-interest table reports $222 million under its stated presentation; investors should reconcile this difference. Customer accounts increased 27% to 517,000, customer equity rose 33% to $129.2 billion, and total customer DARTs increased 43% to 939,000.
- Cash flow: Operating activities provided $1.201 billion, investing used $8 million and financing used $64 million. Cash, cash equivalents and restricted cash increased $1.137 billion to $9.416 billion. Operating cash flow is substantially affected by customer balances and trading-related assets and liabilities, not solely earnings. Adoption of restricted-cash guidance changed presentation; the 2017 comparative operating cash flow was retrospectively adjusted.
- Balance sheet and liquidity: Total assets were $59.1 billion, down from $61.2 billion at year-end; total equity was $6.7 billion versus $6.4 billion. Cash and cash equivalents were $1.9 billion, with a further $7.5 billion segregated for regulatory purposes. Customer receivables were $29.5 billion and customer payables $47.4 billion. Management classified 99.5% of assets as liquid and said available cash flows and borrowing capacity should meet needs for more than 12 months.
- Debt and capital: Short-term borrowings were $19 million; the company reported no variable-rate debt outstanding. Securities repurchase obligations fell from $1.316 billion at year-end to zero. Aggregate excess regulatory capital was $5.2 billion, and regulated operating companies were in compliance with capital requirements.
- Costs and distributions: Non-interest expense rose 16% to $187 million, including $73 million execution and clearing costs and $70 million compensation. The company paid $7 million in common dividends and $61 million in distributions to noncontrolling interests during the quarter.
Material changes and management commentary
- Electronic brokerage pretax income increased 57% to $291 million, supported by higher trading volumes, interest income and customer growth. Management cited a 73-basis-point increase in the average Federal Funds effective rate to 1.43%, plus growth in average customer margin loans and credit balances.
- Market making reported $9 million pretax income versus a $22 million loss a year earlier, reflecting better results in remaining activities and lower costs during the wind-down. The U.S. options business was transferred to Two Sigma Securities in 2017; most non-U.S. options market making had also been exited. An earn-out may provide future income, subject to the transferred business’s performance.
- Management expects approximately $40 million of annual expenses associated with the former options market-making business to be absorbed by electronic brokerage; about 95% of the related resources had been transferred by March 31, 2018.
- Average VIX was 17.2 versus 11.7 in Q1 2017, with a February peak of 50.3. Management said higher volatility generally supports electronic brokerage trading volumes. Rising rates can increase interest income but also increase interest paid to customers and expose the company to mark-to-market losses on government securities.
- The currency-diversification strategy generated $38 million of income, down from $49 million. Management reported a $46 million benefit to comprehensive earnings from the strategy, versus $73 million in Q1 2017; approximately 31% of equity was denominated in currencies other than the U.S. dollar.
- The Tax Act lowered the U.S. corporate rate to 21%. Provisional amounts included a $62 million transition-tax obligation and a $115 million net reduction in deferred tax assets and liabilities recorded in 2017; these estimates remained under review.
Risks, contingencies and unusual items
- Market risks include equity prices, foreign exchange, interest rates, and customer margin lending. Margin loans outstanding were approximately $29.5 billion; rapid market moves, concentrated collateral or illiquid markets could leave collateral insufficient despite automated monitoring and liquidation practices.
- The company disclosed off-balance-sheet exposure from futures and certain other contracts, as well as guarantees to clearing houses and exchanges. Management considered payments under clearing-member guarantees remote, but stated potential liability could exceed posted collateral and was not quantifiable.
- Pending matters include patent litigation by Trading Technologies and an appeal in a customer class-action case concerning liquidation of margin-deficient accounts. Litigation reserves were not material; management said outcomes could affect results in a particular period.
- The company is subject to numerous regulatory inquiries, including matters involving reporting, best execution, short sales, margin lending, anti-money laundering and technology practices. Management expects significant and potentially increasing regulatory fines but said amounts and timing are generally unpredictable.
- No formal financial guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results and cited seasonality, trading conditions, interest rates, regulation and market structure as uncertainties.
Important facts for investors to verify
- Reconcile the MD&A net-interest-income figure of $222 million with the $217 million implied by the income statement and cited elsewhere in the filing.
- Track brokerage growth, customer trading activity, margin balances and interest spreads as rates and market volatility change.
- Monitor the completion and financial effects of the market-making wind-down, including expense transfers and any Two Sigma earn-out.
- Assess the company’s usable liquidity separately from customer and regulatory-segregated funds, and monitor regulatory capital restrictions.
- Follow updates to Tax Act estimates, regulatory inquiries, litigation and potential fines, none of which has a clearly quantified ultimate outcome in the filing.