Interactive Brokers Group, Inc. annual report, FY2010

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Interactive Brokers Group, Inc. — 2010 Form 10-K

Reporting period: Year ended December 31, 2010, with fourth-quarter results noted below. The company is a holding company that consolidates IBG LLC, which it owned approximately 10.8% of at year-end. Its two principal businesses are global electronic market making and electronic brokerage.

Financial results and key metrics

  • Full-year revenue: Total revenue was $988.3 million; after $66.2 million of interest expense, net revenue was $922.1 million, down 16% from $1,100.3 million in 2009.
  • Profit: Income before tax was $340.8 million, down 37%, with a 37% pre-tax margin versus 49% in 2009. Consolidated net income was $280.4 million. After $289.7 million attributable to non-controlling interests, net loss available to common stockholders was $9.3 million, or diluted loss per share of $0.22, compared with 2009 net income available to common stockholders of $36.2 million and diluted EPS of $0.87.
  • Segments: Market making net revenue was $379.2 million and pre-tax income $89.5 million, down 39% and 73%, respectively. Electronic brokerage net revenue was $547.3 million and pre-tax income $274.8 million, up 15% and 19%. Pre-tax margins were 24% and 50%, respectively.
  • Revenue drivers: Trading gains fell 42% to $368.6 million; commissions and execution fees rose 10% to $386.8 million; net interest income rose 104% to $106.3 million.
  • Cash flow and liquidity: Operating cash flow was $1.693 billion, investing cash outflow $17.3 million, and financing cash outflow $1.175 billion. Cash and cash equivalents ended at $1.354 billion. Management reported $28.03 billion, or 98.4% of total assets, as liquid, and $2.75 billion of excess regulatory capital. Operating cash flow was materially affected by changes in trading positions and customer-related balances.
  • Debt: Total indebtedness was approximately $482.0 million at year-end: $187.4 million in short-term borrowings, $194.6 million in senior notes, and $100.0 million drawn on the revolving facility. The revolving-facility balance was repaid January 18, 2011. The senior notes carried 5% or 7% rates and 15- or 18-month maturities.
  • Fourth quarter: Revenue was $203.6 million, net revenue $186.3 million, and pre-tax income $41.9 million. Net loss available to common stockholders was $28.1 million; diluted EPS was $(0.66).

Material changes versus 2009

  • Market making weakened substantially amid narrower bid/offer spreads, lower volatility, high-frequency-trading competition, reduced market-making trades, and adverse currency translation. Average VIX volatility fell approximately 29%; the filing reports spreads about 33% narrower than in 2009 on the cited exchange measure.
  • Brokerage growth partly offset market-making declines: customer accounts increased 18% to approximately 158,000, customer equity rose 45% to $22.1 billion, and total DARTs increased 9% to approximately 379,000.
  • Non-interest expenses increased 5% to $581.3 million, while expenses rose to 63% of net revenue from 51%. Employee compensation increased 14%, including a $9.5 million dividend-equivalent payment to employees with unvested shares.
  • Foreign-currency translation losses recognized in trading gains were $244.0 million, versus $8.7 million in 2009. Management’s non-GAAP presentation reclassifies currency effects and adjusts for specified dividend-related items; it reports 2010 diluted EPS of $0.73 versus GAAP $(0.22).
  • Total equity declined to $4.22 billion from $4.88 billion, primarily reflecting the approximately $1 billion distribution by IBG LLC and the related special dividend. The public company paid $1.79 per share in December; the filing gives an estimated $0.71 per-share impact from the dividend-related tax expense.

Outlook, commentary, risks, and unusual items

  • No specific earnings or revenue guidance is provided. Management expected 2011 gross capital expenditures to be at a similar level to 2010’s $18.1 million, including data-center and backup-facility expansion; future technology investment could increase.
  • Management described market making as inherently unpredictable and dependent on market volume, volatility, spreads, competition, and actual-versus-implied volatility. Brokerage is comparatively more predictable but depends on customer activity, account and asset growth, and interest rates. Management cited continued competition and uncertainty over Dodd-Frank implementation.
  • The December distribution originated with a $990.3 million dividend from Swiss subsidiary Timber Hill Europe AG to IBG LLC. It triggered U.S. tax on previously untaxed earnings; the filing reports $40.8 million of U.S. federal tax on the company’s share before available foreign tax credits. Management says the distribution was cash-flow neutral for the public company after reserving for tax.
  • Key risks include market-making losses or model failure; trading-volume and spread declines; customer, counterparty, and clearinghouse defaults; margin-credit exposure; system outages, cyber incidents, and third-party failures; regulatory changes and compliance costs; foreign-currency exposure; and concentrated voting control. The company disclosed $6.97 billion of customer margin credit at year-end and described related potential exposure as not quantifiable.
  • Trading Technologies International sued the company and affiliates in February 2010, alleging infringement of six U.S. patents and seeking unspecified damages and injunctive relief. The case was at the pleadings stage; management intended to defend it, and loss reserves for litigation were not material. The company also reported ongoing regulatory inquiries but no formal enforcement actions pending against its regulated entities other than matters specifically disclosed.
  • Auditors issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls and internal controls were effective as of year-end.

Investor facts to verify

  • Reconcile GAAP loss per share to management’s non-GAAP EPS, particularly the dividend-related tax and currency-translation adjustments.
  • Track whether market-making profitability stabilizes as volatility, spreads, competition, and currency effects change.
  • Monitor brokerage account, customer-equity, DART, commission, and net-interest-income growth, including sensitivity to low interest rates.
  • Review liquidity and regulatory-capital availability alongside customer balances, margin-credit exposure, and short-term funding needs.
  • Follow the Trading Technologies litigation, regulatory inquiries, and implementation of financial-industry rules.
  • Assess the implications of the special dividend, future dividend policy, debt covenants, and potential future share issuance or dilution under the exchange agreement.