IBKR

Interactive Brokers Group, Inc. (IBKR)

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Interactive Brokers Group (IBKR)

Q3 2010 Earnings Call

October 21, 2010 5:00 pm ET

Executives

Deborah Liston - Director of IR

Thomas Peterffy - Chairman, CEO & President

Paul Brody - CFO

Analysts

Rich Repetto - Sandler O’Neill

Niamh Alexander - Keefe, Bruyette & Woods

Ed Ditmire - Macquarie

Mac Sykes - Gabelli & Company

John Rowan - Sidoti & Company

Rich Repetto - Sandler O’Neill & Partners

Rob Rutschow - CLSA

Presentation

Operator

Good day, everyone, and welcome to the Interactive Brokers Third Quarter 2010 Earnings Results Conference Call. This call is being recorded.

At this time, for opening remarks and introduction, I would like to turn the call over to Ms. Deborah Liston, Director of Investor Relations. Please go ahead.

Deborah Liston

Welcome everyone and thank you for joining us today. Just after the close of regular trading, we released our third quarter financial results. We’ll begin the call today with some prepared remarks on our performance that complements the material included in our press release and allocate the remaining time to Q&A. Our speakers are Thomas Peterffy, our Chairman and CEO; and Paul Brody, Group CFO.

At this time, I’d just like to remind everyone today’s discussion might include forward-looking statements. These statements represent the company’s belief regarding future events that by their nature are not certain and outside the company’s control. Company’s actual results and financial condition may differ possibly materially from what’s indicated in these statements.

For a discussion of some of the risks and factors that might affect the company’s future results, please see the description of risk factors in our filings made with the SEC. I’d also direct you to read the forward-looking disclaimers in our quarterly earnings release.

With that, I’ll turn the call over to Thomas Peterffy.

Thomas Peterffy

Good afternoon, and welcome to our third quarter earnings call. Our latest results reflect a combination of strong currency movements that shifted in our favor from the first half of the year, the challenging environment we continue to face as market makers, and the lighter trading volumes across the world’s exchanges, most notably in the US. The net effect resulted in a boost to our overall results, as compared to the last three quarters. Pre-tax income grew 22% over the prior year and profit margins came in at 54%.

I will discuss these market conditions, as they are related to each of our business segments. I’ll begin with Market Making. Currency movements have been positive for us this quarter, almost netting out the negative effect from the first half of the year. The net effect of currency movements on our earnings for the quarter is positive $44 million as reported in US dollar. This consists of a $206 million gain due to the appreciation of the GLOBAL against US dollars, but $162 million of this shows up as other comprehensive income, and therefore, it is not part of our reported earnings.

As you are probably familiar by now, we are a global market maker trading on exchanges all over the world in multiple currencies and we report our results in US dollars. We choose to hedge our exposure to currency fluctuations by maintaining our equity in proportion to a self-defined basket of currencies we call the GLOBAL. Please refer to our last two earnings calls and our filing on July 2 that details the components of this basket and illustrate how to estimate our transaction gain or loss for any given quarter.

While quarter-to-quarter effects may be bumpy, the balance sheet and income statement impacts generally offset each other over the long-term. Translating the GLOBAL to US dollars yielded $1.06 at the beginning and $1.11 at the end of the third quarter, an increase of approximately 4.5%. This resulted in a positive impact of about $206 million to equity. Due to the relative strength of the Swiss franc against the dollar, approximately $162 million of this increase was recorded in other comprehensive income or OCI on the balance sheet, and the remainder increasing our trading gains on the income statement.

Net effect for the nine months, there is real loss of $11 million when looked up on in US dollar terms. That is due to currency movements, which is composed of $97 million reduction in reported earnings from Market Making and $86 million increase in net worth due to OCI. From the point of view of analyzing our earnings, what all this boils down to is that our reported earnings for Market Making for the third quarter are overvalued by $44 million. But for the nine months, they are still undervalued by $97 million. By overvalued and undervalued, I mean, that they look more or less than what they really were.

Now, I’ll discuss the trading environment. The competitive forces that started to erode our trading gains in early 2009 have been relatively consistent this year with no certain relief in sight. Bid/offer spreads on exchanges remained tight, primarily due to intensive competition we are still seeing from high frequency traders or HFTs.

Average spreads, as reported by the PHLX, contracted 12% from the previous quarter and 33% from a year-ago quarter. I do not foresee any major catalyst reversing the trend of contracting spreads, except for the potential recurrence of sharp price movements similar to May 6, which we are certainly not hoping for.

As I have discussed, HFTs operate without significant regulatory burdens and costs borne by registered market markers, and have effectively elbowed out market makers by copying or slightly bettering market maker quotes. The trading practices of HFTs have been under the spotlight for some time now, as well as their role in the markets on the day of the flash crash.

While the recently-issued SEC report concluded they were not the cause of the crash, they have been criticized for pulling out of the markets during periods of extreme price movements. As fair-weather liquidity providers, they typically retreat during times of turbulence rather than helping to stabilize prices.

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