Executives
David Fleischman - Chief Financial Officer
Salomon Sredni - Chief Executive Officer
Analysts
Matthew Snowling - FBR
Richard Repetto - Sandler O'Neill & Partners
Edward Ditmire - Fox-Pitt Kelton
TradeStation Group Inc. (TRAD) Q1 2008 Earnings Call April 24, 2008 11:00 AM ET
Operator
Good morning, my name is Pamela and I will be your conference operator today. At this time, I would like to welcome everyone to the TradeStation Group first quarter 2008 Earnings Call.(OPERATOR INSTRUCTIONS).
Thank you. Now I would like to turn the call over to our host, Mr. David Fleischman, Chief Financial Officer of TradeStation Group. Sir, you may begin your conference.
David Fleischman
Thank you Pamela. Good morning, and welcome to the TradeStation Group first quarter 2008 conference call. Today's conference call is being broadcast live over the Internet and will be archived for the next 90 days at www.tradestation.com. We would like to thank all of our listeners, including shareholders, customers and analysts for joining us this morning.
My name is David Fleischman, Chief Financial Officer, of TradeStation Group. Here with me today is Salomon Sredni, our Chief Executive Officer. By now, you should have seen our financial results released this morning. If you have not, they are available at our Company website, www.tradestation.com, in the investor relations section. Also, if you are accessing this call through our website, please note that some of the prepared comments you are about to hear are accompanied by graphs and charts, and we invite you to view them as you listen.
Before we start, I would like to emphasize that this conference call will include statements that are forward-looking and are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act. All forward-looking statements are based on current expectations and beliefs and actual results may differ materially from the results suggested in this conference call. Factors that may cause or contribute to such differences include those set forth in today's earnings release, and in the Company's filings with the Securities and Exchange Commission. Please note that the Company undertakes no obligation to update any information presented in this conference call. With that said, it is my pleasure to hand over the call to Salomon Sredni, Chief Executive Officer of TradeStation Group.
Salomon Sredni
Thank you, David. Good morning everyone. The 2008 first quarter was another great quarter for our Company. We produced record revenues, record brokerage commissions, record DARTs and record total accounts. In what, most would describe as challenging conditions for our industry our revenues year-over-year increased 15%. We achieved these record revenues despite a declining interest income, which decreased in the first quarter as a result of the last reductions in the fed funds target rate that were done over the past six months. These record results were generated by record brokerage commissions and fees, which were up 37% year-over-year. This record brokerage commissions and fees were obviously generated by large increase in the number of DARTs. This was the first quarter in our history that our DARTs exceeded 100,000, a true milestone in our industry, and as a percent they were up 56% year-over-year.
I'm also delighted to report that after being recognized by the readers of "Stocks and Commodities" magazine as the best futures brokers in America, and as the best trading partner in seven other categories, last month we were honored by "Barron's" magazine as the best overall online brokerage in the US, as well as the best for options traders and for frequent traders. Our talented employees deserve a lot of recognition and gratitude for making this happen. I'm very proud of what we've been able to accomplish.
Let me share with you some more color on the first quarter. We increased our DARTs in the 2008 first quarter to over 109,000, which as I just mentioned, is a 50% increase in DARTs when compared to the first quarter of 2007. It is also a 21% increase from the 2007 fourth quarter. Please keep in perspective that once again, these DARTs reproduce by roughly just 38,000 accounts. That is obviously a small fraction of the number of accounts that our larger competitors require to produce that many trades. We once again attribute our continued DART growth to the growing diversity of our service offering and the robustness of our business model, particularly when market volatility increases. Through April 22, our DARTs for this month were approximately 89,000, mainly as a result of the decreased volatility in the marketplace during the month of April.
Let's now spend a moment on brokerage accounts. Our 1,921 net new accounts in the 2008 first quarter have brought us to almost 39,000 total accounts, a 17% increase in the size of our customer base year-over-year. While we had very high gross account additions in the first quarter, a large number of our accounts also fell below our 200 account balance threshold and stopped trading or did not trade at all during the first quarter. We expect to see a majority of these accounts show up in our third quarter attrition numbers.
The numbers our brokerage accounts generate also continue to be among the very best in the industry. During the 2008 first quarter, on an annualized basis, our average account traded 730 times; a record for our Company and a 50% increase from the 2007 fourth quarter. And the average account produced $4,100 of revenue. All numbers are substantially higher than those produced by, for example, Ameritrade or E-Trade. Again, with market volatility high, the value of our robustness or our active trader, or client base was clearly demonstrated. What I'd like now to do is to turn the call over to David so he can review our first quarter 2008 performance from a financial statement perspective.
David Fleischman
Thank you Sal. For those of you listening through our TradeStation website, we again invite you to view the graphs and charts accompanying my comments. For the quarter ended March 31, 2008 TradeStation Group had record total revenues, brokerage commissions and fees, daily average revenue trades, and monthly average trades per account. Net income was $8.3 million, or $0.19 per share. These results were achieved despite reduced net interest income as a result of interest rate cuts that unfavorably impacted our 2008 first quarter net revenues. TradeStation Group's 2008 first quarter net income of $8.3 million compared to 2007 first quarter net income of $8.2 million, and 2007 fourth quarter net income of $9.3 million. Even though, we had record revenues in the 2008 first quarter, our quarterly net income decreased compared to 2007 fourth quarter due primarily to the decrease in the interest income, which goes straight to our pre-tax results.
First quarter 2008 net revenues of $40.7 million increased 15% when compared to first quarter 2007 net revenues of $35.3 million, and 1% when compared to 2007 fourth quarter net revenues of $40.2 million, due to increased brokerage commissions and fees, which were partially offset by reduced net interest income. Brokerage commissions and fees of $30.5 million increased 37% from first quarter 2007 brokerage commissions and fees of $22.3 million. Increased market volatility, which began in the latter half of 2007, and continued into the 2008 first quarter, combined with continued account growth, were important factors helping us achieve record brokerage commissions and fees and total revenues, as our active trader customers tend to trade more when there is increase market volatility.
First quarter 2008 net interest income of $8.1 million was a 25% decrease from first quarter 2007 net interest income of $10.8 million, and a 22% decrease from fourth quarter 2007 net interest income of $10.3 million. This decrease was the result of lower interest rates. On January 22, 2008, the federal funds target rate of Interest was reduced by 75 basis points. On January 30, the rate was further reduced by 50 basis points, and on March 18, the rate was again reduced by 75 basis points to its current rate of 2.25%. Most of our interest income is tied to the federal funds target and daily rates of interest. We estimate, based on the size and nature of our customer assets at March 31, 2008 that each basis point increased or decreased in the federal funds target rate of interest impact our annual net income by approximately $61,000. Increases or decreases in our aggregate customer balances over 2008 will affect our net interest income.
In preparing our 2008 second quarter and revised full-year business outlook that was published today. We assumed there will be an additional 25 basis point reduction in April 2008 and in June 2008, 50 basis points in the aggregate, bringing the assumed Federal Funds Target Rate of Interest to 1.75% in June 2008, and then no further reductions or increases for the remainder of 2008.
TradeStation's first quarter 2008 brokerage commissions and fees per employee, which were more than $95,000, were about 50% higher than TD Ameritrade and about 75% higher than E-Trade's brokerage commissions and fees per employee. This also highlights the scalability and leverage of our business model.
During the 2008 first quarter, total expenses were $27.2 million, 67% of net revenues as compared to $22.1 million, 63% of net revenues in the 2007 first quarter. This dollar amount increase of total expenses was primarily the result of increased execution costs due to a higher number of customer trades, and as we continue to grow our accounts and revenues, our increased investments in people, infrastructure, and advertising. The increase of total expenses as a percentage of net revenues was caused mainly by our decrease in net interest income, which has no corresponding course.
For the 2008 first quarter, employee compensation and benefits was $9.2 million as compared to $8.5 million in the 2007 first quarter. At March 31, 2008, the Company had 322 employees as compared to 318 employees at March 31, 2007. As discussed in previous conference calls, in 2008 we plan to increase our employee headcount primarily in product development.
For the 2008 first quarter, clearing and execution of $9.5 million, 31% of brokerage commissions and fees compared to 2007's first quarter clearing and execution of $7.1 million, 32% of brokerage commissions and fees. Increased trading volume and mix of business accounted for the variance in the 2008 first quarter.
Data centers and communications costs in the 2008 first quarter were $2.4 million as compared to $1.7 million in the 2007 first quarter. Beginning in the 2007 third quarter, the company began reclassifying a portion of its recovery of exchange fees within brokerage commissions and fees. Together, with the effect of that reclassification, higher costs for service and exchange fees primarily accounted for the increase. Advertising costs in the 2008 first quarter were $1.3 million as compared to $1.1 million in the 2007 first quarter. We believe for the remaining quarters in 2008, advertising expense will be consistent with the level of expense incurred in the 2008 first quarter.
First quarter 2008 professional services were $1.6 million as compared to $1.2 million the 2007 first quarter. During the 2008 first quarter, the company incurred approximately $950,000 of legal fee expense pertaining to a lawsuit against the Company and certain of its Directors and Officers brought by founders and former officers of onlinetrading.com, a brokerage we acquired in late 2000. This trial concluded in February, and as previously disclosed, the Company and its Directors and Officers prevailed on all claims.
First quarter 2008 occupancy and equipment costs and depreciation and amortization costs were approximately the same as the 2007 first quarter. First quarter 2008 other costs were $1.5 million as compared to $944,000 in the 2007 first quarter. The variance was primarily the result of the cost of a settlement, increased customer debits and errors, and in the 2007 first quarter, the Company had a favorable reserve adjustment.
In the 2008 first quarter, the Company pursuant to its stock buyback plan, spent approximately $3.7 million to purchase approximately 353,000 shares of its common stock. Since buying under the plan began November 13, 2006 through March 31, 2008, the company has spent approximately $20.7 million to purchase approximately 1.7 million shares.
In this morning's earnings release, we issued our business outlook for the 2008 second quarter, and the revised full-year outlook. The 2008 second quarter and full-year business outlook includes approximately $1 million of additional after-tax expense as a result of anticipated early vesting of certain Officers and Directors' stock options. We are estimating for the 2008 second quarter that net revenues will range from $37.5 million to $42 million, and earnings per share will range from $0.12 to $0.16. Without the expense for accelerating vesting of the Officers and Directors' stock options, the estimated earnings per share range would have been $0.14 to $0.18.
We are now estimating for the 2008 year that revenues will range from $154 million to $170 million, and earnings per share will range from $0.61 to $0.75. Without the expense for accelerated vesting of stock options, the estimated earnings per share range for the full year would have been $0.64 to $0.77. Other than this accelerated options vesting expense, the primary factor driving our 2008 earnings per share estimate today, as compared to 2008 earnings per share range we published in February 2008, is the recent large reductions in the federal funds target rate of interest, which were not in our prior assumptions, and which directly impact the net interest income component of our revenues.
When preparing our current business outlook, we assumed, among other things, that accounts will average daily revenue per account for each asset class at approximately the same level they averaged during the six-month period in the March 31, 2008, and that there will be an additional 25 basis point reduction in April 2008 and in June 2008, 50 basis points in the aggregate, bringing the assumed federal funds target rate of interest to 1.75% by the end of June 2008, and then no further reductions or increases for the remainder of 2008.
Also, it should be noted that as a result of the increased stock compensation expense I just mentioned, we estimate that our 2008 second quarter and total 2008 year effective income tax rate will be approximately 42% and 40% respectively. Variations in these or other assumptions, will likely result in material differences to the estimated results in the business outlook.
That concludes my prepared remarks today concerning our financial statement. I'll now turn the call back over to Sal.
Salomon Sredni
Thank you, David. As I mentioned in our February call, we continue to build an impressive and valuable franchise that serves the risk traders in a way we believe no other online brokers can match. We believe the continuing trend towards derivatives trading in our customer base not only emphasizes the value of our service offering, but over time should help offset our sensitivity to changes in interest rates. The vast majority of our interest income today comes from cash equities accounts. This trend also reflects our growing presence and success in the trading markets that are generally considered to be areas of highest potential market-sized growth in our industry. We believe that this trend, which casts us more and more as a force to be reckoned with in the diverse market, is an exciting and important factor, an indicator of our potential future growth. We believe that the market should recognize this significant shift in our business when analyzing the value and prospects for franchise, as well as the value of our Company and its stock.
While we are very excited about our trend towards diverse traders, we are also excited about our potential for growth and further penetration of the US active trader market in both the cash equities and derivatives trader markets.
TradeStation customers and prospects are far more self directed, self reliant and confident in their trading abilities than the typical online trader, and are looking for a powerful rule-based trading platform to help them accomplish their trading objectives. We believe that TradeStation is poised for growth, because it's uniquely positioned to deliver to this market segment a trading platform that offers the complete package of first-rate custom strategy design, accessing information, and order execution capabilities.
TradeStation only pioneered the concept of rule-based trading for the active trader market, but as our recent awards and accolades clearly demonstrate, we have continuously innovated to keep our offering cutting edge and the leader of the pack.
To help assure we continue to remain ahead of the competition, we have several enhancements and new features in the works. As I've also said, we intend to increase our research and development headcount.
I will share with you what we're working on or about the time of their release. One major enhancement recently launched was a trading simulator that now allows brokerage clients to use all of the powerful automation, order execution functions with a TradeStation platform on a simulator or paper trading basis. They can explore and become more comfortable with the platforms' powerful tools before risking any money on their trades. We believe the simulator serves as a powerful training tool that will build our customer base comfort and confidence in trading actively using our platform.
We continue to believe, now more than ever, that electronic automated rule-based trading the core of our award-winning service offering and a unique selling proposition, has huge appeal to the special demands of the active trader market. While rule-based trading is relevant to all serious traders, and as time goes on, we think that our market will expand as more and more traders, both domestically and abroad, become primarily rule-based traders.
I again want to thank your employees for their outstanding achievement and their continued dedication and focus. I continue to be extremely excited about our team, and the potential we have to grow this Company to a new level. That concludes my prepared remarks for today's presentation, and we'll now ask the Operator to open the floor for questions.
Questions -and-Answers
Operator
Thank you sir. (Operator Instructions). And our first question comes from the line of Rich Repetto with Sandler O'Neill.
Richard Repetto - Sandler O'Neill & Partners
Good morning guys.
David Fleischman
Good morning Rich.
Salomon Sredni
Good morning Rich.
Richard Repetto - Sandler O'Neill & Partners
First question is on trading activity in DARTs. Definitely the good news is, you were the only online broker that was up quarter, the quarter here being up 20% where the other guys were down slightly. But, I guess the question is it looks like you're coming back, reverting to the main -- if I got the April to date number -- that's down 18%, and I guess your DARTs are harder to predict than anybody else's. I'm just trying to see if you could give some color why you outperformed, and it is at least on a channel checks, you're down a little more in April than the other guys right now.
Salomon Sredni
Rich, I think we outperform because our platform clearly attracts the elite in the marketplace, and I think that when you match our platform with the volatility and market experience, I think that we have the ability to generate a significant amount of revenues for the Company. As a release to April, again I don't want to get overly excited. It is three weeks into the month, and again volatility has been down. So, I think as we've said in the past, a lot of what happens with our trading volume has to do with volatility, but again we continue to attract those customers, continue to grow that customer base and generate those revenues.
Richard Repetto - Sandler O'Neill & Partners
Okay. And, then the next question Sal is more just in general on the investment -- and David -- on the investment spending and the plan, if you take your guidance now, that the advertising for the rest of the year is going to be flat with 1Q. You'd actually have a year-over-year decline in advertising. So, I guess the question is what's the outlook on investor spending, what's the impetus behind sort of eliminating the advertising, what's the plan here?
David Fleischman
Rich, I think the plan is, we're estimating that it will be about the same as Q1, but if you remember last year when we ramped up our advertising, I think it was in the second quarter of '07, we really ramp it up and it was a little higher then. But, I think we're finding a level now and we'll adjust it as we think is necessary.
Salomon Sredni
Rich, our gross account ads were pretty high this quarter, and I think we're trying to -- we're in a good groove with marketing and we have a good buzz going on. We'll continue that, we expect to continue that throughout the year.
Richard Repetto - Sandler O'Neill & Partners
Okay, makes sense. And, then the last question, and sorry for the details here, but if I heard you right, I thought you said a tax rate in the 40% or 41%, and David, that would be different than the last couple of years. I'm just wondering did I have it correct, and if I do, why the change here?
David Fleischman
Sure Rich. We're expecting our tax rate, effective tax rate to be 42% in the second quarter, and then for the entire year, it will be 40%, and really it's being driven by the one-time non-cash stock compensation expense that we have to pick up, which is not a taxable item, so you don't get an effect there. And, probably in future yes, because we are bringing that expense into 2008, there might be some benefit in 2009 and 2010.
Richard Repetto - Sandler O'Neill & Partners
So out years, we probably would see the tax rate to back to more of the historical levels, is that fair?
David Fleischman
Yeah, absolutely yes, yes.
Richard Repetto - Sandler O'Neill & Partners
Okay thanks guys.
David Fleischman
Thank you.
Salomon Sredni
Thanks Rich.
Operator
(Operator Instructions). And your next question comes from the line of Matthew Snowling with FBR.
Matthew Snowling - FBR
Hi guys, how are you doing?
Salomon Sredni
Good morning Mat.
David Fleischman
Hey Mat, good morning.
Matthew Snowling - FBR
Can you talk a little bit about your international expansion?
Salomon Sredni
Yes Matt. We're actually increasing our international revenues. We did partnerships, as I said, last quarter with various providers and educational sources, and we keep growing that customer base, and we continue to see tremendous opportunity on that. We continue to advance that strategy internally. There's not much I can share with you today as to where we're going to go with that, but I can tell you I'm very excited about that and that we are definitely making progress in the right direction there, and hopefully we'll share more of that as the year goes along.
Matthew Snowling - FBR
Can I ask, are there particular products that you're leading with; is it equities, is it FX?
Salomon Sredni
Well, I think that the best way to say is that the product we're leading with is TradeStation, and what data will go with that will depend on the marketplace, and really on the particular market within each country that we go in after. I can tell you as a starter, we're very excited about the derivative market in Europe, which is basically Eurex and Euronext and the German markets.
Operator
Your next question comes from the line of Edward Ditmire, Fox-Pitt Kelton.
Edward Ditmire - Fox-Pitt Kelton
Good morning guys.
Salomon Sredni
Good morning Ed.
David Fleischman
Morning Ed.
Edward Ditmire - Fox-Pitt Kelton
I wanted to know if, in your quarterly release under the risk factors, you talked about certain institutional trader clients had their balances, their clearing arrangements done at Bear Stearns, and that you were seeing some slowdown in activity and the balances related to those accounts. Can you add any color around that?
David Fleischman
Sure Ed. Just so everybody is clear, we do clear our institutional account at Bear Stearns, and a couple of the large institutional accounts had decided to pull some of their monies out, and therefore, some of the trading decreased there. So that basically is really all that.
Edward Ditmire - Fox-Pitt Kelton
Is there something where you would think, is that something that improved after a certain point, or that I would just think that the point of maximum concern around Bear Stearns is probably past from that perspective?
David Fleischman
Ed I think, I'm really concern this factor, but I think everybody is waiting for the deal to close to go back to normal. In the interim, they're just reducing their potential exposure by reducing their balances at Bear; that's really all they're trying to do, and waiting for that transaction to get close.
Edward Ditmire - Fox-Pitt Kelton
Is there any way you guys can kind of tell us just relatively what kind of portion of your business is derived in that way?
David Fleischman
It's relatively small, and in some ways, we were able to move some accounts to clear with TradeStation, which obviously helps our bottom lines, but it's not a large balance.
Edward Ditmire - Fox-Pitt Kelton
Okay, thanks a lot.
David Fleischman
No problem.
Operator
Your next question comes from Richard Repetto with Sandler O'Neill & Partners.
Richard Repetto - Sandler O'Neill & Partners
Hi guys; just a quick follow-up here. You talked in the prior quarter about -- and you may have addressed this, and I apologize if I missed it David -- but professional services, the legal fees, the $900,000 expected from the settled lawsuit in the first quarter. Was there, in fact, $900,000 in legal fees in the professional services line this quarter?
David Fleischman
Yes, it wasn't from the settlement. That was just actual legal fees for the trial. It was $950,000 in the quarter, yes.
Richard Repetto - Sandler O'Neill & Partners
So, am I right then, the run rate would be back down to more like in the $750,000 --?
David Fleischman
Yeah, I think the answer is yes, but it might be a little higher than that.
Richard Repetto - Sandler O'Neill & Partners
Okay, okay that was my follow-up; thank you.
David Fleischman
Thank you.
Operator
At this time, there are no questions, sir.
David Fleischman
Thank you. There being no further questions, we'd like to thank all of you for joining us this morning. We appreciate your support and look forward to our next conference call. Thank you.
Salomon Sredni
Thank you.
Operator
This concludes today's TradeStation Group conference call. You may now disconnect.
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