Interactive Brokers Group, Inc. Q2 2008 Earnings Call Transcript

Jul.27.08 | About: Interactive Brokers (IBKR)

Interactive Brokers Group, Inc. (NASDAQ:IBKR)

Q2 2008 Earnings Call Transcript

July 24, 2008 5:30 pm ET

Executives

Deb Liston – Director of IR

Thomas Peterffy – Chairman, President & CEO

Paul Brody -- CFO, Treasurer and Secretary

Analysts

Edward Ditmire – Fox-Pitt

Richard Repetto – Sandler O'Neill

John Schneider – Artis Capital

Niamh Alexander – KBW

Chad Griggs [ph] – Fox Point Capital

Greg Lason [ph] – Deking [ph]

Richard Repetto – Sandler O'Neill

David Chamberlain – Oppenheimer

Joseph Carney – Steadfast Financial

Operator

Good day, everyone, and welcome to the Interactive Brokers second quarter 2008 earnings results conference call. This call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to Ms. Deb Liston, Director of Investor Relations. Please go ahead.

Deb Liston

Thank you. Welcome everyone and thank you for joining us today. Just after the close of regular trading, we released our second quarter financial results. We’ll begin the call today with some prepared remarks on our performance that compliments 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 would like to remind everyone today's discussion may 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. The company's actual results and financial condition may differ, possibly materially, from what is indicated in these forward-looking statements. For discussion of some of the risk and factors that could affect the company's future results, please see the description of risk factors in our filings made with the Securities and Exchange Commission. I also direct to 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

Welcome and thank you for joining us. We are happy to be able to deliver another strong year-on-year increase in quarterly figures. Despite the ongoing challenge within the financial sector, we enjoyed double-digit year-over-year revenue and profit growth. Unlike last quarter in our Market Making operations were very strong. This time it was the relative performance of our brokerage segment that stands out. Before I discuss each segment, I’ll briefly review the company’s overall performance and Paul Brody, our CFO will provide further details shortly.

Diluted earnings per share increased by 57% year over year to $0.44, and our pre-tax profit margin was 66%, compared to 56% in the same period in 2007. This performance was driven by higher overall trade volumes and increasing leverage from our efficient automated operations. Our total trade volumes grew 18% year over year. A substantial portion of our volume growth was in futures, which increased at the rate of 34% over the second quarter of last year. Meanwhile our total options volume grew by 12% and stock volume grew by 3% over the second quarter of last year. I’ll first discuss our Market Making operations.

The third inter-market activity in the first quarter was followed by subdued markets in the second. This is usually the case, as these periods are usually followed by quite runs and as you know, the first quarter was extraordinarily active. Actual volatility as measured by the S&P 500 futures declined from 24.3% in the first quarter to 16.3% in the second. In other words, volatility in Q1 was roughly 50% higher than Q2. While our Market Maker profit have increased by 58% from the year-ago quarter, they were behind the first quarter of ’08 by 39%. This was not unexpected. The first quarter circumstances were unusually favorable and all likely to be repeated sequentially. The favorable trend of diversification that is generating an increasing percentage over Market Making profits away from the U.S. option market continued through this past quarter. Again less than half of our profits came from the U.S. option markets with the rest coming from U.S. stocks, futures and European and Asian exchanges.

If you want to highlight their published volume figures, you will notice a 12% drop in our Market Making stock volumes. Please do not get distracted by this data. It has to do with discontinuing a certain strategy we used to provide more liquidity for stocks. It has been marginal for some time. It was volumes that used to be profitable years ago, but has deteriorated in the more recent past, partly because of new trading rules and payment models on U.S. stock exchanges. This activity is going to be replaced by another one that has been updated for present circumstances. It is currently in testing and we are planning to introduce it later on in the current quarter.

As I said before, our Market Making profits depend on three things volumes, competition, and implied versus actual volatility. Our second quarter Market Maker option volumes increased by 13% from a year ago and decreased by 19% sequentially. The sequential decrease is partly due to a much less active market and also to a reasonably increased participation by so called high-frequency traders in the option markets. These folks use computerized hardware items to trade back and forth, and since they are classified as customers, they get the advantage of priority over Market Makers have to pay no exchange fees and even get payment for all their clue [ph] when they trade with Market Makers.

The exchange has had a proposed rule pending at the SEC to reclassify high-frequency traders as non-customers. But the SEC has not acted on it so far. High-frequency traders measure mentions our codes and try to quickly get off of trades they have just done. We have decided to widen our markets and stand aside until they grow enough trading with each other earning small change if anything. Whenever the market moves, they have to get out of their leftover positions and that is when we get to trade with them. This activity introduces all of our additional volume into the markets and accordingly it reduces our market share. But as we earn more money on the wider market, then we otherwise would – it has not much impact on our profitability.

They tend to become inactive when the market becomes volatile and come back when volatility decreases, which is what happened in the second quarter. As far as competition is concerned, there hasn’t been much change in this past quarter. Here I’m talking about competition from Market Makers who provide true liquidity as opposed to high-frequency traders. The markets acquired on after an active period, competition usually increases. Other than this, we have not noticed much change on the part of our Market Maker competitors.

Now as far as actual words as implied volatility is concerned, while actual volatility was 98.6% of implied in the first quarter, it sneaked to 86.6% in the second quarter. This is a substantial change and it reflects – and it is reflected in our results going from Q1 to Q2. It is important that you follow this, so let me repeat. During the first quarter of ’08, actual volatility was 98.6% over implied. So they are almost the same. In the second quarter, actual volatility was 86.6% over implied. So, it was substantially lower than they implied.

As I said on occasions, implied volatility tends to lag actual volatility. Lower actual volatility while the implied volatility remains high is not in our favor. In the first quarter, we saw the opposite. Actual volatility moving up over implied. That was good for us. The reverse is what happened in the second quarter. That is not good for us. Active periods followed by quite ones is a regular pattern in the markets, this makes our Market Making results going from quarter to quarter bumpy. You will see fluctuations along the long-term trend. The fluctuations are not important, the long-term trend is important, and you must be able to determine. I hope you can.

Now going on, generally the scarcity of capital in these days amongst banks and brokers who have store [ph] advantage whenever volatile markets create attractive trading opportunities. For this reason, we have $1 billion in excess regulatory capital. In addition, substantially all of our portfolio is in highly liquid assets, which clearly determine of our volumes. This solid foundation drives our Market Making abilities and it should give our investors and customers peace of mind. I would now like to discuss our brokerage segment, which recorded impressive growth. This is especially true in view of the write-downs by our larger broker competitors and the flattish to slightly increasing results of the Electronic Brokers.

Our net income for the quarter from brokerage increased 32% year on year and 3% sequentially. Year over year, the number of accounts increased by 20%, customer equity increased by 38%, the number of clear trades increased by 51% and the average commission per trade decreased by 11% to $4.30 per trade. These figures clearly indicate that we continue to get larger accounts, who trade more often and they avail themselves of our trade brokerage fees, $4.30 per trade. If you have a brokerage account, please consider how much you are paying to your broker. This may be right time for you to switch.

Our business is becoming more globally diversified as we continue to spread our operations internationally. This is a key advantage that partially shelters our business from isolated local events. In addition, over half of our new customers are currently coming from outside the United States. It is our strong belief that when it comes to growing our customer base, it is perhaps, it is about quality of accounts rather than quantity. High volume experienced traders are our most profitable clientele, and the segments we actively target. It is the financial professionals who understand the impact of minimizing execution on their returns.

They are the ones willing to make the investment in time to familiarize themselves with the very large array of trading and investment tools we offer absolutely free to our customers. We have been successful in attracting this clientele. This is evident by the 26% growth in annualized average DART per account, which grew from 566 to 713 year on year for the quarter. Customer equity per accounts – their account also expanded from 93,000 from the first quarter of ’08 to 99,000 in the second quarter. We have been busy working on several important platform upgrades, which are targeted for rollout by the end of the year.

These enhancements will be very attractive to high volume algorithmic traders and they enforced our position as the broker of choice for sophisticated institutional and individual investors. We are happy to share the heavy bands with you. According to recent independent research statistics published during the quarter, our U.S. buck executions were priced $0.35 per 100 shares better and executed six times faster than the industry as a whole in the second half of 2007. It is this confirmation of our ability to truly offer best execution that will help us capture customers from the large prime brokers and the top customers of online brokers.

These statistics along with the bruised financial credibility of our competitors is also fueling our progress in growing our business. Overall, we are making excellent progress in building out our global platform and leveraging the efficiency of our automated operations. While our competitors are occupied with trying to straighten out the mess find themselves in, we are successfully increasing our technological lead. Our brand power is on their eyes, and may be will be able to fuel customer growth as we continue to demonstrate our distinction as a provider of best execution at the lowest cost. We look forward to continuing this momentum for the remainder of 2008, and we are on track to deliver another record year.

I will now turn it over to Paul Brody, our CFO, who will discuss the financials.

Paul Brody

Thank you, Thomas, and thanks everyone for joining the call. I’ll first review the summary of results and then we’ll talk about segments. Our operating metrics were strong in the relative quarter, although they reflected some of the market conditions that followed the extraordinary first quarter.

Average daily trade volume was 809,000 trades per day, up 16% from the second quarter of '07. Market Making trade volume was down 12% primarily reflecting a lower level of stock trading. However, options contract volume was up 13% compared to the second quarter of '07. In Electronic Brokerage, total customer DARTs were up 38% and cleared customer DARTs were up 51% from the year-ago quarter. These numbers reflect our continuing success as attracting customers who clear and carry their positions in cash with us.

Net revenues are $395 million, up 34% quarter over quarter, and that's versus the second quarter of ’07 Trading gains were up $266 million, up 77% from the same period in '07, although part of that increase stems from the unusual loss as we took on a German stock in the second quarter of ’07. Adjusted for that event, trading gains were up 42% quarter over quarter. Commissions and execution fees were $86 million, up 42%, and net interest income was $26 million, down 57% from the second quarter of '07. And I will explain this decline in more detail as it relates to our business segments.

Non-interest expenses were $136 million, up 5% quarter over quarter, driven in part by increased compensation, occupancy, amortization of internally developed software and communications expenses. In general, we practice aggressive expense management and we seek to grow those expenditures to help to expand the business. Within the non-interest expense category, despite the higher trading volumes, execution and acquiring expenses were down 9%, which I will explain as it relates to each of the business segment. Our push to become direct clearing members at more exchanges has also reduced these expenses.

Compensation expenses were $39 million, reflecting in part the continued phase-in of expenses related to our employee stock incentive plan and the addition of 60 new staff members from our acquisition of FutureTrade, which closed in December. Most of the FutureTrade employees are software developers or related technical staff, and we have been able to assimilate them into our development efforts fairly quickly.

As a percentage of net revenue, total non-interest expenses were 34%. And out of this number, execution in clearing expense accounted for 19% and compensation expense accounted for 10%. At June 30, our total headcount was 713, that's an increase of 5% from the year-end count.

Pre-tax income was $259 million, up 58% from the same period last year. Market Making represented 78% of pre-tax income, and brokerage represented 23% with the offsetting 1% in corporate elimination. These proportions compared to 71% for Market Making and 27% from brokerage in the second quarter of '07, a reflection of the strong performance in Market Making this quarter relative to the year-ago quarter.

Our overall pre-tax profit margin was 66% as compared to 56% in the second quarter of '07. Market Making pre-tax profit margin was 74%, up from 62% in the year-ago quarter. Brokerage pre-tax profit margin grew to 48% from 44% a year ago. The low cost structure we achieved through our automated platform continues to drive incremental revenues to the bottom lines. Diluted earnings per share were $0.44 for the quarter, that’s compared to $0.28 on a pro forma basis for the second quarter of '07.

Turning to the balance sheet, it remains highly liquid with relatively low leverage. We actively manage our excess liquidity and we maintain significant borrowing facilities through the securities lending markets and with banks.

We also continue to maintain excess regulatory capital in our broker-dealer companies around the world. Long-term debt to capitalization at year end was 5.4%, which was a reduction from 11.4% at year end ’07. The consolidated equity capital of our operating companies at June 30, 2008 was $4.03 billion. Now, we’ll turn now to the segments.

In Market Making. trading gains from Market Making for the second quarter of '08 were $262 million, up 82% quarter over quarter, for reasons I described before. The prior quarter was not particularly strong for Market Making. Net interest income from Market Making was $6 million, a decrease of 87% quarter over quarter. As we described in the first quarter call, this is primarily due to the fact that we have integrated our trading and securities lending systems in such a way that trading income and interest income are freely exchangeable. For example, if we are long stock and short forward stock few options or futures, then we will generate more trading income. Conversely, if we are short stock and long forward stock, then we will generate more interest income.

The mix of our positions in the latest quarter produced more trading gains and less interest income than in the year-ago quarter. We are also seeing fewer opportunities to lend EPS at favorable rates, and we can go into this in more detail in the Q&A session.

Net revenues from Market Making were $272 million, up 44% from the second quarter of '07. Despite higher trading volumes, the variable costs of execution and clearing, our largest expense category, amounted to 59% of non-interest expenses, declined 17% from the second of '07 to $41 million. This in part reflects the reduction in exchange-mandated payment for order flow program costs as more options traded in pennies. It also stems from greater options volume being executed on exchanges, that use the make or take a model, where as a market maker, we are paid for providing liquidity instead of paying exchange fees. Pre-tax income from Market Making was $202 million, up 73% quarter over quarter.

Turning to Electronic Brokerage. Our customer trade showed healthy increase across options, futures and stocks. Customer accounts grew by 20% over the total at June 30, 2007, and by about 4% in the latest quarter. Total customer DARTs grew to 326,000, 38% over the second quarter of '07, though down 8% from the hyperactive first quarter of 2008.

Our cleared customer DARTs, which generate direct revenues for the brokerage business grew to 285,000, 51% quarter over quarter, but down only 6% sequentially. In addition, the average number of orders – DARTs per account on an annualized basis was 713, up 26% over the 2007 period, reflecting a continuing trend of attracting larger, more active customers. Customer equity grew to $10.2 billion, up 38% from the second quarter of '07 and up 11% sequentially. We believe this reflects a continuing trend of customers, transferring our accounts through interactive brokerage for safety and security as well as for our advanced execution services.

The healthy trade volumes drove revenue from commissions and execution fees to $86 million, an increase of 42% quarter over quarter, though off 33% sequentially.

Net interest income rose to $21million, up 2.4% from the second quarter of '07 but down 4.5% sequentially. Because the interest rates we pay and charged to our customers are pegged at benchmark rates, net interest income in our brokerage business is primarily a function of customer cash and margin loan balances. However, lower margin – lower market interest rates have some dampening effect on the net interest income we earned on small cash balances. Average U.S. interest rate declined about 1.1% in the second quarter. Net revenues from brokerage were $124 million for the quarter, up 23% from the second quarter of '07 and off 3% sequentially.

As with our Market Making segment, execution and clearing fees, they account for a large part that is 53% of our non-interest expenses in brokerage. Despite this substantial increase in trade volumes, these variable costs increased only 6% to $34 million for the quarter. This in part reflects the reduction in payment to broker-dealer customers for order flow, which is a practice we have substantially discontinued. It also reflects the routing of more customer limit orders to options exchanges that pay for liquidity. These liquidity rebates reduced our execution expenses and we pass this on to our customers, which then reduces our commission revenues by a corresponding amount.

Pre-tax income from Electronic Brokerage was $59 million for the second quarter, up 32% quarter over quarter, and up 2.6% sequentially. As compared to the first quarter, the small drop in commission and execution fee revenue was more than offset by expense reductions in a number of categories.

And I'd like to turn it over to the moderator for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) And we’ll take our first question from Edward Ditmire with Fox-Pitt.

Edward Ditmire – Fox-Pitt

Good afternoon. Certain exchanges are proposed rule changes as you mentioned should modify the classifications at these high-frequency non-Market Maker liquidity providers that you compete with. One, do you think that because you have an impact over say the next year, and then how meaningful would that be on your business?

Thomas Peterffy

If it would have an impact, I’m not – I haven’t though about that how meaningful it would be. I wouldn’t know how to quantify. The rule changes was submitted by the IFC, the CBOE indicated that the ISC few changes were accepted, the CBO would adopt a similar rule change, but the fact is that this has been sitting at SEC for something like 6 to 9 months and they haven’t acted on it.

Edward Ditmire – Fox-Pitt

Okay, and then I have another question if I could. You talk about how more of your business in Market Making is developing away from U.S. options. Can you explain and try to reconcile the volumes in the U.S. options in this theory [ph], definitely moving forward at a very fast clip. Can you talk about some of the dynamics that you are seeing in these markets and why you are growing faster in other areas?

Thomas Peterffy

The reason we are growing faster in other areas is because we want to. We put great deal of emphasis on to growing at other places because the profitability is more lucrative. Secondly, it is our long-term goal to have a totally global system where any of our customers or ourselves as Market Makers can access in the automated exchange around the world, that is our – that’s what we are after, and that’s where we are working at. So, it will be the case that we will keep on adding more and more automated exchanges around the world to our system.

Edward Ditmire – Fox-Pitt

Okay. Thank you. I’ll get back in the queue.

Operator

And we’ll take our next question from Richard Repetto with Sandler O'Neill.

Richard Repetto – Sandler O'Neill

Good evening, Thomas and Paul.

Thomas Peterffy

Hello.

Richard Repetto – Sandler O'Neill

I guess the first question is, these high-frequency traders how much volume do you think that they are creating as percentage, and I know you said it varies with volatility. But in the second quarter with an average of excess say 20 or 21, I’m just trying to see how much they might inflate the volumes where you really don’t want to participate in?

Thomas Peterffy

I do not know about the average mix of 20 or 21. Or you would say that that’s currently the average mix?

Richard Repetto – Sandler O'Neill

No, in the second quarter, that was the average mix, CBO mix in the second quarter, that was the average closing for all the days.

Thomas Peterffy

Okay. First – as you know, I would – I have no information on this. I could only be guessing. Yes?

Richard Repetto – Sandler O'Neill

Okay.

Thomas Peterffy

You understand that.

Richard Repetto – Sandler O'Neill

That is better than mine.

Thomas Peterffy

I would guess may be somewhere between 15% and 25%.

Richard Repetto – Sandler O'Neill

Okay. And then, Paul, I’m just trying to understand these are high-frequency trade and they totally get their own pay, their payment (inaudible), they can write-off your quote. But then on the other hand, in the make or take a model where there’s a rebate, and in your brokerage operation you want the high-frequency guide. Is that correct? I’m just trying to see what’s the difference?

Thomas Peterffy

Yes. We do on them as customers, yes.

Richard Repetto – Sandler O'Neill

Okay.

Thomas Peterffy

And as far as the make or take model is concerned, the high-frequency trader bids on the offer when that is equal to the bid offer prevailing on a combinational exchange. And if that hit [ph] or take and immediately pass after return the combinational exchange. So, what happens is that they get the make fee on the make or take exchange, and if they happen to be trading with a Market Maker on the combinational exchange to pass out of the position, they get a payment for all of their flow.

Richard Repetto – Sandler O'Neill

Got you. I see their advantages. I guess the last question, this concept of actual volatility and implied volatility, I’m just trying to understand – you said it was 86%, or 86.6%. What’s the usage, nominated the VIX you are using because you said it was 16.3, the S&P 500 futures volatility in the second quarter.

Thomas Peterffy

Actual volatility, yes.

Richard Repetto – Sandler O'Neill

Is the denominative (inaudible) later on you said it was 86.6% of implied?

Thomas Peterffy

That’s correct.

Richard Repetto – Sandler O'Neill

And the denominator we are using is the VIX?

Thomas Peterffy

No. I never use the VIX.

Richard Repetto – Sandler O'Neill

Okay. Can you help us with what the denominator is or where you get that from?

Thomas Peterffy

I have an implied volatility of ‘x’. I have an actual volatility of ‘y’ and I just divide ‘y’ by ‘x’.

Richard Repetto – Sandler O'Neill

Okay. Or where do you get – where do you get the implied volatility then?

Thomas Peterffy

If I’ll see on – I think for calculating volatility, when I want to be very precise, I ask one of my associates who specializes in statistics of segments to calculate it for me. Generally, I will not stop telling you this. If you have an interest in broker accounts and you are familiar with the research and the risk metrics and charting software that we have free for our customers, you will find several tools that would help you track and charge these measures. So, we recommend it to all of our listeners to join up an open an account.

Richard Repetto – Sandler O'Neill

Okay. I’m – I hesitate but I’m going to do that now.

Thomas Peterffy

Good.

Richard Repetto – Sandler O'Neill

I would like to ask one last question. So, what you are basically saying is that we can’t – in certain periods is probably not a good proxy just for you to – the U.S. OCC volumes because again in certain periods, you are going to have these outgoes inflating the volumes that you really don’t want to interact with?

Thomas Peterffy

That’s correct. But there are also other reasons if I would practice because even though what created the additional volume, I have in the past spoken of times when there are big dividend plays or interest plays in the marketplace and there are other times when the reason and as I said for example in the first quarter, there were very few big deal high-frequency traders left early on in the quarter when the market really started moving. And so they were in the first quarter as much as they were in the second quarter.

Richard Repetto – Sandler O'Neill

Understood. Okay. I’ll get back in the queue as well. Thank you.

Operator

And we’ll go next to John Schneider with Artis Capital.

John Schneider – Artis Capital

Hi, Thomas and Paul. I just had one quick question, which is which foreign markets are you expecting to be the fastest growers over the next year or two?

Thomas Peterffy

I’m sorry. I don’t want to say because I don’t want to give away things that are currently in the lurks, and as I said many before our competitors never tell us anything than we have to tell them. Sorry.

John Schneider – Artis Capital

Okay. Fair enough.

Operator

And we’ll go next to Niamh Alexander with KBW.

Niamh Alexander – KBW

Hi, thanks for taking my question. (inaudible) I’m sorry to beat the dead horse over. But I just want to follow up on the profitability in the options. Is that not the profitability with regard to the volume. And can you help me understand like these high-frequency traders, weren’t they in the market at this time last year and several quarters ago as well? This is – I guess that you are becoming a global company and you are global company, but it seems like quite a big drop in market share in the U.S. So, was there anything unusual this particular quarter? Is that the result from the activity being either?

Thomas Peterffy

Markets especially depending on that’s more issues join the penny world, and penny option quotes narrowed down by 25% in the – early on in the second quarter. Now, whether that’s due to high-frequency traders or not, let’s forget that. It doesn’t matter whether due to write. So, the fact is that the markets narrowed down and as I said, we did not follow the narrowing. So, we didn’t narrow down our quotes as much as the market has, and that explains why market share dropped.

Niamh Alexander – KBW

But if we – I’m just trying to understand. If the penny quoting doesn’t go away, and these other traders can continue to twist up the rates, they can. It’s still profitable business for you to participate. It’s of less profitable. Is that correct?

Thomas Peterffy

Yes.

Niamh Alexander – KBW

But you actively stood back and then participated –?

Thomas Peterffy

If it is profitable, we are currently rolling out the version of our high-frequency trader software that we are currently testing. We do not expect to make a great deal of profit with it. The reason for doing this is that we do not want to abandon the turf to these people, and you want a – we want to make it more difficult for them to make a profit.

Niamh Alexander – KBW

Okay. And that’s helpful. Thank you. And then just to understand the penny quoting, just if I might take a look back now because you have several quarters with the penny quoting and it’s rolled out. What’s your view Thomas, has it been better for the market and now we’ve seen I guess the ISC changed track and look forward to get roll out more quickly. Help me understand what your thoughts are?

Thomas Peterffy

I think it’s better, definitely better for the customers.

Niamh Alexander – KBW

What rate the Market Makers?

Thomas Peterffy

I think it will take some time until the advantage to the customer translates into increased – proportionally increased volume. The volume does increase as transaction quotes go down as a result of penny transaction quotes go down but the volume increases more slowly. So, it will take some time until their volume catches up with the – additional volume catches up with the decrease in transaction costs.

Niamh Alexander – KBW

Okay. That’s very helpful. And then just one last thing on the penny quoting, this may be dump [ph] question, so apologies. If it were a make or take model and not bifurcated market structure in options, so let’s say it was a similar model across all of the market, would that be a better environment for IBKR?

Thomas Peterffy

I’m not ready to respond to that. I don’t know.

Niamh Alexander – KBW

Okay. Fair enough. Thank you. And then if I could just real quick, on the Naked Shorting, the issue that’s gone out across the brokerage industry and now I guess today we’ve seen more headlines that may be the SEC could potentially expand it on the 19 stocks. Can you walk me through maybe the potential invitations for your business for the Market Making operations and for the brokerage operation?

Thomas Peterffy

It’s certainly is not good for the brokerage because it would diminish stock volume, right. It – from the Market Making operation, I think it’s a mixed bag, as you know, with mass Market Makers are exempt. And so, we are not constrained by having to have borrowed the stock before we can sell it. Although, we do have to – we cannot trade, we do have to deliver the stock plan we show. Generally, this would decrease volume and decreasing volume would decrease liquidity. So, decreased volume is not good for us as Market Makers, decreased liquidity is good for us as Market Makers because we can charge higher mark up for providing liquidity. That I think – safest thing to say is that the two forces will cancel each other.

Niamh Alexander – KBW

Okay. That’s helpful. Thank you very much. And then just real quick if I may lastly, European market, we are seeing a lot of structural changes really starting to drive new competitors into that market environment only in the equities market right now without back and back. Is that a good thing for IBKR, you are a smart router over there. Do you think that might help their volume expand even more quickly?

Thomas Peterffy

More Market Makers you said?

Niamh Alexander – KBW

No. More exchanges that are in use, so, more – and EPS, MTS –?

Thomas Peterffy

The more exchange venues are already good for us, yes.

Niamh Alexander – KBW

Okay, okay. Thanks.

Thomas Peterffy

And we have hooked up to a number of new ones and we are working on hooking up two more.

Niamh Alexander – KBW

Okay. That’s really helpful. Thanks taking my time.

Operator

And we’ll take our next question from Chad Griggs [ph] with Fox Point Capital.

Chad Griggs – Fox Point Capital

My questions are already answered. Thanks.

Operator

Thank you, sir. (Operator instructions) And we are going to Edward Ditmire with Fox-Pitt.

Edward Ditmire – Fox-Pitt

I have another question. The CBOE announced a partnership with 3D Markets that would introduce a crossing system to handle large and institutional orders more electronically than they are currently. Do you think innovations like this make it more likely that interactive could participate in the large portion of a market that is institutional further to a bigger proportion than it does today?

Thomas Peterffy

Definitely. This would be good for us and we very much hope that this situation will be successful. You see what that brand has currently is that many large blocks are done over the contour because the dealers hope to hide their growth from competition and the customers are – don’t really know that they could potentially get a better price. And crossing that work [ph] like this that would be cleared by OCC would enable us to go in there and participate.

Edward Ditmire – Fox-Pitt

Okay. Thank you.

Operator

We'll take our next question from Greg Lason [ph] with Deking [ph].

Greg Lason – Deking

Is the ratio of actual to implied volatility, a calculation based on U.S. indexes?

Thomas Peterffy

Yes.

Greg Lason – Deking

Okay. Then can you give us a sense for the trend in the Market Making segment as the quarter progresses?

Thomas Peterffy

I’d give you a trend for the what–?

Greg Lason – Deking

In the Market Making segment, did the profitability improve toward the end of the quarter? Did the high-frequency traders start to reduce their presence as they clean up in June or did the actual or implied ratio increase closer to 1 as we move along?

Thomas Peterffy

You see I don’t track this the way investors track it. So, I will propose these numbers after the quarter is over because I know that you will ask me about them. So, I have to know the answer. But I really didn’t look at the quarter in more fine gradation than that. Sorry.

Greg Lason – Deking

That’s fair. Thanks.

Operator

We’ll return to Richard Repetto with Sandler O'Neill.

Richard Repetto – Sandler O'Neill

Hi, Thomas.

Thomas Peterffy

Hi.

Richard Repetto – Sandler O'Neill

Just on the way in those 5 minutes since I said I wanted to open the account, I get contacted by a sales representative.

Thomas Peterffy

That is great.

Richard Repetto – Sandler O'Neill

He didn’t give the name, (inaudible), he contact me in that 5 minutes. I swear. Anyway my question here is on the make or take a model, at least by an Archer [ph] in the second quarter, there is lost market share. There’s been some talk that the make or take model wasn’t – that they were loosing some shift. Certainly Archer did, but then you had NASDAQ up a little up, and you had BOX up a little bit. I guess what is your – do you see any FP or any pullbacks towards the make or take a model in the quarter?

Thomas Peterffy

I know that there some forces inside the industry that would like to see make or take back. But I do not believe that they will prevail. These are generally the brokerage firms who sell their customer over their flow. And the Market Making firm said, buy them. You see, they would just like to internalize their flow on the conventional exchanges and the make or take by their mechanism of paying to the maker and tends to sometimes generate tighter course, and the buyers of the old flow in this case have to match their tighter course and therefore, it’s financially difficult for them because they have paid out substantial amounts for the customer order.

Richard Repetto – Sandler O'Neill

Got you. Okay. And then my last question, you’ve introduced – not so much this quarter, but other even at digital metrics in actual versus implied as well as this issue would be – I’ll go traders that are widened volume in penny [ph]. If I would pack inaccurate as it is, but just look at the U.S. OCC volumes, as well as the VIX. It looked a lot – if you just release those metrics it looked a lot closer to 4Q and 3Q than it did to1Q. And then if you look at your earnings, you are in that 4Q range. And I guess what I’m saying and the question is we are probably just not going to – is it fair to say we just can’t predict other than just taking a look at these metrics and taking a guess at a 40,000 foot level of how your Market Making operations are going to perform in a quarter?

Thomas Peterffy

First of all, you know that we maintain that our Market Making operations will grow on the long term 15% per year. So, if you grow at base line to our earnings, you will see Market Making earnings you’ll see that it’s approaching 15%, and either from the up side or the down side that varies by quarter by quarter, and if you just take one step forward on the quarter you can read out from the lines that all things are likely to be. That’s how an engineer would go about it. Now, the second question is – in other words I would say just extrapolate the earnings around 15%, the average earning. The second question is, yes the – as I said to you before, if you look out the implied volatility and the actual volatility and compare that to and if you see they implied much higher than the actual then I would go below that the trend liner and things if you see the way around I would go above the trend liners.

Richard Repetto – Sandler O'Neill

Okay. Okay. I need to be able to call you guide to give me the implied volatility though.

Thomas Peterffy

Just don’t call in everyday, please.

Richard Repetto – Sandler O'Neill

Okay. I’m good. Thank you.

Operator

And we’ll go next to David Chamberlain with Oppenheimer.

David Chamberlain – Oppenheimer

Hi, just I wanted to rephrase the question that Greg had asked. If you look on a month-to-month basis of the quarter, generally and the Market Making business, would you say there was a progression in terms of the profitability in there, say you are going from April to May to June?

Thomas Peterffy

I don’t know the answer. Paul, would you know? You see – look I think when you are going quarter by quarter it’s a crazy thing. Now you want to go month to month or day to day?

David Chamberlain – Oppenheimer

No, the mean time I’m asking is just from what we can see and that this is I guess the problem, I guess. From what we can see is there was girt of volatility starting in the second quarter, and then started to pick up as the quarter ended. And this trans [ph] what the question I’m asking is, can we just make a broad generalization that if you look at VIX or whatever the volatility measure that at least broadly speaking if you look at certain quarter you would think, in two other – you would have gotten – you would have made money in the Market Making business towards the end of the quarter than in the beginning. Is that a wrong assumption to make?

Thomas Peterffy

The assumption is fine. I do not know if they had expected the answer.

David Chamberlain – Oppenheimer

Okay. Fair enough. Thank you.

Thomas Peterffy

You see, I think this preoccupation with the quarter to quarter (inaudible), we tend to forget about the broader slide over [ph] strategy. And our strategy is to grow Market Making profits around 15% per annum and brokerage profits by about 50% per annum. The way we are hoping to achieve that is for Market Making, we develop communications and marketing software to trade on new exchanges and these are usually in developing countries, and we expect that roughly 2% per year, additional profit will come from that. We develop technology to add the new products that the exchanges that we are on are adding, and examples for this from the past is BPS weeks [ph], SSF 4X [ph], binary options etcetera, where we seeing that to generate 2% to 6% additional profit per year depending upon the particular circumstance. We spend a great deal of time and energy all the time to refine the systems that we use at the exchanges that we trade out and the products we trade. We expect this effort to yield approximately 6% to 12% earnings improvement per year. There is general volume growth across of the exchanges, but that goes along with – grows with it’s competitors. And we believe that these two forces should cancel each other, so at the end we come down to 10% to 20% increase in profits from the continuously ongoing developments. In brokerage, we had customers and increased the opportunity for the existing customers to trade by entering new exchanges and that usually attracts local customers, who also had to work internationally. We had new product offerings, we had new trading and investment tools. We also had new customers by charging the lowest commissions and fees and financing cost for high volume customers. We offer better execution prices than our competitors do. We do this in two ways. We do not trade with our customers and do not sell their flow to other Market Makers to trade with them. We built and we continue to build technology that is capable of securing the best price at any moment. And we believe that we currently offer the best trading and account management tools and grow this product base for exchange with the securities and commodities that are on. We continue to work on these systems developing them further. In addition to offering more product in more countries and more currencies than anyone else that I know. Our penetration have had several customer base around the world is very timing. We estimate that we are somewhere in the low single digits. With that we have an extremely strong platform. We believe that we have no problems growing the brokerage business by 50% per year for years to come. So, that’s all I have to say. Thank you very much. One more, who is that?

Operator

And we’ll take our final question from Joseph Carney with Steadfast Financial.

Joseph Carney – Steadfast Financial

Hi, Thomas, how are you?

Thomas Peterffy

Hi.

Joseph Carney – Steadfast Financial

I was wondering if you could comment all on the trends you are seeing here develop in the third quarter –

Thomas Peterffy

No, I can’t.

Joseph Carney – Steadfast Financial

You cannot?

Thomas Peterffy

Yes. You know that we do not talk about unreported quote.

Joseph Carney – Steadfast Financial

Not so much of the earnings, but just the presence of high-frequency traders, the implied versus actual because all the evident volume indicators are that July is tracking significantly above a year ago and above January or August levels that were records?

Thomas Peterffy

You mean the volatility fire?

Joseph Carney – Steadfast Financial

The volatility and the OCC reported volumes which I think you’ve done a pretty good job. Explaining that there’s somewhat skewed but even if they are skewed, they are skewed to extremely high levels vis-a-vis a year ago and vis-a-vis record months of January ’08 and August ’07?

Thomas Peterffy

I agree there. The volatility is higher and the volumes are higher, yes.

Joseph Carney – Steadfast Financial

But you can’t comment on what are they being skewed in your opinion by high-frequency algorithmic traders or not?

Thomas Peterffy

I don’t know the answer to that.

Joseph Carney – Steadfast Financial

Okay.

Operator

Thank you. That does conclude our question-and-answer session. At this time, I would like to turn the call back over to you Ms. Liston for completing remarks.

Deb Liston

Thank you. We'd like to thank everybody for participating today. And this call will be available for replay on our Web site shortly, and thanks everyone again for your time.

Operator

That concludes today’s conference. Thank you for your participation. You may disconnect at this time.

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