Good day, ladies and gentlemen, and welcome to the Interactive Brokers Group Fourth Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference, Ms. Nancy Stuebe, Director of Investor Relations. Ma'am, please go ahead.

Thank you, operator, and welcome, everyone, to our fourth quarter earnings call. Our earnings were released today after the market close and are also available on our website. Our speakers today are Thomas Peterffy, our Chairman and CEO; and Paul Brody, our group CFO. They will start the call with some prepared remarks about the quarter and then we'll take your questions. As a reminder, today's call may include forward-looking statements which represent the company's belief regarding future events, which by their nature are not certain and are outside of the company's control. Our actual results and financial condition may differ, possibly materially, from what is indicated in these forward-looking statements. We ask that you refer to the disclaimers in our press release. You should also review a description of risk factors contained in our financial report filed with the SEC. I'd now like to turn the call over to Thomas Peterffy. Thomas?

Thank you for joining us for our final 2017 earnings conference call. In 2017, we got out of the old by transferring the bulk of our Market Making business to a new owner and into the new, introducing many new products and initiatives from the Interactive Brokers new Debit Mastercard to trading in Bitcoin futures on the first day they began. This past year marked our 40th year in the business and also marked 10 years since our initial public offer. To give you a sense of our growth over those 10 years, at the time of our IPO in 2007, Interactive Brokers had $2.8 billion in total equity. The electronic broker had about 80,000 customers, $7 billion in customer equity and $2 billion in margin loans outstanding. Our customers could trade on about 50 exchanges and market centers in 16 countries. As of December 31, 2017, we had $6.4 billion in total equity. That is after having distributed another $3.8 billion in dividends. Our customers can trade on over 120 exchanges and market centers in 26 countries. We have 483,000 customer accounts, up 6x; $124.8 billion in customer equity, up 18x; and $29.5 billion in margin loans, up 14x. Versus 200 and -- versus 2016, these numbers are up 25%, 46% and 52%, respectively. One thing has clearly not changed during the past 10 years, and that is our rapid growth. If anything, we have seen growth rates accelerate. This accelerating growth is the key to our story. To illustrate, I compare our growth through 2017 to 2016. Number of accounts were up 16% in 2016 and up 25% in 2017. Client equity was up 27% in 2016 and up 46% in 2017. Margin loans were up 14% in 2016 and up 52% in 2017. Can we keep growing…

Thank you, Thomas, and thanks, everyone, for joining the call. We have much to review so I'll jump right in. The fourth quarter operating results showed a solid performance in brokerage, led by stronger commissions and gains and net interest income. As we previously announced, the bulk of our Market Making business was transferred to Two Sigma Securities at the end of the third quarter, so Market Making represented a small portion of overall results. Full year results reflected the increase -- the increasing strength and operational leverage of core brokerage and the winding down of Market Making. Our pretax income of $1.05 billion represented a profit margin of 62%. Excluding the net impact of noncore items, such as the new tax law, market maker exit costs, currency translation effects and Treasury marks, our pretax income was $872 million with a pretax margin of 58%. Overall, operating metrics reflected improved customer trading even as the market volatility remains low. While the market volatility remained muted, we saw an increase in customer trading activity, especially in the third and fourth quarters, with quarterly total DARTs up 14% from last year. Average overall daily trade volume for the quarter was 1.27 million trades per day, down 3% from the fourth quarter of 2016, which reflected the drop in Market Making volume and up 4% sequentially. We continue to see strength this quarter in number of accounts, asset gathering and margin balances in brokerage, as I'll describe in my comments on the segments' performance. Electronic Brokerage metrics showed solid increases in the number of customer accounts and customer equity, up 25% and 46%, respectively. Total and cleared customer DARTs were up 14% and 15%, respectively, from the year-ago quarter even in the face of that low volatility. Market Making contract and share volumes…

[Operator Instructions] Our first question comes from the line of Rich Repetto with Sandler O'Neill.

I guess the first question is the strong margin loan balance growth. This quarter, just quarter-to-quarter, it was up $4.4 billion. It was the strongest quarter-over-quarter sequential quarter growth. And I'm just trying to see -- get a little understanding of a little bit what's driving that. And you talk about the increased trading over in Asia, the pickup. But what made it grow faster than it ever had -- at least by dollar amount, than it has prior?

Well, what is driving it is the extremely low margin rates that we charge. So that is part of the reason that towards the end of the quarter, we have -- or was it even after the end of the quarter? Yes. As of the 22nd of January, we are increasing our margin rates for the very highest borrowers by 5 basis points in order to slow that growth.

If I could just add to that comments then, Rich. There is a portion of the financing that the professionals' hedge funds like to take advantage of when they see market rate opportunities. And so a portion of that strong increase comes from high-end professionals. And it's not the majority of it by any means, but might be 1/4 of it.

And would you consider that, how do I call, sustainable when institutions like hedge funds increase their borrowings?

They do it opportunistically. So it may not be on all the time. But it certainly -- it comes on and off frequently enough that it's become more of a regular part of our business.

Rick, this is -- this has to do with -- there are certain risk-free opportunities in the market right now as far as the option boxes and single stock futures and rates, and some of our customers are taking advantage of that.

Thomas, you're going to need to tell me those risk-free opportunities like that. But anyway, I'm not a trader. The follow-up question would be for Paul. On the taxes, you said that if you -- at current -- with tax reform, that it would have increased your EPS by $0.25. I'm just trying to walk through the mechanics so -- to understand how you get there, if it's possible.

It's not possible in a short conversation. The tax computation itself, as you know, is fairly complex. What we did though was rather than try to provide some forward guidance, we thought that the best measure would be, what if we just ran 2017 through a new tax model as if it had operated under the new tax law. So it doesn't include any of the onetime effects. It includes what 2017 would have looked like as a normal year. But I can tell you that, obviously, there's a benefit from the lower tax rate, but somewhat offsetting that are certain deductions and tax credits that are no longer eligible. So it's not quite a full capture of -- from 35% rate down to 21% rate. I can tell you that we estimated that in that -- in estimating for 2017, whereas our -- roughly our effective income tax rate on the corporate level had been about 36.5% previously, that went to about 22.5%, 22.6% effective for 2017 under the new law. So in other words, a little bit higher than the federal rate.

Yes. And then one last quick one, Paul. You said that out of the $40 million, I think you said 82%. So it sounds like there's still $8 million or somewhere around there to go. So I guess what you're implying is, on a quarterly basis, expense -- you could absorb another couple of million per quarter. Is that -- am I interpreting correctly from Market Making to brokerage?

Yes, well -- yes, I'd like to be clear on that point and not confuse the expenses that have already been absorbed with what we put out as the run rate because I thought that, that is a number that makes sense for modeling going forward. So we're roughly at 82% going forward.

So incrementally a couple of million?

Incrementally, 82% of the $40 million should be now absorbed into brokerage. Of course, the full amount wasn't absorbed during 2017 because it was done in pieces and sequentially.

But 82% is in the fourth quarter run rate, is that fair to say?

No, it's a December 31 point in time going forward because we migrated resources during the year and during the quarter, and so only part of the expenses were actually absorbed. But going forward, we are at a run rate now of just about 82%, and that will continue. Throughout 2018, that should eventually go to 100%.

[Operator Instructions] Our next question comes from the line of Conor Fitzgerald, Goldman Sachs.

Maybe just a follow-up on Rich's question. You're talking about gaining share in margin loans. Can you give us any color in terms of either transfer of accounts or transferring of funds what customer segment you're getting the most share in or perhaps where geography-wise you're taking the share from?

Most of the margin loan increases are from U.S. customers.

That's helpful. And then just on deposit cost, how to think about that next quarter. Can you give us a sense of where the 36 basis points you paid out for customer credits should migrate post the Fed hike in December?

Paul?

Yes, that's a multipart question. Well, so conceptually, what we do is for all balances that are eligible to earn interest, they will step up with the Fed funds rate, at least the U.S. dollar ones will, which is the majority. So that's why we say going forward, we don't -- on a given dollar value of those deposits, we won't earn more because whatever we earn more will be passed through to our customers. Where we do earn more is on smaller balances where we're not paying interest. And obviously, we capture all of the higher rate there. And then, of course, in all the foreign currencies, they don't march to the beat of the same drummer. And just because the Fed is moving around doesn't mean they are. So when we estimate currently in our model for interest rate sensitivity, when we estimate a 25-basis-point increase, it's only for the U.S. dollar amount.

Our next question comes from the line of Mac Sykes with Gabelli.

Thomas, just given your comments about the progress from the IPO and your platform has been pretty much the leader in technology for the industry, I guess, at this point, how much more innovation can we expect? And should we expect the bulk of sort of capital spending to support the overall platform? Or should we expect more engagement tools, products, et cetera? Maybe you could just bucket sort of the kind of the percentages or some qualitative aspect to where you see the industry and your platform going.

Well, the innovation -- opportunity for innovation, in my view, is infinite. And we are going to do as much of it as we are able to hire and manage developers. And that is -- hiring is difficult and management is difficult. It is. It is. But nevertheless, we are -- we expect to spend -- we expect our spending to increase in line roughly with -- in line with our growth. I hope we can spend as much money as we grow.

Just my follow-up. You discussed your customer segments, but have there been any changes in terms of your progress in terms of geography? Any of note over the last year in terms of doing better or worse?

Well, yes. I mean, the highest growth basically is happening in China, Brazil, Hong Kong, Russia. These are roughly the places where our growth rate is very high other than countries where we have just few customers and then an addition of a few number represents a very high growth rate. But the bulk of the higher growth in new customers are coming from the Far East and South America.

Our next question comes from the line of Christopher Allen with Rosenblatt.

Just a couple of questions within NII. I just wonder if you could provide any color on the sequential increase in yields in seg cash. I'm guessing just higher short-term rates helping there. And then maybe some more color just in securities borrowing, the revenues there. You had some really nice growth over the course of the year. Are you seeing additional uptick -- uptake there or is it any specific securities driving outsized activity? Just trying to think about the go-forward path there.

Paul?

Yes. So yes, on the seg cash investments, they float with the market rates. We're fairly limited in what we can invest in. As Thomas said, we're primarily in reverse repo of Treasuries and some Treasuries themselves. And that's why we're spreading to earn some additional yield on things like the insured bank deposit program which is still quite small. So we'll be reporting more of that in the future. Chris, what was your second question?

Yes, just the securities borrowing and lending activity. You've seen really nice growth in the revenue side. Obviously, when we look -- kind of look at the balances there, that's always a little bit murky to kind of look at because it's volatile. Just wondering like what's the kind of key drivers, seeing more uptake of your product which we know is a pretty attractive product or is it just hot activity in certain stocks or…

It's actually both of those things. So there's a growing base as we become more well-known as a place to go to if you want to short stocks because we have very good availability on covering those. In fact, more and more so it grows upon itself because we're able to satisfy customers who want to short securities with customer stock who -- stock that's being held on margin. And also, we have a fully paid program called our Stock Yield Enhancement Program so that if you're holding fully paid shares, you can lend those as well and earn back half of the -- generally, half of the value of what they're being lent for. But your other point is equally true, which is that it's an opportunistic business so that if our customers tend to buy shares of stocks that are hot or are hard to borrow in the borrowing market, then it's simply much more profitable to lend those out. And over time, we've built a lot of tools to help us maximize that -- those earnings by acting quickly and by managing the inventory in an optimal way.

Our next question comes from the line of Chris Harris with Wells Fargo.

Yes, on the tax reform, should we be expecting most of the benefit of that to flow through 100% to your bottom line? And then a related question, how are you thinking about your regular dividend payment in light of the lower tax rate now?

As far as the dividend payment is concerned, we are going to sit tight. The dividend will be unchanged. As far as the taxes, as Paul explained just before, it's not a direct drop from 35% to 21% in our case because there are certain, like the tax receivable agreement. So we didn't pay the full 35% and therefore, it's not -- the benefit is not the entire thing. Paul, would you have an estimate as to what percent of the 14% tax savings actually will pass through to...

Right. So that's what I -- well, what I indicated before was that our effective corporate tax rate on the portion flowing through will be about 22.6%. So in other words, we pay state taxes and so forth. And so it's very similar to previously when there's a 35% federal rate, our effective rate was about 36.5%, including the states and so forth. Now with the 21% rate, it will be up around 22.6%. That's our current estimate. And that's an estimate.

Because I was thinking more of the strategic decisions like whether or not you guys are going to alter your pricing given the lower tax rate, whether you're going to increase your spending, things of that nature. Maybe just conceptually, we don't take it into...

We're not sensitive that way to the tax.

Our next question comes from the line of Doug Mewhirter with SunTrust.

First question was more of a conceptual question on taxes. And I think it's more of a question of the actual wording of the policy. So I assume that there's -- you're still taxed at U.S. rates globally regardless of the local tax rate. Is that why you're -- it's sort of a relatively linear drop to the effective tax rate? So there's no complexities of different tax rates in China or India or Europe or what have you sort of complicating the projection for next year?

Yes, it's -- that's a more intricate question as to -- we obviously continue to pay income taxes in foreign jurisdictions. And then there's the question about losing some of the foreign tax credits because they're limited in a different way than they were before. So I mean, that's a -- it's a fairly complex question you're asking. But as Thomas said, the drop in the U.S. rate doesn't just fall straight to the bottom line as a result of some of those complexities.

That's actually a very helpful answer. And my final question, so you look at the Market Making segment, if you try to just isolate this quarter, $25 million net revenues, $17 million of noninterest expense. So it sounds like that, that transition is pretty much done. Is that sort of a rough order of magnitude of where we would see that segment? Of course, adjusting for the market fluctuations, which would adjust -- make the revenues bounce around. Or is there going to be still some of that $17 million might sort of creep over onto the brokerage side or actually be shedded with additional cuts?

It certainly not will come over to the brokerage side. It's -- you're talking about the revenue, yes?

Well, no, I mean, the cost base, that $17 million cost base, will it...

So the answer is some of it has yet to go. As we said, at a point in time, at the end of the year going forward, we've migrated about 82% of the costs that we expected to migrate, which was the $40 million annual run rate. So looking at the fourth quarter, it's a -- you have to also look at how much was actually migrated during the fourth quarter and it's a little bit more complicated because it didn't all happen on the first day of the fourth quarter and so forth. But I can tell you that we absorbed about $5 million of expense during the fourth quarter. As we had previously indicated, we absorbed $2 million in the second quarter and $3.5 million in the third quarter. So for the year, as actually migrated, it was about $10 million or $11 million. But we're at a more advanced run rate going forward because of those -- those are actual resources and now they're fully absorbed. Those resources that were migrated are fully absorbed into brokerage.

This question comes from the line of Kyle Voigt with KBW.

Just 1 follow-up on Doug's question. I think he was asking in terms of -- on the expense side in the Market Making segment. But on the revenues, is that $25 million, is that the right -- I think you said order of magnitude, is that the right order of magnitude we should be thinking about in terms of revenues? Is there another step down as we head into 2018 as you continue to pull back there?

Well, on the long run, we expect it to peter out to 0 basically.

Along with the expenses, of course, right?

And then, I guess, just one on the -- you said you hadn't started investing in the Asian securities yet. Just wondering if you would give us any time line there and then potentially help us quantify any type of uplift this could provide for that 115 basis point current yield on seg cash.

Right. So we decided it deserves some further study on both pricing and risk management, which is why we weren't in a hurry to roll it in. We don't expect it to have a very large impact. It's -- that market is also in flux with interest rates changing more rapidly than they had been in the past. So we're giving it more study. And we might be able to introduce it in the coming quarter or 2. But I don't think it'll -- it's -- it will improve net interest income, but depending on what the market gives us, probably not by a huge amount.

And that concludes today's question-and-answer session. I'd like to turn the call back to Nancy Stuebe for any closing remarks.

Thank you, everyone, for participating today. As a reminder, this call will be available for replay on our website. And we will also be posting a clean version of our transcript on our site tomorrow. Thank you again, and we will talk to you next quarter end.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.