Good day, ladies and gentlemen and welcome to the Interactive Brokers Group Second Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will follow at that time. [Operator Instructions] I would now like to introduce your host for today's conference, Ms. Nancy Stuebe. You may begin.

Thank you, operator. Welcome everyone to our second quarter earnings call. Our earnings were released today after the market close and are also available on our Web site. 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 reports filed with the SEC. I'd now like to turn the call over to Thomas Peterffy.

Good afternoon and thank you for joining us to review our second quarter 2016 results. Our pre-tax profit for the quarter was $213 million. Of this amount, $191 million was generated by brokerage, $5 million by market making, with the remainder of $17 million from Corporate, primarily the currency translation. The overall impact of holding our equity in proportion to the basket of currency we call the GLOBAL was a loss of less than $2 million. Our pre-tax profit margin was a robust 58%, despite the pullback in margin loans and lower market volatility compared to the first quarter. The big news for the quarter was BREXIT. We had begun preparing for the possible outcomes early in the year by adding the event to our event risk scenarios, which are under regular evaluation by our Risk Committee. We started to adjust margin requirements on the relevant products, first initial margins, so as to prevent the establishment of risky new positions, and later increased maintenance margins. Using this approach, very few existing positions needed to be liquidated. Accordingly, for Interactive Brokers BREXIT was business as usual. We experienced no credit losses and the increased volatility was a positive for our brokerage business. We heard that several brokers suffered outages in the first 2 market days following the vote. We had no such problems. Our volumes were up, but only about 40% over the usual. We generally plan for volume spikes about 300% above normal run rates. During the quarter, we were favorably impacted by the continuing increase in the marked-to-market volume of Treasury bills in which we invest our customers’ cash positions. As we explained in our January earnings call, in the fourth quarter we took a large loss for marking our Treasury portfolio to market, and we continue to make…

Thank you, Thomas. Thanks everyone for joining the call. As usual I will review our summary results and then we'll hit the segment highlights before we take questions. Overall operating metrics were generally strong in the quarter. Average overall daily trade volume was 1.32 million trades per day, up 8% from the second quarter of 2015. Electronic Brokerage metrics showed solid increases in the number of customer accounts and customer equity. Total and cleared customer DARTs were up 5% and 6%, respectively, from the year ago quarter. Orders from cleared customers, who clear and carry their positions and cash with us and contribute more revenue, remained at 92% of total DARTs. Market Making contracts and share volumes were mixed across product types. Second quarter net revenues declined 5% versus last year, while pretax income was down 11%, for a pretax margin of 58%. Our brokerage results were boosted somewhat by high trading volume and the immediate aftermath of the BREXIT vote, although market making was relatively unaffected. Other market factors had the following impacts: Market volatility rose. The average VIX rose 29% year-over-year, while actual to implied volatility rose 5%. However, these figures were each down from the first quarter of 2016 by 14%. From a historical perspective, a relatively low VIX does little to drive trading volume and, therefore, brokerage revenues, while both measures affect our market making business. As we observed, volatility had been priced into the market before the BREXIT vote, which resulted in fewer opportunities for our market making business in particular. The U.S. dollar had a mixed performance against other major currencies in the quarter. As a result, the currency basket in which we keep our equity, which we call the GLOBAL, declined by a minimal 0.03% against the dollar for the second quarter. This…

Thank you. [Operator Instructions] And our first question comes from the line of Rich Repetto with Sandler O’Neill. Your line is now open.

Thomas, good evening, Paul. I guess the first question is a little bit more color on the brokerage expenses and the increase even quarter-to-quarter, the fixed expenses look like they went up a certain amount, a material amount?

Yes. As I said, primarily it is compensation and software development related. We are in an expansionary mode, and we’ve been adding resources in particular to customer service, legal and compliance, and software development.

Okay. And are you able now to or do we have to wait until the 10-Q for the net interest income breakout?

We don’t have breakout right now for you, but we’d like to be in a position to give you a little bit more color come the 10-Q, so that’s our goal. Suffice to say though that as we said before, most of it came from two factors. The increase in credit balances overall, and the fact that the Fed did raise 25 basis points in December and, during the year-over-year comparison, we are up about as much as the previous interest rate sensitivity analysis predicted, plus the additional balances.

And I guess my last question is for you Thomas. You talked about over the next year trying to, I don’t know what exact words you used, but in regards to the market maker, take a hard look at the business and that capital would probably, I am assuming that capital would be moved to the broker…?

That depends on what the result of the hard look is, right? So you're saying that if the result of the hard look were to reduce the market making business or maybe even eliminate it that would free up capital and yes, in that case we would hand it over to the broker.

Okay. Well I guess what other alternatives, just given the results I guess and what you said in your prepared remarks about the trend of the business, could you see other strategies with the market maker?

Yes.

And what might they be?

Yes, other strategies could be to either join together with somebody who does frequent trading, profitable frequent trading not in a market maker mode, or to develop that facility for ourselves.

And when you say not in a market making mode, so in a proprietary trading type of mode?

Yes.

And our next question comes from the line of Chris Allen with Buckingham Research. Your line is now open.

Just following-up on Rich's question, let's just assume from a scenario perspective that the market making business was shuttered, any color in terms of what level of expenses would still be maintained i.e., would that be transferrable to the brokerage and others - there is technology sharing between the two - I am just wondering what would the impact there be?

Paul, you got an answer to that?

I don't have a specific answer. We have done an amount of analysis in that area, so the overall answer is I'll call it a minority portion, we would expect to carry over into brokerage that is sort of in lost synergies and technology and memberships and things like that. But it would be a consumable amount for brokerage.

Got it. And then any color in terms of the customer growth trends, I mean it's still Asia-Pac outpacing Europe and U.S., is there any change to that dynamic from a regional perspective, do you have any color there?

We have all of the color you want, what would you like to know? Ask me a specific question I will give you the specific answer.

Sure - what was the account growth trend by region from a growth perspective?

Okay. So I can tell you that by region, America is 12%, Europe is 11% and Asia is 29%.

And from a customer perspective breakdown in terms of the different buckets in terms of advisors, prop, etc. if you can provide the same metrics that'd be great?

Yes, individuals were 12%, hedge funds were 15%, prop traders were 9%, advisors were 14%, introducing brokers were 29%.

And our next question comes from the line of Mac Sykes with Gabelli. Your line is now open.

The change in currencies that occurred, you say that it's based on relative importance, if you can provide some more color there, is this denomination based on capital, revenue and is the mix forward-thinking in terms of determination of economic impact?

No, we have eliminated the Brazilian real because we have closed our Brazilian operations. We have eliminated the Korean won because the business in Korea does not seem to grow as well as we were hoping, and it is not a really convertible currency. We have added this to the U.S. dollar and to some extent to the Chinese CNH because China is becoming a more and more significant part of our business, and we are trying to have the currency basket to, on the one hand, reflect the relative importance of these economies and, on the other, to provide us with the sufficient funds and the sufficient currency so we can do things like margin lending for example.

And then the Greenwich Advisor Services I hope I said that right.

Yes.

Is this going to be bundled as part of the new relationship with an advisor that comes on the platform or is this going to be sort of independent consultant driven, what's your expectations in terms of revenue for this?

For the moment, it is bundled but when it's in full force, we will charge for it but we will charge for it less than anybody else in this space, much less, just like we charge much less in commissions and provide better executions. So, the idea is that we have all this stuff automated already, and we compete and we have all the data practically and we're competing with people who have to piece the data together, and so it's going to be very, very easy for us and for others it's not so easy.

And then my last question, so when we think about the value of the market making segment, we have the tangible asset which is the capital, maybe you can give us a little color on sort of the amount of personnel that are in market making, maybe some of the intangibles related to it, I don't know whether it's the hardware or the relationships, or anything like that, what other value could you assign to it other than capital at this point if possible?

Well, the value that it has is that it can obviously get in and out of the markets so that it makes profit rather than be another cost like most other market participants have to pay in order to buy or sell securities. We get a profit from buying and selling securities, but it is not enough. So that's one significant value. The second is that we have systems that can manage very large positions in a hedged manner that is the reason why we in almost a hundred quarters haven't had a loss on positions other than front running of, especially, corporate news. So, in diminishing order the next valuable thing is of course all of our exchanges, all of our memberships in exchanges and clearinghouses and a great deal of know-how and experience.

[Operator Instructions] And our next question comes from the line of Rob Koehn with Ivy Lane Capital. Your line is now open.

Thanks for taking my call. Okay, so Thomas, on the market maker, is one of the options, if I heard you right, to potentially build your own platform like a Virtu type of platform, is that one of the things that you are considering?

Yes.

Okay. And can you talk a little bit more about your thought process on that and how you would make that choice? Obviously technology and algorithms are something where you excel?

Yes, technology we are good at. We are less good at signal processing which is what this is basically all about. So, I do not know if we can succeed at that, but we certainly can look at it.

Okay. I guess a naïve question, how will you assess your ability to succeed without trying?

We are going to try, but simulated try.

Okay. Simulated try. Got it. And did you say that that would be over the next year you will be looking at this, or will it be a shorter period of time to that?

Yes, we will consider our options, I am giving myself a year to make a decision here.

Okay. From an investor's perspective, it’s pretty exciting to have the thought that this eventually becomes a pure-play brokerage company, I think a lot of people been waiting a lot of years for that possibility.

Yes, that's part of the consideration.

So, given that, would you ever consider doing this outside of IBKR, in other words…

Yes, that's a possibility, yes.

So spinning off a Virtu type of operation if you could build it?

That's a possibility, yes.

Okay. So the technology is separable and that is a, it is possible maybe to build a business like that in turn, okay. Great, thank you. And then I guess a separate topic. I read the Financial Times interview you did a couple of months ago, and you predicted that the number of brokers would contract by 80% or something like that? Four-fifths would go out of business. So, is it more the technology cost or is it the regulatory cost?

It's both, but it is mostly the technology that is brought on by regulations.

Okay. And if you look at this swath of 80% of brokers, what is the number of firms, what is that 80% in a natural number?

As far as I understand, there are 4,000 broker-dealers in the United States.

Okay. So, of those brokers, I mean do you think that they become introducing brokers, that they just shut down, I mean presumably they are all selling their order flow, is that a good assumption?

Well, many of them are selling their order flow, but simultaneously we have certain efforts going on by the SEC and that you may have heard of. This Broker’s Score what is it called Broker Scorecard by the SEC chairman's proposal and simultaneously the -- I just participated in a subcommittee of the Market Structure Committee that is currently examining the issue of executions, and so I think that there will be tighter, the requirements will be tightened up here.

Okay. And then I guess again and on a separate topic you did the CNBC interview and you talk a lot about what sounds like sort of the Jeff Bezos’ flywheel at Amazon, with the lower cost leading to more customers, leading to more trades and then further lower costs. And it seems that's sort of the focus that most of your advertising, but it doesn’t seem like you…

It is not happening is your question.

No, my question is how come you don’t advertise the platform itself, so the Mosaic platform and its ease of use. I think a lot of people who think about IB think about the old Trader Workstation and it being a pretty complex system and don’t think about, or know about, the Mosaic platform. Why is that?

It’s a difficult question. Well, it is not so easy to advertise it. It's not so easy to tell the story. Everybody tells that what they are doing is the best thing, yes? So, you want me to just go and say that ours is “the best” - nobody will believe that even if it is. It's not factual.

Okay, I think it's an opportunity. Okay I'll get back in the queue. Thank you, guys.

Thank you for the suggestion.

And our next question comes from the line of Doug Mewirther with SunTrust. Your line is now open.

Hi, good evening. I had a quick question for Paul and then unfortunately one more question on the market maker that’s more conceptual. First, Paul, I noticed that your non-controlling interest went down in the quarter. And I’m not sure if it was the same last quarter, I’m just comparing with the beginning of the year. But it looked like your diluted share count went up, but the non-controlling shares didn’t go down. And I just wondered what transpired to affect the share count this way, and would this be a continuing trend?

Yes. This is standard, this happens every second quarter, when our stock incentive plan for employee shares vest in May. So you will always see that, and that has been the case since we went public. So there is a bump and it only affects the public share side, not the non-controlling interest, because these are previously unvested shares that become IBKR shares.

Okay. Thanks. That’s very helpful. Thomas, with the market maker, so it sounds that part of the reason, I think, that market making has been so squeezed is because, I mean there has been just no volatility. I mean the VIX is in the teens. So are you saying that even if the VIX goes back to the 20s that the economics would still not be satisfactory at your present configuration?

So, it’s not only that the volatility is very low, but the intra-day volatility is extremely low. So if you look at the market, it either opens up or down and where it opens and it tends to stay there for the day, so it gives us not too much opportunity to trade so you are right on that score, Doug. But we can’t ignore the long-term trends. So maybe, what we have is there are a large number of market participants who do very frequent trading, and that seem to be doing rather well or, at least that’s the word on the street that they are doing well. And who do they trade with, but us. So the uninformed trades have diminished in frequency, because trading with uninformed traders, because the brokers, the retail brokers are now selling the order flow to Citadeland Susquehanna and Goldman. And so we end up trading with the informed traders, those who successfully trade for a living. So when I said that maybe we find somebody like that to do something together that is what I meant.

Okay. That’s very helpful. Thank you. That’s all my questions.

And our next question comes from the line of Chris Harris with Wells Fargo. Your line is now open.

Thanks guys. Question on new business opportunities, there is a lot of dislocation happening at the European banks and just wondering if you guys were in dialogue or foreseeing any opportunities stemming from that? I am in particular curious about opportunities in prime brokerage.

Well, as far as dialogue we don’t discuss dialogues. Opportunities, yes we do see opportunities and that goes along the lines of, as I said, more and more brokers realize that it doesn’t pay for them to continue to build the technology and do the business on their own rather than using somebody else’s. We do not want to become a bank because we don’t want all the regulations that banks have to go under, otherwise we pursue that space to the extent we can.

All right, my one follow-up would be on your pricing strategy, and this is sort of a long-term trend but it looks pretty clear in this quarter as well, but generally speaking it seems like your newer customers are less active than your legacy customers and maybe they’re less profitable too, but I am not sure about that. Could you guys envision a scenario where you actually modify pricing for these less active customers, in order to perhaps boost some of these per account metrics, say DARTs per account or revenue per account, excuse me.

So the issue there is that these less-often trading customers that are less profitable tend to be introducing brokers’ customers. And as you know -- so we give these introducing brokers an extremely low price because we bundle all the introducing brokers’ customers as though they were one customer, and give them our lower commission tier in proportion to the entire volume provided by the introducing broker. So that is the explanation for that. And to the extent we don’t break it out that’s why it appears like our commissions per trade or revenue per customer is decreasing. So, maybe in the future you give me an idea, maybe we should break that out.

Okay, but then I guess what you are saying, it’s pretty stable, excluding the introducing brokers?

That is what I would think, yes.

Got you. Okay, thank you.

And our next question comes from the line of Conor Fitzgerald with Goldman Sachs. Your line is now open.

Thank you for taking my question. First, could you maybe provide a little more color on some of the products you are thinking about developing for your advisors that they are going to need as they adapt to the fiduciary rule?

I am sorry, but I really don’t want to because you know three months matter here. So if we come out with something and we give three months’ notice to our competitors, and they will be competing with us three months earlier.

And on the prime brokerage opportunity, there has obviously been a lot written about what's going on in the prime brokerage space for the hedge funds. With what you are seeing on your platform at the beginning of the year, what are you hearing from clients in terms of what they need to execute in these markets in the beginning of the year?

What do they need?

In terms of like changing needs or risk systems et cetera?

Well you see, we have basically two large disadvantages. One is that we are a relatively new name in the space and we are certainly not too big to fail. And secondly, we do not do over-the-counter derivatives, which from a profitability point of view is an advantage, but from the product base point of view it isn't, because as you know many of the big prime brokerage customers do those things.

And sorry just one more cleanup from me, just on the bad customer debt, not a big number this quarter at $3 million, but I don't think I heard any color just on what drove that loss for that expense?

I'm sorry, Paul what is this?

The $3 million…

I don't think there's anything in particular, the shift also reflected…

I think it will be last quarter they're referring to, not this quarter?

In other words, this quarter but sometimes, some of that is -- it is a recognition of when an event happens in each quarter you have to make an assessment of the likelihood of taking a loss, and sometimes those assessments play out over time and so they're sometimes taken in that quarter that's past the quarter in which the event happened. And then the shift from year-to-year is also reflecting the fact that last year, if you recall on January of '15, we had that Swiss Bank event in which we took large losses and we actually recouped some of those in the second quarter. So, the shift somewhat overstates what's going on because we had a recoupment of about $1 million or $1 million plus in the prior year's quarter.

We have a follow-up question from Rich Repetto with Sandler O'Neill. Your line is now open.

Yes I will try to make this short Thomas, but when you said you might look at taking the market maker and having a similar operation to Virtu.

I didn't use Virtu, I think you did or somebody else did.

And I'm showing no further questions at this time, I would now like to turn the call back over to Ms. Nancy Stuebe for closing remarks.

Thank you everyone for participating today. As a reminder, this call will be available for replay on our Web site. 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, thanks for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.