StoneX Group - Earnings Call - Q1 2019

Transcript

Speaker 0

Good day, ladies and gentlemen, and welcome to the INTL FCStone First Quarter Fiscal Year twenty nineteen Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. And as a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr.

Bill Dunaway, CFO. Mr. Dunaway, you may begin.

Speaker 1

Good morning. My name is Bill Dunaway. Welcome to our earnings conference call for our fiscal first quarter ended December 3138. After the market closed yesterday, we issued a press release reporting our results for the first fiscal quarter of twenty nineteen. This release is available on our website at www.intlfcstoneas.

Well as a slide presentation, which we'll refer to on this call and our discussions of our quarterly results. You will need to sign on to the live webcast in order to view the presentation. The presentation and an archive of the webcast will also be available on our website after the call's conclusion. Before getting underway, we are required to advise you and all participants should note that the following discussions should be taken in conjunction with the most recent financial and notes thereto as well as the Form 10 Q filed with the SEC. This discussion may contain forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

These forward looking statements involve known and unknown risks and uncertainties, which are detailed in our filings with the SEC. Although the company believes that its forward looking statements are based upon reasonable assumptions regarding its business and future market conditions, there could be no assurances that the company's actual results will not differ materially from any results expressed or implied by the company's forward looking statements. The company undertakes no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events or otherwise. Participants are cautioned that any forward looking statements are not guarantees of future performance. With that, I'll now turn the call over to Sean O'Connor, the company's CEO.

Speaker 2

Thanks, Bill. Good morning, everyone, and thanks for joining our fiscal twenty nineteen first quarter earnings call. Our strong earnings and momentum from 2018 continued into our first quarter of fiscal twenty nineteen. Despite most banks reporting a decline in trading revenues in the December, we reported a 25% increase in operating revenues from a year ago and up nine percent sequentially from Q4. All of our businesses recorded strong increases in transactional volumes with the only exception being FX prime brokerage.

All of our segments except commercial hedging showed double digit growth in both operating revenue and segment income. Commercial hedging had strong transactional volume growth, but reduced revenues. Segment income was a record in our Global Payments and Clearing and Execution Services segment, as well as in our Equity Capital Markets business because of increased volatility and market share. We achieved an increase in pre tax income of 31% versus a year ago and up 19 sequentially from Q4. Net earnings were $18,200,000 versus a loss of $6,900,000 a year ago due to the impact of the new tax legislation in the prior year period.

This also represented a 16% growth in net income over the immediately preceding fourth quarter. Our EPS was $0.94 a share and our ROE was just over 14%. On a trailing twelve month basis, our EPS is now $4.18 per share. Some highlights before I hand off to Bill. We had some noise in our numbers this quarter, which I would like to highlight.

In our Commercial Hedging segment, our structured products and OTC business was negatively affected by approximately $11,000,000 in unrealized mark to market losses at the end of the first quarter. This was due to year end lack of liquidity, which was more severe than normal this year, which caused some longer dated positions to trade away from fair value. These positions were directionally hedged as we always do. And as of today, the bulk of this unrealized loss has reversed and we expect this will continue until these positions roll off later in the year. In addition, operating revenues in our precious metals business were affected by $1,600,000 unrealized mark to market loss on hedges placed against inventory carried at lower of cost of market.

We had a similar situation in the prior quarter when we reported an unrealized mark to market loss of $1,300,000 which reversed in the second quarter of fiscal twenty eighteen. On the positive side, we recorded a $2,400,000 bad debt recovery realized upon the final settlement of outstanding liabilities relating to the physical coal matter and also received a $2,000,000 settlement in our favor, net of legal fees, which was related to the Barclays last look foreign exchange class action matter. The net impact of all of these items was to reduce our pre tax income for the quarter by approximately $8,200,000 Our core operating results excluding these items was well in excess of our target ROE making this one of our better quarters to date. Our equity capital markets business also had a record quarter adding $20,000,000 in operating revenues versus the prior year as we benefited from increased market share, increased volatility and better revenue capture as we internalize more trading spreads. Dollar volume was up an impressive 75% from a year ago and revenue capture improved about 15%.

Global Payments achieved record quarterly operating revenues and record segment income, is up 27% from a year ago and up 18% consecutively. This was due to an increase in both transactional volume and revenue capture.

Speaker 1

This was

Speaker 2

the first time our Global Payments was the largest in terms of segment income. Over the past four quarters, this business has generated an impressive $64,000,000 in segment income with a 61% margin on operating revenues. Our Clearing and Execution Services segment also had a record segment income for the quarter with strong performances in futures, securities clearing and voice brokerage. In January, we closed the acquisition we mentioned last quarter of GMP Securities, which brings over 2,400 institutional relationships and product capabilities focused in high yield convertibles, emerging market debt and certain equities. We have started integrating the two broker dealers and believe that there is a good cross sell opportunity between our rates business and GMP's business.

Lastly, on the option sellers matter, the aggregate receivable due from these clients declined modestly to $29,400,000 We are continuing to aggressively pursue collection of amounts due to us. We have done a detailed assessment of the collectability of these accounts and have concluded we do not have a sufficient basis to determine an allowance against these balances at this time. As we move through the collection process and additional information becomes available, we'll continue to evaluate the likelihood of collection and consider the need for an allowance against these amounts outstanding. With that, I will hand you over to Bill Dunaway for a more detailed discussion of our financial results. Bill?

Speaker 1

Thank you, Sean. I'll be referring to slides and the information we have made available as part of the webcast, specifically starting with Slide number three, which shows our performance over the last five fiscal quarters. The chart depicts our net income, earnings per share and ROE over the last five quarters. As shown, net income in the 2019 was $18,200,000 which represents a 2,500,000 improvement over the immediately preceding quarter. In the prior year comparative quarter, we reported a net loss of $6,900,000 However, in that period, we recorded a charge to income tax expense related to the enactment of tax reform in the amount of 20,900,000 Moving on to slide number four, which represents a bridge between operating revenues for the first quarter of last year to the current period.

Operating revenues were a record $264,700,000 in the current period, up $52,100,000 or 25% over the prior year. As shown, all operating segments showed revenue growth over the prior year with the exception of commercial hedging. This growth was led by our Securities segment, which added $26,000,000 or 60% in operating revenue versus the prior year. Within this segment, Equity Capital Markets had a record quarter adding $20,000,000 in operating revenues versus the prior year as the dollar volume increased 75%. In addition, Debt Capital Markets added $6,300,000 in operating revenues, primarily driven by an increase in interest income in our domestic business, driven by higher short term interest rates, which was partially offset by weaker revenues from our Argentina and municipal securities businesses.

Our Clearing and Execution Services segment added $23,000,000 or 32% in operating revenue as compared to the prior year, driven by a $14,500,000 increase in exchange traded revenues as volumes increased by 57% versus the prior year. Also contributing to growth in exchange traded revenues was a $4,300,000 increase in interest income related to 7% growth in average client balances and higher short term interest rates. Also in this segment, operating revenues and FX prime brokerage revenues increased $2,800,000 primarily related to the class action settlement received as mentioned by Sean. Higher interest rates drove a $2,300,000 increase in correspondent clearing, while independent wealth management and derivative voice brokerage each added $1,700,000 in operating revenues versus the prior year. Operating revenues in our Global Payments segment added $5,100,000 or 21% versus the prior year to a record $29,700,000 as the number of payments increased 7% and the average revenue per payment increased 13% versus the prior year.

This growth was driven by increased activity from our international banking clients as well as increased activity from nongovernmental organizations. Physical commodities added $3,700,000 or 35% in operating revenues versus the prior year, driven by a $2,400,000 increase in precious metals off strong volume growth, which was tempered by the $1,600,000 unrealized mark to market loss Sean mentioned earlier. In addition, Physical Ag and Energy operating revenues added 1,300,000.0 versus the prior year. Finally, operating revenues declined in our Commercial Hedging segment by $1,700,000 versus the prior year to $59,800,000 Exchange traded volumes increased 8% and OTC volumes grew by 25% versus the prior year. However, overall revenues declined due to unrealized mark to market loss Sean mentioned earlier.

Exchange volumes increased as a result of increased client activity in the domestic grain markets, Latin American soft commodities and in our LME business. OTC volumes increased driven by increased client activity in energy, grain and soft commodity markets. In addition, interest income in this business increased 83% to 7,700,000.0 driven by short term rates and a 14% increase in average client equity to $1,000,000,000 The net decline in unallocated overhead operating revenues includes a $2,200,000 loss on economic hedges in place against the effect of the devaluation of the Argentine peso, which was partially offset by revaluation gains in our debt capital markets and asset management businesses in that country. The next slide, number five, represents a bridge from twenty eighteen first quarter pretax income of $18,600,000 to pretax income of $24,400,000 in the current period. Commercial Hedging segment income declined $7,800,000 as a result of the decline in operating revenues I just mentioned, combined with a $4,100,000 increase in variable expenses and a $1,900,000 increase in non variable direct expenses.

Global Payments added $4,000,000 in segment income to a record $18,600,000 while the CES segment added $7,200,000 versus the prior year. In addition, off the back of strong gains in equity capital markets revenues, somewhat tempered by higher interest expense in the debt capital markets business, our Securities segment added $5,000,000 versus the prior year in segment income. The Physical Commodities segment added $4,800,000 in segment income versus the prior year as a result of the increase in operating revenues combined with a $2,400,000 bad debt recovery in the current period, while the prior year period included the $1,000,000 expense on bad debt on physical coal. Slide number six shows the interest and fee income on our investment of client funds in our exchange traded futures and options businesses as well as client balances held in our Correspondent Clearing and Independent Wealth Management businesses. As noted on this slide, our earnings on these balances have increased $7,100,000 versus the prior year to $17,900,000 as our yield on these balances has increased 76 basis points to 2.21% in the current period.

The bottom of this slide shows the potential annualized interest rate sensitivity, which the balances held at the end of the current period have, based upon an increase in short term rates at various levels. As shown, a 100 basis point increase in short term rates has the potential to increase our net income by $15,900,000 or $0.83 per share on an annualized basis. Moving on to Slide seven, our quarterly financial dashboard. I would highlight a couple of items of note. Variable expenses represented 62.9% of our total expenses for the quarter, well above our average of keeping more than 50% of our total expenses variable in nature.

Non variable expenses, which are made up of both fixed expenses and bad debt expense, increased $2,100,000 Excluding the $3,300,000 positive swing in bad debt expense versus the prior year, non variable expenses increased 5,400,000.0 primarily driven by higher trade systems and market data costs, non trading technology costs and non variable compensation and benefits. We reported net income of $18,200,000 in the first quarter for a 14.1 return on equity, slightly below our stated target of 15%. Finally, in closing out the review of the quarterly results, our average revenue per employee increased 16% to $616,000 on an annualized basis, and our book value per share increased $4.08 to close out the quarter at $27.64 per share. We did not repurchase any of our common stock during the first quarter. With that, I would like to turn it back to Sean to wrap up.

Speaker 2

Unlike many of our competitors and banks, we recorded one of our best quarters in terms of core operating performance. Our model allows us to offer a wide range of products and capabilities to our clients, making us more relevant to each client and in turn making each client more valuable to us with more diversified and predictable revenues. Furthermore, unlike more narrowly focused firms, we can leverage our central infrastructure and capital across many different business lines, creating operational leverage and producing better returns on capital. This business model offering our clients vertically integrated execution and clearing in all major asset classes is being validated both through our increased market share as well as through our financial performance, which we believe is best in class. We believe that this is a winning formula for both our clients and our investors.

With that, I'd like to turn it back to the operator and open up for question and answer session. Operator? Operator?

Speaker 0

Thank you. You. One moment for questions. First question comes from Paul Dwyer from Punch and Associates. Your line is now open.

Speaker 1

Hey, good

Speaker 3

morning, guys.

Speaker 1

Hey, Paul.

Speaker 3

To start maybe, can we talk about your ability to drive operating leverage on the unallocated costs relative to segment income and just kind of how you think about how fast unallocated costs will grow in the future?

Speaker 2

Good question. So we are very focused on trying to keep our central overhead cost increases well below the rate at which our segment income grows. I mean, that's what causes our operational leverage. And to do that, what we are working on is really two things to more tightly integrate our offerings, you know, systems wise, and support wise, to try and eliminate costs and create synergies. So for example, we've acquired a lot of businesses over time.

We don't want to have separate accounting teams, separate credit teams, separate compliance teams. We're trying to sort of centralize those things. And then the second, thing we're doing, which is probably costing us money in the short term, is we need to build a much more scalable infrastructure, so that, and this is our objective is that every incremental transaction really costs us close to zero. And at the moment, we are trying to drive that through technology. So if you look probably over the last three or four years, we've had pretty substantial uplifts in our technology spend, as we're trying to achieve that.

And we're not trying to do it sort of in a big bang approach. I think that could be highly detrimental. People who try sort of introduce enterprise wide systems normally fail. But we're spending a lot of money on trying to get to a more scalable infrastructure. I think we are making progress on that side.

And I think that costs will start to flatten. And hopefully, that will allow us to achieve that objective of keeping our central overhead cost growth lower than the growth in our segment income. So those are the two things we try to do is create the internal synergies where we can and you know, organize ourselves smarter. And I think we've done a reasonably good job of that and build better technology. And, you know, we sort of three, four years in to a pretty big incremental build.

And I think that'll be ongoing for a while, but I think we're starting to see some good progress on that side. Does that answer your Yes. Question,

Speaker 3

It does, I think. And then so are there costs running through this that will fall off eventually? Is it more that the spend will moderate?

Speaker 2

Yes, we always think when you sort of agree to these big IT uplifts in costs that maybe they'll go away. I don't think actually that's realistic. What I'm hoping is that'll flatten and those costs will allow us to create more scalable infrastructure, and they will flatten in absolute terms. So I wouldn't think that you should anticipate our costs reducing. But if we do our jobs right, our costs should flatten at some point.

Speaker 3

Okay. A few more questions if that's all right. The

Speaker 2

Yes, sure. Go ahead.

Speaker 3

What do

Speaker 1

you think is a

Speaker 3

reasonable timing to have some sort of estimate for this option seller's potential bad debt?

Speaker 2

Okay, I obviously can't go into too much detail because we sort of involved in litigation all around here. But honestly, this is going to be multiple quarters before I think we have a clearer picture. You know, we are going through a legal process that's most likely going to involve an arbitration of some sort. We are filing all that paperwork now. You know, so I I think towards the end of this fiscal year, we should have much greater clarity.

I mean, that's about as best as I can tell you right now. It's certainly not going be resolved in the next three months or something. I mean, that's for sure.

Speaker 3

Okay. That's fine. And then can you talk so I understand the short term interest rate movement of the business and how that impacts it. Can you talk a little bit about how the slope of the yield curve impacts earnings?

Speaker 2

Well, two thoughts on that. So firstly, we have a float and our float is pretty much sitting at the three month T Bill rate. We invest that both with banks and in T Bills, so that's probably a good proxy. So that's sort of the bulk of our net interest carry. Right?

Yep. We have historically, and if I go back three, four years ago when, the T bill rate was basically zero, we did see an opportunity to create a ladder after two years because we were basically getting sixty, seventy basis points at the two year mark. So we created a ladder of treasuries, which just sort of rolled off and we just replaced them, which allowed us to actually capture on average about 50 basis points. This is from memory, may be a little bit off, but about 50 basis points when the short term rate was zero. We will use the yield curve if it presents an opportunity to us.

I don't think we'll ever want to ladder our exposure out beyond more than say two years. As you know, that's kind of very flat right now. So it doesn't present us an opportunity to enhance our yield over what we're getting now on the short term basis. So that's kind of one part of it. The second part of it is in our rates business, we carry fairly large inventories in mortgage backs and other things which are hedged, and are funded and they are largely funded at about the three month rate.

And obviously they earn a rate that's slightly higher. Honestly, the hedges end up probably negating a lot of that yield curve benefit we might get. But oftentimes there's just a little bit that we kind of squeeze out there, but I don't think it's material. If we didn't hedge those positions, obviously, we'd be getting kind of a carry on the yield curve if there was one. But honestly, don't see much of that just because we hedge everything.

Does that answer your question Paul?

Speaker 3

Okay. It does. And then just last for me is kind of what the M and A landscape looks like for you going forward and kind of what's interesting you and where do you want to go next for acquisitions?

Speaker 2

Yes. This is always a kind of a funny conversation we have with people because as you know, we've done maybe 20 ms and A deals over the last sort of ten years. But we certainly don't have a list on a wall somewhere of companies we'd like to buy. I mean, think that's very dangerous. You end up sort of falling in love with things and overpaying.

But what we do, do is we have got ourselves known as a potential buyer that can move quickly that executes and can close transactions. And as a result of that, we see what's going on. So we're definitely in the flow of acquisitions. And just to give you some sense of it, during 2018, we probably were presented with roughly 50 opportunities that we looked at. We probably got pretty seriously engaged on maybe 10 and we sort of did two I think.

So we're pretty disciplined and picky. We will continue that process. And what we're really looking for is businesses that either bring clients or capabilities we don't have, first of all, and businesses we can add value to. There's no point in us buying something that we can't do a lot with. So we want businesses that can do better on our platform.

We can add value to that can cross sell to our clients, whatever it is. So that's sort of our basic screen and we'll keep looking. So we're pretty opportunistic, would say. As we fill out our offering, I think there's less things that fit. And you start to look at things that are maybe more duplicative.

And then you sort of just thinking about cost synergies. Up until now, we really haven't done a lot of transactions that are just driven by cost synergies. But we're probably going to start to see that a little more. And I think as we've grown and become known in the market, we also see talent just wanting to move across to us. So we've actually recruited a lot of pretty senior people that are bringing with them their relationships.

So that's obviously another way you grow your business. I mean, almost like buying small decks of business, right? So that's sort of our approach. We don't have any big deals in the works. We don't want to sort of chase anyone.

We want to be nimble. We want to be disciplined and we want to be patient in how we build out our business. And frankly, our business is doing great. So we don't feel compelled or under pressure to have to do something to change our trajectory. I mean, are making better returns than any of our competitors.

We are seeing customers onboarding with us and we're talent wanting to work here. So it seems like what we're doing is good and therefore we are afforded luxury of being disciplined. And I think we want to stay that way. Is that helpful, Okay.

Speaker 3

Yeah, that's very helpful. Yeah, I'd agree. Really nice quarter guys. That's all I have. So

Speaker 1

Okay. Nice job.

Speaker 3

We'll talk to again soon.

Speaker 2

Well, thanks for the questions. Appreciate

Speaker 3

Yep. Bye bye.

Speaker 2

Bye. Alright, operator. I don't see any questions up on the list here. So, I think we'll call it a day. So thanks everyone for participating, and we will speak to you again in about three months.

Thank you.

Speaker 0

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a wonderful day.