StoneX Group Inc (SNEX) 2010 Q3 法說會逐字稿

Good day, everyone, and welcome to the International Assets third-quarter 2010 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Bill Dunaway. Please go ahead, sir.

Good morning. My name is Bill Dunaway, CFO of International Assets Holding Corporation. Welcome to our earnings conference call for the third quarter of fiscal 2010 ended June 30, 2010. After the market closed yesterday, International Assets issued a press release reporting its earnings for the fiscal third quarter of 2010. The press release is available on our website at www.intlassets.com.

Additionally, we are conducting a live webcast of this call, which will also be available on our website after the call's conclusion.

Before getting under way, I would like to cover a couple of housekeeping items. On these conference calls and in management's discussion portions of our SEC filings, we present financial information on a non-GAAP basis in order to take into account marked-to-market adjustments in our commodities business. As discussed on previous conference calls and in our filings, the requirements of accounting principles generally accepted in the US, which I will refer to as GAAP, to carry derivatives at fair market value but physical commodities inventory and lower of cost or market value may have a significant temporary impact on our reported earnings. Under GAAP, gains and losses on commodities inventory and derivative which the Company intends to be offsetting are often recognized in different periods.

Additionally, GAAP does not require us to reflect changes in estimated values of forward commitments to purchase and sell commodities. For this reason, we believe that the GAAP numbers do not reflect the commercial results of our commodities business and therefore the Company as a whole. Instead, we assess all of our businesses, as do our banks, on a fully marked-to-market basis in our daily and monthly internal financial reporting.

We also calculate commodities traders bonuses on the basis of fully marked-to-market results, not GAAP results. Readers of our Form 10-Q filings should look at item 2 in our selected summary financial information for a summary of both GAAP a non-GAAP information. This section also provides the reconciliation between GAAP and non-GAAP information as required by the SEC. Please note that whenever we talk about an adjusted number on this call, we are talking about a non-GAAP number.

Secondly, we are required to advise you and all participants should note that the following discussion should be taken in conjunction with the most recent financial statements and notes thereto as well as the Form 10-Q filed with the SEC. This discussion may contain forward-looking statements within the meanings 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 it's forward-looking statements are based upon reasonable assumptions regarding its business and future market conditions, there can 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. Readers are cautioned that any forward-looking statements are not guarantees of future performance.

With that, I will now turn the call over to Sean O'Connor, the Company's CEO.

Thanks, Bill, and good morning, everyone. During our third fiscal quarter, we saw slightly improved market conditions with a slight pickup in volatility generally starting with the flash crash, then the European debt market crisis, and most recently. the Russian wheat situation. This volatility increased trading volumes generally and as a result, our financial results were improved over the second fiscal quarter.

However, this is still a very challenging environment for us with interest rates remaining at almost zero levels and looking like they may remain so for longer than we had anticipated a year ago. Our core activities again produced a positive result, the best so far this fiscal year, but well below our long-term expectations. Bill will take you through all the numbers later, but perhaps I can get you a high-level summary of how we see -- how we saw things playing out.

Our results for Q3 were the best this fiscal year by almost every measure with a diluted EPS of $0.48 for continuing operations on a GAAP basis and $0.27 on a fully marked-to-market basis. On a fully marked-to-market basis, this equates to an ROE of just over 8%, well below our target return on equity. As we have said in the past, we set our minimum target of 15% with a desire to make greater than 20%.

As we said on the last call, we are likely to end the 2010 fiscal year below our target range but expect to reach or exceed that target in the medium term.

The Q3 results includes a cumulative after-tax reduction of approximately $2 million arising from a variety of nonrecurring items, the most significant of which was a $1.4 million increase in provisions arising from a trade dispute in our [Clearing] segment that is now in arbitration. Bill will talk about this more later.

While we are not pleased with these items, it is important to note that our core revenue-generating capabilities are somewhat stronger than our bottom line indicates.

Dealing now with our balance sheet and liquidity, on a marked-to-market basis, we now have long-term capital in excess of $255 million and total debt including convertible notes of $53 million, which is down from $95 million at the end of Q2 and down from $182 million at the start of the year. At quarter end, we held cash of $83 million, which exceeds our aggregate borrowings and was up slightly from Q2, of which $12 million of this cash was restricted.

An estimated $32 million of our surplus liquidity will be utilized with the recently announced Hanley Group acquisition through the assumption of their balance sheet and business and the upfront portion of the purchase consideration. Despite this, we are still very liquid, with significant undrawn banking lines available to us.

Over the nine-month period, total assets have remained roughly similar as have segregated customer balances. However over this period, we have repaid total debt of $129 million.

During the quarter, we implemented our methodology to optimize and maximize the potential interest earnings from the customer balances by every quarter, swapping a portion of our net interest exposure into two-year swaps. The first tranche of these swaps was executed and is now in the money, but unfortunately the net enhancement provided by the two-year swap has eroded significantly this quarter. We believe that over the long term this methodology will be successful and will continue to enhance our net interest earnings from our customer balance.

As we mentioned last time, we have a two-pronged strategic initiative. Firstly, expand the customer base globally, taking advantage of the current cycle where most competitors are not aggressively expanding and midsized corporations are looking for assistance.

Secondly, building out and expanding our capabilities. Currently we are not optimizing the margin we make from our 5000 commercial relationships or offering as many services as we could.

During the quarter, we were successful in concluding the Hanley acquisition and are in the early stages of the integration process. The transaction was made with cash, utilizing some of our surplus liquidity, and is thus completely accretive to shareholders.

The Hanley Group is a major Chicago-based risk management firm that specializes in making markets and exchange-traded agricultural option and the development and trading of complex structured OTC products for the commercial commodity sector. The companies of the Hanley Group Capital will be combined with FCStone's existing OTC trade desk.

Ramping up our OTC and structured products capability is an important strategic initiative which we mentioned in our last call. It will allow us to strengthen our customer relationships by offering a wider range of customized products and will significantly drive revenues as we internalize margin we currently give back to our counterparties or lose out to our competitors.

Our long-term plan is to establish this capability across all our commodity verticals and expand this trading presence geographically to support our growing global customer base. This is a big task but if executed correctly, will strengthen our customer relationships and make us a leading provider of risk management products globally including risk management consulting, futures execution, and complex structured products tailored to specific customer needs.

When combined with our unique physical trading of commodities and our ability to embed risk management products into physical contracts as well as our global foreign exchange capability, we will possess a unique product range not easily matched.

The combination of Hanley with our existing OTC desk and our tremendous broker and sales network creates a completely integrated OTC capability including leading-edge product design, quick and efficient pricing of complex products, and the ability to efficiently trade the risk out through our own pit brokers and sophisticated trading technology.

You may have also seen we announced establishment of a new FCStone 24-hour institutional order execution desk that will serve customers in all time zones across the globe. The new trading desk, which will be located in Chicago, has been designed to serve our institutional customers, including CPAs and clearing and hedging customers of FCStone. This desk will also serve our NCLs and FCStone's internal network of brokers and traders. This capability is provided by a team with over 50 years of experience in handling complex and contingent orders.

Both of these are extremely positive and promising developments for our future. In both cases they are about adding additional expertise, new capabilities, and more advanced systems to our already high level of customer service. Both initiatives will make us stronger and more competitive with our base of commercial and institutional customers.

Expanding these capabilities in addition to some of the other capabilities we have mentioned in these calls the way we envisage, which is globally and across all product lines, is a big undertaking and will take some time to complete. Good progress has already been made but we need to move faster and establish ourselves.

The potential for incremental revenue is enormous and at the same time we can broaden and deepen our customer relationships.

With that, I will hand you over to Bill for a discussion of the financial results. Bill?

Thanks, Sean. Let me remind everyone as I said at the outset of the call that the fully marked-to-market numbers are not in accordance with GAAP. The differences between the GAAP and a fully marked-to-market numbers arise in our commodities and risk management services segment. In all other of our business segments, GAAP results and marked-to-market results are the same.

As Sean mentioned in his comments, the merger with FCStone occurred on the last day of fiscal year 2009, so I will be discussing primarily the results of the third quarter 2010 as compared to the second quarter of 2010, as year-over-year comparisons would not include FCStone's results for the prior year.

Total operating revenues under GAAP for the third quarter were $78.1 million as compared to $65.4 million for the second quarter of 2010. Adjusted operating revenues, which includes a marked-to-market adjustment in our commodity and risk management business, increased by $11.9 million from $60.6 million in the second quarter 2010 to $72.5 million in the third quarter.

As difficult economic conditions linger however, business activity in the industries we serve has shown signs of recovery with volumes increasing in all parts of our business with the exception of debt capital markets over second-quarter levels.

Operating revenues for the third quarter include a marked-to-market gain of $1.1 million on interest rate swaps entered into during the quarter to manage a portion of our aggregate interest rate position as discussed on the second-quarter earnings call. The objective of these interest rate swaps is to invest the bulk of our customer-segregated funds in high-quality short-term investments and swap the resulting variable interest earnings into a more stable medium term interest stream at the holding company level.

Noninterest expenses increased $8.3 million to $62 million as compared to $53.7 million in the second quarter mainly as a result of increased variable expenses related to the increase in operating revenues and volumes. Variable compensation increased $1.3 million to $11.2 million for the third quarter while variable clearing and related expenses increased $2 million to $17.1 million for the third quarter.

Of our total noninterest expenses, 46% were fixed and 54% were variable in the third quarter of 2010 compared with 45% fixed and 55% variable in the second quarter. Compensation and benefits made up 42% of the total noninterest expenses in the third quarter compared with 43% in the second quarter.

Interest expenses increased slightly in the third quarter to $2.7 million as compared to $2.3 million in the second quarter of the fiscal year with the increase coming primarily due to an increased level of average borrowings during the quarter.

Now I will discuss the results in our various reporting segments. As a reminder, the commodity and risk management services segment, which is our largest segment, combined the FCStone [CRM] segment with the INTL physical metals business. This segment now houses all of our commodities activities including exchange traded futures and options, OTC derivatives, and physical trading.

Adjusted operating revenue increased by 29% to $37.1 million in the third quarter as compared to $28.7 million in the second quarter. This increase was driven by record operating revenues in our precious metals business, driven by strong demand in Singapore and Dubai as well as an increase in both exchange traded and over-the-counter volumes in our soft commodity business, which encompasses all of the activities in the segment outside of the metals.

The exchange traded volume increased 30% over second-quarter levels while over-the-counter volumes increased 31%.

Revenue in the base metals business increased 9%, reflecting an increase in the total metric tons traded offset partially by narrowing spreads. Activity in the base metals business continued to benefit from the effect of an overall increase in customer demand.

Adjusted CRM segment operating income increased $4.4 million from $8.8 million in the second quarter to $13.2 million. For the quarter ended June 30, 2010, average customer segregated balances in this segment were $425 million as compared to $399 million in the second quarter. However, interest income continued to be constrained by the effect of historically low short-term interest rates.

The foreign exchange segment consists of the INTL global payments and trading activities as well as FCStone's FX activities, which consist of customer clearing and execution of spot trading as well as the proprietary operation, arbitraging, cash, and futures on foreign exchange contracts.

Operating revenues in the third quarter totaled $11.8 million compared to $10.9 million in the second quarter. Operating revenues in the global payments business was flat as compared to the $6.4 million in the second quarter as continued growth in customer volumes was offset by a narrowing of spreads in the current season which we transact.

Operating revenues in the proprietary arbitrage and customer clearing ForEx business increased $900,000 from $4.5 million in the second quarter to $5.4 million in the third quarter, primarily as a result of the increase in arbitrage opportunities due to market volatility to the proprietary desk. Segment operating income increased from $5 million in the second quarter of 2010 to $5.2 million in the third quarter.

Operating revenues in the security segment, which is accommodation of the equity market making and debt capital markets business declined $900,000 from $5.1 million in the second quarter to $4.2 million in the third quarter of 2010. Activity in our equity market making business recovered slightly as compared to second-quarter levels as operating revenues increased 5% to $4.2 million. This increase was driven by a 21% increase in the number of trades, however, a narrowing of spreads limited the revenue growth.

Operating revenues in the debt capital markets business continued to be constrained by the negative sentiment stemming from the financial crisis, declining from $1.1 million in the second quarter to break even in the current quarter. Security segment income decreased from $1.6 million in the second quarter to $200,000 in the third quarter.

Clearing and execution services remains as the historically reported FCStone CES segment. Adjusted operating revenues in the quarter were $16.9 million in the third quarter as compared to $14.5 million in the second quarter of 2010. Exchange traded volumes in this segment increased 3% from the second quarter to 6.5 million contracts. Average customer deposits in this segment were $591 million for the third quarter which is down from the $657 million in the second quarter.

The CES segment lost $500,000 for the third quarter as compared to earning $100,000 in the second quarter of 2010. The loss in the third quarter was driven by a $2.3 million bad debt provision related to a disputed trade that was given up to FCStone by another futures commission merchant for a customer that held an account with us. Despite expressly informing the FCM that the company would not accept the give up trade, the give up trade was submitted through the electronic clearing process and erroneously cleared by the company.

The customer lacked the financial capacity to cover the resulting account deficit and FCStone has filed a complaint and is seeking legal relief through arbitration against the FCM to have the give up transaction rescinded with an award of appropriate damages.

Finally, the other segment includes INTL's historical asset management group and FCStone's historical financial services segment. Adjusted operating revenues were $2.4 million in the third quarter as compared to $2.3 million in the second quarter. Assets under management were $417 million as compared to $412 million in the second quarter of 2010. Segment operating income was $1.3 million in the third quarter as compared to $1 million in the second quarter of 2010.

There are a couple of other items of note in the other segment for the quarter. During the third quarter, the Company sold its Dubai-based subsidiary, INTL Capital, to an independent third party at its book value. This was one of two Dubai subsidiaries owned by the Company and the Company will continue to maintain and grow its core business through the remaining entity.

As discussed on the second-quarter earnings call, we sold our majority ownership in Agora-X to NASDAQ OMX during the second quarter of the fiscal year. During the third quarter, the Board of Directors of Agora-X decided to discontinue operations of the entity. We accordingly wrote down our remaining investment of $500,000 during this fiscal third quarter.

In accordance with accounting guidance, the results of both INTL Capital and Agora-X including the write-down of the investment in the current quarter are included within discontinued operations net of tax on the condensed consolidated income statement for the three and nine months ended June 30, 2010. Both the operating results of INTL Capital and Agora-X had previously been included in the other segment.

On a GAAP basis, the net income attributable to common shareholders was $6.7 million for the third quarter or $0.38 per fully diluted share as compared to net income of $7.4 million or $0.41 in the second quarter of 2010. On a GAAP basis, net income on continuing operations was $8.6 million for the third quarter or $0.48 per fully diluted share as compared to net income of $6.1 million or $0.33 in the second quarter of 2010.

Adjusted net income from continuing operations was $5.1 million for the third quarter as compared to $3.1 million in the second quarter of 2010. Both net income from continuing operations and adjusted net income from continuing operations exclude the discontinued operations discussed earlier in the other segment as well as the $800,000 extraordinary loss in the current quarter.

The $800,000 extraordinary loss net of tax in the second quarter relates to a purchase price adjustment related to FCStone's acquisition -- to the FCStone acquisition and the valuation of a preacquisition contingency for earn-out payments due in relation to FCStone's acquisition of Downes-O'Neill in 2008.

Looking at our balance sheet at June 30, 2010, total assets were $1.5 billion compared to $1.7 billion at the end of March 2010. This decrease was primarily a result of the decreased level of customer assets on deposit in the CES segment. The balance sheet is very liquid with total cash and cash equivalents of $82.5 million and 93% of our assets consisted of cash, cash equivalents, deposits and receivables from exchanges and counterparties, financial instruments and commodities.

Our commodities inventory increased $20.8 million from the end of March to $94.4 million at the end of June 2010, [state] that the lower of cost or market value.

Borrowings excluding the $16.7 million of convertible notes and the subordinated debt of $500,000 were $36 million at the end of June as compared to $72.3 million at the end of March and $108.7 million at the end of September 2009.

With that, I would like to turn it back to Sean to wrap up.

Thanks, Bill. So to wrap up, business conditions continue to be difficult, albeit moving in a direction -- moving in a more positive direction with each of our three quarters being progressively better. But it has a very important time for us as we do the internal and external (technical difficulty) to take advantage of the full earnings power of our Company's newly combined platform.

We are managing the short term but preparing carefully for the long term where we believe good opportunity to generate returns await us.

As we said on the last call, none of this will be easy or will happen overnight, but we believe we are making good progress on all strategic initiatives. The management team believes we have an opportunity to build a unique customer driven organization with an unmatched set of capabilities and an extensive global customer footprint capable of generating very high returns for our shareholders.

With that, I would like to turn it back to the operator to open the question-and-answer session. Operator?

(Operator Instructions) Chris Donat, Sandler O'Neill.

Good morning, Sean. Good morning, Bill. First question from me is if you could get us a little more color on the precious metals business and the strength in the quarter. I'm trying to get some sense of whether it was driven by some of the extraordinary volatility or if it's more of a sustainable development there.

Well, like with every business there's a multitude of factors, but I think we do like to see volatility generally in all our markets. I think volatility generally correlates to higher activity. Clearly we want to add more customers as well as we build the businesses up.

I think the specific factor that helped during this quarter was the high price obtained on average, which led to a lot of dishoarding of gold from some of our commercial buyers. We tend to do a little bit better margin wise on dishoarding than we do on straight accumulation.

So we sort of went through a little bit of a dishoarding kind of process and that's great. We get this kind of flow both ways. When the prices drop, there tends to be a lot of people accumulating gold and when prices run up quickly, they tend to dishoard gold and we tend to make slightly more on the dishoarding. Normally the volumes are a little bit lower than we do on the accumulation.

Scott, I don't know if you've got anything to add. Scott is on the line as well for questions.

I would simply say in terms of sustainability that we have seen those levels of revenue in the past and I think even higher revenues of level in the past -- revenues in the past. So there is a core customer base and franchise there, it's gradually expanding and I think when the market conditions are right, these are the kinds of earnings that we will see in the future.

Okay, and then sort of same theme but different asset, thinking about the situation we have globally going on in the wheat market, when I think of FCStone's business, I tend to think more about corn. But can you give some color on what sort of exposure you might have there or is it something that's not really in your wheelhouse?

Maybe we -- I think Pete's on the line as well. Pete, this is probably a good question for you.

Chris, we are kind of like the volatility in gold, we saw a substantial rise in wheat price and it gave our commercial grain elevator network and their customers an opportunity to price a substantial amount of the wheat harvest here in the US. And that has really taken place over the last six or eight weeks and we saw substantial run-up in open interest and just volumes reflected in not only wheat but it also drove corn and soybeans up as well. And that is reflected in the last quarter and continues to as we go forward.

Okay, but as far as your business, so you are dealing with the elevators that are working with wheat also, but is it possible to say that it is a certain percentage of your business is wheat versus corn or does it really break that cleanly?

Well, wheat traditionally in the Southwest, especially domestically in the US, has really been strong and then the Eastern wheat belt as well. And one of the benefits as we have gone to more of a global customer base, that is going to reflect as the Australian wheat harvest comes on -- Argentina into Europe and we will see those volumes reflect on our P&L going forward as well.

Wheat is and always has been a substantial portion (multiple speakers)

Yes, it has always been a significant part of the organization. Our office out of Kansas City and Omaha, Nebraska has serviced the customer base in the Southwest in hard (inaudible) winter wheat and then our offices in Bloomington as well as Toledo, Ohio have serviced that Eastern wheat belt as well.

Pete, I think you would concur and say that we probably have the biggest market share in the wheat business of anyone out there.

Yes, I think especially when there's volatility like now and a large crop, and our commercial customer base, our whole operative network and members, they originate the bulk of that production on an annual basis. And that historically is always reflected in our volume.

Got it, okay. And then just one last one for me. I'm not sure who to direct this one to but on the bad debt that you had for the quarter, it sounds like it was one time in nature and I understand you are seeking arbitration. But are there any adjustments you've made to your risk management or compliance procedures to try to prevent this in the future?

I will take that one, I guess. Really this was an operational error, I guess is the best way to describe it. It was not a trade that we allowed a customer to put on. It is not something that we would have allowed a customer to put on. We did not have a get in arrangement in place with the FCM who put this transaction to us. We told them we wouldn't take the trade and it was put through an electronic clearing mechanism on a very high volume day and through an operational error, we took that trade in. We are now in arbitration with the FCM who gave us that trade.

Obviously we have been and will continue to assess what controls we can put in place to make sure that we don't accept trades that we don't believe are valid and that's a continuing process for us.

Okay, thanks very much, gentlemen.

(Operator Instructions) Graeme Rein, Bares Capital.

Sean, could you talk a little bit about the global payments business? I know in the past you've talked about when you get more and more financial institutions, the profit margins can expand quickly. Can you kind of talk about how the business is going and if you are getting closer to that point?

Yes, that business has done fantastically well both over the last quarter and over the last year with significant increases in volumes. And a lot of the incremental volumes coming from our push to work with large banks. Originally we had started with the NGO communities and the large companies that were active in global payments. And we had a good kind of penetration of that customer base.

Starting about two years ago, we started working with banks. And so it takes a long time to do that. We're now starting to see that really come through in terms of volume.

The flip side of that is last year the margins in the countries particularly where we deal had widened considerably due to the credit crisis and just market volatility and dislocation. That has kind of narrowed in substantially, so we have probably come back to more normal levels I think -- who knows? Maybe we will go through another period of volatility and see a wider margin down the line, but the underlying trend for that business is really good at the moment.

We're in with very large global banks who are now outsourcing their payments to us and that's really picking up steam. If we did happen to see a situation where margins had to widen even slightly, with the volumes we are doing now, we could see a potential huge impact on the bottom line of that.

So we're kind of happy where that business is going. I think we've got it to the next level. We have got a lot of critical mass and volume in that business now and it is very profitable for us. If margins happen to widen, we will be there to take advantage of it.

Okay, that's great. The decrease in borrowings down to $36 million -- was that mainly to prepare for the Hanley acquisition or was there some other strategic reason to sort of bring those down so much?

The first thing I will say is you are looking at a snapshot there, a quarter end balance. I think on an average basis we probably were not as low as that would imply. But generally speaking, we haven't been actually conserving cash for any particular reason. Our businesses are profitable. That generates cash and I think we are just managing our liquidity better.

So I don't think there was any active move to do that, but certainly it made it easy for us to do the Hanley acquisition, given that we've got sort of surplus liquidity available. And I think that's a good use of our resources.

Okay, and I know you guys have lots of opportunities to make acquisitions and sort of reinvest in your current business, but at what point does a share repurchase makes sense when it's trading so close to book value?

Well, I think we have discussed this before. One of the problems is we have a covenant in our convertible debt note which prevents us from doing that. If we could buy a substantial line of stock, we would probably pay the penalty and do that. But what we don't want to get ourselves into a situation is having to redeem that note at a premium price for a nonmaterial acquisition of stock.

So we have got to sort of weigh up the fact that if we do do a share buyback, we potentially have to prepay the note in addition to a penalty and we've got to weigh that up against the benefit of buying stock. So it's a little more complicated than just looking at the price for us right now.

Okay, but --

But absence the covenants, absolutely this would be the time we would be buying stock back.

Right, okay. And then the last one about asset management, selling the INTL Capital, how much assets under management was that?

Insignificant.

Okay, so the increase from quarter to quarter of -- I think you are at 4.17 now -- that's mainly down in Gainvest?

Absolutely, yes. And they are now the number one asset management firm down in Argentina and getting a lot of critical mass and starting to launch some new products off the back of that and so they are going very well down there.

Okay, so there is some potential for scale down there?

Yes, but it's a small market. You know, I don't think there's a potential for us to double our assets under management there any time soon. It's just a very small market. We are already one of the larger players. I guess the question is can we leverage that into some of the other markets, and we don't have any pure plans to do that right now.

Okay, thanks for taking my questions.

(Operator Instructions) At this time, we have no further questions in queue.

All right, well let's wrap it up. Thanks everyone for participating. Goodbye.

And that does conclude today's conference. Ladies and gentlemen, again we appreciate everyone's participation today.