StoneX Group Inc (SNEX) 2011 Q2 法說會逐字稿

Good day and welcome to the INTL FCStone Inc. Q2 fiscal 2011 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the call over to Bill Dunaway, CFO. Please go ahead sir.

Good morning, my name is Bill Dunaway, CFO of INTL FCStone, Inc. Welcome to our earnings conference call for the second quarter of fiscal 2011 ended March 31, 2011. After the market closed yesterday, we issued a press release reporting our earnings for the fiscal second quarter. The press release is available on our website at www.intlfcstone.com, as well as a slide presentation which we will refer to on this call in our discussions of both the quarterly and year-to-date results.

This slide presentation is available by clicking on the Investor Relations link on the website and then going into the events and presentation page. You will need to sign on to the live webcast in order to view the presentation. Both the presentation and an archive of the webcast will also be available on our website after the call's conclusion. Before getting underway, I would like to cover a couple of housekeeping items.

On these conference calls and in the management discussion portions of our SEC filings, we present financial information on a non-GAAP basis in order to take into account mark to market adjustments in our commodities business. As discussed on previous conference calls and in our filings, the requirements of accounting principals generally accepted in the United States which I will refer to as GAAP, to carry derivatives of fair market value physical commodities inventory at the lower of cost to market value may have a significant temporary impact on our reported earnings.

Under GAAP, gains and losses on commodities inventory and derivatives 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 commodity's business and therefore of the Company as a whole.

Instead, we assess all of our businesses, as do our banks, on a fully mark to market basis in our daily and monthly internal financial reporting. We also calculate commodity trader bonuses on the basis of fully mark to market results, not the GAAP results. Readers of our form 10-Q filing should look at item two in our selected summary financial information for a summary of both GAAP and non-GAAP information.

This section also gives the reconciliation between GAAP and non-GAAP information 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 file with the SEC.

This discussion may contain forward-looking statements within the meaning of the 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 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'll now turn the call over to Sean O'Connor, the Company's CEO.

Thanks Bill and good morning everyone. In our view our financial performance in the second quarter was a good result and a significant improvement over the prior year and continued to evidence progress in realizing our longer term earnings potential. As in the first quarter we had generally favorable trading conditions with high volatility, although we had perhaps slightly less of a tail wind then we did in the first quarter.

On a non-GAAP mark to market basis, which is how we always look at our results, we recorded adjusted net income of $6.6 million which equated to a 10% ROE and an adjusted EPS of $0.35. While earnings were up 106% over last year, they were down versus our exceptionally good first quarter. The result was still below our target ROE of 15%. Year-to-date non-GAAP earnings for the six months were $18 million, up 169% from the prior year and represented an ROE of 13.5% for the six months. Very close to our target, and an adjusted EPS of $0.96.

GAAP earnings to date were $19.4 million, almost identical to our mark to market earnings for the six-month period. Demonstrating that the difference between the two metrics is largely a timing difference. Mark to market operating revenues were up 64% for the quarter and 65% for the six months to date. All segments showed strong revenue growth in both the quarter and year-to-date. Bill will take us through the earnings in more detail in just a moment.

We have changed the format of the financial portion of this presentation and will be using our financial dashboard, which highlights key components of our results and is color coded to indicate where we are achieving objectives and where we are not. This dashboard can be found on our website under the Investor Relations section and will be referred to by Bill later on. So if you haven't logged into that, probably a good time do that. As is probably obvious, the green highlights indicate a result or a change that is above target or positive and red represents below target and yellow is acceptable, but trending negatively.

Hopefully you'll find this a more efficient way to review the key points of our financial performance. We have now assembled all the capability to provide our target customers, midsize corporations, with a comprehensive range of risk management, treasury and investment banking services. The management team remains focused on ensuring that our wide range of capabilities is delivered more seamlessly to our nearly 8,000 commercial customers and we've become more efficient at internalizing and optimizing the margin imbedded in these products.

We continue to make good progress on rolling up OTC and structured products to our customers and have had some early successes in expanding this capability to new markets such as metals and stocks, which we believe hold significant long-term potential. The recent Hencorp acquisition has started to yield incremental revenues as they roll out our increased capabilities to their customers, validating the original acquisition rational. The Provident investment banking capability has started to leverage the customer base and they have successfully raised a large debt facility for one of our Brazilian companies, amongst other successful mandates concluded.

This has lead to additional mandates from Brazil as well as other parts of the customer base. The early stage synergies seem to be greater than both sides envisaged at the time of concluding this acquisition and we have already seen meaningful revenues from this business. During the quarter, we agreed to two small acquisitions. A year ago we made a strategic decision to establish an LME capability in London. A key GAAP in our product offering to our metals customers.

Obtaining regulation approval is a long and arduous process which can take up to 18 months and some cash burn to attain. The acquisition of Ambrian Commodities in the UK allowed us to accelerate this process by acquiring an existing LME license as well as a small customer base, which is already covering costs, thus saving the expected cash burn as well. This acquisition is conditional on change of control approval from the financial services authority in the UK which we expect to receive by September.

During the quarter, we came to agreement with Hudson Capital Energy team, which has now joined forces with us. They are an experienced group with a wide range in commercial customer base in the energy space. Hudson has been a longstanding Clearing customer of ours and has had a very similar approach and philosophy towards servicing customers. As we have mentioned on previous calls, we have refocused the Clearing business over the last 18 months, [altering] risk management systems and over sight, as well as transitioning out customers that did not fit our risk tolerance.

The result has been a significant reduction in volumes by some 60% from two years ago. This process is now largely complete and the Clearing business has now recorded several good quarters, despite low interest rates, which is a major driver of its revenues. We are pleased with how we have repositioned this business and look forward to steadily increasing customers and revenues, making sure that we stay within our defined risk tolerance and return objectives. Despite the growth in revenues and increased customer activity, we remain very liquid.

On a mark to market basis, we now have long-term equity capital of $280 million and total bank facilities at quarter end of $340 million. Of which only $32 million was drawn, and we held cash of $200 million, of which $65 million was restricted. We continue to roll out our systematic approach to our positive exposure to interest rates which is a meaningful driver to her earnings. This strategy is now starting to deliver higher interest earnings on our customer balances every quarter. I'll now hand you over to Bill Dunaway for a more detailed discussion of the financial results.

Thank you, Sean. Let me remind everyone, as I said at the outset of the call, that the fully mark to market numbers are not in accordance with GAAP. The differences between the GAAP and fully mark to market numbers arise in our commodities and risk management services segment. In all other businesses GAAP results and mark to market results are the same. As noted earlier as well, we have posted on our website, www.intlfcstone.com, a slide presentation which I will now walk through in discussion of both the second quarter and year-to-date results as compared to the prior fiscal year.

I would like to start my discussion with a review of the quarterly results and will refer to the third page of the slide presentation titled quarterly financial dashboard. This slide lays out the quarterly operating results as well as some related balance sheet information in comparison to the prior year period as well as in some cases the internal target which management has for our operating results. Adjusted operating revenues were $99 million for the current period, up 64% from the $60.5 million in the second quarter of 2010.

Every segment of the Company experienced growth in adjusted operating revenues in the second quarter as compared to the prior year period. Adjusted operating revenues in our core Commodity & Risk Management Services segment, increased 93% from the prior year period to $55.5 million in the second quarter of 2011. Exchange traded volumes were 956,000 contracts which was a 46% increase over the prior year period.

An increase in underlying volatility in agricultural commodities driven by the effect of increasing worldwide demand, particularly in corn, wheat, dairy products and cotton, as well as traction gained in the Company's Australian operations, were the main drivers of the increasing exchange traded volumes. In addition, exchange trading and consulting revenues increased in the natural gas markets following the acquisition of the RMI Companies in the third quarter of 2010, and in the coffee markets following the acquisition of Hencorp Becstone Futures at the beginning of the first quarter of 2011. OTC contract volumes increased 143% over the prior year period.

Over-the-counter revenues increased over the year ago period, most notably in Brazil as economic conditions have improved and as the commodities traded there continued to expand into corn and cotton in addition to the historical soybeans and sugar. The acquisition of the Hanley Companies in the fourth quarter of 2010 has lead to an increased offering of structured OTC products to out commercial customers, contributing to the significant increase in operating revenues in the second quarter of 2011. Investable client balances in this segment increased 175% over the prior year period to $1.1 billion, driven by both volume increases and increased margin requirements.

Adjusted operating revenues in our precious metals product line increased 18% to $4.7 million in the second quarter as compared to the prior year period, as an increase in global demand drove a significant increase in the number of ounces traded. Particularly in Singapore and Dubai. In addition the base metals product line had a strong quarter. Increasing adjusting operating revenues by $2.2 million to $5.3 in the second quarter as compared to the prior year period. In our foreign exchange segment, operating revenues in the second quarter totaled $13 million, representing a 19% increase over the prior year period of $10.9 million.

The volume of trades in this Company's global payments business continue to increase as compared to the second quarter of 2010 as the segment continued to benefit from an increase in customers consisting primarily of financial institutions and our ability to offer an electronic transaction order system to our customers. In addition, both the commercial hedging and customer speculative foreign exchange business has increased over prior year levels. And the proprietary foreign exchange arbitrage desk revenues increased $800,000 to $3.4 million in the second quarter of 2011.

Operating revenues in the securities segment increased by 96% from $5 million in the second quarter of 2010 to $9.8 million in the second quarter of 2011. Within this segment, operating revenues in our equity market making business increased 35% to $5.4 million as compared to the prior year, as volumes have increased due to the return of retail volumes driven by the economic recovery. Revenues if our debt capital markets business increased to $3.3 million in the second quarter of 2011 as compared to the prior year period. Most notable as the Provident acquisition which added $3.2 million of revenue in the current quarter.

In the Clearing Execution Services segment, operating revenues were $18.3 million for the second quarter of 2011 as compared to $14.4 million in the prior year period. This increase was driven by an 8% increase in exchange traded volumes over the prior year as a result of rising commodity volatility. Interest income, which is a key component of this segment, continued to be constrained by the effective historically low short-term interest rates, however, increased moderately over the prior year period as investable client balances increased 11% to $735 million.

The other segment, which contains both our asset management and commodity origination and financing product lines, increased 41% to $3.1 million driven primarily by an increase in committed credit facilities available to finance the Company's customers inventories. Overall, operating revenues continue to be constrained by historically low short-term interest rates. However, interest income increased 76% to $3 million dollars for the second quarter as average customer assets on deposit increased 73% over the prior year to $1.8 billion.

Moving on to the expense side of things. Non-interest expenses were $86.4 million, up 62% over the second quarter of 2010. Primarily as a result of the increase in variable compensation and clearing fees associated with the increase in adjusted operating revenues. Also contributing to the increase in non-interest expenses, the Company recorded an impairment charge of $1.7 million related to debentures held by the Company following a debt arrangement transaction in its Singapore operations in 2008.

The Company had arranged these debentures and as a result, retained a 32% ownership in the debentures following the placement. The issuer of the debentures defaulted on their interest payment in the current quarter, which will card our reevaluation of the holdings. Following this impairment, these debentures are carried at their fair value of $3.7 million.

As noted on the slide presentation, internally the Company targets to keep variable expenses as a percentage of total expenses in excess of 50%. During the current period, the majority of non-interest expenses were variable with 54.2% of the total non-interest expenses being variable in nature as compared to 55.7% in the prior year period. The four acquisitions made during calendar 2010, as well as geographic expansion in South America, Europe and Asia, have lead to an increase in fixed costs in the current period, which rose 68% to $39.6 million in the second quarter of 2011.

The Company targets to keep total compensation expense as a percentage of operating revenues at less than 40%. However, the recent acquisition of the Provident Group, which is just beginning to ramp up, as well an increase in payroll taxes and 401k contributions, related to the start of a new calendar year, lead to total compensation expenses being 43.5% of total adjusted operating revenues. The total employees increased to 836 at the end of the second quarter 2011, as compared to 630 at the end of the prior year period.

Adjusted net income from continuing operations for the second quarter was $6.5 million representing 103% increase over the $3.2 million in the prior year quarter. Looking at the trailing 12-months, adjusted net income and adjusted EBITDA increased 130% and 124% respectively over the prior year periods. The Company looks to achieve a minimum return on equity of 15% or greater on its adjusted stock holders equity.

While the return on equity nearly doubled in its current period as compared to the prior year, it still remains lower than the goal at 9.5%. The increase in investable customer funds at 73%, discussed earlier in this segment review, resulted in an increase in total assets on the balance sheet of 32% to nearly $2.3 billion. While adjusted stockholders equity closed the period at $280.2 million, an 11% increase.

Another key metric the Company focused on is keeping a one to one ratio between revenue generating employees and administrative or operating employees. Along these lines, the Company targets to have at least $500,000 in annualized revenues across the entire employee base. For the current period, this metric increased by 23% to $473,000 per employee, however it was still slightly below the Company's target.

Finally in closing out the renew of the quarterly results, the trailing 12 months results have lead to an increase of 8% in the book value per share, closing out the quarter at $15.48 per share. Moving on to the next slide of the presentation, I will speak briefly on the year-to-date results through the first six months of the year. Adjusted operating revenues increased 65% over the prior year period to $207.8 million.

All of the Company's operating segments realized growth in revenues over the prior period with the commodity and risk management services segment, and the securities segment, growing at 111% and 70% respectively. As with the quarterly results, total non-interest expenses increased 56% to $173.4 million primarily as the result of the four acquisitions made in calendar 2010 and the geographic expansion in South America, Europe, and Australia. Variable costs represented 54.1% of total expenses, keeping in line with the Company's goal of having a primary variable expense model.

Total compensation expense, as a percentage of adjusted operating revenues, was nearly in line with the Company's target at 41.2%. Adjusted net income for the first six months ended March 31, 2011 were $17.9 million, 180% increase over the prior year comparable period. For the year-to-date period, the Company achieved a 13.5% return on adjusted stock holders equity, just shy of the targeted 15%.

Through the first six months of the fiscal year the annualized revenue per employee increased 29% to $517,000. This exceeded the stated goal of $500,000 per employee, while the average number of employees increased to 805 for the first six months of the fiscal year. With that, I would like to turn it back to Sean to wrap up.

Thank you Bill. During fiscal 2010 we assembled all the parts of the business that we believe has a unique and unmatched set of capabilities for our customers and prospects around the globe. Fiscal 2011 is focused on integrating and leveraging these increased capabilities to provide a more comprehensive service to our customers.

The last two quarters have validated this strategy and highlighted the long-term earnings potential of the Company. We are still in the early stages of the integration process which combined with an aggressive customer expansion initiative should provide medium and long-term revenue growth, as well as margin expansion which should provide very attractive earnings growth. INTL FCStone is focused on servicing mid-market commercial customers with our earnings leverage to commodity, exchange rate and equities priced volatility, emerging market growth, and increased interest rates.

We like all of these factors. We believe that we are uniquely placed to take advantage of key macro trends and have the strategy, products and capabilities to leverage these into stronger earnings and returns for our shareholders over the long-term.

With that, I would like to turn it back to the operator and open the Q&A session. Operator.

Thank you. (Operator Instructions). We'll go first to Graeme Rein with Bares Capital.

Good morning. Congratulations on a nice quarter.

You'll get the prize, Graeme, for asking the first question every time.

Well I don't know if anyone else is even on the call. I'll fire away here and then we'll see if anyone else wants to ask anything. So it sounds like the Provident Group is starting to make some contributions here. I had a couple of questions about the transaction you guys announced in early April. Is that going to fall in the current quarter? And then also, what type of fee do you guys earn on that as a percentage of capital raised? Can you kind of talk about that business unit?

Okay, Graeme, the transaction you are talking about, is that the San Fernando transaction?

Yes.

Okay. Yes, we're very pleased with Provident. We certainly thought that this was going to be a very good acquisition for us and a plug-and-play opportunity. That said, investment banking is a very unpredictable business, very long lead times, very lumpy revenues which we're trying to smooth out obviously. So I would caution with all of that.

But certainly they have a full pipeline and I think if anything, we have capacity constraint issues at Providence and I think we're really going to start seeing the real benefits of that coming in probably in the next six to 12 months given the lead time on those businesses. In terms of the transaction we did conclude, which was a great transaction for us, the fee on that was north of 1%. So we made just shy of $1 million fee on that transaction and we have a number of other mandates off of the back of that, just in Brazil, lining up.

Additionally, the Provident guys have also now made good inroads in penetrating the rest of our customer basis. As I said, I think we have capacity issues and just long lead times in turning those tow accounts. But all in all, very happy with how that's going.

Okay, that's helpful. And the China office you're opening, what type of activities do you anticipate doing there and can you just kind of talk generally about the thinking?

Okay. Well, FCStone has previously had representation in China more along the lines of a rep office. We've always done a lot of business in China but it's really been sending people from the US on a regular basis, kind of, I guess, suitcase banking is what people would call it. I think we decided with the scope of our facilities and the importance of China in our key product areas that we needed to upgrade our presence. And we're very lucky to find Jim Lambert who is actually one of the people in our group who had worked for us for a long time, understands what we're doing and had worked in China for many years, was fluent in the local languages. So that was just a great opportunity for us.

What we're looking to do now is establish a Wholly Owned Foreign Enterprise, a WOFE as it's called, that will make us a local operating entity and there are a lot of advantages to that and a lot more we can do if we do have a local entity on the ground given the Chinese regulations. It's a long and arduous process setting that up. We're not there yet, but we hope to establish two things. One, have more people on the ground to leverage what we're doing there. And B, have a better infrastructure in the form of a local entity which will expand how we can deal with our customers there. So that's the strategy there.

Okay. And then in the securities segment, maybe, Bill, you can answer this one. There's a significant difference between the net contribution and the segment income in the securities segment, and I guess a piece of that is the ventures that you mentioned. What else? Is there anything else in that delta that is (inaudible).

Yes, there was, as we mentioned, or as I didn't touch on the call but we mentioned in the Q, there is a portion of the revenues being generated by Provident that show up in the securities segment which were legacy mandates that came into the deal. So those mandates are going to have basically a 100% payout. So you're seeing the revenue but you're also seeing basically 100% of the costs either through a third party commission or a compensation to the former owners of Provident.

Okay, that makes sense. Thanks.

And that will roll off, obviously, as those legacy pipeline deals either disappear or get closed and are replaced with new deals originated since they've been with us.

Right. Okay, it makes sense. And then, Sean, the last thing, it terms of capital structure, I know that the $32 million, that's sort of a snapshot in time, but that's a lot lower than we've seen in the past, the $32 million, I guess the debt. What's your thinking there? Is there anything that's going on in the business that's giving you more capital than you were expecting or how do you anticipate sort of going forward from a capital structure sort of prospective?

Okay, good question. I mean, just sort of taking all the variables one at a time. One, our revenues are growing very strongly and we think will continue to grow strongly. And more revenues require us to use more capital. We have just funding mismatches inherent in our business. For example, we have to put up a margin to the exchange today, the customer only pays us tomorrow. We have to hold more inventory, whether it's securities instruments, commodities, that has to be funded. So, more activity implies more capital.

But the usage of that capital is very erratic because it depends on what mismatches we have at the time, are they offsetting capital on the other side? And that's what you would expect with us. If you saw us having lines fully drawn consistently, I would say that is probably a worry because that would mean it's not funding the short term nature of our business. So that said, there has been a change to our capital structure with the growth of our OTC operations and our metals operations, we are finding more customers leaving money with us in the form of margin.

When a customer deals OTC with us, we take that margin in, and unlike the exchange, that margin is not segregated and we can use that to fund our business. And to the extent you have a large book and you can find internal offsetting positions, the margin you have to put up to the exchange or to your counterparties is obviously less than the aggregate margin you're getting from your customers. And that generates some internal funding. We knew that would happen. That is our plan. It allows those businesses to be largely self-funding and obviously generate a very high ROE.

The acceleration of our OTC activities has generated more cash than we had nine months ago, so that's part of it. Even though our usage of our bank lines is erratic and fluctuating, if you look at it over a longer term cycle, it is increasing. We are constantly looking to increase our bank relationships to find more bank partners who can help us with our longer term growth. We are certainly liquid enough and I don't think we have any capacity issues on the capital side in the near term or even in the medium term. But longer term, we are going to need more external funding from banks.

Okay, that's very interesting. Thank you for taking my questions and nice job.

Okay, thank you.

Thank you.

Any other questions ? With that, thanks everyone. We look forward to speaking to you in the next quarter. Thanks.

And that does conclude today's conference. Again, thank you for your participation.