StoneX Group Inc (SNEX) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the INTL FCStone Q4 FY14 earnings call.

(Operator Instructions)

As a reminder, today's conference is being recorded.

I would now like to turn conference over to Mr. Bill Dunaway, CFO of INTL FCStone.

Sir, you may begin.

Good morning.

My name is Bill Dunaway, as mentioned, the CFO of INTL FCStone.

Welcome to our earnings conference call for our fiscal fourth quarter ending September 30, 2014.

After the market close yesterday, we issued a press release reporting our results for the fiscal fourth quarter.

This release is available on our website at www.intlfcstone.com, as well as a slide presentation, which we will 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.

Both 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 discussion should be taken in conjunction with the most recent financial statements and notes thereto, as well as the form 10-K 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 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 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 Chief Executive Officer.

Thanks, Bill, and good morning, everyone, and welcome to our FY14 fourth-quarter earnings call.

This is also our year-end call, so we'll take the opportunity to review both the quarter and the overall 2014 fiscal year.

You may note from our earnings presentation as well as the PowerPoint presentation that we've amended the format.

We've certainly provided, hopefully, more detailed and better information, and hopefully we'll make it clearer and make this call more succinct.

So please let us know what you think of that.

As we mentioned during the last couple of calls, we continue to see modest improvement to our overall market conditions, with increased volatility in certain of our verticals and continued industry consolidation, all of which provide a slight but continuing and improving revenue environment for us.

We achieved record operating revenues for the fourth quarter, which were up 24%, and for the year overall, which was up 4% overall, which stands in contrast to most of our peers and to industry volumes in most instances.

We held overall non-variable expenses to a 3% increase in the fourth quarter and a 1% for the year overall, with fixed compensation actually showing a modest decline partly due to the stronger dollar.

These results were achieved despite us experiencing a higher-than-average level of bad debts, $4.7 million in the fourth quarter, related to a Hong Kong financial LME client, along with a variety of smaller agricultural exposures in Brazil and the US.

Some of these bad debt clients have been making payments in terms of an agreed schedule; however, during the fourth quarter and shortly thereafter, demonstrated significant liquidity issues.

We determined that further payment was unlikely, and us as such, and in accordance with GAAP, they have now been fully provisioned.

The increase in the bad debts, however, was partially offset by a $2.3 million reduction of earn-out payments on recent acquisitions plus lower variable compensation relating to those bad debts.

The result of good revenue growth, along with a modest increase in costs, combined to increase our quarterly net earnings nearly fourfold, although last year's fourth-quarter earnings were especially weak.

On an annual basis, net income was virtually unchanged.

But if we exclude last year's nonrecurring after-tax gain of $5.8 million on the sale of exchange seats and LME shares, net income from continuing operations was up 53% on an annual basis.

This all resulted in ROE of just less than 7% for the fourth quarter and just lightly under 6% for the year overall, a modest improvement, but still below our expectations and the long-term potential we think the business has.

Well, we'll go through results in more detail, but some highlights from the quarter.

Our Global Payments business continued its strong growth with transaction volumes accelerating 54% quarter on quarter, resulting in segment income increasing 45% quarter on quarter.

For the year overall, revenues where up 35%, and segment income up 38%, really exceptional results for this business.

We continue to see steady adoption of our services by large and midsize banks, and despite processing a larger volume of smaller payments, have managed to keep the average revenue per trade almost constant over the year.

Our largest segment, Commercial Hedging, showed much improved results, with revenues up 28% for the quarter and 11% for the year, largely off the back of improved volumes in OTC trading.

We saw a strong turnaround in our Physical Commodities business during the quarter, which, although down on an annual basis, is starting to turn around.

Although modest in incremental dollar terms, we are very pleased to see good growth in our Clearing and Execution Services segment, where segment income was up double for the quarter and up 7% over the year.

We continue to put focus and effort into controlling fixed costs and are making good and steady progress, as evidenced by our modest overall increase in cost for the year.

The increase in the fourth quarter cost was largely due to higher operating revenues and the associated variable payouts.

During the quarter, we continued to enhance our interest earnings from our segregated funds through laddered investments and short-term US Treasuries, which has added nicely to the net earnings.

Now, let me comment briefly on two items of a more strategic nature.

First, we are now moving ahead to consolidate our US broker-dealer with the US-based FCM.

This is likely to take about six months, and once complete, should result in better utilization of capital, ability over time to rationalize systems and infrastructure cost.

As important is the benefit to clients, who will be a will to deal with only one legal entity and execute trades in a variety of markets without the need for additional paperwork, simplifying cross selling and reducing paperwork.

This will put us in an even stronger position to compete for business in a consolidating industry and allow us to better deliver our unique and multi-asset platform to clients.

Second, as most of you saw, we reached agreement to acquire G.X. Clarke, a well-recognized and respected institutional a dealer in government Securities.

G.X. Clarke has been a successful partnership for nearly four decades, and like INTL FCStone, has differentiated its offering through value-added expertise and service.

G.X. Clarke rounds out our capabilities by providing proven expertise in the fixed income and government securities sector, and in addition, brings us deep relationships with over 700 institutional clients.

We are hopeful that G.X. Clarke can not only continue its current success and profitability, but we can also leverage its additional capability and expertise throughout our network and provide a broader product offering to the new institutional clients they will bring to us.

It is [envisioned] that G.X. Clarke acquisition will close in early 2015, and in due course, this business will be merged into the combined FCMBD when that is approved later in 2015.

Ultimately, G.X. Clarke activities will be reported in our Securities segment.

This will allow us to realize capital synergies mentioned above, as well as allow for easier cross selling.

We see an increasing number of acquisition opportunities coming to us as a result of our industry continuing to face challenges and many of the long-standing business models failing to deliver adequate returns, and in many cases, any returns on capital deployed.

We have now looked at many of these opportunities, including some of our peer groups and competitors.

In most instances, we believe that our approach has delivered superior results.

Our client-centric, value-added approach, combined with a diverse, and many instances, complementary capability, has allowed us to leverage our client relationships, our expertise, and our capital to deliver better returns than most of our peers.

We continue to take a disciplined approach to these opportunities and will only act if we see a sustainable client-centric business model that fits our approach and culture and that can be accretive to our shareholders.

As we are doing this call today from London, I thought it would be good opportunity for you to hear directly from Philip Smith, who is the CEO of our EMEA business, and perhaps he can give you some color on our London-based activities.

Philip?

Good morning.

My name is Philip Smith, CEO of INTL FCStone Limited in London and the broader region of Europe, Middle East, and Africa.

I'd like to bring you up to date with the developments in London over the last few years as we continue to expand our operations and capabilities.

London has always been the headquarters for our Global Payments business over the last decade, but 2011 was a transformative year for London when we completed our first corporate acquisition of Ambrian Commodities.

This acquisition provided the platform for us to subsequently acquire the LME business from the administrators of MF Global, which consisted of almost 700 clients and nearly 70 employees between London and New York.

Our license was then upgraded to a category 1 ring-dealing member of the LME and a clearing member of LCH.

Clearnet.

In the same year, we expanded our Commercial Hedging segment in London and began offering Clearing and Execution on global exchanges throughout affiliate clearing memberships.

In 2012, we continued our expansion of London's product offering in the acquisition of TRX Futures Ltd, a soft commodities brokerage and clearing firm.

This added coffee, cocoa, and sugar to our product offering and clearing membership of ICE Europe as it is today being the old life exchange.

This was followed swiftly by the establishment of our FX Prime Brokerage desk, all in 2012.

In 2013, we began implementing the strategy of consolidating our various operating entities, housing different products, a legacy of our growth over the last decade.

The consolidation of our Global Payments business is complete, and the precious metals consolidation should be completed during the course of FY15.

As of today, our INTL FCStone Ltd.

is the primary operating entity outside of the United States, with the regulatory status equivalence of a US broker-dealer, futures commission merchant, and swap dealer.

It is a category 1 ring-dealing member of the London Metal Exchange, a full clearing member of ICE Clear Europe, LME Clear, CME Europe, and LCH EnClear.

So from around 40 people and $30 million in equity in 2011, we have grown to over 150 professionals, $105 million in equity, revenues in excess of $100 million, and post-tax revenues of approximately $14 million.

Our ambition is to offer as broad a product basis possible, which has now grown to processing over 240,000 payments annually, with volumes of $17 billion in 145 currencies, and at the same time, now offer Commercial Hedging in non-ferrous metals on the LME, Commercial Hedging in softs, ags, dairy, and energy, FX Prime Brokerage, precious metals, and securities.

We are very proud of our accomplishments and continued growth.

I'll now hand you over to the Bill Dunaway for a discussion of the financial results.

Thank you, Philip.

I'd like to start my discussion with a review of the quarterly results.

I'll be referring to some new slides in the information we have made available as part of the webcast, specifically starting with slide number 3, which represents a bridge between the fourth-quarter operating revenues from last year to the fourth quarter of FY14.

As noted on the slide, fourth-quarter revenues were record $130.6 million, which represented a 17% increase, as compared to the $111.9 million in the fourth quarter of 2013.

The biggest increase in operating revenues was in our Commercial Hedging segment, which increased $12.9 million to $59.7 million in the fourth quarter.

This is partially driven by a 26% increase in exchange-traded revenues, driven by strong growth in both agricultural commodities as result of improved market conditions, particularly in the United States, as well as in the LME Metals as result of our expansion into the far Eastern markets.

Also driving the increase in Commercial Hedging revenues was a 32% increase in OTC Commodity revenues, driven by increased customer activity in agricultural commodities as well as energy and renewable fuels.

The second largest increase was in our Global Payments segment, in which operating revenues increased 50%, or $5.1 million, in the fourth quarter of 2014 as compared to the prior year.

The continued acquisition of commercial bank clients and the successful of implementation of our new back-office platform led to the 54% increase in the number of payments during the fourth quarter.

Moving onto slide number 4, which represents a bridge from fourth-quarter pretax income in 2013 to the current period.

The biggest contributor to $9.4 million increase in pretax income between the periods was the Commercial Hedging segment, which increased 38% to $4.4 million.

This was driven by the increase in operating revenues, partially offset by $3.6 million in bad debt expense related to account deficits from a Hong Kong commercial LME customer and several agricultural commodity customers in Brazil.

The next largest increase was $2.5 million in the Global Payments segment, which increased 45%, to $8 million for the fourth quarter, driven by the increase in operating revenues, partially offset by higher introducing brokerage expenses.

While operating revenues in the Securities segment had increased $400,000 compared to the prior year, to $21.7 million, driven by stronger performance in Argentina in both debt trading and asset management, declines in equity market making and investment banking operating revenues combined with increases in non-variable compensation and benefits and variable expenses led to a $1.6-million decline in segment income.

Segment income in our Clearing and Execution segment actually increased $1.1 million over the prior year, despite the $1-million decrease in operating revenues, as we continue to focus on higher-margin customers in this segment.

The decline in operating revenue was more than offset by lower variable expenses.

Interest income on customer deposits increased modestly as average segregate customer deposits increased 12% to a record $2 billion, but remained constrained by historically low short-term interest rates.

As discussed during our third-quarter call, we've begun to take steps to take advantage of the steepening of the short end of the yield curve with limited purchases of Treasury Securities with somewhat longer durations, and we plan to make further purchase in the future, along with reimplementing a revised interest rate swap strategy.

Overall interest income declined $900,000 as result of a reduction in commodity repo financing and our a Physical, Ags, and Energy segment, which more than offset the increase in interest on customer deposits.

Moving on to slide number 5, our quarterly financial dashboard, I will highlight couple of items of note.

Non-variable expenses, which are made of both fixed expenses and bad debt expense, increased $1.4 million, or 3%.

However, excluding bad debt, our fixed expenses actually declined 5%, or $2.7 million.

Net income from continuing operations for the fourth quarter was $5.8 million, versus $1.7 million in the prior year.

Over the long term, we look to achieve a minimum return of equity of 15% or greater on our stockholders' equity, and for the current period, the Company was below that target at 6.8%; however, this was an improvement over the 2.1% achieved in the prior year.

Finally, in closing out the review the quarterly results, the trailing twelve-month results have led to a 5% increase in the book value per share, closing out the quarter at $18.29 per share.

Moving on to slide number 6, I will cover our full fiscal-year results.

Our overall operating revenues increased 5% to a record $490.9 million.

Commercial Hedging operating revenues increased $22 million, driven by a 17% increase in exchange-traded revenues as a result of improved market conditions in agricultural commodities and expanse in the LME Metals business.

In addition, OTC revenues increased 7%, driven by higher energy and renewable fuels customer volumes.

Global Payments showed strong improvement over the prior year, increasing 35%, or $14.5 million, while an increase in Securities revenue was more than offset by lower Physical Commodities and the CES revenues.

The $10.3 million decline in unallocated revenues was a result of the $9.2 million gain on the sale of our LME in Kansas City Board of Trade shares in the prior year.

Next, on slide number 7, pretax income increased $4.8 million, to $26 million, driven by operating revenues in Commercial Hedging and Global Payments, partially offset by decline in Physical Commodities.

As with the quarterly results, it is of note that while the CES annual operating revenues declined $7.6 million, pretax segment income actually increased $400,000, and the decline in unallocated income was the result of the share sale in the prior year.

Finally, as is shown in the year-to-date dashboard on slide number 8, the non-variable expenses remained relatively flat, increasing 1%, and net income from continuing operations increased $1 million versus the prior year, to $19.6 million.

However, as Sean mentioned, excluding the after-tax effect of $5.8 million on the share sale in the prior year, net income from continuing operations increased 53% versus the prior-year period.

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

Thanks, Bill.

As you can see from our results, the formula for success is pretty simple.

Keep the revenues going by adding more clients and serving existing clients better, keep cost controlled, and fund the growth through more efficient use of existing capital resources.

A simple and obvious formula that is hard to execute on in practice.

We believe that our client-centric, value-added approach, combined with diversity of capabilities and businesses, are essential ingredients to achieve both revenue growth and capital efficiencies.

And addition, we continue to see better overall environment for revenue growth with slightly improving market conditions and the slowly consolidating industry as smaller players are squeezed of the market and larger players refocus on larger customers.

We are of the view that we are emerging as a leading best-in-class financial services Company, offering advice, market intelligence, value-added execution on all significant exchanges and OTC trading revenues, post-trade settlement, and prime brokerage services in all the major asset classes to our middle-market clients globally.

We have put together global platform that is unique and can make this ambition a reality.

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

Operator?

(Operator Instructions)

John Dunn, Sidoti and Company.

Good morning, guys.

Nice quarter.

Hey, John, how are you?

Good.

Could you talk about --since we are looking at 2015, can you talk about some of the factors that you think will help particularly the Commercial Hedging line and the Global Payments business?

Well, we -- a little bit hesitant to give forward guidance, but what we can tell you is the basic factors that we believe will impact our business and the big market factors that may drive that.

So on the Commercial Hedging side, I think one of the things that has driven our business in the last while, and we think this is probably going to continue, is a recovery in the grains market.

The prior year and maybe for 18 months, we had been dealing with the aftermath of a drought situation, and our domestic grains was a big part of Commercial Hedging.

That's turned around.

As we know, we've got the largest ever crop.

There's a lot of hedging that has to be done.

There's a carry market.

All of that all goes pretty well for us as long as that continues, obviously.

So that's good news.

Our LME business seems to be going from strength to strength, quarter to quarter.

There seems to be a lot of good traction in that market.

Clearly, some banks have got out of that market, and we think that that's an interesting place for us.

Generically, though, the thing that will ultimately drive those revenues beyond that baseline is volatility.

When we get more volatility, we tend to directly see more trading revenues.

And that particularly helps us on the OTC side, and the OTC side is where we have better margins and that's really gives us that additional level of profitability that can really push us to the next level.

So volatility is going to be a key determinant in that.

I think generically, we're starting to see a little bit more volatility.

We've all seen what's gone on in the oil sector.

That's good news for us.

Obviously, volatility ebbs and flows and spikes, but as long as it's generally increasing, that's good for us.

And we think if you look back over the last 18 months, volatility has been pretty subdued in most markets, and that seems to be generally increasing.

So for Commodities business, the Commercial Hedging business, I think those are the main drivers for us.

What will additionally make our businesses better generally is higher absolute prices.

We are typically a producer-biased business, so when prices are higher, that also helps us generate more volume.

I don't really think that we are going to see that.

Obviously, we are in lots of different commodities, and certainly, some of those commodities may show lots of upward price bias, but I think generically in the big markets we are involved in, metals and grains, I don't think there's anything out there that tells me we're heading into a massive bull market, so that's probably not going to be a factor that works for us.

So I'll get on to Global Payments question, but does that answer your question on Commodities, John?

It does.

Can you just mention how the harvest in 2014 was versus prior years and how that may -- what the read-through is for 2015, just briefly?

If you've been following any of the news headlines, you will know that this is the all-time record harvest in the US.

I think there have been good harvests and other parts of the world.

Our key grain franchise in the US, really, at some basic level, is influenced by how much grain is stored in the system.

And when you have a big harvest like we've just had, a lot of the grain is going to be stored, and it's going to be stored for a while.

That's really the underlying determinant for us.

When the grain elevators are full and they keep the grain in the bins, they have to hedge, and if that grain sticks around, they have to roll their hedge, and every time they roll, we make an additional amount of revenue.

So that's really the big change.

Certainly, hard to predict where the patterns out next year, towards end of next year, but there's nothing out there that would suggest that anything will be different from what is now.

They certainly have had great success with the crop here, and absent a bad weather pattern, that's probably going to be repeated I would suggest.

Does that answer your question on that?

It does.

Okay.

So let's move to Global Payments, what's going to drive Global Payments?

I think we've spoken about this now for couple quarters, and honestly, we are probably going to carry on speaking about it for couple quarters.

The main driver there is we have moved this business into the banking business.

In other words, we are now offering these services to financial institutions.

We have signed up I number of financial institutions over the last couple years.

We continue to make progress in signing up other large financial institutions.

This is the ultimate long sale.

This is a long sales process, and once the sales process is done, it is a long adoption process and ramp-up process.

We are in the midst of that entire sign-on, onboarding, and adoption process with a large number of banks, and we know, having gone through this a number of times, that over that two-, three-year period, you ramp up from zero to -- could be a very significant number of payments.

We are right in the midst of that, so the main driver for us on global currencies is focusing on those customers, making sure we deliver what we say we are going to deliver, getting them comfortable with our service and our system and our operational capability.

If we do that, there's every reason to believe that they will continue to ramp up the use of us.

We have unique product offering; it's what the market wants.

There's honestly no one else that can deliver it, and we just have to execute well.

If we do that, think there's going to be a good embedded growth rate.

It may not be exactly linear, and it may not be exactly stable quarter to quarter, but there's a very strong underlying reasons that would underpin that growth rate, at least for the next -- it's hard to go beyond a year or two.

Who knows?

But certainly, for the next while, while we are in the midst of ramping up with these large, large customers, that's going to be the key driver for that business.

Got it.

And then, do you have any idea about how much capital the broker consolidation might free up?

Yes.

These are round-number, big-picture guesses.

In our current broker-dealer, we have about $20-million odd of capital.

The consolidation of the FCM broker-dealer will certainly free that capital up.

And that capital will effectively be released to handle growth.

And the G.X. Clarke acquisition, when we roll that in to that merged entity, and that's likely to only be six months or so out, that will release a further $25 million of capital.

So we will be able to run the businesses we have with something like $25 million to $50 million less capital than we would in the current configuration.

Now, what we think will happen and we hope will happen is these capital efficiencies will be used to fund the growth in our business.

We like to run our businesses with headroom.

We do that because we think this creates headroom.

Obviously, earnings create more capital.

We like to run the businesses with headroom, but the capital efficiencies we get here are pretty substantial.

We effectively get to run two businesses and get two EBITDAs on the same dollar of capital, and that's going to allow us over time to really get our get our returns up to where they need to be.

Great and then one last one for me.

You mentioned the operating environments market environment got a little bit better.

What's the temperature of smaller players potential sellers versus say six months ago?

Great.

And then last one from me.

You mentioned the operating environments, market environments got a little bit better.

What's the temperature of smaller players, potential sellers, versus, say, six months ago?

I would say we've -- and we've probably mentioned this before.

For the better part of two, three years, we've seen a constant pipeline of opportunities coming our way.

Not FCMs, broker-dealers, teams of people, London-based, US-based, and I think there's typical characteristics that we see from those opportunities are smaller type of operators, typically mono-line businesses that have come to the conclusion that the costs of remaining independent from regulatory point of view, the capital required, either from regulators, or sometimes more importantly actually from customers who want to deal with larger customers, those two constraints are causing their business to be unworkable as an independent entity.

And the opportunity we offer is we can sweep those businesses in, immediately give their customers and clients the counterparty creditworthiness that they seek, and additionally, we can defray the infrastructure costs and the regulatory compliance costs over a multitude of businesses.

So it seems to us that the model of being a mono-line business is a really, really tough one to make work.

And what you really need is to defray the costs of operation amongst a multitude, or at least a variety of product lines, and also to make sure you structure those businesses so you can get maximum capital efficiency and maximum leverage of your infrastructure.

And of course, you share the credibility capital, the (inaudible) capital that you need to show your customers.

That seems to us to be the model for a mid-market firm for success.

We think we are well placed for that success.

We are seeing -- as I've said, we've been seen opportunities for the last -- better part of two years.

It does seem to us there's an acceleration in the number of opportunities we are seeing.

Now, that just may be a temporary phenomenon, but we seem to be having more conversations with more of our peer group companies about how do we better structure our activities, how do we figure out to get better returns on our capital, and is a consolidation the way to do it.

Oftentimes, we find that we look at these opportunities and we don't see that consolidation adds value.

In fact, we think our model of finding businesses that add more capabilities to our customers, more diversity to our revenue stream, and better leverage of our infrastructure and capital, that's the model we think is going to work.

But we obviously look at everything that comes our way.

We want to be -- we want to make sure we are diligent in that process, but we also want to make sure that we only take on things that fit our client-centric approach, fit our philosophy, and are accretive to our shareholders.

Those are some pretty tough constraints to satisfy all at the same time.

I hope that answers your question.

It does.

That's helpful.

Thank you very much.

Okay, thank you.

John Leonard, Singular Research.

The morning.

Great quarter.

Hey, John.

Thank you.

I was just wondering if you could provide some more color on the cash management programs, such as the current run rate of incremental earnings, the duration, and the amount invested?

Thanks.

Okay.

I'm going to hand you over to Bill Dunaway who can help you with that.

Okay.

Hey, John.

Hi.

The program that we had, we started in late Q3.

As of the end of the fourth quarter, we had a approximately $400 million of that rolled out.

The average duration on that, if you count all of our investments that are invested in non-money market funds, it was about 20 months.

And at that point, we were probably adding incrementally pretax about a little over $800,000 a quarter to the incremental earnings with the program as it's currently implemented.

Okay, great.

Thanks.

That's all I have.

Okay.

(Operator Instructions)

Russell Mollen, Nine Ten Capital.

Can you explain -- I had a question on this merging of the FCM with the broker-dealer and freeing up capital.

Can you explain the mechanisms of how that works and how you get -- are you taking excess buffer cash away and running it with a lot less, or how does it work with the merging of it that you are able to free up the capital?

All right.

So firstly, the industry standard out there, certainly for entities bigger than us, is to merge the FCM and the BD.

This is how most banks operate.

This is how most investment banks operate.

So that's the way they do it.

Simplistically, and this is a very general high-level overview with lots of exceptions and detail around it, but basically, what you do is you calculate the capital you would require for your futures business.

You then separately calculate the capital you require for your securities business.

And you are required to keep the higher of the two numbers, but you're not required to add the two numbers together.

Okay.

That makes sense.

If they aren't separate entities, you effectively are adding the two numbers together in aggregate, right?

Got it.

As well as keeping a buffer on both of those requirements, Russell.

It's pretty simple math, but again, around that, you've got to think, there's regulated capital.

Then there's operational capital to fund the liquidity requirements of the business, and sometimes that's a different number, so it gets complicated.

But the simple thought process is, you can effectively -- as we said, it's the higher of, not the add -- you don't add both together.

Got it.

And given that our futures -- just to give you some sense of that, our net regulatory capital in the FCM, if you exclude goodwill and fixed assets and all that stuff that the regulators discount, is round numbers about $120 million.

And at that moment, between G.X. Clarke, which is sitting out there -- we have a closed that deal yet -- but G.X. Clarke and our broker-dealer, we have something of the order of about $40 million of regulatory capital.

So as long as that $40 million is below the $120 million, we still only need $120 million.

So we can really -- and this would be a bad way for us to go about our business -- but we can add Securities businesses up to the point that they use about $100 million of capital, and they get a little bit of a free ride.

From how you think about the business from a risk management standpoint, does it change?

Is this taking on more risk than what you would normally feel comfortable with?

Yes, well, a couple things.

I certainly think we always assess our capital on a commercial basis, and in many instances, we believe more capital in the strict regulatory requirement is sometimes desirable and sometimes prudent.

So I'm just giving you the regulatory conversation.

I think we would probably not really -- we wouldn't run the businesses by just ignoring the capital requirement of the Securities business.

So I think we would be somewhere between commercially and how we think about that.

But of course, greater diversity in the portfolio effect, that that provides also the risk (inaudible), right?

So you've got to factor that in.

If we had -- I'm just using a theoretic example -- if we had $120 million of futures capital we needed, and we had $80 million of Securities capital we needed, maybe we would come to the conclusion we need about $150 million, $160 million of capital to be prudent, but I don't think we need $200 million.

So you certainly get some efficiencies.

Got it.

Can you also explain again the bad debt expense and what was going on there, and do you see that as some early warning signs or cracks in credit that you are taking on as you grow?

Sure.

I think there were -- well, a couple things just for clarification.

Looking at the unusual items we had in our quarter, we had the bad debt expense, but to be clear, that was almost exactly offset by write-downs on earn-out payments and also pullbacks from compensation.

The net effect on the quarter wasn't probably as great as you might imagine.

But dealing with the bad debt itself, there were really three categories of bad debts, if you like.

We had one individual, and certainly the largest single amount, was with our LME business.

That arose as we expanded our business into China.

I think we were very keen to support that initiative.

I think we went in with a customer that was very active.

The market got very volatile; they couldn't make a margin call.

This happened some quarters ago.

They have been working with us to reduce that exposure, and basically paid back a significant amount of what was at risk.

Eventually, they became illiquid.

Unfortunately, or fortunately I guess, the way GAAP works is we can only write down an exposure when the customer stops paying us.

We can't -- as long as a customer is making payments to us under an agreed plan, if we have a judgment about whether that customer is going to, in the full analysis, pay all of the debts or not off, we are not allowed to make provision on a subject of assessments.

So we have to wait for that customer basically throws up its hands and says, I can't make anymore payments, and at that point, you crystallize a loss.

Right?

So that happened with LME.

We have significantly off the back of that reworked our exposures in China.

Within China is a critical part of our LME expansion.

We think we need to approach it in a different way with probably smaller, more diverse sets of customers rather than a small number of large customers.

So that's what we've done.

We significant we pared back our exposures.

We don't have any other issues at the moment on that business, so we think that was an isolated event, but we certainly reacted and changed our business approach as result of that.

The next category of losses -- and these were all much smaller amounts.

The LME one was a bigger amount.

The next category was a handful of small amounts.

I think it was two, three in Brazil.

We do provide some threshold financing to some of our customers in Brazil.

We have a really active customer base in Brazil.

And I think what happened there as a trigger for the three customers or so having problems was the turmoil we saw in Brazil.

There was an active -- a very tumultuous time around the election.

We reacted by reducing some of our exposure to some of our customers.

We have a good team down there; they stay on top of it.

And we think that and in those market events, it is possible for us to lose $2 million, $3 million.

We hope those market events in places like Brazil happen infrequently, but given the profitability of that business, that is definitely possible.

The other factor exacerbating that was much lower sugar prices and much lower grain prices, so lower prices, more volatility, movements in the currency rate, all conspired to create stress on some of our customers.

Then we had a handful of a small customers in the US, mainly on renewable energy, that came out of our Physical Ags business.

Again, customers that got stressed with changes in the market.

All of these customers have tried to work with us.

All of these customers have made some attempt to pay that they owe us.

We've just come to the conclusion that probably got to the point where it's going to be tough sledding.

We have security interest on most of these customers.

We are pursuing them.

Our view is always at that point you write it off, and you may find we have write-backs.

If you go look back at her previous quarters, I think we've gone about six quarters now without having any material bad debts, and actually, I think if you look carefully, we've had a couple quarters where we've had positive bad debts, which have really been recoveries from prior quarters.

It -- Murphy's Law -- all happens in one quarter, even though some of these issues have been lingering around for more than one quarter.

But I think if you look over a longer track, we don't think that this is necessarily massively out of the realm of what one would expect, say, over a year.

We certainly don't think this should happen in one quarter, but we could have $2-million to $5-million-type write-downs over the course of a year.

We don't want that; we work hard not to make that happen.

But we take risks.

That's our business, and we've just got to be wide eyed about it.

We don't there any systemic issues or problems in what we are doing if that's your question.

Thanks.

Okay?

Thank you.

Paul Siegel, Columbia Management.

Hi.

So just a quick follow up to that last question.

It sounds like it's normal part of the business, and barring any unforeseen circumstances, we should so back to your normal low level of bad debt for at least a few quarters now.

You know what you normally say when someone says that?

You say from your lips to God's ears.

(Laughter)

I don't know God that well, but I wish you luck.

(Laughter)

But yes, we would agree generically with that statement.

Bad debts for us maybe lumpy.

You may have, just like we've had now, a couple happened in one quarter, but we certainly would not expect to see this level of bad debts as a regular occurrence quarter by quarter.

Okay.

Thank you.

Will [Settle], [Woodlaw].

Yes, good morning.

Last one on the bad debt.

My understanding is you guys take pretty extensive steps to limit risk to any one customer as well.

Could you just elaborate on those policies?

Yes.

If you look at our generic approach to (inaudible), we have 10,000 commercial customers, so we have a wide customer base.

We certainly diversify by commodity, by country, and in terms -- and we have are pretty rigorous credits approach where every single customer is approved, both for the market exposure we prepare to take on their account on a fully collateralized basis, because even on a fully collateralized basis, you still taking exposure on a customer.

Certain customers in the OTC markets, we will waive a portion of the margin required, and obviously, those customers undergo even greater scrutiny.

Our anticipation is based on the exposure we take, on an extreme market move, it should be very unusual for us to lose more than, say, $2 million per customer, and the bulk of our customers would be a fraction of that on the assumption things went really badly.

That's the approach we take.

We look at the customer's capital; we look at our capital.

We look at the liquidity of the instrument they're trading.

We look at the open position.

We look at the credit history of the company, the liquidity our customers have to make margin calls.

And bear in mind, we are never lending our customers money.

Our exposure arises when there's a rapid market move and the customer is unable to send a margin call in to cover his exposure.

That's what gives rise to a loss for us.

We are always collateralized day one.

Some customers we collateralized little bit less than others, but we always collateralized day one.

And our credit assessment is if the market moves rapidly, what are the risks and the chance that that customer will not be able to make the next margin call.

And our risk then arises from that situation.

So that's how we look at risk.

And you did, right, we don't want to take any big risks on individual customers.

But that said we're in the risk business.

There is risk with every single customer that trades with us.

There is some modicum of risk.

If anyone tells you business is risk free, I've never seen such a business in the financial business.

There is some risk, and we are in the business of taking risk.

We just need to do a prudently, and we need to do it and make sure we earn the right amount of money for the risk we take.

Sure.

Does that answer your question, Will?

Yes, that's very helpful.

And jumping into Global Payments, I knew that business would be growing, continue to grow, just from watching it, but the acceleration surprised me, up 45% this last quarter.

Can you talk about the pipeline of just onboarding -- you mentioned some large customers -- and what it looks like now versus this time last year?

Yes, actually it's a tough question.

Almost getting a little worried about explaining who we do business with.

We seem to be running into everyone at the moment.

We are dealing with -- or put this way, we are either in the process of onboarding or have onboarded a significant number of what I would call the tier 1 banks in the world.

Okay?

That's been our focus.

That's where the volumes are.

That's where the real money is for us.

As I mentioned on one of the earlier questions, there is a real long onboarding process, and then once you're through the onboarding, an adoption process.

We're tying into their pipes.

We're fulfilling a really fundamental requirement for these banks.

Obviously, their legal, their compliance, everyone has to be comfortable.

And once you've gone into all of that upfront work, its okay, we trust you guys, but it's trust but verify.

Let's do a few deals, and over a period of one to two years, you will slowly ramp up.

We are in that curve with every one of those customers, and I don't think we've reached near to the end of the curve with any of them.

So if that answers your question, that's our primary focus at the moment is just servicing these big customers.

They account for the major portion of the payments universe we want to target.

So it's a high priority to make sure stay on top of that and we really do a good job.

We have also signed up a number of what I would call second-tier banks.

That's obviously a bigger universe and the next target for us, and we're already starting to go after them given that there's such long lead times.

But honestly, I would very much like our Team to focus on that critical top-tier of financial institutions.

If we crack that, we get that right, and over the next two years get through the adoption curve, I think this is going to be a really fantastic business for us.

Any way to frame the percentage of capture of those banks you've onboarded at this point?

I think I've addressed this on prior calls.

We've now met a lot of payments businesses and been and been out and seen what other people are doing, and frankly, no one is doing what we're doing.

I think we're very unique in the payment sector.

And also, to be clear, we're not focusing on retail payments.

We're more in the institutional commercial space.

But if we have to use some of the metrics I see in investor decks that other payment companies use, I would tell you there are trillions of dollars of payments.

Our customers account for major portion of that.

We'll get a major portion of that.

And if you start doing that, the numbers become [sully], right?

I think having worked at banks and being familiar with institutions, all these big organizations are really, really hard to crack.

They tend to be lots of different divisions and fiefdoms and areas, and they're global, and they've got different subsidiaries, and so it's -- to make this assumption we'll get 80% of their flow because they like as we do a fantastic job I think is a little naive.

Obviously, that's our objective, but I think we've just got to steadily work at it.

As I think I've said on previous calls, I feel very confident saying that absent some huge problem or disaster out there, this business could easily grow top line at 15% or 20%, and I think there's a shot it could be multiples of that.

But I don't know how much confidence I can give you on that curve.

It is really -- we don't have enough data points really to focus on or to give you any color.

Bear in mind, the payments we're looking at, our niche and where we have a unique advantage is the non-OECD payments.

It's the smaller portion of the Global Payments flow, but it is still significant.

It is huge numbers of payments to a vast number of countries.

But we're not focus on the dollar European payments, which are huge.

We're focusing on the other markets.

We're really filling a huge gap in the marketplace.

The underlying potential I think is very large.

We think we have unique product.

All our customers tell us that we provide them with a fantastic value add, and they also tell us there are very few people who do what we do.

So the question is how deep and how far can we get into these organizations and try to fulfill that need, and very hard for me to give you color on that, other than I think it's all good.

It is all going to be upside.

Last question.

On the segment income that you break out in your release and filings, help me understand the cost not allocated to operating segments and how much might be [pad] to the global?

Or I assume that's most the corporate overhead that's difficult to allocate.

What type of corporate investment does it take to support the Global Payments business?

Sorry, Will.

You're very faint.

What was your last sentence?

What type of --?

Trying to understand the corporate -- if you look at this, in the quarter, $25 million of cost not allocated to operating segments, I'm just curious what that investment supports among these different business segments.

(Multiple Speakers)

Let me tell you how our cost waterfall works.

All the people that are directly allocated to their business, or allocated directly to the business unit, all the operational charges related with the settling of that business, the functioning of that business, are allocated to the business.

Any specific IT systems and IT people that are working only for that business are allocated to that business.

So what you are left with is Management, which the rest of the people in our organization would say that's overhead, but Management.

You're left with risk, general IT, people who keep the systems and the servers and the e-mails working and general corporate systems not specific to a business.

Compliance, legal, the cost of the offices.

Because everyone shares those offices, it's hard to allocate those out.

So that's generally what's unallocated.

If we have - and there are a thousand ways we could allocate those out.

I think probably the simplest way might be to look at it on a headcount basis if you wanted to.

Some businesses are heavier users of certain services than even headcount would dictate, and some are lighter.

But if you look at headcounts, on the front office side, so people absorbed in that business and the related operations people, I don't know, it is probably 700 people I'm guessing are allocated out to the units.

And I would say, round numbers, probably 85 of them in the payments area.

So just a quick -- and I'm just doing this on the fly here for you, Will, but I would say it's something like 10% to 15% of that number would be allocated to payments.

Just to confirm, there 70 people allocated to Global Payments, Will, at the end of the year.

So my numbers aren't far off.

I would say it is about 10%.

We could do a hugely complex theoretical exercise, but I don't think it's going to be materially either side of that number.

No.

That's helpful.

Obvious reason for my question is looking at the growth of this segment, the more recurring nature of it, very appealing asset embedded among some other complicated businesses.

Just trying to (inaudible).

The one thing that you should be clear about is while this business doesn't consume vast quantities of central resources or even material amounts of our capital, this business would have a really tough time operating as a very small standalone subsidiary.

The large international banks we're dealing with would not conduct such an important key function with a small company.

That's a fair point, but it obviously could be part of another large company, too.

I'll leave it at that.

Thank you.

All right.

Anything else, Will?

No, thanks.

Happy holidays.

Thank you.

Steven Spartz, International Assets.

Yes, good afternoon, Sean.

Steve, long time.

How have you've been?

Doing well.

Doing well.

Question concerning your current buyback of share programs.

How many shares have we purchased back this past year, and the outlook as far as purchasing shares going forward?

I did note that over the past 18 to 24 months, Bares Capital, they had over 3 million shares, and Leucadia also a big shareholder, and it looks like that 4 million or 5 million shares have been gobbled up in the market as they've liquidated their shares.

It seems to have been absorbed pretty well in the market.

Again, are we doing any sort of an effort on a buyback of shares internally?

Or how are these being absorbed in the marketplace?

I'm going to turn that over to Bill.

Personally, I think your numbers on some of those shareholders are incorrect, so Bill can give you the right ones.

Steve, this is Bill Dunaway.

Bares actually -- what they did is they split their shares out into Nine Ten Partners and the Duke University endowment.

So if you look at the largest holders, those are actually just split offs of shares that previously showed up as holdings of Bares.

So they have not significantly reduced their position in the firm over the last 12 months.

Now, Leucadia has sold some, a smaller portion of their holdings here in the fourth quarter, but certainly have not liquidated their whole position.

We haven't bought back any shares here recently.

We've actually been blacked out because of the G.X. Clarke acquisition.

Because we've been working on that over an extended period of time, we had suspended our stock buyback plan just because of that blackout period.

But we did buyback earlier in the year.

A little a share under $10 million worth of stock or about a little over 500,000 shares of the stock.

So certainly, that was something we were active in prior to ending up in that blackout period.

All right.

And a follow-up also on -- you might have mentioned this -- was the return on equity.

What level did we see this last quarter and for the year, and what is the outlook going forward, and also current book valuation?

Our book is, what, $18.25?

$18.25, and for the fourth quarter, we are at a 6.8% return on equity, and for the full year it was a 5.8%.

Sean (inaudible).

I think the way we think about is, if we continue to do what we do, and certainly, I think there's strong evidence over the last three, four quarters that all the metrics are moving up, but if you keep your revenue growing and you keep your cost flat, it doesn't take too long before that ROE starts to go up pretty materially.

I think we're right at that inflection point now.

We had a lot of headwinds in -- two years ago that started hitting us.

I think those have abated.

Maybe even some of them are starting to swing around in our favor, not materially, but even if it's not a headwind, it's still a big improvement.

We've just got to execute well here, and I think the ROE will take care of itself hopefully.

Very good.

Thank you.

I'm showing no further questions at this time.

I'd like to turn call back over to Mr. Sean O'Connor for any further remarks.

Okay, we'd like to thank everyone for their participation.

We love getting the questions, so this is one of our longer calls with questions, so please keep them coming, and please give us any feedback on the amended formats of our earnings release and also the earnings presentation.

We certainly think it was a better way of doing it, but let us know what you think.

Thanks for your time, and we will speak to you soon.

Cheers.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Have a great day, everyone.