StoneX Group Inc (SNEX) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the INTL FCStone Fourth Quarter Conference Call.

(Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to turn the call over to Mr. Bill Dunaway, CFO.

Sir, you may begin.

Good morning.

My name is Bill Dunaway.

Welcome to the earnings conference call for our fiscal fourth quarter ended September 30, 2017.

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

This release is available on our website as well as a slide presentation, which we will refer to on this call, and our discussions of the quarterly and year-to-date 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 know, the following discussions 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 on 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, our CEO.

Thanks, Bill.

Good morning, everyone, and thanks for joining our fiscal 2017 fourth quarter earnings call.

I'd like to start by discussing our significant and unexpected bad debt charge, which overshadows our otherwise strong fourth quarter results.

We recognize that this is an unacceptable outcome.

For the better part of 15 years, my executive team and I have worked to run a credible professional business that we believe can grow into a large and meaningful financial franchise.

We have prided ourselves on using common sense, putting strong controls in place and always trying to do the right thing rather than the easy thing.

We have run the company like this because we believe it earns us trust and credibility with all our key stakeholders, our investors, our customers, our banks and our staff.

In our business, you simply won't succeed without trust and credibility.

We understand the seriousness of this unexpected loss, and we take it very personally.

That's why the executive team is committed to redoubling our efforts to ensure that this type of situation will not be repeated.

The executive team will be receiving 0 incentive bonus under the executive performance plan for fiscal 2017.

This bad debt occurred in our relatively new physical call trading business based in Singapore.

We were acting as an intermediary between a supplier of coal from Indonesian mines and large international coal mine customers.

We paid for and took delivery of coal on barges, and our supply then facilitated delivery of the coal to our customers' vessels.

The bad debt expense includes amounts due to us from our coal supplier related to coal paid for, but not delivered, reimbursement of penalty charges paid by INTL to its customers and losses incurred relating to the cancellation of open sales contracts.

Our supplier signed a note for the entire amount due to us, but we believe it is very unlikely to be paid to us.

We explored a number of work-out plans with our supplier, but decided to forgo them when it became apparent that they would require additional capital at risk, and that the financial and other risks of recovery outweighed the possible reward.

In this type of situation, I believe it is essential that we run towards problems, not away from them, that we act as passionately and decisively to protect our business.

We took our medicine, and we have exited this business entirely.

The bad debt recorded represents all amounts due from the supplier, apart from $1 million that will be recorded in 2018 first quarter's results, and we do not expect any additional material charges related to this business.

We continue to investigate the matter, and we will pursue all legal avenues available to us.

We will also, related to this, disclose a material weakness in our internal controls over financial reporting regarding the design effectiveness and documentation of our continuous risk assessment process related to new business lines and certain ineffective process level controls related to our physical call trading activities in Singapore.

We believe that these material weaknesses were isolated to the coal business in our Singapore subsidiary, INTL Asia.

So to summarize, we have totally exited the physical coal business.

The aggregate loss is $48 million.

Of this, we have recognized $47 million in fiscal 2017, and $1 million will be recognized in the first quarter of 2018 in accordance with GAAP.

The disclosed loss represents 100% write-down of all our exposures to the various parties involved, and we do not anticipate any further bad debt expense related to the coal business.

With a low tax rate in Singapore, the post-tax impact of the earnings will be $39 million or $2.13 per share after the reversal of executive incentives.

Despite this charge, we remain profitable for the 2017 fiscal year.

We have more capital to support our customers and our growth than we had a year ago.

No customer funds were lost.

The legal entity involved is not regulated and has been recapitalized to make up for the loss.

Our banks have been very supportive and have agreed to effectively treat this item as a discontinued item for covenant purposes, and have passed all the necessary amendments to offer those agreements.

While a major setback, we do not believe that this will have any material impact on our business, our ability to serve and grow our customer base or our earnings potential going forward.

This chapter is now closed and in the rearview mirror for us, and we look forward to focusing on our business, which has shown good growth and accelerating earnings over the last 4 quarters.

Looking at the Q4 results, excluding the impact of this loss, the market environment remained difficult for us, thanks to depressed volatility, especially in the grains equity and FX markets, but we did see a benefit from the interest rate increases that occurred earlier in the year.

And as you all know, we had another interest rate increase announced yesterday.

In addition, both commentators are predicting another 3 to 4 interest rate increases in 2018, as the U.S. and global economies continue to firm up.

As conditions continue to normalize in central banks with pro monetary accommodation, we believe volatility should also start to increase.

In fact, we have already started to see higher intra-day volatility over the last 2 months.

Some highlights to note.

Q4 was our best quarter of the year with operating net income approaching our target ROE before the recognition of the bad debt.

Our operating revenues reached a historical high of $205 million, up 15%.

Transaction volumes are up strongly for our physical coal business, our payments business up 120% and 29% for the quarter, respectively, and both of these businesses showed strong growth of almost 50% in transaction volumes for the overall year.

It was good to see that OTC and futures volumes increase 24% and 12%, respectively, for the quarter, although they were largely flat for the year.

OTC revenues were the strongest we've had in 5 quarters.

Debt trading volumes are up 8% for the quarter and 24% for the year overall.

Segment income was up a very strong 54% for Commercial Hedging off the back of the increased OTC activity, although it was only up 6% year-to-date after weaker performance earlier in the year.

Global Payments continued its strong growth, with segment income come up 21% for the quarter and up 27% for the year.

Our Securities business was down 39% for the quarter and down 33% for the year, largely due to the positive impact of Argentinian devaluation a year ago and also due to lower revenues from both our rates and equities business this year, again, due to lower volatility.

Moving on to more general topics.

As we have proven in our payments business, which continues its very strong growth, a scalable and efficient technology platform designed and tailored to specific client segments can be a key differentiator for success and, if done correctly, can in fact be a disruptor.

We have a number of similar initiatives in other areas and are encouraged with results so far.

In October, we successfully launched our new online platform for structured OTC transactions called SPOC, an acronym for structured product online calculator.

This has allowed us to largely automate and create a digital custom interface in one of our most complex and manual businesses.

This platform allows customers to choose the commodity without exposure, set their specific risk tolerances and design complex structured products to suit their specific needs and receive near-instantaneous indicative pricing.

SPOC provides a much enhanced high-touch customer service and a more efficient and scalable pricing capability.

We believe that this is an industry-leading platform and should drive our market share in the segment.

We already have tangible evidence of new customers on-boarding with us because of this technology.

We continue to see strong growth in our precious metals trading and Physical platforms, both of which are industry leaders and provide both enhanced customer engagement and a more efficient and scalable platform for us.

Lastly, I'd like to report that our acquisition over a year ago of the Sterne Agee business has now been fully integrated and was a positive contributor to the bottom line, earning nearly $1 million pretax for the fourth quarter.

You may remember that when we acquired the Securities, Clearing and wealth management business just over a year ago, it was running at a combined loss of around $4 million pretax.

So with that, I'll hand you over to Bill, who will take you through the financials in a little more detail.

Bill?

Thank you, Sean.

I'll be referring to slides and the information we have made available as part of the webcast, specifically starting with Slide #3, which represents a bridge between operating revenues for the fourth quarter of last year to the current fiscal fourth quarter.

As noted on the slide, the fourth quarter operating revenues were $205.1 million, a record high, and a $26.5 million increase over the prior year.

Looking at the performance in our operating segments, the most notable change was a $13.2 million increase in our Commercial Hedging segment.

This represents a 24% increase over the prior year, driven by a 59% increase in over-the-counter revenues.

The growth was driven by a 24% increase in OTC volumes, primarily in the grain and energy markets.

The exchange rate of revenues increased 3% over the prior year, with increases in agricultural and energy revenues being partially offset by lower LME revenues.

Interest income in this segment increased 77% to $4.4 million compared to the prior year.

The increase in interest income was primarily driven by an increase in short-term rates, as average customer equity declined 7% versus the prior-year period.

Also showing strong revenue growth was our Clearing and Execution Services segment, which added $11.9 million in operating revenues versus the prior year.

Within this segment, the exchange-traded futures and options business increased $4.5 million over the prior year and 14% growth in customer volumes.

In addition, the ICAP voice brokerage business acquired in October 1, 2016 added an incremental $6.9 million in operating revenues in the quarter.

As Sean noted, the Correspondent Clearing business acquired at the beginning of the fourth quarter of 2016 has grown nicely, increasing revenues 32% versus the prior year.

Gains were offset by modest declines in FX Prime Brokerage and in wealth management.

Our Global Payments segment increased operating revenues by $3 million or 16%, as the number of payments made increased by 29% versus the prior-year period.

Securities segment operating revenues declined $2.8 million or 7% versus the prior year.

Within this, equity market-making operating revenues declined 9% or $1.2 million, as low volatility continue to drive a narrowing with spreads realized.

In addition, debt trading revenues declined 7% or $1.5 million, driven by declines in both our domestic fixed income business and our Argentina and Latin American businesses.

Operating revenues in our Physical Commodities segment declined 22% or $3.3 million in the fourth quarter, with precious metals declining $2.6 million versus the prior year, albeit the prior year benefited from the reversal of a $3.1 million unrealized loss from third quarter of 2016 on derivative positions held against inventories.

Physical Ag & Energy operating revenues declined $700,000 versus the prior year due to the decline in our fats and oils and feed ingredient businesses.

Finally, operating revenues in unallocated overhead increased $4.5 million as a result of the $3.6 million in unrealized losses on U.S. treasury notes and interest rate swaps in the prior-year quarter related to our interest rate management program.

Moving on to Slide #4, which represents a bridge from 2016 fourth quarter pretax income of $19.2 million to a $22.5 million pretax loss in the current period.

This decline was driven by the $47 million bad debt expense on physical coal, as mentioned earlier on the call by Sean.

This charge, combined with the decline in precious metals operating revenues, were the primary driver of the $51.7 million decline in segment profitability in the Physical Commodities segment, from $9.1 million segment income in the prior year to $42.6 million segment loss in the current period.

Segment income in our Commercial Hedging segment increased $7.9 million or 54% to $22.4 million in the current period as a result of strong revenue growth noted earlier.

In addition, segment income added $5.9 million to $10.3 million, a 134% increase over the prior year.

As noted in prior quarters, as part of the acquisition of the ICAP voice brokerage business in this segment, the fourth quarter includes the $900,000 charge to compensation of benefits for the terms of the acquisition, which will continue to be expensed through the end of the fiscal 2018.

Our Global Payments segment added 21% or $2.2 million of segment income in the current quarter to $12.8 million, while Securities segment income declined $5.8 million or 39% to $9.1 million.

The decline in Securities segment income was primarily driven by weaker operating revenues in our equity market-making and debt trading businesses, driven by lower market volatility, which led to spread compression in these businesses.

Finally, the variance of the corporate unallocated overhead segment was relatively flat with the prior year.

As shown in the table in our press release, this segment was unaffected by unrealized gains or losses on investments in our interest rate management program in the current period.

However, the prior-year period included the $3.6 million unrealized loss.

Offsetting that loss in the prior-year period was the $6.2 million gain on the acquisition of the Sterne Agee entities.

The current-year period includes the $4.2 million reduction in the executive incentives noted by Sean earlier, partially offset by modest increases in other overhead expenses.

The bottom of the Slide #11 of the presentation shows the after-tax effect of these unrealized gains and losses in the interest rate management program by quarter.

Slide #5 shows the interest income on our investments and our exchange-traded futures and options businesses as well as balances in our Correspondent Clearing and independent wealth management businesses.

As noted on this slide, our interest earnings on these balances have increased $3.1 million versus the prior year to $8 million, as our yield on these balances has increased 36 basis points to 109 basis points in the current period.

The bottom of the slide shows the potential annualized interest rate sensitivities the balances held at the current period have based upon the uniform parallel shift up in the yield curve at various levels.

As noted, the 25 basis point increase in short-term rates has the potential to increase our interest income by $5.8 million on an annual pretax basis.

Moving on to Slide #6, our quarterly financial dashboard, I'll just highlight a couple of items of note.

Variable expenses represented 44.5% of our total expenses for the quarter, below our target of keeping more than 50% of our total expenses variable in nature.

However, this was skewed due to the bad debt discussed earlier.

Non-variable expenses, which are made up of both fixed expenses and bad debt expense, increased $53.8 million, once again primarily driven by the increase in bad debt and, to a lesser extent, the acquisition of the ICAP voice brokerage business at the beginning of this fiscal year.

We reported a net loss from continuing operations for the fourth quarter of $23.6 million, a 20.5% negative ROE versus net income of $16.8 million or a 15.8% ROE in the prior-year period.

Excluding the after-tax effect of the bad debt on physical coal and related executive incentive reversals of $39.4 million, the current period would have reflected net income of $15.8 million or an ROE of 13.2%.

Finally, in closing out the review of the quarterly results, our book value per share increased 2% to $24.02 per share versus the prior year, as shareholder equity increased $16.1 million over the prior-year period.

We did not repurchase any shares of our common stock during the fourth quarter.

Next, I'll move on to a discussion of the year-to-date results and will refer to Slide #7.

Year-to-date operating revenues were up $113 million to $784 million in the current year-to-date period.

The largest increase was in our CES segment, which increased $108.7 million, primarily driven by the acquisitions of the Sterne Agee and ICAP businesses, but also as a result of an $8.8 million increase in our exchange-traded futures and options businesses.

Global Payments operating revenues continued their strong growth, increasing 22% or $16 million versus the prior year and 46% growth in the number of payments made.

Commercial Hedging and Physical Commodities operating revenues added $8.5 million and $8.2 million, respectively, versus the prior year.

These increases were partially offset by a $23.5 million decline in our Securities segment as a result of the narrowing of spreads in the equity market making business as well a strong performance in the prior-year period and debt trading and asset management following the devaluation of the Argentine peso.

Moving on to Slide #8 for a discussion of the variance in pretax income by segment for the year-to-date period.

The largest increase in CES operating revenues resulted in a $15.6 million increase in segment income in CES.

Global Payments and Commercial Hedging increased $10.8 million and $4.1 million, respectively.

These increases were more than offset by the $44.7 million decline in Physical Commodities segment from $13.3 million of segment income in the prior year to a $31.4 million segment loss in the current year, driven by the bad debt on physical coal.

In addition, segment income declined $22.8 million to $46.6 million as a result of the weaker performance in our equity market making and domestic fixed income businesses in the current year as well as the effect of the devaluation of the Argentine peso, which led to strong results in our Argentine debt trading and asset management businesses in the prior year-to-date period.

The $20.5 million negative variance in unallocated overhead was driven by the $5.2 million negative variance on mark-to-market adjustments on the interest rate program, as mentioned in our press release, combined with a $6.2 million gain realized in the prior year on the Sterne acquisition, combined by an increased overhead from both the Sterne and ICAP acquisitions, which was partially offset by the $4.2 million reduction in executive compensation discussed earlier.

Finally, I will touch on the year-to-date dashboard, which is Slide #9 in the presentation deck.

Variable expenses are above our internal target of exceeding 50% of total expenses, coming in at 53.4% of total expenses.

Non-variable expenses increased $98.7 million or 41% over the prior year as a result of the bad debt on physical coal and the acquisitions discussed earlier and increases in several administrative departments, most notably the continued expansion of our information technology department.

Net income was $6.4 million for the current year-to-date period as compared to $54.7 million in the prior year.

The return on equity for the year-to-date period was 1.5%, while our average revenue generated per employee was $501,000, exceeding our internal target.

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

Thanks, Bill.

Our good Q4 operating results have been undercut by the bad debt charge I detailed at the beginning of the call.

While we are severely disappointed with this outcome, we believe it is an isolated one-time event, and we believe we have acted decisively to deal with the situation and put this unhappy chapter behind us.

Our coal business accelerated nicely during 2017, and we believe it is well positioned to continue to strengthen into 2018 and gain market share as the industry continues to consolidate.

Our business model has been to offer vertically integrated execution and clearing in all major asset classes and markets for our customers.

This enables us to create sticky customer relationships, wherein we have increased our advisory, clearing and execution revenue, while also growing our customer balances.

Until recently, however, we have seen limited revenue related to these customer balances due to the historically low interest rates and and thus have been reliant only on the execution revenue generated by our clients.

So in many ways, our business has been operating with one hand tied behind its back.

We believe that with synchronized global growth kicking in, the end of this year of extraordinary monetary accommodation is now in sight.

And that, with expected increases in interest rates, these client balances will produce incremental revenues for us.

These incremental revenues will largely fall to the bottom line and will result in more stable and predictable revenues and earnings, and provide some real balance.

We also continue to experience depressed volatility, which in some instances reached multi-decade lows.

In this environment, customer activity has generally dampened, and our spreads have compressed, compounding the negative impact of low volatility.

In the last 2 months, however, we have seen volatility tick upwards slightly, and we continue to believe that there will be a normalization of interest rates and volatility levels in the future.

The combination of the effect of rising interest rates and our growing client balances and increased transactional revenues due to more normalized volatility should be powerful drivers for us and unleash the full potential of our business model.

After growing our capabilities and our customer base in recent years through acquisitions and organic growth, we continue to focus on upgrading and more tightly integrating our offerings, platforms, marketing strategy and customer experience.

We believe that this is necessary to achieve our goal of becoming a truly best-in-class global financial franchise.

We believe our unique and increasingly scalable platform will enable us to grow existing market share and pursue new market segments as they come into play.

With that, I'd like to turn it back to the operator and open the question-and-answer session.

Operator?

(Operator Instructions)

Well, it doesn't look we have any questions at this time.

So thank you for your attendance, and -- oh, it does look like we have a question.

So let's take that one, operator.

We have a question from the line of Will Settle with Woodmont.

Sean, just real quick.

I appreciate the commentary around the bad debt.

I guess, could you elaborate on maybe why this division was unique in the way it was structured or the type of business that was undertaking that make this -- just gives us comfort this is isolated and at much lower risk that this kind of issue could emerge in one of the other segments?

Okay.

Will, you were very faint there, so let me, for everyone else, paraphrase what I think your question was, is I think what you were asking is, what were the circumstances related to this business?

And how is it different and unique and not relevant to our other businesses?

Is that a correct paraphrase?

Yes, certainly.

Just to make sure this is isolated, give us comfort there.

Yes, okay.

So this business was started up about 2 years ago.

It is not a business we are involved in anywhere else.

We have, in numerous times over the past, started business from scratch that have become very big franchises for us.

We saw an opportunity to start in the coal business in Singapore.

Because this is not a business we do on a global basis and because of the geographic and time remoteness of Singapore, this business was set up with all the controls around this business in the Singapore office.

So from that point of view, it is certainly very unique and very different to what we do elsewhere, where we generally run global businesses.

We have our controls vesting in our large offices, where we have a robust control environment.

Secondly, I think although we believe that the time we set this business up -- as I said at my opening statements, we spend a lot of time on controls and making sure that these kind of events don't happen.

And we certainly designed the business at the outset, I think, in an appropriate way.

I think we had the necessary separation of duties in Singapore with various people checking and crosschecking and making sure that the business was going to be run appropriately, and we also sort of scaled the business appropriately size-wise and capital-wise.

I think the issue we had, and we've sort of disclosed this in our filings, is we did not, on a continuous basis, verify that the control environment we set up was operating as we believed it was.

And in all of our other businesses, we tend to have almost near-continuous review of our control environment, whether it be internal audit department reviewing the business, oversight by senior management, just a more robust environment with more people.

And I think the lesson we learned was if you set up new businesses, you've got to make sure that you more rigorously and more frequently verify and ensure the controls you designed are operating appropriately and make sure that if those controls need changes, you make those changes, and that everyone is doing exactly what you think they should.

And I think the other lesson learned is if you set up those controls in a more remote location, you have to be doubly vigilant and make sure that you test those controls.

And I think that is the failure we've acknowledged.

We certainly don't think that our other businesses are subject to those exact circumstances.

Our other businesses, typically, we run on a global basis.

We've been running them for a long time.

We have very robust controls.

We have near-continuous reporting.

And every time there's a failure, it's investigated in near real time, and we have strong oversight and crosschecks on all those controls.

So that was certainly, I think, the reason for the problem, and we certainly believe it is isolated to this business and to the location.

And having businesses that operates in places that are far away from the center, time-wise, is also a real issue for us that we need to think better about and make sure we have better controls over.

So I hope I've answered your question, Will.

Yes, very helpful.

And just real quick on -- as you think about 2018, could you comment on, within the Global Payments business' kind of pipeline, are you still seeing the opportunity to approach new institutions and roll that, offering it out to them?

Or have things slowed down there?

Yes.

So just a general comment.

What's truly frustrating with the situation we find ourselves in is, for the first time in many, many years, we think that our business is just really poised for a kind of lift-off.

We've seen accelerating earnings in all our businesses.

The macro environment is starting to turn into a tailwind, and we're dealing with the situation.

So as a general comment, I think we feel pretty excited about all of our businesses right now and kind of where we sit.

And the hard work we put into build clearing and attract customer balances, so we can earn money not only just on the execution revenue, but also on those balances, for the first time, we're going to see our business model kicking in.

So generally, we're kind of excited about all of that.

The Global Payments business continues to power on.

Those guys have got a real scalable business.

They've got a very efficient platform.

We, I think, have made enormous inroads into that business, where I think we are now generally accepted as one of the premier providers.

And that becomes a lot easier and self-sustaining and self-fulfilling.

When we started this business 5 years ago and we called on the banks, it was a tough sale.

No one knew who we were.

No one knew why they should deal with us, but I think we've now got ourselves in a really strong position.

And as I said to -- I said on these calls numerous times before, we think there's a long adoption curve with each of our banks, and we're still not fully through on-boarding the banks.

So the combination of getting deeper and further into each of our banks' payment flows and adding new banks, I think is going to sustain that business and sustain that business growth for some time to come.

And then the other thing is, I think, the -- percentage-wise, the decline in the revenue per payment is going to start flattening at some point.

We're now sort of reaching kind of almost -- it's going to decline a little bit for a while, but those rates that have declined are going to start flattening out.

And that's when I think you're going to see more of the revenue growth drop directly to the bottom line.

So we're excited about that.

So, Will, any other questions?

No, and all the best in 2018.

Thanks very much.

Any other questions from anyone?

(Operator Instructions) And we're showing no further...

All right.

I don't see any -- yes, we don't see any further questions, so I'd like to thank all of you for making time to participate in the call.

And I guess, all that remains from me is to wish all of you happy holidays, healthy family time, and we will be talking to you soon about our December quarter.

Thank you.

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

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

Everyone, have a great day.