International Assets Holding Corporation F3Q08 (Qtr End 06/30/08) Earnings Call Transcript

| About: International Assets (IAAC)

International Assets Holding Corporation (NASDAQ:IAAC)

F3Q08 (Qtr End 06/30/08) Earnings Call Transcript

August 12, 2008 4:30 pm ET

Executives

Scott Branch – President

Sean O’Connor – CEO

Brian Sephton – CFO

Analysts

Steve Fagger [ph]

Gram Wayne [ph]

Steven Spark [ph]

Bob Sauk [ph]

Operator

Good afternoon. My name is TK and I will be your conference operator today. At this time, I would like to welcome everyone to the fiscal 2008 third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Mr. Branch, you may begin your conference, sir.

Scott Branch

Thank you. Good afternoon. My name is Scott Branch, President of International Assets Holding Corporation. I will be hosting this earnings conference call for the third quarter of fiscal 2008, ended June 30th, 2008. We have a simple format planned for today. It should last no more than 15 minutes before questions and answers.

Sean O’Connor, our CEO, will present an overview of the quarter’s results. I will then deal with internal and operational developments since our last call. Brian Sephton, our CFO, will then take you through the recent earnings release. And we’ll briefly wrap, and take questions.

If any listeners have suggestions on the format and content of this and future calls, please do not hesitate to contact the company through the Investor Relations email address on our Web site, www.intlassets.com. We filed our 10-Q for the fiscal quarter, ended June 30th, 2008, with the SEC yesterday. It’s posted on our Web site at intlassets.com, under the SEC filings section of the Investor Relations tab.

Before moving on, I would like to advise you and all participants should note that the following discussions should be taken in conjunction with the most recent financial statements and notes thereto as well as the most recent Form 10-Q filed with the SEC on August 11, 2008.

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, many of which are beyond the company’s control, including adverse changes; and economic, political, and market conditions; losses from the company’s market making and trading activities arising from counterparty failures and changes in market conditions; the possible loss of key personnel; the impact of increasing competition; the impact of changes in government regulation; the possibility of liabilities arising from violations of Federal and State Securities laws; and, the impact of changes of technology in the securities, foreign exchange, commodities, dealing, and trading industries.

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 – listeners are cautioned that any forward-looking statements are not guarantees of future performance.

So with that out of the way, I’ll now turn the call over to Sean O’Connor, Sean.

Sean O’Connor

Thanks, Scott. Good afternoon, everyone. Thank you for joining us on our third quarter conference call. As most of you know, and we have stated in many of our prior calls, we do not believe that GAAP accurately reflects the economic results of the company. And we manage the business on a fully mark-to-market basis, as do most other financial businesses.

Over the last year or so, we have given certain non-GAAP information to assist investors in this regard. In the past, we have only disclosed the difference between fair market value of our commodities inventory and the GAAP inventory valuation. This had historically represented the bulk of the difference between the GAAP and the non-GAAP mark-to-market results. And in our view was the simplest and most objective measure available to us.

However, over the past couple of quarters, our commodities business has become more diverse and more complex. And we believe we should not present a full mark-to-market set of results exactly the way we, as management, view them. This involves adjustments, which require greater judgment on the part of management. They relate to the valuation of future purchase and sale commitments, including location discounts and premiums, estimated shipping costs, et cetera. And in addition, the application of a pro forma tax rate of 37.5%, the average rate applicable in our commodities subsidiary. Our latest Q sets this new basis up for the current and historic quarters, together with the reconciliation back to GAAP results.

I think, the fiscal year to date, and we are now in the third quarter, so nine months so far, mark-to-market results can best be described as having had a good tailwind in Q1 and Q2, and a slight headwind in Q3. The first half results were better than anticipated, and were slightly offset by slightly disappointing Q3. Mark-to-market results for the year-to-date show operating revenues up 57% for the nine months, and net earnings up 55% for the nine months over the same period a year ago.

Our discussion in our 10-Q deals with the comparison between Q3 of 2008 and Q3 of 2007. Comparing the June quarter with the March quarter, that’s Q3 with Q2, we saw a 22% decrease in the adjusted operating revenue, and a 55% increase in the adjusted pro forma net income. Let me comment briefly on this.

Firstly, in the equity business, market uncertainty led to reduced activity in April and May. But we had a stronger performance in June. The bulk of the difference was in our base metal business, which was weaker due both – in our commodities business. In this segment, the base metal business is weaker due to both seasonality and reduced physical arbitrage opportunities arising from a lower lead price. Our precious metals business also produced lower results in the June quarter than it had in the March quarter. But we began seeing positive developments from an expanded customer base, both in Dubai and Singapore. Our asset management business showed modest losses on our proprietary managed accounts, and weaker performance in our funds, which led to a callback of some performance fees that have been accrued in the prior quarters.

As a trading business, each of our individual units is subject to a number of external and uncontrollable factors, which make quarterly comparisons difficult. As major shareholders, we do not manage the business for quarterly results, but instead, our focus on building a much larger and more profitable business overall. We believe the best way to evaluate the business is on a trailing 12-month basis. And I’ve also provided this information in our late SQ.

As we mentioned numerous times before, our key metric is return on equity. And for the last two years, we have consistently exceeded a 20% return on a 12-month trailing basis despite more than doubling the equity capital over this period.

As many listeners may have noticed, we filed an S3 registration statement on July 23rd. Let me comment briefly on this. Over the last five and a bit years, since the current management team took over, we have additional capital three times, in each case roughly doubling the existing permanent capital we had. In each instance, we are able to put the new capital to work quickly, and within a two-year period had achieved an acceptable rate of return on the capital.

We have now established a global footprint and have rapidly grown our customer base from (inaudible) flow and revenues, and are able to accelerate our growth with the benefits of some operational leverage. However, we are very conscious of risks, particularly in the current environment, and have limited the scale of our activity to be in line with our permanent capital. Overtrading is a sure way to get into problems in our view.

The current difficult environment, however, is creating wonderful opportunity for us to expand both existing relationships, in other words, do more with our current clients, as well as build additional relationships. As the larger banks deal with the hangover of the credit prices, we are ideally positioned to make a quantum leap. However, we do not believe that this would be prudent unless we have more permanent capital to support this growth.

The filing of the SC was a first step in laying the groundwork to raise additional capital when terms and conditions are considered appropriate. We are in a very fortunate position that our current businesses are performing well and generating very good returns, and growing as well. We would be happy to carry on our current course if capital is not available on terms acceptable to us.

I’ll now hand it over to Scott Branch. He will comment on internal developments, Scott.

Scott Branch

All right. Thanks, Sean. In prior quarters, we had indicated that our infrastructure growth was nearing completion, and we did not anticipate significant future growth in related expenses. I’m pleased to report that our fixed expenses were virtually unchanged from Q2 to Q3 2008. In fact, our total non-interest expenses fell by almost 10% during the quarter. This was largely due to decreased variable expenses, namely lower incentive compensation and clearing expenses resulting from the mildly decreased business activity we experienced during Q3.

While we would clearly prefer increased revenue and business activity, it is reassuring to see that our cost structure is indeed as variable as we had designed it to be and acted as a buffer to offset a portion of the revenue decline. We believe that we have now crafted an infrastructure that is capable of handling peak demand periods, as we saw in Q1 and Q2, and future growth, but without the cost base that is flexible enough to absorb inevitable bumps in the road.

We are continuously reassessing each of our new initiatives as well as existing businesses to make sure that we are earning the right return on committed capital, and also in relation to the overhead assumes. And this is a constant process that we go through pruning our businesses to make sure we’re employing our capital in the best way that we can, and getting the best results.

In the very end of this last quarter, we came to the decision to shutdown our Hong Kong margin FX business. This business has not been profitable, and its closure should eliminate around $1 million of overhead per annum as we release capital for redevelopment in our other more profitable growing activities. We will either close the company or sell it, depending upon the outcome of discussions we are currently engaged in.

We are very pleased that our commodities syndicated loan facility was renewed at the end of June 2008 for an amount $125 million. In addition, in July, our general corporate facility was renewed and increased from $25 million to $35 million. While our foreign exchange trading facility was renewed and increased from $20 million to $25 million. Given the current difficulties in the lending markets, we regard these renewals as expressions of confidence in our business model and are very pleased with the support provided to us by our bankers.

We are continuing with systems enhancement, particularly in our FX activities. These improvements not only allow for greater operational efficiencies, but also closer integration with our existing client base. This integration capability has also opened up opportunities to work with larger financial institutions, satisfy their clients’ demands, as much as we have previously done in our equity market making area.

We have recently received a number of questions about risk management. I think that’s not at all surprising given the current environment and the recent problems reported by most financial institutions. I’m happy to reiterate, almost word for word, my comments from our last conference call. In the period of unprecedented market volatility, our business model and risk management performed as intended. Our primary activity is to earn a bid offer spread by providing liquidity and execution to clients in these markets. As a true dealer, we commit our capital and assume short term market positions, but with limited direct exposure to market price movements. In the process, we also assumed risk and counterparties, including both customers and market participants. All of our clients and counterparties performed fully in line with their obligations during the quarter. We diligently monitor our risk management practices, but do not see any unusual indications of stress.

Lastly, a comment on our approach to investor relations, as many of you are aware, we had always taken the low key approach in tending to provide clear, accurate, and timely information distributed through a variety of media, with the least efforts on our part. While we intend to stick with these principles, a growing market capitalization, wider institutional investor base, and opportunistic approach to raising capital (inaudible) for a slightly more proactive approach to investor relations. We have already undertaken a number of non-deal road shows and conference calls during the quarter, and intend to continue with this practice on a limited basis going forward.

I’ll now hand you over to Brian Sephton for a review of our financial performance, Brian.

Brian Sephton

Thanks, Scott. Good afternoon. May I remind you that we do not give future revenue earnings guidance. This review covers the third quarter of fiscal 2008 ended June 30th, and the year-on-year comparison related to the corresponding quarter of last year.

You will have noticed in our filing that the management discussion now deals with our fully mark-to-market numbers. First of all, apologies for the long table on page 19 of the 10-Q. But we thought it was important to show the quarterly mark-to-market information going to back to the commencement of our physical commodities business. In the future, the information will be confined to the current period and the year-to-date period.

Secondly, I need to emphasize the following points as a caution to listeners. 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 business segment. In all of our other segments, GAAP and mark-to-market numbers are the same. For a reconciliation between the GAAP and the non-GAAP adjusted mark-to-market numbers, please see page 19 of the Form 10-Q. And whenever I talk about an adjusted on this call, I’m talking about a non-GAAP number. So much for the health warnings.

The reason we give you the mark-to-market information is that we don’t believe that it makes sense to discuss the GAAP numbers with you because they don’t reflect the commercial results of our commodities business, and therefore, the results of the company as a whole. We assess all of our business on a fully mark-to-market basis in our daily and monthly internal financial reporting. And we calculate our commodities traders’ bonuses on the basis of fully mark-to-market, not GAAP results.

Moving on, the company’s adjusted operating revenues in the third quarter increased by $4.6 million or 25%, from the $18.7 million last year to $23.3 million this year. However, non-interest expenses increased by $4.2 million or 33%, from $12.7 million last year to $16.9 million in this quarter. As a result, with no change in the interest expense, the company’s adjusted pro forma net income for the quarter of $2 million was virtually the same as the net income of $2 million last year.

To put the expenses in context, our quarterly average employee numbers have gone from 161 to 183 over the past year. And as Scott has pointed out, there is a degree of variability in our expenses that provides a buffer for the company. We have seen a leveling out of our fixed expenses over the past six months, which has also been encouraging. Compensation and benefits make up 59% of total non-interest expenses, compared to 56% last year. And variable compensation that is paid to our traders is based on our mark-to-market revenues.

Interest paid during the quarter was $2.4 million, compared with $2.5 million in the third quarter of 2007. Approximately $475,000 was paid to holders of our convertible notes, both last year and this year. The fact that there was no substantial change in our interest expense compared with the same quarter last year, in spite of the increased levels of business, reflects lower absolute interest rates in our bank facilities, the decrease in margin balances of our commodities brokers as a result of lower mid prices, and generation of cash during 2008 by the company’s businesses.

Comparing the June 2008 quarter with the March 2008 quarter, non-interest expenses decreased 10% from $18.8 million to $16.9 million. Interest expense decreased from $2.8 million to $2.4 million. Adjusted pro forma net income was $2 million in the June quarter, compared with $4.4 million in the March quarter.

Management believes that the company’s performance is best evaluated is a trailing 12 months mark-to-market basis. On this basis, adjusted operating revenue for the last 12 months is $107 million. Adjusted pro forma net income was $14 million. And our adjusted return on average equity has been consistently above 20%.

There were no note conversions during the quarter. The convertible notes, therefore, remain at $25 million. Total assets at the end of June 2008 were $511 million, compared with $398 million at the end of March ’08, and $361 million at the end of September ’07.

The balance sheet at the end of June ’08 includes assets of about $87 million of the INTL Consilium convertible arbitrage fund that we’ve had to consolidate in this past quarter following an additional investment that increased our share of that fund to about 69%. Our balance sheet at the end of June ’08 remained very liquid, with total cash and cash equivalents of $67 million. Eighty two percent of our assets at the end of September – at the end of June consisted of cash, cash equivalents, short term receivables, financial instruments, and liquid investments. This excludes commodities inventory, which has increased from $39 million at the end of September ’07 to $68 million at the end of June ’08, stated at the lower of cost to a market value. The market value of this inventory is approximately $72 million that’s versus the $68 million that we’ve got on the balance sheet. Of this amount, approximately $54 million is metal that we’re able to sell on a very short space of time, including substantial portion of precious metal.

Borrowings, excluding the $25 million of convertible notes were at $123 million at the end of June, compared with $85 million at the end of September last year, and $110 million at the end of March. This represented the spike in usage rather than a typical amount outstanding.

Total third party assets under management in the asset management segment increased from $1.2 billion at the end of June 2007 to $2.3 billion at the end of June 2008, with the vast majority of this increase in INTL Consilium , our asset management joint venture.

I’ll now hand you back to Sean O’Connor to wrap up.

Sean O’Connor

Thanks, Brian. Despite the continued and perhaps worsening situation in the financial markets generally over the last year, our year-to-date results stand out in stark contrast. We are confident that our niche focused approach can generate attractive returns, and believe that the current environment offers fantastic opportunities to accelerate our growth and step in as larger entities retract from niche areas where we have demonstrated expertise. We need to temper our desire to accelerate our growth with the need to run our business prudently and with sufficient permanent capital.

As major shareholders, we need to ensure that we – we need to ensure that we raise capital that is priced efficiently, and are happy to bide our time if need be as we continue growing our current activities.

TK are you there?

Operator

Yes, sir. I am.

Sean O’Connor

Okay. I think we are ready for questions.

Question-and-Answer Session

Operator

Okay. (Operator instructions) Your first question comes from the line of Steve Fagger [ph].

Steve Fagger

Gentlemen, good afternoon.

Sean O’Connor

Hi, Steve. How are you doing?

Steve Fagger

Doing fine. Thank you. Well, an interesting period we’re going through. I was just looking at the Q and the next contribution. I’ve got one question there where you might just share a little extra color, if you would, or a little extra light. I’m looking at the line on asset management. And the number, in terms of the contribution, is essentially unchanged over last year. Yet, by my rough calculation, assets were up by certainly $1 billion over the same period. So what am I missing there?

Sean O’Connor

Okay. Well, there are two factors that go into asset management, which people should be aware of. One is, we have provided some seed capital to our asset management activities. And in fact, that led to the launch of the recent Africa fund, and we think it’s going to help us launch additional products. And that seed capital in aggregate did not do very well for us this last quarter. I mean, it’s going to – we’re slightly down. So we recorded a very small loss on the aggregate seed capital, whereas in prior quarters we had done very nicely. Some of those seed capital accounts were up as much as 50%, 60% per annum. So that’s one aspect.

The second aspect is, while we’re very comfortable with our asset management guys and all of our track records are doing fantastic as well, doing the current quarter, we did fall behind some of our performance benchmarks. And typically, in most of our funds, we have a hurdle rate that gets adjusted monthly. It’s liable on some of the funds. It’s other numbers on other funds. And if we don’t make returns that exceed that, we fall behind that hurdle. And we happened to fall behind that hurdle during this quarter, which means that firstly, we didn’t make performance fees on the current quarter, and in certain instances it led to a – basically, a claw back of prior performance fees that has been reported in the prior quarter. So clearly, we start falling behind on a performance fee basis, you can end up giving back performance fees not just for the current quarter, but for longer periods.

So we had both of those things happening, which offset, quite frankly as you point, the increase asset base that the company’s got. And we’ve continued to see inflow. So investors are very happy with our performance. I think we are now, probably, in the top sort of – definitely, in the top docile of every fund. Some of our funds are number one now in their category, so done very well in a very difficult environment. But that explains the numbers.

Brian, I don’t know if you have anything else to add on that.

Brian Sephton

I mean, Steve, you should just not overlook that we’re getting management fees along with the performance fees. And that forms at least the basis for our income in that segment.

Steve Fagger

Right, right.

Sean O’Connor

Did that answer your question, Steve?

Steve Fagger

Yes it does. No, that’s fine. Thank you very much. Okay.

Operator

Your next question comes from the line of Gram Wayne [ph].

Gram Wayne

Hi, guys.

Sean O’Connor

Hi, Gram. How are you?

Gram Wayne

Doing well. How are you doing?

Sean O’Connor

Good, thanks.

Gram Wayne

Just a follow-up on that last question, how much – can you give a sense of the magnitude of the claw back versus the decline in proprietary account performance?

Sean O’Connor

Brian, do you have those numbers? I don’t have them to hand.

Brian Sephton

I can get them for you, Gram. But I don’t have them to hand right now.

Gram Wayne

Okay.

Sean O’Connor

I mean I would say that there was probably – on the aggregate, probably something like $1 million loss across the board on all that proprietary capital. And any difference beyond that, would be attributable to a claw back of performance fees.

Gram Wayne

Okay.

Sean O’Connor

But I think that accounts for the bulk of the difference. I mean I don’t think it was any great magnitude, any great amount from either of them, but together with enough to make it on a quarter-to-quarter versus on a sequentially quarter basis for us to go backwards in terms of asset management.

Gram Wayne

And is there – any material updates on Gainvest or the Africa – New Africa Hedge Fund?

Sean O’Connor

No. I think Gainvest continues – Gainvest had a difficult quarter, but I think has got a great little business. They continue to do well. Consilium, which is really our – with the bulk of our assets, as I say, performance is going very well. It’s a difficult market, though. I mean, if you’ve looked out there. I don’t what percentage, but certainly, a very big percentage of hedge funds all make it through the year. We’re positive in most of our products.

So we don’t really have any problems. I mean, I think if anything, we’re probably differentiating ourselves in difficult markets. Great businesses always gets (inaudible) in difficult markets. And we’re pretty excited at the moment because we think there’s a lot of pain out there, and a lot of people just on doing that great a job. If we can step in there, we should really be able to draw our business.

Gram Wayne

And just moving to commodities. I feel like I’ve got a pretty good grasp on the unrealized inventory adjustment you guys make. I didn’t fully understand the additional mark-to-market adjustment that you’re making now. Is there any way you can walk through a typical transaction and all the components that might go into that to give me a little bit better understanding?

Sean O’Connor

Well I think, I mean it’s obviously a big issue because we changed the way we’ve done it. And maybe we – I should just give you instead of argue at why we did that and why did it now, and didn’t do it earlier. I guess when these all came about that we started to see that there were major – and they’re really timing differences. At the end of the day, mark-to-market and GAAP, over a long period of time, is going to converge. And it’s already starting to converge if you look at the differences.

But we took the view that we didn’t want to produce a full pro forma because it requires so much judgment by management. And I think, quite rightly, investors always look at it with a little bit of a joined (inaudible) because management does have so much judgment over how to produce a pro forma. So we took the view at the time that something in excess of 90% of the current differences was just an inventory adjustment. And that was a clearly auditable object of number where we didn’t have any judgment over the results. Auditors could review it. They had to do it for a lower of cost of market kind of calculation. And we thought that was just a neat, easy way for us to put forward the information without us having to do a whole pro forma.

And what’s happened over the last a couple of quarters, increasingly is, that difference on its own has just not been capturing the same extent of the difference. And increasingly, those numbers were differing quite significantly from the full mark-to-market numbers that we view. And we just had to jump over the Rubicon and produce pro forma numbers, which is not really half as priced, to tell you the truth.

And a lot of the difference is really accredited to – in the commodities business, we have forward commitments to buy metal, and forward commitments to deliver metal, which we should mark-to-market and do mark-to-market when conditions change. Because both in those contracts are forward freight agreements, cost to deliver, pricing differentials, and so on. And as our business has become bigger, and more complex, and more diverse, there was a big part of the difference that was sitting that was sitting in those contracts. So we decided just to kind of put it all out there. You now see the numbers the way we see them.

I guess, in retrospect, it probably would have been better for us just to be bit in the bullet when we started this on just on a full pro forma. And I guess, if there’s any criticism, and that’s probably a criticism of me for not having done that in the beginning. But that’s the way it is, and we try to give people as much information as we can so they can see the business the way we see it, and make the right judgments.

Scott Branch

Gram, to give you a specific example, which I think would help to clarify some of these. And also, to bring in the fact that as our business has grown and changed, it has had an impact on the components that go into this other mark-to-market category. And in particular, the example I’ll run through relates to the copper business, which is one of our newer activities.

And in the copper business, we are entering into contracts with commercial customers to buy and sell copper at fixed prices in the future. So let’s run through an example where we commit to buy copper at a fixed price. If we commit to buy copper at a fixed price, we would hedge ourselves against the market risk associated with that contract by going short of derivative very similar to what we do in the inventory situation where we’re running physical inventory.

Now, under the accounting that’s out there and in GAAP, we have to mark-to-market that short derivative. But the purchase commitment that we have in place doesn’t get marked-to market and is not included in our GAAP results. And it’s those forward commitments and the other components that Sean mentioned that go into those forward commitments, such as estimates, shipping costs, and some cases, conversion costs of converting metal from one form to another that formed these mark-to-market components. And it was really when – particularly, in the copper business when we began entering into forward priced commitments and put on derivatives against those that hedge out the market risk that we essentially duplicated on commitments, the same situation that we run into with inventory.

Gram Wayne

Okay. Yes. That’s very helpful.

Brain Sephton

Gram, sorry. I’m going to add one more thing just to be clear on the accounting front. If we could, we would like to include these in our numbers. But when we began this business over two years ago now, we have discussions directly with the SEC about some of the more difficult accounting aspects. These forward commitments don’t qualify under FAS133 to be treated as derivatives. And also, they don’t qualify under ARB43 where you’re required to recognize any potential losses on purchase commitments. So on both of those scores, we don’t meet the hurdle for bringing it in under GAAP.

Gram Wayne

Okay. So I mean it’s the same – it’s the exact same hedging strategy as you do for physical inventories. It’s just a forward commitment instead of an inventory.

Scott Branch

That’s a part of it, yes. But in that part of it, it’s virtually identical to what happens with the inventory. But because these purchased commitments also involve us buying things at locations, which are non-market deliverable locations, we end up incurring freight cost or we may buy in a far more great that isn’t exactly deliverable to the marketplace. And the estimate of our costs of getting what we buy to where we want to sell it, and at the – in the form that we want to sell it is also included in these other mark-to-market adjustments.

So as you might expect, for example, as shipping costs go up, we have to change our estimates about that. It’s not a big part of the components, but I don’t want to say it’s simply forward purchased commitments with derivatives offset against it. There are other factors, which come into play as well.

Gram Wayne

Okay. That’s very helpful. Thanks for taking the time to walk me through that.

Scott Branch

Sure.

Gram Wayne

Then the last thing I have is, Sean, any sign of the debt capital markets picking up? I mean –?

Sean O’Connor

It’s very tough out there at the moment, as you can imagine. I mean essentially, we in the business saw bringing smaller issue as to markets. And they’re just not the same appetite there was six, nine months ago. So for us it’s a very small overhead. It’s a small part of our business. It’s not a very meaningful part of our business. I mean it’s a part of our business, I think, we can grow a lot. They do have some very interesting deals in the pipeline. But a lot of these deals are further three to six months delayed from where we expected them originally. So I can’t really give you a clear answer.

I mean it’s a business we’re comfortable with. We have a very small overhead in that business. And if we sort of hit our stride in that business, it can make an enormous return for us, so. Committed to it, we want to see if we can grow it. But no real find as to how things are going to change out there other than the issues are getting more desperate. And we need to see the investors becoming interested so we can match them up, so.

Gram Wayne

Okay. Well, thanks a lot for your time.

Sean O’Connor

Okay. Thank you.

Operator

Your next question comes from the line of Steven Spark [ph].

Steven Spark

Hello, Scott and Sean. Can you hear me?

Sean O’Connor

Yes. I can hear you, Steven. How are you?

Steven Spark

Doing well. Thank you.

Sean O’Connor

Good.

Steven Spark

When I saw the earnings last night, I really felt like, when I came in today, I probably see the stock moving up to $40. So a little bit surprised that the market didn’t have the same sentiment that I had on this. And would you like to add your opinion on how the market reacted to the earnings?

Sean O’Connor

Typically, we just don’t like to take a view on what the market does. I think our job is to get out there and run the business, and try and run the business we can, and build the business. And as I say, I think, we’re extremely excited at the moment. Our business is running very well. We’re achieving fantastic ROEs. And it’s interesting that when the rest of the financial market’s sort of falling over, we continue to do fairly well, in my view. And yes, a bit of a surprise, but you can’t second guess the markets. And our view has always been, if you deliver the results and you deliver the growth, the market will value you correctly. And it’s an interesting thing that was brought up by investment bankers that over five and a half years now, we’re the number one performing financial services stock in the US by a substantial margin.

So I think people have recognized what we’ve done here, and since we built the company up from very small beginnings. But you’re going to have variations from day-to-day. And unfortunately, I think people do look at quarters in a snapshot. And we just don’t believe that’s the right way to look at a business like ours.

Steven Spark

You think perhaps the change of the accounting method confused individuals. For example, last quarter, you were sitting on about $16 million in unrealized gains last quarter. And I had a hard time trying to figure out where do we stand now with that $16 million unrealized.

Sean O’Connor

Well we have about, Brian, $4 million, right?

Brian Sephton

Yes.

Steven Spark

In inventory.

Sean O’Connor

Yes. Just on the inventory side, we have $4 million in unrealized gains forfeiting in inventory. So if we had to close the business down, the commodity business tomorrow, we have realized $4 million profit liquidating on inventory.

Steven Spark

Or about $12 million shy from where we were last quarter. In my calculations, and I was kind of looking at last quarter, at $16 million given the corporate tax rate and the number of shares outstanding, I really had factored that would be roughly $1.10 in earnings. I don’t see where that’s actually occurred.

Sean O’Connor

Yes. Well what’s happened is this discussion that just – we had with the prior caller that there have been other mark-to-market differences that we haven’t disclosed separately, which have to have offset some of that, and hence, why we decided at this point to go for a full mark-to-market even though that involved a lot of judgment. As presenting a full set of pro forma account, I think we thought that was the better way to go. So that’s where some of the difference resides.

And if you would like, you could speak to Brian. He could probably take you through, off the conference call, the numbers that we’ve got in the Q. If you look at page 18, I believe of our Q, you’ll see a lot of information set out there, and that should help you.

Scott Branch

But Steve, also, the significant difference between the GAAP and that income being greater than the mark-to-market or non-GAAP net income is, I know it seems hard to understand when you put it this way, but that is a realization of a substantial portion of those prior unrealized earnings. What happens is, is it comes through in an increase in GAAP over non-GAAP. Because the reason we had GAAP of over $6 million is that it was – a lot of that was the inventory profits being realized. That make sense?

Steven Spark

That’s probably, why, yes, the computing has been going on with the market. Roughly, $30, $31 is probably not that – certainly, not very clear.

Scott Branch

Actually, I think that the market’s reaction probably shows that they do understand our mark-to-market situation. We came out with – in comparison to the preceding quarter, weaker mark-to-market numbers and the stock price went down. But at the same time, we had very good GAAP numbers, which we’re relating to the realization of prior earnings. And I don’t think it’s happened in a way that would really be unanticipated, and the market’s reaction, although, a bit extreme, I think demonstrates that they are following our non-GAAP numbers. And hopefully, understand them.

Steven Spark

A follow-up question also, if I could, on the convertible note holders. What was the timeframe that you could force the conversion there? Wasn’t there some sort of stipulation if it traded over $28, whatever price it was, for over 30 days, and you could force that conversion?

Sean O’Connor

There are two clauses to that. I don’t have the exact numbers or dates in front of me. Brian may have. But yes, we can force conversion if the stock trades. And the number’s more like $38, Steve.

Steven Spark

Oh yes. Okay.

Sean O’Connor

Okay. And in addition, we can call the notes at a 10% premium at a certain date, which I believe is about 18 months away. And clearly, I would expect that if they are more than 10% in the money, the note holders would convert rather than take the 10% premium.

Steven Spark

Right.

Sean O’Connor

So those are the two sort of triggers for us that are available to us at this point.

Brian Sephton

All right. Just to be clear, it’s $38.21 is the price. And it’s anytime from now on where it trades above that price for 20 out of 30 days.

Steven Spark

Thank you, Brian.

Brian Sephton

Okay.

Operator

Okay. (Operator instructions) Your next question then comes from the line of Bob Sauk [ph].

Bob Sauk

I’m a private investor. I was glad to hear you say on a short term basis, the market interpreted the earnings properly. So would you explain a little bit more why the adjusted commodity revenue is down considerably from the preceding two quarters? I understand there are mark-to-market and shipping, and all that stuff. But was it the exotic type of contracts that you entered into? Why the significant change?

Sean O’Connor

Okay. Bob, a couple of things, we don’t do exotic contracts. We do very simple stuff. But it is a seasonal business. It is lumpy. We end up signing big contracts from time to time with people doing big deliveries in certain weeks and none in other weeks. So there is a certain amount of seasonality in the business. And that certainly affects. If you look at our – the same quarter last year, this was also a weak quarter for us last year. So I’m not sure if that means that this is always going to be a weak quarter. But certainly, it was our experience last quarter.

The second thing is, where our base metal – well, both of our precious and base metals businesses sort of earned a super return, if you like, is when the markets become very volatile and price discovery becomes difficult. And it allows us to do certain arbitrages, which really enhance our profitability. So when the lead price was going up very quickly, we were very quick in taking certain opportunities to buy lead at very good prices and certain locations, which gave us a very big profit margin. The market changed a little bit during the quarter. And it led to less of those opportunities being available to us.

So the sort of super profit we had enjoyed maybe in the first two quarters just wasn’t there for us in this quarter. Now, that could change again. But what we would really like is volatile – not too volatile, but somewhat volatile and dislocated markets. That really, for us, is the best scenario. And in some of our metals markets, that didn’t really worked for us this quarter.

So nothing that we’re terribly concerned about, but yes, there was a big difference. And some it seasonality, and some of it is just the prices. As the price moves, it just didn’t work for us, and didn’t allow us to take a bigger spread. But to be clear, we do not take directional views in our commodity business. Where we get kind of lucky, if you like, is when the market allows us to take an exceptional spread out of a trade because the price has moved or we just happen in the right location with the customer and find the metal on the other side, and stuff like that, so. And sometimes you get lucky with stuff, and sometimes it’s not so easy.

Bob Sauk

So the direction of the volatility has something to do with your profitability.

Scott Branch

In the case of the base metals business, it can be a factor. Some of what Sean is referring to is that in – when we look at these location arbitrages in trying to be able to find metal at attractive prices that can – the metal that we can source at attractive prices. But the price movements can lag the overall market.

So what happened, particularly in the case of lead, where we had a rising lead price, there was a widening gap between the market price that we could hedge ourselves at and the price at which we could source lead. As the lead price began to stabilize, and in fact, at the end of the quarter began to come down, the ability to source that physical was still on a rising price mode where the market price had already started to fall. And the arbitrage that we previously found, that window closed for a period of time. And those windows will open and close depending upon price movements. But in that particular segment of the business, yes, we find that arbitrage opportunity in a rising market and not in a falling market.

Bob Sauk

But you do still have opportunities to make money in the falling market?

Scott Branch

Absolutely. It’s this one particular source of metals that we are looking at. But there are other opportunities. They may not be as extreme as they were during the first and second quarter for us. But yes, I mean it’s still a nicely profitable business.

Bob Sauk

Well, thank you. I feel better about it. And I do like your new method of reporting.

Scott Branch

All right. Thanks, Bob. Any further questions?

Operator

No, sir. There are no further questions at this time.

Scott Branch

Okay. Thanks very much. Thanks very much, everyone, for listening in. And as always, if there are questions beyond what we’ve covered in this conference call, we’d be very happy to take them through the Investor Relations section of our Web site. Have a good evening.

Operator

This concludes today’s conference call. You may now disconnect.

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