INTL FCStone Inc. (NASDAQ:INTL) Q2 2019 Earnings Conference Call May 8, 2019 9:00 AM ET
Bill Dunaway - Chief Financial Officer
Sean O'Connor - Chief Executive Officer
Conference Call Participants
Erick Sönne - Private Capital Management
Good morning, ladies and gentlemen and welcome to the INTL FCStone Incorporated Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions].As a reminder, this conference call is being recorded.
I would now like to turn the conference over to your host Mr. Bill Dunaway, Chief Financial Officer. Please go ahead.
Good morning. My name is Bill Dunaway. Welcome to our earnings conference call for our fiscal second quarter ended March 31, 2019. After the market closed yesterday, we issued a press release reporting our earnings for the second fiscal quarter of 2019.
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 in our discussions of our quarterly and year-to-date results. You will need to sign on to the live webcast in order to view the presentation. 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-Q 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 statement whether as a result of new information future events or otherwise. Participants are cautioned that any forward-looking statements are not guarantees of future performance.
With that, I will now turn the call over to Sean O'Connor, the company's CEO.
Thanks, Bill. Good morning, everyone and thanks for joining our fiscal 2019 second quarter earnings call. Market conditions were less favorable during this quarter than they were in the immediately prior quarter, with reduced volatility across the board; trade and political concerns; significant changes in future interest rate expectations, including a yield curve that briefly inverted all weighing on the market. These tougher conditions were reflected in many of the earnings you have seen recently from banks and broker dealers. That said, it seemed as if we're heading into a more positive tone in the market of late with threats of economic slowdown waning and more positive economic news here and abroad and the equity markets hitting new highs.
Our reported Q2 earnings were very strong and almost a record for us. While this appears to be counter to the market conditions just mentioned we did have a reversal of some mark-to-market items from Q1, which we had previously highlighted and discussed. And our core operating earnings excluding these one-off items did show a decline versus the immediately prior quarter, due to the difficult market conditions mentioned above.
For the second quarter, we reported operating revenue of $271 million, up 4% from a year ago and up slightly sequentially from Q1. Net income was $23.4 million, or $1.21 per diluted share both up around 3% from a year ago. This represented an ROE of 17.4%. And sequentially, from Q1 both net earnings and EPS were up 29%. There has been some noise in our earnings for each of the first two quarters, which I would like to highlight.
As mentioned last time, our Q1 earnings were negatively affected by approximately $11 million of unrealized mark-to-market losses, due to year-end lack of liquidity which caused some longer-dated options, which were all directionally hedged to trade away from fair value. In addition in Q1, operating revenues in our Precious Metals business were affected by a $1.6 million unrealized mark-to-market loss on hedges in place against inventory carried at a lower cost of the market.
In Q2, we saw a complete reversal of the $1.6 million mark-to-market loss on Precious Metals and a $6.4 million reversal on our options position. We are thus still carrying around $4.6 million mark-to-market losses on these positions, all of which have been directionally hedged. In addition, Q1 earnings included a $2.4 million recovery on bad debt on physical coal, as well as a $2 million net settlement in our favor in the Barclays last look matter.
Finally, in the second quarter we recorded a non-recurring bargain purchase gain on the acquisition of GMP of $5.4 million. However, this was partially offset by $1.2 million in operating loss for the quarter for this acquired business.
Looking at our year-to-date results. Much of this noise has been eliminated over the two quarters and we are left with approximately $4.3 million of positive adjustments in pre-tax earnings for the six-month period.
On a year-to-date basis operating revenues increased 13% from a year ago and pre-tax income was up 15%. Net earnings were up 163% due largely to the impact of tax reform in the comparative period a year ago. EPS is currently $2.15 for the six months, up 165%. Our ROE over the six-month period was 15.8%.
Some highlights before I hand off to Bill. Our Global Payments business continues to power ahead with strong operating revenue growth versus the prior year and segment income up 17% for the quarter and 22% for the year-to-date. This business is now in a run rate for segment income, which is after all direct costs, up nearly $17 million on an annualized basis.
Commercial Hedging showed modest revenue growth for the quarter, despite very difficult market conditions with low prices and exceptionally low volatility. These results were, of course, impacted by the mark-to-market noise I mentioned earlier, which, if excluded, showed segment income roughly unchanged for the year-to-date period from a year ago. I would like to highlight that our LME desk reported record segment income in the second quarter. This is less than a year after we had a fairly major restructure of the desk to bring in some new talents and better employee technology.
In Securities, our operating revenue was up 31% for the quarter and 44% for the year-to-date, while segment income was down 8% for the quarter, but up 17% for the year-to-date. The apparent decline in margin reflected in these numbers is due to difficult market conditions in our Argentinian business, as well as growth in our securities lending and net repo business, which is a low-margin business for us, but generates stable margin income and creates free cash for us.
An additional factor was the inclusion of GMP, which made a loss for the period, although this trend has started to reverse. And we are also making headway in new activities such as U.S. agency equity execution and prime brokerage.
Operating revenues for Physical Commodities business was up 28% for the quarter and 31% for the year-to-date. Segment income was up 39% for the quarter and up over 100% for the year-to-date period, driven by solid results from our ags business and a record performance for the Precious Metals business, as well as the recovery on the bad debt on physical coal mentioned earlier. Our Clearing & Execution segment income was down 9% as we reviewed and exited some clearing relationships where we did not see the right risk-reward profile for us.
We announced that we'll be acquiring the Futures and Options clearing business of UOB Bank in Singapore. This is a well-established business, owned by one of the premier banks in the region and will give us critical mass in Asia. We are excited by this, which is a transformational step for us in Singapore. We are currently going through the regulatory approval process, but expect to close in Q4.
During the quarter, we also announced the acquisition of CoinInvest, a former client of ours. They bring a technology solution, which will allow clients, mainly investors and traders, to purchase all forms of precious metals and coins in multiple forms and in the denomination of their choice anywhere in the world. This adds enormous reach to a new category of clients in a scalable technology offering.
Following the closing of the acquisition of GMP Securities, we have made good progress on integration. Their broker dealer has been merged into our existing broker dealer. Our rates team has relocated to their premises and we're already starting to see an upturn in revenues and some real evidence of cross-sell. Early days, but all very encouraging.
We also announced our new prime brokerage activity with the addition of a team that we have known well and think very highly of. We have most of the infrastructure and capabilities, such as clearing, custody and stock lending now in place, following the acquisition of the securities clearing business some three years ago.
It was a logical extension for us to offer this capability to the institutional and hedge fund market, especially those entities seeking bulge-bracket capabilities, but too small to gain the attention of these players. This is an organic build-out, but with tremendous potential for us in the long term and should provide operational leverage as we build on existing infrastructure and capabilities.
Lastly, on the OptionSellers matter, we continue to work our way through the legal process and it is only likely we'll know the results of the first arbitration proceeding much later in the year. The aggregate receivable due from these fines remains at $29.4 million and we continue to aggressively pursue collection of amounts due to us.
We have, again, done an assessment of the collectability of these accounts, considered the status of arbitration proceedings and have concluded we do not have a sufficient basis to record an allowance against these balances at this time.
With that, I'll now hand you back to Bill Dunaway for a more detailed discussion of the financial results. Bill?
Thank you, Sean. I'll be referring to slides in the information we have made available as part of the webcast. Specifically starting with slide number 3, which shows our performance over the last five fiscal quarters. The chart depicts our net income, earnings per share and ROE over the last five quarters.
As shown, net income in the second quarter of 2019 was $23.4 million, which represents a $5.2 million improvement over the immediately preceding quarter and a $700,000 improvement over the prior year. It is of note, each of the last five quarters have represented double-digit returns on equity with three of the five quarters exceeding our internal target of 15%.
Moving on to slide number four, which represents a bridge between operating revenues for the second quarter of last year to the current period. Operating revenues were a record $271.1 million in the current period, up $10.9 million or 4% over the prior year. As shown, all operating segments showed revenue growth over the prior year with the exception of Clearing & Execution Services.
This growth was led by our Securities segment, which added $17.1 million or 31% in operating revenues versus last year. Within this segment, Equity Capital Markets added $8.4 million in operating revenue versus the prior year, primarily as a result of increase in securities lending activities as well as a 16% increase in the dollar volume traded versus last year.
In addition, our Debt Capital Markets business added $9.4 million in operating revenue versus the prior year, primarily driven by an increase in interest income in our domestic business driven by higher short-term interest rates as well as the acquisition of GMP Securities. These gains were partially offset by weaker revenues in our Argentine business due to difficult market conditions.
Physical Commodities added $4.3 million or 28% in operating revenues versus the prior year, driven by a $3 million increase in Precious Metals, up strong volume growth and the reversal of the unrealized mark-to-market loss Sean just mentioned.
In addition, Physical Ag & Energy operating revenues added $1.3 million versus the prior year due to increased activity in commodity financing programs. Our Global Payments segment had another strong quarter adding $4 million or 17% versus the prior year to $27.4 million as the number of payments made increased 6% and the average revenue per payment increased 8% versus the prior year.
This growth was driven by increased activity from our international banking clients particularly related to capital transactions, mergers and acquisitions and smaller recurring payment.
Operating revenues increased in our Commercial Hedging segment by $2.3 million versus the prior year to $80.6 million. Exchange-traded volumes declined 13%, driving a $2.2 million decrease in exchange-traded transactional revenues.
In addition OTC volumes declined by 7% versus the prior year. However OTC transactional revenues increased $2.8 million driven by the reversal of unrealized mark-to-market losses Sean mentioned earlier.
Exchange-traded volumes declined due to the lower client activity in the domestic grain markets as a result of lower grain prices and volatility, as well as the decline in volumes from certain omnibus relationships. These declines were partially offset by a strong quarter in our LME business. The decline in OTC volumes is primarily a result of the decline in Brazil -- activity in our Brazilian grain business.
Finally interest income in this business increased 43% to $7.3 million driven by higher short-term rates and a 3% increase in average client equity to $918 million. Finally operating revenues in our Clearing & Execution Services segment declined $14.4 million or 16% as compared to the prior year.
Exchange-traded revenues declined $14.3 million as volumes decreased by 23% versus the prior year following the exit of certain clearing relationships Sean mentioned earlier. However I'll touch on shortly how this declined and tempered -- how this decline had a tempered effect on segment income.
Partially offsetting the decline in exchange rate environment -- interest income in the exchange-traded business increased $2.9 million driven by higher short-term rates which was tempered by a 14% decline in average client equity to $1 billion. Also in this segment Correspondent Clearing operating revenues increased $1.6 million driven by an increase in interest and fee income earned on client balances driven by higher short-term rates.
Independent Wealth Management and Derivative Voice Brokerage operating revenues declined $900,000 and $600,000 respectively versus the prior year. The net decline in unallocated overhead operating revenues of $2.4 million was driven primarily by a $2.4 million mark-to-market swing in the value of exchanged shares held for preferential clearing rates.
The next slide number 5, represents the bridge from 2018 second quarter pretax income of $29.5 million to pretax income of $30.9 million in the current period. Commercial Hedging segment income increased $2.6 million as a result of the increase in operating revenues I just mentioned combined with a $2.1 million decline in variable expenses which was partially offset by a $2 million increase in nonvariable direct expenses including an $800,000 increase in bad debt expense.
Global Payments added $2.3 million in segment income to $15.8 million while Physical Commodities added $2.2 million versus the prior year. While operating revenues increased in our Securities segment, segment income declined $1 million versus the prior year as the $13.8 million increase in interest income in this segment was more than offset by a $15.4 million increase in interest expense primarily in our domestic fixed income and securities lending activities.
As mentioned earlier, while operating revenues in our CES segment declined $14.4 million versus the prior year the segment income declined a more modest $1.1 million due to the increase in interest income as well as lower transaction-based clearing expenses and introducing broker commissions.
Slide number 6 shows the interest and fee income on our investment of client funds in our Exchange Traded Futures & Options businesses as well as client balances held in our Correspondent Clearing and Independent Wealth Management businesses.
As noted on the slide our earnings on these balances have increased $5.8 million versus the prior year to $16.6 million as our yield on these balances has increased 60 basis points to 2.36% in the current period.
Interest income on these balances declined $1.3 million versus the immediately preceding first quarter of 2019, primarily driven by an $85 million decline in Commercial Hedging average client balances as a result of lower domestic grain customer activity, as well as a $311 million decline in average client balances in our CES exchange-traded business following the exit of certain clearing relationships mentioned earlier.
Moving on to slide number 7, our quarterly financial dashboard. I will just highlight a couple items of note. Variable expenses represented 57.4% of our total expenses for the quarter, well above our target of keeping more than 50% of our total expenses variable in nature.
Non-variable expenses, which are made up of both fixed expenses and bad debt expense increased $9.7 million, primarily driven by the recent acquisitions of GMP Securities, PayCommerce financial solutions, and Carl Kliem as well as the launch of our securities prime brokerage initiatives.
We reported net income of $23.4 million in the second quarter for a 17.4% return on equity above our stated target of 15%. Net income in the second quarter includes a $5.4 million pre-tax bargain purchase on the acquisition of GMP Securities. Our total assets increased 31% versus the prior year, primarily due to increased activity in our domestic fixed income and securities lending activities.
Finally, in closing out the review of the quarterly results, our average revenue per employee declined 9% to $595,000 on an annualized basis but still remained above our target of $500,000. And our book value per share increased $4.15 to close out the quarter at $28.89 per share. We did not repurchase any of our common stock during the second quarter.
Next I will move on to a discussion of the year-to-date results and we will refer to slide number 8. Year-to-date operating revenues were up $63 million or 13% to $535.8 million in the current fiscal year. All segments of our business reported increases in operating revenues as compared to the prior year-to-date period.
The largest increase was in our Securities segment, which added $43.1 million, driven by strong growth in Equity Capital Markets volumes as well as increase in interest income related to securities lending and domestic fixed income activities.
Our Global Payments and CES segments added $9.1 million and $8.6 million, respectively while our Physical Commodities segment added $8 million versus the prior year-to-date period. Commercial Hedging operating revenues were relatively flat added -- adding $600,000 versus the prior year.
Moving on to slide number 9, for a discussion of the variance in pre-tax income by segment for the year-to-date period, the largest variance was seen in our Physical Commodities segment, which added $7 million versus the prior year as a result of the increase in operating revenues as well as a positive $3.4 million variance in the bad debt on physical coal.
Our Global Payments segment added $6.3 million versus the prior year as a result of a 6% growth in the number of payments made as well as a 10% increase in the average revenue per trade.
In addition, the CES segment added $6.1 million in operating revenues driven by the $2 million Barclays last look net settlement received in the first quarter as well as a $3.9 million increase in Correspondent Clearing revenue.
Segment income in our Securities segment increased $4 million as a result of the strong performance in our Equity Capital Markets business, which was partially offset by weaker performance in Argentina.
Finally, Commercial Hedging segment income declined $5.2 million primarily as a result of the mark-to-market loss, Sean noted earlier.
Finally, I will touch on the year-to-date dashboard, which is slide number 10 in the presentation deck. Variable expenses are above our internal target of exceeding 50% of total expenses coming in at 60.1% of total expenses.
Net income was $41.6 million for the current year-to-date period as compared to $15.8 million in the prior year with the prior year-to-date period including a 21 -- $20.1 million charge related to tax reform. The return on equity for the year-to-date period is 15.8%, which is above our internal target of 15%.
With that, I would like to turn it back to Sean to wrap up.
Thanks, Bill. We continue to deliver good results from our business model with a record fiscal 2018 and now two solid quarters, which improved upon that result for 2019.
Our franchise is starting to gain traction and we see opportunity to grow organically as clients and talented individuals see the benefit of our unique global platform and capability. In addition, we continue to see larger players exit markets and smaller players consolidate, which provides opportunities to accelerate growth through disciplined acquisition.
Our model allows us to offer a wide range of products and capabilities to our clients, making us more relevant to each client and in turn each client more valuable to us with more diversified and predictable revenues.
Furthermore, unlike more narrowly focused firms, we are leveraging our central infrastructure and capital across many different business lines, creating operational leverage and producing better returns on capital.
With that, I'd like to hand back to the operator and open the Q&A session. Operator?
[Operator Instructions] We have our first question from Erick Sönne with Private Capital Management. Your line is now open.
Good morning, guys. A quick question on the UOB…
How are you? I had a question on UOB acquisition. Just wanted to see if you can provide any additional color in terms of what capabilities that should bring to the table and in terms of size of the opportunity for us. And more or less if there is a way to talk about the valuation of the business if it is material to us.
Okay. Erick so a lot of this is under NDA which haven't been completed. So, unfortunately I'm unable to give you the specifics you desire. But what I can say is this is a business that looks very similar to what we do in the U.S. in terms of offering derivative, exchange execution, and clearing to clients both commercial clients and institutional clients.
They do this out of Asia. They really have a good client footprint in Asia. So, from our perspective, it's kind of the same business we do everywhere else but what we're acquiring is a good client footprint in Asia.
And as I said in my opening remarks, we've always thought that we are underrepresented in Asia given our capability set and the market opportunity there. And I think this will definitely put us on the map in terms of giving us critical mass.
In terms of the acquisition price, this was a good deal for us. The premium we're going to have to pay is very small amount of money. I mean single-digits of millions of dollars. We will have to take on a lot of the infrastructure because we are now moving our Singapore business from being effectively a sales office to being a fully regulated business. We believe that the incremental revenue from various clients will more than offset the pretty significant incremental costs we're going to have to put in place to upgrade our presence.
So, we think this will be a net positive for us with a very small purchase price. But more importantly, I think it just gives us critical mass and scale that we can build upon. So, in overall scheme of things, I don't think it's going to be material to our numbers in any respect, but I do think it's a pretty big step for us from a critical mass point of view.
Okay. Thank you. And then jumping onto Global Payments. The revenue per million kind of inflected upwards in the last two quarters. Is there any specific in the mix that can explain that dynamic?
Well, as you know we did a while ago exit some of change how we interacted with some of these online platforms where we had thousands of small payments. So, that's still working its way through. It's largely out of our numbers now, but there's a little bit of that.
But I think the two other factors that probably were more material with that was the fact that we now have a fully-fledged presence in Brazil and a lot of the payments that we are now facilitating in Brazil have gone up materially in size because prior to that we're capped at $100,000 payment size. Just the local regulations required that. We can now do payments of any size. And so those payments have gone up materially in size and that's a pretty big payments corridor for us.
And then additionally I think we've just found over the last six months for whatever reason we seem to be just getting larger payments from some of our banks. And I don't know why that is to be honest with you because typically the very big payments in the multiples of millions generally went through their own FX desks. But we're starting to find that some of those payments are just being sent through to us now. So, it's a welcome development because obviously we make kind of more money on those payments. So, I think it's all three of those factors combined.
Thank you very much. Congrats on this kind of numbers.
Okay. Operator if there are no -- are there any questions queued up?
We have no further question at this time sir.
Okay. So, thanks everyone. Thanks for joining the call and we will be speaking to you in three months. Thanks. Bye, bye.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You have a wonderful day and you may disconnect.