INTL FCStone Inc. (now associated with StoneX Group Inc.) — Q2 FY2016 Form 10-Q
Business and period: The diversified financial-services company reported its fiscal second quarter and six months ended March 31, 2016. The quarter-over-quarter comparisons below are against the three or six months ended March 31, 2015. The filing presents physical-commodity sales gross but most other business revenue net, so operating revenue is more useful for assessing performance than total revenue.
Financial performance
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Total revenue | $3,708.9m | $14,442.0m | $7,108.8m | $28,069.7m |
| Operating revenue | $166.1m | $156.5m | $317.4m | $294.0m |
| Net operating revenue | $112.9m | $107.9m | $215.6m | $201.1m |
| Income before tax | $20.0m | $18.1m | $32.1m | $31.7m |
| Net income | $14.5m | $13.0m | $23.3m | $22.4m |
| Diluted EPS | $0.76 | $0.67 | $1.22 | $1.16 |
- Q2 operating revenue rose 6%, net income 12%, and diluted EPS 13%. For the six months, operating revenue grew 8% and net income 4%.
- Q2 net operating revenue was about 68% of operating revenue, versus about 69% a year earlier; net income was about 8.7% of operating revenue, versus about 8.3%. These are simple calculated ratios, not company-reported margin measures.
- Q2 expenses included $32.9m transaction-based clearing costs, $13.2m introducing broker commissions, $7.1m interest expense, and $92.9m compensation and other expenses. Interest expense increased 58% year over year, primarily with fixed-income trading and higher working-capital borrowings.
- Segment results were mixed: Q2 Securities operating revenue increased 26% to $45.6m and segment income rose 49% to $18.2m; Commercial Hedging operating revenue fell 15% to $54.7m and segment income fell 36% to $13.8m. Global Payments revenue fell 5% to $17.4m; Physical Commodities revenue increased 23% to $7.9m, while segment income declined 21% to $1.9m; Clearing and Execution Services revenue increased 6% to $33.3m.
Cash flow, balance sheet, debt and liquidity
- Cash and cash equivalents were $203.2m at March 31, 2016, down from $268.1m at September 30, 2015. Six-month operating cash flow was negative $147.3m; investing cash flow was negative $8.0m; financing cash flow was positive $97.4m. The operating cash outflow reflected substantial changes in trading and customer-related balances, including securities purchased under resale agreements and financial instruments.
- Total assets were $5,657.9m and stockholders’ equity was $408.2m at March 31, compared with $5,070.0m and $397.1m at September 30, 2015. Customer payables were $2,458.0m; repurchase-agreement payables were $1,115.7m.
- Total indebtedness was $197.0m: $148.3m drawn on committed credit facilities, $3.2m of equipment-backed bank borrowing, and $45.5m of 8.5% senior notes due July 2020. Total indebtedness was $87.1m at September 30, 2015. The company reported compliance with all debt covenants.
- Committed facilities totaled $370m. The company said $165m of facility commitments were scheduled to expire within 12 months of the filing and expected to renew or replace them. It also had a $50m secured, uncommitted facility. Management stated that cash flows, available cash, and borrowing capacity should meet anticipated liquidity needs.
- Management described approximately 96% of assets as liquid, but much of the balance sheet consists of customer, counterparty, collateral, or regulatory-related balances and should not be treated as unrestricted corporate cash. The filing reported $152.1m of cash, cash equivalents, and available-for-sale securities at foreign subsidiaries; management intended to keep these funds invested abroad.
Changes, outlook, risks and unusual items
- Revenue drivers: Q2 Securities benefited from wider equity-market-making spreads and improved debt-trading results. Commercial Hedging was pressured by a 33% decline in OTC volumes, lower energy prices and volatility, and weaker Latin and South American activity. Global Payments processed more payments, but lower average revenue per trade reduced quarterly revenue. CES benefited from higher FX prime-brokerage volumes.
- Acquisition and comparison effects: The G.X. Clarke fixed-income business contributed to Securities and interest-income growth; the prior-year six-month comparison included it for only part of the period. Management attributed $3.8m of Q2 interest income and $17.0m of six-month interest income to the business, compared with $5.2m in the prior-year six-month period.
- Unusual valuation impact: Q2 operating revenue included a $6.9m pre-tax unrealized gain from the company’s interest-rate management program (Treasury notes and swaps); the six-month period included a $0.2m unrealized gain. The company said it did not actively trade these positions and intended to hold investments to maturity, but fair-value changes flow through earnings and may fluctuate.
- Accounting presentation: A 2015 transfer of part of the precious-metals business to a regulated subsidiary changed precious-metals revenue and cost-of-sales presentation from gross to net. Management said this did not affect operating revenue, pre-tax income, or net income, but it contributes to the large year-over-year decline in reported total revenue.
- Credit and market risks: The business faces counterparty default, margin-call and liquidity risks, as well as volatility in commodity, securities, foreign-exchange and interest-rate markets. Six-month bad-debt expense increased to $4.6m from $2.8m; customer receivable allowances were $12.9m. The filing describes daily collateral and credit-limit monitoring.
- Legal contingency: In the Sentinel litigation, a March 28, 2016 court ruling favored the company on the trustee’s post-petition claim but ruled against it regarding reserve-account funds. Both sides appealed in April 2016. Management said losses related to the trustee’s appeal were neither probable nor reasonably possible and that it intended to defend the case.
- Other forward-looking matters: Management provided no quantified earnings guidance. It highlighted potential effects of market conditions, regulation, competition, key-personnel loss, counterparty failures, and technology changes. Dodd-Frank requirements remained subject to rulemaking, and the company was assessing future MiFID II/MiFIR requirements. Management said there were no material changes to the risk factors in its prior Form 10-K.
- The company repurchased 400,306 shares during the quarter at an average $25.89 per share; 599,694 shares remained authorized under the fiscal 2016 program at March 31.
Investor verification priorities
- Reconcile operating revenue and earnings growth with the $6.9m Q2 unrealized interest-rate-program gain and assess results excluding that valuation effect.
- Review the drivers and durability of Securities’ growth, including G.X. Clarke’s contribution and Argentina-related performance, against the decline in Commercial Hedging OTC activity.
- Track cash-flow volatility, restricted/customer-related balances, borrowing usage, and renewal or replacement of facilities approaching expiry.
- Monitor bad debts, customer and counterparty exposures, collateral adequacy, and the Sentinel litigation appeals and reserve-account issue.
- Distinguish gross physical-commodity sales from operating revenue when comparing periods, and confirm the effect of the precious-metals accounting presentation change.