Stonex Group Inc. quarterly report, Q2 FY2015

Business context and reporting period

INTL FCStone Inc. (now identified in the request as StoneX Group Inc.) filed this unaudited Form 10-Q for its fiscal second quarter and six months ended March 31, 2015. The company provides global financial services across commercial hedging, payments, securities, physical commodities, and clearing and execution. Comparisons below are with the corresponding 2014 periods.

Financial performance and position

Total revenue includes physical commodity sales reported gross; operating revenue deducts their cost of sales and is a more useful measure of underlying revenue generation. Quarterly pretax income was $18.1 million (versus $10.3 million); income tax expense was $5.1 million, at a 28% effective rate. Net operating revenues were about 15% of operating revenues, versus 17% a year earlier; the filing does not present a conventional net profit margin.

For the six months, operating cash flow was $3.8 million, compared with $44.5 million a year earlier. Investing used $9.7 million, including $7.8 million paid for acquisitions; financing provided $18.6 million, including a $23.3 million net increase in borrowings. Cash and cash equivalents rose $12.2 million to $243.5 million.

At March 31, 2015, total assets were $4,462.6 million and stockholders’ equity was $369.5 million. Total liabilities were $4,093.1 million. Borrowings under credit facilities were $45.8 million and senior unsecured notes were $45.5 million, for total indebtedness of $91.3 million. The notes carry an 8.5% coupon and mature in 2020. Committed credit facilities totaled $270 million; the company reported compliance with their financial covenants. Assets and liabilities include substantial customer, clearing, trading and collateral balances, so total assets and cash alone do not indicate freely available liquidity.

Material changes versus the prior comparable period

• Quarterly operating revenue growth was led by Securities, up 110% to $36.1 million, and Global Payments, up 44% to $18.4 million. Securities benefited from stronger equity market-making and the G.X. Clarke acquisition; payment volumes doubled, although average revenue per payment fell 28%.
• Commercial Hedging revenue was nearly flat at $64.7 million: stronger exchange-traded/LME activity was largely offset by weaker OTC energy and renewable-fuels spreads. Physical Commodities revenue rose 25% to $6.4 million, and Clearing and Execution Services revenue rose 2% to $31.5 million.
• Quarterly compensation and other expenses rose 19% to $89.8 million. Bad-debt expense increased to $2.8 million from $0.4 million, primarily involving LME customer deficits, loans related to a former acquisition and uncollectible service fees. Management said G.X. Clarke also increased expenses.
• G.X. Clarke, an institutional fixed-income dealer, was acquired effective January 1, 2015. It contributed $10.5 million of quarterly operating revenue and $1.4 million of earnings. The transaction materially expanded Securities assets and added trading, repo and interest-income activity.
• At March 31, financial instruments owned were $1,217.1 million versus $197.9 million at September 30, 2014; repurchase-agreement payables were $908.9 million, versus none reported at that earlier date. The filing attributes the new securities financing activity principally to G.X. Clarke.

Outlook, commentary, risks and unusual items

No numerical earnings or revenue guidance is provided. Management said available cash, operating cash flows and borrowing capacity were expected to meet future liquidity needs, and that it intended to renew or replace facilities as they expire. $140 million of committed facilities were scheduled to expire within twelve months of the filing; a $50 million secured, uncommitted facility was entered into on May 5, 2015, after quarter-end. A subsidiary’s facility commitment was increased from $30 million to $40 million on April 21, 2015.

Management cited historically low short-term interest rates as a constraint on customer-deposit interest income, while describing its strategy of investing in medium-term U.S. Treasury securities and using interest-rate swaps. Results may be affected by market volatility, narrowing spreads, customer or counterparty defaults, margin and liquidity demands, regulatory changes, competition and key-person risk. Commodity inventory and related derivatives may be recognized in different periods under U.S. GAAP, potentially causing earnings volatility. The company reported that risk factors had not materially changed since its latest Form 10-K.

The company repurchased 224,509 shares for $4.5 million during the six months under a plan authorizing up to 1.0 million shares. A securities class action remained pending after a second amended complaint and a motion to dismiss; the company said loss was not probable and that the possible range could not be estimated. In the Sentinel litigation, a trustee sought recovery of $14.5 million under a new theory; management assessed loss as neither probable nor reasonably possible. The filing reported no material accrued exposure for these matters. The quarter also included $2.4 million of additional bad-debt expense and a lease buyout cost for an aircraft; the amount of the latter is not clearly specified.

Important facts for investors to verify

• Whether growth and profitability excluding G.X. Clarke are sustainable, particularly given the acquisition’s contribution to Securities and interest income.
• How much of the low six-month operating cash flow reflects normal swings in customer collateral and trading balances, and whether cash generation improves.
• The nature, recoverability and potential recurrence of LME customer deficits and notes receivable tied to a former acquisition.
• Renewal or replacement of credit facilities approaching expiration, continued covenant compliance and liquidity available after regulatory and customer-collateral requirements.
• Progress and potential financial exposure in the securities class action and renewed Sentinel trustee claim.
• How spreads, payment mix, interest rates and commodity-market volatility affect segment revenues and reported earnings.