Business context and reporting period
INTL FCStone Inc. filed this unaudited Form 10-Q for fiscal Q1 ended December 31, 2017, compared with the three months ended December 31, 2016. Its global financial-services businesses include commercial hedging, payments, securities, physical commodities, and clearing and execution services. Reported total revenue includes gross physical-commodity sales, so operating revenue is a more useful measure of underlying revenue.
Financial performance and position
- Revenue: Total revenue rose 30% to $7.919 billion, largely reflecting physical-commodity sales. Operating revenue increased 15% to a record $212.6 million; net operating revenue rose 14% to $130.3 million.
- Profit: Income before tax more than doubled to $18.6 million from $8.4 million. A $25.5 million tax expense, including $20.9 million of Tax Cuts and Jobs Act charges, produced a net loss of $6.9 million, or $0.37 per diluted share, versus net income of $6.3 million, or $0.34 per share. Management reported $14.0 million of net income excluding the tax-reform charge; this is a company-presented adjusted comparison.
- Costs and margins: Compensation and other expenses increased 5% to $111.7 million. Variable expenses remained 58% of non-interest expenses. Net income margin on net operating revenue was negative in the quarter because of the tax charge; the filing does not present a standardized operating-margin measure.
- Cash flow: Operating activities used $186.0 million, versus $116.6 million used a year earlier. Investing activities used $3.2 million; financing provided $191.0 million, including a $192.9 million net increase in borrowings from lenders. Cash and cash equivalents increased $6.9 million to $321.8 million.
- Balance sheet and liquidity: Total assets were $6.809 billion and stockholders’ equity was $443.2 million at December 31. Total liabilities were $6.366 billion. Borrowings under loans were $422.9 million, up from $230.2 million at September 30; $350.0 million was outstanding on $532.0 million of committed facilities. The company said about 97% of assets were cash, financing-related assets, receivables, financial instruments, or physical inventory; some assets and subsidiary funds are subject to regulatory restrictions.
Material changes versus the prior comparable period
- Operating revenue increased across all reported operating segments. Clearing and Execution Services led with an $8.6 million increase; Securities rose $5.6 million and Commercial Hedging $4.0 million.
- Segment income increased 16% to $58.3 million. Commercial Hedging rose 37% to $21.1 million and Clearing and Execution Services rose 84% to $10.5 million. Securities segment income fell 15% to $11.0 million, principally as interest and clearing expenses increased; Physical Commodities fell 63% to $1.1 million.
- Interest income increased 131% to $24.0 million, reflecting higher short-term rates and a prior-year unrealized loss on Treasury notes. Interest expense rose 61% to $14.3 million, including higher costs in fixed-income trading and from increased borrowings.
- Cash used in operating activities increased, while financing cash provided was higher. The balance-sheet comparison above is to September 30, 2017; comparative year-end total assets, debt, and equity are also reported as up 8%, 35%, and approximately flat, respectively, versus December 31, 2016.
Outlook, risks, contingencies, and unusual items
- Outlook: No numerical earnings guidance is provided. Management said cash flows, available cash, and borrowing capacity should meet future liquidity needs, and it intended to renew or replace $270 million of committed facilities scheduled to expire within twelve months of the filing.
- Tax reform: The $20.9 million charge comprised $8.9 million for remeasurement of deferred tax balances and a provisional $12.0 million repatriation transition-tax obligation. Management said the charges were largely offset by deferred tax assets and were not expected to cause a significant increase in cash taxes. Estimates remained provisional and could change.
- Business and market risks: The company faces counterparty and customer defaults, margin and funding demands, commodity, securities, foreign-exchange and interest-rate volatility, regulatory change, and refinancing risk. Derivative and short-position exposures are managed with collateral, netting, limits, and monitoring, but losses may occur if markets move adversely or counterparties fail.
- Controls: Management concluded disclosure controls were not effective at December 31 because of previously identified material weaknesses involving risk assessment and physical-coal inventory, supplier-reimbursement controls, and segregation of duties at a Singapore subsidiary. The company was exiting that coal business and implementing remediation; effectiveness had not yet been validated.
- Unusual items and contingencies: The company recorded a $1.0 million bad-debt expense related to the physical-coal business and $0.5 million in professional fees associated with its exit. The contingency period for acquisition earn-outs ended during the quarter; a $1.0 million accrued balance was due for final payment in February 2018. Management reported no material change in legal proceedings and did not expect excess loss contingencies to be material.
- Regulatory capital: Subsidiaries were reported in compliance with applicable regulatory capital requirements and the company reported compliance with credit-facility covenants at quarter-end.
Important facts for investors to verify
- Reconcile the $20.9 million tax-reform charge, provisional transition-tax estimate, and management’s $14.0 million adjusted net-income comparison; assess possible revisions and cash-tax effects.
- Track operating cash use, the increase in borrowing, facility renewals, and covenant headroom, particularly as facilities approach expiration.
- Assess remediation and independent validation of the disclosed material weaknesses; management stated remediation was ongoing, not complete.
- Monitor credit, collateral, market and short-position exposures, including whether customer margin remains sufficient during volatile markets.
- Evaluate segment trends: Securities profitability weakened and Physical Commodities income was affected by coal-related costs and precious-metals derivative losses, despite overall segment-income growth.