Stonex Group Inc. annual report, FY2017

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INTL FCStone Inc. — Fiscal 2017 Form 10-K

Reporting period: Fiscal year ended September 30, 2017, filed December 14, 2017. The filing identifies the registrant as INTL FCStone Inc. (NASDAQ: INTL); the provided request metadata names StoneX Group Inc. This is an annual report, not a standalone fourth-quarter filing, although it includes fourth-quarter results.

Business context

The company is a diversified global financial-services provider in commodities, securities, foreign exchange, payments, clearing and advisory services. It reported five segments: Commercial Hedging, Global Payments, Securities, Physical Commodities, and Clearing and Execution Services (CES). It served more than 20,000 customers in over 130 countries. Fiscal 2017 included the acquisition of ICAP’s EMEA oil voice brokerage business; Sterne Agee clearing and wealth-management operations contributed for a full year.

Financial performance and liquidity

  • Revenue: Total revenue was $29.424 billion, up 99%, largely reflecting gross physical-commodity sales. Operating revenue, after physical-commodity cost of sales, was $784.0 million, up 17%; net operating revenue was $492.6 million, up 11%.
  • Profit: Net income was $6.4 million versus $54.7 million in fiscal 2016; diluted EPS was $0.31 versus $2.90. Pretax income fell to $15.2 million from $72.7 million. Return on average equity declined to 1.5% from 13.2%.
  • Non-GAAP measure: EBITDA was $67.1 million, down from $109.2 million. The filing cautions that EBITDA is not a U.S. GAAP measure.
  • Margins and expenses: Net operating revenue equaled approximately 62.8% of operating revenue; net income was approximately 0.8% of operating revenue. Total compensation and other expenses rose 26% to $477.4 million, including a $47.0 million physical-coal bad-debt charge. Variable expenses were 53% of non-interest expenses, versus 58% in fiscal 2016.
  • Cash flow: Operating activities provided $13.9 million, investing activities used $22.3 million, and financing activities provided $5.7 million. Cash and cash equivalents ended at $314.9 million, down $1.3 million year over year. Capital expenditures were $16.1 million.
  • Balance sheet and debt: Total assets were $6.243 billion and stockholders’ equity was $449.9 million. Loans payable were $230.2 million; the $45.5 million of 8.5% senior notes was redeemed in October 2016. Four committed facilities totaled $532 million, with $194.2 million drawn at year-end; separate uncommitted facilities had $34.0 million outstanding. Approximately 95% of assets were described as liquid, though much of the balance sheet relates to customer, counterparty and financing activity.
  • Liquidity and customer funds: Required customer segregated assets were $2.2 billion. The company reported $52.3 million of excess U.S. segregated assets, $16.4 million of excess secured customer assets and $20.7 million in a securities customer reserve account. These are regulated customer-related balances, not unrestricted corporate cash.

Material changes versus fiscal 2016

  • Operating revenue growth was led by CES, up $108.7 million, including contributions from Sterne Agee and ICAP. Global Payments and Commercial Hedging also grew.
  • CES segment income rose to $30.4 million from $14.8 million; Global Payments rose to $50.6 million from $39.8 million; Commercial Hedging rose to $72.8 million from $68.7 million.
  • Securities segment income fell to $46.6 million from $69.4 million as prior-year Argentine debt-trading and asset-management strength faded and lower volatility compressed equity market-making spreads.
  • Physical Commodities recorded a $31.4 million segment loss, compared with $13.3 million of segment income, principally because of the $47.0 million coal-related charge.
  • Overall segment income declined 18% to $169.0 million, despite 12% growth in segment net contribution, as direct costs and corporate expenses increased.
  • The company redeemed its senior notes, expanded its parent-company syndicated facility to $262 million, and implemented the first phase of a new OTC commodities trading system.

Outlook, risks and unusual items

  • Coal loss and recovery: The $47.0 million allowance followed a supplier’s failure to deliver coal and reimburse related customer charges. The company exited the physical-coal business and canceled remaining open contracts. It expected a further $1.0 million bad-debt expense in fiscal 2018 and did not anticipate additional coal-related bad-debt charges; recovery of amounts due from the supplier remained substantially uncertain.
  • Controls: Management concluded disclosure controls were ineffective and identified material weaknesses tied to risk assessment and controls over physical-coal inventory, supplier reimbursements and segregation of duties at a Singapore subsidiary. KPMG issued an adverse opinion on internal control over financial reporting, while giving an unqualified opinion on the financial statements. Management described remediation steps, including exiting coal and enhancing controls over new business lines.
  • Funding: $245 million of committed facilities were scheduled to expire during fiscal 2018. Management intended to renew or replace them and believed it could do so, but renewal was not assured. The parent facility was amended after year-end to address covenant calculations and increase permitted capital expenditures; the amendment was deemed effective September 30, 2017.
  • Business risks: Results are exposed to market volatility, trading and counterparty credit risk, customer defaults, short-notice margin calls, funding availability, interest rates, regulatory changes, technology and operational failures, and integration of acquisitions. A significant share of debt was variable-rate. Regulatory changes included continuing Dodd-Frank and EMIR implementation and MiFID II/MiFIR requirements scheduled for 2018.
  • Other items: Fiscal 2017 operating revenue included $5.9 million of pretax unrealized losses on interest-rate swaps and Treasury notes; the positions were liquidated during the year. The company provided no specific earnings or revenue guidance. It had no history of paying common dividends, and credit agreements prohibited cash dividends; the board authorized repurchases of up to 1.0 million shares in fiscal 2018.

Important facts for investors to verify

  • Whether the supplier acknowledgment and note produce recoveries against the coal-related receivable, and whether further expenses arise beyond the disclosed expected $1.0 million.
  • Progress and independent validation of remediation for the material weaknesses, including the scope of controls implemented over new businesses.
  • Renewal or replacement terms, borrowing costs, covenant headroom and actual availability of facilities expiring in fiscal 2018.
  • Whether acquired CES businesses sustain their contribution after acquisition-related costs, and whether Securities performance stabilizes.
  • Cash-flow quality and unrestricted liquidity, distinguishing corporate funds from customer and other regulated assets.
  • Effects of market volatility, rates and regulatory implementation on trading revenues, margins, capital needs and customer volumes.