Stonex Group Inc. quarterly report, Q1 FY2015

Business Context and Reporting Period

INTL FCStone Inc. (the registrant named in this filing) is a diversified global financial-services company serving commodity, payments, securities, foreign-exchange, and clearing markets. This Form 10-Q reports its fiscal first quarter, the three months ended December 31, 2014; comparisons are with the three months ended December 31, 2013 unless otherwise noted.

Reported total revenue includes physical-commodity sales recorded gross, while most other activities are reported net. Consequently, operating revenue and net operating revenue are more informative measures of underlying activity than total revenue alone.

Financial and Operating Results

Operating-revenue growth was led by Commercial Hedging, up 50% to $68.4 million, including 89% growth in OTC revenues. Global Payments grew 12% to $15.2 million; Clearing and Execution Services (CES) grew 13% to $31.2 million; and Physical Commodities grew 25% to $6.5 million. Securities declined 20% to $17.2 million, mainly because debt trading in Argentina weakened despite higher equity market-making revenues.

Net operating revenues rose faster than compensation and other expenses, which increased 15% to $79.6 million. Compensation and benefits were 61% of net operating revenues, versus 63% a year earlier. Variable expenses represented 59% of total non-interest expenses, compared with 54%. The effective tax rate was 31%, versus 38%.

At December 31, 2014, total assets were $3,127.2 million, liabilities $2,772.2 million, and stockholders’ equity $355.0 million. Cash and cash equivalents were $278.2 million, up from $231.3 million at September 30, 2014. Cash flow from operations was $25.4 million; investing used $0.9 million; financing provided $23.9 million, including $26.6 million of additional borrowings under credit facilities. Foreign-exchange movements reduced cash by $1.5 million.

Total indebtedness was $94.6 million: $49.1 million of variable-rate credit-facility borrowings and $45.5 million of 8.5% senior notes due 2020. The company had $270 million of committed credit facilities, with $49.1 million drawn. It reported compliance with financial covenants and regulatory capital requirements. Approximately $130 million of facilities were scheduled to expire within the following 12 months; management intended to renew or replace them.

Material Changes, Outlook, and Risks

• Management commentary: Management cited strong Commercial Hedging performance, higher customer activity and market volatility, growth in payments and CES, and modest growth in fixed expenses. Average customer segregated equity increased 21% to $2.1 billion, supporting higher interest income. No quantitative earnings guidance was provided.
• Market and accounting volatility: Management cautioned that U.S. GAAP can recognize gains and losses on physical commodity inventories and related derivatives in different periods, potentially creating temporary earnings volatility. Market, liquidity, interest-rate, foreign-exchange, counterparty, and customer-margin risks are inherent in the business.
• Regulation: Some Dodd-Frank capital and margin rules remained incomplete or not fully implemented, and management said the impact was uncertain. The company was also assessing anticipated MiFID II/MiFIR requirements for its UK business.
• Legal matters: On February 4, 2015, after quarter-end, the court granted the company’s motion to dismiss an amended securities class-action complaint; the plaintiff could amend by March 6, 2015. The company said losses were not probable and that a reasonably possible loss range could not be determined. In the Sentinel matter, an appeals court had ruled for the company and denied rehearing; the company continued seeking its share of reserve-account cash.
• Acquisition: Effective January 1, 2015, the company acquired G.X. Clarke & Co. for approximately $26.0 million of net tangible book value plus a $1.5 million premium, with up to another $1.5 million contingent on profitability.
• Capital and liquidity considerations: $189.4 million of cash, cash equivalents, and available-for-sale securities were held by foreign subsidiaries. Management intended to reinvest these funds abroad; repatriation could incur U.S. tax. The company also reported $2.2 million of acquisition-related contingent liabilities and expected at least $2.1 million of pension contributions during the remainder of fiscal 2015.
• Other: The board authorized repurchases of up to 1.0 million shares in December 2014. During the quarter, 74,509 shares were repurchased under the program for $1.5 million. Management reported effective disclosure controls and no material change in internal control over financial reporting.

Important Facts for Investors to Verify

1. Whether the sharp improvement in earnings is sustainable, particularly given the dependence on Commercial Hedging and volatility-sensitive OTC activity.
2. How much of reported revenue growth reflects gross physical-commodity sales rather than growth in operating and net operating revenues.
3. Renewal or replacement of the $130 million of credit facilities due to expire within 12 months, and continued compliance with facility covenants and regulatory capital requirements.
4. Customer and counterparty exposure, margin-funding needs, and the adequacy and availability of cash, including funds held by regulated subsidiaries or overseas.
5. Developments in the securities litigation, Sentinel recovery effort, acquisition earn-outs, and the integration and performance of the G.X. Clarke acquisition.
6. Potential earnings effects from commodity-price accounting mismatches, interest-rate changes, regulatory implementation, and the Securities segment’s exposure to conditions in Argentina.