Q3 2019 Earnings Call
Good morning, ladies and gentlemen, and welcome to the I M. T. L. FC Stone third quarter 2019 earnings call. At this time, all participants are in a listen only mode.
Later, we will conduct a question and answer session and instructions will follow at that time.
If anyone should require assistance during the current conference. Please press Star then zero on your Touchtone telephone as a reminder, this conference call is being recorded.
I would now like to turn the conference over to your host Bill Dunaway CFO .
Good morning, My name is Bill Dunaway.
Welcome to our earnings conference call for our fiscal third quarter ended June Thirtyth 2019.
After the market closed yesterday, we issued a press release reporting our results for the third fiscal quarter of 2019.
This release is available on our website at Www Dot I NGL FC stone dotcom as well as the slide show presentation, we will refer to on this call in our discussions of the quarterly and year to date results.
You'll need to sign on to the live webcast in order to view the presentation.
The presentation and an archive of the webcast will also be available on our website after the call's conclusion.
Before getting underway, we're required to advise you and all participants should note that the following discussion should be taken in conjunction with the most recent financial statements and notes there too as well as the Form 10-Q filed with the SEC.
This discussion may contain forward looking statements within the meaning of section 27, a of the Securities Act of 933 and section 20 Onee of the Securities Exchange Act of 934.
These forward looking statements involve known and unknown risks and uncertainties, which are detailed in our filings with the SEC.
Although the company believes that its forward looking statements are based upon reasonable assumptions regarding its business and future market conditions. There can be no assurances that the company's actual results will not differ materially from any results expressed or implied by the company's forward looking statements.
The company undertakes no obligation to publicly update or revise any forward looking statements, whether as a result of new information future events or otherwise.
Participants are cautioned that any forward looking statements are not guarantees of future performance.
With that I'll now turn the call over to Sean O'connor the company's CEO .
Thanks, Bill good morning, everyone and thanks for joining our fiscal 2019 headquarter and in school.
Market conditions continued to be generally less favorable during the quarter under review than they were a year ago, especially by equity capital markets business that were positive for our commercial hedging business due to the unusually wet weather, we experienced the planting season in the us.
In the last week or so we have seen some real volatility around interest rates interest rates as it continues around the competitive currency devaluations was about the stock combined with an acceleration of the trade more.
We had a 25 basis point, perhaps on it now appears that may be followed with a further steps which of course negatively affects the interest and fee income we receive on our customer flows, but this could be offset by the positive impact of increased volatility in these markets.
Uh-huh headquarter and engine was 16.3 million or 84 cents, a share down 52% or $7.7 million from a year ago.
As you have seen from our recent announcements we have made a number of small acquisitions and organic growth initiatives in the last year.
We run our business for the long term and believing prudently investing to strengthen and grow our franchise.
We look to make disciplined acquisitions lives and add value for our shareholders and often times the speed. Thus acquiring businesses that are low price that requires us to absorb cost and some negative earnings until we restructured integrating new capabilities.
Organic extensions also save some cost benefits or critical mass is achieved.
This has been the model we have followed us for a number of years now and we believe it is prudent and disciplined disciplined way to grow and expand our business.
During the third quarter. These new expansion initiatives collectively contribute to the $3.5 million pre tax loss for the quarter and around $7.3 million for the year to date period.
These losses were anticipated and we believe these businesses are progressing to breakeven and in the medium term will drive earnings growth.
In addition to the $3.5 million loss from the lean initiatives, we recorded a $2.5 million unrealized mark to market loss in hedging our physical gold inventory. This happens periodically and generally reverse as quickly.
This in Mouses in aggregate to a 6.1 million paid tax drag at around 24 cents a share on the headquarters results and explains the lion's share of the delta versus the prior year period, which also included the sense in the lawsuit settlement of $2 million.
So netting all of these items our core earnings were slightly below those of a year ago, although down slightly on a run rate basis for the current fiscal year.
For the year to date, our earnings were up 45% at $57.9 million $40 99 per share, but that is largely a result of losses tax adjustment for the new tax legislation.
Pre tax and adjusting for the items mentioned above we are roughly in line with last year's record pre tax results.
On a year to date basis, R&D is 14.4% very close to our long term target.
Some highlights for beforehand or both.
Commercial hedging.
Whilst the positive standouts.
For the quarter with revenue up 11% due to some weather related volatility mentioned above.
Which resulted in a 17% increase in segment income Otcs revenues, where we enjoy higher margins, who after strong 19%.
For the year to date revenues and segment income were roughly unchanged from a year ago.
Our global payments business continues to grow with an 8% increase in revenue capture which combined with increased volume drove a 7% increase in segment income.
The addition of our Swift hosting business, which we purchased last year pushed our fixed costs and also include a small loss in the quarter, which should be reversed in the current deal in the coming year.
On a year to date basis segment income was up 17%.
Securities was a mixed bag with our rates business recording revenues up 83% or one of the best quarters in a number of years and our institutional fixed income business overall, showing strong segment income growth.
Offset against that was a weak quarter for the equity capital markets business exacerbated by startup costs related to prime brokerage and startup of the domestic institutional equities business and also losses related to the newly acquired GMP businesses that was restructured.
It should be noted that the large increase in securities revenue was due to the addition of the GMP securities business and as well as the growth of the securities lending business, which is a very low margin activity.
Operating revenues for our physical commodities business were similar to last year. Although segment income was down largely due to the unrealized $2.5 million mark to market loss on hedging our inventory, which I mentioned earlier.
Excluding this item segment income was roughly unchanged or those up 64% from a year ago.
Our clearing and execution segment income was down 13% due to revenue declines in both the futures and options business as well as FX Prime brokerage derivative voice brokerage correspondent clearing and wealth management recorded good gaming revenues.
As mentioned last time, we will be acquiring a futures and options clearing business have you ever be bank in Singapore.
This is a well established business earned by one of the Premier banks in the region, which will give us real critical mass in Asia.
We are excited by this which we believe is a transformational step for us in Singapore.
We are currently going through the regulatory process, but expect to close in Q4 or write off our fiscal year end.
With that I'll now hand, you back to Bill Dunaway for a more detailed discussion of financial results Bill.
Thank you, Sean I'll be referring to slides and the information we have made available as part of the webcast specifically starting with slide number three which shows our performance over the last five fiscal quarters.
The chart depicts our net income earnings per share and return on equity over the last five quarters.
As shown net income in the third quarter of 2019 was $16.3 million, which represents a 7.1 million decline over the immediately preceding quarter and a $7.7 million decrease over the prior year.
Moving on to slide number four which represents a bridge between operating revenues for the third quarter of last year to the current period operating revenues were $283.4 million in the current period of $23.6 million or 9% over the prior year.
This growth was led by our security segment, which added $24.3 million or 49% and operating revenues versus the prior year.
Within the segment equity capital markets added six and a half million in operating revenue.
Versus the prior year, primarily as a result of the $7 million increase in kind of securities like lending activities.
Excluding these activities equity capital markets operating revenues declined half a million dollars. Despite a 17% increase in the dollar volume traded at a lower market volatility drove a decline in our spread captured per trade.
In this segment as Sean mentioned earlier, our debt capital markets had a strong quarter, adding 18.5 million in operating revenues versus the prior year, primarily driven by increased activity in our domestic fixed income business as well as improved performance in our Argentina business and $2.9 million of operating revenues contributed by the newly acquired GMP Securities.
These gains were partially offset by $1.6 million decline in our municipal securities business.
Operating revenues increased in our commercial hedging segment by $8.5 million versus the prior year to 86.4 million.
Exchange traded volumes increased 12% driving a three month.
The transactional revenues, primarily in the domestic agricultural markets.
In addition over the counter volumes increased by 21% versus the prior year driving a $5.1 million increase in LTC transactional revenues off the back of increased activity in both the north and South American grain markets.
Finally interest income in this business increased 4% to $7 million driven by higher short term rates, which was partially offset by a 7% decline in the average client equity so just over $900 million.
Our global payments segment had another strong quarter, adding $2.9 million or 11% versus the prior year to $28.9 million as the number of payments made increased 2% and the average revenue per payment increased 8% versus the prior year.
This growth was driven by increased activity from our existing international banking clients as well as the Onboarding of several new banking clients during the third quarter.
Physical commodities declined 200000, or 1% and operating revenues versus the prior year driven by $800000 decrease in precious metals as a result of the two and a half million dollar unrealized mark to market loss, Sean discussed earlier.
Excluding this unrealized loss precious metals operating revenues increased $1.8 million or 25%.
On on 25% growth in the number of ounces traded.
In addition, physical AG and energy operating revenue added 600000 versus the prior year due to increased activity in commodity financing program.
Finally, operating revenues in our clearing and execution services segment declined 10 million or 11% as compared to the prior year.
Exchange traded revenues declined $12.2 million as volumes decreased by 17% and the average rate per contract declined 16% versus the prior year.
Partially offsetting the decline in exchange traded volumes interest income in the exchange traded business increased 800000, driven by higher short term rates, which was tempered by a 19% decline in the average client equity to $1 billion.
In addition, operating revenues in our FX Prime brokerage business declined $1 million to 4.1 million in the current quarter as lower market volatility drove a 19% decline in volumes.
Partially offsetting these declines correspondent clearing operator operating revenues increased 700000, driven by an increase in interest and fee income earned on client balances.
Driven by higher short term rates.
In addition, independent wealth management and derivative voice brokerage operating revenues increased $1.7 million and 800000, respectively versus the prior year.
Finally, the $1.9 million decline in unallocated overhead operating revenue is primarily related to the net fluctuation in market value of economic hedges held against the Argentine peso and exchange stock held for preferential clearing rate from the prior year period to the current period.
The next slide number five represents a bridge from up to 2018 third quarter pre tax income of $32.9 million.
To the net pre tax income of $21.6 million in the current period.
Commercial hedging segment income increased $4.4 million as a result of the eight and a half million dollar increase in operating revenues combined with a $1.7 million decline in bad debt expense.
Which was partially offset by increases in variable and fixed compensation benefit of $2.2 million and 600000, respectively.
Global payments added $1 million in segment income to 17.9 $17 million as a result of the increase in operating revenues, partially offset by a $1.4 million increase in non variable expenses.
As the result of the acquisition of pay Commerce and the addition of several new front office employees.
While operating revenues increased in our security segment segment income declined 2.1 million versus the prior year.
Within this segment equity capital markets income declined $3.6 million as the majority of the operating revenue growth in our conduit securities lending activity was offset by higher associated interest expense and our non SEC lending activity suffered from weaker performance in our principal equity trading business as well as an increase in costs related to the startup of our equity prime brokerage unit crucial sales businesses.
Segment income on our debt capital markets business increased 2 million driven by the increase in operating revenues, which was partially offset by higher interest expense.
Weaker performance in municipal Securities and increased cost associated with the acquisition of GMP Securities.
Physical commodities declined $2.3 million versus the prior year, primarily driven by unrealized mark to market loss on precious metals inventory as mentioned earlier.
Moving on to the CES segment, while operating revenues in our fee segment declined $10 million versus the prior year segment income declined a more modest $1.8 million due to increase in interest income as well as the lower transaction based clearing expenses and introducing broker commissions.
Finally, the 10.5 million increase in net cost and Onec unallocated overhead were driven by the $1.9 million decline in operating revenues noted earlier, a 1.4 million dollar increase in the cost associated with our recent acquisitions and initiatives as well as increased head count in several administrative departments and higher non trading technology and support costs related to various IP and client engagement systems.
Moving on slide number six shows the interest and fee income on our investment of client funds in our exchange traded futures and options businesses as well as the client balances held in our correspondent clearing and independent wealth management businesses.
As noted on this slide our earnings on these balances have increased $2.8 million versus the prior year to $16.6 million as our yield on these balances increased 61 basis point to 2.37% in the current period.
Interest income on these balances remained relatively flat versus the immediately preceding second quarter of 2019.
As Sean noted earlier, the fed recently dropped short term rates by 25 basis points in the bottom half of this slide shows our sensitivity to movements in both interest rates on our interest and fee income earned on client balances both on upward and downward movement in short term rates.
Moving on to slide number seven our quarterly financial dashboard I will just highlight a couple of items variable expenses represented 59% of our total expenses for the quarter.
Well above our target of keeping more than 50% of our total expenses variable in nature.
Non variable expenses, which are made up of both fixed expenses and bad debt expense increased $12.8 million, primarily driven by the recent acquisitions of GMP Securities pay Commerce solutions are clean and Coinvest corn invest as well as the launch of our new securities Prime brokerage and institutional sales initiatives.
We reported net income of $16.3 million in the third quarter from 11.6% return on equity below our stated target of 15%.
Our total assets increased 38% versus the prior year, primarily due to increased activity in our domestic fixed income and securities lending activities.
Finally in closing out the review of our quarterly results. Our average revenue per employee declined 5% to 605000 on an annualized basis, but still remain above our target of 500000, and our book value per share increased $4 to close up the quarter at $29.82 per share.
Next I'll move on to a discussion of year to date results and I'll refer to slide number eight.
Year to date operating revenues were up $86.6 million or 12% to $809.2 million in current fiscal year.
All segments of our business.
Reported increases in operating revenues as compared to the prior year to date period with the exception of the CES segment.
The largest increase was in our security segment, which added 67.4 million driven by growth in equity capital markets volumes as well as increase in interest income related to our securities lending and domestic fixed income activity.
Our global payments and commercial hedging segment added 12 million and $9.1 million, respectively, while our physical commodities segment added 7.8 million versus the prior year to date period.
CES operating revenues declined $1.4 million versus the prior year.
Finally, the decline in unallocated overhead operating revenues is primarily related to the net fluctuation in the market value of economic hedges held against the Argentine peso as well as the increase in elimination entries eliminate growth among our segments.
Moving on to slide number nine for a discussion of the various in pre tax income by segment for the year to date period. The largest variance was seen in our global payments segment, which added $7.3 million versus the prior year as a result of 5% growth in the number of payments made as well as a 9% increase in the average revenue traded.
Our physical commodity segment added 4.7 million versus the prior year as the result of the increase in operating revenues as well as a positive $3.4 million variance in bad debt expense of physical coal.
In addition, the CS segment added $4.3 million of segment income driven by the $2 million Barclays last look net settlement received in the first quarter as well as improved performance in the correspondent clearing and derivative voice brokerage business.
Segment income in our security segment increased $1.9 million as a result of the strong operating revenue growth noted earlier, which was tempered by higher interest expense and our institutional fixed income and securities lending activities.
As well as declines in performance in our municipal Securities business.
Modestly offsetting these increases commercial hedging segment income declined 800000 as compared to the prior year.
Finally, the $21 million increase in net Cockney unallocated overhead were driven by the decline in operating revenue noted earlier, a $4.4 million increase in the cost associated with our recent acquisitions initiative as well as increased headcount in several administrative departments and higher non trading technology and support costs related to various IP in client engagement system.
Finally, I will touch on a year to date dashboard, which is slide number 10 in the presentation.
Variable expenses are above our internal target of exceeding 50% of total expenses coming in at 59.7% of total expenses.
Net income was $57.9 million for the current year to date period as compared to $39.8 million in the prior year.
With the prior year to date period, including a $20.1 million charge related to tax reform.
The return on equity for the year to date period of 14.4% slightly below our internal target of 15%.
With that I would like to turn it back to Sean to wrap up.
Thanks, Phil the improving conditions of 2018 seem to have given way to slightly more challenging environment for us right now.
With an outlook for low interest rates, but perhaps more bonus to see an improved trading conditions.
We are in many ways in uncharted territory with lots of cross currents and then nodes, but we remain laser focused on serving our clients and the challenges they face in these markets.
We continue to prudently invest in banking franchise and while this can help shorten performance as it did this quarter. We are focused on the long term and confident that these modest investments will pay off well for us down the line.
We are a financial network that connects 20000 institutional and commercial clients and then the 80000 retail clients with the global markets, which include 40 derivative exchanges, most international and domestic equity and fixed income markets foreign exchange in over 175 countries and a wide range of financial swaps, but any network it becomes exponentially more valuable as we add design marketing capability.
In addition to connecting these clients in these markets. We also care custody and setting the trades, which is durable valued business, which is increasingly unique.
On requires capital systems and infrastructure.
This is a capability that is hot and expensive to replicate and in many ways has a motion rambles around that and is becoming more valuable as consolidation in this space continues.
With that I'll turn it back to the operator to open the queue were nice session operator.
Ladies and gentlemen, if you have a question at this time. Please press Star then the number one on your telephone keypad. If your question has been answered or you wish to remove yourself from the queue. Please press the pound key.
Your first question is from the line of Bill these elements.
Thank you.
Couple of questions first of all would you talk in more detail about the three and a half million dollar loss on the acquisitions and strategic initiatives.
Sure. So that is a combination of two things we've started up too.
He started organically two initiatives one is on the prime brokerage side, we've hired a team of people. We believe we have the infrastructure to support the growth of that business.
It's a missing customer segment for us.
That obviously entails some cost because you get the people upfront and you get the revenue later.
We think there's an important add for us so that is proceeding well.
In addition, we are expanding into the us institutional equities business, we already have great touch points with a lot of these institutions on the international side on the rates and fixed income side and just looking to expand our business there, but again you know when you hire teams of people you get costs before you get the revenues. So those two initiatives that is just a straight kind of classic cost.
Our cash burn and so those businesses reach breakeven, which we think that will pretty soon.
And then on the acquisition side, we tend to buy.
Businesses that we think are attractively priced and businesses that we think we can send around so rather than going and paying huge premiums for businesses that are operating very well.
Our view is we don't we can add a lot of value in that instance, the sellers extracting full price we get it.
Sean are you are there and if so are you have gone quiet.
Yeah, I'm, sorry, it sounds like.
We might have lost Sean there real quick.
His line is still connected until the call.
Okay I'll try to continue on there were Sean left off so you know, it's mainly related to the the acquisitions that we started to make early last calendar year with the Carl claiming acquisition.
You know, which really represented our you know our Brexit strategy.
And then continued on with the acquisition of pay Commerce.
And coin invest and then most recently a GMP securities.
Just rounding out our our overall capabilities and then you know certainly we.
Overtime, we start up new initiatives.
You know within organically within our business and so you know we've taken on.
You know the project, starting up kind of equity prime brokerage business and equity institutional sales within equities, which is something that we.
She is key ways to grow our business going forward. So you know, it's mostly just related to that the cost.
Are those businesses, while we try to get those up and running some of those acquisitions that we're doing we're often buying businesses that we need to.
Look at the costs and also look at opportunities to cross sell growing in so they will take some time for us to integrate.
Bill would you Uh huh.
Be able to split that to three and a half million between the businesses that you have purchased a it versus the organic startups that are.
Costing you money.
Oh, no we haven't.
We haven't just put that in the disclosures as now but you know I think that it's probably two thirds one third.
With two thirds of it being acquisitions and one third being startups.
Great. Thank you owe me a shift if I may to the global payments business.
Volumes were only up 2% which is.
Which seems low relative to the activity taking place in the occurrence hearing you know would you would you would you talk to that and then secondarily do you see the ongoing trade a issues.
Benefiting or hurting volumes in that business or is it even a relevant factor.
Sure sure I do think that some of it some of the revenue clear some of the volume growth that we've seen here.
It's coming from the institutional block or the international Bank clients that we have and then we've seen some of that derived from kind of M&A activity and capital transactions in the international markets.
That you know, we end up making the payments for those banking clients and I think we have seen some of that being tempered a bit David just aren't ordinary guys.
Hi, I got my family and my line dropped but anyway.
Okay, and so we have seen some of that being tempered a bit here in the most recent quarter.
You know with the kind of geopolitical and international environment being with the trade wars et cetera, and that's dampened it a bit and that you know I think that perhaps you could see a bit of that going forward, but it's still kind of.
Remains to be seen whether or not.
That'd be a drag going forward and I think that the addition of.
You know, we still have a strong pipeline of new banks coming in and still quite a few banks that.
That have been brought on that are still kind of in their infancy of.
Getting started and taking on more and more payments in more and more countries from us.
And then let me a shift if I, if I could to LIBOR.
Is that a is going to be ending.
And at some point here what impact if any does that have on the on your business where is it where you just simply be finding another.
Another measurement to it to put the O. Tc contract in place.
Hello, Sean do you want me to take that.
Yeah go ahead.
Okay.
No I don't anticipate it having a huge impact on us I mean, we do have some bank lines that are tied to LIBOR floor and you know, we we do a limited amount of interest rate swaps with clients hedging, but you know I think they'll be just a pivot to you know another measurement.
In that space. So we don't I don't see it as having a material impact for us.
Great. Thank you.
Sure. Thank you.
I didn't that is star one for questions.
All right operator, do we have any other questions.
I am showing no further questions at this time I will now turn the conference over back to Sean O'connor.
Okay, well, thanks, everyone enjoy the rest of the summer and we'll be speaking to you for all of fiscal year end call. Thank you.
Thank you.
Ladies and gentlemen. This concludes today's conference. Thank you for your participation have a wonderful day you may all disconnect.