Sean O'Connor - CEO William Dunaway - CFO.

Will Settle - Woodmont.

Good morning, ladies and gentlemen and welcome to the INTL FCStone Q3 FY 2017 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. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the call over to your host, Mr. Bill Dunaway, CFO..

Good morning. My name is Bill Dunaway, CFO of INTL FCStone. Welcome to our earnings conference call for the fiscal third quarter ended June 30th, 2017. After the market close yesterday, we issued a press release reporting our results for the fiscal third quarter.

This release is available on our website at www.intlfcstone.com as well as a slide presentation, which 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.

Both 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 thereto as well as the Form 10-Q filed with the SEC.

This discussion may contain forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. 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 could 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. Readers 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..

the precious metals business when we lost our biggest market due to local regulatory changes, and the agricultural and energy side after we sustained sizeable credit losses over a period of time. Dealing first with agricultural and energy physical business.

About two years ago, we examined the execution of the strategy in the light of the losses incurred and replaced and significantly upgraded the leadership team in this business and refocused the strategy. We're now starting to see the benefits of this materialize, and I'm very happy with the progress made to-date.

Our strategy here is to provide our commercial hedging customers with target and specific solution for physical commodities, which include structured financing, hedging programs that are embedded into physical contracts, and outsource merchandising arrangements where we hedge and market products.

This business is ramping up nicely, and we look forward to seeing better results ahead.

Moving on to the precious metals business, this is a business we have been in for more than 10 years and are one of the leading providers of [Indiscernible] wholesale merchants around the world, particularly in the Middle and Far East, which represents a bulk of the world demand for physical precious metals.

This business has also restructured about three years ago when local regulatory changes in certain Far East markets changed and severely impacted our business. Over the last two years, we have diversified our customer base and expanded our reach and now have a much more balanced and sustainable business than ever before.

As some of you might have seen, we announced earlier in the year the launch of a technology platform for this business. In simple terms, this market has been a very old school, call-around market.

Commercial buyers have call us and other participants in the physical market to determine what inventory existed, in what form and in what location, and then we determine the logistical cost to get this product to the destination they needed it in.

We decided to automate this process by getting the holders of inventory globally to post the quantity in form of metal on a technology platform. Commercial buyers can now access the platform and see in a glance all the available inventory globally, which is then automatically priced to the location of their choice; simple, easy, and effective.

To-date, we have traded 10 tons of gold since the launch of this platform in February of this year. This is a simple but very effective application of technology in a market that had honestly been left behind. We are very excited about this and are witnessing strong adoption by existing and new clients.

The benefit is this platform places us at the center of the market as all trades are priced, settled, and logistically arranged for us for a spread. Of course, we'll then have the capability to add other precious metals products and perhaps even other commodities onto the platform.

But for now, we are laser-focused on getting this platform to critical mass. In addition, in April, we announced that we have become a direct participant to The London Bullion Market Association Gold Auction.

This was done as we continue to drive our business forward to improve our current client offering and cement our permanent positions in the global bullion market. So, with that, I'll hand you over to Bill for a discussion of the 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 represents a bridge between operating revenues for the third quarter of last year to the current year fiscal third quarter.

As noted on the slide, third quarter operating revenues were $197.6 million, which is a $22.6 million increase over the prior year. Looking at the performance in our operating segments, the most notable change was a $32.1 million or 96% increase in our clearing and execution services segment.

This was primarily related to the acquisition of the Sterne Agee Correspondent Securities Clearing and Independent Wealth Management businesses as well as the ICAP voice brokerage business, which collectively added incremental operating revenues of $32.2 million in the current quarter.

Our global payments and physical commodities segment added $4.1 million and $4.3 million in operating revenues, respectively. The number of payments in our global payments business continued to grow adding 54% versus the prior year, driving the growth in operating revenues. Sean previously touched on the key drivers of the physical commodities growth.

These gains in operating revenues were partially offset by declines in our commercial hedging and securities segments. Operating revenues at our commercial hedging segments declined 21% to $57.1 million as exchange traded and OTC revenues declined to 11% and 40% respectively.

These declines were primarily related to low market volatility, as mentioned by Sean earlier, most notably in global grain, LME metals, food service, and dairy markets, as well as the decline in customer interest rate swap activity.

Partially offsetting these declines was a $1.1 million increase in interest income, driven by an increase in short-term rates. Securities segment operating revenues declined $1.6 million, primarily driven by a $1.2 million decline in equity market making operating revenues as a result of a narrowing of spreads realized in that market.

Moving on to slide number four, which represents the bridge between third quarter pretax income in 2016 to the current period. Overall, pretax income declined 30% to $15 million in the third quarter of 2017. The CES segment increased segment income by $3.1 million or 91% to $6.5 million for the third quarter of 2017.

While CES achieved significant growth in operating revenue, a large portion of these revenues are paid out to the independent representatives in the independent wealth management business.

These payments, which were recorded as introducing brokerage commissions, represent the majority of the $16.1 million increase in IB commissions in this segment as compared to the prior year.

In addition, similar to the first two fiscal quarters, as part of the acquisition of the ICAP voice brokerage business, in the third quarter, we accorded a $900,000 charge to compensation and benefits for the terms of the acquisition, which will continue to be expensed through the end of fiscal 2018.

Global payments and physical commodities segments each increased segment income by $3 million versus the prior year, driven by the operating revenue growth. These gains were tempered by declines in segment income in both the commercial hedging and securities segments.

Commercial hedging segment income declined $9.1 million, primarily as a result of the decline in OTC revenues as well as a modest increase in non-variable direct expenses.

The $1.5 million decline in securities segment income was primarily driven by weaker operating revenues in our equity market making and debt trading businesses, driven by lower market volatility, which led to spread compression in these businesses.

As shown in our table and our press release, while corporate unallocated overhead segment was unaffected by unrealized gains or losses on our investments in our interest rate management program in the current period, the prior year period includes a $2.7 million unrealized gain.

This $2.7 million negative variance as well as incremental unallocated cost from the acquisition of the Sterne Agee Correspondent Clearing and Independent Wealth Management businesses and increases in several administrative departments, most notably the continued expansions of our information technology department, contributed to the overall $4.9 million negative variance in corporate unallocated overhead.

The bottom of slide number 11 in the presentation shows the after-tax effect of these unrealized gains and losses in the interest rate program by quarter. Slide number five is a new slide, which we have previously included in our investor presentation posted to our website.

This slide shows the interest income in our investments and our exchange-traded futures and options businesses as well as balances in our Correspondent Clearing and Independent Wealth Management businesses.

As noted on this slide, interest earnings on these balances have increased $3.2 million versus the prior year quarter to $6.5 million as our yield on these balances has increased 20 basis points to 92 basis points in the current period.

In addition, the prior year quarter did not include the Correspondent Clearing and Independent Wealth Management businesses as the acquisition of those businesses was completed at the beginning of the fiscal fourth quarter of 2016.

The bottom of this slide shows the potential annualized interest rate sensitivity the balances held at the end of the current period have based upon a uniform parallel shift up in the yield curve at various levels.

As noted, a 25 basis point increase in short-term rates has the potential to increase our interest income by $5.4 million on an annual pretax basis. Moving on to slide number six, our quarterly financial dashboard, I'll just highlight a couple of items to note.

Variable expenses represented 56.6% of our total expenses for the quarter, exceeding 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 a bad debt expense increased $16.8 million or 29%, primarily driven by the acquisition of the Sterne Agee and the ICAP businesses.

Net income from continuing operations for the third quarter was $12.7 million versus $14.6 million in the prior year period, which resulted in a $10.9 million -- 10.9% return on equity, below our target of 15%. Finally, in closing up the review of the quarterly results, our book value per share increased 11% to $25.08 per share.

We did not repurchase any of our common stock during the third quarter. Next, I'll move on to a discussion of the year-to-date results, and I'll refer to slide number seven. Year-to-date operating revenues were $86.5 million -- were up $86.5 million to $578.9 million in the current year-to-date period.

Similar to the quarterly results, the large increase was in our CES segment, which increased $96.8 million, primarily driven by the acquisitions noted earlier. Global payment operating revenues increased $13 million, as a number of payments made increased to 53% versus the prior year.

Physical commodity operating revenues continue to grow, adding $11.5 million versus the prior year. These increases were partially offset by a $20.7 million decline in our securities segment and a $4.7 million decline in our commercial hedging segment.

Securities segment operating revenues declined as a result of narrowing our spreads in our equity market making business as well as strong performance in the prior year period in debt trading and asset management, following the devaluation of the Argentine peso.

On a year-to-date basis, the unallocated overhead variance of $9.4 million was largely driven by the mark-to-market on the interest rate program with the current year-to-date period reflecting a $5.8 million unrealized loss, while the prior year-to-date period reflected $2.9 million unrealized gain.

Moving on to slide number eight for a discussion of the variance in pretax income by segment for the year-to-date period. The large increase in CES operating revenues resulted in a $9.7 million increase in segment income, once again, somewhat tempered by higher introducing broker commissions in the Independent Wealth Management business.

Global payments and physical commodities increased $8.6 million and $7 million respectively.

The large negative variance down $17 million in the securities segment was primary driven by the strong performance in the prior year in equity market making as well as the effect of the evaluation of the Argentina peso, which led to strong results in our Argentine debt trading and asset management businesses in the prior year-to-date period.

Commercial hedging segment income declined $5.3 million as a result of the decline in OTC revenues. Once again, the $20.3 million negative variance in unallocated overhead was driven by the mark-to-market on the interest rate program. I just discussed as well as the acquisition of the Sterne Agee businesses in the fourth quarter of the prior year.

Finally, I'll touch on the year-to-date dashboard, which is slide number nine in the presentation deck. Variable expenses are above our internal target of exceeding 50% of total expenses coming in at 57.1% of total expenses.

Non-variable expenses increased $44.9 million or 26% over the prior year as a result of the acquisitions discussed earlier and increases in several administrative departments, most notably the continued expansions of our information technology department.

Net income was $30 million for the current year-to-date period as compared to $37.9 million in the prior year. The return on equity for the year-to-date period was 8.8%, below our internal target of 15%. With that, I'd like to turn it back to Sean to wrap-up..

Thanks Bill. We are pleased that we achieved a nearly 11% ROE for the third quarter, given the historically low volatility environment we have experienced.

We continue to see consolidation in our part of the market, which is generally positive and is allowing us to expand our customer footprint, all of which stand us in good stead when market conditions improve.

The management team is now focused on building an efficient and scalable infrastructure, where the marginal costs associated with the incremental transactions is close to negligible. This will be a key differentiator in medium term and will help drive volumes and margins for us.

The result of this is though in the short-term there's been a significant increase in technology-related costs, but we are working hard to ensure that we see a meaningful and enduring payoff for these investments.

We continue to believe that we stand poised to become the best-in-class franchise offering of global customers high-quality execution, both high tough and electronic, insightful market intelligence, and post-trade clearing services in almost all markets and asset classes.

With that, I would like to turn it back to the operator to open the question-and-answer session.

Operator?.

Thank you. [Operator Instructions] Your first question comes from Will Settle from Woodmont. Please go ahead..

Good morning gentlemen..

Hey Will, how are you?.

All right. Figured if no else will ask the question, I will. I got a few here. So, on the payments business, just strong growth again.

Is that driven by new customers, new onboarding folks, or just continued ramp of some of your recent adds?.

Well, I think it's a little bit of everything, to be honest. We still have clients moving up the adoption curve, particularly the big banks with us. We have signed a number of large and medium-size banks over the last six, nine months. So, that's obviously incremental to all of that.

So, it's a combination of both new clients and the existing clients still kind of moving through the adoption curve. So, bit of everything..

Great. And then I remember a couple of years ago and trying to evaluate the global payments segment, we talked about an allocation of corporate overhead, I think around 10% or so of your run rate at that time. Obviously, you've made some acquisitions, corporate G&A has ramped up.

Connected with that, what -- as we try to think about what should be allocated to global payments, have you been out of leverage that corporate overhead level from a couple of years ago or has that ramped up with the growth as well that we need to connect there?.

No, I would say of all our business segments, the global payments is probably the lightest user of central overhead and probably also the lightest user of capital. So, from that point of view, it's definitely our highest margin business, which is why we kind of excited about this business.

That said, if you have to think about -- if you ran the business as a separate business, so for example, if we look to ever spin this off, that's I guess the true test of what corporate overhead would you need to run that business and what capital would you need to run that business.

That's kind of a bit of a different discussion because we are dealing with the biggest banks in the world and I think they get tremendous comfort from the balance sheet that they have facing them and from the fact that we are a public company with lots of oversight managements and somewhat of an institutional banking.

So, even though those aren't directly allocated to that business, I think there's a big halo effect on that business of the infrastructure and the capital that sits in the overall company.

So, it's kind of a -- it's a tough thing to answer because on a factual basis, the usage of both infrastructure and capital is low, but I think that business needs kind of the support we give it to be credible and to face the kind of banks which are now also the biggest part of that business.

Does it make sense?.

Sure. Yes, that makes good sense. And then finally, Sterne Agee, you have little more time with the Clearing and the Asset Management, Financial Advisory, Independent Wealth Management business.

What -- just on the Independent Wealth Management business in general, obviously, market's gone up which should help rising tide there, but just as you kind of evaluate the opportunity for that Independent Wealth Management, what's your latest take -- assessment, if you will?.

Okay. Well, there's sort of, I guess, two parts to that question. So, on the core clearing capability, which is a capability we have thought for a while, Sterne Agee represented a great add for us. It wasn't perfect.

It wasn't perfect in the sense that it was much more focused on retail and introducing broker-dealer type clearing, and honestly, we probably would have preferred getting something focused on institutional to handle small institutional-type business.

That said, being a custodian and being able to handle retail is a much heavier lift and it's a lot easier to move from that direction towards institutional than the reverse. And I think having those custodial capabilities will allow us in due course to build a prime brokerage capability and institutional clearing capability.

So, those are the pieces we need to put in place organically through build and we got a great foundation to do that. And I think we feel pretty confident given the landscape we see in that market where we see massive consolidation in the -- if you exclude the sort of Tier 1 players, probably seven more or less clearers in the second tier space.

And without sounding arrogant in anyway, I think we feel that we can become the clearer of choice in that sector. This is a business, though, that takes time and lot of people have long-term contracts. People don't move their clearing quickly.

So, this is a kind of a slow burn business, but I'm pretty sure in five years' time, we will be sitting here with this business being much bigger than it is now with institutional component, a prime brokerage component and as being recognized as one of the leading securities clearance in the mid-size space.

So, that's the Clearing part of the business. The Wealth Management side of the business currently represents roughly half of the Clearing business we have. So, they -- the Wealth Management business, if you like, is our largest customer. We see it as our largest customer.

We clear for a lot of introducing brokers, both on the securities side and on the futures side. We almost never own introducing brokers. And in this instance, we own our largest introducing broker.

We don't have an issue with that at all, but I'm not sure that we see it as a strategic priority to necessarily aggressively grow the Wealth Management business by committing of the capital to that business. We'd like to grow it slowly and organically. We'd like to be thoughtful about it. We like to make sure that, that business makes a good return.

And most of all, we'd like to see that, that business continues to feed clearing revenue and balances into our infrastructure. So, I don't know if that answers your question, Will, on both of those.

So, I would say, kind of a somewhat passive slightly aggressive approach in Wealth Management, and on the Clearing side, probably a build-out in a much more aggressive pursuit of new customers on that side..

Right. And I understand the relationship there I guess thinking on the Wealth Management, we did $90 million revenue this quarter, but still basically flat on the net income side.

Is that -- I mean, what's your outlook for improving the profitability?.

Yes. So, when we consummated this transaction, which was almost a year ago now, I guess, just shy of a year ago, our best guess was that both the Sterne Agee entities in aggregate were going to lose $4 million pretax and I think we talked about that at the time in the conference call.

And that was part of the reason we drove the economics that we had a bargain gain of around $6 million on the transaction because we knew we were sort of inheriting a loss-making entity.

We put a lot of work into this business in terms of just integrating it and kind of changing reporting lines and upgrading and have even added some people in some instances. We have looked at the client roster, and we have, we believe, upgraded the client roster.

I mean, that has included us reducing some of the clients, that's had somewhat of a negative short-term impact. Some of the clients, we just didn't feel we're priced appropriately or -- from a risk point of view, well appropriate for what we wanted. So, all of those things in the short-term probably exacerbated situation of a $4 million kind of loss.

On the upside, what we found is lots of ways where we could better monetize the balances and the flow that we found in that business. And it was kind of crazy, actually, it was sort of opening up closets and money was falling out them a bit. So, that's the way it's a good surprise.

So, as we were sort of working through integration and figuring out how we could do things smarter, we certainly found ways to monetize their revenues better. And then, of course, we had a third interest rate increase, which kicked in.

So, I think all of those things in the aggregate, I would guess we would like to think that we'd finish up our first year in that business at breakeven or better. So, that's a pretty material -- materially better than we envisaged going into the transaction. And I think we will continue that slow trajectory upwards as we start to add more customers.

Our marketing campaign has kicked in. We have a nice pipeline. We've opened some new accounts. But as I told you, this is a slow business. This is a business that takes time to build those balances. Obviously, any sort of Fed's rate of increase will help enormously, but I think it's going to be slow and steady business.

But for now, I think we are ahead of where we thought we would be, partly through luck and the Fed and some hard work. But we're very happy with the way this business is going. So, we just want to keep it on that trajectory so.

Does that answer your question?.

Yes. That's helpful. Thank you..

Okay. Thanks William..

[Operator Instructions] Your next question comes from Erick Sönne from Private Capital Management. Please go ahead..

Erick? Operator?.

Caller, if you are on mute, please unmute..

We may have lost, Erick. Erick, if you're on mute -- looks like he's off the list..

There are no further questions..

Give him a second. He may find back in. I don't know if he lost his signal or something.

Any other questions from anyone else, while we wait to see if Erick comes back? No?.

All right. Well, I think let's leave it there. Thanks very much for your time and attention, and we appreciate it. And we will be speaking to you again soon. Thank you..

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect..