FCStone, Inc. F2Q08 (Qtr End 02/29/08) Earnings Call Transcript

Apr.10.08 | About: FCStone (FCSX)

FCStone, Inc. (FCSX)

F2Q08 Earnings Call Transcript

April 10, 2008 11:00 am ET

Executives

Bill Dunaway – EVP, CFO

Pete Anderson – President, CEO

Analysts

Chris Donat – Sandler O’Neill & Partners

Mark Lane – William Blair & Company

Mike Vinciquerra – BMO Capital Markets

Rich Repetto – Sandler O’Neill & Partners

Chris Allen – Banc of America Securities

Niamh Alexander – Keefe, Bruyette & Woods

Operator

Good morning ladies and gentlemen and thank you for standing by. Welcome to the FCStone Group 2008 second quarter earnings conference call. (Operator instructions) I would now like to turn the conference to Bill Dunaway, Executive Vice President and Chief Financial Officer. Please go ahead sir.

Bill Dunaway

Great, thank you Eric and good morning everyone. I’d like to welcome you to FCStone’s fiscal second quarter 2008 earnings conference call. Shortly before the market opened today, FCStone issued a press release reporting its earnings for the fiscal first quarter 2008. The press release is available on our website at www.fcstone.com. Additionally we are conducting a live webcast of this call, which will also be available on our website after the call’s conclusion.

During today’s call Pete Anderson, our President and CEO will first provide an overview of our results and commentary on our business and the current market environment. I will then provide details on our financial performance for the second quarter and year to date. Pete will then conclude our presentation with some closing remarks before we open the call up for some Q&A. Please note that today’s conference call is copyrighted material of FCStone and cannot be rebroadcast without the company’s express written consent. I’d also like to remind you that during the course of this call, management will make projections or other forward looking remarks regarding future events of the future financial performance of the company.

We have based these forward looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. It is important to note that such statements about FCStone’s estimated or anticipated future results, prospects or other non-historical facts or forward looking statements can reflect FCStone’s current perspective of the existing trends and information as of today’s date. FCStone disclaims any intent or obligation to update these forward looking statements, except as expressly required by law.

Actual results can be affected by inaccurate assumptions, including the risks, uncertainties and assumptions described in the company’s filings with the Securities and Exchange Commission. In light of these risks, uncertainties and assumptions, the forward looking statements in this earnings call may not occur and actual results could differ materially from those anticipated or implied in the forward looking statements. When you consider these forward looking statements, you should keep in mind these risk factors and other cautionary statements during this earnings call. I’d now like to turn the call over to Pete Anderson, our President and CEO.

Pete Anderson

Thank you Bill. I want to welcome everyone and thank you for joining the call. We just completed our first 12 months as a public company during a time of extraordinary volatility in the commodity and financial markets. It has been an exciting time for FCStone with substantial growth in both revenues and profitability. As you can see from this morning’s release, our second quarter numbers continued to show strong revenue and earnings results as we continued to manage the business to represent the best interests of our customers and to create shareholder value.

Our results have been driven by our focus on our core business segment of commodity and risk management services which has shown steadily improved performance. The clearing and execution business segment also continues to experience strong performance. Revenue for the second quarter of fiscal 2008 was $91.2 million which was up 51% from $60.2 million in the second quarter of fiscal 2007. Net income for the second quarter of fiscal 2008 was $12.1 million or $0.42 per diluted share which represents an increase over second fiscal quarter 2007 net income of $6.9 million or $0.32 per diluted share.

Excluding the onetime loss of discontinued operations of Green Diesel, net earnings for the second quarter of fiscal 2008 would have been $17.7 million or $0.61 per diluted share. Before we discuss the company’s achievements for our second fiscal quarter, I’d like to briefly address some of the recent macro-economic events that have impacted the markets. As most of you are undoubtedly aware, there have been some substantial headwinds for companies in the financial services arena, primarily stemming from credit issues related to structured financial products.

In a recent press release, FCStone stated the company has no direct exposure to subprime mortgage backed securities or auction rate securities nor does the company use third party repo lines to provide liquidity to its regulated entity, FCStone LLC. The company does have operational exposure to the over the counter or OTC commodity markets as an integral part of its service to its customers, the company provides customer access to OTC markets by acting as the principle in the OTC trades with customers. Customer traders are in turn offset either by OTC contracts with major counter parties or by futures or both.

The company continues to deal with all of its traditional major OTC counter parties and is comfortable with these relationships. FCStone continues to mitigate its credit risk by ensuring the performance of its major counter parties through credit default swaps, forward trade credit insurance with excess coverage in place for all of our major counter parties. The most significant risk for FCStone in the current environment of credit tightening is in our client’s ability to maintain adequate credit lines to finance the necessary inventories and inputs in their operations as well as the substantial margin requirements necessary to hedge those positions.

Thus far, lenders in agriculture, energy and other industries have done a commendable job in providing the necessary leverage to finance the unprecedented increase in value of commodity positions of our mutual customers. We communicate closely with our customers and their lenders to ensure that they are able to carry the inventories, positions and additional leverage needed under current conditions. In terms of the impact to either FCStone’s operations or customers I want to be very clear, we have witnessed no fundamental change to our operating model.

We are operating under the same kinds of risks, assumptions and opportunities today as we were 90 days ago. Nevertheless, rest assured that we are prudently monitoring domestic and international economic environments both for our customers and for FCStone as a whole. We believe that we have the people and the processes in place to mitigate any potential issues that may arise but we are continually seeking ways to improve our methods, operating standards and contingency plans for unusual market events.

Most recently the company increased its margin credit line and subordinated credit capacity significantly in anticipation of possible further increases in margin requirements and continuing volatility in the markets. And we continue to explore further measures. Bill will provide additional details in his comments. With one exception to be discussed later, FCStone’s growth initiatives continue to be implemented and accelerated in the current environment. The growth in all market segments of the company has been driven by extraordinary volatility in virtually every commodity and financial market around the world.

This volatility is a reflection of the demand and consumption of underlying energy, agricultural products, metals and soft commodities around the globe as well as the increased speculative interest in commodities as an investment asset class. All of the demand for additional production and inventories of underlying commodities has taken place during a period of tightening credit access. This atmosphere has increased the necessity to manage volatility through conservative risk management services, products, platforms and structures as offered by FCStone.

The need to manage risk of price, position, logistics, credit and execution in production and consumption is as great in our traditional market segments of agriculture and energy as we have ever experienced. Beyond our traditional core businesses of agriculture and energy, we anticipate continued growth of opportunity in the areas of renewable energy, international markets, food service, weather, livestock, forest products, carbon credits and foreign exchange. The driving force in our growth has been and continues to be our team of risk management consultants who are truly the foundation upon which much of our success is built.

These consultants are responsible for developing customer relationships, analyzing the commodity risk of our customers, developing strategies to mitigate this risk and executing these strategies at the direction of the customers. Internationally the company continues to expand in Brazil where the focus is on the company’s core competency of commercial grain production and handling. Other commodities and industries that represent significant growth in Brazil includes sugar, ethanol, coffee, foreign exchange and consulting.

As the US market and domestic demand for grain and production increases, we expect Brazil to see continued expansion in grain production and exports with China driving the consumption side of worldwide demand. Our China division continues to add customers in commercial grain processing and handling, metals, energy, cotton and foreign exchange. In order to sustain our growth, we continue to reassess and develop our training programs to address new and developing products as well as additional industries that have growth potential.

In fiscal 2007 the consultant network increased by 16 to 118 and our goal for fiscal 2008 is to add an additional 20 consultants to the various market segments and geographic regions of FCStone. FCStone currently has 130 consultants, trainees and interns and our consultant members have increased by hiring established industry expertise, our internal training program and through acquisitions. The recent acquisition of Downes O’Neill, our premier risk management firm in the diary industry is a prime example of the type of organization that FCStone is interested in acquiring. Not only does this provide FCStone with a new customer base, the acquisition has also added five new consultants to the FCStone network.

In addition to Downes O’Neill, we’ve also made progress toward our long term growth strategy through the acquisition of Globecot, Inc. and The Jernigan Group, LLC. Through this acquisition we have created a new cotton and textile division which is providing expertise in the global cotton and textile segment for both current and potential FCStone customers throughout the world. All of this while adding six experienced cotton and textile consultants. FCStone will continue to have discussions regarding potential acquisitions of firms that have similar interests and philosophies in serving customers and we’ll continue to remain disciplined regarding the price we’d be willing to pay and the return we would need to see from such opportunities.

The company’s focus and interest regarding strategic acquisitions is in all the various commodities and industries we serve both here domestically and internationally. FCStone historically has prided itself in being an innovator in the risk management industry and made substantial investments to incubate specific programs, products or market segments for the benefit of our customers and the company. Examples of this would include our OTC platform, FCStone trading that was started in the mid 1990’s. The international division was developed over a ten year period in Latin America and Asia and the renewable energy division was organized in the late 1990’s prior to the significant run up in ethanol demand.

Our direct investment in Agora-X and its proposed new electronic communications network which was discussed in our last quarter earnings call is just such an investment in the future for FCStone. The company was formed to develop an electronic communications network for OTC commodity contracts designed to help eligible institutional participants achieve a strategic advantage in the rapidly growing OTC commodity markets. The Agora-X platform will trade commodity OTC options and swaps in energy and OTC swaptions and swaps in agricultural products for institutional OTC trading firms.

Our vision is for the platform to provide liquidity, transparency and trading efficiency for FCStone, our clients and qualified institutional participants. We were very pleased to announce the participation of NASDAQ OMX in this project during the second fiscal quarter. The NASDAQ OMX group has agreed to invest up to $7.5 million as a co-owner of this platform. Another initiative that FCStone has been incubating is in the carbon markets. FCStone is helping its customer base mitigate carbon emissions. FCStone carbon aims to create, represent and market technologies that improve efficiencies in the renewable energy industry sector as well as livestock, grain production and processing segments.

FCStone is offering to all of these industries not only a carbon marketing platform, but also a suite of technologies and services that will help find a pathway to being a low cost producer and a low carbon emitter. FCStone carbon continues to develop aggregation agreements, technology and the carbon credit inventory that it has acquired. Today the company has several aggregation agreements that represent the creation of significant tons of carbon credits annually after underlying protocols are validated and verified. To date FCStone has marketed 395,500 tons of carbon credits, realizing about $520,000 of revenue.

As the carbon market matures, we believe FCStone carbon is positioned to effectively represent our customers in marketing their carbon credit production or emission credit needs. While FCStone continues to innovate and pursue commodity related opportunities, it recognizes that it must continually evaluate its commitment to new ventures. One initiative and area that FCStone has decided to exit arises from its participation in a venture to develop an innovative bio-fuels plant.

The Green Diesel operation was expected based on expert investigations and plant developer representations to create a plant based on a novel continuous flow process of production that was represented to be cost effective to build, to operate and to maintain. Despite extensive efforts, the plant has not met our expectations after almost two years of development and substantial investment by Green Diesel, the plant developer and FCStone, the plant has not yet passed bio-diesel production commissioning tests. As a result, we have decided not to continue with development and are in the process of closing the plant.

We are proceeding with an effort to sell the plant as it is. Although FCStone believes the plant may have a liquidation value, such value cannot be determined or reasonably estimated. However, we are seeing interest in the facility and expect to realize a fair valuation during the second half of the fiscal year. As a result, FCStone will recognize a onetime loss on the closure of this plant net of tax in the amount of $5.7 million, representing a write down of FCStone’s entire investment.

The last are of importance for FCStone is interest income. Interest rates continue to soften but that weakness in interest rates has been offset by the significant growth in customer funds, prudent investment management and secure lawful investments and continued direct hedging of interest rates. Customer funds have grown to $1.45 billion at the end of our second fiscal quarter 2008 versus $861 million during the same period a year ago.

The company invests the majority of customer funds in exchange approved money market funds and treasuries with a smaller portion placed in overnight reverse repurchase agreements on treasuries. Hedge gains were proved on a mark to market basis for the second fiscal quarter 2008, all of this is reflected in interest income of $18.8 million for second quarter fiscal 2008 versus $10.7 million for the same period in 2007. Now I’d like to turn the call over to Bill Dunaway, our CFO for a detailed financial review. Bill.

Bill Dunaway

Thanks Pete. As Pete mentioned we are pleased to report continues growth in our second fiscal quarter as revenues net of costs of commodities sold reached $91.2 million. Compared to the prior year period of $60.2 million, the second quarter revenues increased 52%. Our pretax income was $28.5 million for the quarter compared to $11.1 million for the same period last year and our net income was $12.1 million for the second quarter this year, compared to $6.9 million for the prior year period. As Pete noted, during the second quarter we wrote down our investment in Green Diesel developmental stage bio-diesel facility.

This impairment loss is reflected in the $5.7 million loss on discontinued operations net of tax reflected during the second quarter. In completing the disposal of the facility we may incur up to $3 million in additional charges during the second half of fiscal 2008. Our net income from continuing operations was $17.8 million for the second quarter this year, 154% increase compared to the $7 million for the prior year period. Now let me take a few minutes to talk through the main components of the quarter’s results. Starting with the $31 million increase in revenues.

First, commissions and clearing fees were up nearly $13 million or 38% with approximately $14.5 million of this increase coming from exchange trades, offset by a $1.7 million decrease in our Forex commissions and clearing fees. Next, our service consulting and brokerage fees which are primarily our over the counter product brokerage fees, were up about $14.4 million for the quarter over last year, which is more than 1.5 times the fees recorded in the second quarter of fiscal year 2007.

The bulk of the increase for this quarter came from our energy, renewable fuel and Brazilian customers. Our interest income was up $18.9 million, up $8.1 million from the same period last year. The entire $8.1 million increase is attributable to the account balances held at our commodity and risk management services and clearing and execution services segment, with a $700,000 decrease in our financial services segment being offset by a $700,000 increase in our corporate segment.

The significant increase in the commodity risk management and clearing and execution segments was the result of much higher customer segregated funds and over the counter margin deposits that we are carrying during the quarter and a $4.4 million mark to market gain on our interest rate hedges. Our total marked balance sheet assets were just below $2.5 billion at February 29th, 2008 whereas on August 31st, 2007 they were just over $1.4 billion. As we look at total expenses, our expenses net of the costs of commodities sold increased approximately $13.7 million for the quarter over the same period last year.

Upon a closer examination of the expenses, volume related variable expenses of broker commissions and compensation as well as benefits, pit brokerage and clearing fees accounted for about $14.5 million of the increased expenses. This increase was partially offset by lower interest expense of $2.4 million due to the sale of our part of the majority interest of our grain merchandising segment that we no longer consolidate and the reduction of subordinated and general corporate debt which was paid off as a result of the IPO.

Other expenses increased by $1.8 million due to an increase in professional fees, insurance premiums and volume based data processing fees. Taking a closer look at the performance within our two main business segments, our CRM full service segment generated operating income of $21.8 million compared to $9.2 million last year. This segment benefited from significantly higher over the counter revenues as noted earlier and interest income was up $2.8 million, primarily as the result of the much higher customer segregated funds and over the counter margin deposits.

Commissions and clearing fees also finished higher by $1.4 million. We continued to be pleased with the favorable margins in this core business segment. Our clearing and execution segment had operating income of $8.7 million compared to $3.4 million in the prior year. This segment had a 56% increase in commissions and clearing fees revenue and also higher interest income by $5.3 million, primarily as a result of higher customer segregated balances.

Reviewing our balance sheet, our total assets are $2.46 billion as of February 29th, 2008, up from approximately $1.42 billion at August 31st 2007. This $1.04 billion increase was due to approximately $455 million in additional customer segregated funds, $424 million from additional OTC customer margin deposits and open positions, $100 million from our financial services repurchase program and a $21 million increase in Forex deposits. The primary reasons for these increases was the continued commodity volatility and the resulting increased trading volume and margin deposits.

As Pete mentioned earlier, we have recently expanded our margin call credit facilities to address increased margin requirements and the continued volatility in the commodity markets. Our margin call credit facilities have increased by $100 million to a total of $170 million. In addition we have recently increased our subordinated debt facility by $12 million to a total of $15 million. We will continue to evaluate our credit facility to ensure they are at appropriate levels.

During the second quarter we were pleased to announce the recent additions of Globecot, Inc. and The Jernigan Group LLC as well as Downes & O’Neill LLC to our product offering. As noted previously, these acquisitions are expected to be accretive immediately as part of our growth initiatives, we will continue to evaluate all opportunities to further our vision of providing the best services to our customers across the board in respective commodity markets. With that, I’ll turn it back over to Pete for some concluding remarks.

Pete Anderson

Thank you Bill. Overall we believe that the traditional commitment to the best interest of our customers, the strength of the FCStone consultant’s experience and expertise and our various alternative platforms to manage our customer’s risk will continue to drive the growth and development of FCStone. The company will continue to expand the business and grow over the long term while also thriving in the current market conditions. With that, operator, Eric, we’ll take questions now.

Question-and-Answer Session

Operator

Thank you sir. (Operator instructions). Our first question comes from Chris Donat with Sandler O’Neill, please go ahead.

Chris Donat – Sandler O’Neill & Partners

Good morning, I’m just trying to get a better handle on your exchange traded volumes and seeing if there’s some way we can track them more accurately. If I look back over your volumes historically, it seems like when you go back to say fiscal 2006 and early 07, your exchange traded volumes would be pretty flat quarter on quarter, maybe move by a single digit number and I know you added the professional traders toward the end of fiscal 07. Can you give us a sense of where the volume came from in this past quarter, is it from the professional traders, is it from your regular kind of elevator customers getting more active, is it from new customers?

Bill Dunaway

If we look at kind of the increase in exchange traded volumes from the first quarter to the second quarter, you know about 250,000 of it came from the commodity risk management side, so that’s going to be our core customer base. And about 4 million of that increase came from the clearing and execution segment. You know what you’ve seen is in that clearing and execution segment starting in the fourth quarter of last year, you know you did see that dramatic rise with the addition of that group of professional traders.

And I think in the clearing and execution side you were just really seeing that as the markets start to trade more and more electronically, you get a lot more people, a lot of our professional traders that were on the floors of the exchanges are moving upstairs and are allowed not only to just trade the commodities that they were traditionally dealing with, but trading electronically now they have access to more commodity markets. And it’s just helped drive the continued growth in exchange traded volume.

Chris Donat – Sandler O’Neill & Partners

Okay so this is trading going on in the CME group and at NYMEX and other exchanges also?

Bill Dunaway

And the ICE cleared, we do a lot of what used to be the NYBOT which is now ICE cleared in the soft commodities and at the NYMEX in the energy and the metals.

Chris Donat – Sandler O’Neill & Partners

Okay, so based on that being really only 250,000 contracts coming out of the CRM, it’s not, they’re not really moving that much, it’s more the new professional traders?

Bill Dunaway

At the exchanges, yes, where you’re seeing more growth is in the over the counter and the commodity risk management side.

Chris Donat – Sandler O’Neill & Partners

Okay.

Bill Dunaway

It did represent the 250,000 in the commodity risk management side you know obviously showed what was a significant increase over what you saw in the second quarter.

Chris Donat – Sandler O’Neill & Partners

Right. And then I’m not sure I caught the exact number there on the FX commissions, I think you said $1.7 million decrease?

Bill Dunaway

From last year.

Chris Donat – Sandler O’Neill & Partners

From last year?

Bill Dunaway

[Overlay] 2007.

Chris Donat – Sandler O’Neill & Partners

So the absolute number in FX commissions, can you give that to me?

Bill Dunaway

It was roughly for the second quarter about $2.6 million.

Chris Donat – Sandler O’Neill & Partners

Okay. And then just on the interest expense, I want to make sure I got this right, you said there’s $4.4, or interest income, $4.4 million mark to market gains from hedging?

Bill Dunaway

Yes.

Chris Donat – Sandler O’Neill & Partners

Okay and that’s, as we [unintelligible] the company and try to model it, any suggestion for, I know you’ve hedged it going out but how far out are these hedges? Can we expect similar sorts of things in future quarters or how should we look at it?

Bill Dunaway

I mean generally we’ve gone out about two years with the hedges. You know one thing that we will see going forward is you know because of FASB we have marked to market these interest rate derivatives that we have in place. So you know you’re not going to quite get the smoothing that’s intended from a true hedge position, but you realized the marked to market gains here at February 28th.

Chris Donat – Sandler O’Neill & Partners

Okay and when you say you’ve gone out two years, you put some of these on six months ago, a year ago?

Bill Dunaway

We started right at about the end of last fiscal year.

Chris Donat – Sandler O’Neill & Partners

Okay, does that mean, would I be correct then in thinking about this as you had $4.4 million in gains, we should expect to see low single digit millions of gains going forward from hedging for a few quarters?

Bill Dunaway

You know we can’t really predict what the interest rate environment will do but I would say that you’re on the right track as far as I don’t think you’ll continue to see, unless a significant drops, because it’s all marked to market in this quarter, I don’t think you’ll see the sizable gain going forward from the collar.

Chris Donat – Sandler O’Neill & Partners

Okay, so, yeah because of the collar if rates are similar to where they were before, you’ve marked it to market and there we are. Okay. Thanks very much.

Operator

Our next question comes from Mark Lane with William Blair & Company, please go ahead.

Mark Lane – William Blair & Company

Good morning, just a few. First, Pete on the number of consultants, so you know you’ve gone from 118 to 130, but 11 of those have come from acquisitions if I understand it correctly. Why haven’t you been able to or been willing to hire more external consultants?

Pete Anderson

To some degree we have. You know that also takes into consideration some attrition. You know a handful of consultants that just went back into industry and we had one satellite office that we closed where we had a couple consultants in that office that had just not produced. And so basically we’ve added a couple from industry as well as through acquisition and expanded through our training program as well.

Mark Lane – William Blair & Company

So how do you expect to get to another 10 consultants in the second half?

Pete Anderson

We continue to look for and have discussions with other acquisition alternatives and targets as well as we’re looking for people in industry and to some degree have targeted some of the new initiatives that we’ve put in place over the last couple years in let’s say specifically food service, we recently hired a new consultant in forest products, we’re looking for additional capacity there. And it really comes down to really finding the expertise. You know in a number of cases, it still comes down to we’ve done it like we have traditionally in the past by hiring some of our best clients and customers as they mature and become pretty sophisticated.

Mark Lane – William Blair & Company

Okay, Bill can you talk about some of the variable costs, some of the variable trading costs, the pit brokerage clearing fees, the IB commissions, why there seems to be such a variance from commission growth this quarter?

Bill Dunaway

Well you’re still seeing kind of a little bit when you’re looking year over year, I mean you’re still seeing a significant drop in the commissions, you know over $1 million drop, about $1.3 million of the drop IB commissions is coming from that Forex business as we, kind of like we talked about in the first quarter where you kind of had some real ramp up in growth last year in the Forex and a fair portion of that had an IB commission type to it and you know the business is starting to ramp up again but we’re not at the levels we were last year.

Mark Lane – William Blair & Company

Okay so the IB is lower because Forex is lower is what you’re saying, right?

Bill Dunaway

Yup.

Mark Lane – William Blair & Company

Okay what about pit brokerage and clearing I mean it’s up over 70% in commission growth is under 40%.

Bill Dunaway

As a percentage, pit brokerage and clearing fees you know kind of as a percentage of you know there’s, you’re seeing it up over 70%?

Mark Lane – William Blair & Company

25 versus 15 right?

Bill Dunaway

Yeah. You know you’re starting to see with fees going up with some of the exchanges you’re seeing more and more charges related to electronic trading. But we’d have to dig into it a little bit more to see what else there is, but I mean really you know the majority of that is just volume related and kind of product mix of what exchanges people are trading on and also whether or not we have, you know a little bit of the product mix becomes where we’re directly charging the client a commission rate with the fee in it versus one that is charged just a net fee.

Mark Lane – William Blair & Company

Okay, back on the interest income, so what is the collar tied to, treasury rates or what is it tied to?

Bill Dunaway

It’s a LIBOR hedge.

Mark Lane – William Blair & Company

Okay, LIBOR hedge. So if, I mean if LIBOR hadn’t changed between today and the end of the quarter, you’d have zero mark to market gains right? I mean the way that the hedge is set up?

Bill Dunaway

Well, yeah the way the hedge works, yeah, if there’s no change in LIBOR between the beginning and end of the quarter, yeah you would be virtually flat there.

Mark Lane – William Blair & Company

Right, so can you just remind us in terms of customer funds you know outside, get rid of the financial services business, what the mix of investment was by area, treasuries, money markets, repos?

Bill Dunaway

At the end of the quarter we were looking at about 40% of the funds were invested in, somewhere about 40-45% of the funds were invested in money market funds and the rest in direct treasuries or overnight repos.

Mark Lane – William Blair & Company

Okay and so we’re talking about three six month treasuries?

Bill Dunaway

Correct.

Mark Lane – William Blair & Company

And how much discretion do you have in changing that mix as you move forward or extending the duration of the treasury component?

Bill Dunaway

You know I mean we have kind of full discretion as weighing the risks associated with certain investments and we’re not going to get into some of the auction rates and some of the other areas where there has been issues, so we’re staying fairly conservative with while we want to maximize interest in the company we also, preservation of the capital is the number one driver for us. So where it merits, we’ll go farther out on the treasury curve, when it comes to getting into some more exotic investments, that’s something that we’re not really looking to do now.

Mark Lane – William Blair & Company

And how would you compare the overnight repo rates to treasury rates?

Bill Dunaway

They track, they’re fairly, you know certainly now you’ve seen in this quarter you’ve seen more of a disconnect between those than you ever have with the flight to quality but traditionally they’ve been fairly, they’ve correlated pretty well.

Mark Lane – William Blair & Company

Okay, alright thank you.

Operator

Our next question comes from Mike Vinciquerra with BMO Capital Markets, please go ahead.

Mike Vinciquerra – BMO Capital Markets

Thank you, good morning. I want to follow up just on I think Bill you went through where the balance growth had come from on a I think you were talking about a year over year basis you were hitting on the OTC margin versus the segregated assets, can you just walk through those numbers for us again?

Bill Dunaway

We were actually going through August 31st to Feb.

Mike Vinciquerra – BMO Capital Markets

Okay.

Bill Dunaway

On the balance sheet. And that would have been, let me pull my note back out here. Customer segregated assets grew $455 million from August 31st to February 29th. $424 million of the increase on the balance sheet came from over the counter margin deposits. I will note that you know on that portion of that is the open contracts, the open mark to market value of contracts on the OTK which is not necessarily investible assets and those increased by about $270 million.

So the $424 million in the OTC deposits, about $170 of that is not an interest item, it’s just a mark to market gain, or mark to market value increase of open positions carried by clients. $100 million of it came from the additional activity in the financial services segment and about $21 million of the increase came in the Forex deposits.

Mike Vinciquerra – BMO Capital Markets

Okay, thank you. Alright and then just on the, one more time on the interest income, you had the gain this quarter, the way I think about it you were a gain on the collar, you recognized that essentially to where it is at the end of the quarter, so it’s kind of a, if a catch of it, it already reflects the value created in that collar by the lower interest rate so we will actually though see the impact on your underlying investment of the funds coming as the quarter progresses now that we’ve had these Fed cuts, am I thinking about it right that your core interest income will actually be your yield at least will be sliding over the next 90 days or so so at the end of this quarter we’ll see the yield on your client assets, it’ll be more reflected and it was essentially overwhelmed by the collar gain this quarter. Am I saying that right?

Bill Dunaway

Yeah, I think you’re on the right track Mike.

Mike Vinciquerra – BMO Capital Markets

Okay, alright, so we saw an outsized, when I look at your numbers just to put it this way, your segregated assets actually grew less than your interest income this quarter but once I back out the $4.4 million gain we start to see the real trend line in terms of where your yields are.

Bill Dunaway

Correct. And also you really have to factor in the total investible assets we have. You know because, we have more than just segregated assets of $1.4 billion, you know when you start factoring in investible OTC deposits and the cash, you know the corporate cash on the books as well as Forex deposits and the notes receivable in the financial services segment, the total interest earned assets is more than the $1.4 billion.

But you’re on the right track, we obviously would have in the underlying assets you would have realized some of the interest rate decline already in the second quarter with the Fed cuts that were there, especially where it relates to overnight repurchase agreements and stuff where you don’t have an extended maturity on those.

Mike Vinciquerra – BMO Capital Markets

Sure, okay, that makes sense and then just the last thing from me, just you mentioned that you guys have been establishing some additional liquidity at the corporate level recently, can you talk about just under what scenarios you guys actually need to cap liquidity yourselves, is it primarily for when you’re waiting for your clients to post additional margin, you have to float that in an overnight basis with the exchanges?

Bill Dunaway

Yeah I mean that’s right on Mike, it’s virtually, it’s mostly tied to our exchange traded business to where we settle up twice a day with all the exchanges. We settle up in the afternoon for the a portion of the day’s activity, kind of a mid day inter-day snapshot, you settle up with the exchange and then we actually, the residual effect between where they take that snapshot and the true settlement you settle up the next morning. There is either an inflow or an outflow of funds in the afternoon that we’ve got to make to the exchanges and we’ll be settling up all that with the majority of our clients the next day.

Mike Vinciquerra – BMO Capital Markets

Okay great that’s helpful, thanks guys congratulations on the quarter.

Operator

Our next question comes from Rich Repetto with Sandler O’Neill, please go ahead.

Rich Repetto – Sandler O’Neill & Partners

Yeah, hi guys. I’ll make it brief because Chris already asked a few questions but I guess the first thing on the seg cash, just directionally in March you know just, not that we need a number but directionally did it go up or down, you know we’ve seen more volatility or at least more volatility in some of the commodities, so just trying to get a more real time gauge.

Bill Dunaway

You have seen its grown throughout the quarter. But you know I think that not, it wasn’t all right at February 29th if that’s your questions. It’s kind of grown throughout the quarter.

Rich Repetto – Sandler O’Neill & Partners

Well no my question is from the end of the quarter of February 29th to now, you know we’re a month or more after that, just directionally where has it gone since the end of February?

Bill Dunaway

You know Rich, we don’t really give guidance or really anything forward but I mean I will say that you’ve seen continued expansion of margin requirements at exchanges which has been one of the drivers of our customer seg deposits.

Rich Repetto – Sandler O’Neill & Partners

Understood. Okay and then the discontinued ops, you know we can see the impact in this quarter clearly as you broke it out. I’m just trying to see, is there an impact, if you backed that out it’s $0.60 plus in this quarter, I’m trying to see whether it impacted prior quarters, was there expenses and investment spending in prior quarters that we couldn’t see because it was in the other expenses?

Bill Dunaway

It was petty de minimis in the previous quarter. What any loss from discontinued operations would be, it was under $100,000. But the $0.60 you lost me on the effect of it, it ends up being about $0.19, the discontinued loss on a fully diluted basis.

Rich Repetto – Sandler O’Neill & Partners

And then you go from $0.42 up to $0.61, that’s why the $0.60 I’m saying. I rounded by a penny.

Bill Dunaway

I thought you were indicating that the loss on a per share basis was $0.60 so my apologies. I misunderstood you.

Rich Repetto – Sandler O’Neill & Partners

Gotcha and then the very last question, the margins were stellar in both segments and incremental margins were very high, is this a fair run rate I guess of margins going forward if you maintain, I guess that’s the question, the sustainability of margins.

Bill Dunaway

Well once again we don’t do the forward projections a whole lot I will say that you know we obviously benefitted from a margin standpoint from the continued growth in interest income as we’ve talked here a little bit, you’re going to feel some pressure on that now that we’ve realized the mark to market gain on the interest rate collar.

But you know the other portion that really has helped to increase some of those margins has been the continued growth in our over the counter business and that’s something that we’re looking to continue to grow that business. We’re with these acquisitions that we’ve brought on, those were traditionally just exchange traded businesses that we’ll look to continue to expand those markets to start trading over the counter. So we think that we can continue to grow that over the counter business but we will feel some pressure on margins form an interest rate standpoint.

Rich Repetto – Sandler O’Neill & Partners

Great, congrats guys on a great quarter.

Operator

Our next question comes from Chris Allen with Banc of America Securities, please go ahead.

Chris Allen – Banc of America Securities

Hey guys, great quarter. Just a couple of quick questions. Can you help us think about what the impacts form the acquisitions was during the quarter, was it material to earnings or not?

Bill Dunaway

We haven’t disclosed that yet, I think that because they came in kind of late in the quarter you know obviously it’s not going to be material to the quarter at this point. I think really what those two acquisitions are doing for us is really expanding our product offering into both commodities that we have not traditionally been leaders in and also geographic locations, so it’s really more of a growth story acquisition than what the immediate effect was. But they, we do, like we’ve mentioned, expect those to be accretive right out of the gate.

Pete Anderson

And the other issue Chris is that I think as Bill said a while ago, you know those two segments have not traditionally utilized OTC products and our intent is to really ramp that up in both the textile cotton markets as well as the dairy industry and really leverage the dairy expertise into our food service group.

Chris Allen – Banc of America Securities

Gotcha. And is one way to think about it is that you added I guess eight consultants between the two acquisitions, thinking about that from a production per consultant basis, are they kind of in line with what your normal consultants produce?

Pete Anderson

I think you know some of them are but I think really with the added OTC platform and fee based processes that we utilize to really educate and develop customers, we’re really educating that new network in the cotton and textiles as well as the food service and diary and I think leveraging that we’ll see that ramp up over time.

Chris Allen – Banc of America Securities

Great. One of the things that people are chattering about obviously these days is counter party credit risk, can you just give us some insight into your view of the health of your kind of core customers in your consulting business?

Pete Anderson

Well you know as I said earlier in my comments you know our counter party risk is really pretty minimal. You know from an exchange standpoint, it’s basically all treasury instruments and the exposure there is pretty insignificant. From an OTC standpoint you know we’re really comfortable with all of our counter parties and have them insured against default either through outright swaps or outright insurance. And so those we’re really comfortable with as well.

You know our risk on a day to day basis is really with our clients and their ability to procure financing and you know the industry both ag and energy has been really volatile, as I said earlier, I really commend the lenders in both these industries that have really stepped up, provided the financing to a large extent to carry the inventory and also the positions with us and really the rest of the industry. And have really stood in there and provided that financing. You know I think to a large extent it’s been substantial leveraged above what we’ve seen historically but we’re also in a new paradigm I think as far as price. So to their credit again those lenders have really stepped up.

Chris Allen – Banc of America Securities

Great and then just thinking about like the agricultural markets and energy markets right now into your third quarter I mean just looking at the volumes, pricing, volatility levels, it doesn’t seems like anything has fallen off. I mean from an industry perspective I mean has the volatility been stabilized at this higher level right now and what are your thoughts just in terms of where it can go from here?

Pete Anderson

I think that’s part of the difficulty for the industry today is just the extreme volatility that we see in the markets. Recently the limits were expanded for grains, specifically in corn, wheat and soybeans which to some degree puts more pressure on the commercial participant in the market to really provide adequate capital and credit lines to really margin those positions and the volatility that comes with that.

And so it’s as volatile as I’ve ever seen in my experience and my career in ag as well as energy and you know to a large extent as I’ve said earlier that’s really mandated by renewable fuels as well as really export demand as really strong worldwide basis driven to some degree by the weakness of the dollar. So that demand at least from our perspective is probably not going to go away any time soon.

Chris Allen – Banc of America Securities

Great and then one final question it sounds like you guys are starting to, the balls starting to roll a little bit more in China right now. Are you seeing any material impact from China yet or is will just take a little more time?

Pete Anderson

No you know it’s, from a regulatory standpoint there’s still only a number of commercial firms that are really approved to trade directly outside the country and so those volumes continue to increase but at some point from a regulatory standpoint, once those hurdles are eliminated, that’s when I think we’ll see significant growth out of China in particular. One of the things that has and will help going forward is with the acquisition of Globecot and Jernigan, they’ve had a significant presence in cotton across Asia and I think that will help enhance our efforts as we move forward.

Chris Allen – Banc of America Securities

Great, thanks a lot guys and great quarter.

Operator

Our next question comes from Niamh Alexander with KBW, please go ahead.

Niamh Alexander – Keefe, Bruyette & Woods

Good morning, congratulations on the quarter. I had a few quick questions at this point, if I could go back to the CRM business because that was the biggest dollar volume growth as well as proportionately if we look at that brokerage service consulting and brokerage revenue, you mentioned in the prepared remarks that it was primarily Brazil renewable energy trading there, but even if I look at Q on Q, so sequentially you’ve seen strong growth, can you maybe help me understand what drove some of the strength you know sequentially rather than kind of year on year, I’m trying to gauge and see maybe how much Brazil is adding to it, if they’re helping offset some of the seasonality, thanks.

Bill Dunaway

Niamh we don’t really break it out by dollar figure among the different individual groups of customers but Brazil obviously continues to be one of the strongest growth areas for us. We’re rapidly adding more consultants down there and customers. So really the Brazil and the renewable fuels and also other areas of Latin America has been a real strong driver and then just even domestically here the energy markets have really helped to drive that over the counter growth.

Niamh Alexander – Keefe, Bruyette & Woods

Okay that’s helpful, thank you. And then if I could go back to the credit market environment and we’re hearing a lot now the CFTC is hosting a public meeting because there’s, some of the grain elevators are struggling with these increased margin requirements and then with lenders, can you help me understand what if anything might come out of some of the grain community pushing right now to kind of get slow down in the increasing of the position limits and you know offset shall we say some of the speculation in the market if that’s possible.

Pete Anderson

I think right now the grain industry to a large extent has really stepped back to almost a spot market in trying to reduce the exposure form a forward cash purchase book or purchasing program. And really tried to move into a spot market to eliminate as much as of the margining requirements of risk as possible. And you know as far as the CFTC you know we’ve said from the beginning that traditionally we though the limits had been adequate and to some degree those lower limits took some of the steam out of the market and the emotion out of the market. But you know I guess from our perspective we don’t necessarily see that being rolled back. I do think that what will happen is there will be significantly fewer opportunities for producers to book forward cash contracts just based on the exposure that it takes to carry those positions from one crop year to the next.

Niamh Alexander – Keefe, Bruyette & Woods

Okay that’s helpful thank you and then just lastly if I may, the exchanges and stocks like yours have all kind of gotten hit hard in the last quarter, the last calendar quarter on fears of deleveraging across the market, are you seeing any change in behavior in for example your professional trading customers, I mean there’s always going to be a need for your core customers to hedge and to take positions but in the professional trading community, has there been any change in trading behavior, any pull back or you know is the deleveraging impacting trading revenue there at all?

Pete Anderson

I don’t think we’ve seen any real pullback in this point, in fact as Bill said earlier I think the one thing we’ve experienced is as the professional trader moved from the floor or the pit to upstairs, those that have migrated really moved from trading the one commodity to multiple commodities and I think that’s where we’ve seen significant volumes ramp up as that migration has taken place.

Niamh Alexander – Keefe, Bruyette & Woods

Okay that’s helpful, thanks for taking my questions.

Operator

This time we have time for one final question, our last question is a follow up from Mike Vinciquerra, please go ahead.

Mike Vinciquerra – BMO Capital Markets

Just one question on the OTC side, we have to kind of back into the average RPC for your over the counter contracts because you’ve got consulting fees in there and so forth but when I look at it, it looks like it may have jumped somewhere on the order of $10.00 per contract sequentially and last quarter when it had dipped I think Bill you had mentioned that there was, it was either Forex or less weather trades, one or the other, can you talk about impact on the average RPC in the over the counter side if I’m looking at it appropriately?

Bill Dunaway

I think what we said in the first quarter was that there was, we had done quite a bit of fairly vanilla exchange lookalike type of hedging in that first quarter that had with it a little lower margin requirement. And I think what we’ve seen in the second quarter, a little bit more structured products where you tend to have a little more work involved and they’ll tend to have a little bit higher incremental margin.

Mike Vinciquerra – BMO Capital Markets

So somewhere between what we saw last quarter and this quarter, that’s probably a reasonable range when we’re trying to make projections going forward?

Bill Dunaway

I think that would be a correct statement Mike.

Mike Vinciquerra – BMO Capital Markets

Okay, thanks guys.

Operator

This does conclude our question and answer session, I’d like to turn the call back over to management for any concluding remarks they may have.

Pete Anderson

Okay I’d just like to thank everyone for joining us on the call today and we look forward to speaking with you again next quarter. Thank you.

Operator

Ladies and gentlemen, this does conclude the FCStone Group 2008 second quarter earnings conference call, you may now disconnect and I would like to thank you for your participation, have a pleasant day.

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