StoneX Group Inc (SNEX) 2008 Q3 法說會逐字稿

Good morning ladies and gentlemen, thank you for standing by. Welcome to FCStone Group 2008 third quarter earnings conference call. (OPERATOR INSTRUCTIONS). This conference is being recorded today, Thursday, July 10th, 2008. I would now like to turn the conference over to Bill Dunaway, Chief Financial Officer.

Thank you, and good morning everyone. I'd like welcome you to the FCStone fiscal third quarter 2008 earnings conference call. Shortly before the market opened today FCStone issued a press release reporting its earnings for the fiscal third quarter 2008. The press release is available on our website at www.FCStone.com. Additionally we're 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 in the current market environment. I will then provide details on our financial performance for the third quarter and year-to-date. Pete will then conclude our presentation with closing remarks before we open the question 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 would also like to remind you that during the course of this call management will make projections or other forward-looking remarks regarding future events or 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's 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 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 filings 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 cautionary statements during the earnings call. I would now like to turn the call over to Pete Anderson, our President and CEO.

I want to welcome everyone and thank you for joining the call. We're pleased to report FCStone's third quarter fiscal quarter 2008 results. It has been an exciting time for FCStone as a result of extraordinary volatility in the commodity and financial markets. As you can see from this morning's release our third quarter numbers net of extraordinary items continue to reflect growth in our core operating segments as we generated stronger revenue and earnings results.

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 over the past several quarters. The Clearing and Execution business segment also continues to experience strong performance.

Revenue for the third quarter of fiscal 2008 was $83.4 million which was up 29% from $64.5 million in the third quarter of fiscal 2007. Net income for the third quarter of fiscal 2008 was $8 million, or $0.28 per diluted share, which represents a decrease versus third quarter fiscal 2007 net income of $8.1 million, or $0.29 per diluted share. Results for the three months ended May 31, 2008 includes an after-tax reduction in net income of $4.2 million, or $0.14 per diluted share.

This after-tax reduction in net income included $1.1 million net bad debt write-off, primarily related to the consequences of unprecedented synthetic settlement pricing in the cotton market and the $3.1 million decline in the fair value of interest rate derivative hedge instruments, which had the effect of reversing previously recognized unrealized gains. These are derivative instruments were liquidated during the three months ended May 31, 2008, and were entered into to manage FCStone's consolidated exposure to short-term interest rates. Excluding these particular items, our net income for the third quarter of fiscal 2008 would have been $12.2 million or $0.42 per diluted share.

Before we review the Company's performance for our third quarter -- third fiscal quarter, I'd like to briefly address some of the recent macroeconomics trends and events that have impacted the markets and FCStone. Similar to our earnings report for the second fiscal quarter, the third fiscal quarter represented a period of substantial headwinds for the Company in the financial services arena as well as the agricultural and energy industry.

Historically high volatility, commodity price levels and constrained credit capacity in both deregulated and OTC commodity are derivative markets are having an impact on FCStone's operating environment. We believe each of these concerns should be placed into context. In terms of the impact either FCStone or its customers I want to be very clear. We're making no fundamental changes to our operating model.

Despite these macroeconomic circumstances our business continues to operate under the same risks, assumptions and opportunities today as it has in the past. Rest assured that we're prudently monitoring domestic and international economic environments, both for our customers and FCStone as a whole. We believe we have the people and processes in place to mitigate potential issues as we continue to improve our methods and operating standards, including in particular our risk management function.

Recent trends in agriculture have caused significant concerns about anticipated grain production for the current crop year, and access to adequate capital and credit capacity to produce future crops, carry inventories and maintain hedge positions. In order to understand the current situation we must look at historical supply and demand. The 2007 corn crop in the United States as reported by USDA set an all-time record with 93.6 million acres planted and production of 13.1 billion bushels. By comparison, the latest USDA projection of corn production for 2008 was 86 million acres with projected production of 11.7 million bushels.

Current estimates for potential loss of production this year caused by current flooding conditions across the Midwestern Corn Belt would reduce USDA estimates to 11.3 billion bushels. Despite a significant loss of production from flooding and crop damage, if the above estimates hold true the 2008 corn crop would still be the third-largest domestic corn crop in history.

In addition, the state of the soybean and wheat crop must be taken into account. Both soybean and wheat production have seen increases over the past year as considered in terms of the June 8, 2008 USDA domestic bushel production estimates of corn, soybeans and wheat for crop year 2007 to 2008, the expected reduction currently stands at only 2.56%. Although this volume reduction will be reflected in the amount of corn and soybeans FCStone's commercial customers handle, merchandise or consume, we expect decline in bushels of corn and soybeans hedged will be offset by the continued volatility and strong volume in both domestic and international commodity markets we serve.

FCStone may also benefit from increased funds required to be deposited by customers as a result of higher absolute price levels for corn and soybeans resulting in potential margin increases from increased volatility. Another concern for us and our investors is the continuing ability of our commercial customers in both the agricultural and energy sectors to access adequate financial capacity to carry inventories and adequately margin hedge positions. To date and to the great credit of lenders in both agricultural and energy industries, such vendors have done a stellar job in providing leverage to their borrowers and our customers through the turbulent and volatile periods.

Both industries in general have moved to a spot market to provide liquidity and to maintain a reserve against significant moves in the market they use to hedge. However, we recognize that credit capacity is not unlimited and it is FCStone's responsibility in conjunction with our customers, and their lenders, to manage demands for capital within specific limits. Thus far the credit capacity of our customers have been adequate and we anticipate with measures taken to provide liquidity to the market, the short and tenor of positions as well as customers obtaining increased leverage were warranted, we will continue to see adequate financing in the agricultural and energy markets.

During this critical time of extreme volatility and tight credit in the industry -- and tight credit, the industry experienced an unprecedented circumstance in the cotton markets. In early March the Exchange settled a cotton contract synthetically, leaving the commercial industry and market participants unprepared or unable to meet the margin call. As a result of the situation, FCStone experienced bad debt write-offs of $1.1 million, or $0.03 per diluted share for the quarter. FCStone's customers were adequately margin for limit move, but neither they nor we could have anticipated that settlement prices would be established synthetically by the Exchange.

We're aggressively pursuing collection of these debts and understand and have received assurance that the process of synthetically settling commodity prices will not be used again.

In spite of the current macroeconomic headwinds and industry environment, FCStone's growth initiatives continue to be implemented and accelerated in the current environment. This is evidenced by our continued growth in the contract volumes in both the exchange based instruments as well as OTC instruments and structures.

In the commodity and risk management segment Exchange volume was up 220,580 contract year-to-date for an increase year-over-year of 9.9%, while OTC volumes are up over 500,000 contracts for a year-over-year increase of 108.8%. The clearing and execution segment has also seen significant growth with an increase of 36.6 million contracts for an increase of 90.5% year-to-date versus the same period in 2007.

The growth in all market segments of the Company has been driven by a volatility in virtually every commodity and financial market around the world. This volatility is a reflection of the increased demand and consumption of underlying energy, agricultural products, metal and stock 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 offered by FCStone.

Beyond our traditional core business of agriculture and energy we anticipate continued growth opportunities in the areas of renewable energy, particularly biodiesel, international markets, foodservice, dairy production and consumption, livestock, cotton and textile, forest products, carbon credits and foreign exchange.

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 include sugar, ethanol, coffee, foreign exchange and consulting.

Revenues through fiscal third quarter 2008 have increased 109% versus the same period in 2007. As the United States 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. Revenues for this region have increased through fiscal third quarter 2008 by 90% over the same period in 2007.

Recent purchase of Downes-O'Neill and Globecot demonstrates our ability to further expand our presence and service offerings in new industries through successful add-on acquisitions. These types of acquisitions follows -- allow us to both leverage our industry experience while also adding seasoned, high-quality consultants to the FCStone family.

We continue to explore opportunities with potential acquisition candidates that have similar interests and philosophies in servicing customers, and we will continue to remain disciplined regarding the price we would 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.

As you know, none of this growth would be possible without the hard work of our risk management consultants. Our current roster of 130 consultants, trainees and interns has been built through a combination of hiring established industry expertise, our internal training program and through acquisitions. The mix of consultants includes 28 focused on international business in Latin America, Asia and Europe, with the balance targeting domestic markets.

We continue to reassess and develop our training programs to address new and developing products, as well as additional industries in regions that have growth potential and will make the necessary additions where we deem appropriate. Our goal through acquisitions and additional hires is to add five to ten additional consultants by the end of our fiscal year.

Finally I would like to provide an update on a few other recent initiatives that FCStone has been diligently working on. We continue to make solid progress on Agora-X, our innovative new OTC trading platform that we're developing in partnership with NASDAQ OMX. When completed, this platform will provide liquidity, transparency and trading efficiency for FCStone, our clients and qualified institutional participants.

Agora-X is currently in discussions with a number of potential qualified equity participants that will make an investment in the platform as well as commit to significant transactional volume. The platform is also negotiating with a number of clearing facilities to provide centralized clearing for Agora-X. We anticipate the platform will be operational in the last calendar quarter of 2008.

FCStone Carbon also continues to develop aggregation agreements, technology in the carbon credit inventory that it has acquired. To date, the Company has several aggregation agreements that represent creation of significant tons of carbon credit annually after underlying protocols are validated and verified. As the carbon markets mature, we believe FCStone Carbon is positioned to effectively represent our customers in marketing their carbon production or emission credit needs.

We're confident in our ability to thrive in all market environments and remain excited about the new growth prospects that we have in place, as well as our ability to continue to expand the business and grow over the long-term by focusing both domestically and internationally on the corn issues and business segments that have been the foundation of the organization, the agricultural and energy markets. Now I would like to turn the call over to Bill Dunaway, our CFO, for a detailed financial review.

As Pete mentioned, we're pleased to report continued growth across our core operating segments during our third fiscal quarter, as revenues net of cost of commodities sold reached 83.4 million. Compared to the prior year period of 64.5 million, the third quarter's revenues increased 29%. Our pretax income was 13.2 million for the quarter compared to 13 million for the same period last year. Our net income was 8 million for the third quarter this year compared to 8.1 million for the prior year period.

As mentioned earlier, excluding the effect of interest rate derivative instrument and the bad debt write, our net income for the quarter would've been 12.2 million, a 51% increase over the prior year period. Now let me take a few minutes to talk through the main components of the quarter's results, starting with 18.9 million increase in revenues.

First, commissions and clearing fees were up more than 14.1 million or 40% with approximately 13.5 million of this increase coming from exchange credit contracts, and other 600,000 of this increase coming from Forex commissions. Next, our service consulting and brokerage fees, which are primarily our over-the-counter brokerage fees, were up 15.9 million or 147% for the quarter over the same period last year. 15.5 million of this increase was related to over-the-counter brokerage with the remaining 400,000 comprised of an increase in consulting fees.

The increase in the over-the-counter brokerage is driven by continued strong growth at our international operations, primarily Brazil, as well as with our renewable fuels customers. Continued volatility in the energy markets has also driven growth in our over-the-counter brokerage with customers in that industry.

Interest income was 5.3 million for the quarter, down from 12 million in the same period last year. 5 million of this decrease was attributable to the decline in the fair value of the interest rate derivative hedge which was liquidated during the third quarter. The remainder of the decline in interest income was the result of significantly lower short-term interest rates during the third quarter when compared the prior year quarter. This was partially offset by much higher customer segregated and over-the-counter margin deposits we were carrying during the quarter.

Now I would like to address some of the issues we've experienced this quarter related to the interest rate markets. Across our two primary operating segments, we've recognized a substantial impact during the recent quarters based on market interest rates. During the month of September 2007, first month of the FCStone's fiscal year, the average Treasury bill rate for ninety-day T-bills stood at 3.99%. Since that time the average monthly ninety-day T-bill hit a low in this past quarter in April of 1.32%.

During the first nine months of the current fiscal year the average rate earned on our money market investments declined from 4.82% in September 2007 to 2.68% in May 2008. In spite of the substantial headwinds, FCStone experienced a $6.4 million increase in interest income during the first nine months of the current fiscal year when compared to the same period of the previous fiscal year, driven by growth in customer segregated assets from 997 million at the beginning of the fiscal year to 1.4 billion at the conclusion of our third quarter.

The Company also saw substantial increases in customer deposits in its over-the-counter platform, FCStone Trading, during the period.

At the same time net interest rates began to decline, we began to scale on hedges on FCStone's exposure to short-term interest rates using three-month LIBOR instruments with a two-year tenor. While the instruments were intended to be hedges against interest rate declines over a two-year period in order to meet GAAP accounting standards, FCStone is required to mark the infrastructures to market at the end of each quarter.

During the current fiscal year, we recognized a 652,000 unrealized gain in our first quarter, or $0.014 per diluted share, and 4.4 million unrealized gain in our second quarter or roughly $0.10 per diluted share. The difficulty that this accounting standard presents is the fact that the hedge instrument is structured for 24 month period, but the gain is recognized at each snapshot in time.

While the three-month LIBOR settings were virtually unchanged during the third quarter, the LIBOR curve steepened sharply with two-year LIBOR softs rising 106 basis points during the quarter. The entire structure was liquidated during our fiscal third quarter with substantially no gain, which had the effect of reversing all the previously recognized unrealized gains, reducing the Company's income for the third quarter by $0.11 per diluted share.

As we look at our total expenses, our expenses net of the cost of commodities sold increased approximately 19 million for the quarter over the same period last year. Upon a closer examination of the expenses, revenue volume related variable expenses of broker commissions and compensation, as well as benefits in pit brokerage clearing fees, accounted for approximately 16.4 million of these increased expenses.

This increase was offset by lower interest income -- or interest expense of 1.2 million, primarily due to the sale of our majority interest in our Grain Merchandising segment that we no longer consolidate. In addition, as discussed by Pete earlier, bad debt expense increased 1.6 million over the previous year period.

Taking a closer look at the performance within our two main business segments, our Commodity and Risk Management full-service segment generated operating income of 15.4 million compared to 9.9 million last year. This segment benefited from significantly higher OTC revenues as noted earlier, and exchange related commissions and clearing fees were up 3.9 million. This total increase was offset by 4.7 million in lower interest revenues from this segment.

Our clearing and execution segment had operating income of 1.3 million compared to 3.8 million in the prior year. The segment had a 44% increase in commissions and clearing fee revenue but interest income declined by 1.7 million.

Reviewing our balance sheet our total assets are 2.43 billion as of May 31st 2008, up from 1.42 billion as of August 31st 2007. This 1 billion increase was primarily a result of approximately 400 million in additional customer segregated funds, 142 million from additional OTC customer margin deposits, a 272 million increase in the value of open customer over-the-counter positions, 31 million from our financial services repurchase program. These increases were primarily driven by continued commodity volatility and increased trading volumes of our customers related to higher margin deposits.

Despite several items discussed earlier, operationally we had another strong quarter with growth in our core revenues of commission and clearing fees and service consulting and brokerage fees in comparison to both the prior year quarter and the second quarter of the current fiscal year. Additionally, with the significant increase in customer margin deposits, we're positioned to benefit from a rise in short-term interest rates. We remain excited about the core growth of our company and anticipate a continued trajectory of growth moving forward.

With that I'll turn it back over to Pete for some concluding remarks.

FCStone remains committed to its mission of improving our customers' bottom-line results by leveraging the expertise and experience of our customer -- of our consultants as well as utilizing the most appropriate platform or instrument to manage commodity risk. FCStone intends to leverage the industry dynamics and momentum that are in place to drive our volumes and the growth of the Company in the future. We believe the Company is well positioned for long-term success and to drive shareholder value.

With that, that concludes our prepared remarks. Operator, we would be happy to open the call up for questions.

(OPERATOR INSTRUCTIONS). Rich Repetto, Sandler O'Neill.

Good morning. I guess the first question, I don't want to get too elaborate on the call, but on this hedge you said you reversed an unrealized gain. But you had -- what I don't understand is that you had a realized gain in the prior quarter. So what was this unrealized portion that you had to reverse?

It was unrealized in the fact that we had not -- we had not liquidated or got out of the position. We mark to market the position at the end of each reporting quarter. So technically an accounting standpoint, it's not realized. It's recognized as a marked to market valuation of the interest rate derivative, but the only way of -- technically be a realized gain is in fact if you closed it out, if that makes sense. We saw the first quarter, the value of those instruments rose 652,000, but we did not close them out. It's an unrealized appreciation in the fair value of the instrument.

So the 4 point -- I think it was 4 million in the first quarter, are we not talking about the same instruments or not?

It was 652,000 in the first quarter. It was a 4.4 million in the second --

Right, in second quarter. Exactly.

And in the third quarter we liquidated it, and it becomes a recognized realized gain because we closed it out and in effect reversed out those previously unrealized but recognized gain.

Rich this is Pete. The issue I think from second quarter to third quarter was at end of the second quarter it's brought to market, but we still looked at it in terms of there's 24 month hedge position. And at that time, all indications were that fed fund rates were going to continue to decline, which they did over time. But at the same time there became really a disconnect between fed fund rates and LIBOR, which is what the hedge position was in or the collar was in.

And so as that disconnect became more dramatic, really we looked at it in terms of at some point, we had to make a determination that is there value in keeping that position on or is there real substantial risk incurring that position forward? And we really made the determination that there was far more risk carrying it forward than there was to maintain the hedge going forward. Hindsight is always 20/20. Had we picked a time or spot in time where we should have liquidated it, probably at the end of the second quarter would have been that time.

Understood, and I can follow up off-line more. The next question is on the actual volumes of contracts and the respective rates. For example, the OTC volume quarter-to-quarter from the prior fiscal second quarter went down 20%, 21%, but your rate went way up. Even on the exchange contract volume, it was a little bit less than the proxy, but your rate went up again. I guess the question is did we lose any of the high-volume active trading traders that are at a lower rate? Would that explain sort of what we're seeing in the volume and the rate numbers?

Certainly on the exchange traded volumes, yes, you saw some of the customers that had came on that were the very high-volume low rate -- their volumes were reduced in the second to third quarter. But once again, the impact of revenues is fairly small from those customers, because it is very low rate, lower margin. Good incremental business, but it does not have near the effect on revenues as it does on volume.

We actually saw increases in volume across some of our other exchange traded customers in that -- with that shift kind of in the mix, it really helped the rate for contracts. And when it comes to the over-the-counter, where volumes were down a little bit you actually saw more -- we saw more of a mix of structured products that carry with them a little bit more -- a higher margin basically for a contract. It's a little something that's not quite as fixed as an exchange rate for a contract, so the over-the-counter rate per contract is more fluid.

Okay. That's it, thank you.

Chris Allen, Banc of America Securities.

How are you doing? Could we just start on the bad debt expense? If you could give us a little bit more color on what actually occurred, because I know I don't understand when you say synthetic settlement of cotton prices.

Basically the cotton over a period of time in early March was moving limit higher. And as it moved limit higher it continued to trade in the option market. And so the exchange settled, basically, versus the option trading and marked or settled the futures contract versus that option trading or structure synthetically. They basically took an estimated price out of the options trade, or pit, and brought it back to the futures settlement price.

And the industry looked at really locked limit prices for their -- for a number of days, and the real confusion I think became for the customer as well as the lender, the bank. Providing capital to make those margin calls got confusing enough that it got to the point where basically lenders just stopped making loans for margin requirements.

And we were fortunate, as we went through that process, that it really only amounted to a handful of accounts that it affected, and just didn't have the leverage or the capital to adequately margin the account. But that was caused by the confusion of just settlement pricing. You would see a limit move, and a significantly higher price would be what the settlement was required on.

So ex-the cotton, the bad debt expense would have been roughly about 600,000, is that fair?

No. Virtually the entire was. Where you may have gotten 600,000 was Pete was talking at after-tax (multiple speakers) and I mentioned it pretax.

So virtually zero ex this issue. How did -- you alluded to a little bit before, is the health of your overall customer in that satisfactory state where you don't see any meaningful bad debt issues going forward?

No. In fact I think it the real good news is we have gone through the third quarter and really the last six months, or even the entire fiscal year and the most volatile period that we had ever seen at least in my career, in commodities, in my experience. Our bad debt in the grain traditional grain and agricultural industry as well as energy has been really minimal. And like I said in my comments earlier, to the credit of the lenders and agriculture and energy, they really stepped up and supported their customers as well as our client, and provided that leverage that was really needed.

If you look historically, the balance sheet for agriculture was really built for $2.50 corn, and we're trading $6.50 to $7 to $8 dollar corn. And those lenders have stepped up and made the margin call. And so I think that's the real good news as we've gone through this period is that the systems and processes and the margin requirements that we had through this period have really performed and been adequate.

Just on the compensation expense, this is probably the real big surprise for me. The big sequential increase in looking at the percentage of revenues ex-NII jumped as well. I am just wondering, what drove the sequential increase from the prior quarter?

I think the piece to point out there is we do not pay compensation expense on interest.

Even when you pull that out, it looks like it increased sequentially.

I think there was a slight increase; I think it was about 21% to 23%.

Exactly.

The rate that we pay out to our consultants fluctuates on -- based on what kind of revenues they are generating. Given the higher margins in the over-the-counter markets we do pay a higher compensation rate out to the brokers or the consultants on over-the-counter products. So that's going to drive it as much as anything.

So going back to Rich's question with the structured products driving up the rate per contract, when something like that occurs you should also expect to [count] the revenue issues to inflate slightly as well?

When you see -- when over-the-counter revenues are growing faster than Exchange based revenues, you will see a slight uptick in the compensation expense as a percentage of revenues.

Just on the over-the-counter business, were there any weather-related trades in there, and also is the environment such that it lends itself or more structured products? Will that change going forward?

There were no weather contracts. We do not have any of those during the current quarter, and I think in times of volatility, like we're seeing in the markets where you have people wanting to have the ability to lock in prices or limit prices at certain levels and still benefit from possible prices dropping or possible prices rising, in a real volatile market like this I would say it lends itself more to structured products where you really give yourself some real optionality of really covering yourself from a hedge standpoint, but still benefiting from -- depending on which side of the market you're on, benefiting from falling prices or rising prices, still being able to participate in those markets.

One last question. The falloff in customer segregated assets from April levels or prior quarter levels at end of May, it has spooked some people here. Was that just a function of where the markets ended up in May? Have we seen an improvement in June as agricultural volumes have picked up?

That's the real kind of -- the main number is just a snapshot in time. That's closing balance one day. The grain markets were significantly off on the last day of May. And when you see a significant price movement of something like that, we will be sending money out to the exchange. And in fact volumes will decrease for that one day, and you'll collect them back the next morning. Big price volatility movements there will kind of affect that. If you look at it -- if we look at it not on an average basis, it would be virtually unchanged from April to May.

Now we're seeing a big pickup in June volumes on ag side --

And you've seen margin requirements in the agricultural space go back to where they were, back in the May period when we reported seg funds. So you've seen those go -- corn is back up to $0.30 per bushel, so --

Thanks a lot, I'll get back in queue.

Mike Vinciquerra, BMO Capital Markets.

I want to go back to the OTC thing one more time, because I think one of the big questions is with the volumes down, as Rich said, 21% is the same number we got. Why -- what are we thinking about in terms of a go forward basis? It seems like you benefited from a mix shift which helped you actually grow revenues sequentially in the consulting business this quarter, but next quarter, how do we think about what volumes are going to be? Did you actually have lower volumes because of the structured product mix shift, or is it -- are those two pieces actually kind of independent, I guess volume versus the mix?

Part of the issue I think is -- some market segments are really migrating totally, almost totally to OTC products, or instruments or structures. And we see that by region, we see it by commodity to some degree. And I think -- I mentioned in my comments earlier, the grain industry, and not as much maybe in the energy industry, but the grain industry has really gone through to some degree I think a significant change in process almost, from really a forward cash contract and contracting method of buying and selling, to for all practical purposes the spot market.

A year ago we probably could've gotten you a bid for '08 corn, '09, '10. And today you can bid get a bid out maybe six months or so. For all practical purposes the market has moved back to its spot on a spot basis. I think it's still yet to be seen how that will affect us and the industry.

But I think going forward we will be dealing in shorter tenored instruments, and to some degree I think that volume dropped off a little bit just because there was so much value already captured by the producer or the farmer in the industry. And so I think as they went through a late planting season as well, as the exchange of base volume kind of stepped back from that, and -- but I do think a lot of the new business, a lot of the new regions, a lot of the new commodities that we're dealing in are really ramping up on the OTC side versus traditional exchange based products.

So the takeaway then is the drop off in volume, we should not look at that is being any sort of sign that your customers have pulled back in terms of their hedging, or that it's a long-term issue. It was an issue in the May quarter that would not really be expected to be repeated on a go forward basis.

Yes, I think to a large extent. And like I said earlier, we still raise the 13 billion bushel corn crop last year where it's going to be -- that's yet to be seen, but 11 plus probably this coming year. And so the supply eventually will come across our commercial customers or clients' books, and that will be reflected on -- through our volumes at some point.

Okay.

And that traditionally historically has been Exchange based instruments or product versus OTC.

All right. Back to -- just on the interest rate issue one more time, am I reading it right, that basically you had a basis risk issue in terms of how you hedge versus the way the interest rates actually moved at least their risk between LIBOR versus Fed fund?

As it relates to the interest rate derivative?

Yes.

Yes. There is not a lot of -- there's not a perfect -- there's not a perfect hedge out there for interest rate exposure. Historically the LIBOR has been as liquid and as correlated as you have seen. And it's one we've used before. But you certainly saw a significant disconnect here in the third quarter, and you saw a rapid steepening of that LIBOR curve.

And I think some of that had a little bit to do with -- there seem to be a little bit of funny business being played in the LIBOR rates that were reported. And I think they were reacting -- and even the curve and the trading at two-year swaps in LIBOR were affected a little bit more by some economic data than were the underlying investments that we were investing in. So all of that kind of really made the correlation not what it had been historically.

So when we look at where you are investing your clients' cash today, what is the best instrument in the open market for us to look at in terms of gauging whether or not you're seeing higher yields or lower yields?

Really it gets back to what the -- roughly the ninety-day Treasury bill is doing in conjunction with money market rates. As I discussed earlier, the money market rates were about 270, 260, 270 at the end of the quarter, and ninety-day treasury bills -- they had kind of dropped to 132 in April. They actually rallied pretty -- about 40 basis points towards the end of May. So they have come up a little bit and I think they stayed fairly flat from there. And then really the other rate is that overnight reverse repurchase we talked about in the past, but really it's going to correlate pretty closely to the ninety-day treasury.

Just finally, just on rates and I'll let someone else in queue here. If you were to look at a 25 basis point increase in Fed funds, is that not really a direct connection, it doesn't sound like, to what you're going to earn? So we can't actually say for every 25 basis point increase you guys are going to see an X-million dollar increase in your net interest revenue?

I think Fed funds and -- when you get rid of some of the [flight] to quality issues you had with treasury bills, and then being driven very low, they got the correlation between that and Fed funds and T-bills really kind of got as wide as it could there in the second quarter. But I think going forward, that would be a fairly accurate measure. I think it's going to kind of track some correlation to Fed funds.

And I think you could look at roughly $1.25 million, $1.5 million worth of interest based on $2 billion worth of -- assets between the Fed funds and OTC as being increased interest income as you see rates go up.

On an annualized or on a quarterly basis?

That would be quarterly.

Thank you.

Mark Lane, William Blair.

Good morning. So keep Pete, on the bad debt issue, between June 1st and as of five minutes ago, are you saying you had no material bad debt write-off in the fiscal fourth quarter so far?

Fiscal fourth quarter?

Yes.

I'm sorry, I missed the last part.

We had no bad debt write-off.

Have you had any credit issues in the current quarter up until this call?

We haven't had anything material that we would report, no.

And Pete, the number of consultants was 130 at the end of May, and it was also 130 as of the end of February. So what gives you confidence that you're going to be able to hire five to ten people in the fourth quarter?

We look at it in terms of -- we do -- we talked about really we added basically ten consultants through the acquisition of Downes-O'Neill and Globecot Jernigan. And we're still talking to a number of potential acquisition candidates, and our intent is to continue to pursue those, and through that process, if we get that done, could be more than 10. But the intent is to try and reach that goal, at the beginning of the fiscal year we wanted to add 20, and we basically added 12, and so the goal still is to basically get to about close to 140.

So that -- what I hear you saying is that includes the high probability of doing another deal?

We're trying.

And on the net interest income, so Pete, if I take out the interest revenue from the financial services business, and I take out the hedge, the last three quarters including this quarter, the underlying interest revenue in the first quarter was 11.1 million. In the second quarter it was 12.1 million. And then it dropped to 8.5 million.

I don't know if -- I know the business grew more first quarter to second quarter than it did second quarter to this quarter. But you didn't see the falloff last quarter from the drop in interest rates, which was probably quite similar to this quarter. So it seems like this 8.5 million is a pretty washed out number that all your duration risk is run through. Everything is rolled over, etc., etc. Is this -- would you consider this sort of a low point from a yield perspective, everything else equal?

I would certainly think so. At the beginning of that second quarter you saw four money market rates (inaudible) [out] at the 4.8, 4.9 range and treasury bills up over 3%. And the big -- the most dramatic fall in the treasuries and even the money market and certainly the overnight rates happened much more in the February to March timeframe than it did earlier in the second quarter. So I think you're seeing a significantly larger interest rate drop off in the third quarter than you did from first to second. The first to second Treasury bill started falloff, but the money market really tend to hold their value.

But you don't have anything that is extended or anything that's going to rolloff at lower rates? Everything that's in invested right now is invested at these lower rates, correct?

We generally always stayed -- the money markets may have a sixty to ninety-day weighted average maturity, and the T-bill investments will sometimes be -- were generally less than 90 days. Sometimes we have historically gone out a little bit farther than that, but fiscally never farther than six months. So as far as the duration, you would be correct.

Good enough. Appreciate it.

Rich Repetto, Sandler O'Neill.

Not to beat interest rate thing to death, the run rate that you came out -- again, you talked about the rate drop early in the quarter. The run rate that you exit say in June, would that be a run rate -- I didn't subtract the finance interest, but your net interest ex the hedge of about 10.2 million?

Yes. Gross, yes.

Exactly, gross.

Yes.

Okay. My only other sort of question was, Pete, in the prepared remarks you talked about constraint, the constrained -- the market conditions. I'm just trying to get a better understanding for what you really were talking about there. Is that the volatility we're seeing that constrained people from -- or what?

I think the real issue, especially for a lot of our commercial clients, both in agriculture and energy, is as I said earlier, one of our regional managers, Bob Mortenson, I think described it best when he said that agriculture industry's balance sheet was built for $2.50 corn, and we've seen basically $6.50 or $7.50 corn. And the capital end of -- and the leverage it takes to really finance those inventories is substantially greater than what it was two years ago.

And a lot of that leverage that you looked at two years ago might have been might have been for every dollar working capital you had $5 of financing capacity or borrowing capacity. And that leverage went from 1 to 5, to 1 to 8, to 1 to 10, to in some cases as high as 1 to 15. And I think industry to a large extent -- and so I think to the great credit of the lenders and participants in the industry, they stepped up and made the margin call and provided the leverage.

But I think they and the industry got to the point where they just could not -- and were not willing to take anymore risks beyond that amount of leverage. And that's really what forced, I think, industry back to a spot market and substantially more liquidity than we've seen in the past.

I don't necessarily -- I don't believe we will probably go back to the historical model of forward cash contracts out for a tenor of one or two or three years, at least utilizing the process where the commercial entity takes that risk and provides that capital and that leverage. I think we and others are working on alternatives to provide that capital and leverage and you'll see the system evolve. But that's really the difficulty that you see in agriculture and energy to some degree, and -- but as we go through that process I think that really -- there is really a need for our services and products and the expertise of our consultants even more today in that atmosphere than there was even before.

It appears we're going to shorter durations on everything because of volatility. But I guess as a guy new to the ag market, as it moves more towards spot and the prices are so -- at historic highs, isn't this the most profitable period of your clients right now? Other than -- again, the financing and we understand the finance positions are the longer duration, but on the spot basis these guys are making as much money as they ever have, wouldn't you agree?

From a farmer/producer perspective, that's really true. And that's the real benefit of those forward cash contracts is really for the producer or the farmer. The real difficulty, though, is that commercial participant, that temporary elevator, grain handler, is -- the leverage in the capital that he has been required to really provide for the last year or two years has really put them under significant pressure of basically covering the need for the capital, number one, and the cost of carrying that margin position for the last 12 months or 24 months and really borne the cost of that.

Understood, thanks guys.

Mike Vinciquerra, BMO Capital Markets.

Staying on the hedging and consulting side here, just to be sure, your clients, although they're selling more on the spot market, they're not being less aggressive in utilizing your services. Is that fair to say?

No. In fact, the margin -- markets are so volatile now that you just to a large extent you can't afford to be unhedged. We've seen corn go from early spring down to $5.50 basically on the spot market, $5.50 per bushel to near $8 a bushel and back down to what, $6.50 right now. So you have seen a range of almost $3 in a ninety-day period. So you cannot afford to just sit open. The exposure and the risk is just too substantial.

That's going to be basically for all commodity markets that we deal in. There's not really a market without volatility right now.

So I understand, how do you guys benefit or how do you make money in a spot market if your clients aren't using over-the-counter forwards or futures contracts? How do you get paid when clients are selling all their product spot?

They're still utilizing them. They're just staying in a shorter duration. Rather than hedging their corn in diesel 9 or [d-10] corn, they're hedging it in the September 2008 contract.

I see (multiple speakers)

-- shorter duration, still utilizing either exchange traded derivatives or over-the-counter evidence, they're just staying shorter and tenor with their hedges.

So you're just referring, when you say spot, you're meaning like a ninety-day market not --

Right. Not like a spot currency area, not a cash --

Understood, that's helpful. Thank you.

At this time there are no further questions in the queue. I will turn it back to you for any closing remarks.

Thank you. We appreciate of everyone participating on today's call and we look forward to talking after our fiscal year end in August 31st. And thank you all for your support.

This concludes FCStone Group 2008 third quarter earnings conference call. If you'd like to listen to a replay of today's conference please dial 303-590-3000, or 800-405-2236 with an access code of 11116686. Once again those numbers are 303-590-3000, or 800-405-2236 with an access code of 11116686 pound. ACT would like to thank you for your participation. You may now disconnect.