Annual Reports

 
Quarterly Reports

 
8-K

 
Other

FCStone Group 10-K 2009
Amendment #2 to Form 10-K
Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-K/A

(Amendment No. 2)

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended: August 31, 2008

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to            

 

Commission file number: 001-33363

 

 

 

FCStone Group, Inc.

 

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   42-1091210

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1251 NW Briarcliff Parkway, Suite 800, Kansas City, Missouri   64116
(Address of principal executive office)   (Zip Code)

 

Registrant’s telephone number, including area code: (816) 410-7120

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $0.0001 par value   The NASDAQ Stock Market LLC

 

Securities registered pursuant to 12(g) of the Act: None

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x    Accelerated filer ¨
Non-accelerated filer ¨    Smaller Reporting Company ¨
(Do not check if a smaller reporting company)   

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

 

The aggregate market value of the 17,030,284 shares of common stock of the registrant held by non-affiliates of the registrant on February 29, 2008, the last business day of the registrant’s most recently completed second fiscal quarter, computed by reference to the closing sale price of such stock on the NASDAQ Global Select Stock Market on that date was $794,292,446.

 

As of November 13, 2008, the Registrant had 27,913,627 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s definitive proxy statement for its Annual Meeting of Stockholders to be held on January 14, 2009, are incorporated by reference into Parts II and III of this Report on Form 10-K.

 

 

 


Table of Contents

EXPLANATORY NOTE

 

This Annual Report on Form 10-K/A (“Form 10-K/A”) is being filed as Amendment No. 2 to our Annual Report on Form 10-K for the fiscal year ended August 31, 2008, which was filed with the Securities and Exchange Commission on November 14, 2008 (the “Original Filing”). We subsequently filed an amendment to the Original Filing on November 19, 2008 (“Amendment No. 1”). This Form 10-K/A is being filed to:

 

(1) Revise Item 1 to expand the disclosure under the heading “Regulatory Matters” on page 6 to provide a discussion of our net capital requirements and to provide more detail about the regulatory provisions applicable to our business;

 

(2) Revise Item 6 to include cash dividends declared per common share in the Statement of Financial Condition Data;

 

(3) Revise the signature page to include the signatures of the members of the board of directors; and

 

(4) Revise Exhibits 31.1 and 31.2 to conform the certifications to the exact form prescribed by Item 601(b)(31) of Regulation S-K by referring to the “report” rather than the “annual report”.

 

The following sections in this report have been amended as a result of the restatement:

 

Part I-Item 1: Business

 

Part II-Item 6: Selected Financial Data; and

 

Part IV-Item 15. Exhibits and Financial Statement Schedules.

 

For the convenience of the reader, this Form 10-K/A sets forth the Original Filing, as amended by Amendment No. 1, in its entirety. However, this Form 10-K/A only amends and restates the Items described above, and we have not modified or updated other disclosures presented in our Original Filing or Amendment No. 1. Accordingly, this Amendment No. 2 does not reflect events occurring after the filing of our Original Filing and Amendment No. 1, and does not modify or update those disclosures affected by subsequent events, except as specifically referenced herein. Information not affected by this restatement or Amendment No. 1 is unchanged and reflects the disclosures made at the time of the Original Filing on November 14, 2008.

 

1


Table of Contents

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

 

This report includes forward-looking statements, such as those pertaining to our plans, strategies and prospects, both business and financial. These statements involve known and unknown risks, assumptions, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance, strategy, anticipated, estimated or projected results or achievements expressed or implied by these forward-looking statements. These factors include, among other things, customer/counterparty credit and liquidity risk, customer acceptance of risk management, interest rates, commodity price volatility, transaction volumes, and our ability to develop new products for our customers. You should consider the risks described in the “Risk Factors” section beginning on page 9 of this annual report on Form 10-K, in evaluating any forward-looking statements included in this report.

 

In some cases, you can identify forward-looking statements by use of words such as “will be,” “intend,” “continue,” “believe,” “may,” “expect,” “hope,” “anticipate,” “goal,” “forecast,” or other comparable terms, or by discussions of strategy, plans or intentions.

 

There is no assurance the events discussed or incorporated by reference in this report or circumstances reflected in the forward-looking statements will occur and actual results, performance or achievements could differ materially from those anticipated or implied in the forward-looking statements. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this report whether as a result of new information, future events or otherwise.

 

PART I

 

Item 1. Business

 

General

 

FCStone Group, Inc. is an integrated commodity risk management company providing risk management consulting and transaction execution services to commercial commodity intermediaries, end-users and producers. We assist primarily middle market customers in optimizing their profit margins and mitigating their exposure to commodity price risk. In addition to our risk management consulting services, we operate one of the leading independent clearing and execution platforms for exchange-traded futures and options contracts. We serve more than 8,000 customers and in fiscal 2008, executed more than 100.0 million derivative contracts in the exchange-traded and over-the-counter (“OTC”) markets. As a complement to our commodity risk management consulting and execution services, we also assist our customers with financing, transportation and merchandising of their physical commodity requirements and inventories through our financial services segment and equity affiliations.

 

We began offering commodity risk management consulting services to grain elevators in 1968. We originally operated as a member-owned cooperative that was governed by a mission to deliver professional marketing and risk management programs to enhance the profitability of our members and other customers. In 2004, we converted to a stock corporation to improve our access to financial capital and to facilitate continued growth in our operations.

 

We provide our customers with various levels of commodity risk management services, ranging from value-added consulting services delivered through our Integrated Risk Management Program (“IRMP”) to lower-margin clearing and execution services for exchange-traded derivative contracts. Within our Commodity and Risk Management Services (“C&RM”) segment, our IRMP involves providing our customers with commodity risk management consulting services that are designed to help them mitigate their exposure to commodity price risk and maximize the amount and certainty of their operating profits. In performing consulting services, we educate our customers as to the commodity risks that they may encounter and how they can use the derivative markets to mitigate those risks. The IRMP forms the basis of our value-added approach, and serves as a

 

1


Table of Contents

competitive advantage in customer acquisition and retention. We offer our customers access to both exchange-traded and OTC derivative markets, integrating the two platforms into a seamless product offering delivered by our 130 commodity risk management consultants.

 

Within our Clearing and Execution Services (“CES”) segment, we also offer clearing and execution services to a broad array of participants in exchange-traded futures and options markets including commercial accounts, professional traders, managed futures funds, introducing brokers and retail customers. Our futures commission merchant (“FCM”) subsidiary holds clearing-member status at all of the major U.S. commodity futures and options exchanges. As of August 31, 2008, we were the third largest FCM in the U.S., as measured by required customer segregated assets, not affiliated with a major financial institution or commodity producer, intermediary or end-user. Our exchange-traded futures and options transaction volumes have grown from 16.3 million contracts in fiscal year 2003 to 98.6 million contracts in fiscal 2008. As of August 31, 2008, we had $1.5 billion in customer segregated assets.

 

To compliment our two primary segments, C&RM and CES, we also operate a Financial Services segment. In our Financial Services segment, through FCStone Financial, Inc. (“FCStone Financial”) and FCStone Merchant Services, LLC (“FCStone Merchant Services”), we offer financing and facilitation for our customers with respect to physical commodity inventories and operations. FCStone Financial offers financing services that help our customers finance physical grain inventories, while FCStone Merchant Services provides the same services for grain inventories, as well as other commodities. FCStone Merchant Services also provides structured commodity financing in transactions where it shares in profits with customers in commodity or commodity-related projects in exchange for financial support. The Financial Services segment, while not a primary source of revenue or profit, serves as a facilitation business for C&RM customers, enabling us to provide additional value-added services to our customers.

 

Operating Segments

 

We operate through a number of wholly-owned subsidiaries and currently in three reportable segments, consisting of C&RM, CES and Financial Services. We also report a Corporate and Other segment, which contains income from equity investments not directly attributed to an operating segment, corporate investment income and direct corporate expenses and expenses of a startup subsidiary. See Note 25 to our consolidated financial statements for a description of segment financial information.

 

Commodity and Risk Management Services

 

The C&RM segment is the foundation of our company. Consistent with our original structure as a cooperative serving our grain elevator members, we approach middle-market intermediaries, end-users and producers of commodities with the objective of serving as their commodity risk manager. Within the C&RM segment, we serve customers through our force of risk management consultants with a level of service that maximizes our abilities and the opportunity to retain the customer. We provide our risk management consulting customers with assistance in the execution of their hedging strategies through our exchange-traded futures and options clearing and execution operations as well as access to more customized alternatives provided by our OTC and foreign exchange trading desks. Generally, our customers direct their own trading activity and we do not have discretionary authority to transact trades on behalf of our customers. When transacting OTC and foreign exchange contracts with our customers, we will generally offset the customers transaction simultaneously with one of our trading counterparties. On a limited basis, our OTC and foreign exchange (“Forex”) trade desks will accept a customer transaction and will offset that transaction with a similar but not identical position on the exchange. These unmatched transactions are intended to be short-term in nature and are conducted to facilitate the most effective transaction for our customer.

 

Within the C&RM segment, we currently serve approximately 6,000 customers, including approximately 520 through our IRMP. Our customers are served through 13 domestic offices and four international offices, including China, Brazil, Canada and Ireland.

 

2


Table of Contents

We deliver our consulting services through an experienced force of approximately 130 risk management consultants. The average tenure of our consultants is seven years, while the annual turnover rate has averaged approximately 8% over the past four fiscal years. We maintain a formal training program for our incoming consultant trainees, which provides a foundation in the basics of our business, including risk management, futures and options markets, OTC markets, financial statement analysis and derivative accounting. As part of the training process, new consultants apprentice with an experienced risk management consultant for up to two years before independently managing customer relationships.

 

We organize our marketing efforts within the C&RM segment into customer industry segments, and currently serve customers in the following areas:

 

   

Commercial Grain—The commercial grain customer segment represents the foundation of our C&RM segment, as the roots of our company can be traced back to this business. Within this sector we provide services to grain elevators, traders, processors, manufacturers and end-users.

 

   

Energy—The energy customer segment targets companies where energy represents a significant input cost into the production of their product or service. Customers in this segment include producers, refiners, wholesalers, transportation companies, convenience store chains, auto and truck fleet operators, industrial companies, railroads and municipalities.

 

   

Introducing Brokers—Introducing Brokers within our C&RM segment include individuals or organizations that maintain relationships with customers and intermediate transactions between the customer and ourselves. The customers within this segment are primarily agricultural producers.

 

   

Latin America/Brazil—The customers within this customer segment are located predominantly in Mexico and Brazil. Our customers are involved in all sectors of agribusiness, including livestock production and feeding, flour milling and baking, oilseed crushing and refining, grain merchandising, meat processing and sugar/ethanol production. We believe there are significant opportunities to deepen the penetration of risk management practices within this customer segment in this region.

 

   

China—The China customer segment represents both Chinese FCMs as well as commercial companies seeking to hedge their commodity risk exposures. The Chinese FCMs are similar to introducing brokers, facilitating the transactions of their clients in the U.S. commodities markets. The commercial accounts generally represent significant processors of grain or other commodities.

 

   

Dairy/Food Service—The dairy and food service segment targets the dairy industry and users of agricultural commodities in the food industry. We believe only a small percentage of this industry currently utilizes derivatives to manage commodity price risk, and OTC products in particular are an effective strategy for use in these industries. Through our acquisition of Downes-O’Neill, we have added extensive depth and expertise.

 

   

Cotton/Textiles—The cotton segment targets the domestic and international market for cotton and textiles. This segment was created through the acquisitions of Globecot Inc. and Jernigan Group, LLC.

 

   

Renewable Fuels—The renewable fuels customer segment targets producers of ethanol and biodiesel products. While in the short-run this business presents challenges due to the financing environment, we believe overall growth prospects are still strong driven by retrofitting of new technology that makes plants more efficient and productive, and narrower margins make hedging more important for realizing sufficient returns.

 

   

Forex—We also offer foreign exchange trading services to customers seeking to mitigate currency risk or to profit from currency trading.

 

   

Other—We maintain a number of developing customer segments where the adoption of risk management practices is increasing and our consultative approach is serving as a catalyst to customer adoption. These customer segments currently include customers with risk management needs in the areas of forest products, transportation and weather-related products. In addition, we are participating in

 

3


Table of Contents
 

the development of markets for carbon and emission credits. We have partnered with third parties that would, depending on further developments, enable us to market carbon and emission credits generated by renewable fuel industry participants and share in the proceeds from sales of such credits.

 

Our integrated platform allows our customers, aided by our risk management consultants, to execute and clear commodity futures and options contracts for the purpose of establishing and maintaining their hedge positions through our C&RM segment. Alternatively, we are able to meet more customized hedging needs through our OTC trading desk. Our OTC trading desk, through broad access to commodity market participants as well as major financial institutions, is able to design hedge arrangements that may contain features with respect to contract performance, time period, commodity types, and transaction size that are not achievable in the highly-standardized exchange-traded commodity futures and options markets. Further, our OTC capability has provided an ability to create products that assist our customers, in turn, to offer value-added services to their clients. We believe that we are unique in offering both exchange-traded and OTC products to our middle-market target customers.

 

LOGO

 

Source: Company Information

 

Within our C&RM business, we have experienced strong growth in contract trading volumes. Since 2004, growth in exchange-traded contract trading and OTC contract trading have both been robust, driven by record harvested crop production, sustained commodity price volatility and acceptance of derivatives as tools for hedging risk.

 

In fiscal 2008, the C&RM segment had consolidated income before minority interest, income tax and corporate overhead of $67.5 million, an increase of $21.8 million, or 47.7%, from $45.7 million in fiscal 2007. The C&RM segment represented approximately 76% and 78% of our consolidated income before minority interest, income tax and corporate overhead in fiscal 2008 and 2007, respectively.

 

See Note 25 to the consolidated financial statements for a table showing a summary of our consolidated revenues by geographic area.

 

4


Table of Contents

Clearing and Execution Services

 

We seek to provide inexpensive and efficient clearing and execution of exchange-traded futures and options for the institutional and professional trader market segments through the Stone division of our subsidiary, FCStone LLC. Through our platform, we accept customer orders and direct those orders to the appropriate exchange for execution. We then facilitate the clearing of our customers’ transactions. Clearing involves the matching of our customers’ trades with the exchange, the collection and management of margin deposits to support the transactions, and the accounting and reporting of the transactions to our customers. We seek to leverage our capabilities and capacity by offering facilities management or outsourcing solutions to other FCMs.

 

FCStone LLC is a registered FCM and a clearing member of all major U.S. commodity futures exchanges including the Chicago Mercantile Exchange (“CME”) and its divisions: the Chicago Board of Trade (“CBOT”), the New York Mercantile Exchange (“NYMEX”) and the COMEX; ICE Futures US formerly know as the New York Board of Trade (“NYBOT”), Kansas City Board of Trade (“KCBT”) and the Minneapolis Grain Exchange (“MGEX”).

 

We service approximately 2,000 customers though a Wholesale Division and a Professional Trading Division:

 

Wholesale Division. Wholesale division customers generally consist of non-clearing FCMs, introducing brokers and clearing FCMs for which we provide back-office services such as trade processing and accounting. These customers serve as intermediaries to the ultimate customer transacting the futures or options contract.

 

Professional Trading Division. The professional trading customers consist of retail-oriented introducing brokers, professional traders and floor traders. In this division, we target high-volume users of the futures and options markets and also target managed futures funds, hedge funds and commodity trading advisors. This segment of our customer base has benefited from the emergence of electronic trading, providing them a greater opportunity to trade across markets and commodities.

 

LOGO

 

Source: Company Information

 

In fiscal 2008, the CES segment had consolidated income before minority interest and income tax of $20.2 million, an increase of $10.6 million, or 110.4%, from $9.6 million in fiscal 2007. The CES segment

 

5


Table of Contents

represented approximately 22% and 16% of our consolidated income before minority interest, income tax and corporate overhead in fiscal 2008 and 2007, respectively.

 

Financial Services

 

Our Financial Services segment is comprised of FCStone Financial and FCStone Merchant Services. FCStone Financial serves as a grain financing and facilitation business through which we lend to commercial grain-related companies against physical grain inventories. We use sale/repurchase agreements to purchase grain evidenced by warehouse receipts at local grain elevators subject to a simultaneous agreement to sell such grain back to the original seller at a later date. We account for these transactions as product financing arrangements, and accordingly no grain inventory, grain purchases or grain sales are recorded.

 

FCStone Merchant Services serves as a financing vehicle for a number of different commodities, including grain, energy products and renewable fuels. These arrangements can take the form of fixed repurchase agreements, hedged commodity transactions or traditional lending arrangements, which includes providing letters of credit.

 

In fiscal 2008, the Financial Services segment had consolidated income before minority interest and income tax of $1.7 million, an increase of $0.6 million, or 54.5%, from $1.1 million in fiscal 2007. The Financial Services segment represented approximately 2% of our consolidated income before minority interest, income tax and corporate overhead in fiscal 2008 and 2007, respectively.

 

Regulatory Matters

 

Regulation and Exchange Memberships

 

We have a long history of operating in a highly regulated industry. Our business activities are extensively regulated by a number of U.S. and foreign regulatory agencies and exchanges. These regulatory bodies and exchanges are charged with protecting customers by imposing requirements relating typically to capital adequacy, licensing of personnel, conduct of business, protection of customer assets, record-keeping, trade-reporting and other matters. They have broad powers to monitor compliance. If we fail to comply with applicable regulations, we may be subject to censure, fines, cease-and-desist orders, suspension of our business, removal of personnel, civil litigation, revocation of operating licenses or other sanctions. Furthermore, new regulations, changes in current regulations as well as changes in the interpretation or enforcement of existing laws or rules may affect our business and operations and the policies and procedures we follow.

 

Minimum capital requirements are a significant part of the regulatory framework in which we operate. We are subject to stringent minimum capital requirements in the United States, pursuant to Section 4(f)(b) of the Commodity Exchange Act. The Commodity Exchange Act prescribes rules and regulations under Part 1.17 of the rules and regulations of the Commodity Futures Trading Commission. These rules specify the minimum amount of capital that we must have available to support our clients’ open trading positions, including the amount of assets we must maintain in relatively liquid form, and are designed to measure general financial integrity and liquidity. Net capital and the related net capital requirement may fluctuate on a daily basis. Compliance with minimum capital requirements may limit our operations if we cannot maintain the required levels of capital. Moreover, any change in these rules or the imposition of new rules affecting the scope, coverage, calculation or amount of capital we are required to maintain could restrict our ability to operate our business and adversely affect our operations. We currently maintain regulatory capital in excess of all applicable requirements. See Note 6 to the consolidated financial statements.

 

Our primary regulators in the United States are the Commodity Futures Trading Commission, the National Futures Association and the Chicago Mercantile Exchange, which is our designated self-regulatory organization. We are a member of Chicago Mercantile Exchange/Chicago Board of Trade, New York Mercantile Exchange, ICE Futures US, Minneapolis Grain Exchange and the Kansas City Board of Trade.

 

6


Table of Contents

We operate a broker-dealer to offer money market funds to our customers that is regulated by the Securities and Exchange Commission, the Financial Industry Regulatory Authority and state securities regulators. This aspect of our operations is not material to our business.

 

In addition to those rules and regulations that are imposed by the various regulators, self-regulatory organizations and exchanges, the U.S. federal and state governments as well as non-U.S. governments have imposed a number of other regulations with which we must comply, including:

 

USA PATRIOT Act-Anti-Money Laundering Laws

 

The USA PATRIOT Act of 2001 (the “PATRIOT Act”), contains anti-money laundering and financial transparency laws and mandates the implementation of various regulations applicable to broker-dealers and other financial services companies. The PATRIOT Act seeks to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Anti-money laundering laws outside of the United States contain similar provisions. We believe that we have implemented, and that we maintain, appropriate internal practices, procedures and controls to enable us to comply with the provisions of the PATRIOT Act and other anti-money laundering laws.

 

U.S. Office of Foreign Assets Control

 

The United States maintains various economic sanctions programs administered by the U.S. Treasury Department’s Office of Foreign Assets Control. Some of these programs are broad and comprehensive country- specific economic sanctions (such as those targeting Burma (Myanmar), Cuba, Iran, North Korea, Sudan and Syria); other programs target “specially designated” individuals and entities that are engaged in certain activities, such as proliferation of weapons of mass destruction, terrorism and narcotics trafficking, as well as activities particular to certain countries, such as undermining democratic processes or institutions in Zimbabwe. The OFAC-administered sanctions take many forms, but generally prohibit or restrict trade and investment in and with sanctions targets; some programs also require blocking of the sanctions target’s assets. All “specially designated” individuals and entities are generally referred to as “SDNs” and are placed on a list maintained by OFAC called the list of Specially Designated Nationals and Blocked Persons, which contains over 7,500 names and is updated often. Generally, the OFAC-administered sanctions are applicable to “U.S. persons”, or U.S. citizens, permanent resident aliens, entities organized under the laws of the United States (including their foreign branches), regardless of where they are physically located, and persons actually present in the United States (regardless of nationality), but non-U.S. persons are bound in certain instances. Violations of any of the OFAC-administered sanctions are punishable by civil fines, as well as criminal fines and imprisonment. Penalties for violating the OFAC-administered sanctions can be severe, including civil penalties per incident of the greater of (a) $250,000 and (b) twice the amount of the transaction in respect of which the penalty is imposed, and criminal penalties per incident of $1,000,000 and up to 20 years in prison. We have established policies and procedures designed to assist our and our personnel’s compliance with applicable OFAC sanctions. An entity’s compliance program is one factor that OFAC will consider in deciding whether to impose penalties, and at what level, in the event of a violation. Although we believe that our policies and procedures are effective, there can be no assurance that our policies and procedures will effectively prevent us from violating the OFAC-administered sanctions in every transaction in which we may engage.

 

Information Privacy Laws

 

U.S. federal and state laws and regulations require financial institutions to protect the security and confidentiality of consumer information and to notify consumers about their policies and practices relating to their collection and disclosure of consumer information as well as their policies to protect the security and confidentiality of that information. These requirements generally require all businesses to provide notice to and obtain the consent of individuals prior to using their personal information and restrict the transfer of such information. We believe that we have implemented, and that we maintain, appropriate internal practices,

 

7


Table of Contents

procedures and controls to enable us to comply with these laws and regulations related to the privacy of consumer information.

 

Sales and Marketing

 

We have a comprehensive sales and marketing program that is primarily implemented by our staff of risk management consultants. Our risk management consultants are compensated on a commission basis and are responsible for developing new customers and providing services to new and existing customers. Our executive management team also engages in significant sales and marketing activities.

 

Sales efforts are primarily centered on consulting services and on presenting our ability to obtain and utilize commodity intelligence information to support customer needs and improve customer profitability. Specifically, we emphasize our IRMP, which provides the most comprehensive level of service offered by us. Sales efforts are supported by systems, staff and resources, including current commodity information and intelligence systems, communications systems, archives of commodity basis and pricing information and related presentation and analytical tools, marketing materials, an internet web site, advertising, and educational materials.

 

We engage in direct sales efforts to seek new customers with a strategy of extending our services from our existing customer base to similar customers not yet served and to different kinds of customers that have risk management needs similar to those of our existing customer base. We seek to serve not only those customers that currently use risk management methods, but also those customers that we believe should use risk management methods. We are expanding our services into new business segments and are expanding our services geographically into foreign markets, particularly in Asia, Latin America and Canada.

 

We stay in regular contact with existing customers to provide commodity information and services, usually on a daily basis, by direct personal contact and by issuing current market commentary by fax or e-mail. We also offer educational programs on risk management methods and regular outlook meetings for our customers as well as the customers of our customers.

 

Competition

 

The commodity and risk management industry can generally be classified into four basic types of companies: (1) pure consultants, (2) clearing FCMs providing trade execution but not broad-based consulting services, (3) captive businesses providing consulting and trade execution as divisions of financial institutions or larger commodity-oriented companies, and (4) integrated FCMs providing both consulting and trade execution from an independent platform. As a result, we compete with a large number of smaller firms that focus on personalized service, and a small number of large companies that focus less on personalized service but have significant execution capabilities and market presence. We believe that our C&RM segment, which operates as an integrated FCM, serves the needs of middle market companies that require both the personalized consulting services provided by our risk management consultants and the trade execution services that we offer as an FCM.

 

We compete with a large number of firms in the exchange-traded futures and options execution sector and in the OTC derivatives sector. We compete primarily on the basis of price and value of service. Our competitors in the exchange-traded futures and options sector include international brokerage firms, national brokerage firms, regional brokerage firms (both cooperatives and non-cooperatives) as well as local introducing brokers, with competition driven by price level and quality of service. Many of these competitors offer OTC trading programs as well. In addition, there are a number of financial firms and physical commodities firms that participate in the OTC markets, both directly in competition with us and indirectly through firms like us. We compete in the OTC market by making specialized OTC transactions available to our customers in contract sizes smaller than those usually available from major counter-parties.

 

In the Financial Services segment we compete with traditional lenders, including banks and asset-based lenders. In addition, we also compete with specialized investment groups that seek to earn an investment return

 

8


Table of Contents

based on commodities transactions. We compete on price and service, industry expertise and by managing commodity risks at small dollar thresholds that traditional lenders may seek to pass up. We are an extremely small participant in the financial services industry, which consists of a very large number of large and small firms. We do not attempt to compete generally in this industry. Rather, we focus our energies on filling a specific niche of supporting commodities transactions.

 

Technology

 

We utilize front-end electronic trading, back office and accounting systems that process transactions on a daily basis. These systems are integrated to provide recordkeeping, trade reporting to exchange clearing, internal risk controls, and reporting to government entities, corporate managers, risk managers and customers. Our futures and options back office system is maintained by a third-party service bureau which is located in Chicago with a disaster recovery site in New York. All other systems are maintained in our West Des Moines information technology headquarters data center and system backups are stored off-site.

 

All of these systems are accessed through a wide area network. All systems are protected by a firewall and require proper security authorization for access. Our wide area network is managed by a service bureau which has redundant data facilities in Kansas City. We are currently building a disaster recovery plan to utilize the West Des Moines and Kansas City data centers to house redundant systems.

 

Our risk managers access market information from network-based software systems. Market information includes real-time quotes, market history (futures/cash), news and commentaries. Market information also includes our historic database of market pricing and trend information used in the IRMP. This information is used to analyze the markets to help risk managers determine the best strategy for a customer to minimize risk and maximize profit margins, especially when used in conjunction with the IRMP.

 

We also utilize Sungard’s KIODEX platform in conjunction with our proprietary back office trade system to process OTC derivative trades. We use Globex, Clearport, eAcess, CQG, Transact, TT, RTS, RANorder and PATS electronic trading/order routing platforms.

 

Employees

 

As of August 31, 2008, we employed 448 people. This total is broken down by business segment as follows: C&RM had 244 employees; Clearing and Execution Services had 129 employees; Financial Services had 3 employees; and Corporate had 72 employees. We believe our relationship with our employees is good, and we have not suffered any work stoppages or labor disputes. None of our employees operate under a collective bargaining agreement. Many of our employees are subject to employment agreements. It is our current policy to obtain an employment agreement containing noncompetition provisions from each risk management consultant.

 

Available Information

 

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 are available free of charge on our website at www.fcstone.com as soon as reasonably practicable after such reports have been filed with or furnished to the Securities and Exchange Commission.

 

9


Table of Contents

Item 1A. Risk Factors

 

Our business depends on commodity market conditions and general economic conditions. We generate significant revenues from commissions and clearing fees we earn from executing and clearing customer orders, fees for providing commodity risk management consulting services and interest income we earn on cash and investment balances in our customers’ accounts. These revenue sources are substantially dependent on customer trading volumes, interest rates and related services and activities. The volume of transactions our customers conduct with us, interest rates and demand for our related services and activities are directly affected by domestic and international commodity market conditions and economic conditions that are beyond our control, including:

 

   

commodity market conditions, such as price levels and volatility,

 

   

business activity for which commodities are a significant input,

 

   

concerns about terrorism and war,

 

   

the level and volatility of interest rates,

 

   

inflation,

 

   

availability and cost of funding and capital,

 

   

credit capacity or perceived creditworthiness of the futures industry in the marketplace,

 

   

legislative and regulatory changes, and

 

   

currency values and changes in government monetary policies.

 

Declines in the volume of trading in the markets in which we operate generally result in lower revenue from our most profitable segments, which would adversely affect our profitability.

 

We are exposed to the credit risk of our customers and counterparties and their failure to meet their financial obligations could adversely affect our business. Each segment of our business is subject to credit risk. Credit risk is the possibility that we may suffer a loss from the failure of customers or counterparties to meet their financial obligations as it relates to exchange traded, over the counter, or financing transactions. As a clearing broker, we act on behalf of our customers for all trades consummated on exchanges. We must pay initial and variation margin to the exchanges before we receive the required payments from our customers. Accordingly, we are responsible for our customers’ obligations with respect to these transactions, including margin payments, which exposes us to significant credit risk. Customer positions which represent a significant percentage of open positions in a given market or concentrations in illiquid markets may expose us to the risk that we are not able to liquidate a customer’s position in a manner which does not result in a deficit in that customers account. A substantial part of our working capital is at risk if customers default on their obligations to us and their account balances and security deposits are insufficient to meet all of their obligations.

 

With over-the-counter derivative transactions we act as a principal, which exposes us to both the credit risk of our customers and the counterparties with which we offset the customer’s position. As with exchange traded transactions, our over-the-counter transactions require that we meet initial and variation margin payments on behalf of our customers before we receive the required payment from our customers. In addition, with over-the-counter transactions, we are at the risk that a counterparty will fail to meet its obligations when due. We would then be exposed to the risk that a settlement of a transaction which is due a customer will not be collected from the respective counterparty with which the transaction was offset. Customers and counterparties that owe us money, securities or other assets may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons.

 

Our financial service activities, which primarily relate to financial accommodations to customers used to acquire and carry commodities, expose us to substantial credit risks due to possible defaults or nonperformance of our customers. The transactions are collateralized with warehouse receipts or related negotiable instruments, but price movements or market conditions related to the commodities or the financial condition of the warehouse

 

10


Table of Contents

receipt holder involved may result in a situation in which we are not holding sufficient collateral with respect to amounts advanced to our customers, and we may not be able to acquire additional collateral from our customer.

 

These risks expose us indirectly to the financing and liquidity risks of our customers and counterparties, including the risks that our customers and counterparties may not be able to finance their operations. Throughout the agriculture and energy industries, higher commodity prices and continued volatility has required increased lines of credit, and placed a strain on working capital debt facilities, leveraging customers to unprecedented levels in order for them to continue to carry inventory and properly execute hedging strategies. Recent volatility in the financial markets has tightened credit further, and increased the difficulty in obtaining financing.

 

Although we have procedures for reviewing credit exposures to specific customers and counterparties to address present credit concerns, default risk may arise from events or circumstances that are difficult to detect or foresee including rapid changes in commodity price levels. Some of our risk management methods depend upon the evaluation of information regarding markets, clients or other matters that are publicly available or otherwise accessible by us. That information may not, in all cases, be accurate, complete, up-to-date or properly evaluated. In addition, concerns about, or a default by, one institution could lead to significant liquidity problems, losses or defaults by other institutions, which in turn could adversely affect us. We may be materially and adversely affected in the event of a significant default by our customers and counterparties.

 

In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the U.S. Congress enacted legislation on October 3, 2008 referred to as the Emergency Economic Stabilization Act of 2008 (“EESA”). Pursuant to the EESA, the U.S. Treasury has the authority to, among other things, purchase up to $700 billion of mortgage-backed and other securities from financial institutions for the purpose of stabilizing the financial markets. There can be no assurance what impact the EESA will have on the financial markets, including the extreme levels of volatility currently being experienced. Although we are not one of the institutions currently authorized to sell securities to the U.S. Treasury pursuant to the EESA, the ultimate effects of EESA on the financial markets and the economy in general could materially and adversely affect our business, financial condition and results of operations, or the trading price of our common stock, as the commodity markets rely on availability of financing to support activity.

 

We are subject to regulatory capital requirements and failure to comply with these rules would significantly harm our business. The CFTC and various other self-regulatory organizations have stringent rules with respect to the maintenance of specific levels of net capital by our FCM subsidiary. Failure to maintain the required net capital may subject a firm to limitations on its activities, including suspension or revocation of its registration by the CFTC and suspension or expulsion by the NFA and various exchanges of which our FCM subsidiary is a member. Ultimately, any failure to meet capital requirements could result in our liquidation. Failure to comply with the net capital rules could have material and adverse consequences such as limiting our operations, or restricting us from withdrawing capital from our FCM subsidiary.

 

If these net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require the intensive use of capital would be limited. Also, our ability to withdraw capital from our regulated subsidiaries is subject to restrictions, which in turn could limit our ability to pay dividends, repay debt and redeem or purchase shares of our common stock. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our present levels of business, which could have a material adverse effect on our business. We cannot predict our future capital needs or our ability to obtain additional financing.

 

We are subject to margin funding requirements on short notice; failure to meet such requirements would significantly harm our business. Our business involves establishment and carrying of substantial open positions for customers on futures exchanges and in the OTC derivatives markets. We are required to post and maintain margin or credit support for these positions. Although we collect margin or other deposits from our customers for

 

11


Table of Contents

these positions, significant adverse price movements can occur which will require us to post margin or other deposits on short notice, whether or not we are able to collect additional margin or credit support from our customers. We maintain borrowing facilities for the purpose of funding margin and credit support and have systems to endeavor to collect margin and other deposits from customers on a same-day basis, there can be no assurance that these facilities and systems will be adequate to eliminate the risk of margin calls in the event of severe adverse price movements affecting open positions of our customers. Generally, if a customer is unable to meet its margin call, we promptly liquidate the customer’s account. However, there can be no assurance that in each case the liquidation of the account will not result in a loss to us or that a liquidation will be feasible, given market conditions, size of the account and tenor of the positions.

 

Low short-term interest rates negatively impact our profitability. The level of prevailing short-term interest rates affects our profitability because a portion of our revenue is derived from interest earned from the investment of funds deposited with us by our customers. At August 31, 2008, we had $1.5 billion in customer segregated assets, which are generally invested in short-term treasury securities and money market funds. Our financial performance generally benefits from rising interest rates. Higher interest rates increase the amount of interest income earned from these customer deposits. If short-term interest rates remain low or continue to fall, our revenues derived from interest will decline which would negatively impact our profitability.

 

Short-term interest rates are highly sensitive to factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory authorities. In particular, decreases in the federal funds rate by the Board of Governors of the Federal Reserve System usually lead to decreasing interest rates in the U.S., which generally lead to a decrease in short-term interest rates.

 

Our revenue depends on trading volume which depends in large part on commodity prices and commodity price volatility. Trading volume is driven largely by the degree of volatility—the magnitude and frequency of fluctuations—in prices of commodities. Higher volatility increases the need to hedge contractual price risk and creates opportunities for arbitrage trading. Energy and agricultural commodities markets periodically, have experienced significant price volatility and such volatility has recently increased. In addition to price volatility, increases in commodity prices lead to increased trading volume. As prices of commodities have risen, especially energy prices, new participants have entered the markets to address their growing risk-management needs or to take advantage of greater trading opportunities. Sustained periods of stability in the prices of commodities or generally lower prices could result in lower trading volumes and, potentially, lower revenues. Lower volatility and lower volumes could lead to lower customer balances held on deposit, which in turn may reduce the amount of interest revenue based on these deposits.

 

Factors that are particularly likely to affect price volatility and price levels of commodities include:

 

   

supply and demand of commodities,

 

   

weather conditions affecting certain commodities,

 

   

national and international economic and political conditions,

 

   

perceived stability of commodities and financial markets,

 

   

the level and volatility of interest rates and inflation, and

 

   

financial strength of market participants.

 

Any one or more of these factors may reduce price volatility or price levels in the markets for commodities trading, which in turn could reduce trading activity in those markets. Moreover, any reduction in trading activity could reduce liquidity which in turn could further discourage existing and potential market participants and thus accelerate any decline in the level of trading activity in these markets.

 

12


Table of Contents

Current levels of volatility in the capital and credit markets are unprecedented. The capital and credit markets have been experiencing extreme volatility and disruption for more than twelve months. Recently, the volatility and disruption have reached unprecedented levels. In some cases, the markets have exerted downward pressure on stock prices and credit capacity for certain issuers. Our plans for growth require that we and our customers have regular access to the capital and credit markets. If current levels of market disruption and volatility continue or worsen, access to capital and credit markets could be disrupted making growth through acquisitions and development projects difficult or impractical to pursue until such time as markets stabilize.

 

We may issue additional equity securities, which would lead to dilution of our issued and outstanding stock. The issuance of additional common stock or securities convertible into our common stock could result in dilution of the ownership interest in us held by existing stockholders. We are authorized to issue, without stockholder approval 20,000,000 shares of preferred stock, par value $0.001 per share, in one or more series, which may give other stockholders dividend conversion, voting, and liquidation rights, among other rights, which may be superior to the rights of holders of our common stock. In addition, we are authorized to issue, without stockholder approval, a significant number of additional shares of our common stock and securities convertible into either common stock or preferred stock.

 

Our customers are concentrated in the agricultural sector and related industries and we are therefore subject to government policies and regulations affecting those industries. We do a substantial amount of business with companies in the agricultural sector and related industries. Economic forces, including agricultural commodity, energy and financial markets, as well as government policies and regulations affecting the agricultural sector and related industries could adversely affect our operations and profitability. Agricultural production and trade flows are significantly affected by government policies and regulations. Governmental policies affecting the agricultural industry, such as taxes, tariffs, duties, subsidies and import and export restrictions on agricultural commodities and commodity products, can influence industry profitability, the planting of certain crops versus other uses of agricultural resources, the location and size of crop production, whether unprocessed or processed commodity products are traded and the volume and types of imports and exports.

 

Many of our customers are in the energy and related renewable fuels industries and our revenues could decline as a result of adverse developments in these industries. Energy prices and energy price volatility are affected by local, regional and global events and conditions that affect supply and demand for the relevant energy-related commodity. Adverse developments in the energy markets could adversely affect the operations and profitability of our customers in these industries, which could adversely affect demand for our commodity risk management services in this area and our revenues. The renewable fuels industry is a developing industry that involves a high degree of risk. Generally, renewable fuel production is profitable as long as energy prices remain at relatively high levels and feed stocks are readily available at acceptable price and volume levels. In addition, government subsidies of the renewable fuel industry and favorable environmental regulations are critical to the industry’s profitability at this time. In the short-term the renewable fuels industry presents challenges due to the financing environment, however growth prospects are driven by retrofitting of new technology that makes plants more efficient and productive. However, the recent decline in oil prices and tightening credit markets, are having a significant adverse effect on the price and profit margins of the renewable fuels industry.

 

We face substantial competition that could negatively impact our revenues and our profitability. The commodity risk management industry and the broader financial services industry are very competitive and we expect competition to continue to intensify in the future. Many of the companies with which we compete are better capitalized than we are and have greater financial, technical, marketing and other resources than we have. Our primary competitors include both large, diversified financial institutions and commodity-oriented businesses, smaller firms that focus on specific products or regional markets and independent FCMs. As a result, we compete with a large number of smaller firms that focus on personalized service, and a smaller number of larger, better capitalized companies that generally focus less on personalized service but have significant execution capabilities and market presence.

 

13


Table of Contents

Some of our competitors offer a wider range of services, have broader name recognition and have larger customer bases than we do. Some of them may be able to respond more rapidly to new or evolving opportunities, technologies and customer requirements than we can, and may be able to undertake more extensive marketing activities. If we are not able to compete successfully in the future, our business, financial condition and results of operations would be adversely affected.

 

We have experienced intense price competition in our clearing and execution business in recent years. Some competitors may offer clearing and execution services to customers at lower prices than we are offering, which may force us to reduce our prices or to lose market share and revenue. In addition, we focus on developing and marketing complex strategies to our clients that are specifically designed to address their commodity risk management or merchandising needs, or the needs of their customers. As the market adopts these strategies, competitors may have the ability to replicate our services. As a result, the need for our services in relation to these strategies could be significantly reduced.

 

Future growth could strain our personnel and infrastructure resources. We anticipate a period of significant growth, which we expect to place a strain on our administrative, financial and operational resources. Our ability to manage growth effectively will require us to improve existing, and implement additional, operational, financial and management controls and reporting systems and procedures. We will also be required to identify, hire and train additional risk management consultants as well as administrative staff. We cannot assure you that we will be able to improve or implement such controls, systems and procedures in an efficient and timely manner or that they will be adequate to support our future operations. Furthermore, we may not be able to identify, hire and train sufficient personnel to accommodate our growth. If we are unable to manage growth effectively, maintain our service or if new personnel are unable to achieve performance levels, our business, operating results, prospects and financial condition could be materially adversely affected.

 

Difficulties integrating our acquisitions could lower our profit. We plan to pursue select acquisitions in the future. If we are unable to complete acquisitions we have identified, our growth strategy could be impaired. In addition, we may encounter difficulties integrating our acquisitions and in successfully managing the growth we expect from the acquisitions. Furthermore, expansion into new businesses may expose us to additional business risks that are different from those we have traditionally experienced. Because we may actively pursue a number of opportunities simultaneously, we may encounter unforeseen expenses, complications and delays, including difficulties in employing sufficient staff and maintaining operational and management oversight. To the extent we encounter problems in identifying acquisition risks or integrating our acquisitions, our operations could be impaired as a result of business disruptions and lost management time, which could reduce our profit.

 

Our business could be adversely affected if we are unable to retain our existing customers or attract new customers. The success of our business depends, in part, on our ability to maintain and increase our customer base. Customers in our market are sensitive to, among other things, the costs of using our services, the quality of the services we offer, the speed and reliability of order execution and the breadth of our service offerings and the products and markets to which we offer access. We may not be able to continue to offer the pricing, service, speed and reliability of order execution or the service, product and market breadth that customers desire. In addition, once our commodity risk management consulting customers have become better educated with regard to sources of commodity risk and the tools available to facilitate the management of this risk and we have provided them with recommended hedging strategies, they may no longer continue paying monthly fees for these services. Furthermore, our existing customers, including IRMP customers, generally are not obligated to use our services and can switch providers of clearing and execution services or decrease their trading activity conducted through us at any time. As a result, we may fail to retain existing customers or be unable to attract new customers. Our failure to maintain or attract customers could have a material adverse effect on our business, financial condition and operating results.

 

14


Table of Contents

We rely on relationships with introducing brokers for obtaining some of our customers. The failure to maintain these relationships could adversely affect our business. We have relationships with introducing brokers who assist us in establishing new customer relationships and provide marketing and customer service functions for some of our customers. These introducing brokers receive compensation for introducing customers to us. Many of our relationships with introducing brokers are non-exclusive or may be cancelled on relatively short notice. In addition, our introducing brokers have no obligation to provide new customer relationships or minimum levels of transaction volume. Our failure to maintain these relationships with these introducing brokers or the failure of these introducing brokers to establish and maintain customer relationships would result in a loss of revenues, which could adversely affect our business.

 

We are dependent on our management team, and the loss of any key member of our team may prevent us from executing our business strategy effectively. Our future success depends, in large part, upon our management team who possess extensive knowledge and management skills with respect to commodity risk management. The unexpected loss of services of any of our executive officers could adversely affect our ability to manage our business effectively or execute our business strategy. Although these officers have employment contracts with us, they are generally not required to remain with us for a specified period of time. In addition, we do not maintain key-man life insurance policies on any of our executive officers.

 

Competition for risk management consultants could result in our being unable to attract and retain the highly skilled risk management consultants that we need to support our business or we may be required to incur additional expense to do so. We strive to provide high-quality risk management consulting and execution services that allow us to establish and maintain long-term relationships with our clients. Our ability to continue to provide these services, maintain these relationships and expand our business depends, in large part, upon our risk management consultants. As a result, we must attract and retain highly qualified personnel. Competition for the services of consultants is intense, especially for people with extensive experience in the specialized markets in which we participate or may seek to enter. If we are unable to hire highly qualified people, we may not be able to enter new markets or develop new products. If we lose one or more of our risk management consultants in a particular customer segment in which we participate, our revenues may decrease and we may lose market share in that particular segment.

 

In addition, recruitment and retention of qualified personnel could require us to pay sign-on or guaranteed bonuses or otherwise increase our employee costs. These additional costs could adversely affect our profitability.

 

We operate in a highly regulated industry and we may face restrictions with respect to the way we conduct certain of our operations. Our businesses, and the commodity brokerage industry generally, are subject to extensive regulation at the federal level. These regulations are designed to protect the interests of the investing public generally rather than our shareholders. Self-regulatory organizations, including the NFA and the CME (our designated self-regulatory organization), require compliance with their extensive rules and regulations. The CFTC and other federal agencies extensively regulate the U.S. futures and commodities industry.

 

Some aspects of our business are subject to extensive regulation, including:

 

   

the way we deal with and solicit clients,

 

   

capital requirements,

 

   

financial and reporting practices,

 

   

required record keeping and record retention procedures,

 

   

the licensing of our operating subsidiaries and our employees,

 

   

the conduct of directors, officers, employees and affiliates,

 

   

systems and control requirements,

 

15


Table of Contents
   

restrictions on marketing, and

 

   

client identification and anti-money laundering requirements.

 

Failure to comply with any of the laws, rules or regulations of any federal, state or self-regulatory authority could result in a fine, injunction, suspension or expulsion from the industry, which could materially and adversely impact us.

 

We and our employees, including our officers, may be subject to censure, fines, suspensions or other sanctions which may have a material and adverse impact on our business. Even if any sanction does not materially affect our financial position or results of operations, our reputation could be harmed.

 

The government agencies that regulate us have broad powers to investigate and enforce compliance and punish noncompliance with their rules, regulations and industry standards of practice. We or our directors, officers and employees may not comply with the rules and regulations of, and may be subject to claims or actions by, these agencies. In addition, because our industry is heavily regulated, regulatory approval may be required prior to expansion of business activities. We may not be able to obtain the necessary regulatory approvals for any desired expansion. Even if approvals are obtained, they may impose restrictions on our business or we may not be able to continue to comply with the terms of the approvals or applicable regulations. The implementation of unfavorable regulations or unfavorable interpretations of existing regulations by courts or regulatory bodies could require us to incur significant compliance costs or cause the development or continuation of business activities in affected markets to become impractical.

 

Changes in legislation or regulations may affect our ability to conduct our business or reduce our profitability. The legislative and regulatory environment in which we operate has undergone significant change in the past and may undergo significant change again in the future. The financial crisis affecting the banking system and financial markets may result in regulatory changes that have an impact on us. The federal government, the CFTC, the SEC, the CME, the NFA and other U.S. or foreign governmental authorities continuously review legislative and regulatory initiatives and may adopt new or revised laws and regulations. These legislative and regulatory initiatives may affect the way in which we conduct our business and may make our business less profitable. Changes in the interpretation or enforcement of existing laws and regulations by those entities may also adversely affect our business.

 

We are subject to a risk of legal proceedings, which may result in significant losses to us that we cannot recover. Many aspects of our business subject us to substantial risk of potential liability to customers and to regulatory enforcement proceedings by federal and other regulators. These risks include, among others, potential civil litigation triggered by regulatory investigations, potential liability from disputes over terms of a trade, the claim that a system failure or delay caused monetary losses to a customer, that we entered into an unauthorized transaction or that we provided materially false or misleading statements in connection with a transaction. Dissatisfied clients can make claims against us, including claims for negligence, fraud, unauthorized trading, failure to supervise, breach of fiduciary duty, employee errors, intentional misconduct, unauthorized transactions by associated persons and failures in the processing of transactions. These risks also include potential liability from disputes over the exercise of our rights with respect to customer accounts and collateral. Although our customer agreements generally provide that we may exercise such rights with respect to customer accounts and collateral as we deem reasonably necessary for our protection, our exercise of these rights could lead to claims by customers that we have exercised these rights improperly.

 

Additionally, employee misconduct could subject us to financial losses and regulatory sanctions and could seriously harm our reputation and negatively affect our business. It is not always possible to deter employee misconduct and the precautions taken to prevent and detect employee misconduct may not always be effective. Misconduct by employees could include engaging in unauthorized transactions or activities, failure to properly supervise other employees, engaging in improper or unauthorized activities on behalf of clients or improperly using confidential information. We cannot assure you that these types of proceedings will not materially and adversely affect us.

 

16


Table of Contents

Employee errors, including mistakes in executing, recording or reporting transactions for clients, could cause us to enter into transactions that clients may disavow and refuse to settle, which could expose us to the risk of material losses until the errors are detected and the transactions are unwound or reversed. If our clients are not able to settle their transactions on a timely basis, the time in which employee errors are detected may be increased and our risk of material loss can be increased. The risk of employee error or miscommunication may be greater for products that are new or have non-standardized terms.

 

Misconduct by employees of our customers in dealing with us can also expose us to claims for financial losses or regulatory proceedings when it is alleged we or our employees knew or should have known that the employee of the customer was not authorized to undertake certain transactions.

 

In addition to the foregoing financial costs and risks associated with potential liability, the defense of litigation includes increased costs associated with attorneys’ fees. The amount of outside attorneys’ fees incurred in connection with the defense of litigation could be substantial and might materially and adversely affect our results of operations for any reporting period.

 

Our compliance and risk management methods might not be effective, which could increase the risk that we are subject to regulatory action or litigation or otherwise negatively impact our business. Our ability to comply with applicable laws, rules and regulations is largely dependent on our establishment and maintenance of compliance, audit and reporting systems, as well as our ability to attract and retain qualified compliance and other risk management personnel. If we fail to effectively establish and maintain such compliance and reporting systems or fail to attract and retain personnel who are capable of designing and operating such systems, it will increase the likelihood that we will become subject to legal and regulatory infractions, including civil litigation and investigations by regulatory agencies.

 

For us to avoid a number of risks inherent in our business, it is necessary for us to have polices and procedures that identify, monitor and manage our risk exposure. Management of operational, legal and regulatory risk requires, among other things, policies and procedures to record properly and verify a large number of transactions and events. Such policies may not be fully effective. Some of our risk management policies and procedures depend upon evaluation of information regarding markets, customers or other matters that are publicly available or otherwise accessible by us. That information may not in all cases be accurate, complete, up-to-date or properly evaluated. Further, our risk management policies and procedures rely on a combination of technical and human controls and supervision, which are subject to error and failure. Some of our risk management policies and procedures are based on internally developed controls and observed historical market behavior and also involve reliance on industry standard practices. These policies and procedures may not adequately prevent future losses, particularly as they relate to extreme market movements, which may be significantly greater than comparable historical movements. We may not always be successful in monitoring or evaluating the risks to which we are or may be exposed. If our risk management efforts are ineffective, we could suffer losses that could have a material adverse effect on our financial condition or operating results.

 

We operate as a principal in the OTC derivatives markets which involves the risks associated with commodity derivative instruments. We offer OTC derivatives to our customers in which we act as a principal counterparty. We endeavor to simultaneously offset the commodity price risk of the instruments by establishing corresponding offsetting positions with commodity counterparties. We also hold limited, short-term proprietary OTC positions that result when we accept customer transactions and offset those transactions with similar but not identical positions on an exchange. To the extent that we are unable to simultaneously offset an open position or the offsetting transaction is not fully effective to eliminate the commodity derivative risk, we have market risk exposure on these unmatched transactions. Our exposure varies based on the size of the overall positions, the terms and liquidity of the instruments brokered, and the amount of time the positions remain open.

 

To the extent an unhedged position is not disposed of intra-day, adverse movements in the commodities underlying these positions or a downturn or disruption in the markets for these positions could result in a

 

17


Table of Contents

substantial loss. In addition, any principal gains and losses resulting from these positions could on occasion have a disproportionate effect, positive or negative, on our financial condition and results of operations for any particular reporting period.

 

Transactions involving OTC derivative contracts may be adversely affected by fluctuations in the level, volatility, correlation or relationship between market prices, rates, indices and/or other factors. These types of instruments may also suffer from illiquidity in the market or in a related market.

 

OTC derivative transactions are subject to unique risks. OTC derivative transactions are subject to the risk that, as a result of mismatches or delays in the timing of cash flows due from or to counterparties in OTC derivative transactions or related hedging, trading, collateral or other transactions, we or our counterparty may not have adequate cash available to fund its current obligations.

 

We could incur material losses pursuant to OTC derivative transactions because of inadequacies in or failures of our internal systems and controls for monitoring and quantifying the risk and contractual obligations associated with OTC derivative transactions and related transactions or for detecting human error, systems failure or management failure.

 

OTC derivative transactions may be modified or terminated only by mutual consent of the original parties and subject to agreement on individually negotiated terms. Accordingly it may not be possible to modify, terminate or offset obligations or exposure to the risk associated with a transaction prior to its scheduled termination date.

 

We must obtain and maintain credit facilities to operate; failure to maintain such facilities would require curtailment of our operations and result in losses. We carry significant open futures positions on behalf of our customers in the C&RM and the Clearing and Execution Services segments of our business. These credit facilities are necessary in order to meet immediate margin funding requirements, to cover any abnormal commodity market fluctuations and the margin calls they produce, and to maintain positions required for our own risk management position in futures and OTC markets. If our credit facilities are unavailable or insufficient to support future levels of business activities, we may need to raise additional funds externally, either in the form of debt or equity. If we cannot raise additional funds on acceptable terms, we may not be able to develop or enhance our business, take advantage of future opportunities or respond to competitive pressure or unanticipated requirements.

 

Our international operations involve special challenges that we may not be able to meet, which could adversely affect our financial results. We engage in a significant amount of business with customers in Asia, Brazil, Latin America and Canada, as well as other international markets. Certain additional risks are inherent in doing business in international markets, particularly in a regulated industry. These risks include:

 

   

the inability to manage and coordinate the various regulatory requirements of multiple jurisdictions that are constantly evolving and subject to unexpected change,

 

   

tariffs and other trade barriers,

 

   

difficulties in recruiting and retaining personnel, and managing international operations,

 

   

difficulties of debt collection in foreign jurisdictions,

 

   

potentially adverse tax consequences, and

 

   

reduced protection for intellectual property rights.

 

Our operations are also subject to the political, legal and economic risks associated with politically unstable and less developed regions of the world, including the risk of war and other international conflicts and actions by governmental authorities, insurgent groups, terrorists and others. Specifically, we conduct business in countries

 

18


Table of Contents

whose currencies may be unstable. Future instability in such currencies or the imposition of governmental or regulatory restrictions on such currencies could impede our foreign exchange business and our ability to collect on collateral held in such currencies.

 

In addition, we are required to comply with the laws and regulations of foreign governmental and regulatory authorities of each country in which we conduct business. These may include laws, rules and regulations, including registration requirements. Our compliance with these laws and regulations may be difficult and time consuming and may require significant expenditures and personnel requirements, and our failure to be in compliance would subject us to legal and regulatory liabilities. We have customers in numerous countries around the world in which we are not registered. As a result, we may become subject to the regulatory requirements of those countries. We may also experience difficulty in managing our international operations because of, among other things, competitive conditions overseas, established domestic markets, language and cultural differences and economic or political instability. Any of these factors could have a material adverse effect on the success of our international operations or limit our ability to grow our international operations and, consequently, on our business, financial condition and operating results.

 

Although most of our international business is settled in U.S. dollars, our international operations also expose us to the risk of fluctuations in currency exchange rates. Our risk management strategies relating to exchange rates may not prevent us from suffering losses that would adversely affect our financial condition or results of operations.

 

If we are unable to manage any of these risks effectively, our business could be adversely affected.

 

Our financial services activities involve substantial operational risk. We are exposed to various customer operational risks relating to the handling and preservation of the underlying commodities that form the basis of our financial services transactions. Losses in and to the ownership of these commodities, which could be caused by fraud, misappropriation or other uninsured loss, could cause loss to us. Many of our financial services transactions depend on documents of title issued to, or held by, us. If such documents were invalid or not fully enforceable, it could cause a material loss. There are government programs that back grain warehouse receipts, but these could be inadequate to fully reimburse us for the value of grain evidenced by our warehouse receipts in the event of the business failure of the issuer of the receipt.

 

Computer systems failures, capacity constraints and breaches of security could increase our operating costs and cause us to lose clients. We are heavily dependent on the capacity and reliability of the computer and communications systems supporting our operations, whether owned and operated internally or by third parties. We receive and process a large portion of our trade orders through electronic means, such as through public and private communications networks. These computer and communications systems and networks are subject to performance degradation or failure from any number of reasons, including loss of power, acts of war or terrorism, human error, natural disasters, fire, sabotage, hardware or software malfunctions or defects, computer viruses, intentional acts of vandalism, customer error or misuse, lack of proper maintenance or monitoring and similar events. Our systems, or those of our third party providers, may fail or operate slowly, causing one or more of the following:

 

   

unanticipated disruptions in service to our clients,

 

   

slower response times,

 

   

delays in our clients’ trade execution,

 

   

failed settlement of trades,

 

   

decreased client satisfaction with our services,

 

   

incomplete, untimely or inaccurate accounting, recording, reporting or processing of trades,

 

19


Table of Contents
   

financial losses,

 

   

litigation or other client claims, and

 

   

regulatory sanctions.

 

The occurrence of degradation or failure of the communications and computer systems on which we rely may lead to financial losses, litigation or arbitration claims filed by or on behalf of our customers and regulatory investigations and sanctions, including by the CFTC, which require that our trade execution and communications systems be able to handle anticipated present and future peak trading volumes. Any such degradation or failure could also have a negative effect on our reputation, which in turn could cause us to lose existing customers to our competitors or make it more difficult for us to attract new customers in the future. Further, any financial loss that we suffer as a result of such degradations or failures could be magnified by price movements of contracts involved in transactions impacted by the degradation or failure, and we may be unable to take corrective action to mitigate any losses we suffer.

 

We must keep up with rapid technological changes in order to compete effectively. The markets in which we compete are characterized by rapidly changing methods, evolving customer demand and uses of our services, frequent product and service introductions employing new methods, and the emergence of new industry standards and practices that could render our existing systems obsolete. Our future success will depend in part on our ability to anticipate and adapt to these changes. Any upgrades or expansions may require significant expenditures of funds and may also increase the probability that we will suffer system degradations and failures. We may not have sufficient funds to adequately update and expand our networks, and any upgrade or expansion attempts may not be successful and accepted by the marketplace and our customers. Any failure to adequately update and expand our systems and networks or to adapt our systems to evolving customer demands or emerging industry standards could have a material adverse effect on our business.

 

We depend on third-party software licenses. The loss of any of our key licenses could adversely affect our ability to provide our brokerage services. We license software from third parties, some of which is integral to our business. These licenses are generally terminable if we breach our obligations under the licenses or if the licensor gives us notice in advance of the termination. If any of these relationships were terminated, or if any of these third parties were to cease doing business, we may be forced to spend significant time and money to replace the licensed software. These replacements may not be available on reasonable terms, if at all. A termination of any of these relationships could have a material adverse effect on our financial condition and results of operations.

 

We may not be able to protect our intellectual property rights or may be prevented from using intellectual property necessary for our business. We rely primarily on trade secret, contract, copyright and trademark law to protect our proprietary information and methods. It is possible that third parties may copy or otherwise obtain and use our proprietary information and methods without authorization or otherwise infringe on our rights. We may also face claims of infringement that could interfere with our ability to use information and methods that are material to our business operations.

 

In the future, we may have to rely on litigation to enforce our intellectual property rights, protect our trade secrets, determine the validity and scope of the proprietary rights of others or defend against claims of infringement or invalidity. Any such litigation, whether successful or unsuccessful, could result in substantial costs and the diversion of resources and the attention of management, any of which could negatively affect our business.

 

Item 1B. Unresolved Staff Comments

 

None

 

20


Table of Contents

Item 2. Properties and Locations

 

We lease office space for our principal business operations. Effective September 1, 2007, our corporate headquarters relocated to Kansas City, Missouri. We have entered into a lease term on a newly constructed building in Kansas City, which we began to occupy during the fourth quarter of fiscal 2008. This new lease will be in place through July 2015. Previously, our corporate headquarters was located in West Des Moines, Iowa, where we still operate and lease office space. We have other offices in Chicago, Illinois; New York, New York; Kansas City, Missouri; St. Louis, Missouri; Omaha, Nebraska; Minneapolis, Minnesota; Bloomington, Illinois; Buford, Georgia; Indianapolis, Indiana; Spirit Lake, Iowa; Bowling Green, Ohio; Nashville, Tennessee; Westcliffe, Colorado; Summit, New Jersey; Winnipeg, Canada; and Campinas, Brazil. We have established representative offices in Beijing in the People’s Republic of China and in Dublin, Ireland. All of our offices and other principal business properties are leased, and we believe that our leased facilities are adequate to meet anticipated requirements for our current lines of business for the foreseeable future.

 

Item 3. Legal Proceedings

 

Securities Litigation

 

The Company and certain of our officers have been named as defendants in an action filed in the United States District Court for the Western District of Missouri on July 15, 2008. The action, which purports to be brought as a class action on behalf of purchasers of FCStone common stock between November 15, 2007 and July 9, 2008, seeks to hold defendants liable under §§ 10b and 20(a) of the Securities Exchange Act of 1934 for alleged false statements and failure to disclose adverse facts relating to an interest rate hedge and our bad debt reserve. The litigation is in its early stages, and we believe we have meritorious defenses.

 

A purported shareholder derivative action was filed against the Company (solely as a nominal defendant) and certain officers and directors on August 5, 2008 in the Circuit Court of Platte County, Missouri, alleging breaches of fiduciary duties, waste of corporate assets and unjust enrichment. The litigation is in its early stages, and we believe we have meritorious defenses.

 

Sentinel Litigation

 

On August 29, 2008, the bankruptcy trustee of Sentinel filed adversary proceedings against FCStone and 10 other futures commission merchants in the Bankruptcy Court for the Northern District of Illinois seeking avoidance of alleged transfers or withdrawals of funds received by the futures commission merchants within 90 days prior to the filing of the Sentinel bankruptcy petition, as well as avoidance of post-petition distributions. The trustee seeks recovery of pre- and post-petition transfers totaling approximately $15.5 million. The case is in its very earliest stages; the court has not made any substantive rulings, discovery has not commenced and no trial date has been set. However, FCStone LLC intends to defend the matter vigorously, and to coordinate its defense with the other futures commission merchants.

 

Other

 

From time to time and in the ordinary course of our business, we are a plaintiff or are a defendant in other legal proceedings related to various issues, including worker’s compensation claims, tort claims, contractual disputes and collections. We carry insurance that provides protection against certain types of claims, up to the policy limits of our insurance. It is the opinion of management that none of the other known legal actions will have an adverse impact on the our financial position, results of operations or liquidity.

 

We are currently unable to predict the outcome of these claims and believe their current status does not warrant accrual under the guidance of Statement on Financial Accounting Standards No. 5, Accounting for Contingencies, since the amount of any liability is neither probable nor reasonably estimable. As such, no

 

21


Table of Contents

amounts have been accrued in the financial statements. We intend to vigorously defend the claims against us and will continue to monitor the litigation and assess the need for future accruals.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

No matter was submitted to a vote of security holders during the last quarter of the fiscal year covered by this report.

 

Item 4A. Executive Officers of the Company

 

The following table sets forth the names, ages, positions and certain other information regarding the Company’s executive officers as of August 31, 2008. Officers are elected annually and serve at the discretion of the Board of Directors.

 

Name

   Age   

Positions

Paul G. (Pete) Anderson

   55    President and Chief Executive Officer and Director

Stephan L. Gutierrez

   57    Executive Vice President and Chief Operating Officer

William J. Dunaway

   37    Executive Vice President and Chief Financial Officer

Jeffrey M. Soman

   57    Executive Vice President of FCStone, LLC

Eric A. Bowles

   46    Senior Vice President of FCStone Trading, LLC

 

Pete Anderson has been employed by our company since 1987, served as President and CEO since 1999, and was appointed a director in November 2006. Prior to becoming president, Mr. Anderson was the Vice President of Operations. Mr. Anderson is the past president of the Kansas Cooperative Council and past founding chairman of the Arthur Capper Cooperative Center at Kansas State University. Mr. Anderson sits on the board of directors of Associated Benefits Corporation and is a member of National Council of Farmer Cooperatives, the National Feed and Grain Association and several other state associations.

 

Stephan Gutierrez has been employed as Executive Vice President and Chief Operating Officer of the company since 2002. He also serves as president of our subsidiaries, FCStone, LLC and FCStone Trading, LLC. Prior to his positions with FCStone, Mr. Gutierrez worked at Cargill as a Division Managing Director and Trading Manager. Mr. Gutierrez has 32 years of experience in trading, risk and asset management oversight with respect to multiple commodities.

 

William Dunaway has been employed as Chief Financial Officer of the company since January 2008. Mr. Dunaway has over 15 years of industry experience with the company, or one of its predecessor companies, most recently as Executive Vice President and Treasurer. Prior to that, he served as Vice President and Assistant Treasurer of Accounting and Finance with responsibility over the regulatory accounting of FCStone, LLC.

 

Jeffrey Soman has been employed as Executive Vice President of FCStone, LLC since 2000. Mr. Soman has over 27 years of experience managing the clearing, internal risk management and brokerage facilities of several major brokerage firms. During the last 16 years he has worked in this capacity for FCStone, LLC or one of its predecessor companies.

 

Eric Bowles has been employed by our Company since 2004 and presently serves as the Senior Vice President of FCStone Trading, LLC where he oversees the daily OTC trading activity of both energy and agricultural markets. Mr. Bowles has over 23 years of experience in trading and risk management. Prior to joining the Company, Mr. Bowles worked for Bankers Trust Corporation and Macquarie Bank in the agricultural OTC markets.

 

22


Table of Contents

PART II

 

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

 

(a) Market Information. The following table sets forth, for the quarterly periods indicated, the high and low sales prices per share for our common shares on the NASDAQ Global Select Market under the trading symbol “FCSX.” Prior to March 16, 2007, our common shares were not traded on any exchange.

 

     Share price
     High    Low

2008

     

Fourth quarter

   $ 41.12    $ 13.00

Third quarter

     46.18      18.39

Second quarter

     53.25      39.02

First quarter

     43.98      28.67

2007

     

Fourth quarter

   $ 42.97    $ 26.76

Third quarter

     34.56      18.17

 

The closing price for our common shares on the NASDAQ Global Select Market on November 10, 2008 was $2.72 per share.

 

(b) Holders. As of November 4, 2008, there were approximately 229 record holders of our common stock.

 

(c) Dividends. The board of directors has not declared a dividend during fiscal 2008 or 2007. Any determination to pay future regular dividends will be at the discretion of our board of directors, and will depend upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory, rating agency and any contractual restrictions on the payment of dividends and any other factors our board of directors deems relevant.

 

(d) Securities Authorized for Issuance Under Equity Compensation Plans. The following table sets forth as of August 31, 2008 (a) the number of securities to be issued upon exercise of outstanding options, warrants and rights, (b) the weighted average exercise price of outstanding options, warrants and rights and (c) the number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)).

 

Plan Category

   (a)
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
   (b)
Weighted average
exercise price of
outstanding options,
warrants and rights
   (c)
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
     (amounts in thousands, except per share amounts)

Equity compensation plans approved by stockholders

   2,937    $ 10.36    438

Equity compensation plans not approved by stockholders

   —        —      —  
                

Total

   2,937    $ 10.36    438
                

 

As of August 31, 2008, all of our equity compensation plans have been approved by our stockholders.

 

(e) The following performance graph shows a comparison, from March 16, 2007 (the date our Common Stock commenced trading on The NASDAQ Global Select Market) through August 31, 2008, of the cumulative total return for our Common Stock, the NASDAQ Composite Stock Index (COMP) and the NASDAQ Other Financial Index (CFIN).

 

23


Table of Contents

The performance graph assumes the value of the initial investment in our common stock and each index was $100 on March 16, 2007. Such returns are based on historical results and are not intended to suggest future performance.

 

LOGO

 

(f) Repurchases of Equity Securities:

 

Period

   Total Number
of Shares
Purchased
   Average
Price Paid
per Share
   Total Number of
Shares Purchased as
Part of Publicly
Announced Program
   Dollar Amount
Remaining to be
Purchased Under
the Program
     (amounts in thousands, except per share amounts)

June 1, 2008 to June 30, 2008

   —      $ —      —      $ —  

July 1, 2008 to July 31, 2008

   100      17.97    100      18,201

August 1, 2008 to August 30, 2008

   —        —      —        —  
                       

Total

   100    $ 17.97    100    $ 18,201
                       

 

On July 15, 2008, our board of directors authorized a stock repurchase program, permitting the purchase of up to $20.0 million of our common stock outstanding at that time. At August 31, 2008, we had purchased 100,000 shares under the program and had authorization to purchase an additional $18.2 million of our common stock. The stock repurchase program expired on October 13, 2008, in accordance with the terms of the authorized program.

 

Item 6. Selected Financial Data

 

The table shown below presents our summary financial data at the date and for the periods indicated. The summary financial data as of August 31, 2008 and August 31, 2007 and for each of the years in the three-year period ended August 31, 2008 have been derived from our audited consolidated financial statements included elsewhere in this report on Form 10-K. The summary financial data as of August 31, 2006, 2005 and 2004 and for each of the years in the two-year period ended August 31, 2005 have been derived from our audited consolidated financial statements that are not included in this report on Form 10-K. Historical per share data has been omitted for each fiscal year prior to the fiscal year 2005 because under our previous cooperative structure in place during those periods, earnings of the cooperative were distributed as patronage dividends to members based on the level of business conducted with the cooperative as opposed to common stockholder’s proportionate share of underlying equity in the cooperative.

 

24


Table of Contents

You should read the data set forth below in conjunction with our audited consolidated financial statements and the related notes thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and other financial information included elsewhere in this report.

 

    Year Ended August 31,
    2008     2007     2006     2005     2004
    (amounts in thousands, except per share amounts)

Statement of Operations Data:

         

Revenues:

         

Commissions and clearing fees

  $ 179,188     $ 145,077     $ 105,622     $ 76,674     $ 67,594

Service, consulting and brokerage fees

    97,700       47,679       33,388       18,913       12,008

Interest

    48,294       42,957       23,174       8,177       3,982

Other

    10,372       4,497       2,638       7,463       4,521

Sales of commodities

    1,972       1,101,752       1,129,983       1,290,620       1,536,209
                                     

Total revenues

    337,526       1,341,962       1,294,805       1,401,847       1,624,314
                                     

Costs and expenses:

         

Cost of commodities sold

    1,069       1,084,205       1,112,949       1,275,094       1,519,221

Employee compensation and broker commissions

    65,936       49,524       44,229       32,578       30,160

Pit brokerage and clearing fees

    104,045       67,978       47,613       33,141       26,713

Introducing broker commissions

    33,304       36,050       22,826       14,459       10,704

Employee benefits and payroll taxes

    13,746       10,678       9,801       8,044       7,136

Interest

    5,705       9,937       5,705       3,946       4,418

Depreciation and amortization

    1,996       1,748       1,674       1,551       861

Bad debt expense

    1,998       1,632       1,909       4,077       716

Other expenses

    31,585       25,983       23,568       18,926       15,365
                                     

Total costs and expenses

    259,384       1,287,735       1,270,274       1,391,816       1,615,294
                                     

Income from continuing operations before income tax expense and minority interest

    78,142       54,227       24,531       10,031       9,020

Minority interest

    (146 )     639       (226 )     (499 )     576
                                     

Income from continuing operations after minority interest and before income taxes

    78,288       53,588       24,757       10,530       8,444

Income tax expense

    30,867       20,000       9,500       3,950       2,030
                                     

Net income from continuing operations

    47,421       33,588       15,257       6,580       6,414
                                     

Loss from discontinued operations, net of tax

    (6,829 )     (311 )     —         —         —  
                                     

Net income

  $ 40,592     $ 33,277     $ 15,257     $ 6,580     $ 6,414
                                     

Basic shares outstanding(1)

    27,749       24,500       21,749       19,607    

Diluted shares outstanding(1)

    28,934       25,051       21,749       19,607    

Basic earnings (loss) per share:

         

Continuing operations

  $ 1.71     $ 1.37     $ 0.70     $ 0.34    

Discontinued operations

    (0.25 )     (0.01 )     —         —      
                                 

Net income

  $ 1.46     $ 1.36     $ 0.70     $ 0.34    
                                 

Diluted earnings (loss) per share:

         

Continuing operations

  $ 1.64     $ 1.34     $ 0.70     $ 0.34    

Discontinued operations

    (0.24 )     (0.01 )     —         —      
                                 

Net income

  $ 1.40     $ 1.33     $ 0.70     $ 0.34    
                                 

Cash dividends declared per share(4)

  $ —       $ 0.28     $ 0.13     $ —      
                                 

 

25


Table of Contents
     August 31,  
     2008     2007     2006     2005     2004  
     (amounts in thousands)  

Statement of Financial Condition Data:

          

Total assets(3)

   $ 2,421,478     $ 1,420,194     $ 1,057,207     $ 809,584     $ 603,827  

Notes payable and subordinated debt(3)

     48,202       22,539       55,169       42,411       47,281  

Obligations under capital leases(3)

     —         —         3,575       4,125       4,675  

Minority interest(3)

     4,855       —         3,607       4,755       5,488  

Common stock and equity

   $ 227,558     $ 173,668     $ 58,895     $ 45,185     $ 39,829  
     Year Ended August 31,  
     2008     2007     2006     2005     2004  
     (amounts in thousands)  

Segment and Other Data:

          

Income (loss) before minority interest and income tax expense:

          

Commodity and Risk Management Services

   $ 67,550     $ 45,721     $ 21,937     $ 11,160     $ 7,907  

Clearing and Execution Services

     20,161       9,610       10,981       5,152       3,359  

Financial Services

     1,689       1,052       (19 )     556       (447 )

Grain Merchandising(3)

     —         2,130       (430 )     (2,037 )     2,230  

Corporate

     (11,258 )     (4,286 )     (7,938 )     (4,800 )     (4,029 )
                                        
   $ 78,142     $ 54,227     $ 24,531     $ 10,031     $ 9,020  
                                        

Revenues, net of cost of commodities sold(2)

   $ 336,457     $ 257,757     $ 181,856     $ 126,753     $ 105,093  

EBITDA(2)

   $ 85,989     $ 65,273     $ 32,136     $ 16,027     $ 13,723  

Return on equity

     20.1 %     33.8 %     30.1 %     15.4 %     16.5 %

Exchange contract trading volume

     98,611       60,979       47,467       36,240       29,911  

OTC contract volume

     1,361       751       326       153       63  

Customer segregated assets, end of period

   $ 1,528,028     $ 997,436     $ 764,847     $ 594,733     $ 389,953  

 

(1) The basic and diluted shares outstanding, for all periods, have been adjusted to reflect the three-for-one stock split effected on February 26, 2007 and the three-for-two split distributed on September 27, 2007. Additionally, the calculation of the basic and diluted shares outstanding for the year ended August 31, 2005 assumes the shares issued as a result of the restructuring, from a cooperative to a corporation, have been issued and outstanding for the full year.
(2) See “Non-GAAP Financial Measures” below.
(3) On June 1, 2007, we closed an equity purchase agreement to sell our majority interest in FGDI to Agrex, the other existing member of FGDI. Subsequent to the sale, we retain a 25% interest in the equity of FGDI and account for this non-controlling interest on the equity method of accounting. Accordingly, our consolidated statements of financial condition at August 31, 2008 and 2007 do not include FGDI’s assets and liabilities. Also, our consolidated statement of operations at August 31, 2007 includes FGDI’s revenues and expenses for only the nine month period ended May 31, 2007. Minority interest attributable to Agrex prior to the sale of our controlling interest are reflected for the years ended August 31, 2006, 2005 and 2004, respectively. We have recorded our equity interest in FGDI’s operating results subsequent to the sale as other revenue.
(4) Such information has been adjusted to reflect retroactively the three-for-one stock split effective February 26, 2007, and the three-for-two split effective on September 27, 2007. Historical dividend data has been omitted for fiscal years prior to 2005 because earnings were distributed as patronage dividends to members based on the level of business conducted.

 

26


Table of Contents

Non-GAAP Financial Measures

 

The body of U.S. generally accepted accounting principles is commonly referred to as “GAAP.” A non-GAAP financial measure is generally defined by the SEC as one that purports to measure historical or future financial performance, financial position or cash flows, but excludes or includes amounts that would not be so adjusted under applicable GAAP guidance. In this report on Form 10-K, we disclose EBITDA and revenues, net of cost of commodities sold, both of which are non-GAAP financial measures. EBITDA is not a substitute for the GAAP measures of net income (loss) or cash flows. Revenues, net of cost of commodities sold, is not a substitute for the GAAP measure of total revenues.

 

EBITDA

 

EBITDA consists of net income before interest expense, income tax expense and depreciation and amortization and loss on discontinued operations, net of applicable taxes. We have included EBITDA in this report on Form 10-K because our management uses it as an important supplemental measure of our performance and believes that it is frequently used by securities analysts, investors and other interested persons in the evaluation of companies in our industry, some of which present EBITDA when reporting their results. We use EBITDA to evaluate our performance as compared to other companies in our industry that have different financing and capital structures and/or tax rates. Our management also believes that EBITDA is a useful tool for measuring our ability to meet our future debt service, capital expenditures and working capital requirements, and EBITDA is commonly used by us to measure our ability to service indebtedness. EBITDA is not a substitute for the GAAP measures of net income or cash flows and is not necessarily a measure of our ability to fund our cash needs. In addition, it should be noted that companies calculate EBITDA differently and, therefore, EBITDA as presented for us may not be comparable to EBITDA reported by other companies. EBITDA has material limitations as a performance measure because it excludes interest expense, income tax expense and depreciation and amortization and losses on discontinued operations, net of tax. The following table reconciles EBITDA with our net income.

 

     Year Ended August 31,
     2008    2007    2006    2005    2004
     (dollars in thousands)

Net income

   $ 40,592    $ 33,277    $ 15,257    $ 6,580    $ 6,414

Plus: interest expense

     5,705      9,937      5,705      3,946      4,418

Plus: depreciation

     1,996      1,748      1,674      1,551      861

Plus: income tax expense

     30,867      20,000      9,500      3,950      2,030

Plus: loss on discontinued operations, net of tax

     6,829      311      —        —        —  
                                  

EBITDA

   $ 85,989    $ 65,273    $ 32,136    $ 16,027    $ 13,723
                                  

 

Revenues, Net of Cost of Commodities Sold

 

Revenues, net of cost of commodities sold, consists of total revenues presented as determined in accordance with GAAP, less the cost of commodities sold. Revenues, net of cost of commodities sold, is a non-GAAP financial measure that is used in this report on Form 10-K because our management considers it an important supplemental measure of our performance. Management believes revenues, net of cost of commodities sold, is a more relevant measure of our economic interest in these commodities transactions because it removes the effect of commodity price driven changes in revenue and cost of commodities sold, which may not have a meaningful effect on net income. In managing our business, management has historically focused on revenues derived from sales of commodities, net of cost of commodities sold. This financial measure is meaningful in managing our business as profit is driven more by the margin on commodities sold rather than the price of the commodities and analyzing consolidated costs and expenses as a percentage of total revenue is not meaningful because total revenues related to commodity sales in fiscal 2007 and 2006 is a disproportionately large number compared to margin. Measuring expense as a percentage of revenues, net of cost of commodities sold, provides a clearer understanding of the trends in costs and expenses and expense management.

 

27


Table of Contents

The following table reconciles revenues, net of cost of commodities sold, with our total revenues.

 

     Year Ended August 31,
     2008    2007    2006    2005    2004
     (dollars in thousands)

Revenues:

              

Commissions and clearing fees

   $ 179,188    $ 145,077    $ 105,622    $ 76,674    $ 67,594

Service, consulting and brokerage fees

     97,700      47,679      33,388      18,913      12,008

Interest

     48,294      42,957      23,174      8,177      3,982

Other

     10,372      4,497      2,638      7,463      4,521

Sales of commodities(1)

     1,972      1,101,752      1,129,983      1,290,620      1,536,209
                                  

Total revenues

     337,526      1,341,962      1,294,805      1,401,847      1,624,314

Less: Cost of commodities sold(1)

     1,069      1,084,205      1,112,949      1,275,094      1,519,221
                                  

Revenues, net of cost of commodities sold

   $ 336,457    $ 257,757    $ 181,856    $ 126,753    $ 105,093
                                  

 

(1) As a result of our sale of our controlling interest in FGDI on June 1, 2007, we have no sales of commodities and cost of commodities sold related to our previously presented grain merchandising segment for the year ended August 31, 2008. For the year ended August 31, 2007, sales of commodities and cost of commodities sold include only nine months of results from the operations of our grain merchandising segment. For the years ended prior to fiscal 2007, sales and cost of commodities sold include the full year operations of our grain merchandising segment. See Operations by Segment included within Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

28


Table of Contents

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following is a discussion and analysis of our financial condition, results of operations and liquidity and capital structure for the years ended August 31, 2008, 2007 and 2006. This section should be read together with our audited consolidated financial statements and related notes included elsewhere in this report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this report on Form 10-K, including information with respect to our plans and strategies for our business, includes forward-looking statements that involve risks and uncertainties. You should review the “Risk Factors” section of this report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in, or implied by, the forward-looking statements contained in this report on Form 10-K.

 

Overview

 

We are an integrated commodity risk management company providing risk management consulting and transaction execution services to commercial commodity intermediaries, end-users and producers. We assist primarily middle market customers in optimizing their profit margins and mitigating commodity price risk. In addition to our risk management consulting services, we operate one of the leading independent clearing and execution platforms for exchange-traded futures and options contracts. In fiscal 2008, we served more than 8,000 customers and transacted more than 100.0 million contracts in the exchange-traded and OTC markets. As a complement to our commodity risk management consulting and execution services, we also assist our customers with the financing, transportation and merchandising of their physical commodity inventories.

 

Fiscal 2008 Highlights

 

   

Record revenues, net of cost of commodities sold, of $336.5 million.

 

   

Record level of customer segregated assets of $2.1 billion set during April 2008 and $1.5 billion at August 31, 2008.

 

   

A 325 basis point decrease in the Federal Funds rate during the year

 

   

Successful completion of three acquisitions – Downes-O’Neill, LLC and Jernigan Group, LLC/Globecot, Inc.

 

   

Replacement of previous margin and subordinated credit lines with a $250 million margin call facility and a $55 million subordinated debt facility with a syndicate of lenders.

 

   

OTC and exchange-traded contract volumes increased 81% and 62%, respectively, from fiscal 2007.

 

   

Ceased construction and testing of Green Diesel’s developmental stage biodiesel plant resulting in a loss on discontinued operations of $6.8 million, net of tax

 

We operate in three reportable segments consisting of Commodity and Risk Management Services (“C&RM”), Clearing and Execution Services, and Financial Services. In years prior to fiscal 2008, we also reported a Grain Merchandising segment. We also report a Corporate and Other segment, which contains corporate expenses and equity investments not directly attributable to our operating segments. Our profitability is primarily driven by the C&RM and Clearing and Execution Services segments of our business, as shown in the table below. The table sets forth for each segment the income (loss) before minority interest and income tax expense for each of the three fiscal years ended August 31, 2008.

 

     Year Ended August 31,  
     2008     2007     2006  
     (in thousands)  

Commodity and Risk Management Services

   $ 67,550     $ 45,721     $ 21,937  

Clearing and Execution Services

     20,161       9,610       10,981  

Financial Services

     1,689       1,052       (19 )

Grain Merchandising(1)

     —         2,130       (430 )

Corporate and Other

     (11,258 )     (4,286 )     (7,938 )
                        

Income before minority interest and income tax expense

   $ 78,142     $ 54,227     $ 24,531  
                        

 

29


Table of Contents

 

(1) As a result of our sale of our controlling interest in FGDI on June 1, 2007, we have no sales of commodities and cost of commodities sold related to our previously presented grain merchandising segment for the year ended August 31, 2008. For the year ended August 31, 2007, sales of commodities and cost of commodities sold include only nine months of results from the operations of our grain merchandising segment. See Operations by Segment included within Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Factors that Affect Our Business

 

Our results of operations have been, and we expect will continue to be, affected principally by customer creditworthiness and liquidity, counterparty creditworthiness, customer acceptance of risk management, commodity price volatility, transaction volumes, interest rates, customer fund balances and our ability to develop new products for our customers.

 

Customer Creditworthiness and Liquidity

 

Our customers’ ability to maintain and access adequate credit facilities is critical to our results. Throughout the agriculture and energy industries, higher commodity prices and continued volatility has required increased lines of credit, and placed a strain on working capital debt facilities, leveraging customers to unprecedented levels in order for them to continue to carry inventory and properly execute hedging strategies. Recent volatility in the financial markets has tightened credit further, and increased the difficulty in obtaining adequate financing.

 

Counterparty Creditworthiness

 

Our ability to maintain or grow our OTC business is dependant on our ability to find counterparties willing to transact, and our ability to insure those counterparties against default. Developments in the financial markets may hinder our ability to obtain insurance on certain counterparties, or that insurance may be at an increased cost. Failure to obtain this counterparty insurance would reduce the number of counterparties of with which we can transact. Additionally, counterparties may require additional margin be deposited, which we may not be able to pass thru to the customer and accordingly have to reduce business transacted, which affects our results of operations.

 

Customer Acceptance of Risk Management

 

The growing sophistication of company managers and the heightened expectations of investors have increased the acceptance of commodity risk management strategies. Demand for risk management consulting services is growing in industries that have not traditionally been significant users of hedging techniques and the derivatives market. This increased demand drives our fee revenue from risk management consulting services and our commission and interest income generated from the trading activity of our customers. As we expand our customer base beyond the traditional users of derivative products, our ability to provide an analysis of the commodity markets and advise our customers about how to manage the commodity risk inherent in their businesses will continue to be an important driver in our ability to generate future revenues.

 

Commodity Price Volatility

 

Rising commodity price volatility historically has led to increases in transaction volume and better financial performance in both our C&RM and CES segments. High commodity price volatility affects our financial performance by increasing the uncertainty of the profit margins of intermediaries, end-users and producers, which ultimately leads them to derivatives as a way of mitigating their financial risk from changing prices. At the same time, market volatility creates opportunities for professional traders, who find derivatives a more efficient way to transact relative to traditional physical commodities. In general, high commodity price volatility increases the demand for risk management consulting services and trade execution and clearing by commodity producers,

 

30


Table of Contents

intermediaries, end-users and professional traders. However, high commodity prices also forces our customers to obtain additional lending capacity. Failure of our customers to obtain necessary financing capacity would limit their use of derivative products for hedging strategies.

 

Transaction Volumes

 

Market transaction volume, as measured by numbers of contracts, has continually increased over the past five years due to higher commodity price volatility, product innovation and a shift to electronic trading. As noted above, high commodity price volatility results in increased demand for risk management consulting services and increased transaction volumes. In addition, product innovation in both the international exchange-traded and OTC markets has resulted in higher transaction volumes. The continued convergence of derivatives and cash markets and the expanded use of derivatives for hedging and investment purposes have been the primary drivers of this industry trend. The shift from open outcry, pit-based trading to electronic trading platforms has increased trading volume as customers are drawn to more efficient and lower cost markets.

 

Interest Rates

 

The level of prevailing short-term interest rates affects our profitability because a significant portion of our revenue is derived from interest earned from the investment of funds deposited with us as margin for trading activities by customers in our C&RM and CES segments. The level of customer segregated assets deposited with us is directly related to transaction volume, open contract interest of our customers and the level of margin required for each position. As the majority of the interest we earn relates to client balances, held with us on deposit, on which we return a portion of the interest to our customers, we report interest revenues, net of interest returned to customers. Our financial performance generally benefits from rising interest rates. Rising interest rates increase the amount of interest income earned from these customer deposits. In contrast, declining interest rates decrease the amount of interest income earned on customer deposits.

 

Customer Fund Balances Held on Deposit

 

The amount of customer funds on deposit with us affects our profitability because a significant portion of our revenue is derived from the investment of funds deposited with us as margin for trading activities by customers in our C&RM and CES segments. The amount of this balance is affected by the volume of business transacted, the level of commodity prices and the level of required margin.

 

Product Development

 

Our ability to develop customized products to meet our customers’ specialized needs affects the overall profitability of our operations. These customized products often have unique and complex structures based on OTC traded contracts and we provide value-added service components to our customers that make these products more profitable for us.

 

Statement of Operations

 

Revenues

 

Our revenues are comprised of: (1) commissions and clearing fees, (2) risk management service, consulting and related brokerage fees, (3) interest income, (4) other revenues and (5) sales of physical commodities.

 

Commissions and clearing fees. Commissions and clearing fees represent revenues generated from exchange-traded and Forex transactions that we execute or clear in our C&RM and Clearing and Execution Services segments. Commissions and clearing fee revenue is a product of the number of transactions we process for our customers and the rate charged on those transactions. The rate that we charge our customers varies by type of customer, type of transaction and a customer’s volume of trading activity.

 

31


Table of Contents

Service, consulting and brokerage fees. Service, consulting and brokerage fees are revenue generated in the C&RM segment. Service revenues are monthly fees charged to IRMP customers for customized risk management consulting services. Brokerage fees are generated from OTC derivative trades and Forex trades executed with our customers and with other counterparties. These brokerage fees vary on a per trade basis depending on the level of service provided and the type of transaction. When transacting OTC and foreign exchange contracts with our customers, we will generally offset the customers transaction simultaneously with one of our trading counterparties. On a limited basis, our OTC and Forex trade desks will accept a customer transaction and will offset that transaction with a similar but not identical position on the exchange. These unmatched transactions are intended to be short-term in nature and are conducted to facilitate the most effective transaction for our customer. Consulting fees are primarily fees we charge for providing various other risk management-related consulting services to customers, which are generally performed on either a monthly or project-by-project basis.

 

Interest income. Interest revenue is primarily driven by the level of customer segregated assets deposited with us and the level of short-term interest rates. The level of customer segregated assets deposited with us is directly related to transaction volume and open contract interest of our customers. The majority of the interest we earn relates to client balances, held with us on deposit to satisfy margin requirements, on which we may return a portion of the interest to our customers. We report interest revenues, net of interest returned to customers. Additionally, we earn interest from our internally-generated cash balances invested at short-term interest rates, and also from financing fees related to commodity inventory repurchase programs within our Financial Services segment.

 

Other revenue. Other revenue represents various ancillary revenue streams, including transportation related income, profit-share arrangements and patronage income in our Financial Services segment, dividend income and income from equity investments and non-recurring items. Historically, income from non-recurring items have included gains on the sale of exchange membership stock or exchange seats, special dividends and litigation settlements, and can vary significantly from period to period. Losses on investments with Sentinel were included in this line in fiscal 2007.

 

Sales of commodities. During fiscal 2008, sales of commodities represent revenue generated from the sale of Chicago Climate Exchange (CCX) carbon financial instruments (CFIs). During fiscal 2007 and 2006, the majority of the sales of commodities represented the sale of grain in the previously-reported Grain Merchandising segment. When evaluating commodity sales, management focuses on the margin (gross profit) from commodity sales (see “Non-GAAP Financial Measures”). The focus on gross profit from commodity sales removes the effect of commodity price driven changes on revenue and cost of goods sold, which may not have an effect on net income.

 

Costs and Expenses

 

Cost of commodities sold. During fiscal 2008, cost of commodities sold represents the product of the volume of purchased CFIs and their related cost. During fiscal 2007 and 2006, the majority of the cost of commodities sold represented the purchase of grain in the previously-reported Grain Merchandising segment.

 

Employee compensation and commissions. Employee compensation and commissions consists of salaries, incentive compensation and commissions and is one of our primary operating expenses. We classify employees as either risk management consultants or salaried and support personnel, which includes our executive officers. The most significant component of our compensation expense is the employment of our risk management consultants, who are compensated with commission based on the revenues that their customers generate. Accordingly, our commission expense component is variable and is dependent on our commissions revenue and service, consulting and brokerage fee revenue.

 

Pit brokerage and clearing fees. Pit brokerage and clearing fees relate directly to expenses for exchange-traded futures and options clearing and settlement services, including fees we pay to the exchanges and the floor pit brokers. These fees are variable and fluctuate based on transaction volume. Clearing fees are passed on to our

 

32


Table of Contents

customers and presented gross in the consolidated statements of operations under the Financial Accounting Standards Board (“FASB”) Interpretation No.39, Offsetting of Amounts Related to Certain Contracts (as Amended), as there is no right of off-set.

 

Introducing broker commissions. Introducing broker commissions are commissions that we pay to non-employee third parties that have introduced customers to us. Introducing brokers are individuals or organizations that maintain relationships with customers and accept futures and options orders from those customers. We directly provide all account, transaction and margining services to introducing brokers, including accepting money, securities and property from the customers. The commissions we pay an introducing broker vary based on a variety of factors, including on the trading volume of the customers introduced to us. This expense is variable and is directly related to the overall volume of trades by those customers.

 

Employee benefits and payroll taxes expense. Employee benefits and payroll taxes expense consist primarily of employee health insurance, a defined benefit pension plan, two defined contribution plans (401(k) and ESOP), and payroll taxes. Accordingly, these expenses normally fluctuate in relation to employee compensation and commissions and the number of employees. In July 2008, all benefit accounts under our defined benefit pension plan were frozen. See Note 9 to the consolidated financial statements.

 

Interest expense. Interest expense consists of interest charged to us by our lenders on the loans, lines of credit and letters of credit outstanding. Our interest expense depends on the amount of debt outstanding and the interest rate environment, with all of our credit lines bearing interest at variable rates. This expense is primarily related to interest paid to lenders in our financial services segment.

 

Depreciation and amortization. Depreciation expense arises from the depreciation of property, equipment and leasehold improvements. Amortization arises from the amortization of intangible assets with determinable useful lives.

 

Bad debt expense. Bad debt expense consists of both amounts written off based on known defaults of customers and brokers, as well as an allowance for accounts that we believe may become uncollectible through our review of the historical aging of our receivables from customers and brokers and our monitoring of the financial strength of our customers, brokers and counterparties.

 

Other expenses. Other expenses consist primarily of office and equipment rent, communications, marketing information, travel, advertising, insurance, professional fees and other various expenses. The majority of these expenses are relatively fixed in nature and do not necessarily vary directly with changes in revenue.

 

Minority interest. On March 3, 2008, the Company executed an agreement with NASDAQ OMX Group, Inc. (“NASDAQ”) in which NASDAQ contributed cash of approximately $5.0 million in exchange for preferred units in the Company’s subsidiary, Agora-X, LLC (“Agora-X). The NASDAQ’s initial interest associated with the preferred units is 13.33% ownership in Agora-X, and NASDAQ has agreed to contribute additional cash consideration, upon the completion of certain conditions, for a potential ownership interest of 20%.

 

On November 9, 2007, we acquired an additional 45% of the ownership interest in Green Diesel for a total ownership interest of 70%. As a result, we included the financial statements of Green Diesel in the consolidated financial statements since the acquisition date and initially recorded the minority interest held by an unaffiliated third party in Green Diesel. As a result of allocation of the impairment loss included in the loss from discontinued operations, the minority interest held by the unaffiliated third party has been reduced to zero and all activity for the periods presented has been reflected in the loss from discontinued operations. Subsequent to August 31, 2008, the Company completed the sale of its ownership interest in Green Diesel, which included recognition of an additional $0.2 million in loss on discontinued operations, net of tax.

 

Prior to June 1, 2007, minority interest reflected the 30% minority interest held by Agrex in FGDI, the subsidiary that comprised our previously-reported Grain Merchandising segment. Such minority interest ended effective June 1, 2007, when Agrex purchased a majority interest in FGDI (see Notes 18 and 25 to the consolidated financial statements).

 

33


Table of Contents

Prior to March 31, 2006, minority interest also included a 30% interest held by an unaffiliated third party in FCStone Merchants Services. Effective March 31, 2006, FCStone Merchants Services redeemed the minority ownership interest in accordance with the limited liability company agreement.

 

Income tax expense. Income tax expense consists of current and deferred tax expense relating to federal, state and local taxes. We file a consolidated federal income tax return and combined state and local income tax returns for all wholly-owned subsidiaries.

 

Loss from discontinued operations. The loss from discontinued operations is comprised of impairment losses from Green Diesel’s biodiesel development plant, operating losses from the discontinuance of its operations and costs incurred in disposition of the plant.

 

Revenues, Net of Cost of Commodities Sold

 

Revenues, net of cost of commodities sold, consists of total revenues presented as determined in accordance with GAAP, less the cost of commodities sold. Revenues, net of cost of commodities sold, is a non-GAAP financial measure that is used in this report on Form 10-K because our management considers it an important supplemental measure of our performance. As discussed below, prior to our sale of a controlling interest in FGDI, LLC (“FGDI”) in fiscal 2007, the consolidation of FGDI’s high revenue, low margin grain merchandising business made it very difficult for the reader of our financial statements to discern trends in profit margins and business drivers. Management believes revenues, net of cost of commodities sold, is a more relevant measure of our economic interest in these commodities transactions because it removes the effect of commodity price driven changes in revenue and cost of commodities sold, which may not have a meaningful effect on net income. In managing our business, management has historically focused on revenues derived from sales of commodities, net of cost of commodities sold. This financial measure is meaningful in managing our business as profit is driven more by the margin on commodities sold rather than the price of the commodities and analyzing consolidated costs and expenses as a percentage of total revenue is not meaningful because total revenues related to commodity sales is a disproportionately large number compared to margin. Measuring expense as a percentage of revenues, net of cost of commodities sold, provides a clearer understanding of the trends in costs and expenses and expense management.

 

As a result of the Company’s sale of its controlling interest in FGDI on June 1, 2007, the Company is no longer consolidating the assets, liabilities, revenues and expenses of FGDI in its consolidated financial statements. Subsequent to the sale date, the remaining 25% equity interest in FGDI is recorded under the equity method, as a component of other revenues. Sale of commodities and cost of commodities sold included in the consolidated statement of operations for the years ended August 31, 2007 and 2006 related to FGDI were $1,077.9 million and $1,060.6 million, respectively, and $1,077.5 million and $1,061.0 million, respectively.

 

Critical Accounting Policies and Estimates

 

Our consolidated financial statements and accompanying notes have been prepared in accordance with GAAP applied on a consistent basis. The preparation of these consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate these estimates and assumptions on an ongoing basis. We base these estimates on the information currently available to us and on various other assumptions that we believe are reasonable under the circumstances. Actual results could vary materially from these estimates under different assumptions or conditions and could adversely impact our operating results and financial condition.

 

Our significant accounting policies are summarized in Note 1 to our consolidated financial statements. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made; if different estimates reasonably could have been used; or if changes in the estimate that are reasonably likely to occur periodically could materially

 

34


Table of Contents

impact the consolidated financial statements. We believe the following critical accounting policies reflect the significant estimates and assumptions used in the preparation of our consolidated financial statements.

 

Commission Revenue and Clearing and Transaction Fees

 

Commissions on futures contracts are recognized on a half-turn basis in two equal parts. The first half is recognized when the contract is purchased (opened) and the second half is recognized when the transaction is closed. Commissions on option contracts are recognized upon the purchase or sale of the option. If the Company is required to perform additional services when an option is exercised or closed, a separate commission can be charged and recognized at that date. Commissions and fees are charged at various rates based on the type of account, the products traded, and the method of trade. Clearing and transaction fees are charged to customers on a per exchange contract basis based on the trade date. Such fees are for clearing customers’ exchange trades and include fees charged to the Company by the various futures exchanges.

 

Service, Consulting and Brokerage Fees

 

Service fees include brokerage fees and margins generated from OTC derivative trades executed with customers and other counterparties and are recognized when trades are executed. Service fees also include IRMP fees which are billed and recognized as revenue on a monthly basis when risk management services are provided. Such agreements are generally for one year periods, but are cancelable by either party upon providing thirty days written notice to the other party and the amounts are not variable based on customer trading activities. Service, consulting and brokerage fees also includes income from limited forms of proprietary trading. This trading involves taking short-term proprietary positions in derivatives and foreign currencies. These strategies involve relatively short-term exposure to the markets and are usually undertaken in conjunction with the use of derivative contracts, designed to mitigate the risk of customers through hedging strategies.

 

Allowance for Doubtful Accounts

 

We maintain allowances for doubtful accounts for trade receivables and deficits on customer commodity accounts. The allowances for doubtful accounts are significant estimates, and are maintained at a level considered appropriate by our management based on analyses of the historical aging of receivables from customers and brokers, availability of capital and liquidity for specific accounts, historical trends of charge-offs and recoveries, and current and projected economic, market and other conditions. If we become aware of a customer’s inability to meet its financial obligations, we establish a specific allowance for a potential bad debt expense to reduce the net recognized receivable to the amount we reasonably believe will be collected. Additionally, different assumptions, changes in economic circumstances or the deterioration of the financial condition of our customers could result in additional provisions to the allowances for doubtful accounts and increased bad debt expense. The valuation of the allowances for doubtful accounts is performed on a quarterly basis.

 

Open Contracts—Over-The-Counter and Forex

 

We broker over-the-counter option and commodity swap contracts between customers and external counterparties. The contracts are generally arranged on an offsetting basis, limiting our risk to performance of the two parties. The offsetting nature of these contracts eliminate the effects of market fluctuations on the Company’s operating results. Due to our role as a principal participating in both sides of these contracts, the option and swap contracts are presented gross on the consolidated statement of financial condition at their respective market values, net of offsetting assets and liabilities at the customer or counterparty account level where right of offset exists. Fair values are based on pricing models intended to approximate the amounts that would be received from or paid to a third party in settlement of the contracts. Factors that may affect the determination of market values include credit spreads, market liquidity concentrations, and funding and administrative costs incurred over the life of the instrument. If estimates regarding the valuation of these open option and swap contracts are less favorable than management’s assumptions, we may be at risk of overstating both contract assets and liabilities or understating both contract assets and liabilities on the consolidated statements of financial condition. The offsetting nature of the contracts eliminates the effects of market fluctuations on our consolidated statements of operations.

 

35


Table of Contents

We broker foreign exchange forwards, options and cash, or spot, transactions between customers and external counterparties. A portion of the contracts are arranged on an offsetting basis, limiting our risk to performance of the two offsetting parties. The offsetting nature of the contracts eliminates the effects of market fluctuations on our operating results. Due to our role as a principal participating in both sides of these contracts, the amounts are presented gross on the consolidated statements of financial condition at their respective market values, net of offsetting assets and liabilities. Upon applying Financial Accounting Standards Board (“FASB”) Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts”, our elected policy is such that open contracts with the same customer or counterparty are netted at the account level, in accordance with master netting arrangements in place with each party, as applicable.

 

We also hold proprietary positions in the OTC and Forex lines of business. On a limited basis, our OTC and Forex trade desks will accept a customer transaction and will offset that transaction with a similar but not identical position on the exchange. These unmatched transactions are intended to be short-term in nature and are conducted to facilitate the most effective transaction for our customer. These forwards, options, swap and spot contracts are accounted for as free-standing derivatives and reported in the consolidated statements of financial condition at their fair values. We do not seek hedge accounting treatment for these derivatives, and accordingly, the changes in fair value during the period are recorded in earnings as a component of service, consulting and brokerage fees. Fair values are based on pricing models intended to approximate the amounts that would be received from or paid to a third party in settlement of the contracts. Factors taken into consideration include credit spreads, market liquidity concentrations, and funding and administrative costs incurred over the life of the instrument.

 

Pensions

 

We have noncontributory defined benefits pension plans that cover certain employees. Our funding policy for the plans is to contribute amounts sufficient to meet the minimum funding requirement of the Employee Retirement Income Security Act of 1974, plus any additional amount we may deem to be appropriate. In July 2008, the Board of Directors authorized a resolution, effective September 1, 2008, to amend the plan, freezing all benefit accruals. No additional benefits will be accrued for active participants under the plan. The plan freeze represents a curtailment under FASB 88, “Employers’ Accounting for Settlements and Curtailments of Defined Pension Plans and for Termination Benefits” (SFAS 88), and accordingly, we recorded a charge to net periodic pension cost of $1.5 million during the fourth quarter of fiscal 2008.

 

We adopted the recognition and disclosure provisions of SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS 158) on August 31, 2007. SFAS 158 requires an entity to recognize the funded status of its defined benefit pension plans measured as the difference between plan assets at fair value and the projected benefit obligation on the balance sheet and to recognize changes in the funded status, that arise during the period but are not recognized as components of net periodic pension cost, within other comprehensive income, net of income taxes. Since the full recognition of the funded status of the defined benefit pension plans is recorded on the consolidated statement of financial condition, the additional minimum liability is no longer recorded under SFAS 158. Additionally, SFAS 158 has a provision requiring the measurement date for plan assets and liabilities to be consistent with the statement of financial condition for companies with fiscal years ending after December 15, 2008. We elected to change its measurement date for plan assets and liabilities to its fiscal year-end date during fiscal 2008. We elected the transition method allowing us to project net periodic pension cost for fourteen months from July 1, 2007 to August 31, 2008. Under this transition approach, we allocated two-fourteenths of net periodic pension cost determined for the period July 1, 2007 to August 31, 2008 to retained earnings (net of tax) and to accumulated other comprehensive income (net of tax). The effect of applying this statement was a $0.3 million reduction to retained earnings and a $0.1 million increase in accumulated other comprehensive income.

 

We adopted the recognition and disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R) (“SFAS 158”) on August 31, 2007. SFAS 158 had no impact on pension expense recognized in the consolidated statements of operations, but the new standard required us to recognize the funded status of pension plans on our consolidated statement of financial condition as of August 31, 2007. This unfunded obligation represents the difference between the projected benefit

 

36


Table of Contents

obligation and the fair value of plan assets. The overall impact of the adoption of SFAS 158 was a $5.3 million increase in accrued expenses and a $3.1 million net of tax decrease in stockholders’ equity (accumulated other comprehensive income). The accounting for our defined benefit pension plans requires that amounts recognized in financial statements be determined on an actuarial basis. Additionally, SFAS 158 requires the measurement date for plan assets and liabilities to coincide with the sponsor’s year-end. In previous periods, we used a June 30 measurement date for our plans; but changed our measurement date to August 31 beginning in fiscal 2008.

 

To account for the defined benefit pension plans in accordance with SFAS No. 87, “Employers’ Accounting for Pensions,” (“SFAS 87”) the Company must make three main determinations at the end of each year. These determinations are reviewed annually and updated as necessary, but nevertheless, are subjective and may vary from actual results. First, the Company must determine the actuarial assumptions for the discount rate used to reflect the time value of money in the calculation of the projected benefit obligations for the end of the current fiscal year and to determine the net periodic pension cost for the subsequent fiscal year. The objective of our discount rate assumption is to reflect the interest rate at which pension benefits could be effectively settled. In making this determination, the Company took into account the timing and amount of benefits that would be available under the plans. The discount rate at August 31, 2008 is based on a model portfolio of high-quality fixed-income debt instruments with durations that are consistent with the expected cash flows of the benefit obligations. The discount rate assumptions at August 31, 2007 and 2006 are based on investment yields available on AA rated long-term corporate bonds with cash flows that are similar to expected benefit payments.

 

Second, the Company must determine the actuarial assumption for rates of increase in compensation levels used in the calculation of the accumulated and projected benefit obligation for the end of the current fiscal year and to determine the net periodic pension cost for the subsequent fiscal year. The salary growth assumptions at August 31, 2007 and 2006 reflect the Company’s long-term actual experience, the near-term outlook and assumed inflation. Retirement and mortality rates are based primarily on actual plan experience and standard industry actuarial tables, respectively. As a result of the plan freeze, no additional benefits will be accrued for active participants under the plan, and accordingly no assumption will be made for the rate of increase in compensation levels in the future.

 

Third, the Company must determine the expected long-term rate of return on assets assumption that is used to determine the expected return on plan assets component of the net periodic pension cost for the subsequent year. The expected long-term rate of return on asset assumption was determined, with the assistance of the Company’s investment consultants, based on a variety of factors. These factors include, but are not limited to, the plan’s asset allocations, a review of historical capital market performance, historical plan performance, current market factors such as inflation and interest rates, and a forecast of expected future asset returns. The Company reviews this long-term assumption on an annual basis.

 

Stock-Based Compensation

 

Effective September 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment (“SFAS 123R”), using the modified prospective transition method, which requires the measurement and recognition of compensation expense based on estimated fair values beginning September 1, 2006 for all share-based payment awards made to employees and directors. Under SFAS 123R, the Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is the vesting period. This model also utilizes the fair value of common stock and requires that, at the date of grant, the Company use the expected term of the stock-based award, the expected volatility of the price of its common stock, the risk free interest rate and the expected dividend yield of its common stock to determine the estimated fair value. Due to our lack of trading history, the Company utilizes historical volatilities of peer companies when computing the expected volatility assumption to be used in the Black-Scholes calculations for new grants. The minimum value method was used in determining fair value of stock options granted prior to September 1, 2006 as allowed under SFAS 123, which involves setting the assumption for volatility to zero. The Company determined the amount of stock-based compensation expense in the year ended August 31, 2008, based on awards that are ultimately expected to vest, reduced for estimated forfeitures. SFAS 123R requires forfeitures to

 

37


Table of Contents

be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. See Note 11 to the consolidated financial statements for a table showing the assumptions used to value the awards granted during fiscal 2008 and 2007.

 

Income Taxes

 

We account for income taxes under SFAS 109, “Accounting for Income Taxes.” Under the standard, certain assumptions are made which represent significant estimates. These estimates are required because: (a) income tax returns are generally filed months after the close of our annual accounting period; (b) tax returns are subject to audit by taxing authorities and audits can often take years to complete and settle; and (c) future events often impact the timing of when we recognize income tax expenses and benefits. Our assumptions are supported by historical data and reasonable projections and are reviewed quarterly by management. We routinely evaluate all deferred tax assets to determine the likelihood of their realization. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. We have not recorded a valuation allowance as of August 31, 2008, August 31, 2007, and August 31, 2006.

 

Contingencies

 

As discussed in Note 20 to the consolidated financial statements (“Note 20”), certain legal proceedings are pending or threatened in the United States and various foreign jurisdictions. We record provisions in the consolidated financial statements for pending litigation when it is determined that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. To the extent a range of potential outcomes is identified and no outcome is deemed more likely than another, we record our liability at the lower end of the range. (1) We have not concluded that it is probable that a loss has been incurred in any of the pending litigation; (2) we are unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation; and (3) accordingly, we have not provided any amounts in the consolidated financial statements for unfavorable outcomes, if any. Management intends to vigorously defend these claims and will continue to monitor the status and results of the claims and assess the need for future accruals.

 

Results of Operations

 

Year Ended August 31, 2008, Compared to Year Ended August 31, 2007

 

Executive Summary

 

Net income increased $7.3 million or 22.0% from $33.3 million in fiscal 2007, to $40.6 million in fiscal 2008 and included losses from discontinued operations, net of tax of $6.8 million in fiscal 2008 and $0.3 million in fiscal 2007, respectively.

 

Net income from continuing operations increased $13.8 million, or 41.2%, from $33.6 million in fiscal 2007 to $47.4 million in fiscal 2008. During fiscal 2008, we continued to experience significant growth in service, consulting and brokerage fees, primarily driven by the demand for OTC-based products. During fiscal 2008 such service, consulting and brokerage fees increased $50.0 million, or 104.9%, as demand from new and existing customers increased OTC contract volume by 0.6 million contracts or 81.3%, to 1.4 million contracts. Additionally, we added revenue from the OTC and Forex trade desks. We also experienced strong growth in commission and clearing fee revenues of $34.1 million, or 23.5%, as exchange-traded contract volumes increased by 37.6 million contracts or 61.7% to 98.6 million. Both the OTC and exchange traded volume increases were affected by the continued period of ongoing volatility in the grain and energy markets. Interest income, net, increased $5.3 million, or 12.4%, from $43.0 million in fiscal 2007 to $48.3 in fiscal 2008. Growth in our interest revenue was slowed in fiscal 2008 by the significant decrease in short-term interest rates.

 

In February 2008, we undertook extensive engineering design and production tests related to the manufacturing of biodiesel at Green Diesel’s developmental stage plant in Houston, Texas. Based on the testing results, current industry economic conditions and additional capital required to complete the project, we decided to cease construction and development of the biodiesel facility and pursue immediate sale of the plant assets and inventory. Accordingly, during the second quarter of fiscal 2008, we classified Green Diesel’s biodiesel plant as a discontinued operation. In connection with the plan of disposal, we determined that the carrying value of the

 

38


Table of Contents

underlying plant asset exceeded its fair value at February 29, 2008, and we recorded an impairment pre-tax loss of $10.8 million, of which $2.2 million was allocated to the unaffiliated third party minority interest holder, which is included in loss on discontinued operations, net of tax. The total loss on discontinued operations, net of tax, was $6.8 million for the year ended August 31, 2008. Subsequent to August 31, 2008, we completed the sale of our ownership interest in Green Diesel.

 

As a result of our sale of our controlling interest in FGDI on June 1, 2007, we no longer include the assets, liabilities, revenues and expenses of FGDI in our consolidated financial statements. Subsequent to the sale date, the remaining 25% equity interest in FGDI is recorded using the equity method, as a component of other revenues within the Corporate and Other segment. Sales of commodities and cost of commodities sold included in the consolidated statement of operations for fiscal 2007 related to FGDI were $1,078 and $1,061 million, respectively.

 

The following chart provides revenues, costs and expenses, and net income for the period comparison:

 

    Year Ended August 31, 2008     Year Ended August 31, 2007     Variance  
    In Thousands     % of Revenues,
Net of Cost of
Commodities
Sold
    In Thousands     % of Revenues,
Net of Cost of
Commodities
Sold
    In Thousands     % Change  

Sales of commodities

  $ 1,972     N/M     $ 1,101,752     N/M     $ (1,099,780 )   (99.8 )%

Cost of commodities sold

    1,069     N/M       1,084,205     N/M       (1,083,136 )   (99.9 )%
                             

Gross profit on commodities sold

    903     0.3 %     17,547     6.8 %     (16,644 )   (94.9 )%

Commissions and clearing fees

    179,188     53.3 %     145,077     56.3 %     34,111     23.5 %

Service, consulting and brokerage fees

    97,700     29.0 %     47,679     18.5 %     50,021     104.9 %

Interest

    48,294     14.4 %     42,957     16.7 %     5,337     12.4 %

Other revenues

    10,372     3.0 %     4,497     1.7 %     5,875     130.6 %
                                         

Revenues, net of cost of commodities sold(1)

    336,457     100.0 %     257,757     100.0 %     78,700     30.5 %
                                         

Costs and expenses

           

Employee compensation and broker commissions

    65,936     19.6 %     49,524     19.2 %     16,412     33.1 %

Pit brokerage and clearing fees

    104,045     30.9 %     67,978     26.4 %     36,067     53.1 %

Introducing broker commissions

    33,304     9.9 %     36,050     14.0 %     (2,746 )   (7.6 )%

Employee benefits and payroll taxes

    13,746     4.1 %     10,678     4.1 %     3,068     28.7 %

Interest

    5,705     1.7 %     9,937     3.9 %     (4,232 )   (42.6 )%

Depreciation and amortization

    1,996     0.6 %     1,748     0.7 %     248     14.2 %

Bad debt expense

    1,998     0.6 %     1,632     0.6 %     366     22.4 %

Other expenses

    31,585     9.4 %     25,983     10.1 %     5,602     21.6 %
                                         

Total costs and expenses (excluding cost of commodities sold)

    258,315     76.8 %     203,530     79.0 %     54,785     26.9 %
                                         

Income from continuing operations before income tax expense and minority interest

    78,142     23.2 %     54,227     21.0 %     23,915     44.1 %

Minority interest

    (146 )   (0.1 )%     639     0.2 %     (785 )   (122.9 )%
                                         

Income from continuing operations before income tax expense

    78,288     23.3 %     53,588     20.8 %     24,700     46.1 %

Income tax expense

    30,867     9.2 %     20,000     7.8 %     10,867     54.3 %
                                         

Net income from continuing operations

    47,421     14.1 %     33,588     13.0 %     13,833     41.2 %

Loss from discontinued operations, net of tax

    (6,829 )   (2.0 )%     (311 )   (0.1 )%     (6,518 )   N/M  
                                         

Net income

  $ 40,592     12.1 %   $ 33,277     12.9 %   $ 7,315     22.0 %
                                         

 

39


Table of Contents

 

(1) Revenues, net of cost of commodities sold, consists of total revenues presented with the sales of commodities net of cost of commodities sold. See “Selected Financial Data—Non-GAAP Financial Measures” for further discussion of revenues, net of cost of commodities sold.

 

N/M—Percentage is not meaningful

 

Revenues and Cost of Commodities Sold

 

Revenues, net of cost of commodities sold, increased $78.7 million, or 30.5%, from $257.8 million in fiscal 2007, to $336.5 million in fiscal 2008.

 

Commissions and Clearing Fees. Commissions and clearing fees increased $34.1 million, or 23.5%, from $145.1 million in fiscal 2007, to $179.2 million in fiscal 2008, primarily due to the increase in exchange-traded contract volume of 37.6 million contracts, or 61.7%, from 61.0 million contracts in fiscal 2007, to 98.6 million contracts in fiscal 2008. The increase in exchange-traded contract volume was primarily driven by the fiscal year’s significant price volatility across all commodities, and specifically, in the grain and energy markets. The majority of the contract volume increase was in our Clearing and Execution Services segment, where we experienced a large amount of high-volume, low-margin electronic trades gained from several new customers acquired during the fourth quarter of fiscal 2007 with trading activities continued throughout fiscal 2008. The increased volume also reflects an increase in agricultural commodity contracts executed by our C&RM customers, resulting from 2007’s record crop production. Offsetting the increase is decreased revenues from Forex customer trading, resulting primarily from a decrease in customer trade activity. See “Operations by Segment” for further discussion of revenue and contract volumes.

 

The following table shows commissions and clearing fees by exchange trades and Forex trades and the number of exchange-traded contracts that we have executed or cleared for our customers in the C&RM and Clearing and Execution Services segments for the fiscal years ended August 31, 2008 and 2007.

 

     Year Ended August 31,
   2008    2007
   ($ in thousands)

Commissions and clearing fees—Exchange trades

   $ 171,113    $ 130,932

Commissions and clearing fees—Forex trades

     8,075      14,145
             

Total commissions and clearing fees

   $ 179,188    $ 145,077
             

Exchange contract trade volume (in millions)

     98.6      61.0

 

Service, Consulting and Brokerage Fees. Service, consulting and brokerage fees increased $50.0 million, or 104.9%, from $47.7 million in fiscal 2007, to $97.7 million in fiscal 2008. This increase was primarily due to a significant increase in OTC contract volume from our energy, renewable fuels, grain risk management and Brazilian and Chinese customers. OTC contract volume increased 610,295 contracts, or 81.3%, from 750,909 contracts in fiscal 2007, to 1,361,204 contracts in fiscal 2008. The overall OTC rate per contract remained relatively constant during fiscal years 2008 and 2007. Additionally, we experienced an increase in consulting fees and higher average fees in the IRMP. Also, in fiscal 2008, we added revenues from OTC and Forex trade desk activities of $14.4 million. On a limited basis, our OTC and Forex trade desks will accept a customer transaction and will offset that transaction with a similar but not identical position on the exchange. These unmatched transactions are intended to be short-term in nature and are conducted to facilitate the most effective transaction for our customer. The following table sets forth our OTC contract volume for the fiscal years ended August 31, 2008 and 2007.

 

     Year Ended August 31,
     2008    2007
     ( in thousands)

OTC contract volume

   1,361    751

 

40


Table of Contents

Interest Income. Interest income increased $5.3 million, or 12.4%, from $43.0 million in fiscal 2007, to $48.3 million in fiscal 2008. The increase was primarily due to the growth in exchange customer segregated assets and OTC customer margin assets which have exceeded the effect of declining short-term interest rates. The increase in investable exchange customer segregated assets and OTC customer margin assets are related to the increase in exchange contract and OTC contract trading volumes, and higher margin requirements due to continued volatility in the commodity markets. Interest revenue growth was offset by decreased activity in the grain inventory financing programs and a reduction of corporate interest revenue. See “Operations by Segment” for further discussion of interest income.

 

The following table sets forth customer segregated assets and average 90-day Treasury bill rates for the fiscal years ended August 31, 2008 and 2007.

 

     Year Ended August 31,  
     2008     2007  
     ($ in thousands)  

Customer segregated assets, end of period

   $ 1,528,028     $ 997,436  

90-day Treasury bill average rates for period

     2.24 %     4.94 %

 

Other Revenues. Other revenues increased by $5.9 million, or 130.6%, from $4.5 million in fiscal 2007, to $10.4 million in fiscal 2008. Excluding non-recurring items, other revenues increased by $3.3 million, primarily the result of income from equity investments which increased by $2.9 million, primarily resulting from the income of our equity interest in FGDI. In fiscal 2007 FGDI’s results for only the three month period subsequent to the sale of our majority interest of $0.2 million were included in other revenues. Fiscal 2008 included a non-recurring $3.8 million realized gain on the sale of exchange stock and trading rights. Fiscal 2007’s non-recurring items included a $3.7 million realized gain on the sale of exchange stock, a $2.6 million realized gain on the sale of our majority interest in FGDI and a special dividend of $0.5 million, offset by a $5.6 million realized loss on investments held at Sentinel Management Group, Inc.

 

Sale of Commodities and Cost of Commodities Sold. Sales of commodities decreased by $1,100.0 million, or 99.8%, from $1,101.8 million in fiscal 2007, to $2.0 million in fiscal 2008. Cost of commodities sold decreased $1,083.1 million, or 99.9%, from $1,084.2 million in fiscal 2007, to $1.1 million in fiscal 2008. During fiscal 2007, the majority of the sales and cost of commodities sold related to the purchase and sale of grain by FGDI, and the significant decrease in each are due to the fact that beginning in the fourth quarter of fiscal 2007, we no longer include the financial statements of FGDI in our consolidated financial statements. During fiscal 2008, sales and costs of commodities sold relate to CCX CFIs purchased and sold through FCStone Carbon’s operations, which are included within the C&RM operating segment.

 

Other Costs and Expenses

 

Employee Compensation and Broker Commissions. Employee compensation and broker commissions increased $16.4 million, or 33.1%, from $49.5 million in fiscal 2007, to $65.9 million in fiscal 2008. Excluding FGDI’s employee compensation in fiscal 2007, employee compensation and broker commissions increased $21.5 million, or 43.4%. This expense increase was primarily a result of volume-related increased broker commissions driven by higher exchange contract, OTC and Forex revenues in our C&RM segment. Additionally, the increase in expense is a result of adding non-broker personnel in recently-formed subsidiaries and accounting, risk and compliance departments, and an increase in incentive pay based on our operating results.

 

Pit Brokerage and Clearing Fees. Pit brokerage and clearing fees increased $36.1 million, or 53.1%, from $68.0 million in fiscal 2007, to $104.0 million in fiscal 2008. This increase was primarily related to increased volume of exchange-traded contracts.

 

Introducing Broker Commissions. Introducing broker commissions expense decreased $2.7 million, or 7.6%, from $36.0 million in fiscal 2007, to $33.3 million in fiscal 2008. The decrease was due to a significant

 

41


Table of Contents

decrease in introducing broker commission related to Forex trades in the C&RM segment. Offsetting this decrease was volume-based increases in introducing broker fees related to exchange-traded contracts in the C&RM and CES operating segments.

 

Employee Benefits and Payroll Taxes. Employee benefits and payroll taxes increased $3.1 million, or 28.7%, from $10.7 million in fiscal 2007, to $13.8 million in fiscal 2008. Excluding FGDI’s employee benefits and payroll taxes in fiscal 2007, employee benefits and payroll taxes increased $4.4 million, or 41.1%. The increase is primarily due to higher payroll taxes from increased employee compensation and broker commissions. Also, we incurred additional pension expense of $1.5 million resulting from the curtailment of future benefits under both defined benefit plans effective September 1, 2008.

 

Interest Expense. Interest expense decreased $4.2 million, or 42.6%, from $9.9 million in fiscal 2007, to $5.7 million in fiscal 2008. Excluding FGDI’s interest expense in fiscal 2007, interest expense decreased $1.3 million, or 18.6%. The majority of interest expense relates to the commodity inventory financing programs, which experienced an overall decrease in expense due to decreased activity and lower short-term borrowing rates. We also incur interest expense on periodic borrowings on margin and subordinated debt facilities.

 

Depreciation and Amortization. Depreciation and amortization expense increased $0.3 million, or 14.2%, from $1.7 million in fiscal 2007 to $2.0 million in fiscal 2008. Excluding FGDI’s deprecation expense in fiscal 2007, depreciation and amortization expense increased $0.8 million, or 67.2%. The increase was primarily due to additional depreciation on new equipment and software and also a result of amortization of intangible assets with determinable lives, acquired as part of acquisitions completed in fiscal 2008.

 

Bad Debt Expense. Bad debt expense increased $0.4 million, or 22.4%, from $1.6 million in fiscal 2007, to $2.0 million in fiscal 2008. In fiscal 2008, bad debt expense reflects the increase to the allowance for doubtful accounts, net of recoveries, and direct write-offs recorded in the C&RM segment and CES segment for specific customer deficit accounts. Certain customer account deficits were related to unprecedented synthetic settlement pricing in the cotton market occurring on March 3, 2008 as the customers were unable to meet the margin calls to us in amounts as required by the exchange. In fiscal 2007, excluding FGDI’s bad debt expense of $0.2 million, $1.4 million of bad debt expense was primarily a result of losses recorded for failure of a commodity pool limited partnership to meet margin requirements, of which we recovered $1.1 million during fiscal 2008.

 

Other Expenses. Other expenses increased $5.6 million, or 21.6%, from $26.0 million in fiscal 2007, to $31.6 million in fiscal 2008. Excluding FGDI’s other expenses in fiscal 2007, other expenses increased $9.9 million, or 45.6%. This additional expense was due primarily to increases in professional fees of $2.7 million; office, equipment and facilities rent and expenses of $2.5 million; printing and office supplies of $1.6 million; travel of $0.6 million; communication and marketing information of $0.5 million and insurance of $0.4 million. These increases relate primarily to operational and administrative costs from the growth we are experiencing.

 

Income Tax Expense. Our provision for income taxes increased $10.9 million, or 54.3%, from $20.0 million in fiscal 2007, to $30.9 million in fiscal 2008. This increase was due primarily to higher profitability, as income from continuing operations before income taxes was $53.6 million in 2007 compared to $78.3 million in 2008. Our effective income tax rate was 39.4% in fiscal 2008 compared to 37.3% in fiscal 2007. The increase in the effective tax rate is primarily due to an increase in state tax rates subsequent to the sale of our majority interest in FGDI. The elimination of FGDI’s grain sales from our consolidated revenues has affected our apportionment calculations and increased state tax apportionment factors.

 

Loss from Discontinued Operations. We reported a loss from discontinued operations, net of tax, of $6.8 million relating to Green Diesel’s developmental stage biodiesel facility in Houston, Texas. During February 2008, we decided to cease construction and development of the biodiesel facility and pursue an immediate sale of the plant assets and inventory. On October 7, 2008, we executed a sale agreement for all of our ownership interest in Green Diesel. The total loss from discontinued operations for the year ended August 31, 2008 was $13.7 million, of

 

42


Table of Contents

which $2.3 million was allocated to the unaffiliated third party minority interest holder. The loss on discontinued operations includes impairment of the plant in the amount of $11.8 million, as well as $1.9 million in operating expenses. Additional impairment and operating expenses recorded in the fourth quarter of fiscal 2008 totaled $1.1 million and $0.5 million, respectively.

 

Year Ended August 31, 2007, Compared to Year Ended August 31, 2006

 

Executive Summary

 

Net income increased $18.0 million or 118.1% from $15.3 million in fiscal 2006, to $33.3 million in fiscal 2007 and included losses from discontinued operations, net of tax of $0.3 million in fiscal 2007. There were no losses from discontinued operations in fiscal 2006. This increase was primarily driven by higher exchange-traded and OTC contract trading volumes from new and existing customers, along with higher interest rates applicable to larger segregated customer balances. The following chart provides revenues, costs and expenses, and net income for the period comparison:

 

    Year Ended August 31, 2007     Year Ended August 31, 2006     Variance  
    In Thousands     % of Revenues,
Net of Cost of
Commodities
Sold
    In Thousands     % of Revenues,
Net of Cost of
Commodities
Sold
    In Thousands     %
Change
 

Sales of commodities

  $ 1,101,752     N/M     $ 1,129,983     N/M     $ (28,231 )   (2.5 )%

Cost of commodities sold

    1,084,205     N/M       1,112,949     N/M       (28,744 )   (2.6 )%
                             

Gross profit on commodities sold

    17,547     6.8 %     17,034     9.4 %     513     3.0 %

Commissions and clearing fees

    145,077     56.3 %     105,622     58.1 %     39,455     37.4 %

Service, consulting and brokerage fees

    47,679     18.5 %     33,388     18.4 %     14,291     42.8 %

Interest

    42,957     16.7 %     23,174     12.7 %     19,783     85.4 %

Other revenues

    4,497     1.7 %     2,638     1.5 %     1,859     70.5 %
                                         

Revenues, net of cost of commodities sold(1)

    257,757     100.0 %     181,856     100.0 %     75,901     41.7 %
                                         

Costs and expenses

           

Employee compensation and broker commissions

    49,524     19.2 %     44,229     24.3 %     5,295     12.0 %

Pit brokerage and clearing fees

    67,978     26.4 %     47,613     26.2 %     20,365     42.8 %

Introducing broker commissions

    36,050     14.0 %     22,826     12.6 %     13,224     57.9 %

Employee benefits and payroll taxes

    10,678     4.1 %     9,801     5.4 %     877     9.0 %

Interest

    9,937     3.9 %     5,705     3.1 %     4,232     74.2 %

Depreciation and amortization

    1,748     0.7 %     1,674     0.9 %     74     4.4 %

Bad debt expense

    1,632     0.6 %     1,909     1.0 %     (277 )   (14.5 )%

Other expenses

    25,983     10.1 %     23,568     13.0 %     2,415     10.2 %
                                         

Total costs and expenses (excluding cost of commodities sold)

    203,530     79.0 %     157,325     86.5 %     46,205     29.4 %
                                         

Income from continuing operations before income tax expense and minority interest

    54,227     21.0 %     24,531     13.5 %     29,696     121.1 %

Minority interest

    639     0.2 %     (226 )   (0.1 )%     865     (382.7 )%
                                         

Income from continuing operations before income tax expense

    53,588     20.8 %     24,757     13.6 %     28,831     116.5 %

Income tax expense

    20,000     7.8 %     9,500     5.2 %     10,500     110.5 %
                                         

Net income from continuing operations

    33,588     13.0 %     15,257     8.4 %     18,331     120.1 %

Loss from discontinued operations

    (311 )   0.1 %     —       —         (311 )   N/M  
                                         

Net income

  $ 33,277     12.9 %   $ 15,257     8.4 %   $ 18,020     118.1 %
                                         

 

43


Table of Contents

 

(1) Revenues, net of cost of commodities sold, consists of total revenues presented with the sales of commodities net of cost of commodities sold. See “Selected Financial Data—Non-GAAP Financial Measures” for further discussion of revenues, net of cost of commodities sold.

 

N/M—Percentage is not meaningful

 

Revenues and Cost of Commodities Sold

 

Revenues, net of cost of commodities sold, increased $75.9 million, or 41.7%, from $181.9 million in fiscal 2006, to $257.8 million in fiscal 2007.

 

Commissions and Clearing Fees. Commissions and clearing fees increased $39.5 million, or 37.4%, from $105.6 million in fiscal 2006, to $145.1 million in fiscal 2007. Total exchange-traded contract volume increased by 13.5 million exchange-traded contracts, or 28.5%, from 47.5 million contracts in fiscal 2006, to 61.0 million contracts in fiscal 2007, which accounted for $26.3 million of the increase. This increase was primarily the related to the fiscal year’s significant price rally and its continuing effects and volatility in the grain markets and continued volatility in the energy markets. Revenues increased in line with trading volume, as there was little change in the average revenue per trade during the year. Additionally, Forex trades increased significantly due to the addition of several large customers and accounted for approximately $13.1 million of the higher commissions and fees.

 

The following table shows commissions and clearing fees by exchange trades and Forex trades and the number of exchange-traded contracts that we have executed or cleared for our customers in the C&RM and Clearing and Execution Services segments for the fiscal years ended August 31, 2007 and 2006.

 

     Year Ended August 31,
     2007    2006
     ($ in thousands)

Commissions and clearing fees—Exchange trades

   $ 130,932    $ 104,602

Commissions and clearing fees—Forex trades

     14,145      1,020
             

Total commissions and clearing fees

   $ 145,077    $ 105,622
             

Exchange contract trade volume (in millions)

     61.0      47.5

 

Service, Consulting and Brokerage Fees. Service, consulting and brokerage fees increased $14.3 million, or 42.8%, from $33.4 million in fiscal 2006, to $47.7 million in fiscal 2007. This increase was primarily due to a significant increase in OTC contract volume from our energy, renewable fuels, grain risk management and Brazilian and Chinese customers. OTC contract volume increased 425,124 contracts, or 130.5%, from 325,785 contracts in fiscal 2006, to 750,909 contracts in fiscal 2007. The overall OTC rate per contract was lower as we had an increase in lower-rate renewable fuels trades during the year. In addition, we experienced an increase in consulting fees due to more customers and higher average fees in the IRMP.

 

The following table sets forth OTC contract volumes for the fiscal years ended August 31, 2007 and 2006.

 

     Year Ended August 31,
     2007    2006
     ( in thousands)

OTC contract volume

   751    326

 

Interest Income. Interest income increased $19.8 million, or 85.4%, from $23.2 million in fiscal 2006, to $43.0 million in fiscal 2007. The increase was primarily due to increased exchange customer segregated assets and OTC customer margin assets, higher short-term interest rates and increased activity in the grain inventory financing programs.

 

44


Table of Contents

The following table sets forth customer segregated assets and average 90-day Treasury bill rates for the fiscal years ended August 31, 2007 and 2006.

 

     Year Ended August 31,  
     2007     2006  
     Year Ended August 31,  

Customer segregated assets, end of period

   $ 997,436     $ 764,847  

90-day Treasury bill average rates for period

     4.94 %     4.42 %

 

Other Revenues. Other revenues increased by $1.9 million, or 70.5%, from $2.6 million in fiscal 2006, to $4.5 million in fiscal 2007. This increase was primarily the result of several non-recurring items, including a $3.7 million gain on the sale of excess CME Group Inc. stock, a $2.6 million gain on the sale of a portion of our FGDI membership units, a $0.5 million special dividend from CBOT and a $0.1 million gain on the conversion of a membership seat to common stock. These gains were offset by the $5.6 million loss on investments held at Sentinel Management Group, Inc (“Sentinel”). As a result of the merger between the CBOT and the CME, the share requirements to trade on the exchanges were revised and resulted in the Company having excess shares of CME that no longer need to be pledged for clearing purposes. The loss on investments resulted when a portion of our excess segregated funds invested with Sentinel were sold to an unaffiliated third-party at a significant discount.

 

Sale of Commodities and Cost of Commodities Sold. Sales of commodities decreased by $28.2 million, or 2.5%, from $1,130.0 million in fiscal 2006, to $1,101.8 million in fiscal 2007. Cost of commodities sold decreased $28.7 million, or 2.6%, from $1,112.9 million in fiscal 2006, to $1,084.2 million in fiscal 2007. The decrease in sales and cost of commodities sold was due to a decrease in the number of financing transactions we entered into as a principal, in the Financial Services segment, accounting for a $21.1 million decrease in energy sold and a $7.5 million decrease in arrangements whereby we periodically participate as a principal in back-to-back ethanol transactions in the C&RM segment.

 

In addition, the sales of commodities and cost of commodities sold from our Grain Merchandising segment reflected similar revenue and related cost totals, however the fiscal 2007 amounts only include nine months of activity, as described above. Grain bushels handled were 235.9 million bushels in fiscal 2006 and 174.1 million bushels in the first nine months of fiscal 2007. The discrepancy in the bushels handled was offset by the significant increase in grain prices during fiscal 2007.

 

Gross profit on commodities sold increased $0.5 million, or 3.0%, from $17.0 million in fiscal 2006, to $17.5 million in fiscal 2007 with the gross margin percentage increasing slightly from 1.5% to 1.6%.

 

Other Costs and Expenses

 

Employee Compensation and Broker Commissions. Employee compensation and broker commissions increased $5.3 million, or 12.0%, from $44.2 million in fiscal 2006, to $49.5 million in fiscal 2007. The expense increase was primarily a result of volume-related increased broker commissions driven by higher revenues in our C&RM segment, and to a lesser extent, additional personnel.

 

Pit Brokerage and Clearing Fees. Pit brokerage and clearing fees increased $20.4 million, or 42.8%, from $47.6 million in fiscal 2006, to $68.0 million in fiscal 2007. This increase was directly related to increased volume of exchange-traded and Forex traded contracts.

 

Introducing Broker Commissions. Introducing broker commissions expense increased $13.2 million, or 57.9%, from $22.8 million in fiscal 2006, to $36.0 million in fiscal 2007. The increase was due to higher contract trading volumes from customers introduced by our introducing brokers in both the C&RM and Clearing and Execution Services segments.

 

45


Table of Contents

Employee Benefits and Payroll Taxes. Employee benefits and payroll taxes increased $0.9 million, or 9.0%, from $9.8 million in fiscal 2006, to $10.7 million in fiscal 2007, primarily due to higher payroll taxes from increased employee compensation and broker commissions.

 

Interest Expense. Interest expense increased $4.2 million, or 74.2%, from $5.7 million in fiscal 2006, to $9.9 million in fiscal 2007. The increase was primarily due to higher borrowings as a result of significantly increased activity in the grain inventory financing programs and higher borrowings in the first nine months of our grain merchandising operations. Additionally, higher short-term interest rates were also a factor of the increased interest expense.

 

Depreciation and amortization. Depreciation and amortization expense was $1.7 million in fiscal 2006 and 2007, respectively.

 

Bad Debt Expense. Bad debt expense decreased $0.3 million, or 14.5%, from $1.9 million in fiscal 2006, to $1.6 million in fiscal 2007. Bad debt expense in fiscal 2006 related primarily to a $1.0 million charge resulting from the bankruptcy of a customer in our Grain Merchandising segment. In fiscal 2007 the expense is primarily due to the inability of a commodity pool limited partnership, for which a subsidiary of the Company acted as a general partner and commodity pool operator, to meet a margin call from assets of the pool. The resulting liquidation of the pool positions under continuing adverse market conditions resulted in a charge of $1.3 million, of which $1.1 million was recovered in fiscal 2008.

 

Other Expenses. Other expenses increased $2.4 million, or 10.3%, from $23.6 million in fiscal 2006, to $26.0 million in fiscal 2007. This additional expense was due primarily to a $1.1 million increase in professional fees, which include costs of Sarbanes-Oxley compliance and development of our carbon credits program, a $0.8 million increase in data processing fees and a $0.3 million increase in insurance costs.

 

Income Tax Expense. Our provision for income taxes increased $10.5 million, or 110.5%, from $9.5 million in fiscal 2006, to $20.0 million in fiscal 2007. This increase was due primarily to higher profitability, as income before income taxes was $24.8 million in 2006 compared to $53.3 million in 2007. Our effective income tax rate was 38.4% in fiscal 2006 compared to 37.5% in fiscal 2007. The amount of permanent differences was lower, which had the effect of reducing our effective income tax rate.

 

Loss from Discontinued Operations. Discontinued operations related to Green Diesel’s developmental stage biodiesel facility in Houston, Texas. The loss on discontinued operations amounted to $0.3 million in fiscal 2007.

 

Operations by Segment

 

Our reportable operating segments consist of C&RM, Clearing and Execution Services and Financial Services. Direct corporate revenues and expenses and equity earnings from equity affiliates that are not identified with one of our three operating segments are reported in the Corporate and Other segment. Segment income (loss) before minority interest and income taxes is defined as total segment revenues less total segment costs and expenses before reconciling amounts, corporate expenses, minority interest and income taxes. Reconciling amounts represent the elimination of interest income and expense and commission income and expense between segments. Such transactions are conducted at market prices to more accurately evaluate the profitability of the individual business segments. A reconciliation of total segment revenues and segment income before minority interest and income taxes to the consolidated statements of operations is included in Note 25 in the notes to the consolidated financial statements for the three fiscal years ended August 31, 2008.

 

We prepared the financial results for our operating segments in accordance with SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information.” We have allocated certain common expenses among segments differently than we would for stand-alone financial information prepared in accordance with GAAP. This presentation aligns with how we internally measure segment performance.

 

46


Table of Contents

Segment income before minority interest and income taxes may not be consistent with measures used by other companies. The accounting policies of our operating segments are the same as those applied in the consolidated financial statements.

 

The segment results that follow present the segment information from continuing operations and exclude Green Diesel’s operating results. All historical information has been restated to conform to this presentation.

 

Commodity and Risk Management Services

 

Our C&RM segment offers risk management consulting and access to the commodity derivative markets with the objective of helping our customers mitigate commodity price risk and optimize their profit margins. In this segment, we generate revenues from four primary sources: (1) commission and clearing fee revenues from exchange-traded futures and options contracts and Forex trades, (2) brokerage fees from OTC transactions, (3) interest income, net of interest returned to customers, derived from both investable exchange customer segregated asset balances and OTC customer margin assets, as well as from our proprietary excess funds, and (4) risk management service and consulting fees. Our customers in this segment consist of middle-market commodity intermediaries, end-users and producers, focused primarily in the areas of domestic and international grain, renewable fuels and energy. In fiscal 2008, this segment represented approximately 76% of our consolidated income before minority interest, income tax and corporate overhead. The principal factors that affect our financial performance in this segment include:

 

   

the level of volatility in commodity prices,

 

   

the level of knowledge and sophistication of our customers with respect to commodity risk,

 

   

the development of new risk management products for our customers,

 

   

the volume of commodities produced and consumed by our customers, and

 

   

the level of short-term interest rates and the amount of cash balances in our customers’ accounts.

 

The following table provides the financial performance for this segment.

 

     Year Ended August 31,
     2008    2007    2006
     (in thousands)

Sales of commodities

   $ 1,972    $ 3,806    $ 11,336

Cost of commodities sold

     1,069      3,727      11,053
                    

Gross profit on commodities sold

     903      79      283

Commissions and clearing fees

     55,871      54,367      36,886

Service, consulting and brokerage fees

     98,140      48,227      33,990

Interest

     18,972      20,445      9,610

Other revenues

     3,475      4,476      148
                    

Revenues, net of cost of commodities sold

     177,361      127,594      80,917

Costs and expenses:

        

Expenses (excluding interest expense)

     109,118      81,480      58,825

Interest expense

     693      393      155
                    

Total costs and expenses (excluding cost of commodities sold)

     109,811      81,873      58,980
                    

Segment income before minority interest and income taxes

   $ 67,550    $ 45,721    $ 21,937
                    

 

47


Table of Contents

Year Ended August 31, 2008, Compared to Year Ended August 31, 2007

 

Revenues, net of cost of commodities sold, increased $49.8 million, or 39.0%, from $127.6 million in fiscal 2007, to $177.4 million in fiscal 2008. Following is a discussion of the significant components of that growth:

 

Commissions and clearing fee revenues increased $1.5 million, or 2.8%, from $54.4 million in fiscal 2007, to $55.9 million in fiscal 2008. This increase in commissions and clearing fees is primarily due to a $7.6 million increase in the exchange-traded revenues. The exchange-traded revenue increase results primarily from the increase in the volume of exchange-traded contracts, as executed contracts increased 0.4 million contracts, or 13.5%, from 3.1 million contracts in fiscal 2007 to 3.5 million contracts in fiscal 2008, and a slight increase in the average rate per contract during fiscal 2008. The increased contract volume relates primarily to the fiscal year’s significant grain commodity price volatility. Offsetting this increase in exchange-traded revenue was a decline in Forex trade commissions of $6.1 million.

 

Service, consulting and brokerage fees increased $49.9 million, or 103.5%, from $48.2 million in fiscal 2007, to $98.1 million in fiscal 2008. This increase was primarily due to a significant increase in OTC brokerage volume from renewable fuels and Brazilian customers. Total OTC contract volumes increased from 750,909 contracts in 2007 to 1,361,204 contracts in 2008. The overall OTC rate per contract remained relatively constant during fiscal years 2008 and 2007. We experienced an increase in consulting and IRMP fees due to additional customers and higher average fees in the IRMP. Additionally, we added revenue of $14.4 million from proprietary transactions in the OTC and Forex markets.

 

Interest income decreased $1.5 million, or 7.2%, from $20.4 million in fiscal 2007, to $19.0 million in fiscal 2008, primarily due to lower short-term interest rates, despite increased investable exchange customer segregated assets and OTC customer margin assets.

 

Other revenues decreased $1.0 million, from $4.5 million in fiscal 2007, to $3.5 million in fiscal 2008. Other revenues in fiscal 2008 included a non-recurring $2.9 million realized gain related to the sale of excess exchange stock. Other revenues in fiscal 2007 included a non-recurring $3.7 million realized gain related to the sale of excess exchange stock and a $0.5 million special cash dividend from the CBOT.

 

Sales of commodities decreased $1.8 million, or 48.2%, from $3.8 million in fiscal 2007, to $2.0 million in fiscal 2008. The cost of commodities sold decreased $2.6 million, or 71.3%, from $3.7 million in fiscal 2007, to $1.1 million in fiscal 2008. The sales and cost of commodities sold during fiscal 2008 reflect the purchase and sale of CCX CFIs, and generated $0.9 million in gross profit. The sales and cost of commodities sold during fiscal 2007 reflect our occasional participation, on behalf of customers as a principal in back-to-back ethanol transactions, and generated minimal gross profit. There was no such activity during fiscal 2008.

 

Expenses, excluding interest expense, increased $27.6 million, or 33.9%, from $81.5 million in fiscal 2007, to $109.1 million in fiscal 2008. The expense increase was primarily related to the large volume and revenue growth and included a $22.3 million increase in employee compensation and broker commissions and related benefits, a $0.4 million decrease in introducing broker commissions, a $6.8 million increase in pit brokerage and clearing fees and a $0.5 million decrease in bad debt expense. Bad debt expense of $0.9 million incurred during fiscal 2008 was the result of specific customer deficit accounts arising during the third quarter of fiscal 2008, while bad debt expense during fiscal 2007 was primarily a result of losses recorded for failure of a commodity pool limited partnership to meet margin requirements, of which we recovered $1.1 million during fiscal 2008. Interest expense increased $0.3 million, from $0.4 million in fiscal 2007 to $0.7 million in fiscal 2008, primarily due to the periodic drawdown of additional subordinated debt.

 

48


Table of Contents

Year Ended August 31, 2007, Compared to Year Ended August 31, 2006

 

Revenues, net of cost of commodities sold, increased $46.7 million, or 57.7%, from $80.9 million in fiscal 2006, to $127.6 million in fiscal 2007. Following is a discussion of the significant components of that growth:

 

Commissions and clearing fee revenues increased $17.5 million, or 47.4%, from $36.9 million in fiscal 2006, to $54.4 million in fiscal 2007. This increase in commissions and clearing fees was primarily due to a $13.1 million increase in our Forex trading commissions, from the addition of several significant customers. Additionally the increase was due to the fiscal year’s significant grain market price rally and continued grain commodity price volatility, resulting in a 0.6 million exchange-traded contract, or 24.0%, increase in trading volume for exchange-traded contracts from 2.5 million in the year ended August 31, 2006 to 3.1 million in the year ended August 31, 2007. Offsetting this increase in trading volume was a slight decline in the average rate per trade due to higher volumes from customers with lower average commission rates.

 

Service, consulting and brokerage fees increased $14.2 million, or 41.8%, from $34.0 million in fiscal 2006, to $48.2 million in fiscal 2007. This increase was primarily due to a significant increase in OTC brokerage volume from renewable fuels and Brazilian customers. Total OTC contract volumes increased from 325,785 contracts in 2006 to 750,909 contracts in 2007. The overall OTC rate per contract was lower as we had an increase in lower-rate renewable fuels trades during the year. Also, we experienced an increase in consulting fees due to more customers and higher average fees in the IRMP.

 

Interest income increased $10.8 million, or 112.5%, from $9.6 million in fiscal 2006, to $20.4 million in fiscal 2007, primarily due to increased investable exchange customer segregated assets and OTC customer margin assets as well as, higher short-term interest rates.

 

Other revenues increased $4.4 million, from $0.1 million in fiscal 2006, to $4.5 million in fiscal 2007, resulting primarily from a $3.7 million gain on the sale of excess CME stock and a $0.5 million special cash dividend from the CBOT.

 

Sales of commodities decreased $7.5 million, or 66.4%, from $11.3 million in fiscal 2006, to $3.8 million in fiscal 2007. Costs of commodities sold decreased by $7.4 million, or 66.3%, from $11.1 million in fiscal 2006, to $3.7 million in fiscal 2007. These declines were due to significantly lower volumes sold during fiscal 2007, as there was a decrease in the number of arrangements where we participated as a principal in back-to-back ethanol transactions.

 

Expenses, excluding interest expense, increased $22.7 million, or 38.6%, from $58.8 million in fiscal 2006, to $81.5 million in fiscal 2007. The expense increase was primarily related to the large volume and revenue growth and included a $6.9 million increase in employee compensation and broker commissions and related benefits, a $5.6 million increase in introducing broker commissions, a $5.6 million increase in pit brokerage and clearing fees and a $1.0 million increase in bad debt expense. The bad debt expense increase was primarily due to the inability of a commodity pool limited partnership, for which a subsidiary of the Company acted as a general partner and commodity pool operator, to meet a margin call from assets of the pool. The resulting liquidation of pool positions under continuing adverse market conditions resulted in a charge of $1.3 million. Interest expense was approximately $0.2 million in fiscal 2006 and approximately $0.4 million in fiscal 2007.

 

Clearing and Execution Services

 

The Clearing and Execution Services segment offers low-cost clearing and execution for exchange-traded futures and options to the wholesale and professional trader market segments. In this segment, we generate revenues from two primary sources: commissions and clearing fee revenues from the execution and clearing of exchange-traded futures and options contracts, and interest income derived from cash balances in our customers’

 

49


Table of Contents

accounts. In fiscal 2008, this segment represented approximately 22.0% of our consolidated income before minority interest, income tax and corporate overhead. The principal factors that affect our financial performance in this segment include:

 

   

the level of volatility in commodity prices, and

 

   

the level of short-term interest rates and the amount of cash balances in our customers’ accounts.

 

The following table provides the financial performance for this segment.

 

     Year Ended August 31,
     2008    2007     2006
     (in thousands)

Sales of commodities

   $ —      $ —       $ —  

Cost of commodities sold

     —        —         —  
                     

Gross profit on commodities sold

     —        —         —  

Commissions and clearing fees

     124,070      91,486       69,246

Service, consulting and brokerage fees

     —        —         —  

Interest

     22,237      15,707       10,702

Other revenues

     878      (5,420 )     —  
                     

Revenues, net of cost of commodities sold

     147,185      101,773       79,948

Costs and expenses:

       

Expenses (excluding interest expense)

     126,957      91,570       68,541

Interest expense

     67      593       426
                     

Total costs and expenses (excluding cost of commodities sold)

     127,024      92,163       68,967
                     

Segment income before minority interest and income taxes

   $ 20,161    $ 9,610     $ 10,981
                     

 

Year Ended August 31, 2008, Compared to Year Ended August 31, 2007

 

Commissions and clearing fees increased $32.6 million, or 35.6%, from $91.5 million in fiscal 2007 to $124.1 million in fiscal 2008. This increase was the result of increased trading volume due to energy, metals and soft (coffee, sugar and cocoa) commodities price volatility and the addition of several large-volume customers. Exchange-traded contract volume increased 37.2 million contracts, or 64.3%, from 57.9 million in fiscal 2007 to 95.1 million in fiscal 2008. The significant increase in contract volume in fiscal 2008 compared to fiscal 2007 is primarily from the addition of several new large customers during the fourth quarter of fiscal 2007, which have remained during fiscal 2008. The infusion of these high-volume, low-margin electronic trades has resulted in a slight decrease in the average rate per contract from fiscal 2007 as compared to fiscal 2008.

 

Interest income increased $6.5 million, or 41.6%, from $15.7 million in fiscal 2007 to $22.2 million in fiscal 2008, primarily due to significant growth of investable customer segregated funds that continued throughout fiscal 2008, offset by lower short-term interest rates.

 

Other revenue increased $6.3 million from a loss of $5.4 million in fiscal 2007, to $0.9 million in fiscal 2008. Other revenue in fiscal 2008 included non-recurring $0.7 million realized gains related to the sale and conversion of excess exchange stock and memberships. Other revenues in fiscal 2007 included a non-recurring $5.6 million loss on excess segregated funds invested with Sentinel.

 

Expenses, excluding interest expense, increased $35.4 million, or 38.6%, from $91.6 million in fiscal 2007, to $127.0 million in fiscal 2008. This increase in expenses was primarily due to volume-related increases in pit brokerage and clearing fees of $29.3 million and volume based data processing transaction fees, offset by the decrease in introducing broker commissions of $2.4 million. Additionally, bad debt expense increased

 

50


Table of Contents

$0.8 million as a result of specific customer deficit accounts arising during the third quarter of fiscal 2008. Interest expense decreased from $0.6 million in fiscal 2007 to $0.1 million in fiscal 2008. The interest expense relates to periodic subordinated debt borrowings, and the decrease is primarily due to the reduction in the amount of subordinated debt borrowings outstanding after our initial public offering in fiscal 2007.

 

Year Ended August 31, 2007, Compared to Year Ended August 31, 2006

 

Commissions and clearing fees increased $22.3 million, or 32.2%, from $69.2 million in fiscal 2006 to $91.5 million in fiscal 2007. This increase was the result of increased trading volume due to energy, metals and soft (coffee, sugar and cocoa) commodities price volatility. Exchange-traded contract volume increased 12.9 million contracts, or 28.7%, from 45.0 million in fiscal 2006 to 57.9 million in fiscal 2007. The average rate per contract remained relatively constant from year-to-year. Interest income increased $5.0 million, or 46.7%, from $10.7 million in fiscal 2006 to $15.7 million in fiscal 2007, primarily due to higher short-term interest rates and increased customer segregated funds. The Clearing & Execution Services segment incurred a loss in Other revenue in 2007 due to a $5.6 million loss on excess segregated funds invested with Sentinel. Sentinel, a registered FCM, was a money manager that provided cash management services to other FCMs. In August 2007, Sentinel halted redemptions to customers and sold a certain portion of the assets it managed to an unaffiliated third-party at a significant discount. As of August 31, 2007, we had an outstanding receivable for $0.8 million of funds temporarily held back by the bankruptcy trustee, which we collected in fiscal 2008.

 

Expenses, excluding interest expense, increased $23.1 million, or 33.7%, from $68.5 million in fiscal 2006, to $91.6 million in fiscal 2007. This increase in expenses was primarily due to volume-related increases in clearing and pit brokerage expenses of $15.5 million, and introducing broker commissions of $7.5 million. Interest expense was approximately $0.6 million in fiscal 2007 and $0.4 million in fiscal 2006 . The interest expense relates to increased subordinated debt in the first six months of our fiscal year prior to our IPO.

 

Financial Services

 

The Financial Services segment is composed of two wholly-owned subsidiaries: FCStone Financial and FCStone Merchant Services. Through these subsidiaries, we finance and facilitate physical commodity inventories through product financing arrangements, or by entering into repurchase agreements or hedged commodity transactions with our customers. In addition, at times, we enter into arrangements with clients to share profits from transactions in physical commodities in exchange for financial support.

 

In this segment, we generate revenues from three primary sources: (1) interest income derived from commodity inventory financing through sale/repurchase agreements with commercial grain customers, (2) revenues from profit-share arrangements where we act as an agent in the transaction trades, and (3) revenues from the sale of energy and other various commodities in profit-share arrangements where we act as a principal in the transaction. For transactions in which we participate as an agent, the revenue recorded is limited to the contracted profit-share. For transactions in which we participate as a principal, we are required to record the gross amount of revenue from commodity sales and the gross amount of related costs. In fiscal 2008, this segment represented approximately 2% of our consolidated income before minority interest, income tax and corporate overhead. Our customers in this segment consist primarily of commercial grain-related customers in the grain repurchase program and renewable fuels producers. The principal factors that affect our financial performance in this segment include:

 

   

the level of commodity prices, and

 

   

the volume of commodities produced and consumed by our customers.

 

51


Table of Contents

The following table provides the financial performance of this segment.

 

     Year Ended August 31,  
     2008    2007    2006  
     (in thousands)  

Sales of commodities

   $ —      $ 20,007    $ 41,094  

Cost of commodities sold

     —        19,904      40,906  
                      

Gross profit on commodities sold

     —        103      188  

Commissions and clearing fees

     —        —        —    

Service, consulting and brokerage fees

     —        —        —    

Interest

     6,494      7,179      3,320  

Other revenues

     2,692      1,798      1,491  
                      

Revenues, net cost of commodities sold

     9,186      9,080      4,999  

Costs and expenses:

        

Expenses (excluding interest expense)

     2,378      2,344      2,302  

Interest expense

     5,119      5,684      2,716  
                      

Total costs and expenses (excluding cost of commodities sold)

     7,497      8,028      5,018  
                      

Segment income (loss) before minority interest and income taxes

   $ 1,689    $ 1,052    $ (19 )
                      

 

Year Ended August 31, 2008, Compared to August 31, 2007

 

The sale of commodities and cost of commodities sold were $20.0 million and $19.9 million, respectively, in fiscal year 2007. These sales and cost of commodities sold generated minimal gross profit, and relate to several financing transactions during fiscal year 2007, that we entered into as a principal, which requires us to record the gross amount of revenues and costs from commodity sales. There were no such financing transactions during fiscal year 2008.

 

Interest income decreased $0.7 million, or 9.5%, from $7.2 million in fiscal 2007, to $6.5 million in fiscal 2008. This decrease resulted from decreased activity in the grain inventory financing program and lower short-term interest rates. Other revenues increased $ 0.9 million, or 49.7%, from $1.8 million in fiscal 2007, to $2.7 million in fiscal 2008, primarily due to increased transactional financing, transportation related income and patronage income.

 

Expenses, excluding interest expense, are comprised primarily of railcar lease costs and employee compensation, and were essentially flat in fiscal 2008 as compared to the prior year. Interest expense decreased $0.6 million, or 9.9%, from $5.7 million in fiscal 2007, to $5.1 million in fiscal 2008. The decrease in interest expense resulted from reduced borrowings related to the decreased activity in the grain inventory financing program and lower short-term interest rates.

 

Year Ended August 31, 2007, Compared to August 31, 2006

 

Sales of commodities decreased $21.1 million, or 51.3%, from $41.1 million in fiscal 2006, to $20.0 million in fiscal 2007. The cost of commodities sold decreased $21.0 million, or 51.3%, from $40.9 million in fiscal 2006, to $19.9 million in fiscal 2007. These decreases were primarily due to the decrease in the number of financing transactions we entered into as a principal, which require us to record the gross amount of revenue and costs from commodity sales.

 

Interest income increased $3.9 million, or 118.2%, from $3.3 million in fiscal 2006, to $7.2 million in fiscal 2007. This increase resulted from increased activity in the grain inventory financing programs and higher short-term interest rates. Other revenues increased $0.3 million, or 20.0%, from $1.5 million in fiscal 2006, to $1.8 million in fiscal 2007, primarily due to an increase in the profitability of financing transactions entered into as an agent.

 

52


Table of Contents

Expenses, excluding interest expense, remained consistent, with $2.3 million in fiscal 2006 and fiscal 2007, respectively, and are comprised primarily of railcar lease costs and employee compensation. Interest expense increased $3.0 million, or 111.1%, from $2.7 million in fiscal 2006, to $5.7 million in fiscal 2007. The increase in interest expense resulted from additional borrowings related to the increased activity in the grain inventory financing programs and higher short-term interest rates.

 

Corporate and Other

 

The Corporate and Other segment consists of income from investments in other companies accounted for using the equity method, interest income on corporate funds and overall corporate level expenses primarily related to employee compensation and benefits, travel, technology, professional fees, director fees, and general insurance. Additionally, expenses incurred in the ongoing development of Agora-X, a start-up subsidiary formed to develop an electronic communications network for OTC commodity contracts is reported within the Corporate and Other segment. The Corporate and Other segment generated $4.0 million of revenues, including $3.0 million from the equity interest in the earnings of FGDI and $0.6 million of investment income on corporate funds during fiscal year 2008. In fiscal year 2007, this segment generated $3.9 million of revenues, primarily from a $2.6 million realized gain on the sale of a portion of our ownership interest in FGDI and investment income on corporate funds. This segment generated insignificant amounts of revenue during fiscal year 2006. Corporate expenses consist primarily of non-broker related employee compensation, related employee benefits, professional fees, printing and compliance filing fees and corporate interest expense, in fiscal 2007 and 2006. In fiscal 2008, corporate expenses totaled $15.2 million and included $1.6 million of expenses incurred related to Agora-X. The increased corporate expense in fiscal 2008 primarily results from an increase in compensation and related benefits, professional fees and corporate administrative fees. In fiscal 2007, corporate expenses totaled $8.2 million and included $0.5 million of expenses related to Agora-X. In fiscal 2006, corporate expenses totaled $7.9 million.

 

Liquidity and Capital Resources

 

Overview

 

Liquidity is of critical importance to us and imperative to our normal operations on a daily basis. We have responsibilities to meet margin calls at all exchanges on a daily basis, if necessary. Margin required to be posted to the exchanges is a function of the net open positions of our customers and the required margin per contract. During the fourth quarter of fiscal 2008, we increased our line of credit availability for margin calls by $100.0 million to $270.0 million, and believe through our available capacity under our revolving credit facilities, projected operating cash flows and our remaining balance of available cash and temporary cash investments we can continue to support additional growth in each segment of our operations. We continuously monitor our liquidity position and evaluate the availability of credit and capital markets, and have successfully expanded amounts available under subordinated debt facilities during the fourth quarter by $40.0 million to $56.0 million. To date, $15.0 million of this available subordinated debt funding has been utilized.

 

Customer and Counterparty Credit and Liquidity Risk

 

Our operations expose us to credit risk of default of our customers and counterparties. The risk includes liquidity risk to the extent our customers or counterparties are unable to make timely payment of margin or other credit support. These risks expose us indirectly to the financing and liquidity risks of our customers and counterparties, including the risks that our customers and counterparties may not be able to finance their operations. Throughout the agriculture and energy industries, higher commodity prices and continued volatility has required increased lines of credit, and placed a strain on working capital debt facilities, leveraging customers to unprecedented levels in order for them to continue to carry inventory and properly execute hedging strategies. Recent volatility in the financial markets has tightened credit further, and increased the difficulty in obtaining financing.

 

53


Table of Contents

As a clearing broker, we act on behalf of our customers for all trades consummated on exchanges. We must pay initial and variation margin to the exchanges before we receive the required payments from our customers. Accordingly, we are responsible for our customers’ obligations with respect to these transactions, which exposes us to significant credit risk. Our customers are required to make any required margin deposits the next business day, and we require our largest customers to make intra-day margin payments during periods of significant price movement. Our clients are required to maintain initial margin requirements at the level set by the respective exchanges, but we have the ability to increase the margin requirements for a customer based on their open positions, trading activity, or market conditions.

 

With over-the-counter derivative transactions we act as a principal, which exposes us to both the credit risk of our customers and the counterparties with which we offset the customer’s position. As with exchange traded transactions, our over-the-counter transactions require that we meet initial and variation margin payments on behalf of our customers before we receive the required payment from our customers. Over-the-counter customers are required to post sufficient collateral to meet margin requirements based on Value at Risk models as well as variation margin requirement based on the price movement of the commodity in which they transact. Our customers are required to make any required margin deposits the next business day, and we may require our largest clients to make intra-day margin payments during periods of significant price movement. We have the ability to increase the margin requirements for a customer based on their open positions, trading activity, or market conditions.

 

In addition, with over-the-counter transactions, we are at the risk that a counterparty will fail to meet its obligations when due. We would then be exposed to the risk that a settlement of a transaction which is due a customer will not be collected from the respective counterparty with which the transaction was offset. We continuously monitor the credit quality of our respective counterparties and mark to market our positions held with each counterparty on a daily basis. We carry trade credit insurance in amount in excess of the exposure to each counterparty and will adjust levels of insurance or positions with a given counterparty based on the exposure to that counterparty.

 

During the first quarter of our fiscal year 2009 ended November 30, 2008, we expect to record a pre-tax bad debt provision up to $25.0 million in connection with losses by three domestic accounts for which we serve as the clearing firm or counterparty. These losses relate primarily to a significant energy trading account, and to a lesser extent, a renewable fuels account and a foreign exchange account As part of our business, we clear transactions for third parties in the exchange-traded and OTC markets. We are responsible for ensuring performance by the third party, which exposes us to the risk of default by the third party. As a clearing member, we must settle at the clearinghouse any shortfall resulting from these transactions. We believe this range of bad debt provision properly reflects all shortfall for which we are currently responsible as it relates to this third-party account. Under our agreement with the introducing broker for the third party, the introducing broker is responsible for 50% of any losses, including losses resulting from a debit balance in a customer account, but no assurances can be given as to the amount and timing of recovery that may be obtained under that agreement. We have taken specific steps intended to reduce the market risk associated with the trading position of the energy account.

 

Primary Sources and Uses of Cash

 

Operating cash flow provides the primary source of funds to finance operating needs, capital expenditures and equity investments. Prior to our IPO in March 2007, we supplemented operating cash flow with debt to fund these activities, primarily in the previously-reported Grain Merchandising segment. We continue to utilize our credit facilities to fund our financing operations in the Financial Services segment. FCStone, our FCM, occasionally uses its margin line credit facilities, on a short-term basis, to meet intraday settlements with the commodity exchanges prior to collecting margin funds from our customers. Also, from time-to-time FCStone utilizes subordinated debt to increase its excess regulatory capital.

 

54


Table of Contents

We have liquidity and funding policies and processes in place that are intended to maintain significant flexibility to address both company-specific and industry liquidity needs. The majority of our excess funds are held with high quality institutions, under highly-liquid reverse repurchase agreements, with a maturity of typically three days or less, and AA rated money market investments.

 

Cash Flows

 

Unrestricted cash and cash equivalents consist of unrestricted cash and all money market accounts not pledged to an exchange, with original maturities of three months or less. Changes to our unrestricted cash and cash equivalents balances are due to our operating, investing and financing activities discussed below.

 

The following table sets forth our cash flows from operating activities, investing activities and financing activities for the three fiscal years ended August 31, 2008.

 

     Year Ended August 31,  
     2008     2007     2006  
     (dollars in thousands)  

Cash flows provided by (used in):

      

Operating activities

   $ (43,003 )   $ (29,759 )   $ 41,011  

Investing activities

     (44,709 )     (48,873 )     (14,819 )

Financing activities

     70,634       108,959       8,489  

Discontinued operations

     671       —         —    
                        

Net (decrease) increase in cash and cash equivalents

   $ (16,407 )   $ 30,327     $ 34,681  
                        

 

Cash Flows from Operations

 

In the commodities industry, companies report trading activities in the operating section of the statement of cash flows. Due to the potential volatility in the commodities market, wide fluctuations in the balances of customer segregated assets, deposits held at various exchanges, marketable securities and customer commodity accounts may occur from day-to-day. As a result of this volatility, cash flows from operations may fluctuate positively or negatively at the end of a reporting period. These fluctuations may not be indicative of the health of our business.

 

Cash used in operations was $43.0 million for the year ended August 31, 2008, which consisted of net income from continuing operations of $47.4 million decreased by $11.9 million of non-cash items and $78.5 million of cash utilized for working capital. The uses for working capital primarily resulted from the increases in net commodity accounts receivable/payable, marketable securities, customer segregated assets, counterparty deposits and customer advances of $89.2 million. These were offset by increases in accounts payable and accrued expenses.

 

Cash used in operations was $29.8 million for the year ended August 31, 2007, which consisted of net income of $33.3 million decreased by $4.0 million of non-cash items and $59.1 million of cash provided by working capital. The $59.1 provided by working capital primarily consisted of increases in commodity accounts receivable/payable, net, marketable securities and customer segregated assets, net, open contracts receivable/payable, net and other assets. These were offset by increases in trade accounts payable and accrued expenses and a decrease in counterparty deposits and accounts receivable.

 

Cash Flows from Investing Activities

 

Cash used in investing activities was $44.7 million for fiscal 2008, primarily consisting of $39.4 million of net cash issued on notes receivable associated with the grain inventory financing programs within the Financial

 

55


Table of Contents

Services segment. Additionally, we used cash of $7.0 million for strategic acquisitions and $4.4 million for capital expenditures. The capital expenditures relate primarily to technology development, computer software and hardware and office furniture and equipment. These uses of cash were offset by proceeds of $5.2 million from the sale and conversion of exchange stock and trading rights.

 

Cash used in investing activities was $48.9 million for fiscal 2007, primarily consisting of $25.0 million of proprietary marketable securities purchased with proceeds from the IPO, $27.3 million of net issued notes receivable, associated with the increased activity of the grain inventory financing programs within the Financial Services segment, and $1.9 million used to purchase an exchange membership on the Board of Trade of the City of New York, Inc., common stock of InterContinental Exchange, Inc. and a membership seat of the COMEX Division of the New York Mercantile Exchange. We also invested $2.8 million in fixed asset expenditures primarily for office furniture and equipment and computer software and hardware. Offsetting these cash investments were $6.8 million in proceeds received from the sale of FGDI membership units, reduced by cash held by FGDI at the sale date, and $3.9 million from the sale of exchange stock.

 

Cash Flows from Financing Activities

 

Cash provided by financing activities was $70.6 million for the year ended August 31, 2008, primarily consisting of $40.7 million of net proceeds drawn on our credit facilities used to support the grain inventory financing programs and $15.0 million of net proceeds drawn on our subordinated debt facility. Additionally, we received proceeds from the issuance of stock related to option exercises of $3.7 million, and recognized $8.4 million in excess tax benefits from employee stock option exercises. Our subsidiary, Agora-X, issued preferred units and 13.3 percent ownership interest in the subsidiary to a third party in exchange for a cash contribution, net of underwriting costs, of $4.6 million.

 

Cash provided by financing activities was $109.0 million for the year ended August 31, 2007, primarily consisting of $129.6 million of net proceeds after deducting underwriting discounts and commissions of $9.9 million and other offering costs of $1.3 million from our IPO in March 2007. We used a portion of the proceeds to redeem 2.2 million shares of common stock immediately prior to the consummation of the offering at a cost of $48.5 million. We also used a portion of the IPO proceeds to repay subordinated debt in the amount of $14.5 million. Additionally, $36.0 million has been drawn on our credit facilities to support the grain inventory financing program. We also received $1.4 million in proceeds from the issuance of additional stock, discussed below. A portion of proceeds were used to pay dividends, declared in November 2006, in the amount of $6.1 million.

 

Stock Repurchase Program

 

On July 15, 2008, our Board of Directors authorized a stock repurchase program, permitting the purchase of up to $20.0 million of our common stock outstanding at that time. During the period the authorized program was in effect, we purchased 100,000 shares for a cost of $1.8 million.

 

Dividend Policy

 

The Board of Directors has not declared a dividend during fiscal 2008 or 2007. Any determination to pay future regular dividends will be at the discretion of our board of directors, and will depend upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory, rating agency and any contractual restrictions on the payment of dividends and any other factors our board of directors deems relevant.

 

Short-and Long-Term Debt

 

We believe we have adequate lines of credit available to conduct our business. See “—Credit Facilities.” Certain of the credit facilities are used to a greater extent than others, and represent a significant portion of the proceeds drawn

 

56


Table of Contents

on our lines. Our Financial Services segment has total available lines of credit of $180 million available for its commodity financing programs, and also funds a repurchase program on a transaction-by-transaction basis with Standard Chartered Bank, London. These programs’ demand tends to fluctuate throughout the year. While usage corresponds to demand fluctuations, the lines are used continuously throughout the year at various levels. As a result of the sale of a portion of our controlling interest in FGDI’s membership interests in the third quarter of fiscal 2007, we no longer consolidate FGDI’s available lines of credit.

 

Credit Facilities

 

We maintain a number of lines of credit to support operations. A summary of such lines is noted below.

 

Creditor

 

Renewal/Expiration

Date

 

Use

  Total
Commitment
Amount at
August 31, 2008
  Amount
Outstanding at
August 31, 2008
            (dollars in millions)

Syndicate of lenders(1)

  July 22, 2009   Margin Calls   $ 250.0   $ —  

Syndicate of lenders(1)

  July 22, 2010  

Subordinated Debt for Regulatory Capital

    55.0     15.0
               

Total Syndicate of lenders

        305.0     15.0
               

CoBank, ACB

  April 1, 2009   OTC Margin     10.0     —  

CoBank, ACB

  April 1, 2009   OTC Margin     10.0     —  

CoBank, ACB

  December 31, 2008   Repurchase Agreements     100.0     22.0
               

Total CoBank, ACB

        120.0     22.0
               

Deere Credit, Inc.

  April 1, 2009   Repurchase Agreements     50.0     5.2

Fortis Capital Corp.

  Demand  

Financial Services operations

    20.0     —  

Bank of Tokyo-Mitsubishi UFJ, Ltd.

  Demand  

Financial Services operations

    10.0     —  

Harris, N.A.

  February 28, 2009   Grain Deliveries     5.0     —  

Del Mar Onshore Partners, L.P.

  Demand   Biodiesel Operations(2)     5.0     5.0

Other Subordinated Debt

 

December 31, 2008

    and June 30, 2009

  Regulatory Capital     1.0     1.0
               
    Total   $ 516.0   $ 48.2
               

 

(1) In July 2008, FCStone completed the closing of syndicated credit facilities with a lending syndicate consisting of BMO Capital Markets, Bank of America, N.A., Deere Credit, Inc., and CoBank, ACB, and BMO Capital Markets, Bank of America, N.A. and Deere Credit, Inc. on the subordinated debt line.
(2) The Company ceased construction and development of Green Diesel’s biodiesel facility during fiscal 2008. On October 7, 2008, subsequent to year-end, the Company completed a sale of its ownership interest in Green Diesel. In conjunction with the sale, the $5.0 million outstanding loan payable to Del Mar Onshore Partners, L.P. was retained by Green Diesel, without recourse to the Company.

 

At August 31, 2008, we had approximately $516.0 million available under current credit agreements. During fiscal 2009, $426 million of our available lines of credit expire, including our $250 million margin call line of credit which expires on July 22, 2009. While there is no guarantee that we will be able to replace current credit agreements when they expire, based on our strong liquidity position and capital structure, we believe we will be able to do so. However, given the current turmoil in the credit markets, it is impossible to determine at this time the amount of credit that will be available to us, the applicable interest rates and other costs associated with borrowings and the extent of financial and other covenants applicable to the us and our operations.

 

All of our credit facilities include financial covenants and the failure to comply with any such covenants could result in the debt becoming payable on demand. With the exception of the matter described below, we were in compliance with all debt covenants effective August 31, 2008.

 

57


Table of Contents

As a result of the plant’s non-operational status, Green Diesel was out of compliance with certain of the operational covenants of its line of credit agreement with Del Mar Onshore Partners, L.P. (Del Mar) as of September 30, 2007, and certain financial covenants as of December 31, 2007. During fiscal 2008, Del Mar agreed to forebear any action with regard to these defaults under the credit agreement while a plan of disposition of the plant assets was negotiated. On October 7, 2008 we completed the sale of our ownership interest in Green Diesel, and the outstanding loan balance of $5.0 million was retained by Green Diesel, without recourse to the Company.

 

We carry significant open futures positions on behalf of our customers in the C&RM and the Clearing and Execution Services segments of our business. The above lines of credit in place for margin calls are rarely used, but necessary to cover any abnormal commodity market fluctuations and the margin calls they may produce. With our own and customer funds on deposit and the available credit lines noted above, management believes we have adequate capital reserves to meet any foreseeable market fluctuations based upon current commodity market activities.

 

Other Capital Considerations

 

Our wholly-owned subsidiaries, FCStone LLC and FCC Investments, Inc., are subject to various regulations and capital adequacy requirements. Pursuant to the rules, regulations, and requirements of the CFTC and other self-regulatory organizations, FCStone LLC is required to maintain certain minimum net capital as defined in such rules, regulations, and requirements. Net capital will fluctuate on a daily basis. FCStone, LLC’s adjusted net capital and minimum net capital requirements at August 31, 2008 were $97.3 million and $67.7 million, respectively. FCC Investments, Inc. is required to maintain certain net capital as defined by the SEC and at August 31, 2008 the net capital and minimum capital requirements were $609,278 and $250,000, respectively.

 

During March 2008, we entered into a securities purchase agreement with NASDAQ OMX related to NASDAQ OMX acquiring up to a 20 percent interest in Agora-X represented by preferred membership units in exchange for total consideration of $7.5 million. Prior to the agreement, Agora-X was a wholly-owned subsidiary. During March 2008, Agora-X issued 13,334 Series A Preferred Units in exchange for a capital contribution of $5.0 million from NASDAQ OMX. As a result of the transaction, we recorded minority interest of $5.0 million, and no gain has been recorded in the consolidated statement of operations. Subsequent to the capital contribution, we maintain an 86.7% ownership interest in Agora-X. Agora-X is creating an electronic communications network (ECN) for institutional trading in certain OTC commodities contracts. The proceeds of the NASDAQ OMX investment were used to repay a portion of the advances we made to Agora-X, and are being used to continue such development, and, for general business purposes. We expect to continue to seek additional equity investors in Agora-X.

 

Seasonality and Fluctuations in Operating Results

 

None

 

Off-balance Sheet Financing Activities

 

We are a member of various commodity exchanges and clearing organizations. Under the standard membership agreement, all members are required to guarantee the performance of other members and, accordingly, in the event another member is unable to satisfy its obligations to the exchange, may be required to fund a portion of the shortfall. Our liability under these arrangements is not quantifiable and could exceed the cash and securities we have posted as collateral at the exchanges. However, management believes that the potential for us to be required to make payments under these arrangements is remote. Accordingly, no contingent liability for these arrangements has been recorded in the consolidated statement of financial condition.

 

58


Table of Contents

Contractual Obligations

 

The following table describes our cash payment obligations as of August 31, 2008:

 

     Payments Due by Period
     Total    Less than
1 Year
   1-3
Years
   3-5
Years
   After
5
Years
     (in thousands)

Repurchase obligation(1)

   $ 46,988    $ 46,988    $ —      $ —      $ —  

Notes payable

     32,202      32,202      —        —        —  

Subordinated debt

     16,000      16,000      —        —        —  

Operating leases

     9,964      3,114      3,316      1,875      1,659
                                  

Total

   $ 105,154    $ 98,304    $ 3,316    $ 1,875    $ 1,659
                                  

 

(1) FCStone Merchant Services is obligated to provide commodities back to its customer, as part of an offsetting repurchase agreement. It must either exercise its right to repurchase the commodities from the financial institution it sold the commodities to or purchase similar commodities in the marketplace. As a result, we recognize a liability based on the obligation to repurchase the commodities and values this liability based on the applicable benchmark futures contract of the underlying commodities as of the balance sheet date (see note 1 to the consolidated financial statements).

 

Based upon our current operations, we believe that cash flow from operations, available cash and available borrowings under our lines of credit will be adequate to meet our future liquidity needs.

 

Inflation

 

We believe that our results of operations are not materially affected by moderate changes in the general inflation rate. Inflation did not have a material affect on our operations in the fiscal years ended August 31, 2008, 2007 and 2006. Severe increases in inflation, however, that would affect the global and U.S. economies could have an adverse affect on our business, financial condition and results of operation.

 

Recently Issued Accounting Standards

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement” (“SFAS 157”) which defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Additionally, it explains key concepts that are needed to apply the definition, including “market participants,” the markets in which a company would exchange the asset or liability and the valuation premise that follows from assumptions market participants would make about the use of an asset. Also, SFAS 157 establishes a fair value hierarchy that prioritizes the information used in arriving at a fair-value estimate and determining the disclosure requirement. We will adopt SFAS 157 on September 1, 2008, as SFAS 157 is effective for the consolidated financial statements issued for the fiscal year beginning September 1, 2008. We anticipate the impact of SFAS 157 will significantly increase disclosure surrounding the judgments and assumptions underlying all fair value measurements, particularly with regard to financial instruments that do not have a readily determinable market price.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115” (“SFAS 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value. The impact of the adoption will be dependent on the extent to which we elect to measure eligible items at fair value. SFAS 159 was amended on February 6, 2008 to defer the effective date one year for certain nonfinancial assets and liabilities. We will adopt SFAS 159 on September 1, 2008, as SFAS 159 is effective for the consolidated financial statements issued for the fiscal year beginning September 1, 2008. The Company does not believe the adoption of SFAS 159 will significantly impact its consolidated results of operations and financial condition.

 

59


Table of Contents

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”), which replaces SFAS 141. SFAS 141R establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is to be applied prospectively to business combinations for which the acquisition date is on or after an entity’s fiscal year that begins after December 15, 2008. We do not expect this will impact our consolidated financial condition, results of operations or cash flows as currently presented.

 

In December 2007, FASB issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements—an amendment to ARB No. 51” (“SFAS 160”). SFAS 160 establishes accounting and reporting standards that require the ownership interest in subsidiaries held by parties other than the parent be clearly identified and presented in the consolidated balance sheets within equity, but separate from the parent’s equity; the amount of consolidated net income attributable to the parent and the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of earnings; and changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently. This statement is effective for fiscal years beginning on or after December 15, 2008. We have not completed our evaluation of the potential impact, if any, of the adoption of SFAS 160 on our consolidated financial statements.

 

In May 2008, FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk related contingent features in derivative agreements. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is evaluating the impact that the adoption of SFAS 161 will have on its consolidated financial statements.

 

In May 2008, FASB issued SFAS 162 “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles. SFAS 162 becomes effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments AU Section 411 “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company does not expect that the adoption of SFAS 162 will have a material impact on its consolidated financial statements.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Market Risk Disclosures

 

Margin Risk

 

Our customers with exchange-traded positions, including OTC trades submitted for clearing, are required to maintain margin sufficient to support their open trading positions. While we initially establish each client’s margin requirement at the level set by the respective exchanges, we have the ability to increase the requirements to levels we believe are sufficient to cover their open positions, a client’s subsequent trading activity or adverse market changes may cause that client’s previous margin payments to be inadequate to support their trading obligations, which, in instances where we serve as the exchange clearing member for the trade, would require us to cover any shortfall and thereby expose us to potential losses. When we act as a clearing broker, we are also responsible to our clearing clients for performance by the other party to the transaction. While the other party is often a clearinghouse (through “novation” or substitution), in some OTC trades it may be another clearing broker or even a counterparty and, unless the other side is a counterparty, we generally do not receive collateral to

 

60


Table of Contents

secure its obligations. Our margin risk also arises when a clearing member defaults on its obligations to a clearinghouse in an amount larger than its margin and clearing fund deposits, and the shortfall is absorbed pro rata from the deposits of other clearing members. Such a default by a clearing member of a clearinghouse of which we are also a clearing member could result in losses to us, including losses resulting from the defaults of other market participants.

 

Interest Rate Risk

 

In the ordinary course of our operations, we have interest rate risk from the possibility that changes in interest rates will affect the values of financial instruments. We generate interest income from the positive spread earned on customer deposits. We typically invest in U.S. Treasury backed agency securities, reverse repurchase agreements involving U.S. Treasury backed agency securities or AA rate money market funds. We have an investment policy which establishes acceptable standards of credit quality and limits the amount of funds that can be invested within a particular fund and institution.

 

We manage interest expense using floating rate debt. The debt instruments are carried at their unpaid principal balance which approximates fair value. All of the debt outstanding at August 31, 2008, has a variable interest rate and matures within the next 12 months. Variable rate debt is used to finance certain notes receivable to customers in the Financial Services segment. The interest charged on the related notes receivable is also at a variable rate, therefore effectively mitigating the interest rate risk on that debt.

 

Foreign Currency Risk

 

We conduct most of our business with international customers in U.S. dollars, but there remains a minor risk regarding foreign currency fluctuations. Foreign currency fluctuations do, however, impact the ability of foreign buyers to purchase U.S. agricultural products and the competitiveness of U.S. agricultural products compared to the same products offered by alternative sources of world supply.

 

Item 8. Financial Statements and Supplementary Data

 

Our audited consolidated financial statements are filed under this Item, beginning on page F-1 of this Report. Our financial statement schedules are filed under Item 15 “Exhibits and Financial Statement Schedules.”

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None

 

Item 9A. Controls & Procedures

 

Evaluation of disclosure controls and procedures. The Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) have evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K (the “Evaluation Date”). They have concluded that, as of the Evaluation Date, these disclosure controls and procedures were effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities and would be disclosed on a timely basis.

 

Management’s Report on Internal Control Over Financial Reporting. The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act of 1934 (the “Exchange Act”). The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. Under the supervision

 

61


Table of Contents

and with the participation of management, including our Chairman and Chief Executive Officer and Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control over financial reporting as of August 31, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control—Integrated Framework.

 

Based on our assessment using the criteria set forth by COSO in Internal Control—Integrated Framework, management concluded that our internal control over financial reporting was effective as of August 31, 2008. KPMG LLP (“KPMG”), the independent registered public accounting firm that audited the consolidated financial statements included in this Annual Report on Form 10-K, has also audited the effectiveness of our internal control over financial reporting as of August 31, 2008, as stated in its report which appears on page F-1.

 

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures. As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Exchange Act). Based on this evaluation, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

 

Changes in Internal Controls Over Financial Reporting. There were no changes in our internal control over financial reporting during our most recently completed fiscal quarter that have materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information

 

None

 

62


Table of Contents

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance.

 

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item, other than that referred to below, is incorporated herein by reference to:

 

  (i) the information under the caption “Item 1: Election of Directors—What is the structure of our board and how often are directors elected?” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009;

 

  (ii) the information under the caption “Item 1: Election of Directors—Who are this year’s nominees?” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009;

 

  (iii) the information under the caption “Item 1: Election of Directors—What is the business experience of the nominees and of our continuing board members?” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009;

 

  (iv) the information under the caption “Executive Officers of the Company” in Part I of this report;

 

  (v) the information under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009;

 

  (vi) the information under the caption “Corporate Governance and Board Matters—Consideration of Director Nominees” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009;

 

  (vii) the information under the caption “Corporate Governance and Board Matters—Code of Ethics” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009; and

 

  (viii) the information under the caption “Corporate Governance and Board Matters—Committees of the Board—Audit Committee” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009.

 

Item 11. Executive Compensation.

 

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to:

 

  (i) the information under the caption “Executive Compensation and Related Matters” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009;

 

  (ii) the information under the caption “Corporate Governance and Board Matters—Director Compensation” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009; and

 

  (iii) the information under the caption “Corporate Governance and Board Matters—Compensation Committee Interlocks and Insider Participation” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009.

 

63


Table of Contents

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to:

 

  (i) the information under the caption “Principal Stockholders” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009; and

 

  (ii) the information under the caption “Securities Authorized For Issuance Under Equity Compensation Plans” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009.

 

Item 13. Certain Relationships and Related Transactions.

 

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to:

 

  (i) the information under the caption “Related Party Transactions” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009;

 

  (ii) the information under the caption “Item 1: Election of Directors—What is the structure of our board and how often are directors elected?” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009; and

 

  (iii) the information under the caption “Corporate Governance and Board Matters—Committees of the Board” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009.

 

Item 14. Principal Accountant Fees and Services.

 

Pursuant to General Instruction G(3) to Form 10-K, the information required by this Item is incorporated herein by reference to the information under the caption “Independent Auditor Fees and Services” in our definitive Proxy Statement to be used in connection with the Annual Meeting of Stockholders to be held on January 14, 2009.

 

64


Table of Contents

PART IV

 

Item 15. Exhibits and Financial Statement Schedules.

 

(a)  

Financial Statements and Schedules

  (1)      

The following financial statements are filed as a part of this Report on Form 10-K:

   

Report of Independent Registered Public Accounting Firm

   

Consolidated Statements of Financial Condition as of August 31, 2008 and August 31, 2007

   

Consolidated Statements of Operations for the years ended August 31, 2008, August 31, 2007 and August 31, 2006

   

Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended August 31, 2008, August 31, 2007 and August 31, 2006

   

Consolidated Statements of Cash Flows for the years ended August 31, 2008, August 31, 2007 and August 31, 2006

   

Notes to Consolidated Financial Statements

  (2)  

The following financial statement schedules are filed as a part of this Report on Form 10-K:

   

Schedule I—Parent company only condensed financial statements

   

Schedule II—Valuation and qualifying accounts

(b)  

Exhibits

 

The exhibits listed in the Exhibit Index immediately preceding the exhibits are filed as part of this Annual Report on Form 10-K or incorporated herein by reference as indicated below.

 

65


Table of Contents

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   FCSTONE GROUP, INC.

May 12, 2009

  

/S/    PAUL G. ANDERSON        

Date   

Paul G. Anderson,

Chief Executive Officer

(Principal Executive Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated

 

Signature

  

Title

 

Date

/s/    PAUL G. ANDERSON        

Paul G. Anderson

  

President and Chief Executive Officer and Director (Principal Executive Officer)

  May 12, 2009

/s/    WILLIAM J. DUNAWAY        

William J. Dunaway

  

Chief Financial Officer (Principal Financial and Accounting Officer)

  May 12, 2009

/s/    BRUCE KREHBIEL        

Bruce Krehbiel

  

Chairman of the Board, Director

  May 12, 2009

/s/    ERIC PARTHEMORE        

Eric Parthemore

  

Vice Chairman, Director

  May 12, 2009

/s/    JACK FRIEDMAN        

Jack Friedman

  

Vice Chairman, Director

  May 12, 2009

/s/    BRENT BUNTE        

Brent Bunte

  

Director

  May 12, 2009

/s/    KENNETH HAHN        

Kenneth Hahn

  

Director

  May 12, 2009

/s/    DOUG DERSCHEID        

Doug Derscheid

  

Director

  May 12, 2009

/s/    DAVE ANDRESEN        

Dave Andresen

  

Director

  May 12, 2009

/s/    DAVE REINDERS        

Dave Reinders

  

Director

  May 12, 2009

/s/    DARYL HENZE        

Daryl Henze

  

Director

  May 12, 2009

/s/    ROLLAND SVOBODA        

Rolland Svoboda

  

Director

  May 12, 2009

 

66


Table of Contents

INDEX TO COMPANY FINANCIAL STATEMENTS

 

FCStone Group, Inc. and Subsidiaries

  

Audited Consolidated Financial Statements

  

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Statements of Financial Condition as of August 31, 2008 and 2007

   F-4

Consolidated Statements of Operations for the Years Ended August 31, 2008, 2007 and 2006

   F-5

Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the Years Ended August  31, 2008, 2007 and 2006

   F-6

Consolidated Statements of Cash Flows for the Years Ended August 31, 2008, 2007 and 2006

   F-7

Notes to Consolidated Financial Statements

   F-9

 

F-1


Table of Contents

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

 

FCStone Group, Inc. and Subsidiaries:

 

We have audited the accompanying consolidated statements of financial condition of FCStone Group, Inc. and Subsidiaries as of August 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended August 31, 2008. We also have audited the Company’s internal control over financial reporting as of August 31, 2008, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FCStone Group, Inc. and subsidiaries as of August 31, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended August 31, 2008, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of August 31, 2008, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

F-2


Table of Contents

As discussed in Note 1 to the consolidated financial statements, in 2007 the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share Based Payment.”

 

As discussed in Note 9 to the consolidated financial statements, in 2008 the Company adopted the measurement date provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132R, and the recognition and disclosure provisions of SFAS No. 158 in 2007.

 

/s/ KPMG LLP

 

Kansas City, Missouri

 

November 14, 2008

 

F-3


Table of Contents

FCSTONE GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(in thousands, except share and per share amounts)

 

     August 31,  
     2008     2007  
ASSETS     

Cash and cash equivalents:

    

Unrestricted

   $ 73,646     $ 90,053  

Segregated

     8,355       14,250  

Commodity deposits and receivables:

    

Commodity exchanges and clearing organizations—customer segregated

     1,306,477       686, 441  

Proprietary commodity accounts

     253,998       77,690  

Receivables from customers, net of allowance for doubtful accounts of $2,748 in 2008; $2,400 in 2007

     19,603       16,868  
                

Total commodity deposits and receivables

     1,580,078       780,999  
                

Marketable securities, at fair value—Customer segregated and other

     241,333       307,828  

Counterparty deposits and trade accounts receivable, net of allowance for doubtful accounts of $575 in 2008; $500 in 2007

     71,714       20,746  

Open contracts receivable

     308,016       120,219  

Notes receivable and advances, net of allowance for doubtful accounts of $250 in 2008; $0 in 2007

     77,979       49,291  

Exchange memberships and stock

     11,473       10,366  

Furniture, equipment, software and improvements, net of accumulated depreciation of $3,828 in 2008 and $3,323 in 2007

     7,267       4,763  

Deferred tax assets

     11,519       6,736  

Other assets

     30,098       14,943  
                

Total assets

   $ 2,421,478     $ 1,420,194  
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Liabilities:

    

Commodity and customer regulated accounts payable

     1,486,299       935,515  

Trade accounts payable and advances

     257,941       115,145  

Open contracts payable

     297,926       121,101  

Accrued expenses

     51,709       38,632  

Notes payable and repurchase obligations

     79,190       35,133  

Subordinated debt

     16,000       1,000  
                

Total liabilities

     2,189,065       1,246,526  
                

Minority interest

     4,855       —    

Stockholders’ equity:

    

Preferred stock, no par value, authorized 20,000,000 at August 31, 2008 and 2007, respectively, none issued and outstanding at August 31, 2008 and 2007, respectively

     —         —    

Common stock, $0.0001 par value, authorized 40,000,000 at August 31, 2008 and 2007, respectively; issued and outstanding 27,911,127 and 27,416,567 shares at August 31, 2008 and 2007

     108,016       104,267  

Additional paid-in capital

     10,777       1,115  

Treasury stock

     (2,185 )     (376 )

Accumulated other comprehensive loss

     (1,632 )     (3,620 )

Retained earnings

     112,582       72,282  
                

Total stockholders’ equity

     227,558       173,668  
                

Commitments and contingencies (notes 13, 16 and 20)

    

Total liabilities and stockholders’ equity

   $ 2,421,478     $ 1,420,194  
                

 

See accompanying notes to consolidated financial statements.

 

F-4


Table of Contents

FCSTONE GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

     Year Ended August 31,  
     2008     2007     2006  

Revenues:

      

Commissions and clearing fees

   $ 179,188     $ 145,077     $ 105,622  

Service, consulting and brokerage fees

     97,700       47,679       33,388  

Interest

     48,294       42,957       23,174  

Other

     10,372       4,497       2,638  

Sales of commodities

     1,972       1,101,752       1,129,983  
                        

Total revenues

     337,526       1,341,962       1,294,805  
                        

Costs and expenses:

      

Cost of commodities sold

     1,069       1,084,205       1,112,949  

Employee compensation and broker commissions

     65,936       49,524       44,229  

Pit brokerage and clearing fees

     104,045       67,978       47,613  

Introducing broker commissions

     33,304       36,050       22,826  

Employee benefits and payroll taxes

     13,746       10,678       9,801  

Interest

     5,705       9,937       5,705  

Depreciation and amortization

     1,996       1,748       1,674  

Bad debt expense

     1,998       1,632       1,909  

Other expenses

     31,585       25,983       23,568  
                        

Total costs and expenses

     259,384       1,287,735       1,270,274  
                        

Income from continuing operations before income tax expense and minority interest

     78,142       54,227       24,531  

Minority interest

     (146 )     639       (226 )
                        

Income from continuing operations before income tax expense

     78,288       53,588       24,757  

Income tax expense

     30,867       20,000       9,500  
                        

Net income from continuing operations

   $ 47,421     $ 33,588     $ 15,257  

Loss from discontinued operations, net of tax

     (6,829 )     (311 )     —    
                        

Net income

   $ 40,592     $ 33,277     $ 15,257  
                        

Basic shares outstanding

     27,749       24,500       21,749  

Diluted shares outstanding

     28,934       25,051       21,749  

Basic earnings (loss) per share:

      

Continuing operations

   $ 1.71     $ 1.37     $ 0.70  

Discontinued operations

     (0.25 )     (0.01 )     —    
                        

Net income

   $ 1.46     $ 1.36     $ 0.70  
                        

Diluted earnings (loss) per share:

      

Continuing operations

   $ 1.64     $ 1.34     $ 0.70  

Discontinued operations

     (0.24 )     (0.01 )     —    
                        

Net income

   $ 1.40     $ 1.33     $ 0.70  
                        

 

See accompanying notes to consolidated financial statements.

 

F-5


Table of Contents

FCSTONE GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

(in thousands, except per share amount)

 

     Common
Stock
    Additional
Paid-In
Capital
    Treasury
Stock
    Accumulated
Other
Comprehensive
Income (Loss)
    Retained
Earnings
    Maximum
Cash
Obligation
Related to
ESOP
Shares
    Total
Stockholders’
Equity
 

Balance at August 31, 2005

   $ 21,524     $ —       $ —       $ (4,555 )   $ 32,703     $ (4,487 )   $ 45,185  
                                                        

Net income

     —         —         —         —         15,257       —         15,257  

Pension adjustment, net of tax

     —         —         —         2,600       —         —         2,600  
                    

Total comprehensive income

     —         —         —         —         —         —         17,857  

Dividends paid ($0.13 per share)

     —         —         —         —         (2,898 )     —         (2,898 )

Stock compensation

     —         120       —         —         —         —         120  

Change in value of shares held by ESOP

     —         —         —         —         —         (1,369 )     (1,369 )

Cash received on shares issued

     223       —         —         —         —         (223 )     —    
                                                        

Balance at August 31, 2006

     21,747       120       —         (1,955 )     45,062       (6,079 )     58,895  
                                                        

Net income

     —         —         —         —         33,277       —         33,277  

Unrealized holding gains arising during the period

     —         —         —         1,478       —         —         1,478  
                    

Total comprehensive income

     —         —         —         —         —         —         34,755  

Pension adjustment, net of tax

     —         —         —         (3,143 )     —         —         (3,143 )

Dividends paid ($0.28 per share)

     —         —         —         —         (6,057 )     —         (6,057 )

Proceeds from initial public offering, net of costs

     129,643       —         —         —         —         —         129,643  

Payment for redemption of common stock

     (48,496 )     —         —         —         —         —         (48,496 )

Proceeds from issuance of common stock

     1,373       —         —         —         —         —         1,373  

Stock compensation

     —         620       —         —         —         —         620  

Treasury stock acquired

     —         375       (376 )     —         —         —         (1 )

Reclassification of shares held by ESOP

     —         —         —         —         —         6,079       6,079  
                                                        

Balance at August 31, 2007

     104,267       1,115       (376 )     (3,620 )     72,282       —         173,668  
                                                        

Effects of changing pension plan measurement date pursuant to SFAS No. 158, “Employers Accounting for Defined Benefit Pension and Other Postretirement Plans” ( net of tax of $33 and $172, respectively)

     —         —         —         56       (292 )     —         (236 )
                                                        

Balance at August 31, 2007, as adjusted

     104,267       1,115       (376 )     (3,564 )