Good day, everyone, and welcome to the INTL FCStone Q2 FY '13 Earnings Call. Today's call is being recorded. At this time, I'd like to turn the call over to Bill Dunaway. Please go ahead

Good morning. My name is Bill Dunaway, CFO of INTL FCStone Inc. Welcome to our earnings conference call for the fiscal second quarter ended March 31, 2013. After the market closed yesterday, we issued a press release reporting our earnings for the fiscal second quarter. The press release is available on our website at www.intlfcstone.com, as well as a slide presentation, which we will refer to on this call in our discussions of our quarterly and year-to-date results. This slide presentation is available by clicking on the Investor Relations link on the website and then going into the Events & Presentations page. You'll need to sign on to the live webcast in order to view the presentation. Both the presentation and an archive of the webcast will also be available on our website after the call's conclusion. Before getting underway, I'd like to cover a couple of housekeeping items. On these conference calls and in the management discussion portions of our SEC filings, we present financial information on a non-GAAP basis in order to take into account mark-to-market adjustments in our physical commodity product lines, which are included in both our CRM and Other segments. As discussed on previous conference calls and in our filings, the requirements of accounting principles generally accepted in the U.S., which I'll refer to as GAAP, to carry derivatives at fair market value but physical commodities inventory at the lower of cost or market value may have a significant temporary impact on our reported earnings. Under GAAP, gains and losses on commodities inventory and derivatives, which the company intends to be offsetting, are recognized in different periods. Additionally, in certain circumstances, GAAP does not require us to reflect changes in estimated values of forward commitments to purchase and sell commodities. For this reason, we believe…

Thanks, Bill, and good morning, everyone. Our Q2 2013 results were below our expectations due to tough market conditions, which were largely due to cyclical issues in the grain market and generally lower volatility in all asset classes. Despite the very challenging market conditions for us, the company remained profitable. Our aggregate mark-to-market revenues in our Commodity segment was down 19% versus a year ago, largely due to a decline in revenues from our ag business, which is a material portion of our commodities revenues. The record drop last year resulted in a small amount of grain sitting in storage, which needed to be hedged, combined with much lower prices, which has not provided an incentive for hedging of new crop production. We feel this is largely a cyclical issue and the flip side of the very positive market conditions we had a couple of quarters ago, when the drought conditions resulted in record high prices and elevated volatility. It is likely that there will be a record crop coming to market this year, which again could result in good fundamentals for this part of our business. Despite generally lackluster market conditions during the quarter, our Other segments performed very well, with foreign exchange in our Global Payments business up 24% versus a year ago and Securities up 55%. The good growth in Securities was driven largely by the Tradewire acquisition coming on stream and ramping up ahead of our original expectations. As mentioned in the last call, management's primary objective has been to sharpen our focus on integrating all of our acquisitions, growth initiatives and new capabilities to realize revenue synergies and cost efficiencies. Our net margin on incremental revenue is a little over 50% and therefore, small and perhaps seemingly insignificant changes in gross revenue can have a…

Thank you, Sean. I'd like to start my discussion with the review of the quarterly results and will refer to the fifth page of the slide presentation titled Quarterly Financial Dashboard. This slide lays out the quarterly operating results, as well as related balance sheet information in comparison to the prior year period, as well as in some cases, the internal target, which management has for our operating results. Adjusted operating revenues were $116.6 million for the current period, which represents a 4% decline from the $121.9 million in the second quarter of 2012. Adjusted operating revenues were relatively flat with $116.5 million recorded in the first quarter 2013. Adjusted operating revenues in the first quarter, however, included $9.2 million in realized gains in the sale of our LME and Kansas City Board of Trade shares. And thus, excluding those nonrecurring revenues from the first quarter, second quarter adjusted operating revenues increased 9% over the immediately preceding quarter. While the core CRM adjusted operating revenues declined and the CES segment was relatively flat, all other segments of the company's experienced growth in adjusted operating revenues in the second quarter as compared to the prior year. Looking at our revenues on a segmental basis, adjusted operating revenues in our Commodity & Risk Management Services segment decreased 19% from $68 million in the prior year period to $55 million in the second quarter of 2013. Adjusted operating revenues increased 7% as compared to the first quarter revenues at $51.4 million. Our CRM segment is further broken down into 3 different product lines: soft commodities, precious metals and base metals. Starting with soft commodities. Operating revenues decreased 21% from $54.2 million in the second quarter of 2012 to $42.8 million in the current period. First quarter 2013 revenues were $40.5 million. Exchange traded…

Thanks, Bill. Generally, we believe market conditions remain tough for us and most external proxies such as market volumes and performance by our competitors indicate this. We are critically dependent on customer volumes generally and market volatility specifically. Cyclical factors in certain of our commodity verticals can cause significant volatility in quarterly results, as we've seen this quarter and also in the record Q4 quarter last year. While we cannot control any of these factors, we can -- we do continue to expand our core customer base at a very high rate and have also worked hard to diversify our revenue sources by vertical market and region. All of these factors have served us well over the long term. And as our many growth initiatives start to ramp up, we should see even greater diversification. We are pleased to see that our expenses are starting to flatten. This has been a core focus for the management team, and we are now seeing tangible signs of progress on the cost side. So with that, I'd like to turn it back to the operator and open up for questions, if there are any. Operator?

[Operator Instructions] And we'll take our question from Bill Jones with Singular Research.

I just want to ask, the return on equity target that you had, for as long as I've followed the company, of mid-teen or 15%, do you think that, that is still reasonable? Or do you think about that in the current environment with regulations?

Yes, well, I think what we generally said, and we don't like to change long-term targets unless we have to, but we've always said, I think probably for 10 years now, that our long-term targets, return on equity is 15%. I think there can be a reasonably significant delta around that, up or down, based on market conditions. In 2011, which was pre the MF Global kind of collapse, which was sort of the Lehman situation for our industry, we did, making some small adjustments for noncash items, we did about 17% ROE. And last year, we were sort of in the high-single digits, which was a really tough year for us and I think we're sort of coming out of that. But clearly, in the short term, our numbers are way below that. So I do think we like to set long-term growth targets. We want to shoot for long-term targets. But in the short term, we can see some significant deltas around that, and deltas are caused by things like interest rates. I mean, we have a significant push on interest rates by market volatility. And then of course, we have some cyclical factors. And I think the better way to look at our results, honestly, is sort of the trailing 12 months, so you can even out some of those short-term fluctuations. And then what's left is more cyclical sort of medium, short-term-type industry issues. And I think we're in a pretty strong headwind at the moment, as is the rest of the industry. So to answer your question more specifically, I think in the current environment 15% is very challenging. I don't see many companies out there making 15%. But we set targets. We're long-term investors. We set targets for the long term. Makes sense?

Okay, I think so. And then we sit here, it's May 9, can you -- obviously, you said conditions are still challenging. Can you say anything more specific about the early Q3 relative to Q2?

We definitely don't -- we do not like to give any sort of forward-looking guidance at all. It's still too early in the quarter for us to sort of have a feel for how things can play out. So we'll just have to see how it goes. So the answer is, no, we're not going to tell you anything. Sorry.

Fair enough. There's a press release on the website about account transfer agreement with First Capital. Can you talk about any color on that?

Yes, you've seen that on our Securities side. We started making some moves. I mean, that was the original business of the company. We have a very strong presence in the foreign OTC-traded market for equities. These are big name companies, Nestlé, for example, Sharp, Nintendo, Porsche. All these companies do not trade on either the New York or NASDAQ. That's been a traditional business we've been in for ages. We're very well recognized by our customers for that. And we've now started to see some opportunities as stock market conditions have started to weed out competitors to expand that business. So the Tradewire acquisition was the first part of that, and that was a very complementary business, which really handled the flow into the U.S. Our traditional equities market making business is really handling U.S. investors investing in overseas stocks that are not listed. So what we now are getting is the reciprocal flow of that. And the Tradewire acquisition came on board. It was a very easy deal for us in the sense there wasn't a big purchase price. We already took over the team and gave them an earn-out. That business has ramped up pretty nicely. And this addition that you're mentioning, which is -- it's backed, First American clearing, really provides us with a clearing and custody solution for these broker-dealers in the emerging markets who are looking for us to help them execute their U.S.-bound flow. So not only can we now be the execution counterparty, but we can also custody their assets. And it's really sort of a prime brokerage-type business. We really bulk up those assets and then we custody them in turn with a big clearer locally. So it's moving our Securities business almost in line with what we have on the futures side. As I mentioned in my script, I think it kind of gives us a really interesting capacity because I think we're one of the few mid-sized firms now who can deal cross-asset class and custody and hold assets for people. And I think with the Dodd-Frank world, it's still too early to know how everything is going to play out but I think that's going to be a very valuable capacity for us. So it's a small acquisition. Again, not a lot of money, but certainly gives us a good start in building that capacity up, but all part of our Securities business, which is now sort of expanding quite significantly over the last 6 or 9 months. So kind of an interesting time for us, though.

And we'll take our next question from Justin Hughes with Philadelphia Financial.

You mentioned the MF Global event as being kind of an industry-changing event that's permanently impacted profitability. I just wondered if there are specific rule changes that have happened. I know there's been some rules on client segregation of funds. I mean, is that what you're talking about? And second of all, if there have been specific rule changes, do you expect them to reverse those rules in order for you to get back to a double-digit ROE?

Okay. Well, I'm sure Bill can chime in here because he knows more detail about some of the stuff than I do. But I think the 2 broad factors we're talking about is when MF Global happened, I guess, 18 months ago, right, the industry in terms of volumes kind of came to a standstill, and it hit us pretty hard. I mean, we estimate we'd lost, I don't know, anywhere between $50 million and $70 million of revenue in the first half of last fiscal year just because people were panicked. They didn't know where their collateral was. They didn't know what was happening. And I think it's taken -- I think, certainly, the situation is better now, but I think it's taken a long time for people to become more confident with who they deal with. And there's a shakeup in the industry happening because of that. And we think we're probably a net beneficiary of that. We see that we are opening a lot of new accounts. So people are coming to us. And I would like to think we're sort of on the upper end of the quality spectrum, so maybe people are moving from smaller FCMs to us. So that's sort of what's happening on the revenue side. On the regulatory side is, as a response to what happened with both MF Global and Peregrine, there has been a significant ratcheting up of compliance across the board, specific rules in terms of how we deal with customer funds, general oversights, day-to-day compliance and supervisory procedures. I mean, the whole thing has just been ratcheted up. And in some instances, it was probably due for that, the industry, honestly, if you look at where it stood, say, compared to the securities industry. But this is all…

No, I think it's very well covered.

Justin, does that answer your question?

Yes. What about the rules, the specific rules on the client fund segregation? How much of those impacted your profitability?

Well, I wouldn't say that -- Justin, this is Bill. I wouldn't say that they specifically have adjusted the affected profitability in any way. Certainly, long term, some of the proposed rules that they're looking at under which ultimately FCMs will be responsible for covering customer deficits and segregated accounts on a real-time basis throughout the day. That has effect -- I mean, that could significantly push costs down to the customer level of them having to maintain more and more funds with FCMs, which may inhibit the amount that they're doing -- they trade. But that remains to be seen whether or not those rules are actually changed in that manner. But that's just a...

So it's your expectation that they're going to increase collateral, which you're asking from the client. So it's not going to impact you directly, but it's going to make their trading cost more expensive?

It could, yes. I mean, the FCMs won't really have a choice but to push that down to, ultimately, clients if regulatory change like that has to come through.

Well, Justin, I think there's probably 2 general themes coming through from the regulators. One is that they want more capital supporting trading, and the other rule is they want more collateral supporting tradings. Two different things, right? So the problem is, for the FCM industry as a whole, the entire industry is unprofitable in our estimation. There is -- there's not an FCM out there, other than probably us, who's making a return. And if they are making a return like us, it's not a return that justifies the capital investments at this point. So if the regulators start wanting more capital in the industry as a whole, I don't know why anyone would do that. I mean, it would be an uneconomic kind of investment. So your response to that would be you would raise your rates to your customers and that would probably lead to less revenue and it would mean you have to raise your rates even more. At some point, there has to be an equilibrium where capital earns a return. So that's sort of on the capital side. And then, again, on making sure there is more collateral from customers, I think the regulators are saying, "We want the FCMs to put up the collateral. Well, that's more capital." So either we push that requirement down to the customer and then the customer has the problem and he's got to go to his bank and he's got to find more money and that may lead to less volume, or we've got to do it and then we're back into the capital argument. So it's going to be interesting to see how they square the circle. I think it's very easy for regulators just to say, "Oh, it's great for everyone if there's more capital supporting the business." But there's consequences for that, and capital needs to earn an economic return. And if it doesn't, there will be cost changes, and that may impact the very people they're trying to protect. We don't know how that's all going to play out.

Okay. And then related question. You said longer term, you could benefit from Peregrine and MF Global going away. But if you have someone -- if you have a potential client walk into your office and he said, "I'm with a small FCM. I'm little -- I'm concerned. I want to move my account," what's your pitch to them on why they should come to INTL rather than if they're worried about financial soundness not going to Goldman, JPMorgan or if you want an independent guy, Newedge, going to one of the big 3 or 4 market leaders, but just going from a small firm to a mid-sized firm?

Okay. Well, there are couple of things. I mean, firstly, the banks have the exact same challenges that we have. The only difference is the banks' cost structures are multiples of what ours are. And so a lot of banks don't want mid-sized accounts anymore. So the kind of customers we're targeting, I don't think they have the choice necessarily to go to a Goldman's. Goldman's doesn't want the kind of business we do. They can't make any money out of it. So the question is, are you going to stay with a small private firm? Are you going to come to us? Or are you going to go to one of our peer group companies? And I think every time we've seen this kind of scenario happen, and it's happening in the broker-dealer market, 25 FCMs have closed down in the last 9 months. There probably are going to be another 60 closed down. The costs of running this business have gone up and it's creating a barrier to entry. The business that was at the bottom end of the market is going to have to go up the ladder. And some of those guys will go into the big banks, but I don't think the big banks want the sort of mid-sized business. It just -- it doesn't pay for them. But like everything, there's a tiering of where the customers fit and you've got to target for our sort of core space. And if anything, I think what we're seeing is banks are kicking out mid-sized customers who're now looking for alternatives. And where do they go? So we may be in the spot where we're getting sort of the smaller customers being kicked out of the banks and the bigger customers so the small guys are coming up to us. So it's hard for us to know how it's working. All we know is we're signing up a lot of new accounts at 400, 500 new accounts sort of every month, which is, orders of magnitude, larger than we've ever done before.

And we have no further questions at this time. I will turn it back to Mr. O'Connor for any additional or closing remarks.

Okay. Well, I think that concludes our call. So thanks, everyone, for participating. See you next time.