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FXCM, Inc. (NYSE:FXCM)

Q4 2012 Earnings Call

March 7, 2013 8:15 AM ET

Executives

Jaclyn Klein – Head, Corporate Communications and Investor Relations

Drew Niv – Chairman and CEO

Robert Lande – CFO

Analysts

Rahul Nevatia – JP Morgan

Andrew Gadlin – CJS Securities

Rich Repetto – Sandler O’Neill

Howard Chen – Credit Suisse

Bill Katz – Citigroup

Patrick O’Shaughnessy – Raymond James

Operator

Good day, ladies and gentlemen and welcome to the FXCM Fourth Quarter and Full Year 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now turn the call over to your host, Jaclyn Klein, Head of Corporate Communications and Investor Relations. Please go ahead.

Jaclyn Klein

Good morning and thank you everyone for joining us for FXCM Inc.’s fourth quarter and full year 2012 earnings conference call. Joining me today are Drew Niv, FXCM’s Chief Executive Officer, and Robert Lande, our Chief Financial Officer.

A live audio webcast, a copy of FXCM’s earnings release, which was sent earlier this morning and presentation slides used during the conference call are all available at www.fxcm.com under the Investor Relations tab. A replay of this conference call will also be available later today on our website.

Before I turn the call over to Drew, I would like to remind everyone that in today’s remarks, we will refer to certain non-GAAP financial measures including adjusted pro forma EBITDA, adjusted pro forma net income and adjusted pro forma net income per share. These measures should not be considered in isolation from or as a substitute for measures prepared in accordance with Generally Accepted Accounting Principles. Reconciliations of these non-GAAP financial measures to the most comparable measures calculated and presented in accordance with GAAP are available in the earnings release on the Investor Relations portion of our website.

As usual, this call is intended for investors and analysts and may not be reproduced in the media in whole or in part without the expressed written consent of FXCM. Before we begin, we would like to remind everyone that the remarks and responses to your questions that we provide today may contain forward-looking statements.

These statements do not guarantee future performance and undue reliance should not be placed on them. These statements are based on current expectations of management and involve inherent risks and uncertainties that could cause actual results to differ materially from those indicated in any forward-looking statements including those identified in the Risk Factors section of our Annual Report Form 10-K filed with the SEC and available on our website. As such factors may be updated from time to time in our SEC filings. FXCM assumes no obligation to update any forward-looking statements.

With that, I would like to turn the call over to our CEO, Drew Niv.

Drew Niv

Good morning. You’re going to have to forgive me for my voice, but today we’ll be discussing our results for full year 2012, the fourth quarter and our outlook for 2013. 2012 was our second full year as a public company and the 13th since our inception, definitely one of the toughest years for the FX business that I can remember.

Since starting the company, we have been a firm believer that scale and diversified sources of revenue are critical to the success of an FX broker. To achieve this, we pursued a dual path strategy starting with organic growth and adding selected acquisition when the opportunities present themselves.

Slide two describes features of our strategy in more detail. Our strategy is designed to generate better returns and exploit expanded opportunities in good market. While providing valuable protection in challenging market conditions against regulatory changes in different marketing segments or jurisdictions like those we have experienced over – for the last three years.

As you can see, for example, that increase our penetration in many parts of Europe as well as emerging markets while also steadily increasing our dominant position in Asia. It’s all to buffer against regulatory changes in other jurisdictions that were negative.

As seen on Slide three in 2012, we saw some of the lowest volatility in recent memory. With annual averages down 22% from the year prior and a monthly average at year-end 43% lower than December of last year. In fact, currency volatility has been declining steadily for many years, and it finished the year at levels we have not seen since mid-2007, which in itself was a multi-decade low for volatility. Not so coincidentally by the way that was followed by decade high volatility in 2008.

Volatility in currency is much more – we believe is a function of not just interest rate speculation but a divergence to interest rate speculations in different countries or currencies. Those were nearly non-existent. In the last few years, speculation as such has begun to bubble up in 2013 and that’s where you’re seeing the slight pickup in the volatility that they’re seeing in the last two months.

Moving to slide four, we are therefore pleased that by executing our strategy, FXCM’s scale and revenue diversification enabled it to weather the difficult conditions in 2012 and still grow revenues, EBITDA and active accounts modestly, while making solid improvements in client equity and cash from operations.

Some of our achievements in 2012 include successfully expanding our distribution by adding nearly two dozen white label partners in France, Spain, Turkey, Eastern Europe, Southeast Asia, Hong Kong, U.K. and the U.S., including to enormous potential white labels in E*Trade and Barclays, completing integration of two Japanese brokers to create one of the top 10 FX brokers by volume in Japan, adding scale and diversity in our retail institutional mix by purchasing Lucid markets, and launching FastMatch in partnership with Credit Suisse.

Our retail institutional shift has moved from institutional business contributing just 7% in 2011 to 15% in 2012 with a full year contribution of from Lucid, that number would have been 25% and above.

We are also more diversified geographically. As an example, volume from U.S. clients now represent just 11% of our total for 2012 versus 21% in 2010. You see us constantly mention that stat minimizing our exposure to the U.S. clients we’ve done in other presentations primarily because the U.S. jurisdiction represents one of the least friendlier to FX from a regulatory perspective. So we consider it, if you will, sort of a risk factor to have business here. Diversifying the business from the United States is a critical mission for FXCM that we believe in 2012 we’ll achieve in sufficient scale.

Considering the macro environment and looking at the performance of other FX brokers, it was an achievement to show the modest growth in 2012. We believe that steps we have taken to increase our scale and diversity were critical to our 2012 results.

Slide five illustrates our increasing our scale, representing here by our growth in the client equity has helped FXCM maintain volume levels despite the drop in volatility. You can see our selected acquisitions of ODL, GCI and Foreland have added to organic – have added to our organic growth and contribute to growing client equity by more than three times over the period, cumulative annual growth of over 55%.

We believe we’re nearly doing in $1.2 billion in assets. We are in excellent position to take advantage of improved market conditions. Since the start of the New Year, volatility has picked up somewhat, rising from December’s low level and returning to levels we last saw in September. Volatility is still below the ten year average and well below the averages seen in the last five years.

On slide six, we see some of our key operating metrics for the month of February. We are doing a modest increase in volatility in January and February. We were able to deliver two of the highest volume months we’ve ever had. In fact the ADV for February was a record for FXCM. We have also seen an increase in active accounts since the beginning of the year as more clients return to the market.

The volatility not only drives our volumes, but it attracts traders to the marketplace. We saw strong surge on institutional side as volumes climbed back to levels we saw in Q2 of 2012. The volatility has also helped increase attractiveness of retail clients to trade and you will be seeing in the months to come, a meaningful pickup we believe in what should be – sorry – a meaningful pickup in sales and additional new clients.

We’re looking to the year ahead on slide seven. We are optimistic on a number of fronts. We started the year with bigger, more diverse base than 2012. We are already seeing how this translates into higher volumes with better market conditions. If these conditions continue or improve, we’re well-positioned for higher growth. If conditions slow again or adverse regulatory changes are enacted in different jurisdictions, we believe we can hold our course better than our competitors and continue to gain market share.

Regulatory changes have been a constant in the market for the past four years. We expect this will continue in 2013. While they can presents challenges in select geographies or segments, we continue to believe they present us with more opportunities than obstacles and there are a number of regulations, some already enacted, some proposed and some potential which will impact other asset classes making product types more attractive and have an asymmetric impact on other FX brokers presenting opportunities for FXCM.

Some of the examples we would like to go over today. First one is financial transaction tax enacted in Europe. Contrary to some of the press you may have read, spot foreign exchange is completely exempted from the financial transaction tax. Moreover, the financial transaction tax will hit hardest in terms of the quantity of the tax percentage of the instrument.

Our direct competitors in Europe, who largely rely on single share CFDs to compete with us, a product we do not have and is the biggest obstacle traditionally to our market share growth in Europe. The tax on that product is likely to make that product much less attractive to trades for clients, making clients much more FX centric than they were in the past. That would lead them to choose FXCM a higher percentage of the time, and we believe have higher market share gain potential in many parts of Europe for ourselves. This tax is being enacted slightly differently in nine different countries in Europe. So far we have only the details for Italy and France.

In Italy, for example, the tax, just to give you an idea, on CFDs is about the equivalent of $100 per million. As you can see that is a significant cost that should make more traders choose spot FX. And we believe again we will be big beneficiaries of this.

There’s other regulatory changes that include minimum regulatory capital requirements across the entire EU, which will hit many of the lightly regulated firms some must have grown into medium-sized brokers all of which have been hiding, if you can call it that in or regulated in the peripheral jurisdictions of Europe, so I will just still call themselves EU regulated firms. They’re actually less or not regulated at all based in Cyprus, Malta and other – sorry Ireland and other jurisdictions of – that are not very heavily regulated jurisdictions.

Lastly, in the U.S. there are two other potential regulations that are coming. One is a proposed regulation regime on the futures industry that is now being discussed and we believe close to being enacted that has come out of the MS Global TFG debacle over the last few years. Without going into the minutia of the regulation, they effectively create a much less attractive trading environment for the Futures industry. That is important to us in FX because Futures represents the largest indirect competitor and many times direct competitor to FXCM in the fact that obviously we currency Futures are a hundred-billion dollars a day complex in the United States.

This is something that we believe will make spot FX relatively more attractive in Futures, much more so on the retail side and, again, optimism for market share gains here as well. A – I now propose, if you will, more of a speculative rule that we believe will come in the near future is the fact that in recent times given – because of Dodd-Frank, regulators have essentially turned the markets where institutions of directly traded with banks to when Dodd-Frank is fully enacted regime where all institutions must trade with – this is over-the-counter instruments – must trade through multi dealer trading facilities only, where they are essentially seeing multiple bids and offers in a competitive environment.

It is difficult to imagine that while the government is going to nanny large hedge funds and corporations into a multi dealer environment that it would leave one loophole and that is that retail clients in the United States for FX is still able to trade with a sole principal market maker as a counterparty without a multi-dealer competitiveness. We believe that that loophole, which is now used to be the law, now looks like a loophole will be closed sometime in the near future, and this is something that obviously directly benefits FXCM to the detriment to the majority of its U.S. competitors.

This is already the case in a market like Korea where firms are not allowed to be principal and must use a minimum of two independent and regulated counterparties to trade with. We believe that this is going to – obviously a trend that will not be just be a U.S. trend, but will migrate across the world as well, as it already has in certain jurisdictions.

Summing things up, we are very optimistic about our strategy, our current platform and what lies ahead in 2013.

With that I’d like to turn it over to Robert Lande who will go through our financial and metrics in more detail.

Robert Lande

Thank you, Drew. Some of the highlights for Q4 were our adjusted pro forma revenues of $108.1 million, we’re up 3% from Q4 of 2011; adjusted pro forma EBITDA of $29.8 million, that was up 13% versus Q4 2011; adjusted pro forma EPS of $0.13 a share; cash EPS of $0.25 a share; and GAAP EPS of $0.11 a share.

Our retail revenue per million was $94 – $95 per million, it’s a mid-point of our historic range. We repurchased 525,000 shares for $5.3 million in the quarter. We repaid $64 million of Lucid seller note in December and Lucid rolled another $23 million for one additional year. We increased our credit facility to $155 million.

And turning to the year, adjusted pro forma revenues were up 1% to $417.3 million; adjusted pro forma EBITDA was also up 1% to $112.9 million. We had adjusted pro forma EPS of $0.58 a share, cash EPS of $1.07 a share, and GAAP EPS of $0.37 a share.

When we go through the income statement you’ll see that we had reductions in absolute dollars to some important categories of expenses, namely referring broker fees, pro forma compensation and benefits and advertising in 2012 versus 2011.

And I’ll also take you through a bit more today on our cash flow story, which is a very big positive in both Q4 and for 2012 in all. We generated after-tax cash flow from operations of $102.1 million in a pretty muted environment for trading.

So, let me go through the income statement in greater detail. On slide 10 is our income statement, shown on it are adjusted pro forma presentation. Adjusted pro forma results, I think you all know, are adjust to exclude certain items and reflects the conversion of all units of FXCM holdings for shares of classic common stock of FXCM Inc. and assumes that we adopt the unconventional corporate tax structure and tax as a C corporation in the U.S. at prevailing corporate rates and elsewhere at prevailing corporate rates where income is sourced. In a reconciliation of U.S. GAAP to adjusted pro forma results is included at the end of the presentation.

Looking at the quarter, retail trading revenues were down 12%, Q4 2012 versus Q4 2011, to $83.9 million, really just a reflection of the trading conditions in the quarter that Drew talked about. The average daily volatility in Q4 2012 was 7.5 versus 13.2 in Q4 2011, a full 42% decline.

So while we would of course and hope for a better result in retail trading revenue in the quarter, it was still a pretty impressive performance given the market conditions in the quarter. Revenue per million came in right at the midpoint of our traditional range of $95 per million.

Institutional revenues were up 170% to $19.1 million. FXCM Pro generated $3 million of that. They did $13 per million on the volume we’ve already disclosed of $223 billion and Lucid revenues were $16.1 million for the quarter. Lucid was down 27% sequentially from Q3 2012, and more than what the proxies would suggest were more in the 10% declines sequentially.

Relative to an ECM, Lucid is disproportionately affected by low volatility, low liquidity conditions, which were certainly prevalent in Q4 2012 and definitely in December as well. However, we’re pleased to say that Lucid is very much back in form and enjoying a strong first quarter so far. They’re averaging $374,000 in revenues per day and that’s up 37% from Q4 2012. For Q4 2012, Lucid generated high margins and had an EBITDA margin of 63% for a total EBITDA $10.9 million.

Net interest income was $619,000 for the three months, down 12% from a year ago, reflecting a low interest rate environment. Other income was up $2.5 million or 121% in the quarter versus last year. A $1.3 million of that was accounts dormancy fees charged on accounts that had not traded in over a year, and a $1.2 million of that was better results from our U.K. on exchange business. In all, total pro forma net revenues were up 3% to $108.1 million versus Q4 2011.

Referring broker fees declined 14% to $17.7 million and were 21.1% of retail trading revenue. As we already disclosed, volume in the quarter from referring brokers and white labels was 46% of total volume, pretty consistent through all of 2012.

Turning now to expenses. Compensation and benefits were down 9% from Q4 2011 to $21.6 million and down 1% sequentially as well, reflecting our tight control environment. Q4 2012 compensation and benefits includes amortization of the theoretical value of restrictions we put on the shares given to Lucid. Excluding that amount, which was $782,000 in the quarter, would make comp and benefits down 12% from Q4 2012, and even more on a sequential basis from the 1% you see.

Likewise, advertising and marketing was down 28% to $7.6 million. I’ll discuss a bit more our thoughts on advertising and marketing when I go through the full year results.

Communication and technology was up 27% or $2.2 million to $10.5 million. $1.4 million of that increase was a one-time expense relating to an Oracle contract of ours, which should not repeat going forward.

Trading costs were up three fold to – or $5.1 million to $6.7 million. This increase is really due to Lucid. $4.6 million of the $5.1 million increase is due to Lucid now being included in our results in Q4 2012 versus last year.

G&A was down a touch from Q4 2011 to $14.2 million. It was up a little under $1 million sequentially and all of that was due to an extraordinary levy that we accrued for in the U.K. that was given by the FSA to all of its members there.

Depreciation and amortization was up 105% or $6.2 million to $12 million. $5.4 million of that increase relates to Lucid now being included in our results versus Q4 2012 here. Q4 2012 we had interest on borrowing, $605,000 of that was interest on Lucid’s seller note.

Income tax provision was $5.9 million or an effective rate of 35.4%. When looking at the comparable for Q4 2011, you may recall that Q4 2011 had an $8.2 million or $0.11 per share tax benefit in it as we recorded deferred tax benefits in Japan with our FXCM Japan acquisition.

After Lucid minority interest we’re left with earnings per share of $0.13 versus $0.28 2011. However, adjusting for the Japanese deferred tax benefits I just referred to, Q4 2011 would have been $0.17, and I’d also point out that even after making this adjustment for comparison purposes – Q4 2011 actually was a very good quarter in the currency markets and the average daily CVIX was 13.2 versus Q4 2012’s rather anemic 7.5.

Turning now to the full year, I do not propose going through every line item because it was similar story to Q4 2012. However, I would point out a few things of note. On the revenue side when you’re comparing year-over-year, you should note that 2011 had $6 million in deferred revenues that were recorded in the first quarter of 2011 in other revenues and that was regarding FXCM Japan.

There was also $3 million in Q4 of 2011 that was attributable to a re-measurement of a tax liability as a result in a change in tax rate and that was in other revenues for 2011 as well. So, $9 million of unusual items.

Likewise 2012 had in other income, in the beginning of the year, a $1.4 million gain from a settlement with the former owners of ODL. So all-in-all a more normal other revenue line would have been $7 million for 2011 and $10.9 million for 2012.

On the expense side, you’ll see that compensation benefits were lower in absolute terms for the year, $84.3 million versus $85.8 million, and keep in mind that 2012 also had $1.7 million in amortization of the theoretical value of restrictions we put on the shares given to Lucid. So excluding this amount, comp and benefits would have been down a full $3.2 million or 4% in 2012 versus full year 2011.

Advertising and marketing was down 12% in 2012 to $30.9 million. Looking forward to 2013, we will not be renewing our sponsorship of the CNBC Currency Show, which will save $2.4 million for the year starting this month and $1 million in other contracts that we will not be renewing as well.

Communication and technology for the full year was up 16% or $5.2 million. $1.4 million was the Oracle contract expense in Q4 2012 that I talked about, $600,000 was Lucid now being included in our results, and $1.3 million of that was due to a full year of expense in 2012 for Foreland at FXCM Japan.

G&A was up 25% or $11.8 million. A few unusual items here I would point out to you for the full year, $1.2 million was an extraordinary levy by the U.K. FSA on all of its members, $4.4 million was due to relocating our corporate headquarters, and $1.4 million related to the relocation of FXCM Japan’s operations.

Depreciation and amortization increased 83% or $16.7 million to $38.8 million, $11.4 million is due to the amortization of intangibles related to Lucid, $1.6 million due to a full year of expense for FXCM Japan at Foreland, and $3.6 million due to higher capitalized software amortization.

Interest on borrowing was $2.8 million for the year, $1.2 million related to the credit agreement and $1.6 million related to the Lucid seller notes.

Turning on to the balance sheet on Slide 11, we continue to have a very strong balance sheet with considerable excess liquidity and capital. At each of our regulated entities we had collectively $165 million in excess capital over minimum capital requirements at December 31st of last year.

And on the liquidity front, we finished the year with $272 million in our own cash. $85 million drawn under our credit facility and $22.9 million in a one year note payable to Lucid as they rolled part of the amount we owed them for another year, as I mentioned before.

Also a great new story that I would point out is client equity grew 14% or $143.8 million to $1.2 billion, and really the rest of the balance sheet movements are what you would be familiar with from the last quarter reflecting the acquisition of Lucid.

Finally, turning to slide 12, this is a graph of our net cash flow from operating activities. When we filed our 10-K you will see that this is straight off of our cash flow statement, cash flow from operations after-tax and you can see that in 2012 it was up a full 21% to $102 million and what did we spend it on? Lucid in cash terms costs $36.6 million. We invested $4 million in FastMatch, our JV with Credit Suisse. We returned $21.7 million in dividends and distributions to our shareholders and we repurchased $7.5 million in common stock.

And how did we generate so much cash you may ask? Well, part of the answer is the table in the below left, below the graph, where you can see the extent of noncash charges now in our income statement. Depreciation and amortization were $36.8 million for 2012 and equity-based comp was $23.0 million, a full $59.8 million of noncash items in our income statement under U.S. GAAP.

And this wasn’t a year of muted volume. If trading volumes were to pick up, you can just imagine what the cash generation potential of FXCM would be.

With that I’ll turn it over to Drew. Of course, if you have any more detailed questions, I’m happy to answer in Q&A.

Drew Niv

Thank you, Robert. Just to sum up before we get to Q&A. Currency wars, if you’ve seen sort of the headlines how to potential – and potential moves in interest rates, all of because of the worries about the end of QE and economy improving are helping FX markets come back to life. This is something that we are hopeful to keep volatility, although cannot be assured they will keep volatility high.

A little bit on 2012, just to sum up all those slides in one little sentence: FXCM is one of the largest currency trading shops in the world; in 2012 did nearly $13 trillion trailing – trillion with a “T” – of trading, if you include a full year of Lucid in the 2012 results.

This significantly increased our scale to benefit from even modest improvements in currency trading. January and February were not large increases in volatility, do not even represent going back to 2011, much less 2010, as those things were to happen obviously we exit them even much more significant rise in OM P&L. And FXCM maintains as Robert just went over a very strong balance sheet is generating significant cash flow to capitalize on future opportunities in the FX industry.

And while we head off to question, on use of cash while we are on the lookout for acquisitions, acquisitions have remained – the pickup in volatility, a little over – more elusive given that everybody in the industry is doing better and therefore prioritization for use of that increase in cash will be paying down our debt as well as buying back shares.

And with that, operator can go to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ken Worthington from JP Morgan. Your line is open.

Rahul Nevatia – JP Morgan

Hi this is Rahul on behalf of Ken this morning. I’ve got few questions. First one, can you give us an update on China? What is happening with the currency controls there and how do you think that China currency situation evolves through the year and what this means for FXCM?

Drew Niv

There has been very little changes in capital control. There’s been a lot of changes in the past eight months to a year or so in what the Chinese are allowing. And so, for example, in 2012 they approved FXCM to begin trading the Chinese renminbi as a fully transparent trading renminbi versus USD on our platform. We released it in the latter half of 2012 only for clients in China and Hong Kong and I believe as of a week ago we just released it to majority of our global clients and I believe some of the last year’s fixtures like the United States will be seeing it soon.

And so that’s kind of the only real changes in China. I would say the timeframes for more liberalization are probably not a one year or so timeframe, but it is fully expected that – I mean consensus in the world, right, nothing that I can do in personally but consensus in the world amongst people who are better connected than I to this issue is that in the next few years, the regime there will liberalize in a much more quicker fashion simply because of the fact that China stem inflation and China move toward much more of a market-based economy than before.

Rahul Nevatia – JP Morgan

Okay. Another question on FastMatch, any update on FastMatch and how the product is going now, the platform is going this year?

Drew Niv

Sure. So FastMatch is – we’re very happy with its performance. It was out there only after a few months of launching in 2012, it has already reached $2 billion a day of volumes. We believe we are probably about four months to six months away from breakeven on this JV. It is something that is picking up steam. Lot of – dozens and dozens of new clients and traction this year picked up even more significantly.

It is something that we, if you’ve seen in recent press releases, just added Bank of New York as a partner to this joint venture which obviously enable us to tap into a source of flow that is unavailable today to other ECNs which is some of the best flows in the FX market which is obviously the stuff that Bank of New York specializes in, and this is something that we believe will not just have a positive effect on its own for FastMatch, but also will have the effect of drawing other participants to FastMatch to enable them to tap into this opportunity.

Rahul Nevatia – JP Morgan

Great. Another question on deal activity. You know, with FX trading has rebounded so far this year to some extent, what does this mean for potential sellers and for FXCM as well?

Drew Niv

So, as you would expect to companies that are mostly run by traders...

Rahul Nevatia – JP Morgan

Yep.

Drew Niv

The second they see higher P&L they believe the world is great. That would include us, but the – we’re a little bit more patient, most people aren’t. It’s something that has definitely ended a few conversations though we’re very close in 2012 put them off that in to – but we do see obviously as, you know, volatility rebounded, you’ve gotten some of it as a price based revision and expectations, some of it is a wanting to stay in independent for longer to test the waters.

The – that will definitely put a damper on M&A. That is not going to spend M&A only because if you go to slide seven and go over the regulatory changes, despite any improvement in business conditions these regulatory changes are going to mean the extension, you know, of many, many firms in our industry.

If you are not prepared or don’t have the scale or just, you know, be worthless for them to – to live under a world of new regime and I think that is something that we do see some acquisitions because of those – because of those issues and we see a lots of market share pickup, you know, because of that.

Something I didn’t go over in the presentation but was something that was released publicly a few months ago was a ban which has not yet been enacted but is close to being enacted by the – by U.S. regulators on credit card payments. While not affecting U.S. residents as much simply because U.S. residents have many other alternatives of sending money relatively quickly and efficiently through their online banking or through debit cards, it’s something that lots of smaller emerging market customers do not have the benefit of those substitutions and many of our competitors in the U.S. run an entity that services those foreign clients from its U.S. entity and unlike FXCM which has the ability to take those foreign clients in a foreign entity.

And does just exactly that and has been doing that for many years, the people who don’t have a choice will see a significant slowdown in business because of this and even then, just that rule should lead to consolidation and has already led to consolidation just if you look at the last six – six months in the U.S. we’ve seen, if I remember correctly three firms back out of the U.S. jurisdiction, leaving us with only about eight competitors in the U.S. today.

Rahul Nevatia – JP Morgan

All right. If I can squeeze in one more question. Can you talk about the market environment for Lucid now? EBS may change to get stabilization. How did that impact the currency market and specifically does that impact how Lucid interacts with the market or its level of its profitability?

Drew Niv

It impacts everyone in a sense that, you know, people have to recalibrate their, you know, market making engines to essentially, you know, interact with a jurisdiction that has mandated higher spread. Mandated higher spread is overall a good thing for a market maker, not a bad thing.

It is something that, you know, market makers if you ask them like in equities would rather go back to fractions because their minimum spreads are higher. So the same thing in – you know, in FX. Obviously, it takes time to adjust to such a thing, but, you know, as Roberts was alluding to – and he’s not alluding, he said so in his remarks, Lucid is up 37% on average 2013 from the Q4 2012. So I wouldn’t take the Q4 2012 as an indicative of what they’re able to do.

Rahul Nevatia – JP Morgan

Great. Thank you. This is all I have.

Operator

Our next question comes from Andrew Gadlin from CJS Securities. Your line is now open.

Andrew Gadlin – CJS Securities

Good morning. Could you discuss the institutional migration, your progress and what you’ve seen as the difference between traders with the new platform and the old one?

Drew Niv

As we remarked a few months ago, we are about six months to seven months behind on our institutional migration. Somewhat due to technical issues with our own software, mostly due, though, to essentially lack of staff and resources on the part of many of our clients, primarily banks who have been with lots of restructuring and turmoil and layoffs which you have all read about.

The – though I can tell you that we have overcome most of our in-house technical hurdles today and we are just left with external hurdles, we are continuing a pace with the migration of clients. We definitely have found that clients who have migrated from third party platform to our own as you can see in the last two months of institutional trading volume which is up significantly over the latter half of 2012 that represents the fact that customers have migrated, have increased our trading. Like I said, the migrations are going slower because of hang-ups on the customer side, but we do see that something we will definitely be completing this year.

Andrew Gadlin – CJS Securities

In terms of timing do you still target something in Q2?

Drew Niv

Yeah. We’re hoping – we’ll never get all the clients. And the point was, from the beginning when we were initially discussing this, was never to get all clients over because there still be clients who will want to use third-party platforms they are using and we are not, against – principally against selling that. We’re just – but we will finish the migration that we have planned we’re hoping by Q2, yes.

Andrew Gadlin – CJS Securities

And can you give us a sense of the size of the – or the magnitude of the increased trading that they are doing once they migrate.

Drew Niv

It varies significantly between clients, from client to client. Some of it is, kind of 20% increase, some of that is in a few hundred percent increase. It’s a – different clients are doing different things.

I will say what we’ve said before the institutional business has structurally taken a huge hit in the past 12 months because the regulatory changes affecting other instruments affect the business here, the reduction in speculation by, trading by banks and other things of – significantly weighed on the institutional FX business which is overly reliant on large and regional banks, and that is something that, has hurt all market participants in 2012, and we believe shall continue to do so for, not for foreseeable future, but probably for the next year before rebounding strongly once Dodd-Frank is fully implemented and things are certain, we think that FX is a long-term beneficiary and a lot of our clients will go back to doing what they have historically done and under the new platform we should be able to see even higher volumes in that.

Given that – given our small market share in institutional business we will see higher volumes in institutional business regardless of what happens in the FX market simply because of how tiny we are relative to our competitors.

Andrew Gadlin – CJS Securities

Got it. Thanks. On the – that’s it for now. Thanks very much.

Operator

Our next question comes from Rich Repetto from Sandler O’Neill. Your line is now open.

Rich Repetto – Sandler O’Neill

Good morning. Good morning, Drew. Good morning, Robert.

Drew Niv

Good morning.

Robert Lande

Hey, Rich.

Rich Repetto – Sandler O’Neill

So I guess the first question, you know, we talked – Robert sort of hinted at it but the scalability of the operating leverage in the platform. So with the uptick in January, February, so the question is like what kind of incremental margin can we expect from the increased trading activity?

Robert Lande

Well, you know, Rich I think I highlighted on the expense side kinds of what was unusual in Q4, so some of those items will go away. I highlighted what is going to happen in advertising and other than that I think the expense side is what it is, not going up. So...

Drew Niv

With exception I would just add the exception of the reseller the variable portions will obviously go up.

Rich Repetto – Sandler O’Neill

Sure.

Robert Lande

So you will have the resellers and the Lucid portion of trading costs will go up. So, you know, I think it’s really just a mathematical exercise that you can run through to see – to see what, but as you know, our incremental margins are very high and so when volume comes, it really translates into the bottom-line nicely.

Rich Repetto – Sandler O’Neill

Got it, got it. Excuse me. And then, Robert, you did hit on my second question, which is, on the expense side there was it seemed like a lot of one-time items, I guess, but where could you say you are because I thought we were in this, reduction over 4Q and 1Q, the $10 million reduction in there. Where are we, can you give us an update on how that factors into how we look at expenses here?

Robert Lande

Yeah. I think, you know, if you start to add up the things that I was talking about, I think we’re on track and I still see further improvements coming. We were able to merge in this quarter finally Foreland and FXCM Japan. That will have going forward, three quarters of a million dollars of savings, but I think you’re also going to see about another quarter million dollars a quarter in ancillary savings there from not having to maintain two platforms and all of that.

I talked about advertising will be coming down and then some of these G&A items, for sure, for example communication and technology I don’t intend to have to, have another $1.4 million as with we had in Q4 to do with Oracle. I can’t predict the FSA in the U.K. I would hope that they would stop hitting the whole industry for extraordinary levies, but that is the way they do things over there where if – if a member goes down or they need to bail out a member, they spread the joy around all the membership.

So I think you will continue to see continued progress in absolute dollars of us being able to reduce – reduce it and so I would say yes, we are hoping to have probably in the order of $10 million more coming out of – out of the fixed costs quote unquote “fixed costs base” in the next quarter or two.

Rich Repetto – Sandler O’Neill

Okay. Very helpful. And one last – so my last question would be, Drew, you pointed out something interesting on the Dodd-Frank sort of regulation front and the loophole. I’m just trying to see if they ever did – if in say the U.S., the model was forced to go agency, you know, I could see how it could hurt certain competitors that have the principal model, but how do you see it helping you? Is it just the idea that now the whole industry and you would go after their clients and pick up incremental clients or...?

Drew Niv

Think about it this way, Rich, the easiest way to think is kinds of multi-dimensional arguments to it. One is certain people today under the scale that they have, which is much lower, are only surviving by virtue of their dollars per million being vastly higher than ours is their dollars per million were to, just to equalize to ours, they would have a much harder time justifying staying with certain jurisdictions like the U.S. which are very high costs jurisdictions.

There are other people that if you think of an anomaly of a business is that we have competitors and this is very typical and not extraordinary at all who display to our customers and their customers a lower spread than we do yet make a higher dollar per million than we do and this is not little margin errors you’re talking about on averages presenting a spread that is about half the spread we offer our clients or a third – a third less or half less and making significantly more than we are making per million.

Obviously, that would not happen if the principal business and risk taking was not allowed, so you would see the price composition issue fix itself to a degree, you would definitely see consolidation in market share organically, as well as acquisition opportunities from people who get squeezed out by this.

Rich Repetto – Sandler O’Neill

Got it. That’s very helpful. That’s all I have. Thanks guys.

Operator

Our next question comes from Howard Chen from Credit Suisse. Your line is open.

Howard Chen – Credit Suisse

Hi. Good morning, Drew. Good morning, Robert.

Drew Niv

Good morning, Howard.

Robert Lande

Good morning, Howard.

Howard Chen – Credit Suisse

Drew, you mentioned it more optimistic outlook for retail account growth over coming months. What’s specifically is driving that thinking of yours and what drove that small decline in active accounts during February you know, when you had a nice improvement in the trading environment?

Drew Niv

It’s hard to look at it month-over-month, and I have no idea what happens in a say February probably we’ll take a look when we do Q1 probably go over that but these anomalies are hard to tell – the – you know, month-over-month. What I can tell you is as of sort of trends that I have seen hold true for many, many years. FX clients are attracted to volatility. Therefore, they’re much more likely to disengage and stop trading during periods of lower volatility but when periods of higher volatility it’s just the opposite, they’re much more likely to re-engage. And I think you will see that accounts should be picking up because of that because – and essentially everything gets better.

It’s not just present trading volume. Volatility drives lower costs for acquisition of clients, drive because obviously it’s driving client’s interest. And so, you know, we sell to sell direct customers, with no device, no things to either coddle or promote trading. So the customer has to want to trade and that’s what he’s aiming to do is obviously much more likely to happen when it is more interesting to trade, so we obviously are expecting, you know, sales to be picking up dramatically.

Howard Chen – Credit Suisse

Okay. Thanks. And then I wanted to revisit the incremental margins. I think it’s a really important driver. Just aside from the referring broker fees and variable expenses related to Lucid and the core business, each expense forecast you mention is directionally down for 2013. I’m just curious, why don’t factors like inflation just put a little upward pressure to your overall expense base? And then, under what scenario, Drew, do you think you starts reinvesting some of that $10 million-ish that drops out?

Drew Niv

So, you are right. Obviously, people will not keep working if you didn’t give them raises. So there is an issue of your base of employees and this is a truism for everyone that just inflates every year. We have been making – the reason comp is down because bonuses are down, because results were down unit-by-unit, if you will, and comp is down because we’ve had some reduction in personnel.

We continue to have a reduction in personnel, results – I’ll say it like this, bonuses are not likely to be down any more, but the reductions in personnel is something that we’ve planning and probably continues to be the case. It’s not dramatic and it’s not something that we believe cuts into any muscle, but it is something that we have been doing gradually for the last year or so.

The – in terms of lots of our other costs, as Robert mentioned, are just – structurally we’re just becoming more efficient. Once we got permission to move – about 1.5 months ago, a permission to move the Foreland – clients out of the Foreland system. As Robert said, that essentially saves us $4 million over a 12-months period of time.

So, those kinds of things just reduce the expense line. Structurally, you have – in terms of reinvesting, there are some of the advertising that Robert mentioned, we’re now planning to reinvest – there’s other advertising that we didn’t mention that we’re cutting. And we do plan it to reinvest and we may reinvest a little bit more depending on a few things.

One, the timing and the scale of the opportunity in certain European countries around the financial transaction tax, which we think could be very meaningful to us. And the end of the lifting of our business improvement order in Japan which essentially, if you will, made us not – we weren’t allowed to aggressively grow the business in Japan in the past six months to nine months simply because – until we fixed certain regulatory things and so we were able to keep present levels and present levels of advertising, for example, but not allowed to increase them.

Once the business improvement order in Japan is lifted, we were able to lift that advertising up to market conditions in markets like – in the end, not markets, but in the end pairs continue to be what they have been we will probably reinvest some advertising there as well.

Howard Chen – Credit Suisse

Okay. Okay. Thanks. And then maybe just asked another way. I mean, Robert, if I do that mathematical exercise you mention, I mean the company should be trending a few hundred basis points above that 42%, 43% EBITDA margin target you laid out 15 months ago, is that the way you see it and is that still the target?

Robert Lande

Well, absolutely. The target of 42% net EBITDA margin is something that we did layout and have absolutely all hope, desires to over achieve on. So, yeah, it is – when you do the math, you will see definitely a pickup in our overall margins and it will be a combination of the growth because of the volume increases this quarter and as well as, hopefully, some further improvement on the cost side that we’ll report in a couple of months from now.

Howard Chen – Credit Suisse

Okay. Great. Thanks for taking the questions.

Operator

Our next question comes from Bill Katz from Citigroup. Your line is open.

Bill Katz – Citigroup

Okay. Thank you very much. Thanks for taking my questions. First question is I might have missed this I apologize. Robert, is there a shift in the methodology for adjusted earnings in terms of what you are excluding from a compensation perspective?

Robert Lande

No. It’s the same. We just add back the stock option grant to do with the IPO. The number might be a little bit different in Q4. It always is every Q4 because we actually under accounting rules you have to look at what was the actual forfeiture rate. You know, this is to do with employees leaving and giving up their options. And so you have a true-up at the end of each year as you observe actual forfeiture rates and so sometimes that expense gets modified in Q4, but other than that that was it. There’s no additional modification to the pro forma.

Bill Katz – Citigroup

Okay and then second question is just, I wrote it down $10 million of savings over the next quarter or two. Are those annualized savings?

Robert Lande

Yes.

Bill Katz – Citigroup

Okay. I see the CVIX has trended off a little bit in terms of into March, and obviously it’s early days, but have – has the stepped up volume continued even as you see a little bit of a slowing in the CVIX improvement?

Drew Niv

No. The volume follows CVIX.

Bill Katz – Citigroup

Yeah. Okay and just the last question. As you think about the regulatory environment, you mentioned a lot of things that are working in your favor. You hope to work in your favor. From the other side of the coin, what are some of the key risks that you see that could potentially be a partial offset if any?

Drew Niv

So, you know, as the environment continues to not be hospitable for brokerage firms, the – let’s talk about minor stuff first. So you’ve got – so I was talking about the FSA levies, I actually believe I do recall in the recent Board meeting in the U.K. that they did say some firms blew up there. Not a great – not a great amount, but we’re going to get another levy that’s relatively small, but we – I expect more of those.

We do have an obviously risks like we said before, that you will have more things that will hit us as well in terms of much higher costs of implementing compliance and, there’s always those type of things. Outside of the stuff that we normally talked about, there’s nothing new.

I mean everything is – as if the rates are always the same and has been pretty much the same.

We believe that actually the more recent regulatory changes we’re very much attuned for and have been ready for a long time and, you know, are something that, work to our benefit. For example, in the U.S. the Futures industry has been under a more lack regime than the FX industry since the regulators felt that the FX industry needed more attention because of the MS global and PSG blogs they sort of turned their attention back to Futures.

It’s not that they’re not granting us any attention. They certainly are. But the – they’re definitely trying to harmonize with the things that they perceive to be kind of escaped the heavy hand and we certainly cannot be accused of escaping the heavy hand.

Bill Katz – Citigroup

Just one last one for me and thanks for taking my questions. Rob, sorry, I’m going to reach you a little bit, and maybe we can discuss it offline if I’m not fully understanding, but just looking at footnote number one from your presentation today about just the definition of what is excluded and it just looks to be a more broader definition than what’s historical been the case. So that’s what I was just seeing just confused on that box into prior quarters.

Robert Lande

Sure. Yes. We can go through that later Bill, but there’s nothing unusual in the quarter. In total you’ll see in Q4 $3 million was added back in comp and benefits and that’s really to do with the IPO stock option grant, but we think – I can talk to you later.

Bill Katz – Citigroup

Okay. Sorry to take-up your time. Thank you so much.

Operator

Our final question comes from Patrick O’Shaughnessy from Raymond James. Your line is open.

Patrick O’Shaughnessy – Raymond James

Hey. Good morning guys.

Robert Lande

Morning, Patrick.

Drew Niv

Good morning.

Patrick O’Shaughnessy – Raymond James

So I would anticipate that a lot of your strength so far this quarter has been in Japan, certainly with the handover as much as it has. Is that a fair assumption and then, if so, what are the ramifications for that on kind of your mix between direct to indirect? If I recall correctly, you come and do more of the stuff in Japan directly so that might have kind of positive margin implications for you.

Drew Niv

It does. I wouldn’t put too much emphasis on it only because don’t think of yen as being traded by Japanese customers. Think of obviously, Japanese customers disproportionally trade yen, but volatility picks up in the yen pairs, all customers around the world are trading more yen, from China to New Jersey if you will.

So if you’ve got to look at that as a – you know, our indirect customers have traded more, direct customers have traded more yen. So yes, our Japanese business, because it’s even more yen centric than the average customer base would be, is up and that has an improvement, but that’s more of a slight improvement, not a huge improvement, where because like – it’s not like the entire improvement is from the geography of Japan, right? Most of it is not.

Patrick O’Shaughnessy – Raymond James

Okay. That’s fair. A question on Lucid. So last year in 2011 they did about $150 million of revenue. I think in 2012 they did something just a little bit under $100 million for the full year. Is there any change given the run rate that they’re on to the future earn-out that you guys are going to be paying out?

Robert Lande

No. There’s no change. You know, when we bought Lucid, we already had seen the first two quarters of the year and already were well aware of that they follow volatility as we do and that it was going to be a decline from a pretty solid 2011, and we priced out the deal based on that. So they came in pretty much as we thought for the year and, we still think we got a great price and made a great acquisition and they’re having a solid Q1, so no changes to the earn-out.

Patrick O’Shaughnessy – Raymond James

Okay. And then last one from me. On your share repurchases, so you guys are up to your authorization during the fourth quarter. You bought back a little bit over 5 million shares, I believe. Now that your share prices happily had a nice run over the last few weeks, how does that impact your view on your aggressiveness with share repurchases and I guess since M&A doesn’t so seem to be really on the table for the near-term, does that kind of shift your capital allocation more towards debt pay down in the near-term?

Drew Niv

Yes. So I think we’re definitely prioritizing pay down over stock buybacks. I am not saying exclusively, but – because that depends on prices, but definitely that’s something – the payback is more important.

Patrick O’Shaughnessy – Raymond James

All right. Very helpful. Thank you, guys.

Operator

I will now turn the call back over to management for closing remarks.

Jaclyn Klein

Thanks. We just want to – on behalf of Drew Robert and everyone here at FXCM, we would like to thank everyone for joining us this morning and we look forward to speaking with you next quarter.

Operator

Ladies and gentlemen, that does conclude today’s conference. You may all disconnect. And have a wonderful day.

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