FXCM's CEO Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 7.13 | About: FXCM Inc. (FXCM)


Q2 2013 Results Earnings Call

August 7 2013 8:15 AM ET


Jaclyn Klein - Head, Corporate Communications and Investor Relations

Drew Niv - Chief Executive Officer

Robert Lande - Chief Financial Officer


Alex Kramm - UBS

Rich Repetto - Sandler O’Neill

Steve Fullerton - Citi

Ashley Serrao - Credit Suisse

Patrick O’Shaughnessy - Raymond James

Arnie Ursaner - CJS Securities

Ken Worthington - JP Morgan


Good day, ladies and gentlemen. And welcome to the FXCM Second Quarter 2013 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 be given at that time. (Operator Instructions)

As a reminder, today’s conference call is being recorded. I’d now like to turn the conference over to your host, Ms. Jaclyn Klein, Head of Corporate Communications and Investor Relations. Please go ahead.

Jaclyn Klein

Thanks Operator. Good morning. And thank you everyone for joining us for the FXCM Inc.’s second quarter 2013 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 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.

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

Drew Niv

Thank you, Jaclyn. We’re going to start the presentation of slide three, the highlights of the second quarter 2013 and before I start, I want to apologize in advance for all the self congratulations and gloating you are about to hear. We are very excited to share with you the results of our second quarter which we achieved records in most of our financial and operating metrics.

Together, with the last quarter, the first half of this year, this is a showcase time for FXCM to show you when market conditions improve, how much -- how scalable our earnings are.

The growth that we are experiencing is largely due to FXCM’s strategy to grow our customer base both organically and by acquisition over the last three years. The larger business that we operate today enabled us to take advantage of even small improvements in market conditions and increased volatility, translating to the kind of results we saw in the second quarter.

As we have grown the scale of the business on the customer side, we are starting to see the advantages of our operating model which provides high incremental margins as we add additional revenue.

The increased profitability from our scale and improved market conditions translates into improved generation of cash, which was evident in the second quarter. In addition to cash we generate ourselves internally we have accessed a significant amount of cash in the marketplace. In total, this adds up to over $500 million of liquidity.

Having access to that liquidity is an important tool for us in mergers and acquisitions. Our M&A pipeline remains robust, perhaps stronger than it’s ever been and finally, while overall volatility in markets dropped a bit in July, we continue to see solid volume from our retail and traditional trading businesses in comparison to significant drops in comparable companies on institutional and retail side.

On slide four, I’d like to give you a little more detail some of our financial highlights in the second quarter. We have record quarterly revenues of $140.1 million, which was up 53% over the same quarter last year, on volumes of $1.2 trillion, which were up 33% over the same quarter last year.

Our growth over Q1 of ‘13 which was a strong quarter for us was also impressive. Revenues up 14% and volume up 11%, sequentially.

Our GAAP earnings per share were $0.32 on a fully diluted basis versus GAAP loss of $0.06 a year ago. On a sequential basis, our GAAP EPS is up 39% over Q1 ‘13.

Our adjusted pro forma EBITDA for the quarter was $54.5 million, 159% increase over last year and the second highest EBITDA in FXCM history. The only higher quarter was Q4 of 2008 when the world was melting down and volatility hit an all-time high. Our net EBITDA margin for the quarter was also improved to 46.3%.

Our adjusted pro forma EPS of $0.31 for fully diluted share was 182% higher than the same quarter last year.

Our revenue per million remains steady at $90 per million, we had another strong quarter of cash generation. We generated $62 million in after-tax cash flow from operations in the quarter. Continuing our practice of returning capital, we repurchased 853,000 shares for $12 million in Q2 at an average cost of $14.08 and paid $6.4 million in dividends and distributions to shareholders.

On slide five, you can see the graph showing the market environment over the last five years. The average CVIX in the second quarter was 9.6, which was 10% improvement over the prior quarter and 4% above the average for last year which are both positive developments. But to put the volatility in a larger perspective, these numbers are down 10% from the second quarter last year and down 20% from the five-year average.

The last time we had earnings this good, CVIX was above 20 and the rates were -- short-term rates were significantly higher, if the business was 20% of its present size. If we had our present size at those levels in 2008, the numbers would be significantly higher and hopefully, this quarter shows you the potential, if that ever happens, what could be -- what earnings could be.

On slide six, we see some graphs of our key performance metrics. In the upper left hand corner, you can see that we achieved record quarterly volume on a daily basis of $17.7 billion. Moving across our dollar -- moving across, our dollar per million was $90, an improvement over Q1 but below our average for the prior 12 months.

Our average trades increased dramatically in Q2. Finally, we saw growth in every region around the world in the second quarter on both sequential basis and when compared to the same quarter last year.

Moving to slide seven, we have some highlights from our institutional business, where we continue to see progress and improvement. Institutional volumes were up 50% from Q1 and 38% from the year earlier.

Lucid continues its strong performance averaging $392,000 a day in revenue, up 7% from Q1 performance, while the EBITDA grew by 11% sequentially from Q1.

We are very encouraged by what we have coming up in this space -- in the institutional space and very -- as optimistic as ever about our institutional business.

On slide eight, with global uncertainty in financial markets and the opportunities that this presents for growth and acquisition, we believe that it was prudent to increase our cash position while the credit markets were favorable.

On May 28th, we successfully issued 172.5 million in convertible notes, carrying interest rate of 2.25% and 32.5% conversion premium. The offer was very positively received. We initially were seeking $125 million with an expected interest range -- interest rate range of 2.25% to 2.75% and a conversion premium between 27.5% and 32.5%.

We received $800 million in demand and as a result increased the size of the offering and exercise the greenshoe. We also purchased a bond hedge to increase the effective conversion price by 50% to $21.24 per share.

On slide nine, accretive acquisitions will continue to play an important part in our growth strategy. We have a number of other opportunities we are looking at across geographies, business line and deal sizes.

As we’ve said in the past, we walk away from more deals than we finish and today we have never regretted one. The deals we have completed have been successful for both FXCM and the sellers.

And as I said in the opening remarks that we see our M&A pipeline very strong, the strongest that we’ve ever seen it and we believe that this year, we are look -- this year we will close one if not more of our deals, some small, some large, and we’ve -- while we obviously cannot guarantee any of it, it is something that’s looking as a higher probability.

With that, I’ll now turn the call over to Robert to take you through the financials and the metrics.

Robert Lande

Thank you, Drew. Let me now take you through the income statement on slide 10. Starting with the quarter on the left-hand side, it was as Drew said a strong quarter and importantly, I think it shows just how significant our incremental margins are and the operating leverage that we have.

Retail trading revenues in the second quarter were up 34% all from trading volume increases as revenue per million of $90 per million in Q2 ‘13 was the same as it was this quarter last year.

Average retail trading volume in the second quarter of 2013 was a quarterly record for us at $17.7 billion per day.

Sequentially retail trading revenue also showed a strong performance from an already very solid quarter last quarter and our retail trading revenues were up sequentially $12.8 million, that’s a 14% increase on 11% higher volume in the quarter as also markup increase from $88 to $90 per million.

Regarding the expansion in our markup in the quarter, there was a slightly better currency mix of what our customers traded with a bit more euro being traded primarily in June with the Fed’s announcement around tapering.

Institutional trading revenues were up 183% Q2 ‘13 over Q2 of last year. Most of this was to do with Lucid, which contributed $25.5 million in revenues this quarter versus only $3.9 million in Q2 of last year, as it was only acquired in mid-June of last year.

Sequentially institutional trading revenues were up $4.2 million or 15% from the first quarter of this year. Lucid revenues this quarter increased $2.5 million or 11% sequentially and FXCM Pro, our institutional ECN increased $1.7 million sequentially or 38%, a very good performance.

Other income was $3.7 million, up $2.1 million versus Q2 of last year or 128%, a $1 million of that increase is due to a better performance in ODL brokerage business versus last year and $1.1 million is due to account maintenance fees that we charged in the quarter.

Sequentially, other income was pretty much flat from Q1 ‘13 as Q1 ‘13 had some ancillary one-time revenue in it as well. Looking out to Q3, we are looking at other revenue probably in the mid $2 million range.

Compensation and benefits were up $4.7 million or 24% versus Q2 of last year and up $3.1 million or 14% sequentially from last quarter. Comp came in a bit higher than I had indicated last quarter as we had higher bonus accruals given the strong quarter, as well as some new hires in our institutional area that brought comp up a bit.

Advertising and marketing was down $1.3 million or 18% versus Q2 of last year and down $1.2 million or 16% sequentially from last quarter. We expect marketing to be around $7 million next quarter.

Communication and technology was up $1.2 million or 15% versus Q2 ‘12, a $0.5 million of the year-over-over increase was due to Lucid being included for a full quarter in our results and about $700,000 was for additional costs with some of our platforms and higher technology costs in general such as data center costs. For the next quarter we are probably looking at around the same number for communication and technology.

Trading cost, prime brokerage and clearing fees were $9 million up $7 million versus Q2 ‘12 and pretty much all due to the inclusive of Lucid for full quarter in our results this year versus a week and a half last year.

Sequentially trading costs, prime brokerage fees and clearance fees up $1 million or 13% from Q1 and that’s pretty much in line with the 15% growth in the topline of our Institutional business this quarter over last.

G&A was $13.4 million up $0.5 million versus Q2 and up $1 million or 8% sequentially from last quarter. That’s better than the $1.5 million increase I had projected last quarter and Q2 ‘13 is a reasonable run rate for next quarter’s G&A.

Our share of FastMatch’s lost in the quarter was $397,000. FastMatch is still a few quarters away likely from breakeven, but doing very well in its first full year of operations as it grows its market share. Our share of FastMatch losses should be around the same level next quarter.

That leaves us with EBITDA for the quarter of $54.5 million and a net EBITDA margin of 46.3%, up from EBITDA of $21 million and a net EBITDA margin of $29.3% last year, a pretty meaningful expansion of our EBITDA margin.

It’s maybe worth pausing a moment and discussing a bit how we have achieved this. If you were to look at where we were in the fourth quarter of last year for example, in Q4 ‘12 we had net revenues of $90.4 million and operating expenses of $57.7 million, with a resulting EBITDA of $29.8 million.

Now two quarters later we have net revenues of $117.7 million and operating expenses of $63.2 million with an EBITDA of $54.5 million. So in two quarters we have increased revenues by $27.3 million, but operating expenses under our control has increased over $5.5 million from $57.7 million to $63.2 million, and that is an example of the operating leverage that we have been talking about.

And while a solid quarter of volume, the volatility in the second quarter as Drew pointed out was not particularly exceptional in relation to the past few years and we still do not have meaningful contribution from interest rates, so the interest on our cash and our customer’s cash, and even for us more importantly from customers pursuing carry trade strategies and the spread that we earn on overnight customer positions.

Continuing on the income statement, depreciation and amortization increased $5.6 million versus Q2 of last year, most of that has to do with the Lucid intangible amortization being in for full quarter this year.

Interest on borrowings increased $1 million due primarily to the convertible that we issued at the end of May of this year. For Q ‘13 -- Q3 ‘13 assuming no borrowings under our credit facility, which is currently undrawn, we expect interest expense to be $2.9 million.

This quarter there has been a change in mix between provision for income tax and the Lucid minority interest. Overall, the level for this quarter of these two items combined versus last year is about the same at around 43% of pre-tax income, but the income tax provision piece has come down and the proportion going to the minority interest has gone up.

This has to do with that the main Lucid operating entity is a partnership and that the non-FXCM ordinary members who are part owners basically received their income as is typical in a partnership pre-tax.

We have changed the way we account for this with the consolidated tax provision reflecting a portion of the income is being not taxed, but likewise the benefit of all of this accrues entirely to the ordinary member’s minority interest of Lucid non-FXCM.

So from an EPS perspective, it’s a zero sum game, but the allocation has changed, lower effective tax rate on consolidation, but higher minority interest. Anyone who has more questions on this, I’m happy to take you through in more detail either after this call or in the question period.

Net income attributable to FXCM been at $23.3 million versus $7.9 million, an increase of $15.4 million or 196% year-over-over. Pro forma earnings per share for the quarter was $0.31, up 182% from last year and up 35% from last quarter.

I do not propose going through all the six month numbers basically it’s an extension of the themes of this quarter. However maybe worth pointing out, is that our six month pro forma EPS of $0.54 is almost ahead of the $0.58 a share we did for the whole year last year and the $98.3 million EBITDA for the six months is very close to the $112 million in EBITDA that we did for the whole year of last year.

Turning now to slide 11, the main change in the balance sheet was the closing of the convertible. You can see now that on the liability side of the balance sheet, a bond payable of $143.8 million.

The actual fees and amount of the convertible is $172.5 million. The way these things worked under accounting is that it will accrue up to the face value of $172.5 million over the next five years. The difference between the $172.5 and the $143.8 million, which accounting treat as an embedded warrant on the stock sits an additional fee in capital.

With the convertible issued and the cash flow that we have generated, we now have $373.8 million of our own cash at June 30th. Together with the $155 million that’s undrawn on our credit facility that leaves us with $530 million in liquidity.

In addition with the $606 million in total equity and the $71 million in global regulatory capital requirements we have at the end of June, you can see that our balance sheet has significant strength.

Turning now to the next slide, slide 12 regarding our cash flow. This is a graph of our cash flow from operations which I have presented the past few quarters. As a result of our recent acquisitions and particularly the acquisition of Lucid mid last year and the resulting intangible amortization, there’s a fairly significant difference between our book income and our cash flow as many of you know. These non-cash charges are highlighted in the box below the graph.

Turning to the graph, you can see that in Q2 it was a particularly strong generator of cash flow, after-tax cash flow from operations was $62 million in the quarter up 89% from the first quarter. The $95 million of cash flow from operations for the first six months of this year is already 93% of last year’s $102 million of after-tax operating cash flow.

Turning now to a summarized version of our cash flow statement for the six months on the right side in a gray box, you can see the $95 million that we generated from operations and that we spent $11 million on capital expenditures.

And that level of capital expenditures is in line with what I’ve been saying that this year CapEx should be coming down from last year’s $27 million, as last year was elevated a bit as we built a data center in Japan to improve the network speeds with our Japanese clients.

With $84.1 million in cash flow, after-tax after capital expenditures, you can then see where we spent the money. The large uses were the repayment of $85 million under our credit facility, $23 million due to Lucid sellers.

It’s also worth noting that we didn’t repurchase any stock in the first quarter of this year, but we bought back $12 million in the second quarter, as Drew mentioned earlier, an average price of $14.08 per share. We still have $34.2 million outstanding on our $80 million stock buyback authorization.

Bottom line, our cash has increased $101.4 million since December 31st of last year and of that $84.1 million came from after-tax, cash flow from operations after capital expenditures.

Turning now to our July metrics on slide 13. We’re pleased to announce the July was a very solid month, which may have surprised some of you who had been looking at some of the proxies that reported recently, where you might have seen daily volumes falling 30% -- 31% at EBS, sequentially the CME down 33% and Thomson Reuters was down 22%.

For the month, FXCM had the third highest retail volume in our history, $388 billion traded. Our ADV of $16.9 billion a day was the fourth highest in our history and down only 4.5% from the average in Q2 ‘13. Retail active accounts increased 1.3% from last month to 184,534 accounts and retail DARTs fell 12% from our Q2 ‘13 average.

Our institutional business also had a solid quarter continuing the strength of recent quarters and was the second highest in July in FXCM history, with $185 billion traded. ADV was $8 billion a day, still a ways to go to the $100 billion to $150 billion a day level of the large ECM, but definitely trending well over the past few quarters.

Not on the page, but also worth highlighting is, Lucid which in July had revenues per day of $309,000 per day. That’s down from the $392,000 a day it averaged in Q2 and $361,000 a day it averaged in Q1.

Although, well ahead of $260,000 a day it averaged in Q4 of last year, and that’s pretty consistent with the big venues which as I mentioned EBS, CME and Thomas where Lucid trades every day.

So to wrap up, we on balance had a really great performance in July and hope we pleasantly surprised some of you.

And with that, I’ll turn things back to Drew.

Drew Niv

Thank you, Robert. In summary, the second quarter provided a glimpse of FXCM’s earnings power in more favorable trading environment. With just a slight increase in market volatility, we saw solid performance across our business sectors retail, institutional and Lucid.

Our cash position is the strongest as it’s ever been with over $500 million of liquidity. We had a (inaudible) product continue to expand our business organically and through acquisition, and as always our goal remains to deliver strong returns to our shareholder.

With that, Operator, we’re ready for questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Alex Kramm of UBS. Please go ahead.

Alex Kramm - UBS

Hey. Good morning.

Drew Niv

Good morning.

Alex Kramm - UBS

I just wanted -- and this I guess more on the numbers side? But I think when you guys walked through the expenses and the outlook for the third quarter, you didn’t really talk that much about comps and obviously, there were -- that was running a lot higher this quarter than last. I understand the whole bonus accrual item? But I think in the past if we’ve looked at there is much more of a fixed line item?

So maybe you can give us a little bit more detail how you are accruing, what the outlook is for the next few quarters depending on the volume environment, so we can model that a little bit better going forward? Thank you.

Robert Lande

Yeah. Sure, Alex. I think last quarter I said it would be up $1 million, it came up $3 million from where it was. The -- most of the salary increases for staff occurred in the second quarter not at the beginning of the year, so that was part of it.

The way we -- the bonus accrual is obviously tied a little bit to results but it’s a discretionary item. So if revenues remain robust, I think we’ll probably have comp levels at around here. If this is a short-term thing and we’re looking at returning to last year then we won’t be paying out bonuses like that. So its -- that’s kind of how the bonus accrual is thought.

It’s really tied to what we’re going to be doing in reality which is we think about comp and keep a tight control on it. But if things are going very well and people deserve a bit more that’s built in there.

I also mentioned that there is, in the quarter there were some institutional people hired and we are looking to expand a bit the institutional side. We think that there’s a very good opportunity there and we have been seeing some high quality people come available to us. And that too is not an insignificant piece of it, which will probably contribute to a bit more on the comp side as well.

So, right now I think in the absence of any kind of material change in the outlook for Q3, that the levels that we have now in comp is a reasonable proxy for where we are going forward

Alex Kramm - UBS

All right. Thanks for the detail there. And then secondly, I guess, little bit more a bigger picture, but obviously you’ve been telling us for a couple of quarters now that that you’re still pretty focused on M&A but we haven’t seen anything? I think, Drew, in your remarks you kind of even alluded to different businesses?

So I was more expecting a scale acquisition, like gain. So is that still the most likely outcome or are there other things that you are looking at and maybe give us a little more flavor for what those things are that still fit into your business? Thanks.

Drew Niv

Yeah. I mean, I can clearly tell you, it’s not gain specifically, but we are looking at a scale acquisition on the, in comparable size to gain or somewhat with, obviously not the same size, but somewhat similar on that level to occur and we are talking to a number of parties and we think we are relatively close to a deal at least one.

We have also a few smaller things that we are looking at that are also looking like they may happen this year. So its, we are not walking away from the large scale stuff. Obviously, the larger the transaction the lower probability of a close, simply because it’s trickier, but it is something we are focused on. We have the money to do it and we’re very, I think we’re pretty confident we’ll get something done this year or early next year.

And I want to sort of highlight that starting in January 1, 2014 there’s new capital requirements starting in Europe, which are pretty onerous for our industry and sort of related industries. We’ve talked about this in the past few quarters.

And then throughout 2014 Europe gets hit with a whole slew of new restrictions, edicts and compliance costs from a whole host of new rules we talked about and I think that is going to be a catalyst to shake the tree even more, so things that don’t close in ‘13 may close in ‘14, in early ‘14 because I think this is a something that, these rules are now set in stone most of them and are definitely coming.

As well as in this country, Dodd-Frank continued to march forward and its costs are creeping ever higher for everybody and there’s lots of different, if you will, things we’ve talked about in the past are really causing M&A to be a more likely opportunity.

And yes, we haven’t done it in a if few quarters, because we essentially feel that we are going to get some of these things anyway and it’s better to be patience and we’ll get them at the right price rather than overpaying now for something that we are, is going to be forced to come online, forced to come to us anyway.

As you know in this business, this is, all the acquisitions we’ve done in the past were single bidder, no competition acquisitions, the -- we sort of like it that way and we will wait for the right opportunities to do it. So while we’re going to be patience you’re not going to have to wait years for this to happen.

Alex Kramm - UBS

And I’m sorry, just stay on that item, but when I meant, scale of my question, I mean retail, so it sounds like you are really just focused on retail and not other ancillaries business?

Drew Niv

That’s a -- on a large-scale basis we are focused on retail, but we do have potential in the institutional space as well, somewhat usually smaller but on the smaller side, but we are looking at that, too.

Alex Kramm - UBS

All right. Thank you.


Our next question comes from Rich Repetto of Sandler O’Neill. Please go ahead.

Rich Repetto - Sandler O’Neill

Yeah. Good morning, Drew. Good morning, Robert. Congrats.

Drew Niv


Rich Repetto - Sandler O’Neill

Congrats on the strong quarter.

Drew Niv


Robert Lande


Rich Repetto - Sandler O’Neill

So my question, Drew and Robert is, with the strong cash flow that you experienced in the first half of this year? Can you walk through where you think, what are the ins and outs that are coming, there was a lot of, there was a convertible bond hedge and some different things going on in the first six months? Where do you think you’re going to deploy or use the excess cash flow going forward and we know you did the buyback, are you out the store more cash versus the buyback for these potential acquisitions you just talked about?

Drew Niv

So, you’re going to see us, for sure we will buy enough stock to cancel out any dilution from option exercises by employees. So we’re determined to kind of hold that number of shares to not dilute shareholders.

So we will make sure of that, but we have a lot of employees with IPO, stock grant, from the IPO, they are now in the money. So we will buyback enough cancel those out and that’s what we started to do in Q2.

And then, I think, other than that you should expect, our parts being opportunistic if something happens, you should expect essentially for us to reserve for M&A for the balance of this year because this is going to be where, like I said we are seeing it relatively imminent stuff.

Rich Repetto - Sandler O’Neill

Okay. And I guess, well, I don’t want to waste anymore, but the magnitude of the European capital requirement, I guess, that has to be back then too. But anyway my second question would be in regards to interest rates and we know about the carry trade, but I’m just trying to make sure I’m catching the overall impact?

Are there other things other than just the macro impact on currencies and the carry trade, as far as sensitivity of your model to interest rates and a little bit about like, how we look at in July regards to revenue capture as well?

Drew Niv

We don’t have rev capture for July yet. My sense is ranged on market that pretty -- that was pretty weak and the, I mean, the market was pretty weak that we’re probably on the lower end of the rev capture, but that’s kind of an estimate. That’s from my gut feeling.

We have the, in the mix I think there was more again in this month I think than it was, but I haven’t looked at it. But I can say in terms of, sorry…

Rich Repetto - Sandler O’Neill

Interest rate.

Drew Niv

… the first question, the interest rate question is that, interest rates are something that, think of them as sort of the basis fundamental model for looking at currencies. And so without changes in rates, if you think about your equivalent rates like as an analyst, who is trying to analyze currency movements, the predictable -- the most predictable model and the base model everybody used to use was interest rate differentials and obviously, the most reliable was short-term differentials. And there was like the difference between the 10 years of let’s say the German bonds and we have treasuries and those type of things.

As those have become less reliable in the last few years, just the macro funds in FX have had a terrible time trying to predict currencies. You’ve had a breakdown in those models and that affect the institutional business, that affects the retail business because the retail --our crowd is looking at a lot of the same stuff.

So having rates come back is important not just from a revenue perspective, but from -- that is the basis of how currency trading works. Currency trading is really a part of fixed income trading and it’s mostly and it is part of that complex.

You can see it obviously the reason why it’s sick in most banks because it’s part of fixed income. I think you’ll see it as rates are fundamental to that business. And so when that comes back, a lot of piece of the puzzle that are missing come back on lot of levels and we can sort of discuss the main issue offline but there is lots of little that’s needless to say is a much bigger impact in just currencies. It does lots for participation of people in the thing, certainty of analysis which again sort of ties into participation, customers, volumes and the like.

Robert Lande

And Rich, maybe quantify little bit what we could on that. So in 2008 when we last had interest rates. About 15% of our retail trading revenues was derived purely from the spread, we earned on customers’ holding positions overnight and that’s effectively zero today, is very small number.

So we would have had another -- and that’s all margin as you know. So we would have had about another $15 million in the quarter alone, just from overnight positions. So instead of $55 million in EBITDA, we would have had $70 million. Then you have -- on top of it in the quarter, we earned whopping $600,000 on our $1.5 billion of cash. We would have, obviously more than whatever it is, 12 basis points that we managed to do. So that quantifies a little bit.

But then you have something which we cannot quantify which is what Drew was saying about that, a whole bunch of volume and participation occurs because of carry trades. Then people coming in at minutes before 5 o’clock to capture the overnight rate and the like. So you would see that and that’s also a very significant number but obviously difficult to quantify unless you know exactly what kind of interest rate differentials are going on.

Rich Repetto - Sandler O’Neill

Very, very helpful, guys and congrats on a great quarter.

Drew Niv

Thank you.

Robert Lande



Our next question comes from Bill Katz of Citi. Please go ahead.

Steve Fullerton - Citi

Hi, this is Steve Fullerton filling in for Bill.

Robert Lande

Hi, Steve.

Steve Fullerton - Citi

Hi. Quick question on retail active accounts. You had some solid growth in July, in the last few months. Can you talk about the mix of that growth?

Robert Lande

In terms of what kind of accounts it was?

Steve Fullerton - Citi

Yeah. Where are you gaining traction in opening accounts?

Robert Lande

It’s relatively across the board. There is no -- where we have had standouts before, we continue to do. So Asia continues to be sort of our strongest place geographically. But we’re gaining accounts in the U.S. We are gaining accounts in Europe. I mean, we are climbing pretty much everywhere.

You can see in the volume growth -- I forgot which slide it was in the presentation. The volume grew in all the sectors. So account sort of mimics that, accounts grew in all the geographies as well.

Steve Fullerton - Citi

Okay. Great. And then the institutional volume was actually up month-over-month and talk about some of the other proxies that were down. Can you kind of talk about how you are gaining share there and any proxy that we should use, maybe for forecasting going forward given you guys are gaining quick share?

Robert Lande

Yeah. The way you should think about it is we are so small. Our institutional ECN business is so small in comparison to our six large competitors that dominate the space. That unfortunately there’s not a lot of proxies there to use because we are grabbing market share.

We are still rounding for the guys that we’re competing with, rounding error anymore but we’re definitely not a real threat to anyone yet. But that is something that just gives us a lot of room to grow relatively faster than the rest of the industry or even when the industry is not growing simply because we own so little of the institutional trading space.

And that, I think, just leaves us a lot of room and lot of flexibility there because we’re not in any sort of defensive mode, protecting market share. We’re purely in an offensive attack and that’s a good thing. So I don’t have comps for you that much but we’re obviously affected by market conditions.

So having a very quiet July in the FX market does not help but it does show you that we have been able to onboard more customers. And it’s really just onboard more customers from our legacy platforms onto our new organic platform, which as I said in prior quarters, allows us to lower costs for our clients and increase our market share on that clients. I don’t think that our market share increases materially, impacted anyone else’s, market share decrease but not yet. But that’s something we hope to achieve in the future.

Steve Fullerton - Citi

Okay. Great. Thanks.


Our next question comes from Howard Chen of Credit Suisse. Please go ahead.

Ashley Serrao - Credit Suisse

Good morning, Robert and Drew. This is Ashley Serrao on behalf of Howard.

Drew Niv

Hi Ashley.

Robert Lande


Ashley Serrao - Credit Suisse

Hi. So Drew, if you were to focusing on the institutional business, when you bought Lucid, you expressed an interest, you kind of leveraged your technology into other asset classes. What are your latest thoughts there?

Robert Lande

There’s been lots of changes in the FX space. Lucid, think of it as a specialist on -- as we talked about before, the specialist on some of these ECN class exchanges. And therefore they -- there has been lot of changes with these places to market structure in the way they quote and what they do.

So Lucid has spent a lot of time adapting to all of those changes. That has sort of for a very small staff of guys there that has sort of unfortunately put some of the expansion plans. It has delayed them. I can tell you that was the last 12 months but that is not going forward. So we are now in a fairly aggressive way going to start moving toward that expansion. And I think you’re going to see that in the quarters to come and that’s something that we are working very hard on.

Ashley Serrao - Credit Suisse

Got it. And then if I switch gears to your FXCM Pro business. If I look at 2Q, you managed to grow volumes nicely without really sacrificing pricing. Would it be safe to say we reached a trough at this sort of $11 per million traded. And then on the volume front, are we done with all the onboarding of clients from your old legacy outsource solution? And then at what level of volume, do you think you’ll cease to become as you put it, Drew, a rounding error?

Drew Niv

So we still have a little bit less than half to migrate over. So that’s still ongoing. We have migrated more than half of the customers over but we still have more to do, which kind of gives you there’s more upside there in those transitions. There is a lot of preparation we have done to grow this business. We have had hires in the past year in this business that kind of helped us grow that business. We’ve done a bunch of things.

I would say the smallest of the big six is Hotspot at about -- I think recently it’s about the $30 billion or so a day ADV. So I think once we get -- we are eight. So once we get to 30, I think we are no longer a rounding error. But obviously, if you look at the top four avenues there over 100 of ADV each per day. So obviously this is -- that is the end goal. And but I think this is something that to get to Hotspot’s level is sort of our intermediate term goal of what we are aiming for. And I think this is something that is doable.

Pricing, the institutional business is a tough business, extraordinarily competitive. Unlike the retail business where FXCM has dominant brand position. It is able to maintain premium prices to its competitors. This is not going to be the case.

In this business, if you want to have a polar position but -- so if we want to get to $100 billion a day, we’re not going to be able to maintain that level but we’re not there yet. So I think right now, we value money and earnings over market share and our focus there. So if we sacrifice $1, we’re going to do it to make more in absolute dollars not to gain share for the sake of ranking higher against somebody.

Ashley Serrao - Credit Suisse

Got it. Thank you. I’ll get back in line.


Our next question comes from Patrick O’Shaughnessy of Raymond James. Please go, ahead.

Patrick O’Shaughnessy - Raymond James

Hi. Good morning, guys.

Drew Niv

Good morning, Patrick.

Patrick O’Shaughnessy - Raymond James

So my first question is you had some pretty decent growth in your account base over the last few quarters but your customer equity kind of keeps ticking down. How much of that is a function of customers are putting cash to work elsewhere. I think you talked about that a little bit last quarter and can you just, kind of, talk about the dynamics there?

Robert Lande

Yeah. So -- and I would say the first four months of the year, the first three month of the year you had, if you recall about 40% of our balance is are yen balance -- or customer balances are yen balances. And yen devalued by 20%, so in dollar terms as we present here that was down 20%.

But the customer balance is actually growing because the customers are making money. And we’re on-boarding more customers but in dollar terms didn’t show that growth. And obviously yen is, while hasn’t kept devaluing, its still at devalued levels in comparison to last year. So you’re still seeing a big chunk out of that. I mean, without that we would have grown.

In Q2, there’s -- that held steady for there is really the decline -- decline to explain that’s not yen-related is the sequential Q1 to Q2 decline. And that was a small decline that’s largely due to in a more volatile quarter. We had a few big customers with -- holding large losses and that sort of the mark-to-market equities they have is lower and that’s somewhat common in this -- in the industry.

But I think that’s something where you’ll see that kind of cyclical and that kind of turns around. But I think if you look at overall customer growth and what customers are putting with that, that is, we are growing in position for higher balances. So I think that, we have March balances higher through acquisitions and organically about a 100% a year. In the last five years, we perceive to that’s something that we probably can’t do it at that same rate simply because of the scale it is now. But growing down by the 15% a year or so is not unrealistic whatsoever. So that’s kind of the target.

Patrick O’Shaughnessy - Raymond James

Okay. Got you. Understood. Second topic is, I think somebody talked about previously, Drew, in how the CFTC is going to treat retail foreign exchanges rolling spot. Can you just kind of provide an update on what the latest you’re hearing is on that?

Drew Niv

Yeah. So, the CFTC position is still obviously and that’s not changed. The spot FX exemption from Dodd-Frank was meant for deliverable spot and is not meant for what we do which is rolling spot and that hasn’t changed. I mean, now that as required, for example, FXCM and gain in capital for their non-deliverable give up institutional business or institutional customers have a margin account with us because that is rolling spot, that is a swap.

And therefore, we had to register swap dealers which obviously does no -- us no favors on the compliance cost department which is part of that, my sort of ever -- my consistent guidance and the issue that we see those costs keep on going up. But as there is no change from what we’ve said in previous quarters on this issue.

Where we see that is a -- as we mentioned in the past, if you look at the regime that is going to be put into place gradually, so for example for over-the-counter derivatives. So for example, was considered swaps options in NDF in FX. At some point, clearing mandate will be given for those.

We think NDFs should be relatively soon, options some times next year. And that -- then those price have to go to swap execution facility as you guys probably have known from covering other companies. And on the swap execution facilities, they have to have multiple price providers. Now, rolling spot essentially, we believe because swap too will have to go to multiple price providers and kind of the be under the same regime of the dealers now out to be the only price source for its clients.

And I think that’s something that is our business model. And we’ve already complying that and that’s something that we can definitely do and think that the industry will be better off for it. And if you think about right now, our retail FX has given us its -- defined as rolling swap is actually the only swap that is currently because it’s in an RFED, which is an entity at pre-date Dodd-Frank.

It is not mandated by this, if you will, best execution type requirements over there. That is something that will change, we believe will change. And I can’t believe the regulators have spent a lot of time in other regulatory edicts that they’ve passed on harmonizing our regulatory issues with other financial institutions. So this should be around the same.

There’s talk of the same stuff overseas. In fact, I recently was in Japan talking to Japanese authorities. There’s lots of discussions about this issue there. I think this is something that they’ve been studying the issue very carefully, because, in Japan, retail FX is one of the big retail asset classes and actually even bigger than equities in Japan.

So this is something that is very -- is more pressing in a country like Japan. And so, I think this is something you’ll start to see. And we believe that that has a lot to our -- adds to our advantage, both on organic market share front, M&A front and as well as really putting retail into much more good light and legitimate light to remind everyone that most of our competitors do not have our trading model and our principle base dealers on the other side of the retail client bases.

And we do not believe that engenders a lot of trust with the retail customers and that’s something that -- if the regulator edict says that can’t be done, the customers who trust it more. And I think that’s something that will accrue to the industry’s favor in the long run, even though it may cause a shakedown in the short run. It will accrue to the industry’s favor in the long run in a pretty big way.

Patrick O’Shaughnessy - Raymond James

Got you, understood. And then, last one, quickly for me, so you guys had a really strong quarter. I suspect that a lot of other retail FX brokers had a pretty strong quarter. Does that hurt the prospects of M&A in the short run, do they look at the results say what if we can keep doing this, we don’t need to sell?

Drew Niv

It did in the beginning. So like the first quarter you definitely saw as people were improving they were like, you know we’re great. Thank god 2012 ended, now all is well. I think as people are entering, sort of -- even though Q2 was better than Q1 and that was probably across the board for many people, not everyone but many people. That you’re still running into those structural barriers which are now coming more into focus.

So the European regulators much like the U.S. regulators not exactly timely with passing rules and giving lots of warning and clarifying what all those rules are, the CRD IV, for example, capital requirement formulas are still played with exactly what they are going to be. But the deadline is January 1, 2014 for implementation.

And I think that what you are seeing is the -- even though results are better, the structural rules, stuff that’s coming down is going to be -- people are starting to realize that, slowly but surely. And I think realizing that they have no future as an independent operation in such an operating environment. And I think that that’s beginning to dawn more on people.

So we got lead to probably slightly higher multiples on some of the deals, probably because people are doing better. So do they deserve more money per se -- per se completely distressed but do they have an independent operating future? Most of them don’t, simply because -- and its not just the European thing but Europe is a good textbook example of sort of overregulation and I think you’ll see that in 2014 is going to crash the brokerage sector in Europe irrespective of asset class. And it’s going to crush it pretty hard between financial transaction taxes and capital requirements, EMIR which is a Dodd-Frank equivalent.

In 2015, I don’t see most firms having the wherewithal of the capital, the resources to withstand this. And Dodd-Frank and other things in the U.S. -- for example specifically to our industry, if industry trading don’t pass, a lot of our principal competitors don’t -- also don’t stand a chance against that either. And I think that -- especially the smaller ones and I think that that’s something where we see a lot of opportunity that comes regardless of near-term performance.

Patrick O’Shaughnessy - Raymond James

Guys I appreciate the thoughts. Thank you.

Robert Lande

Thank you.


Our next question comes from Arnie Ursaner of CJS Securities. Please go ahead.

Arnie Ursaner - CJS Securities

Hi. Good morning. Many of the questions I have been answered but maybe I can sum them up in a simple question. You used to provide a slideshow that had base EBITDA and then on top of that you would have various initiatives that would be accretive, things like cost-cutting, China, retail on white label, Lucid.

The base EBITDA number we used to use was more like $25 million to $30 million. You clearly are running now at a very different level. To the extent you were thinking about the same slide you had six, nine months ago, how would we think about the base EBITDA and maybe freshen up some of the initiatives you have that would enhance that?

Drew Niv

I think the base EBITDA is very much -- so much subject to the weather. So, as I said in the opening remarks is that we’re someone just excessively gloating here based on good weather conditions that volatility is higher and -- but is really what it was to do is to showcase the fact that when trading conditions are good, our base does rise pretty significantly. And -- so I can’t really put -- obviously the basis is still the 25 because we couldn’t view 2012 as that base.

Robert Lande

That fourth quarter, $25 million in EBITDA, that -- you can never -- never tempt the weather Gods but that really was a pretty crummy condition. CVIX reaching nearly multi, multi-year lows and the like. So, I think as Drew says, I think that still is the base. Now, we’re not in that condition and so clearly the base has shifted with the weather.

Drew Niv

But I would say that upside, you can see some of the upside just in the base that’s what we’re showcasing here. I would say if you go to some of our labels that we’ve announced before have launched. Some have more traction than others. And we look forward to showing you some of that in the near future.

There is a -- if you will, there is sort of other upward cases still remain there and slowly being acted on as you can see from an institutional trading side and others. And so we will definitely be updating that in the quarters to come. But rest assured that graph hasn’t changed, there’s still upside. I think it’s just -- if you will a higher, I don’t want to use base case but to a higher sort of floor given that a better market conditions.

Arnie Ursaner - CJS Securities

Okay. Sure sounds like a higher base case. And then the other question I have, you mentioned several times, you’ve been asked several times about acquisition opportunities. I guess my question is looking at the multitude of opportunities you have, would any of them require or would several of them require any additional external financing to accomplish your goal?

Drew Niv

No. At this juncture, we think we are amply capitalized from multiple acquisitions and obviously going to try to use as much cash as we can, 100% if the seller allows. It’s one of those things that we are amply stocked for this type of stuff and obviously in their present cash generation mode where stocking even more every quarter. So I think it’s something we are very -- we don’t see any need for any other financing in the near future at all.

Arnie Ursaner - CJS Securities

Okay. One more real quick question, you obviously launched the OptionsXpress, White Label for Schwab. And at the time you thought others might react to the fact that they were moving forward and were alive. Is it leading to greater dialogues in the short run and opportunities for you?

Drew Niv

I think they launched about two weeks ago. They put it live on their site, probably nobody hasn’t noticed yet because they are not advertising it. But if you’re on their side, you can see ForEx now fairly clearly as part of their, sort of, all-in-one package. And I think that that’s -- probably take may be a few months or a quarter or two for other people to notice that maybe to be threatened by it.

But that is something that we believe could make a big dent in the market. The value proposition that they bring to the table is pretty significant and absolutely very differentiated than most of the things in the market.

I think that the fact that now you’ve got more -- a few E*Trade and OptionsXpress doing that with their ability to essentially now attract the people who do not want to be full time FX guys and doing FX casually. Everyone is allowed while they mostly do equities or other things.

I think that’s going to start to be a -- enable us to compete against the multi asset brokers that we are competing with, which Interactive Brokers and TradeStation. And it will enable us to really open sort of a whole new segment of the market that wasn’t really previously opened to us because previously since we had to dedicate a pile of money just to FX and you couldn’t do anything else with it because we’ve been operating other products. So I think that’s something that’s gradually going to open up lots and lots of opportunities for us. And I don’t think that will go -- if it’s successful I don’t think they will go unnoticed at all.

Arnie Ursaner - CJS Securities

Thank you very much.


Our next question comes from Ken Worthington of JP Morgan. Please go ahead.

Ken Worthington - JP Morgan

Hi. Thanks for taking my questions. And I apologize if I missed this. But as you think about the competitive landscape, it seems like the market was kind of filled but definitely they were weaker in weakening smaller competitors. And as just kind of mentioned, they’ve been thrown away flying by the better market conditions.

But have the smaller competitors or maybe to what extent of the smaller competitors gone from just surviving to really back to kind of wanting to compete and grow. And if they are wanting to compete, how aggressively are they trying to grow and win share and be aggressive and are there regions where competition is kind of perked up more than others?

Drew Niv

So what I would say is that’s just a function of market conditions, more of a function of regulatory regime. So what you’ll see is sort of my response as to Patrick’s question in places where regimes, regulatory regimes are very suffocating if you will, you are seeing despite their market conditions, our retrenchment of competition because even people who are doing better because of marking conditions are really just getting thrown a life line by those market conditions. They are -- that’s not lean than to actually have confidence in the future and to compete more aggressively.

They maybe do some more desperate things which leads to some pricing pressures but now is the case, kind of in 2011 and ‘12 and the same people are still doing that now. I just like them around. The way you are seeing competition ramped up is in the same places as you saw competition ramp up in 2011 and ‘12, which is in the lighter or regulated jurisdictions in emerging markets.

We’re seeing a lot of people focus there because that is where they feel there is optimism. One, because obviously the macro growth in those markets obviously in private wealth and GDP of those countries but also in the fact that the regimes they are not suffocating. And people feel more optimistic. They have a future there.

Now, if you’re strong in Asia, you feel optimistic about your future periods. If you’re not strong in Asia and you’re just trying to be, you overall don’t feel very optimistic about your future no matter what kind of market conditions are. And I think that if you’re strong in Europe, I think you’re crying in your sleep everyday right now.

I think that this is one of those things that very much mirroring the rest of the market that U.S. and Europe are very much stagnant to down and as the -- and its same in all financial services. Asia is growing and I think that that’s something where we see lots of opportunities in the stagnant to down markets for M&A.

Ken Worthington - JP Morgan

Okay. Perfect. Why don’t you think about kind of may be longer term organic growth and I was thinking about in two direction. One is the client equity and other was on the account growth. So, you mentioned kind of client equity being hard to kind of get a handle on given all the changes in FX.

May be another way to approach it is, from like a net new asset basis. And to the extent you -- no off-hands or good guess at it. How do you think net new assets have changed here in the second quarter? And how would that compare to may be the first quarter. You have that money coming in but is it accelerating and may be like orders of magnitude there. So we can kind of get a sense of what’s going on beneath that total number you’re reporting?

Drew Niv

Yeah. And I don’t have scientifically but anecdotally and this is held steady for years. When the markets are more volatile, more people come back. So dormant accounts that close before or stop trading to start trading again. So they refund their accounts. You have more clients coming in, because they are attracted to the FX volatility, even though these are self-directed clients. So they are, sort of, need that market excitement to get excited to trade.

So market volatility generally leads to more money and more accounts coming in.

And that’s why you got sort of double whammy when the markets are really quite in like ‘12 .Our current acquisition costs are lower -- I mean higher, attracting customers as harder because their market excitement is less.

In higher volatility markets, the market excitement is higher. Generally speaking, you get more accounts and we will get more account equity and that’s the very normal thing and that’s why you are seeing sort of in the past six months in a net new (inaudible) took out the [UGN] movements and all of those things.

I think you would have seen growth there. You are going to have some people sort of have disproportional losses, things like that. So bunch of big customers are kind of skew a little bit, again skew the net.

But if you look at efforts from clients, they are definitely up and there is more of them. We look at -- like I said, these are relationships that held steady for years through the cycles. And in the previous answer also on interest rates, when interest rates come back there is that non-cyclical excitement if you will. Excitement is the wrong word -- reason to trade FX which is for interest rate reasons that doesn’t exist now and that will bring the whole new segment of growth to market that doesn’t -- that’s not even in sight -- in factor now.

Ken Worthington - JP Morgan

Could you actually take a shot at gauging what organic growth is right now -- on a currency neutral manner?

Drew Niv

I think that if you look at the last few years, organic growth was like 18% of current account equity. It looks like kind of the net new asset issue. I’m relatively sure that we are the around the same with probably in the volatile quarter customers are less profitable. So you have to discount that by the fact that ex-Japan where customers are still doing pretty well, customers are less profitable. Also that kind of takes away from that 18% a little bit.

Ken Worthington - JP Morgan

Okay. Okay. Great. Thank you very much.

Drew Niv

Thank you.


With that, I’d now like to turn the conference back over to Ms. Jaclyn Klein for any closing remarks.

Jaclyn Klein

Thanks. On behalf of Drew, Robert and everyone here at FXCM, we would just like to thank everyone for joining us this morning. And we look forward to speaking with you on next quarter. Have a good day.


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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!