FXCM Inc. (NYSE:FXCM)
Q2 2014 Earnings Conference Call
August 7, 2014 04:45 PM ET
Drew Niv - CEO
Robert Lande - CFO
Rich Repetto - Sandler O'Neill
Steve Fullerton - Citi
Patrick O'Shaughnessy - Raymond James
Ken Worthington - JP Morgan
Vijay Gowda - CJS Securities
Alex Kramm - UBS
Ashley Serrao - Credit Suisse
John Dunn - Sidoti & Company
Good day, ladies and gentlemen, and welcome to the Second Quarter 2014 FXCM Incorporated 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 call is being recorded.
I would now like to introduce your host for today’s conference, Jaclyn Klein. You may begin.
Thanks operator. Good afternoon everyone, and thank you for joining us. 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 evening, and presentation slides used during the conference call are available at www.fxcm.com under the Investor Relations tab. A replay of this conference call will also be available later this evening 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 in 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.
Thank you Jaclyn. Good afternoon everyone. The challenging market conditions continued in Q2. Currency volatility which has been declining steadily since June 2013 continued to drop throughout the second quarter hitting record lows near to end of June and continuing to drop in the month of July. The volatility dropped to levels lower than any in the 21 years in the currency volatility index has been calculated. Last quarter, I said that the first three months of this year were the worst trading conditions I had seen in the 15 plus years I have been in this business, and I need to revise that statement that Q2 was much worse.
The headwinds from extremely low volatility and the depressed trading environment can be seen the differences between our performance in this past quarter when compared to the second quarter of last year when we saw volatility that would have been considered mild to moderate, in the historical context, it looks astronomical when compared to the conditions this year. You can see this in the comparisons of our revenue, EBITDA, and EPS on slide three.
Adjusted pro forma revenues were $97.9 million versus $140.1 million a year ago and $111.3 million in Q1 of this year. Adjusted pro forma EBITDA was $13.4 million versus $54.5 million a year ago and $24.6 million in the first quarter. Adjusted pro forma EPS was a loss of $0.02 per diluted share versus $0.31 per diluted share a year ago and $0.07 per diluted share in Q1 of this year.
Despite the fourth consecutive quarter of challenging trading conditions, each more challenging than in the one that preceded it, we were able to achieve some success in Q2. Growing our client equity 10% year-to-date; on a relative basis, we are weathering this storm better than our competition evidenced by our gains in market share in both retail and institutional markets. The growing strength of our CFD business helped contribute to our retail revenue per million at the high end of our range at $96 per million. Our core franchise remains strong growing client equity and active customers in retail, and volumes in market share in our institutional business. If we exclude the investments in V3 and the volatility-driven decline in Lucid profits, we would have had a slightly positive adjusted pro forma EPS for the quarter.
Turning to slide four. You see an updated graphic on currency volatility, the 20-plus-year trend that’s shown on the top half of the slide. This gives some perspective where market condition sits relative to the last two decades, while no one expects volatility to return to the levels we saw from late 2008 to mid-2010. It’s not an unreasonable expectation that conditions would fall within the range seen between ’93 and 2008, the moderate volatility that was saw in Q2 of last year is squarely in the middle of the volatility of that 15-year period. The actual conditions we’re dealing right now are highlighted in the graph on the bottom right, which shows currency volatility for the past 13 months. The bottom line is these are very challenging market conditions for all participants in the FX industry. On a relative basis, we’re still faring better than others. The trading conditions in the first half of this year were not only characterized by lower volatility which impacts the volume of all brokers, agency, or market makers, but also by narrow trading ranges present serious challenges for brokers making markets against their customers.
As an agency-model broker, we are not exposed to these levels of market risks, which are forcing many firms to exit the industry, presenting opportunities for FXCM. As we’ve said in prior quarters, we do not assume that market conditions will improve. Instead, we focus on what makes sense in this environment; cost controls and opportunities to gain market share organically via new product introductions and through acquisitions of other brokers. When volatility does return, and we believe that it never really will, FXCM will be well positioned to prosper for this as we have demonstrated in the past.
Turning now to slide five. We have our retail metrics for the quarter; average daily volume was $11.8 billion in the quarter. Retail dollars per million was behind of our range at $96 per million, principally due a change in the [end] mix and increasing contribution to our CFD business.
Retail DARTs followed overall volume decline in Q2, and geographic mix of our volume did not change materially.
Moving to slide six, our institutional business. Our institutional volume continued to grow in Q2 reaching our record level of $596 billion. FXCM Pro and the FastMatch platforms are clearly gaining traction and picking up market share, and the results are continuing as Rob will show you later in the presentation when reviewing our July operating metrics. July was an all-time record for volume for our institutional business, and all this accomplished in the month of record low CVIX on average.
Turning to Lucid, Lucid’s revenue for the quarter dropped 24% to $11.8 million versus declines of 20% to CME, 18% at Thomson Reuters, and 13% EBS, although the EBS number slightly understates the decline on an apple-to-apple basis, and it includes volume for EBS Direct, which Lucid does not participate in.
Lucid, as many of you know, is more impacted by broader institutional market conditions, but margins remained high with EBITDA at $6.8 million. Q2 was our first full quarter of operations for V3 market. Integration is proceeding as planned. We are partnering with Lucid to broaden the opportunities for their successful algorithmic market making into new asset classes. We believe that the cost structure we have in place will enable us to breakeven in low volatility environment like today. There’s a tremendous upside should volatility pick up in different asset classes and in V3 trade.
Turning now to slide seven. Despite considerable headwinds for market condition, FXCM continues to pursue growth both organically and via acquisition. As stated earlier, despite market conditions we’ve grown client equity by 10% this year in part by pursuing larger clients.
Low volatility not only dampens enthusiasm and activity of our existing clients, but it makes it more challenging to attract new ones.
The currency volatility index is up by more than 50% in the last 12 months. Despite that, FXCM’s active retail accounts have declined only 3%. While our goal is always growth in absolute terms, maintaining our current level over the past year is a measure of the strength of our ability to add new account.
FXCM’s brand, scale, and reach are global enabling us to find pockets of growth in an otherwise staggering environment. These may be in emerging markets, could be in established markets where we’re gaining share at the expense of our competitors. We have gained share in the United Kingdom, in France, in Australia, and among active traders in Germany. Gains in these markets and the success of our institutional platform are examples of our ability to gain market share organically.
Challenging market conditions like these present market leaders like FXCM with opportunities is to grow via acquisition. This is a subject we address every quarter highlighting both the abundance of opportunities and our disciplined approach. While we would always like to fill this space with a long list of completed transactions in our real world, it doesn’t happen that way.
Smaller acquisitions of client accounts, as our late May acquisition of the U.S. accounts of FXDD, are relatively straight forward in nature. Larger acquisitions of multinational brokers are more complex. We continue to pursue a number of these acquisitions and are in active discussions with multiple targets and will of course let you know when there is news to report.
Given the rather extraordinary market conditions in a number of opportunities that we’re still engaged with, we are extending the timeline we establish for use of corporate cash for either acquisitions or buyback, while deadline extensions aren’t exactly credibility enhancing, and we understand that many of you are disappointed. The current set of market conditions present a once-in-a-life-time opportunity to buy significant growth on the cheap and trigger meaningful consolidation in the industry.
Moving to slide eight. As we mentioned earlier, our CFD business remained strong in Q2 and has potential to grow further. At present, we offer CFDs on [indiscernible], metals, and energy, recent initiatives to begin more agency trading on some of our offering, and shifting our CFD offering are bearing fruit against the very tough environment. We have not offered CFDs on single shares, a significant source of revenue for many of our competitors, especially in Europe. We will be soft launching our single associate [indiscernible] offering in the full.
We believed the revenue opportunities from these are significant both from trading single share CFD themselves and also from FX revenues we currently lose from European clients who want to trade both from within a single account.
As we described in prior conference call, this is a $100 million to $200 million revenue enhancement opportunity that we are in a very early and promising beginning stages of capturing. Finally, we’ve always focused on keeping operating costs in check. If the market environment persists and we do not see the organic or acquired growth materialize, we will make significant cost reductions at any given time across our global operations.
We have geographies that are generating solid profits and others that are not. We have initiatives that are currently producing results and others that require additional investment or time. If we do not see improvement, we set the bar higher and we make the cuts in geographies and initiatives and other expenses that fall below that higher bar. We’re talking about reductions in the order of 10% to 15% or even more. To provide a little more color on the current expense structure, I’ll turn this over to our CFO Robert Lande to take you through this in more detail.
Thank you, Drew. Turning to slide 9 – before going through the results, I thought I would take you through, as I have in the past, of our operating-end costs before and after including V3 markets, which you will recall we started consolidating at the end of January this year. The top part of the table are our operating costs excluding V3 markets. The middle of the table are V3’s costs. Note for Q1 that is for only 2 months versus Q2, which is for all three months.
In the bottom is what we report on a consolidated basis. Focusing on the top, excluding V3 markets, you can see that total expenses rose modestly sequentially by $200,000 to $62.6 million and are down $200,000 from the second quarter of last year. Sequentially, from Q1 of this year, compensation was down a little over $1 million from last quarter consistent with what I said on last quarter’s call, marketing expense was up $600,000 to $7.1 million. We believe this is an anomaly and actually we expect marketing will be coming down from Q1 and Q2’s levels in the coming quarter as we further rationalize marketing spend.
Communication and technology was down $500,000 sequentially from Q1, primarily due to lower software costs. Trading costs were down $400,000 from last quarter, due to lower activity in volumes in this quarter. And G&A was up $1.5 million due to higher annual regulatory levies in the UK. As some you may know, when the FCA, the UK regulator has to bail out a bank or a brokerage firm, it spreads the costs around member firms, and we’ve been given a new annual levy for this year. We only receive notice of the actual levy around this time of the year.
Turning now the V3 box in the middle, you can see as we told you that we were going to bring costs down. In Q1 ’14, V3 has $4.9 million just for the first two months as the deal did not close till the end of January, and this quarter for full three months, V3’s costs were $5.2 million. As Drew indicated, we continue to rationalize costs of V3, so that it can make money even in this low volatility market and expect further reductions going forward.
As Drew mentioned in our highlights, if we exclude the investments that we’ve made in V3 and the volatility-driven declines from Lucid, our adjusted pro forma EPS would have been slightly positive for the quarter. Turning now slide 10, our income statement presented on an adjusted pro forma basis; revenues on the retail side were down 29% in the quarter, a reflection of volumes being down 33% versus this time last year, and the CVIX being down 35% from the same time last year.
You will recall Q2 of last year was our best quarter of the year and in fact of FXCM history, with decent yen volatility as well as the Fed announcing that it was considering tapering. The decline in volumes were partially offset by a better revenue per million of $96 per million in this quarter versus $90 per million for Q2 of last year.
Likewise, institutional revenues were down 31% or $10 million with $13.7 million of the decline coming from Lucid, which is likewise heavily tied to currency volatility and volume. I think I’ve covered off expenses pretty much on a previous slide versus last year total operating expenses including the loss on equity method investments were up $4.8 million, and that is all – and then some due to the inclusion of V3 markets now in our results. Without V3 markets, operating expenses would actually have been down around $400,000 from Q2 of last year.
Depreciation and amortization is up $600,000, primarily due to our capital expenditures over the past year, and the incremental amortization of intangibles brought from our acquisitions of Faros, V3, and FXDD’s U.S. clients. Interest expense now has two full quarters of interest expense on our convertible bond, which we only did at the end of May last year. Our effective tax rate was just under 26%, and after minority interest, our net loss was $1.5 million or $0.02 a share for the quarter.
Adjusting for various non-cash items such as non-cash equity based comp, the non-cash interest component of our convertible bond interest, and our non-cash amortization expense. All net of taxes, our EPS would be positive $0.05 per share for the quarter as Drew mentioned in the highlights, and would have been $0.18 per share for the year-to-date.
I do not propose going through the year-to-date results, but happy to answer any questions you may have later during the question period. Turning now to Slide 11, our balance sheet at the end of the second quarter as compared to the end of the last year; since year-end, our total cash has declined by $16.5 million to $348.8 million, although the main reason for this is the acquisition of the V3 assets, and you can see the amounts now held at brokers couple of lines down, which is actually cash as well, and that increased $18.9 million from year-end to $24.4 million.
Client equity growth, as Drew pointed out, has been very strong increasing $121.4 million or 10% from year-end to $1.31 billion to an all-time high quarter-end number for FXCM. Only $23 million of that was from acquisitions, namely in the purchase of the U.S. FXDD accounts last quarter, and the rest is all organic. In the quarter, we also amended our credit facility to give us some flexibility in this environment, bringing up the maximum debt-to-EBITDA leverage ratio, removing certain one-time expenses in the computation of our EBITDA for the last 12 months like the FCA fine, and restitution that we paid, and at the same time, we brought down the total size of the facility from $205 million to $150 million, which will save us on commitment fees.
Worth noting is that we have the ability to account in EBITDA the pro forma EBITDA of any acquisitions we make as if we had owned it for the whole 12 months, a pretty attractive feature. So, in all, this facility, the credit facility is well setup to accommodate acquisitions together with the cash we have on hand. Right now, as you can see, we are only $25 million drawn on the credit facility as of June 30. We finished the quarter with total stockholders’ equity of $644.7 million versus a little under $100 million in minimum regulatory capital requirement, so we remain very well capitalized. In sum, FXCM has a strong balance sheet with significant liquidity, which we believe positions us well in this environment versus our competitors.
Turning now to Slide 12, our July operating metrics. July, as you could see from a CVIX chart Drew took you through earlier, was a new all-time low on average for the CVIX, although it did spike up a bit the couple of days. Total retail volume in July was $263 billion with $11.4 billion a day on average in our retail business. Active accounts increased from June 30 to a 179,082 in total. The big story of the month though was the continued market share gains being in our institutional business. As you can see, July’s $262 billion in volume was an all-time record for FXCM’s institutional business, and we accomplished this in the worst month on average for the CVIX since they began recording this statistic. So, we’re very pleased with the traction that our institutional business is gaining.
And now to wrap things up, I would like to turn it back over to Drew.
Thank you, Robert. Moving on Slide 13, as we have stated almost in every way possible during this presentation, market conditions are terrible for FX. Yet, despite this, life must go on and plan must made for FXCM to prosper without volatility. FXCM is committed to this goal whether we acquire our way out of this situation by increasing scale and consolidating competitors or right size the business to its most profitable franchises, while we appreciate many of you are impatiently waiting for this to happen, and we have been slow to deliver, we will deliver it in a way that it is sustainable and does not seek to appease you for a quarter or two during the long-term fashion.
Thank you very much and now operator, I will turn it back to address some questions.
(Operator Instructions) Our first question comes from the line of Rich Repetto of Sandler O'Neill. Your line is now open.
Rich Repetto - Sandler O'Neill
Hi Drew, Hi Robert. I guess my question, Drew, is just a little bit more color on the acquisition front, because given the conditions you’d expect, I guess, a little bit more succumbing to recognizing that it may not come back as quickly as some of these people, I would think, expect, so I’m just trying to see, and you did say I think last quarter there were, I believe, four targets, or I don’t know how would you categorize it, but four potential acquisition targets, where does that number stand and just more on that, the acquisition front?
I mean in terms of targets, it is still the same in terms of discussions are still ongoing, some harder than others have joined some have dropped. I think there is a -- the big thing, the problem is that, industry participants are shell shocked by the -- like I said in the beginning, people thought Q1 just can’t get any worse, Q2 just miserable, July continues that trend. I mean, it’s very much something that I think obviously plays into the value that we’re offering in consideration and something that people are finding hard to accept, given there’s just the delta, and this stuff is changing so much. So, this is something that is ongoing, and we think we need to give ourselves more time. It’s just very unlikely to put this in historical perspective as we’re going to find a time where the stress is so high in our industry where we can buy growth this cheap, and sort of our little self-composed deadline sets us up to in a bad negotiating position if you will. And I think it is just something that we will -- in another six months, we will be able to flush it out whether this can be done on a reasonable basis or are people just going to crumble away by themselves, and we’re just gaining market share as people die.
Either way, what I can tell you is the number of participants is dropping by the sheer size of the decline in volume, so therefore the client revenues for these firms. And as I said in the last call, people are producing significant net losses. Now, a lot of them are not able to sustain that for much longer, so we think giving ourselves a little more time really gives us the limits as to whether we’re able to acquire them or not or they just wither and die, but I don’t think many will turn, short of a miracle happening tomorrow. This is something I’m confident of, so I think we are in a good place.
Rich Repetto - Sandler O'Neill
Okay. And then you said – my one follow up would be, you said the alternative plan if the cash isn’t used for acquisition or the return of capital, and I guess could you talk a little bit about that? I guess the scenarios where there isn’t the acquisition, both I guess the cost cutting, a little bit more specific than the 10% to 15%, and how are you coming up with that numbers as well as the use of cash, if something doesn’t happen in the six-month time?
The use the cash as what we spoke about before, so it really just goes out another six months, the use of cash is still those share buybacks if we don’t have acquisitions. I think the -- from a cost cutting perspective, I don’t want to give a lot of specifics as to the sensitivity of it, but I can’t tell you that what I said in the prepared remarks was that we have geographies that are still doing well and are very profitable, we have geographies that are not, we have certain business lines and certain initiatives that are doing extremely well today, certain ones that are not, and in a normalized situation, we would let – let’s not write a little longer because we have the long term faith in it, in if this situation that we’re currently in keeps going, then we don’t have the luxury of that time, and we will obviously cut loose those geographies and those initiatives.
Rich Repetto - Sandler O'Neill
Understood. Everybody understands it is a tough environment out there. So thanks.
Thank you. Our next question comes from the line of Bill Katz of Citi. Your line is now open.
Steve Fullerton - Citi
Hi, it’s actually Steve Fullerton filling in for Bill. Can you just talk about what’s driving the market share gains for institutional, and where you see that going forward, how big the opportunity may be from here?
Sure. On the institutional business, I think we’ve kind spoke to a little bit about in the prior calls, not much difference, it’s a mix, so there’s a few factors. one is emerging market clients, a lot of institutions, mainly banks are continuing to scale back coverage of emerging markets in terms of having less sales people and traders in those areas, having less, just in general, coverage in FXCM because of our heavy exposure and presence in the emerging markets. We have a lot of contacts in these institutions, we cover them pretty well, that’s our bread and butter, and therefore we do very well with those clients. So that’s, I would say pocket number one we’re gaining market share. Pocket number two where we are gaining market share is the high frequency trading space. As everybody knows, obviously this thing is under a lot of debate. In FX, the debate is different because this not being an exchange-traded market mainly, the HFT debate in FX is not so much the government against the HFT/exchange community, it’s the – the debate is more the banks versus the HFTs. The banks have undue influence over a lot of the ECNs on the FX-base. The ECNs have been making many of them, many anti-HFT if you will measures that they have taken that people in, like, randomizations and other things that in equities, the anti-HFT components can only be dreaming of.
That’s already occurred in FX or in multiple platforms. That has obviously hurt the HFT community participation in those platforms. Our platform obviously seeks to make it completely – take a completely different approach than we have, and because of that, we believe are gaining market share that are offering better prices to our clients because we have participants more in -- doing in a more intense way where they cannot do in other places. That’s primarily the two of the reasons, and we think that’s continuing because both of those trends are ongoing structural, and very much politically, if you will, engrained in both places as organizations cut back, and most of the FX organizations tend to be British or American-based companies. The first place they cut is Asia, the first place they cut is emerging markets. They don’t generally -- the people out of just sheer human factor of it, do not cut their headquarters. So, that’s something where we see that’s where coverage is slipping and that’s where we’re taking advantage.
Steve Fullerton - Citi
Okay, great. And then just to touch on -- can you provide some detail of the regulatory environment in Europe, I guess might as well go around the globe, how is that affecting your business and how is that affecting possible deal targets?
So the regulatory environment in Europe is very interesting. So, obviously the Europeans are taking the slow and crawl approach implementation that the U.S. took with Dodd-Frank, and is still taking with Dodd-Frank, the Europeans are taking that same approach with MiFID II and EMIR with most of this going to be implemented in ’15 and ’16, although some stuff has already been implemented, so right now most of the European regulatory changes are mostly contributing to, as we keeping saying, just the higher compliance expenses in terms of higher headcount of people we need to do, technology resources for extra reporting and extra just more check-the-box things that need to happen. As enormous amount of regulatory burden that is being piled on in Europe over the past year or so and that obviously keeps trending up, as MiFID II and EMIR gets fully implemented in ’15 and ’16, some of the mandated transparency that’s going to take hold is going to obviously put further pressure on the industry. We think obviously way before then, volatility is going to cause consolidation in anyway, but this is something that will put pressure on the lot of firms in the industry also, again all of this is -- on a net basis, short-term is not positive obviously in this environment for us, but on a long-term basis it’s positive for us because it will lead to extreme consolidation as we think most people just cannot survive, because these rules obviously were meant for much larger institutions with much more resources, and most of these firms are able to muster and the fact that the rules applied to all financial institutions equally just as it applied to big banks, make it just more harder for the smaller firms to deal.
Thank you, our next question comes from Patrick O'Shaughnessy of Raymond James; your line is now open.
Patrick O'Shaughnessy - Raymond James
So, just want to follow up on the consolidation talk, and I’m just curious what do you think is going to be the point of capitulation for some of these smaller FX brokers, just you guys obviously had a ton of scale and we can see what your numbers are. So I would imagine that these smaller guys are basically bleeding cash at the moment. So, I get that they’re shell shocked, but at some point don’t they basically have to look for an exit strategy and what’s going to be that trigger for them?
So with some people the trigger is going to be their regulatory capital -- they’re going to fall below it -- and they’re going to get visited by regulators and I tell them to get out or fold tent. So that’s usually a trigger point in some jurisdictions those are higher requirements and in others they trigger faster. In some jurisdictions, regulators are more on the ball than others about doing that. So, it’s just depends where that is but that is something that’s very sensitive in a lot of places we think that’s trigger point for some, or the anticipation of such an event. The thing about shell shocked, why it is important is that as I have said before a lot of these firms are run by entrepreneurs, non-institutions there is no institutional ownership with extraordinarily emotional decisions, there is a lot of people, this or group of people have worked with their employees for a long time, they’re attached to that, they’re attached to their “baby” as I’d like to call their company and so.
This is not a simple decision for people and I think that this is something that is very understandable. I understand it perfectly. I think most people do. It is just, it’s kind of intuitive that it’d be this way, but these are -- if you look at the headlines and this is kind of what I think fooling people would like, if you read the political, when I say political, -- world event headlines okay, it would seem that the market should be bursting with volatility. If you look at actual market movements there it looks like the world is at peace and there is absolutely nothing going on, right, no that ISIS has captured I mean Iraq and go flood out the country.
And I think with that those are the kind of things that people look at those to discrepancies and they believe that vol just has to be around the corner, be at that eminent rise in interest rate, but eminent rise of speculation of rising interest rates or again political turbulence be it in Ukraine or Iraq or other places effecting oil and other things. I think this is something where if you look at the headlines they screen volatility, if you look at the market there is not, and I think that just -- I think that’s leading a lot of people to just have a lot of false hope, but this is I think I have said this before on an average, these firms have been around for 10 plus years.
So one that’s good because most of them these owners have not had liquidity for that longer time, but on the other hand this is their life’s project and this is a very difficult decision, so that’s why it’s taking so long. I think this is something though that like I said, if the situation continues it is a mathematical inevitability that these firms will close. They may not tell to us but it is a mathematical inevitability that they will close.
Patrick O'Shaughnessy - Raymond James
Okay, great. I appreciate that detail. And from my follow-up as we’re looking at Lucid’s performance and you’ve touched on this in your prepared remarks but it does seem to have underperformed some of the larger venues whether that’s Thomson Reuters or whether it’s ICAP, how is the current market environment affecting its ability for Lucid’s market making capabilities to actually participate on these venues?
So unfortunately with vol being so low this is just disproportionately bad and they are underperforming any sort of -- if you will kind of the weakest portion of our business currently is sort of the Lucid and V3 businesses and we would have actually had a much better quarter without these, but this is therein the prop trading business and prop trading business in FX is largely a volatility driven business and they’re under-performing venues because it is such a record low that the opportunities presenting themselves are little to none.
If you think about sort of when the markets are really moving there is bigger -- think about like the intra-minute, intra-second movements in the markets are wider because there is bigger orders coming through and things like that. Right now, when markets are in such tight ranges, it’s essentially primarily it is because participation is down and it’s disproportionally down and the macro-funds doing lots of trading therefore the banks hedging those trades in large amounts, so there is a growing amount of that, that one element of it.
And obviously one of the biggest issues is that ECNs have in FX is that banks who still directly deal with the majority of clients in foreign exchange, essentially internalize large amounts of their flow and the lower volatility the easier is for them to internalize a larger portion and so those portions really reach essentially the less volumes from clients is reaching these ECNs and I don’t want to suggest that these ECNs are largely into dealer venues, they’re not , but the dealers make up a big portion of the trading on these ECNs and I think that this is something that, that is hurting the ECN market. Again all of this snaps back into gear when the volatility comes back and therefore opportunity comes back.
So I think this is something that Lucid -- they keep telling me and we keep improving things that -- they have never today if you ask them, they will tell you that they never had a better outgo and never been in better shape more put together than it is today, they’re obviously fighting very hard for every penny, evolvers to come back they would outperform historical performance because of the fact that this environment has made them by necessity get better and better and I think that is something that just like with us they can’t just use that excuse every quarter. And therefore they’re moving and one of the reasons behind every three purchase was to move all that intelligence and all that research into other markets which are more volatile and so have non correlated volatility like some other commodities and futures in commodities they’re not related to interest rates and the interest rate complex and other things where all of this stuff is tied to.
Thank you. Our next question comes from Ken Worthington of JP Morgan. Your line is now open.
Ken Worthington - JP Morgan
Hi good afternoon. First on Lucid the three view paid for Lucid with deferred payments I think it’s sort of earn out. Based on what has happened with EBITDA and revenue we expect a decline in the next share payment and is there any claw-back on what’s already been paid?
No. So I guess there was 9 million shares in kind of 3 million shared tranches one that just happened and then one next year, keep in mind while this is not as strong as they have been – and it is still very profitable and it’s still generating decent amount of EBITDA year-to-date. So there isn’t a provision for claw-backs and as for the next payment, next year we’ll wait and see but I think it’s still reasonable valuation that we got on it even this is kind of where we are at.
Ken Worthington - JP Morgan
Thanks. And then on the customer balances a couple of here , did FX have any impact on the increase and if not why are balances increasing if volume volatility you’re finding the successful levels what kind of customers coming in I thought it may be like carry trade type of investor so any flavor there. And then are they levering up their accounts giving the low level volatility and if so to what magnitude is leverage increasing within the accounts?
Let me start leverage I honestly have not checked so I don’t know I can’t answer that question we can get back to you on that, it would be reasonable to say people are leveraging more but I’m not sure we haven’t checked that fact. In terms of balances too, the balance is actually is a very optimistic picture, so as we said majority of the balances were organic only of the 120 something only 23 were from FXDD so about 100 is organic increases and it came from two sources, one is, the death of competitors okay. So as I have said before obviously those people are not selling to us but there is people dying, death is not stopping just because people are [indiscernible] that’s happening because people are bleeding cash and closing business.
So there is a decline in competition, that is happening that is one source and I would take that at about 30% of the increase and rest of it is the fact that in range bound markets retail clients tend to do much better especially the bigger ones and what we’ve seen is increased customer profitability and therefore increase balances especially for our larger clients and that is obviously is one of the reasons why, and if you recall the last conference call we spoke about what’s interesting about this what’s doubly hard for the competitors who are market makers in this space is many of them just – what we call an industry lingo are just B-book players, meaning they just take the other side of a lot of their clients’ trade now all that significant portions hoping as volatility does the job of those clients losing money because of very high volatility but in the low volatility environment customer just disproportionately are not losing and obviously some are making as you can see with our balances and that is having obviously a very bad impact on the people who are on the other side of that because that’s their money that being taken where with us obviously that’s not the case.
So that’s something where we think there was an extraordinary amount of pressure why we believe in the M&A pieces, is this pressure is not just volumes and increased cost because volume decrease and increases cost because of compliance. We’ve now entered a new dimension that’s extraordinary where the overall clients are doing well (inaudible) and the bigger clients and this is something that is pressuring lot of the market makers in the business and something that we are obviously beneficiaries.
Thank you. Our next question comes from Arnie Ursaner of CJS Securities. Your line is now open.
Vijay Gowda - CJS Securities
Hi, this is Vijay Gowda for Arnie. On the revenue per million side how much was related to the changes in currency mix versus the structural shift to more CFD revenue? And then as a follow-up, if we’re going to be introducing the single share CFDs in the fall could that give sort of more permanent structural lift to the historical range?
So, I don’t have scientific numbers for you on that either. We will have to get back on that because we didn’t check 100%. All I can tell you CFDs had a disproportionate impact that is continuing in July as well that is something that’s we think again I bothering it has this disproportional impact. And it is something that we think that is going to become more structural because as we increase our share of CFDs given the two initiatives we have is one of the agents in the index energy business as well as which increased market share there as well as introducing the single share CFDs. This will have much higher structural way of bringing up the dollar per million until the over the next 12 months I think you will see that play out, it should enable dollar per million, from the dollar per million contribution from CFDs to rise [indiscernible] sort of other things that may happen.
Vijay Gowda - CJS Securities
Great and then switching gears a little bit, now that you won’t be free for a quarter any early takeaways in terms of Lucid’s ability to integrate its best practices despite the environment?
So I would say by nature of our obsessive compulsive behavior on just things that irritated by cost. We focused on cost in a big way and the cost reduction at V3 as Robert highlighted is very much under control a lot of that is Lucid as a culture brought into V3 about being able to do things much cheaper in a much more cost effective fashion as you can see obviously from the EBITDA margin. In terms of implementing the Lucid algos into V3 that’s not yet in full swing, but still in development. So right now the V3 revenue is coming from all the V3 legacy desk that we kept so to remind you when we did the deal. We dropped most of the training desks there that’s where either not consistent or not doing well. We kept only the best of the best that they have.
Those legacy trading desks are doing well despite pretty dramatic decline and volatility which obviously affect their business in a very bad way and we are now brought down cost to the point that even the legacy business should be a very-very profitable business it welcomes back. And we should not lose any more money and actually in July – I meant to say this is, in July V3 was profitable, so while in Q2 we lost money. So that’s kind of signs of a turnaround that’s all the legacy business we believe some time in the fall, we will start implementing on a more industrial scale some of the Lucid’s marks into V3 and kind of that experimental phase of that, which is now being down, will end and I think that will by end of the year that should be in full swing.
Thank you. Our next question comes from the line of Alex Kramm of UBS. Your line is now open.
Alex Kramm - UBS
I wanted to actually kind of like to go big picture question, I think it ties in some of the questions from before but obviously we’re discussing a lot of the cyclical pressure into the business and I certainly appreciate that, but I do wonder to what degree management and maybe even the Board goes back and looks at the business and the account growth and other metrics and sense are we meeting something because when you talk to some maybe like smaller FX players maybe even some up starter out here, some of those guys actually still growing very nicely.
And I see volume growth despite the overall environment, so just wondering, if when you look at your business, do you think now you’ve become so big that you have a lot old accounts that are not doing much maybe you are not attracting the right accounts anymore maybe this whole agency thing which is great and then seems to be the right way to do business maybe it’s hurting you because people are not coming to you because your spreads are not tight enough, things like that, any sort of metric you can give us that we still confident that you are in fact attracting good accounts and that we should be hopefully because you’re so big and it is sometimes tough to see.
Yes, and I think that’s a great question and we’re going to be talking a lot more about that in the future as to give you more detail and kind of if we have to do, we do not want to do it for competitive reasons if we start making cost cuts as we talks about earlier we are going to kind of lay it all out a little bit more details to give you more transparency and I think we will start to answer your questions a little bit more so let me kind of give you a preview of it just in broader terms. So, we have geographies that are growing fast, are doing quite well, cost are lower, not suffocated by compliance as much obviously some but not in a crazy amount and we are doing really well, there and even though there is lower volatility so revenue per client is down, client growth is up a lot, when I think client growth it is the account equity growth because we’re consciously raising minimum account balance as in doing things to -- if you will extricate ourselves out of smaller and unprofitable clients into bigger and more profitable clients. So their account numbers per se are some misleading the account equity is actually pretty good and remember we get paid in percentage terms so account equity counts more.
The thing I would say is this we have some geographies that doing quite well in terms of growth and some geographies are underperforming fairly dramatically as well and some of that has to do with nature of what’s going on in those geographies and some of it has to do with the fact that they (inaudible) pricing pressure they are higher I would say this FXCM charges anywhere between 70% we’ve said this before between 40% to 70% more than most of our competitors we’ve not gone in to massive price wars with our competitors as we could for obvious reasons of wanting to preserve the bottom line is being more careful about it and our model and our brands and the trust that people have with us continues to enable us to charge a premium for our service. If in certain geographies that proves not to be the case I know in the long run then that then we can take that step but I can tell you, what sort of drowned in here is that what you are seeing is an extraordinarily diverse business in many many geographies where you’ve seen a consolidated view and it’s a tale of 10 cities. So, there is 10 different stories inside this one generalized story, some are great stories some are not so great stories and we will obviously let’s say from the cost-cutting perspective the one that continue to be miserable tales we are going burn them down.
Alex Kramm - UBS
Okay, that’s fair enough and then just one quick one for Robert, I might have missed this at the beginning, but obviously the share count dropped a lot because of I guess I don’t know if it’s earn out or whatever you call that, but is that not a good share count to use going forward and I don’t know what the end of period share count is that we should be using so basically my question is what the share count next quarter?
You are looking at GAAP or you’re looking at the adjusted proforma.
Alex Kramm - UBS
Yes, no it shouldn’t be it, it’s down because of 76 million shares, that was down because there was a net loss and it was an anti-diluted adjustment to share count. So, I think it’s probably look more towards Q1 assuming that we’re not going to be continuing to have net losses and that would be the more for GAAP – for the EPS shares at least.
Thank you. Our next question comes from Ashley Serrao of Credit Suisse, your line is now open.
Ashley Serrao - Credit Suisse
Good afternoon guys, thanks for taking my questions. Drew, can you please refresh us on your financial thresholds for a deal and what are your limits to discipline I mean in other words how aggressive are you willing to be and what size deals are we potentially talking about now in light of the global decline in volumes?
The size deals – I will take those first easy to answer, we’ve said before, we have deals in the works that if all are completed, we are looking at about 50 plus million in EBITDA potential which is obviously quite significant. In terms of what we’re willing to pay that’s a number that’s moving around but obviously we’re being very conservative given the current situation. So we don’t overpay obviously we could have overpaid and done a bunch of deals already but we think that when we do a deal, that deal would be a good deal and so [I’m not give you] – total benchmarks because every deal is little bit different some of the companies are bigger have more scale with better franchises, we pay more for those, some companies are in deeper trouble, have much less valuable franchises are in much greater decline, we will pay less for those, it really depends on the circumstance but we’re trying to do something that has long-term improvement potential that has to build the franchise for multi-year period of time and not do something that would, we know it will be great for few quarters, but then sort of not be relevant at all long-term.
So we’re trying to do something meaningful that means right now we have to stick to conservative estimates but as I said there is some franchises are healthier than others have more long-term value to us and so we’re obviously going to be more aggressive with those.
Ashley Serrao - Credit Suisse
All right. Thank you for all the color there. Rob I had a few clarification in expenses, I believe one of you said that you see potential for moving about 10% to 15% of expenses -- is that of the $68 million expense base this quarter and then what was the UK levy, does that in this quarter and how the V3 rent savings being realized?
V3 had one month under the old rent in Q2, where it was 300,000 and now it’s gone to 30,000 so there will be a little bit of further savings in Q3 which would show up in G&A. So you can see they really don’t have very much G&A at all. And the UK levy is unfortunately something that we’ve received and that’s going to be spread out over the next four quarters until we next receive the next levy. So you can expect now that level of G&A is now a decent run rate. The only thing that I would say is that marketing we expect will be coming down in Q3 to levels we think even lower than Q1 of this year. And then to the 10% to 15% I guess it probably be on the $62 million I’m not sure how much more, we’re going to pull more cost [out of] V3 between now and the end of the year but it’s getting a lean point by that point. And then as Drew said, coming end of the year we’re still looking at the same condition then we’re going to be taking actions to take 10%, 15% out of cost of that $62 million expense base that we have.
Thank you. Our next question comes from the line of John Dunn of Sidoti & Company. Your line is now open.
John Dunn - Sidoti & Company
Thanks, wanted to piggyback of the CFD question from earlier and just now that you’re little bit into the process, how it is playing out and are others moving in that direction and the couple of larger competitors reacting to you pushing in.
I think this is something that a lot of people in this industry have done, doing as well and obviously it is a competitive industry to begin with there is lots of players in it. The good thing about this is that if you recall my European regulatory stalemates between that and volatility a lot of the CFD players are going to die like the FX players and therefore market share is going to grow for the survivors by virtue of that, that’s number one, number two we’re one of the bigger brands in the space and expanding our CFD offering will have an immediate effect we think on market share that we’re able to get because we simply don’t offer certain things today so it’s a very low bar to get single share CFD market share because we have zero today and we actually think that given our brand given the (inaudible) of competitors plus our brand dominance in this industry, we’ll gain a fairly significant market share despite any and all things that other people may want to do.
So I think that’s something that we are fairly confident and something that we know it’s our number one request from our clients in Europe is to offer these products so we have lots of existing clients that would upgrade their account, lots of people who said they’re open, if it had this we’re very confident in this.
John Dunn - Sidoti & Company
And then I know it’s early days but 3Q could be slightly more incrementally better July or June. Can you give us a sense how the quarter is shaping up although like I said it’s early days?
I say, I’ll give you July or we can say by July we saw the metrics, so what I can tell you is this so that digging into those metrics a little bit, let me just go back to Q2 for a second. So April was the worst month in Q2 from a volume perspective, July from an FX perspective was as bad as April so May and June improves a little bit on April and then July went back to April so from an FX perspective, July is as bad as the worst of Q2. From a CFD perspective, we’ve had one of our better month in July and CFD sort of the March onwards if you will of the growing market share of CFD in our business growing market share in -- is continuing so we still see dollars to million corresponding to what they were in Q2 so far because of the increase in the CFD business and what’s -- our FX is very weak in July, our CFD was pretty strong and that’s again one month out of three so I know that one month doesn’t make a quarter but that so far what the conditions are.
Thank you, we have a follow up question from the line of Arnold Ursaner of CJS Securities, your line is now open.
Vijay Gowda - CJS Securities
So just a quick follow-up regarding the acquisitions and the idea that it has the potential of doing $50 million of EBITDA combined. What does that assume for the volatility environment is that current or do we need to recover it?
No, that’s actually was current so obviously as a material upside pretty dramatic material upside is volatility recovers but obviously in our assumption is that volatility obviously stays same. And obviously the big bid asset spread between us and the people who are buying is they want to assume that volatility will recover in those projections that we want to assume that it stays the same and obviously that’s a number that’s not exactly the similar number.
Vijay Gowda - CJS Securities
And then can you just remind people of the general seasonality we think Q3 we can normally see in your business?
Yes so, generally speaking most years with the exception of the few wrap around the crisis years if you will kind of ’07, ’08, usually summers are weaker specifically last half of August is weaker specifically for the institutional business with obvious vacations and such and it’s weaker for retail is the market is dead then it’s obviously weaker so, so far July has been uncharacteristically weaker than it should be. I don’t know about August. So I mean the volatility (inaudible) hard to surprises obviously when it pops up the [power for] any time but so far July like I said has been very muted. So it doesn’t pretend well for having such a some crazy summer of volatility so that doesn’t look like that’s happening as of yet.
Thank you, I’m showing no further questions at this time, I’m turning call back over to Jaclyn Klein for any closing remarks.
Thanks on behalf of Drew, Robert and everyone here at FXCM. I would like to thank you for joining us this evening and we look forward to speaking with you next quarter. Have a great night.
So, ladies and gentlemen thank you for participating in today’s conference. This does conclude today’s program and you may all disconnect. Have a great day everyone.
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