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FXCM > SEC Filings for FXCM > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Form 10-K for FXCM INC.


Annual Report

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

The following discussion should be read in conjunction with our audited consolidated financial statements and the related notes included in Item 8. Financial Statements and Supplementary Data. This discussion contains forward-looking statements that are subject to known and unknown risks and uncertainties. Actual results and the timing of events may differ significantly from such forward looking statements due to a number of factors, including those set forth in Item 1A. Risk Factors.

The following table sets forth Selected Historical Consolidated Statement of Financial Data:

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                                                              Year Ended December 31,
                           2012                  2011                  2010                  2009                  2008
                                                       (In thousands except per share data)
Statements of
Operations Data
Retail trading      $         339,685     $         363,774     $         318,472     $         291,668     $         281,385
Institutional                  62,033                28,908                27,833                21,107                18,439
trading revenue
Trading revenue               401,718               392,682               346,305               312,775               299,824
Interest income                 3,571                 3,644                 2,373                 1,289                 9,085
Interest expense                  277                   329                   116                   125                 2,168
Net interest                    3,294                 3,315                 2,257                 1,164                 6,917
Other income                   12,303                19,581                11,599                 8,666                13,731
Total revenues                417,315               415,578               360,161               322,605               320,472
Referring broker               76,585                92,832                81,365                76,628                64,567
Compensation and              105,779                95,086                76,195                62,588                54,578
Advertising and                30,860                34,897                23,788                29,355                24,629
Communication and              37,113                31,869                27,120                24,026                21,311
Trading costs,
prime brokerage                16,935                 8,167                 6,597                 4,542                 2,655
and clearing fees
General and                    63,043                63,077                31,480                21,911                17,592
Depreciation and               36,773                20,053                 9,306                 6,542                 6,095
Total operating               367,088               345,981               255,851               225,592               191,427
Total operating                50,227                65,597               104,310                97,013               129,045
Other Expense
Interest on                     2,763                     -                     -                     -                     -
Income before                  47,464                65,597               104,310                97,013               129,045
income taxes
Income tax                      8,986                10,816                 4,149                10,053                 8,872
Net income                     38,478                58,781               100,161                86,960               120,173
Net income
attributable to
non-controlling                23,131                46,045               100,015                86,960               120,173
interest in FXCM
Holdings, LLC
Net income
attributable to
non-controlling                 6,389                     -                     -                     -                     -
interest in Lucid
Markets Trading
Net income
attributable to     $           8,958     $          12,736     $             146     $               -     $               -
Weighted average
shares of Class A              24,086                16,567                17,319                     -                     -
common stock
Net income per
attributable to
stockholders of
Class A common
stock of FXCM
Basic               $            0.37     $            0.77     $            0.01                     -                     -
Diluted             $            0.37     $            0.77     $            0.01                     -                     -
Statements of
Condition Data
Cash and cash       $         272,332     $         184,721     $         193,330     $         139,858     $         179,967
Cash and cash
equivalents, held   $       1,190,762     $       1,046,983     $         641,152     $         353,825     $         253,391
for customers
Total assets        $       2,065,170     $       1,487,133     $       1,047,793     $         517,936     $         451,044
Customer account    $       1,190,762     $       1,046,984     $         641,152     $         353,825     $         253,391
Total equity        $         574,915     $         293,432     $         268,007     $         130,788     $         140,454


Industry Environment

Economic Environment - Currency volatility in 2012 was low throughout the year. The daily JPMorgan Global FX Volatility Index was down 22% on average in 2012 compared with 2011. This reduced volatility suppressed trading volumes in both retail and institutional markets.

Volatility in the currency markets significantly impacts customer trading volumes which in turn impacts our financial performance. In general, in periods of elevated volatility customer trading volumes tend to increase, however, significant swings in market volatility can also result in increased customer trading losses, higher turnover and reduced trading volume. It is difficult to predict volatility and its effects in the FX market.

Competitive Environment - The retail FX trading market is highly competitive. Our competitors in the retail market can be grouped into several broad categories based on size, business model, product offerings, target customers and geographic scope of operations. These include U.S. based retail FX brokers, international multi-product trading firms, other online trading firms, and international banks and other financial institutions with significant FX operations. We expect competition to continue to remain strong for the foreseeable future.

Regulatory Environment - Our business and industry are highly regulated. Our operating subsidiaries are regulated in a number of jurisdictions, including the United States, the United Kingdom (where regulatory passport rights have been exercised to operate in a number of European Economic Area jurisdictions), Hong Kong, Australia and Japan.

Business Strategy

Since our inception, we have pursued a strategy to grow the business to reap the benefits of scale and the protection of diversified sources of revenue.

Increase our Scale Goal: Operating efficiency, sustainable results, resilience across good/bad markets

Organic growth supplemented by selective acquisitions

Take advantage of market turbulence to increase share

Expand distribution through white labels and similar relationships

Build a Diversified Revenue Base Goal: Exploit global opportunities, protection against downturns in a geography or segment

Establish/expand presence in best markets globally

Offset declines in one jurisdiction with growth from others

Increase institutional presence to balance our strength in retail

Executive Summary

In 2012, we experienced some of the lowest currency volatility in recent history, with annual averages down 22% from the year prior and the monthly average at year end 43% lower than December of last year. In fact, currency volatility has been declining steadily for many years and finished the year at levels we have not seen since mid 2007. Despite these difficult market conditions, our scale and diverse revenue base enabled us to grow revenues, active accounts modestly while making solid improvements in client equity and cash from operations. Some of our achievements in 2012 include successfully expanding our distribution by adding white label partners including two with significant potential in E*Trade and Barclays; completing integration of three Japanese brokers to create one of the top 10 FX brokers by volume in Japan; and adding scale and diversity in our market segments by purchasing Lucid and launching FastMatch. Our retail and institutional revenue mix has moved from Institutional contributing 7% in 2011 to 15% in 2012 and would have been 25% with a full year of contributions from Lucid. We are also more diversified geographically - volumes from U.S. clients represent 11% of our total in 2012, vs. 21% in 2010. We believe this further diversification will better prepare for unfavorable market conditions, including changes in the regulatory environment.


Our focus on growing retail customer equity was one of the reasons why we were able to maintain volume levels despite the drop in currency volatility. In addition, selective acquisitions of ODL, GCI and Foreland have added to our organic growth and contributed to our growing our client equity by more than 4x since 2008. We believe with $1.2b in customer assets, a cumulative annual growth of 47% over the last four years, we are in an excellent position to take advantage of improved market conditions.

Looking ahead to 2013, we are optimistic that market conditions will improve and our focus on diversification should translate into higher volumes and ultimately generate better returns. If conditions slow again or adverse regulatory changes are enacted, we believe we can hold our course better than our competitors and continue to gain market share. Regulatory changes have been a constant in our market for the past 4 years and we expect this will continue in 2013. While they can present challenges in different geographies or segments, we continue to believe they present us with more opportunities than obstacles. There are a number of regulations some already enacted, some proposed and some potential, which will impact other assets classes making spot FX more attractive; or impacting other FX brokers presenting opportunities. We believe regulatory changes, market conditions and the importance of scale will continue to fuel consolidation in 2013 across all major geographies. We would expect to continue to be active but selective in making acquisitions throughout the upcoming year.

Primary Sources of Revenues

Most of our revenues are derived from fees charged as a markup or commission when our retail or institutional customers execute trades on our platform with our FX market makers. This revenue is primarily a function of the number of active accounts, the volume those accounts trade and the fees we earn on that volume.

Retail Trading Revenue - Retail trading revenue is our largest source of revenue and is primarily driven by: (i) the number of active accounts and the mix of those accounts -high volume accounts are charged a lower markup; (ii) the volume these accounts trade, which is driven by the amount of funds customers have on deposit, also referred to as customer equity, and the overall volatility of the FX market; (iii) the size of the markup we receive, which is a function of the mix of currency pairs traded, the spread we add to the prices supplied by our FX market makers and the interest differential between major currencies and the markup we receive on interest paid and received on customer positions held overnight; and (iv) retail revenues earned from CFD trading, fees earned through white label relationships, payments we receive for order flow from FX market makers and income from spread betting. For both the years ended December 31, 2012 and 2011, 27% of our retail trading revenues were derived from the activities noted in item (iv).

Institutional Trading Revenue - We generate revenue by executing spot FX trades on behalf of institutional customers through our institutional trading segment, FXCM Pro, enabling them to obtain optimal prices offered by our FX market makers. The counterparties to these trades are external financial institutions that hold customer account balances and settle these transactions. We receive commissions for these services without incurring credit or market risk. We also earn revenues from market making and electronic trading in the institutional FX spot and futures markets through our subsidiary Lucid. The income we earn on market making and electronic trading in FX spot and futures markets represents the spread between the bid and ask price for positions purchased and sold and the change in value of positions purchased and sold.

Other - We are engaged in various ancillary FX related services and joint ventures, including use of our platform and trading facilities, providing technical expertise, and earning fees from data licensing. In addition, through FXCM Securities Limited we earn commission revenues through equity and related brokerage activities.

Primary Expenses

Referring Broker Fees - Referring broker fees consist primarily of compensation paid to our referring brokers and white labels. We generally provide white labels access to our platform, systems and back-office services necessary for them to offer FX trading services to their customers. We also establish relationships with referring brokers that identify and direct potential FX trading customers to our platform. Referring brokers and white labels generally incur advertising, marketing and other expenses associated with attracting the customers they direct to our platform. Accordingly, we do not incur any incremental sales or marketing


expense in connection with trading revenue generated by customers provided through our referring brokers and/or white labels. We do, however, pay a portion of the FX trading revenue generated by the customers of our referring brokers and/or white labels and record this under referring broker fees.

Compensation and Benefits Compensation and benefits expense includes employee salaries, bonuses, stock compensation awards, benefits and employer taxes. Changes in this expense are driven by fluctuations in the number of employees, increases in wages as a result of inflation or labor market conditions, changes in rates for employer taxes and other cost increases affecting benefit plans. In addition, this expense is affected by the composition of our work force. The expense associated with our bonus plans can also have a significant impact on this expense category and may vary from period to period. The Lucid acquisition resulted in $9.4 million of deferred compensation of which $1.7 million was recognized as expense for the year ended December 31, 2012. See "Results of Operations, Acquisitions" for additional details.

At the time of our IPO and in 2011 and 2012, we granted awards of stock options to purchase shares of our Class A common stock pursuant to the our Long-Term Incentive Plan ("LTIP") to certain employees and independent directors. We recorded stock compensation expense of $10.2 million and $9.5 million for the year ended December 31, 2012 and 2011, respectively, related to these awards which is included in compensation and benefits. The LTIP also provides for other stock based awards ("Other Equity Awards") which may be granted by our Executive Compensation Committee (the "Committee"). During the year ended December 31, 2012, we granted 945,847 of its Class A common stock as Other Equity Awards. The Other Equity Awards were fully vested at the date of the grant. Stock compensation expense of $11.1 million for this Other Equity Awards is included in Compensation and benefits for the year ended December 31, 2012. See Note 15 to our consolidated financial statements in "Item 8. Financial Statements and Supplementary Data."

Advertising and Marketing - Advertising and marketing expense consists primarily of electronic media, print and other advertising costs, as well as costs associated with our brand campaign and product promotion.

Communications and Technology - Communications and technology expense consists primarily of costs for network connections to our electronic trading platforms, telecommunications costs, and fees paid for access to external market data. This expense is affected primarily by the growth of electronic trading, our network/ platform capacity requirements and by changes in the number of telecommunication hubs and connections which provide our customers with direct access to our electronic trading platforms.

Trading Costs, Prime Brokerage and Clearing Fees - Trading costs, prime brokerage and clearing fees primarily represent fees paid to third party clearing banks and prime brokers for clearing foreign exchange spot futures currency and contract transactions, transaction fees paid to exchanges, equity options brokerage activity fees, and fees paid to third party providers for use of their platform for our market making trading business. Clearing fees primarily fluctuate based on changes in volume, rate of clearing fees charged by clearing banks and rate of fees paid to exchanges.

General and Administrative - We incur general and administrative costs to support our operations, including:

Professional fees and outside services expenses - consisting primarily of legal, accounting and outsourcing fees;

Bank processing fees - consisting of service fees charged by banks primarily related to our customer deposits and withdrawals;

Regulatory fees - consisting primarily of fees from regulators overseeing our businesses which are largely tied to our overall trading revenues; and

Occupancy and building operations expense - consisting primarily of costs related to leased property including rent, maintenance, real estate taxes, utilities and other related costs.

Our general and administrative expenses have increased as a result of the additional legal, accounting, insurance and other expenses associated with being a public company.

Depreciation and Amortization - Depreciation and amortization expense results primarily from the depreciation of long-lived assets purchased and internally developed software that has been capitalized.


Amortization of purchased intangibles primarily includes amortization of intangible assets obtained through our acquisitions of ODL, FXCMJ", Foreland and Lucid.

Income Taxes - Our sole operating subsidiary, Holdings operates in the U.S. as a limited liability company that is treated as a partnership for U.S. federal and state income tax purposes. As result, FXCM Holdings, LLC's income from its U.S. operations is not subject to U.S. federal income tax because the income is attributable to its members. Accordingly, subsequent to the IPO, our U.S. tax provision is solely based on the portion of Holdings' income attributable to FXCM Inc. and excludes the income attributable to other members of Holding's whose income is included in Net income attributable to non-controlling interest.. Prior to the IPO, we operated as a limited liability company that was treated as a partnership for U.S. federal income tax. As a result, our income from U.S. operations was not subject to U.S. federal income tax because the income was attributed to its members and included in the tax returns of its members.

In addition to U.S. federal and state income taxes, we are subject to Unincorporated Business Tax which is attributable to FXCM Holdings, LLC's operations apportioned to New York City. Our foreign subsidiaries are also subject to local taxes.


Non-Controlling Interest - As a result of the IPO, FXCM Inc. is a holding company, and its sole material asset is a controlling membership interest in Holdings. As the sole managing member of Holdings, FXCM Inc. operates and controls all of the business and affairs of Holdings, LLC and, through FXCM Holdings, LLC and its subsidiaries, conduct our business. FXCM Inc. consolidates the financial results of Holdings and its subsidiaries, and the ownership interest of the other members of FXCM Holdings, LLC is reflected as a non-controlling interest in the consolidated financial statements of FXCM Inc. We also consolidate the financial results of Lucid in which we have a 50.1% controlling interest. The 49.9% ownership interest of the other Lucid members is reflected as a non-controlling interest in the consolidated statements of FXCM Inc.

Segment Information

ASC Topic 280, Segment Reporting - The FASB establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Our operations relate to FX trading and related services and operate in two segments - retail and institutional, with different target markets with separate sales forces, customer support and trading platforms. For financial information regarding our segments, see Note 24 to our consolidated financial statements in "Item 8. Financial Statements and Supplementary Data".

Common Stock Repurchase Program

On May 17, 2011 and October 17, 2011, our board of directors approved the repurchase of $30.0 million and $20.0 million of its Class A common stock (the "Stock Repurchase Program"), respectively. On November 7, 2012, the Board of Directors approved a $30.0 million increase in the Stock Repurchase Program for an aggregate of $80.0 million. As of December 31, 2012, we had repurchased 3.2 million shares for $33.8 million under these authorizations.

Pursuant to an agreement between the FXCM Inc. and Holdings, anytime the FXCM Inc. repurchases shares of its Class A common stock FXCM Holdings enters into an equivalent Holding Unit transaction with the FXCM Inc. Therefore, as of December 31, 2012, FXCM Holdings has repurchased 3.2 million of Holding Units from FXCM Inc. related to FXCM Inc. Class A common stock repurchases noted above.

Credit Agreement

In December 2011, we entered into a three year credit agreement (the "Credit Agreement") with a syndicate of financial institutions. The Credit Agreement provided for a revolving credit line of up to $75.0 million. The credit facility is guaranteed by certain subsidiaries of ours and is secured by a pledge of all of the equity interests in certain of our domestic subsidiaries and 65% of the voting equity interests in certain


of our foreign subsidiaries. On November 8, 2012, we entered into an amendment to the Credit Agreement (the "Amendment"). The Amendment provides us with the ability to increase the credit facility during the term of the Credit Agreement up to a maximum of $175.0 million. Additionally, the Amendment modified certain terms of the Credit Agreement, among other things, to provide additional flexibility regarding financing and investment initiatives. Simultaneously, on November 8, 2012, we received additional commitments from a group of financial institutions, both new and existing lenders, and increased the credit facility to $155.0 million. See "Liquidity and Capital Resources" for more information.


On June 18, 2012 (the "Acquisition Date"), we acquired a 50.1% controlling interest in Lucid, an electronic market maker and trader in the institutional foreign exchange spot and futures markets headquartered in the U.K., to expand the our presence and capabilities in the institutional marketplace. As consideration, we issued a $71.4 million, 3.5% unsecured promissory note, and 9.0 million unregistered shares of the Corporation's Class A common stock to Lucid sellers as well as a $15.8 million, 3.5% unsecured promissory note for all liquid assets for a total estimated purchase price of $177.5 million. Any of the Corporation's common shares issuable to a Lucid seller on an anniversary from closing will be restricted (the "Lucid Liquidity Restriction") for sale until the eighth anniversary of the closing of the Acquisition if the recipient ceases to be employed by us.

The assets acquired, liabilities assumed and non-controlling interest were recorded at their estimated fair values at the Acquisition Date. This resulted in the recording of intangible assets of $84.9 million primarily related to proprietary technology which will be amortized over a weighted average life of 4.1 years. Goodwill of $236.5 million was recorded as the excess over the estimated fair value of the net assets acquired. In addition, the estimated fair value assigned to the Lucid Liquidity Restriction was $9.4 million which is accounted for as deferred compensation and recognized over a 3 year term.

On October 7, 2011 and March 31, 2011, we acquired a 100% interest in Foreland (the "Foreland acquisition") and FXCMJ (the "FXCMJ Acquisition"), respectively, two Japan based foreign exchange providers. The acquisitions were designed to increase our profile in the Japanese market and accelerate its growth in Asia, utilizing Foreland and FXCMJ's relationships and sales force. As consideration, we provided $37.7 million and $15.7 million in cash, respectively.

On October 1, 2010, we acquired a 100% interest in ODL, a leading broker of FX, CFDs, spread and equity options headquartered in the U.K. (the "ODL Acquisition"). The ODL Acquisition was designed to increase our profile in the U.K. market and accelerate our growth in continental Europe, utilizing ODL's relationships and sales force. As consideration, we provided $2.2 million in cash and issued a 5.25% equity interest in the Company to ODL's shareholders for a total purchase price of $54.6 million. The acquisitions noted above resulted in a significant increase in goodwill and intangible assets in our consolidated statements of financial condition. Intangible assets acquired include non-compete agreements, retail customer relationships, institutional customer relationships, trade name and other items.

The acquisitions noted above will result in a significant increase in amortization of intangible assets in our consolidated statements of operations and comprehensive income as these intangible assets are amortized over their estimated useful lives. In addition, the acquisitions of these entities contributed to year over year revenue and operating expense fluctuations highlighted in our discussion of year over year results since we begin reporting their respective revenues and operating expenses as of the acquisition date. Therefore, a full year of their associated revenues and operating expenses are not reflected in the year in which the respective entity was acquired.


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