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FXCM > SEC Filings for FXCM > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for FXCM INC.

Form 10-K for FXCM INC.


17-Mar-2014

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


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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:

                                                       Year Ended December 31,
                                    2013          2012          2011          2010          2009
                                                (In thousands except per share data)
Consolidated Statements of
Operations Data
Revenues
Retail trading revenue           $ 365,285     $ 339,685     $ 363,774     $ 318,472     $ 291,668
Institutional trading revenue      103,994        62,033        28,908        27,833        21,107
Trading revenue                    469,279       401,718       392,682       346,305       312,775
Interest income                      2,614         3,571         3,644         2,373         1,289
Interest expense                      (258 )        (277 )        (329 )        (116 )        (125 )
Net interest revenue                 2,356         3,294         3,315         2,257         1,164
Other income                        17,953        12,303        19,581        11,599         8,666
Total revenues                     489,588       417,315       415,578       360,161       322,605
Operating Expenses
Compensation and benefits          105,470       105,779        95,086        76,195        62,588
Allocation of Income to Lucid
members for services provided       21,290             -             -             -             -
Total compensation and benefits    126,760       105,779        95,086        76,195        62,588
Referring broker fees               84,231        76,585        92,832        81,365        76,628
Advertising and marketing           27,091        30,860        34,897        23,788        29,355
Communication and technology        38,441        37,113        31,869        27,120        24,026
Trading costs, prime brokerage
and clearing fees                   30,821        16,935         8,167         6,597         4,542
General and administrative          68,230        63,043        63,077        31,480        21,911
Depreciation and amortization       53,729        36,773        20,053         9,306         6,542
Total operating expenses           429,303       367,088       345,981       255,851       225,592
Total operating income              60,285        50,227        69,597       104,310        97,013
Other Expense
Loss on equity method
investments, net                       752             -             -             -             -
Interest on borrowings               7,673         2,763             -             -             -
Income before income taxes          51,860        47,464        69,597       104,310        97,013
Income tax provision                17,024         8,986        10,816         4,149        10,053
Net income                          34,836        38,478        58,781       100,161        86,960
Net income attributable to
non-controlling interest in FXCM
Holdings, LLC                       24,850        23,131        46,045       100,015        86,960
Net income attributable to other
non-controlling interests           (4,846 )       6,389             -             -             -
Net income attributable to FXCM
Inc.                                14,832         8,958        12,736           146             -
Weighted average shares of Class
A common stock outstanding
Basic                               32,789        24,086        16,567        17,319             -
Diluted                             33,957        24,086        16,567        17,319             -
Net income per share
attributable to stockholders of
Class A common stock of FXCM
Inc.
Basic                            $    0.45     $    0.37     $    0.77     $       -     $       -


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Diluted                          $      0.44     $      0.37     $      0.77     $         -     $       -
Consolidated Statements of
Financial Condition Data
Cash and cash equivalents        $   365,245     $   272,332     $   184,721     $   193,330     $ 139,858
Cash and cash equivalents, held
for customers                    $ 1,190,880     $ 1,190,762     $ 1,046,983     $   641,152     $ 353,825
Total assets                     $ 2,223,947     $ 2,065,170     $ 1,487,133     $ 1,047,793     $ 517,936
Customer account liabilities     $ 1,190,880     $ 1,190,762     $ 1,046,984     $   641,152     $ 353,825
Total equity                     $   635,381     $   574,915     $   293,432     $   268,007     $ 130,788

OVERVIEW

Industry Environment

Economic Environment - Currency volatility remained at historically low levels in 2013. The daily JPMorgan Global FX Volatility Index was down 2% on average in 2013 compared with 2012. 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 impact 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 U.S., the U.K. (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

Despite muted currency volatility in 2013, we are pleased with our 2013 results with retail trading volumes increasing 13% in 2013 compared to 2012 and our institutional trading volumes increasing substantially in 2013 to $2.0 trillion compared to $1.2 trillion for 2012. We are confident in our view that we will be able to continue to grow our revenues and profits in what are still moderately volatile market conditions as compared to the past few years, because of the expansion of our scale,


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geographic reach and diverse sources of revenue. As our near-record results in the first half of 2013 demonstrated, small improvements in trading conditions can lead to significant increases in client volumes.

Looking forward, we are optimistic that market conditions will improve in 2014. In particular, rising interest rates will increase our interest income and bring the return of the carry trade. In 2014, we will continue to pursue our strategy of increasing our scale and building a diversified revenue base by pursuing additional white label opportunities, expanding our institutional platform and increasing our presence in emerging markets. Our balance sheet strength and strong cash flow puts us in a position to pursue this strategy through organic growth and selective acquisitions. We will continue to monitor the regulatory landscape. Regulatory changes have been a constant in our market and we expect this will continue. 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 asset classes making spot FX more attractive, or impacting other FX brokers, presenting opportunities.

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 contract for differences ("CFD") trading, fees earned through white label relationships, payments we receive for order flow from FX market makers and commission income earned from spread betting, equity and related brokerage activities. For the years ended December 31, 2013 and 2012, 31% and 27%, respectively, 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 desks:
FXCM Pro and Faros Trading LLC ("Faros"), a company in which we recently acquired 50.1% controlling interest. See "Acquisitions, Faros" under "Results of Operations". 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 market risk. We also earn revenues from market making and electronic trading in the institutional FX spot and futures markets through 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.

Primary Expenses

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, changes in the composition of our workforce, 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. The expense associated with our bonus plans can also have a significant impact on this expense category and may vary from period to period. Compensation and benefits also includes the portion of the 49.9% of Lucid's earnings allocated among the non-controlling members of Lucid based on services provided. This allocation is reported as a component of compensation expense under "Allocation of net income to Lucid members for services provided."

At the time of our IPO and thereafter, we have periodically granted awards of stock options to purchase shares of FXCM Inc.'s Class A common stock pursuant to the Long-Term Incentive Plan ("LTIP") to certain employees and independent directors. Stock options granted to employees in connection with our IPO were our largest grant to date representing 79.8% of our stock options awards granted. For the years ended December 31, 2013, 2012 and 2011, we recorded stock compensation expense related to stock options granted of $10.8 million, $10.2 million and $9.5 million, respectively. Of these amounts, $8.8 million related to stock options granted at the time of our IPO for each of the years ended December 31, 2013 and 2012 and $9.2 million for the year ended December 31, 2011, respectively. The LTIP also provides for other stock based awards ("Other Equity Awards") that may be granted by our Executive Compensation Committee. We did not incur any expense for Other Equity Awards for the year ended December 31, 2013. In June 2012, our Executive Compensation Committee granted 945,847


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of FXCM Inc.'s Class A common stock as an Other Equity Award. The Other Equity Award had a fair value of $11.1 million and vested at the date of grant. Accordingly, Compensation and benefits for the year ended December 31, 2012 includes $11.1 million of expense for this Other Equity Award.

The Lucid acquisition resulted in $9.4 million of deferred compensation of which $3.1 million and $1.7 million was recognized as expense for the years ended December 31, 2013 and 2012, respectively. See "Results of Operations, Acquisitions, Lucid" for additional details.

Referring Broker Fees - Referring broker fees consist primarily of compensation paid to our brokers and white labels. We generally provide white labels access to our platform systems and back-office services necessary for them to offer trading services to their customers. We also establish relationships with referring brokers that identify and direct potential 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 trading revenue generated by the customers of our referring brokers and/or white labels and record this expense as Referring broker fees.

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 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. Regulatory fees also includes fines and restitution imposed
          by regulators from time to time; 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.

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 various acquisitions.

Income Taxes - FXCM Holdings, LLC ("Holdings") operates in the U.S. as a limited liability company that is treated as a partnership for U.S. federal, state and local income tax purposes. As a result, Holdings' income from its U.S. operations is not subject to U.S. federal income tax because the income is attributable to its members. Accordingly, 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 Holdings whose income is included in Net income attributable to non-controlling interest in FXCM Holdings, LLC in our consolidated statements of operations.

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


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taxes. In addition, Lucid Markets LLP is a limited liability partnership treated as a partnership for income tax purposes. As a result, Lucid Markets LLP's income is not subject to U.K. corporate income tax because the income is attributable to its members. Therefore, Lucid's tax provision (a component of the Company's tax provision) is solely based on the portion of its income attributable to its managing member, Lucid Markets Trading Limited, a U.K. limited liability company subject to U.K. corporate income tax and excludes the income attributable to other members of Lucid Markets LLP whose income is included in Allocation of net income to Lucid members for services provided reported in our consolidated statements of operations as a component of compensation and benefits expense.

Other

Net income attributable to non-controlling interest in FXCM Holdings, LLC - 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 and, through Holdings and its subsidiaries, conducts our business. FXCM Inc. consolidates the financial results of Holdings and its subsidiaries, and the ownership interest of the other members of Holdings is reflected as a non-controlling interest in our consolidated financial statements.

Net income (loss) attributable to other non-controlling interests and Allocation of net income to Lucid members for services provided - We consolidate the financial results of Lucid in which we have a 50.1% controlling interest. The 49.9% ownership interest of the non-controlling Lucid members is reflected as follows:

The portion of the 49.9% of earnings allocated among the non-controlling members of Lucid based on services provided to Lucid is reported as a component of compensation and benefits expense in our consolidated statements of operations.

The portion of the 49.9% of earnings allocated among the non-controlling members not allocated based on services provided is reported as a component of Net income (loss) attributable to other non-controlling interests in our consolidated statements of operations.

We also consolidate the financial results of other entities in which we have a controlling interest. The ownership interests of the non-controlling members is reported in net income (loss) attributable to other non-controlling interests in the consolidated statements of operations.

Adjusted Pro Forma Results - We utilize and report results presented on an Adjusted Pro Forma basis that excludes certain income and expenses not in the ordinary course of business 1 , certain items relating to the IPO of FXCM Inc. and also reflect the exchange of all units of FXCM Holdings, LLC for shares of Class A common stock of FXCM Inc. We manage our business using these measures and believe that these Adjusted Pro Forma measures, when presented in conjunction with comparable generally accepted accounting principles in the United States of America ("U.S. GAAP") measures, are useful to investors to compare our results across different periods and facilitate an understanding of our operating results. Income and expense items not in the ordinary course of our business are noted throughout our management discussion and analysis. Further, the differences between Adjusted Pro Forma and U.S. GAAP results and reconciliations of our Adjusted Pro Forma results with our results presented in accordance with U.S. GAAP are detailed in the Non-GAAP Financial Measures section of our Management's Discussion and Analysis.

1 2013 items primarily include a $16.6 million regulatory settlement with the FCA, a $7.0 million benefit related to acquisition contingent consideration, a $3.5 million asset impairment charge and compensation costs of $3.8 million in connection with the renegotiation of a certain employment contract. 2012 items primarily include compensation costs of $13.8 million related to the renegotiation of an employee contract and a $4.4 million regulatory settlement with the Japan FSA. Please refer to Non-GAAP Financial Measures for additional information.

Segment Information

Accounting Standards Codification ("ASC") 280, Segment Reporting - The Financial Accounting Standards Board ("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 26 to our consolidated financial statements.


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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 our 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, 2013, we had repurchased 5.0 million shares for $61.9 million under these authorizations.

Pursuant to an agreement between FXCM Inc. and Holdings, anytime FXCM Inc. repurchases shares of its Class A common stock, Holdings enters into an equivalent Holding Units transaction with FXCM Inc. Therefore, as of December 31, 2013, Holdings has repurchased 5.0 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 provided 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

On November 15, 2013, we entered into an amendment to the Credit Agreement (the "2013 Amendment"). The 2013 amendment extended the final maturity date of the credit facility to December 2016 and provided us with the ability to increase the credit facility during the term of the Credit Agreement up to a maximum of $250.0 million. Additionally, the 2013 Amendment modified certain terms of the Credit Agreement, among other things, to provide additional flexibility regarding financing and investment initiatives. Simultaneously, on November 15, 2013, we received additional commitments from existing lenders and increased the credit facility to $205.0 million.

See "Liquidity and Capital Resources" for more information.

Convertible Senior Notes due 2018

In June 2013, FXCM Inc. issued $172.5 million principal amount of Convertible Notes and received net proceeds of $166.5 million, after deducting the initial purchasers' discount and offering expenses. The Convertible Notes pay interest semi-annually on June 15 and December 15 at a rate of 2.25% per year, commencing December 15, 2013. The Convertible Notes will mature on June 15, 2018. We used $10.5 million of the net proceeds of the offering to fund the net cost of the convertible note hedge and warrant transactions entered into concurrently with the issuance of the Convertible Notes, repaid $80.0 million of outstanding borrowings under our revolving credit agreement and repaid $22.9 million of outstanding promissory notes issued in connection with the Lucid acquisition. We intend to use the remaining net proceeds from the offering for general corporate purposes, including potential future acquisitions. See "Liquidity and Capital Resources" for more information.

RESULTS OF OPERATIONS

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