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FXCM Q1/15 Earnings Conf. Call transcription + slides

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Link to pdf of slides from Conference Call

http://files.shareholder.com/downloads/AMDA-13JM9E/10718650x0x828147/6966B132-EE6D-470B-B946-E819E1D58514/FXCM_Q1_2015_Earnings_Presentation_-_FINAL.pdf


FXCM's (FXCM) CEO Drew Niv on Q1 2015 Results - Earnings Call Transcript

May 11, 2015 08:15 AM ET

Executives

Jaclyn Klein - IR

Drew Niv - CEO

Robert Lande - CFO

Analysts

William Katz - Citi

Niamh Alexander - KBW

Kevin Starke - CRT Capital Group LLC

Operator

Good day, ladies and gentlemen and welcome to the FXCM Incorporated Q1 2015 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 today's conference is being recorded.

I would now like to introduce your host for today’s conference call Ms. Jaclyn Klein. One moment. [Technical Difficulty]

Ladies and gentlemen please stand-by your conference will resume momentarily. You may now begin your conference.

Jaclyn Klein - IR

Good morning and thank you for joining us for the FXCM, Inc. first quarter 2015 earnings conference call. Joining me today are Drew Niv, FXCM’s Chief Executive Officer; and Robert Lande, our Chief Financial Officer. A live audio webcast, a copy of FXCM’s earnings release, which was sent on Friday May 8th and presentation slides used during the conference call are all available at www.fxcm.com under the Investor Relations tab. A replay of this conference call will also be available later tonight on our website.

Before I turn the call over to Robert, I would like to remind everyone that in today’s remarks we will refer to certain non-GAAP financial measures, including adjusted EBITDA. 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 express written consent of FXCM.

Before we begin we would like to remind everyone that the remarks and responses to your questions that we provide today may contain forward-looking statements. These statements do not guarantee future performance and undue reliance should not be placed on them. These statements are based on current expectations of management and involve inherent risks and uncertainties that could cause actual results to differ materially from those indicated in any forward-looking statements, including risks associated with the events that took place in currency markets on January 15, 2015 and the subsequent financing agreement, as well as 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 CFO, Robert Lande.

Robert Lande - CFO

Thank you Jaclyn. Good morning thank you for joining us today. Before we go through results I think it might be a good place to start to take you through some of the major reporting changes and accounting items of this quarter, which stem from the events of January 15, the subsequent financing package provided by Leucadia and our announced plan to sell certain non-core assets.

First of all, as we have identified a collection of assets that we will be selling to repay the debt to Leucadia, the first of which was our Japanese business sold for $62 million right after quarter end, we will now be classifying our business into continuing and discontinued operations. Our continuing operations will remain our core retail FX business to emerging and developed world customers that we serve from our U.S., UK and Australian subsidiaries. As we pointed out on last quarter's call, those businesses that remain as continuing operations represented around $70 million of last year's $107 million in EBITDA. So by far the lion’s share of FXCM's financials.

This quarter we have recorded a $265 million loss in bad debt expense as the provision for bad debts related to January 15 events, net of recoveries we made in the quarter. And then we have a bunch of non-cash items. First we have written down certain of our deferred tax assets and a liability we had under our tax receivable agreement that results in $145 million in new and other income and $178 million in provision for income tax. While these numbers are large it is worth pointing out that they are purely non-cash. It is just the judgment call whether it is more likely than not that they would be used in the near-term. Obviously with the sizable NOLs created on January 15th these additional amounts are not something we feel maybe used and have accordingly made evaluation allowance for.

Second, we have recorded an unrealized loss on derivative liability expense of $292 million in the quarter. Under U.S. GAAP we have fair valued the Letter agreement under the Leucadia financing which entitles Leucadia to a number of economic rights. We have determined that an increase in value by that amount in the quarter. The Leucadia financing analysis [ph] on our balance sheet as we will go through a few slides is a $189.5 million for the credit agreement and $386.2 million as the fair value of the Letter agreement or $575.7 million in total. Under GAAP we do not fair value the credit agreement each quarter just the Letter agreement.

Thirdly, we have recorded a $96 million impairment loss related primarily to goodwill and intangibles in our institutional business following the events of the 15th. As you can imagine we assessed the goodwill on our books and felt it prudent to record an impairment. We are now left with a relatively small $28 million in goodwill and $13 million in intangibles on our balance sheet in continuing operations.

So these are the large items in this quarter's results, with the exception of $265 million loss related to bad debt on the 15th, which as everyone knows at this point was replenished the next day, with the $300 million gross $279 million net financing package. All of these items of other income provision, provision for income tax, goodwill impairment and unrealized loss on derivative liability are all non-cash items. In fact, as I will take you through in a couple of slides, our cash and regulatory capital position is as strong as it is been in a while right now.

Slide four, turning to the headline revenue and net income numbers, including all of the special and extraordinary items, under US GAAP for continuing operations our Q1, '15 revenues were $215.2 million versus $82.8 million Q1 ‘14 and our Q1 ‘15 total net loss attributable to FXCM, Inc. of $393.3 million or $8.35 per diluted share versus a net loss of $0.8 million or $0.02 per diluted share in Q1 ‘14. However, excluding these special extraordinary items on an adjusted basis Q1 ‘15 adjusted revenue from continuing and discontinued ops of $98.8 million versus $111.3 million last year’s quarter and Q1 ‘15 adjusted EBITDA from continuing and discontinued ops of $14.5 million versus $24.6 million Q1 ‘14.

Retail revenue per million from continuing operations was $67 per million in the quarter and our Q1 ‘15 total retail volume from continuing operations was $935 billion. So all-in-all given the events in the quarter the business is operating well in what was, in the end not the greatest quarters for currency volume and yet we generated just under $100 million in revenues and $14.5 million in EBITDA.

Turning to slide five, as I mentioned at the beginning of the presentation FXCM is in solid financial position. As of today we have repaid $81.6 million of the Leucadia loan leaving us with $228.4 million in principal outstanding. As Drew will update you on an assets sales slides in a couple of slides we feel as good as ever that we are going to be able to sell assets and repay most if not all of the debt in the near future.

Our cash position is strong with $328 million in operating cash, our customer equity has been resilient after the 15 and at March 31st we stand at $1.03 billion in client equity and perhaps most comforting is how strong our capital position is with minimum regulatory capital requirements of $84.2 million and regulatory capital of $284.8 million. That is a surplus of $200.6 million and is as strong as it has been in recent years.

Slide six, this is just a recap of the operating metrics for the retail business for the past few quarters. I don’t propose going through it but you will note that just for ease for comparison we’ve added a red box, so that you can see what the discontinued operations would have added to the continuing operations.

Turning to slide seven, this table presents combined continuing and discontinued operations for Q1 ‘15 versus Q1 ‘14 on an adjusted basis. For Q1 ‘15 obviously the big adjustments were the bad debt expense resulting from the 15th and the revenue and other income associated with the write-down of the liability under our tax receivable agreement. The derivative liability mark-to-market and the tax provision increase due to the deferred tax asset write-down was below the EBITDA line. We also eliminated $1.8 million of G&A resulting from legal and investment banking bills to do with some of the items that came out of the 15th such as putting in place the shareholders rights plan.

What you can see, if you look at the far right column is that revenues were down $12.5 million quarter-over-quarter last year and expenses were down $2.2 million. Really the decline in revenues was due to our change at the end of Q3 last year to a commission model in many of our jurisdictions and the resulting decline in revenues per million partially offset by higher volumes and also partially from revenues from Lucid. In the quarter Lucid generated $13.4 million in revenues versus $15.5 million Q1 ‘14.

On the expense side compensation and benefits were up $4.3 million, a $1.9 million increase from a full quarter of V3 in 2015 versus the partial quarter in 2014 and $3.6 million from a retention plan we put in place were partially offset by lower headcount overall and lower stock compensation expense of the IPO stock grant fully vested as of December 2014. You could see that pretty much all other costs, referring broker fees, advertising, communication and technology and trading costs were down year-over-year and G&A was up only slightly.

Turning to slide eight, while we talked quite a bit about it we might as well summarize for everyone in one place how the Leucadia financing is being accounted for. The Leucadia financing package to recap again consisted of a $300 million term loan as laid out in a credit agreement as well as a Letter Agreement that allocates cash distributions between FXCM and Leucadia. The credit agreement was recorded in a $198.5 million consisting of a $300 million of principal net of an original issuance discount of $101.5 million. The original issue discount and a $10 million financing fee will be amortized over the two year life of the credit agreement at an effective interest rate.

FXCM has concluded the appropriate accounting is to account for the Letter Agreement separately from the credit agreement and that the Letter Agreement should be accounted for as a derivative liability. As at March 31, 2015 the fair value of the Letter Agreement was estimated at $386 million and accordingly the $292 million increase in the estimated fair value of the Letter Agreement within the quarter is recorded as an expense in the income statement. FXCM estimated the fair value of the Letter Agreement using a combination of approaches, including using the common price of FXCM, a guideline public company method as well as a discounted cash flow method and then used an option pricing model for the allocation of enterprise value amongst various components. As you can imagine, small changes in assumptions in the models used could materially change the estimated fair value.

In the end this expense, I should remind everyone, is a non-cash item and purely reflects the value of potential payments to Leucadia in the future relative to other FXCM stakeholders. This does not impact our regulatory capital, cash balances or customers.

Turning to slide nine, our balance sheet, when we moved to have continuing and discontinued operations one of the more significant changes is that the balance sheet, of all the discontinued operations are collapsed in a couple of lines now, and you can see them on current assets held for sale, non-current assets held for sale, current liabilities held for sale and non-current liabilities held for sale.

As you can see by March 31, 2015 balance sheet all of the assets and liabilities of our discontinued operations are classified as current, as we expect for them all to be sold in less than a year. Other changes in the balance sheet to note now is you see the Leucadia financing in the liability section. Keep in mind what I said on the previous slides the Letter Agreement liabilities is a really an estimate value of potential payments to Leucadia due to their economic rates to certain of our cash distributions, not a true liability as we all would normally think of such as a loan. And you will see now that our deferred tax assets have come way down to $1.8 million as well as due to related parties pursuant to tax receivable agreement, which has come down to nil from a $145.2 million.

In sum, our shareholders equity is now in a deficit position but much of this is due to the accounting items we have talked about, and resides up at the parent company level. Underlying -- our regulated entities have regulatory capital of $284.8 million and a surplus over requirements of $200.6 million.

With that I will turn things over the Drew to update you on our strategy and where we stand on asset sales.

Drew Niv - CEO

Thank you, Robert. Moving to slide ten, as we discussed in our call in March, FXCM the near-term strategy has two principle objectives. We are targeting a significant reduction in our debt due to the sale of non-core assets and cash generated from our operations. I will give you an update on that in the next slide. So we are also focused on growing our core business through a number of FX and CFD initiatives as we described in detail in the last call including expanding CFD offerings and a number of innovations in our core FX offering.

It's worth repeating that not too long ago FXCM was an extremely successful business almost entirely focused on retail FX. We remain confident that our core retail and CFD franchise are extremely strong and backed by the strongest global brand in the retail FX business.

Moving to slide 11, I want to update you on our plans to sell non-core assets. We made the decision to exit the Japanese and Hong Kong markets, selling our locally regulated subsidiaries in each country. We completed the transaction to sell FXCM Japan in early April, resulting in $62 million of sales proceeds net of cash. We are in the final phase of our sales process for our Hong Kong regulated entity.

On the institutional side we are early in the process to sell our stakes in FastMatch, Lucid and V3 Markets. As I mentioned in our last call we continue to receive many unsolicited indications of interest from credible bidders from all these investments and continue to believe the auction process will very be robust. Finally, FXCM Securities in London, a small trading desk offering listed products such as options, futures and equities to UK customers is also in the final phase of being sold. We believe the sales proceeds plus cash freed from the balance sheet of these entities will go long ways towards repaying all or our significant portion of the balance remaining under Leucadia loan. One clarification is our Hong Kong regulated entity, which we are selling primarily services to Hong Kong residents and this does not mean that we are selling our China or the rest of Asia business, which is primarily serviced out of our UK entity.

Moving to slide 12, we have our April operating metrics. It's important to note here that these are trading metrics from continuing operations, which exclude volumes and accounts from units that has been offered for sale. April ADV of $13.9 billion represents 7% decline from March and a 37% increase from April 2014. Industry benchmarks for April have declined between 9% and 23%. As many will have noticed, volatility has picked up in May. Retail active accounts continued to grow to a new record level in April, another indicator that despite the challenges we have faced in January 2015 our core franchise remains strong. Institutional volumes dropped in April 10% with the principal contributor being world volatility.

Finally summing things up on slide 13, through all of the complicated accounting changes and non-cash items in this quarter's results, I want to stress that despite the events of January 15, FXCM today remains in an extremely strong competitive position. Our adjusted revenues for the quarter, including both continuing and discontinuing operations, our $98.8 million EBITDA was $14.5 million [ph], we have $329 million in operating cash, over a $1 billion in customer equity. Half the retail FX accounts continue to sale record month after month and our regulatory capital surplus is $201 million.

With that I would like turn things over to the operator and open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first quarter comes from Bill Katz with Citi.

William Katz - Citi

Thanks very much. Just sort of focusing on the discontinued list and continuing operations, I know you are stressing the combined entity. But if I look at the continuing operations, your EBITDA was about $4 million. But if I simply add back a couple of million for some of the legal noise you highlighted, still I get pretty depressed rates. How you're thinking about EBITDA margin in the short term or your expense base given where revenues are and now as we think about go forward EBITDA.

Drew Niv - CEO

Yeah, I think that the some of the stuff that we didn’t [ph] want to repeat this quarter but if you look at the items we highlighted last quarter, Bill in terms of our initiatives that we are on small accounts moving to principal May [ph] trading on the expansion of the CFD business, all of those things are on track, all the early experiments with the [indiscernible] principal trading show that our dollars per million in our others [ph] will be quite higher in that business than they are in the agency business. And we believe that over the next six months or so as we kind of fully transition all of these things and initiatives that we are doing, our EBITDA margins will be quite healthier, as obviously the business is not yet at what the earnings power that it was pre January 15. But we think that it’s getting back to there in quite a rapid state and it’s something that we’re certainly confident that we’ll resume kind of historical operating margins later this year or maybe early next year.

William Katz - Citi

Yeah, that’s helpful. And then just I know it’s pretty big wide spread between what Leucadia has valued in their Letter agreement versus you guys presumably there’s some kind of maybe fair value accounting, but just sort of stepping back what type of underlying EBITDA growth assumptions are you using to get to the value on your balance sheet?

Robert Lande - CFO

Yeah, that’s not something that gets disclosed Bill. We are going to be publishing our Q later today. You will see the assumptions that are in there, that are disclosed but keep in mind we triangulated using -- it’s not just a DCF approach. We triangulated using as well comparative companies and multiples of them as well as the FXCM stock price. So we deployed three methods and you put it in and there is assumptions then about to get through the Black-Scholes model in terms of volatility and tranches and the like.

So what we are disclosing regarding the valuation, which is consistent with reporting standards will be in the Q later today.

William Katz - Citi

Okay, and just one final one from me thanks for taking the questions. One of your smaller competitors, I think announced recently that they are going to pay about 5% interest on excess client balances. I am sort of curious as you think from a competitive perspective how you might respond to that and does that sort of shift the opportunity in terms of earnings leverage, if rates were to start going higher?

Drew Niv - CEO

So that’s been -- I don’t want to use the too negative as the condition only, what I can say [ph] it’s a ploy or a gimmick that has been used by many people. It’s a gimmick that rarely works. We’ve used it in the past as well overseas, didn’t really -- it’s not something that our clients really respond to and hasn’t affected. If you member people come to FXCM, competitors of FXCM primarily come to trade, they don’t mind [ph] saving money, this is not investment money, this is trading money it’s different. And I think it’s something that is not treated that way. So we have seen this for years when interests were high, when interest were low. It hasn’t made a material difference.

William Katz - Citi

Okay, thank you for taking my questions.

Operator

[Operator Instructions]. Our next question comes from Niamh Alexander with KBW.

Niamh Alexander - KBW

…my questions. With respect to the run rate or record for the retail customer group, just on the continuing operations going forward, just trying to get a sense of the 67, is that kind of -- I know the environment’s changed but we heard some competitors talk about a lot of one way trading. We need [ph] depression in the rate card that in the first quarter, is that something you experienced also or should we think about this being a more normalized level unless volatility kind of makes another jump there?

Drew Niv - CEO

I think that if you look at our -- we don’t have -- our $67 is primarily agency trading in FX and has obviously principal trading for CFDs in it. So it doesn’t really move -- all this stuff about market conditions and all other stuff doesn’t really affect it that much. It’s really a question for us that if you look in the short-term, we move to commissions obviously post January 15th, we move to commissions in fall of ’14, post January 15, we have had to discount more certain large customers, obviously if to think about sort of our struggles, majority of FXCM’s customers now have been -- stayed put. If you think about the people that we are most concerned with, January 15, where they are very large customers. So we have discounted for some of those to keep them. I think that there is a notion that is something that we will have forever.

Also as we introduce larger mix of CFD trading and a larger mix of principal trading as the small customers transition to principal for trading and as this is -- if you remember from the last call this is small customers under $20,000 in certain jurisdictions, so for example non-U.S. That is something where we think that will have -- start to move the rates turning up pretty significantly. So while it is hard to say whether it is going to be in the next quarter or so I think something by next year we would be looking at this far higher than it is today.

Niamh Alexander - KBW

Okay, thanks, Drew. And then I guess just to try and help us understanding the modeling on the go forward basis for the continued items then, what’s a good tax rate to think about as we kind of exclude maybe a lot sort of the international business or how should we think about normalized tax rate going forward.

Robert Lande - CFO

Well, as you know on the cash basis our taxes will -- won’t be very significant if anything. You know that’s fair point, Niamh, I hadn’t put tons of thought yet into the going forward tax rate. I certainly -- probably keep in mind that while we getting rid of a number of foreign businesses what is left is going to be the U.S., really basically the U.S. and the UK. The UK is around 20% and that actually is a much larger entity. So I would think just off the top of my head that we would be in the low 20’s.

Niamh Alexander - KBW
Okay, fair enough, that’s helpful. But in reality on a cash basis you probably would have some losses?
Robert Lande - CFO
Right, exactly.
Niamh Alexander - KBW
In all the regions?
Robert Lande - CFO
Yes.
Drew Niv - CEO
In the UK especially right?
Robert Lande - CFO
Yes,
Niamh Alexander - KBW
Okay, fair enough.
Drew Niv - CEO
And we won’t be paying cash taxes.
Robert Lande - CFO
I mean the loss filter through all of the entities so...
Niamh Alexander - KBW
Yes, okay, helpful, thanks. And then I guess with respect to the mix of business from referring brokers with the shift to the discontinued, what’s a good proxy to think about for that?

Drew Niv - CEO

I think that in the short run the Hong Kong regulated entity and the Japanese regulated entity as an example, were ones that we had no assurance of [ph] whatsoever. So the mix in the short run goes up, the mix in the long run we are strategically targeting it to go down, strategically targeting a much bigger increase in the organic business, a smaller, much smaller increase in the referring broker business. So we think that mix should in the long-term go down.

Niamh Alexander - KBW
Okay, fair enough, thanks.
Drew Niv - CEO
Only once they go down, go in favor of organic.
Niamh Alexander - KBW
Okay, that’s helpful, thanks. And then just to get back the disposition and paying down this expensive debt. You have kind of -- you have a couple in final stages and so help me think about what are you targeting say by year end this year, in terms of being able to repay the financing and maybe what you are targeting for next year because it just looks a hefty interest load there?
Drew Niv - CEO
Yeah, I think that as we said last time, our hope is that by the fall or latest end of year the debt is completely gone.
Niamh Alexander - KBW
End of this year?
Drew Niv - CEO
End of this year. As of now we are on track for that to happen. The assumptions underlying that still require certain outcomes that are not far from guarantees in some of the larger asset sales but I think that so far we have gotten and the stuff we have announced and stuff yet to be announced is so far for higher prices than we initially expected when we were first doing this. But this is something that, as I said, obviously this is far from certain outcome simply because assets sales you never know but the target that we set for ourselves is to do this before the end of the year.
Niamh Alexander - KBW
Okay thanks so much for the color.

Operator

And I'm not showing any further questions at this time. I'd like to turn the call back over to management for closing remarks. Actually we do, someone just queued up for questions, do you want go and take their question?
Jaclyn Klein - IR
Yes, operator.

Operator

It’s from Kevin Starke with CRT Capital.

Kevin Starke - CRT Capital Group LLC

Good morning. Could you just tell us what's your NOL carry forward is now at the end of the first quarter?
Robert Lande - CFO
No, not off the top of my head. But obviously we had a now $265 million bad debt provision, in respect of that because of the high interest rate the quarter was a loss. So it's going to be something up to $300 million if I was to estimate it now.
Kevin Starke - CRT Capital Group LLC
Do you think you could explain briefly why the tax receivable liability goes to zero?
Robert Lande - CFO
Yes, that's just because we have such significant NOLs resulting from the quarter. Those tax receivables were created as from the conversion of units into common shares and the public company inheriting all of this goodwill to be amortized over 15 years. So the GAAP standard is while you think it's more likely than not you're going to use that in the near term, while the near term we’re pretty sure we're going to be using the first line of defense which is the NOLs which got created this quarter because of the bad debt expense. So that's purely why we took down the deferred tax assets. That additional amount of tax benefit we're not going to really need that in the near term.
Kevin Starke - CRT Capital Group LLC
If I were to put it in slightly different terms, the tax receivable reliability stems from your basis in your assets going up overtime as units are converted into common, right.
Robert Lande - CFO
At the public company level, yes.
Kevin Starke - CRT Capital Group LLC
Right and then this loss reduces the basis so massively that the contribution from those convertibles is kind of lost in translation, that’s purely about it.
Robert Lande - CFO
No, no I just think -- I think they're kind of separate things here. That was the basis that was created and the ability to amortize that step up overtime. That still is there, that hasn't changed, just the only question now is well can you use that in the near term, and in the near term the company has other losses to use for it. So in GAAP you have a relatively short time frame on looking at these deferred taxes. And so we just don't think in the near term we're going to need those additional amount of deferred taxes that we had on our balance sheet.

So we're just providing evaluation allowance on it because the NOLs created in the quarter are going to be enough in the near term to handle -- to shield profits that we have.
Kevin Starke - CRT Capital Group LLC
So it's almost more of a sequencing function.
Robert Lande - CFO
Yeah, it's more of the sequencing function exactly.
Kevin Starke - CRT Capital Group LLC
Okay, my technology is fairly limited, thank you very much. That's all.

Operator

And this is the end of our question-and-answer session. I would like to turn the call over to management for closing remarks.
Jaclyn Klein - IR
Thank you. On behalf of Drew, Robert and everyone here at FXCM we would like to thank you for joining us this morning and we look forward to speaking with you next quarter. Thanks operator.

Operator

You're welcome. Ladies and gentlemen this does conclude today's presentation. You may now disconnect and have a wonderful day.