Virtu Financial, Inc. — Q1 2018 Form 10-Q Summary
Business context and reporting period
Virtu is a technology-driven global market maker and execution-services provider. This unaudited Form 10-Q covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017. Results include KCG Holdings for the full first quarter of 2018 following the July 2017 acquisition; the 2017 comparison reflects Virtu before the acquisition. Reportable segments were Market Making, Execution Services and Corporate.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $815.1 million | $147.3 million | +453% |
| Trading income, net | $406.2 million | $139.6 million | +191% |
| Commissions, net and technology services | $53.8 million | $2.8 million | +1,838% |
| Other, net | $337.1 million | $0.1 million | Primarily BondPoint sale gain |
| Operating expenses | $346.5 million | $123.4 million | +181% |
| Income before taxes and noncontrolling interest | $468.5 million | $23.9 million | +1,862% |
| Net income | $410.0 million | $21.1 million | +1,845% |
| Net income available to common stockholders | $174.8 million | $4.6 million | +3,716% |
| Diluted EPS | $1.86 | $0.10 | +1,760% |
| Adjusted Net Trading Income | $340.3 million | $82.2 million | +314% |
| Adjusted EBITDA | $222.7 million | $47.7 million | +367% |
Adjusted Net Trading Income was $340.3 million, consisting primarily of $313.5 million from Market Making and $26.7 million from Execution Services. Adjusted EBITDA margin was 65.4%, compared with 58.0% in the prior-year quarter. The reported net income margin based on Adjusted Net Trading Income was 120.5%, versus 25.6%, reflecting the unusually large BondPoint disposal gain.
Net cash provided by operating activities was $119.0 million, compared with $32.1 million in Q1 2017. Investing activities provided $388.7 million, including $400.2 million of gross proceeds from the BondPoint sale. Financing activities used $405.8 million, including a $276.0 million repayment of the senior secured term loan, $99.0 million distributed to noncontrolling interest holders and $22.4 million of dividends. Cash and cash equivalents increased $104.4 million to $637.3 million.
At March 31, 2018, total assets were $7.76 billion, total liabilities were $6.30 billion and total equity was $1.46 billion. Long-term borrowings were $1.12 billion carrying value, representing $1.16 billion of principal, and short-term borrowings were $20.9 million. Additional short-term credit facilities with prime brokers had $131.4 million outstanding, while broker-dealer facilities had $24.5 million outstanding against $850.0 million of availability. Management stated that cash flows, cash on hand and available facilities should meet liquidity needs for more than the next twelve months.
Material changes versus the prior comparable period
- The KCG acquisition materially expanded Market Making and Execution Services, increasing trading volumes, commissions, technology revenue, personnel, connectivity, financing and other operating costs.
- Market Making Adjusted Net Trading Income increased 295% to $313.5 million. Americas Equities increased to $215.7 million from $28.1 million, while Global FICC, Options and Other increased to $66.3 million from $34.1 million.
- Execution Services Adjusted Net Trading Income increased to $26.7 million from $3.1 million.
- BondPoint was sold to Intercontinental Exchange on January 2, 2018, for $400.2 million of gross cash proceeds. Virtu recorded a net gain of approximately $329.0 million after transaction costs, including an $8.3 million goodwill allocation and $8.6 million of transaction costs.
- Operating expenses rose substantially, including $20.0 million for termination of office leases, $6.0 million of accelerated debt-refinancing costs, $7.5 million of transaction advisory fees and $16.3 million of payments for order flow, which did not occur in Q1 2017.
- The company prepaid $276.0 million of term-loan principal during the quarter and repriced the senior secured term loan. It subsequently prepaid another $100.0 million on April 19, 2018.
- Virtu adopted ASC Topic 606 revenue guidance on January 1, 2018, using the modified retrospective method; no transition adjustment was recorded. The adoption primarily affected commissions and technology-services revenue.
Outlook, commentary, risks and unusual items
Management expects liquidity to be adequate for more than twelve months, with future needs driven primarily by margin requirements associated with trading activity and expansion. The filing does not provide formal revenue, earnings or trading-volume guidance.
Important unusual items include the BondPoint gain, office-lease termination costs, debt-refinancing costs, transaction advisory expenses, connectivity termination costs, equipment write-offs, share-based compensation and acquisition-related amortization. Normalized Adjusted Net Income was $145.0 million, or $0.76 of Normalized Adjusted EPS, compared with $22.0 million and $0.16, respectively, in Q1 2017.
The company recorded a 12.5% effective tax rate for the quarter. The accounting for the 2017 Tax Act remained provisional; Virtu expected to complete its analysis by the third quarter of 2018, and future adjustments could materially affect income-tax expense. Tax receivable agreement obligations were approximately $147.0 million, generally payable over the next 15 years as tax savings are realized.
Key risks include lower trading volumes or volatility, market and foreign-currency risk, counterparty and clearing-house failures, reliance on liquidity and trading venues, system or cybersecurity failures, regulatory and market-structure scrutiny, payment-for-order-flow restrictions, competition, KCG integration risk, substantial indebtedness, regulatory capital requirements, litigation and international operations. Virtu reported compliance with applicable debt covenants at March 31, 2018. Three U.S. broker-dealers had aggregate regulatory capital of $508.0 million against aggregate requirements of approximately $6.7 million.
The company was subject to various regulatory reviews and investigations. An AMF fine against a European subsidiary was reduced to approximately $3.9 million and fully reserved at March 31, 2018. A shareholder litigation matter related to the KCG acquisition was pending, with no damages amount stated. Management did not expect currently known matters to have a material adverse effect overall, but noted that individual-period impacts could be material.
Investor verification priorities
- Separate recurring operating performance from the approximately $329.0 million net BondPoint disposal gain and other one-time adjustments.
- Verify the comparability of Q1 2018 and Q1 2017 given the KCG acquisition and the absence of KCG in the prior-year period.
- Reconcile GAAP net income, Adjusted EBITDA, Adjusted Net Trading Income and Normalized Adjusted EPS, including the effects of noncontrolling interests and assumed unit exchanges.
- Monitor trading volumes, volatility, Americas Equities performance, payments for order flow and execution-services growth.
- Track debt repayments, leverage and interest-coverage compliance, including the subsequent April 2018 $100.0 million term-loan prepayment.
- Assess tax-rate and tax-receivable-agreement changes arising from final implementation of the 2017 Tax Act.
- Review regulatory, litigation, cybersecurity, counterparty, clearing and market-structure developments, including the pending KCG-related litigation and AMF matter.