Virtu Financial, Inc. — Q2 2017 Form 10-Q Summary
Business context and reporting period
Virtu is a technology-enabled market maker and liquidity provider operating in one reportable segment across equities, commodities, currencies, options, fixed income and other securities. The unaudited filing covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods.
The company completed its all-cash acquisition of KCG Holdings on July 20, 2017; therefore, KCG was not included in the June 30, 2017 operating results. The transaction and related financing are disclosed as subsequent events and materially change the company’s post-quarter capital structure and risk profile.
Financial performance and key metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $144.9 million | $174.2 million | $292.2 million | $366.8 million |
| Trading income, net | $136.2 million | $166.5 million | $275.7 million | $352.8 million |
| Adjusted Net Trading Income | $74.0 million | $102.3 million | $153.4 million | $219.6 million |
| Net income | $4.4 million | $39.3 million | $25.5 million | $90.6 million |
| Net income available to common stockholders | $0.9 million | $8.4 million | $5.5 million | $18.7 million |
| Basic and diluted EPS | $0.01 | $0.21 | $0.11 | $0.48 |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $82.4 million | $85.5 million |
Q2 net income margin was 5.7% using management’s non-GAAP denominator, compared with 37.6% in the prior-year quarter. EBITDA was $25.2 million, with a 32.8% EBITDA margin, versus $59.3 million and 56.8% in Q2 2016. Adjusted EBITDA was $40.9 million, with a 53.1% margin, versus $65.8 million and 63.0%.
Interest and dividends income increased to $5.6 million in Q2 from $5.4 million, while technology services revenue increased to $3.1 million from $2.2 million. Operating expenses increased to $139.7 million from $129.8 million in Q2, despite lower brokerage fees and employee compensation.
Liquidity, capital and debt
- At June 30, 2017, cash and cash equivalents were $164.9 million and restricted cash was $1.119 billion, primarily escrowed acquisition financing.
- Total assets were $4.374 billion, total liabilities were $3.856 billion and total equity was $517.5 million.
- Long-term borrowings were $1.628 billion, compared with $565.0 million at December 31, 2016. Principal long-term debt was approximately $1.681 billion before deferred financing costs and discounts.
- The company issued $500 million of 6.750% senior secured second-lien notes due 2022 and entered into financing arrangements that resulted in $1.150 billion of first-lien term loans after the KCG closing.
- Short-term credit facilities had $493.0 million of aggregate capacity and $160.3 million outstanding. Broker-dealer facilities had $200.0 million of capacity and $13.0 million outstanding.
- Six-month investing cash use was $15.9 million, including $5.7 million for the acquisition of strategic telecommunications assets from Teza Technologies. Financing activities provided $1.031 billion, primarily from acquisition-related debt financing.
- Management stated that operating cash flow, available cash and available borrowings were expected to satisfy liquidity needs for more than the next twelve months, subject to margin requirements and other operating needs.
Material changes versus the prior comparable period
- Q2 revenue declined 16.8%, trading income declined 18.2%, and Adjusted Net Trading Income declined 27.7%, primarily because of lower market volume and volatility across major asset classes.
- For the first six months, revenue decreased 20.3% and Adjusted Net Trading Income decreased 30.2%. Adjusted Net Trading Income per trading day declined approximately 30.3% to $1.23 million.
- Q2 operating expenses increased 7.6%, driven by $4.5 million of debt refinancing costs and $8.5 million of KCG transaction advisory fees, partly offset by lower brokerage and employee costs.
- Six-month operating expenses were essentially flat, decreasing 0.2%, as lower volume-related costs and compensation offset transaction, refinancing, communications and administrative expenses.
- The AMF fine related to the company’s European subsidiary was reduced from €5.0 million to €3.0 million in May 2017, producing a $2.2 million reserve release.
- The company completed employee exchanges of approximately 1.0 million Virtu Financial units for Class A common stock during the first half of 2017, increasing its ownership interest in Virtu Financial to approximately 30.2% at June 30.
Guidance, outlook, commentary and risks
The filing does not provide a specific revenue, earnings or margin forecast. Management expects results to remain sensitive to trading volumes, market volatility, spreads, liquidity and the mix of asset classes and geographies. Technology services revenue is expected to benefit from agency execution and technology customers, but it remains a small portion of total revenue.
The principal post-quarter event is the KCG acquisition. Virtu issued approximately $712.5 million of Class A stock at closing, expected additional equity issuances were approximately $31.2 million, and the company incurred approximately $1.650 billion of new indebtedness in connection with the transaction. A $100 million voluntary term-loan prepayment was made on August 8, 2017.
- Integration risks include systems integration, data-center migration, employee retention, customer relationships, unexpected costs and failure to realize projected synergies or cost reductions.
- The filing identifies substantial leverage, variable-rate debt, restrictive covenants, refinancing risk and potential acceleration of debt as material risks.
- Market-making results depend on trading activity and volatility and are exposed to counterparty, clearing, technology, cybersecurity, regulatory and foreign-currency risks.
- Legal and regulatory matters include the AMF proceeding, pending KCG merger-related shareholder litigation, and regulatory reviews and investigations involving KCG and Virtu-related entities.
- Tax receivable agreement obligations were approximately $231.6 million at June 30, with expected future payments of approximately $238.6 million over 15 years, subject to realization of tax benefits. Certain change-of-control events could accelerate these obligations.
Most important facts for investors to verify
- Reconcile post-acquisition debt, cash usage, interest expense and covenant compliance after KCG is fully consolidated.
- Assess whether KCG integration costs, data-center migration and expected synergies are tracking management’s assumptions.
- Monitor trading volumes, volatility, spreads and Adjusted Net Trading Income per day, rather than relying solely on reported revenue.
- Review the final purchase accounting for KCG, including goodwill, identifiable intangibles, assumed liabilities and any valuation adjustments.
- Evaluate liquidity available to meet margin requirements, debt service, tax receivable agreement payments and regulatory capital requirements.
- Follow the AMF appeal, KCG-related shareholder litigation and other regulatory investigations for potential cash or reputational effects.