Virtu Financial, Inc. 10-Q Summary
Business context and reporting period
Virtu Financial is a technology-enabled global market maker and execution-services provider. The unaudited Form 10-Q covers the three and six months ended June 30, 2018, with comparisons to the corresponding 2017 periods. Following the July 20, 2017 acquisition of KCG Holdings, the Company reports Market Making, Execution Services, and Corporate segments. The 2017 comparative periods largely exclude KCG, limiting direct comparability.
Financial performance and condition
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total revenue | $328.1 million, versus $144.9 million | $1.143 billion, versus $292.2 million |
| Adjusted Net Trading Income | $202.9 million, versus $77.1 million | $543.2 million, versus $159.2 million |
| Net income | $46.6 million, versus $4.4 million | $456.6 million, versus $25.5 million |
| Net income available to common stockholders | $25.2 million, versus $0.9 million | $200.0 million, versus $5.5 million |
| Diluted EPS | $0.24, versus $0.01 | $2.02, versus $0.11 |
| Adjusted EBITDA | $112.4 million, versus $40.9 million | $335.1 million, versus $88.6 million |
| Adjusted EBITDA margin | 55.4%, versus 53.1% | 61.7%, versus 55.6% |
Trading income increased to $258.6 million in the second quarter and $664.8 million for the first six months. Commissions and technology services increased to $46.6 million and $100.4 million, respectively. The six-month results include a $337.6 million gain on the sale of BondPoint; net of transaction costs, the gain was approximately $329.0 million.
GAAP net income margin, calculated against total revenue, was approximately 14.2% in the second quarter and 39.9% for the six months. The Company’s disclosed non-GAAP net income margin, calculated against Adjusted Net Trading Income, was 23.0% and 84.1%, respectively. The six-month margin is substantially affected by the BondPoint gain.
Cash and cash equivalents were $660.1 million at June 30, 2018, compared with $532.9 million at December 31, 2017. Net cash provided by operating activities was $310.3 million for the six months, versus $82.4 million in the prior-year period. Investing activities provided $373.7 million, principally from $400.2 million of BondPoint sale proceeds. Financing activities used $553.8 million, including $384.8 million of senior secured facility repayments, $165.6 million of distributions to noncontrolling interest, $48.3 million of dividends, and $44.0 million of treasury-stock purchases.
At June 30, 2018, long-term borrowings were $1.016 billion carrying value, with $1.047 billion of principal outstanding. Short-term borrowings were $44.0 million, and additional short-term credit facilities had approximately $119.8 million outstanding. Broker-dealer facilities had $47.0 million outstanding against $700.0 million of available financing. Total equity was $1.442 billion, including $410.9 million of noncontrolling interest.
Material changes versus the prior comparable period
- Second-quarter revenue rose 126.5%, while six-month revenue rose 291.3%; the increases primarily reflect the inclusion of KCG and higher trading activity.
- Second-quarter Adjusted Net Trading Income increased 163.3%, driven by a 410.9% increase in Americas Equities market-making income and a 745.7% increase in Execution Services.
- Six-month Adjusted Net Trading Income increased 241.1%, with Americas Equities up 550.1% and Execution Services up 800.2%.
- Operating expenses increased 99.4% in the second quarter and 137.6% for the six months, reflecting KCG-related scale, higher brokerage and connectivity costs, increased compensation, payments for order flow, interest expense, amortization, and lease termination costs.
- Payments for order flow, which were not present in the 2017 comparative periods, were $15.8 million in the second quarter and $32.1 million for the six months.
- The Company prepaid $384.8 million of its senior secured term facility during the first six months and repriced the facility in January 2018. Long-term borrowing carrying value declined from $1.389 billion at year-end 2017 to $1.016 billion.
- The May 2018 secondary offering included 10.5 million shares sold by the Company, with proceeds used to purchase corresponding Virtu Financial LLC units and Class D shares. The Company also repurchased approximately 1.38 million shares or common units for approximately $40.5 million through June 30.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide formal revenue, earnings, or trading-volume guidance. Management expects operating cash flow, cash on hand, and available broker-dealer facilities to cover liquidity needs for more than the next twelve months. Primary anticipated liquidity needs include increased margin requirements from higher trading activity and expansion into new markets.
Management emphasizes that results depend on trading volumes, market volatility, bid-ask spreads, competition, access to liquidity, counterparty and clearing-house performance, and the reliability and security of proprietary technology. Market-making results are designed to be directionally neutral but remain exposed to position, derivative, interest-rate, currency, operational, and counterparty risks. A hypothetical 10% increase in equity prices was estimated to produce a $6.3 million gain, while a 10% decrease was estimated to produce a $4.4 million loss, after considering offsets and hedges.
Unusual or nonrecurring items include the BondPoint gain, office-lease termination costs of $21.9 million for the six months, $8.4 million of accelerated debt-refinancing costs, $9.2 million of transaction advisory expenses, $7.1 million of connectivity early-termination costs, and acquired-intangible amortization of $13.7 million.
The Company recorded provisional effects of the 2017 Tax Act, including approximately $90.6 million of deferred tax expense, and expected to complete its analysis by the third quarter of 2018. Adjustments could materially affect income-tax expense. Tax receivable agreement obligations were $211.6 million at June 30, 2018, with expected payments of approximately $3.6 million to $16.0 million annually over the next 15 years, subject to realization of tax benefits.
The Company is subject to litigation, regulatory reviews, and investigations involving market structure, best execution, high-frequency trading, payment for order flow, anti-money laundering, sanctions, cybersecurity, and related matters. An AMF fine relating to a European subsidiary was reduced to approximately $3.9 million and fully reserved. A shareholder litigation matter related to the KCG acquisition remains pending, with no damages amount stated. Management does not currently expect these matters to have a material adverse effect on the business, although individual-period effects could be material.
The Company reported compliance with applicable debt covenants and regulatory capital requirements as of June 30, 2018. Subsequent to quarter-end, it prepaid an additional $41.2 million of senior secured facility principal, declared a $0.24 per-share dividend, and expanded its share-repurchase authorization to $100.0 million through September 30, 2019.
Important facts for investors to verify
- Separate the recurring operating performance of the combined Virtu-KCG business from the one-time BondPoint gain and other integration-related items.
- Assess the sustainability of trading income and Adjusted Net Trading Income under lower volatility or trading volumes.
- Review debt maturities, interest costs, leverage and interest-coverage covenants, including the December 2021 term-loan and June 2022 second-lien-note maturities.
- Evaluate liquidity needs arising from margin requirements, securities financing, collateral movements, and regulated broker-dealer capital requirements.
- Monitor payments under the tax receivable agreements and potential changes from finalization of the 2017 Tax Act accounting.
- Review the status and potential financial impact of regulatory investigations, market-structure matters, the AMF fine, and KCG-related litigation.
- Reconcile non-GAAP measures such as Adjusted Net Trading Income, Adjusted EBITDA, and Normalized Adjusted EPS to GAAP results before comparing Virtu with peers.