Virtu Financial, Inc. — Form 10-Q Summary
Business context and reporting period
Virtu Financial is a technology-driven global market maker and execution-services provider. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared primarily with the corresponding 2016 periods. The July 20, 2017 acquisition of KCG Holdings materially changed the company’s scale, operating segments, capital structure and year-over-year comparability. KCG results are included only from the acquisition date through September 30, 2017.
Beginning in the third quarter, the company reported Market Making, Execution Services and Corporate segments. The company owned approximately 48.0% of Virtu Financial at September 30, 2017 and consolidated the remaining interests as noncontrolling interests.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Total revenue | $271.3 million | $164.8 million | $563.5 million | $531.6 million |
| Trading income, net | $203.9 million | $156.7 million | $479.6 million | $509.5 million |
| Commissions, net and technology services | $43.4 million | $2.9 million | $49.2 million | $7.2 million |
| Operating expenses | $317.8 million | $126.9 million | $580.9 million | $390.6 million |
| Income before taxes and noncontrolling interest | $(46.5) million | $37.9 million | $(17.4) million | $141.0 million |
| Net income (loss) | $(40.0) million | $33.0 million | $(14.5) million | $123.7 million |
| Net income (loss) attributable to common stockholders | $(13.5) million | $7.0 million | $(8.0) million | $25.8 million |
| Basic and diluted EPS | $(0.17) | $0.18 | $(0.17) | $0.66 |
| Adjusted Net Trading Income | $159.8 million | $97.2 million | $319.0 million | $321.1 million |
| Adjusted EBITDA | $58.9 million | $56.9 million | $146.9 million | $203.8 million |
Adjusted Net Trading Income increased 64.4% in Q3, driven principally by KCG, but declined 0.6% for the first nine months. Reported net income margin based on Adjusted Net Trading Income was negative 25.0% in Q3 2017 and negative 4.5% for the nine months, compared with 34.0% and 38.5%, respectively, in the prior-year periods. Adjusted EBITDA margin was 36.8% in Q3 and 46.0% for the nine months, versus 58.6% and 63.5% in the comparable periods.
Cash flow, balance sheet, debt and liquidity
- Net cash provided by operating activities was $215.8 million for the nine months ended September 30, 2017, compared with $187.1 million in 2016.
- Net cash used in investing activities was $826.5 million, including $799.3 million for the KCG acquisition, compared with $53.7 million in 2016.
- Net cash provided by financing activities was $980.2 million, primarily reflecting new borrowing and $736.0 million of common-stock issuance proceeds.
- Cash, cash equivalents and restricted cash increased by $377.8 million to $559.2 million at September 30, 2017; cash and cash equivalents alone were $558.0 million.
- Total assets were $7.74 billion and total equity was $1.17 billion at September 30, 2017, compared with $3.69 billion and $534.4 million, respectively, at December 31, 2016.
- Long-term borrowings had $1.481 billion of principal outstanding, consisting primarily of a $950.0 million first-lien term loan, $500.0 million of 6.750% second-lien notes due 2022 and approximately $31.1 million of SBI bonds. The balance-sheet carrying amount was $1.435 billion after financing fees and discounts.
- Short-term credit facilities had $159.1 million outstanding against $543.0 million of availability. Broker-dealer borrowings were $15.0 million against a $125.0 million uncommitted facility.
- The first-lien term loan matures in December 2021 and is subject to leverage and interest-coverage covenants. The second-lien notes mature in June 2022.
- Management stated that operating cash flow, available cash and available borrowings were expected to satisfy liquidity needs for more than the next twelve months. Liquidity needs include margin requirements, trading activity, debt service, tax receivable agreement payments and integration costs.
- On November 4, 2017, after quarter-end, broker-dealer subsidiaries entered into a committed $500.0 million revolving credit facility secured by eligible securities and deposits.
Material changes versus the prior comparable period
- The KCG acquisition increased Q3 revenue but also materially increased expenses, interest costs, amortization, headcount, connectivity costs and transaction-related charges. KCG contributed $149.3 million of revenue and a $12.6 million pretax loss from July 20 through September 30, 2017.
- Q3 revenue increased 64.6% to $271.3 million, while operating expenses increased 150.4% to $317.8 million, producing a pretax loss versus pretax income in Q3 2016.
- For the first nine months, revenue rose 6.0%, but operating expenses increased 48.7%, resulting in a pretax loss compared with $141.0 million of pretax income in 2016.
- Q3 Market Making revenue increased 41.1% to $228.6 million, while Market Making pretax income declined to a $19.3 million loss from $36.9 million of income. Nine-month Market Making revenue declined 1.8% and pretax income fell to $17.2 million from $138.6 million.
- Execution Services revenue increased to $39.1 million in Q3 and $45.0 million for the nine months, principally from KCG agency execution and technology services, but the segment reported losses of $6.0 million and $4.9 million, respectively.
- Major Q3 expense increases included employee compensation of $72.3 million, communication and data processing of $46.0 million, financing interest expense of $24.6 million, transaction advisory fees of $15.7 million, payments for order flow of $12.1 million and purchased-intangible amortization of $6.4 million.
- Common shares outstanding increased substantially because of approximately $748.7 million of equity issued to Aranda/Temasek and North Island in connection with the acquisition financing, plus employee exchanges.
Guidance, outlook, commentary and unusual items
- The filing provides no formal quantitative revenue or earnings guidance. Management stated that results are highly dependent on trading volumes, market volatility, spreads, client activity and liquidity conditions.
- Management expects to migrate KCG trading operations onto a single technology, risk-management and analytics platform and expects the combined company to benefit from broader products, clients and potential synergies. The filing cautions that integration costs, delays and expected synergies remain uncertain.
- Q3 and nine-month results included significant unusual or acquisition-related items: $15.7 million and $24.2 million of transaction advisory fees, $9.3 million of debt-refinancing costs for the nine months, $23.1 million of acquisition-related retention bonuses, $9.3 million of Q3 severance, and $6.4 million of acquired-intangible amortization in Q3.
- The company sold its NYSE American designated market-maker business in September 2017. On October 24, 2017, it agreed to sell BondPoint to ICE for $400.0 million in cash, subject to working-capital adjustments, regulatory clearances and other closing conditions.
- The company’s AMF fine was reduced in May 2017 to €3.0 million, with a total accrued amount of approximately €3.3 million; the company continues to appeal. A KCG stockholder action concerning the acquisition remains pending, although the preliminary-injunction motion was withdrawn.
- Management identified risks from lower trading activity, market volatility, counterparty and clearing-house failures, technology or cybersecurity failures, regulatory requirements, client concentration, data-center migration, acquisition integration, substantial leverage, variable interest rates and assumed KCG liabilities.
- The planned migration of KCG’s Jersey City data center operations was expected to be completed by the end of April 2018 and could cause operational disruption, additional costs or delays.
- The company expected to adopt the new revenue-recognition standard on January 1, 2018 using the full retrospective method and estimated no material overall impact, although evaluation of certain technology, soft-dollar and contract-cost matters remained ongoing.
Most important facts for an investor to verify
- Whether KCG integration delivers the expected revenue benefits, cost reductions, synergies and technology migration without disrupting trading or client relationships.
- The sustainability of adjusted earnings, given the decline in nine-month Adjusted Net Trading Income and the company’s sensitivity to market volume, volatility and spreads.
- Compliance with the first-lien credit agreement’s maximum leverage and minimum interest-coverage covenants as results and debt service evolve.
- Cash requirements for debt service, margin financing, tax receivable agreement obligations of approximately $238.6 million over the expected next 15 years, dividends and acquisition-related costs.
- The closing and net proceeds of the proposed $400.0 million BondPoint sale and other announced asset dispositions.
- The status and potential financial impact of regulatory investigations, the AMF appeal, the Greenway stockholder litigation and liabilities assumed from KCG.
- The effect of the post-acquisition share count and noncontrolling interests on per-share earnings and distributions.