Virtu Financial, Inc. — 2019 Q3 Form 10-Q Summary
Business context and reporting period
Virtu Financial is a technology-enabled financial services firm operating two segments: Market Making and Execution Services, plus Corporate. It provides liquidity, agency execution, workflow technology, analytics and trading solutions across more than 25,000 financial instruments, 235 venues and 36 countries.
This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods. Results include Investment Technology Group, Inc. (ITG) from its March 1, 2019 acquisition date; all prior-period results exclude ITG. Virtu acquired ITG for approximately $1.0 billion in cash.
Financial performance and key metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Total revenue | $385.4 million | $295.1 million | $1.127 billion | $1.438 billion |
| Trading income, net | $220.1 million | $235.7 million | $683.6 million | $900.5 million |
| Commissions, net and technology services | $139.6 million | $40.3 million | $359.9 million | $140.7 million |
| Operating expenses | $391.2 million | $265.7 million | $1.215 billion | $890.7 million |
| Net income (loss) | $(5.2) million | $15.6 million | $(74.3) million | $472.3 million |
| Net income (loss) available to common stockholders | $(4.3) million | $8.6 million | $(40.9) million | $208.6 million |
| Diluted EPS | $(0.04) | $0.08 | $(0.38) | $2.04 |
| Adjusted Net Trading Income | $249.8 million | $177.9 million | $717.5 million | $721.1 million |
| Adjusted EBITDA | $103.9 million | $88.3 million | $317.3 million | $423.4 million |
Q3 revenue increased 30.6%, while operating expenses increased 47.2%, resulting in a pretax loss of $5.8 million versus pretax income of $29.4 million. The reported net income margin was approximately negative 1.3% in Q3 2019 versus 5.3% in Q3 2018. Adjusted EBITDA margin was 41.6% versus 49.6%.
For the first nine months, revenue declined 21.7% and operating expenses increased 36.5%, producing a pretax loss of $88.6 million versus pretax income of $547.6 million. The prior-year period included a $337.6 million gain on the sale of BondPoint. Adjusted Net Trading Income was essentially unchanged, declining 0.5%.
- Market Making revenue declined 5.1% in Q3 and 22.3% for the nine months, primarily reflecting lower volatility and trading volumes. Market Making Adjusted Net Trading Income declined 10.8% in Q3 and 30.2% for the nine months.
- Execution Services revenue increased 292.8% in Q3 and was $359.9 million for the nine months, principally due to ITG. Execution Services Adjusted Net Trading Income increased 467.7% in Q3 and 266.8% for the nine months.
- Employee compensation and payroll taxes rose to $90.6 million in Q3 and $282.1 million for the nine months, including increased headcount, share-based compensation and severance.
- Amortization of purchased intangibles increased to $18.9 million in Q3 and $50.4 million for the nine months because of ITG-related acquired assets.
- Termination of office leases totaled $66.5 million for the nine months, including impairments and write-offs related to office consolidation and integration.
Cash flow, liquidity, debt and capital
- Cash and cash equivalents were $372.7 million at September 30, 2019, compared with $729.5 million at December 31, 2018. Cash, cash equivalents and restricted cash totaled $394.8 million.
- Operating cash flow was negative $346.2 million for the nine months, versus positive $313.5 million in the prior-year period.
- Investing cash flow was negative $882.8 million, including $835.6 million of cash consideration for ITG. Financing cash flow was positive $897.8 million, primarily from $1.5 billion of long-term borrowings.
- Long-term borrowings totaled $1.934 billion net of discounts and issuance costs, representing approximately $1.982 billion of principal. Short-term borrowings were $94.9 million, and additional short-term credit facilities of approximately $133.4 million were netted against broker-dealer receivables.
- The company had $37.0 million outstanding under broker-dealer credit facilities with $800 million of capacity. Management stated that operating cash flows, cash on hand and available borrowings were expected to meet liquidity needs for more than the next twelve months.
- Total assets were $9.187 billion and total equity was $1.297 billion at September 30, 2019. Virtu owned approximately 62.1% of Virtu Financial LLC, with the remainder reflected as noncontrolling interest.
- Domestic U.S. broker-dealers had aggregate regulatory capital requirements of $5.8 million and substantial excess capital at quarter-end.
Material changes, outlook and unusual items
- The ITG acquisition added $100.1 million of Q3 revenue and contributed a pretax loss of $8.7 million. The purchase accounting allocation included approximately $479.6 million of acquired intangible assets and $359.0 million of goodwill.
- On October 9, 2019, Virtu borrowed $525.0 million of incremental first-lien term loans, used with cash on hand to redeem the $500.0 million of 6.75% second-lien notes due 2022. The incremental debt matures in March 2026. A five-year interest-rate swap effectively fixes the incremental borrowing cost at 4.8% through September 2024.
- The company declared a $0.24-per-share dividend on November 5, 2019, payable December 16, 2019.
- The $100 million share repurchase program expired September 30, 2019. Approximately $65.9 million had been used, leaving reported capacity of approximately $34.1 million at quarter-end; no repurchases under the public program occurred during the nine months.
- Tax receivable agreement obligations were $256.7 million at September 30, 2019. Expected payments were approximately $2.6 million to $19.9 million annually over the next 15 years, subject to realization of related tax benefits.
- There was no formal earnings or revenue guidance disclosed in the provided filing text. Management highlighted sensitivity to trading volumes, volatility, liquidity requirements, integration execution and market conditions.
Risks, contingencies and controls
- Key risks include lower trading activity or volatility, counterparty and clearing-house failures, market and interest-rate risk, technology or system failures, cybersecurity incidents, dependence on exchanges and third-party infrastructure, competition, regulatory capital requirements, and legal or regulatory actions.
- The company remains subject to regulatory reviews and investigations and heightened scrutiny of market structure, best execution, high-frequency trading, alternative trading systems, payment for order flow, cybersecurity and anti-money-laundering compliance.
- A proposed settlement was reached in October 2019 in litigation related to the KCG acquisition, subject to definitive documentation and court approval. The filing states that the company continued to deny liability.
- A former ITG employee sought approximately $65 million in damages; a FINRA panel subsequently awarded $3 million in compensatory damages plus approximately $3 million of fees and expenses. The company paid the award and is seeking insurance reimbursement for a portion.
- The company had fully reserved a €3.0 million AMF monetary penalty, expected to be paid during 2019.
- Management concluded that disclosure controls were effective as of September 30, 2019 and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether ITG integration produces the expected revenue growth, cost savings, synergies and capital release without further material restructuring or severance charges.
- The sustainability of Execution Services growth relative to weakness in Market Making and the company’s exposure to trading volumes and volatility.
- Debt-service capacity after the October refinancing, including the $525 million incremental term loan, interest-rate swap and remaining approximately $1.45 billion first-lien term loan principal at September 30.
- Cash conversion and liquidity, given negative nine-month operating cash flow, substantial collateralized trading balances and reliance on broker-dealer and prime-broker financing.
- Potential cash obligations under tax receivable agreements, leases, regulatory matters, litigation and assumed ITG liabilities.
- The effect of non-GAAP adjustments on reported performance; Q3 2019 Normalized Adjusted Net Income was $39.6 million and Normalized Adjusted EPS was $0.21, compared with GAAP net loss available to common stockholders of $4.3 million and diluted EPS of $(0.04).