Virtu Financial, Inc. — Q1 2019 Form 10-Q Summary
Business context and reporting period
Virtu is a global technology-enabled financial services firm operating in Market Making, Execution Services and Corporate. It provides liquidity and execution, workflow technology and analytics across more than 25,000 financial instruments, 235 venues and 36 countries. This unaudited filing covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018.
The results include Investment Technology Group, Inc. (ITG) from its March 1, 2019 acquisition date through March 31, 2019. The approximately $1.0 billion all-cash ITG acquisition expanded Execution Services and was financed substantially with new debt.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $363.0 million | $815.1 million | (55.5%) |
| Adjusted Net Trading Income | $228.8 million | $340.3 million | (32.7%) |
| Operating expenses | $379.2 million | $346.5 million | 9.4% |
| Income before taxes and noncontrolling interest | $(16.2) million | $468.5 million | Loss versus profit |
| Net income | $(13.6) million | $410.0 million | Loss versus profit |
| Net income available to common stockholders | $(6.7) million | $174.8 million | Loss versus profit |
| Basic and diluted EPS | $(0.07) | $1.89 and $1.86 | Lower |
| Adjusted EBITDA | $124.2 million | $222.7 million | (44.2%) |
| Adjusted EBITDA margin | 54.3% | 65.4% | Down 11.1 points |
GAAP net income margin, calculated using Adjusted Net Trading Income as the denominator, was negative 6.0% versus 120.5% in the prior-year period. The prior-year results included a $337.6 million gain on the sale of BondPoint; excluding this unusual item, the year-over-year revenue comparison is less distorted.
- Trading income, net declined 36.6% to $257.5 million, primarily due to lower volatility and trading volumes across major asset categories.
- Interest and dividends income increased 62.3% to $29.1 million.
- Commissions, net and technology services increased 39.6% to $75.1 million, primarily from ITG and its workflow and analytics revenues.
- Market Making revenue declined 35.4% to $279.2 million; Execution Services revenue declined 78.2% to $83.5 million because Q1 2018 included the BondPoint gain, although Execution Services Adjusted Net Trading Income increased 91.1% to $51.0 million.
- Employee compensation and payroll taxes increased 66.7% to $107.8 million, including $17.6 million paid to former ITG management employees at closing and higher headcount.
Cash flow, liquidity and debt
| Item | March 31, 2019 | December 31, 2018 |
|---|---|---|
| Cash and cash equivalents | $771.0 million | $729.5 million |
| Restricted or segregated cash | $17.3 million | $6.5 million |
| Total assets | $9.08 billion | $7.38 billion |
| Total liabilities | $7.64 billion | $5.89 billion |
| Long-term borrowings, net | $1.98 billion | $907.0 million |
| Total equity | $1.44 billion | $1.49 billion |
- Operating cash flow was $(210.0) million versus $119.0 million provided in Q1 2018.
- Investing cash flow was $(848.0) million, including $835.6 million for the ITG acquisition.
- Financing cash flow was $1.11 billion, reflecting $1.49 billion of new long-term borrowings, $400.0 million of long-term debt repayment, dividends and other equity-related uses.
- Cash and cash equivalents increased by $52.3 million to $788.3 million, including restricted cash, at quarter-end.
- Outstanding principal of long-term debt was approximately $2.03 billion, consisting primarily of a $1.5 billion first-lien term loan due 2026, $500.0 million of 6.75% second-lien notes due 2022 and $31.6 million of SBI bonds due 2020.
- Short-term borrowings included approximately $136.1 million under short-term credit facilities, $17.0 million under broker-dealer facilities and $146.3 million of international settlement overdrafts.
- Management stated that operating cash flows, cash on hand and available borrowings should satisfy liquidity needs for more than the next twelve months. The company was in compliance with applicable credit agreement and notes covenants at March 31, 2019.
Material changes versus the prior comparable period
- The ITG acquisition materially increased assets, goodwill, intangibles, lease assets and debt. Preliminary purchase accounting recorded $357.3 million of goodwill and $479.6 million of acquired intangible assets.
- Execution Services revenue from contracts with customers was $70.1 million, including commissions, workflow technology and analytics. ITG contributed $35.9 million of revenue and a $48.4 million pretax loss from closing through March 31, 2019.
- Operating expenses rose despite lower revenue, driven by ITG-related compensation, amortization, transaction advisory fees, debt refinancing costs and higher financing expense.
- Adjusted Net Trading Income from Global Equities declined 43.9%, while Global FICC, Options and Other declined 45.5%.
- The company adopted lease accounting guidance effective January 1, 2019, recognizing $350.4 million of operating lease right-of-use assets and $394.8 million of operating lease liabilities. The income statement impact was immaterial.
- The company repurchased 325,195 shares or Virtu Financial Units for $8.8 million, primarily to satisfy employee tax-withholding obligations. Approximately $34.1 million remained available under the $100 million repurchase authorization.
Outlook, commentary, risks and unusual items
The filing does not provide formal quantitative revenue or earnings guidance. Management emphasized that Market Making results depend on trading volumes, volatility, spreads, asset-class mix and market conditions. Management also expects liquidity needs to be driven principally by margin requirements and trading activity.
- Key risks include lower trading activity or volatility, competition, counterparty and clearing-house failures, dependence on liquidity and third-party infrastructure, technology or cybersecurity failures, regulatory capital requirements, foreign exchange movements, and legal or regulatory actions.
- The company faces integration risk, significant new indebtedness and potential assumed liabilities following the ITG acquisition. Expected synergies, cost savings and capital release may not be achieved.
- Legal and regulatory matters include putative class actions related to ProShares inverse-volatility ETFs, the KCG-related fiduciary-duty litigation, assumed ITG matters and ongoing regulatory reviews. Management believes the matters will not have a material adverse impact overall, but acknowledges that a material judgment, fine or sanction could affect a particular period.
- The company had fully reserved an approximately $3.4 million AMF fine and expected to pay it during 2019.
- Tax receivable agreement obligations were approximately $214.4 million, with expected payments of approximately $4.7 million to $17.0 million annually over the next 15 years, subject to realized tax savings. A change of control or other specified events could accelerate payments.
- A $0.24 per share dividend was declared on May 3, 2019, payable June 17, 2019 to holders of record June 3, 2019.
Most important facts for investors to verify
- Whether trading volumes and volatility recover sufficiently to improve Market Making Adjusted Net Trading Income.
- The pace and cost of integrating ITG, including whether the acquired business reaches profitability and produces expected synergies.
- Debt-service capacity and refinancing risk, particularly the $500 million second-lien notes due 2022 and springing maturity provisions in the first-lien credit agreement.
- Trends in compensation, amortization and other acquisition-related expenses relative to recurring revenue.
- Liquidity after margin requirements, restricted cash, regulatory capital needs, dividends, share repurchases and tax receivable agreement payments.
- Developments in legal, regulatory, cybersecurity and market-structure matters, including potential fines or restrictions affecting payment for order flow and execution services.
- The effect of the new lease obligations, preliminary ITG purchase-price allocation and future goodwill or intangible-asset impairment testing.