Virtu Financial, Inc. — Q2 2019 Form 10-Q Summary
Business context and reporting period
Virtu is a 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 Form 10-Q covers the three and six months ended June 30, 2019, compared primarily with the same periods in 2018. The March 1, 2019 acquisition of Investment Technology Group, Inc. (ITG) materially affects comparability: Q2 2019 includes ITG for the full quarter, while six-month 2019 results include ITG only from the acquisition date through June 30.
Financial performance and key metrics
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Six months ended June 30, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Total revenue | $378.5 million | $328.1 million | $741.4 million | $1.143 billion |
| Trading income, net | $205.9 million | $258.6 million | $463.5 million | $664.8 million |
| Commissions, net and technology services | $145.1 million | $46.6 million | $220.3 million | $100.4 million |
| Total operating expenses | $445.0 million | $278.5 million | $824.2 million | $625.0 million |
| Net income (loss) | $(55.5) million | $46.6 million | $(69.1) million | $456.6 million |
| Net income (loss) available to common stockholders | $(29.9) million | $25.2 million | $(36.6) million | $200.0 million |
| Diluted EPS | $(0.27) | $0.24 | $(0.34) | $2.02 |
| Adjusted Net Trading Income | $238.9 million | $202.9 million | $467.7 million | $543.2 million |
| Adjusted EBITDA | $89.2 million | $112.4 million | $213.4 million | $335.1 million |
Q2 total revenue increased 15.3%, but the company reported a pretax loss of $66.6 million and a net loss of $55.5 million. Six-month revenue declined 35.1%, primarily because the 2018 period included a $337.6 million gain on the sale of BondPoint. The filing reports net income margin of negative 23.2% for Q2 2019 and negative 14.8% for the six-month period, based on Adjusted Net Trading Income.
Q2 Adjusted Net Trading Income increased 17.7% year over year, driven by a $78.8 million increase in Execution Services, partially offset by a $42.9 million decline in Market Making. Six-month Adjusted Net Trading Income declined 13.9%; Market Making declined 36.4%, while Execution Services increased 194.7%.
Material changes versus the prior comparable periods
- ITG added $106.2 million of revenue and produced a $1.7 million pretax loss in Q2; for the post-closing six-month contribution, ITG generated $142.1 million of revenue and a $50.1 million pretax loss.
- Execution Services revenue increased 248.3% in Q2 to $142.0 million and declined 46.9% for six months to $225.5 million because the 2018 six-month period included the BondPoint gain.
- Market Making revenue declined 18.3% in Q2 and 28.6% for six months. Management attributed the decline in trading income to lower volatility and trading volumes across major asset categories.
- Operating expenses increased 59.8% in Q2 and 31.9% for six months, reflecting ITG-related costs, higher employee compensation, amortization of acquired intangibles, and office consolidation charges.
- Employee compensation increased to $83.7 million in Q2 and $191.5 million for six months, including ITG-related headcount and compensation costs. The six-month period included $17.6 million paid to certain former ITG management employees upon termination.
- Amortization of purchased intangibles increased to $20.6 million in Q2 and $31.5 million for six months, primarily due to ITG acquisition-related intangible assets.
- Virtu recognized $65.2 million of office-lease termination costs in Q2 and for the six-month period, including $25.9 million of right-of-use asset impairments, $37.9 million of leasehold and fixed-asset write-offs and $1.4 million of dilapidation charges.
Cash flow, debt and liquidity
- Cash and cash equivalents were $458.1 million at June 30, 2019, compared with $729.5 million at December 31, 2018. Cash, cash equivalents and restricted cash totaled $497.6 million.
- Six-month operating cash flow was an outflow of $377.3 million, compared with an inflow of $310.3 million in the prior-year period. Investing cash flow was an outflow of $864.4 million, including $835.6 million for the ITG acquisition.
- Financing cash flow was an inflow of $1.006 billion, primarily reflecting $1.5 billion of new long-term borrowings, partially offset by debt repayments, dividends, distributions to noncontrolling interests and debt issuance costs.
- Long-term borrowings were $1.932 billion net carrying value, or $1.982 billion principal, at June 30, 2019. This included $1.450 billion of first-lien term loans, $500 million of 6.75% second-lien notes due 2022 and $32.5 million of SBI bonds.
- Additional short-term obligations included $92.0 million under broker-dealer facilities, $156.9 million under short-term credit facilities and $59.5 million of short-term bank overdrafts.
- The $1.5 billion first-lien term loan matures in March 2026, subject to a springing maturity provision tied to repayment or refinancing of at least $400 million of the second-lien notes. The company stated that it was in compliance with applicable debt covenants at June 30, 2019.
- Management stated that cash flows from operations, available cash and available broker-dealer borrowings are expected to cover liquidity needs for more than the next twelve months, subject to trading-related margin requirements and other factors.
Guidance, outlook, commentary and risks
The filing does not provide formal quantitative revenue or earnings guidance. Management emphasized that results depend on trading volumes, market volatility, spreads, liquidity, execution activity and the performance of counterparties and clearing organizations.
Key risks include integration of ITG, significant acquisition-related indebtedness, potential failure to realize expected synergies or cost savings, regulatory capital requirements, market-structure and payment-for-order-flow scrutiny, competition, technology and cybersecurity failures, dependence on trading venues and third-party infrastructure, foreign-exchange exposure, litigation and regulatory investigations.
Virtu reported several ongoing legal and regulatory matters. These include securities litigation relating to ProShares inverse-volatility ETFs, litigation inherited from KCG, an ITG-related FINRA arbitration claim seeking approximately $65 million plus additional amounts, and regulatory reviews by U.S. and foreign authorities. A French market regulator fine of approximately $3.4 million was fully reserved and expected to be paid in 2019. Management stated that the ultimate outcomes of pending matters are not expected to materially affect the business overall, but individual periods could be materially affected.
The company adopted lease accounting guidance on January 1, 2019, recording $318.3 million of operating lease right-of-use assets and $388.1 million of operating lease liabilities at June 30, 2019. The company also expects future tax receivable agreement payments generally ranging from approximately $2.6 million to $19.9 million annually over the next 15 years, subject to realization of tax benefits.
On August 8, 2019, the board declared a dividend of $0.24 per Class A and Class B share and per restricted stock unit, payable September 16, 2019.
Most important facts for investors to verify
- Whether ITG integration produces sustainable revenue growth, cost savings and earnings improvement without further restructuring or impairment charges.
- The effect of lower market volatility and trading volumes on Market Making revenue and Adjusted Net Trading Income.
- Debt-service capacity, covenant headroom and the springing maturity provisions affecting the first-lien term loan and revolving facility.
- Cash conversion and liquidity needs, particularly given negative operating cash flow in the first half and substantial trading-related collateral and margin requirements.
- The sustainability and quality of non-GAAP Adjusted EBITDA and Normalized Adjusted EPS relative to GAAP losses and recurring financing, compensation and technology costs.
- Pending litigation, regulatory investigations, the approximately $65 million ITG-related arbitration claim and the reserved French regulatory fine.
- Tax receivable agreement obligations, future dividend capacity and the potential impact of changes in tax attributes or a change of control.
- Fair-value sensitivity of the SBI investment and other market, foreign-exchange, counterparty, technology and cybersecurity exposures.