Virtu Financial, Inc. — FY2018 Form 10-K Summary
Business context and reporting period
Virtu is a technology-enabled global market maker and execution-services provider operating across more than 25,000 securities and financial instruments, over 235 venues, and 36 countries. The filing covers the fiscal year ended December 31, 2018; quarterly information includes the three months ended December 31, 2018. Operations are reported through Market Making, Execution Services, and Corporate segments. The 2018 results include a full year of KCG operations following the July 2017 acquisition.
Key financial metrics
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Total revenue | $1.879 billion | $1.028 billion | +82.8% |
| Adjusted Net Trading Income | $1.020 billion | $556.3 million | +83.4% |
| Net income | $620.2 million | $18.9 million | Significant increase |
| Net income available to common stockholders | $289.4 million | $2.9 million | Significant increase |
| Diluted EPS | $2.78 | $0.03 | Significant increase |
| Adjusted EBITDA | $620.0 million | $251.4 million | +146.7% |
| Adjusted EBITDA margin | 60.8% | 45.2% | +15.6 points |
| Operating cash flow | $714.6 million | $290.6 million | +145.9% |
| Cash and cash equivalents | $736.0 million | $532.9 million | +$203.2 million |
FY2018 total operating expenses were $1.182 billion, compared with $914.8 million in 2017. Income before taxes was $696.4 million, and the income-tax provision was $76.2 million, producing a 10.9% effective tax rate. Net income margin measured against Adjusted Net Trading Income was 60.8%, although this measure benefits materially from unusual items.
Market Making revenue was $1.384 billion and segment income before taxes and noncontrolling interest was $422.6 million. Execution Services revenue was $496.3 million and segment income was $325.0 million. Market Making generated $923.9 million of Adjusted Net Trading Income, while Execution Services generated $96.3 million.
For the fourth quarter of 2018, total revenue was $440.4 million, net income was $147.9 million, net income attributable to Virtu Financial was $80.9 million, and diluted EPS was $0.74. The filing does not provide a separate fourth-quarter Adjusted EBITDA value in the presented supplemental data.
Material changes versus the prior comparable period
- Trading income increased 65.4% to $1.267 billion, reflecting higher market volumes and volatility and the contribution of KCG-related trading capital.
- Commissions, net and technology services increased 58.2% to $184.3 million, primarily from KCG and new agency-execution customers.
- Other, net increased to $340.2 million, principally because of the $337.6 million gain on the sale of BondPoint. BondPoint was sold to ICE in January 2018 for $400.2 million of gross proceeds; the net gain after transaction costs was approximately $329.0 million.
- Operating expenses increased 29.2%, including higher brokerage and clearing fees, communications and data processing, employee compensation, payments for order flow, interest and dividends expense, and amortization.
- The company prepaid $500.0 million of term-loan principal during 2018, reducing outstanding principal under the term loan to $400.0 million at year-end. Total term-loan prepayments since origination were $750.0 million.
- Cash flow from investing activities changed from $838.0 million used in 2017 to $329.2 million provided in 2018, mainly because of the BondPoint sale and the absence of KCG acquisition spending.
- The company completed a May 2018 secondary offering involving 17.25 million Class A shares. It repurchased approximately 2.6 million Class A shares and Virtu Financial Units for approximately $65.9 million under its repurchase program, leaving approximately $34.1 million of authorization at year-end.
Debt, liquidity, dividends, and capital
Long-term borrowings were $931.9 million in principal, consisting of $400.0 million under the first-lien term facility, $500.0 million of 6.75% second-lien notes due 2022, and $31.9 million of SBI bonds due 2020. Net long-term borrowings reported on the balance sheet were $907.0 million. Additional borrowings included $17.0 million under broker-dealer facilities and $184.6 million under short-term prime-broker and financial-institution facilities.
Management stated that cash from operations, cash on hand, and available borrowing capacity were expected to meet liquidity needs for more than the next twelve months. Primary liquidity needs include margin requirements, debt service, capital expenditures, dividends, and tax receivable agreement payments. The company was in compliance with applicable debt covenants at December 31, 2018, and reported aggregate domestic regulatory capital requirements of approximately $4.0 million.
The board declared quarterly dividends of $0.24 per share during 2018, or $0.96 per share for the year. The stated policy targets annual dividends of at least 70% of net income, subject to board discretion, debt covenants, regulatory capital requirements, liquidity, and business conditions.
Outlook, commentary, risks, contingencies, and unusual items
- The company provides no specific 2019 earnings or revenue guidance in the filing. Results are expected to remain sensitive to trading volumes, realized volatility, bid/ask spreads, market structure, competition, and client activity.
- Management emphasizes scalable proprietary technology, diversification, automation, and real-time risk controls. However, system failures, cyberattacks, capacity constraints, third-party infrastructure failures, and operational errors could cause trading losses or business interruption.
- Regulatory risks include changes affecting electronic trading, payment for order flow, exchange fees and rebates, alternative trading systems, best execution, market access, transaction reporting, capital requirements, MiFID II, the Consolidated Audit Trail, and the SEC transaction-fee pilot.
- Market-making and self-clearing activities expose the company to counterparty, clearinghouse, liquidity, financing, settlement, and inventory risks. The company held approximately $2.6 billion of long financial instruments and $2.5 billion of short financial instruments at year-end, before considering applicable netting and collateral.
- Tax receivable agreement obligations were $214.4 million at year-end. The company generally pays 85% of realized cash tax savings to specified equityholders; payments may be substantial and may accelerate upon certain change-of-control events.
- The company is controlled by the Founder Post-IPO Member, which held approximately 84.1% of combined voting power at December 31, 2018. Virtu Financial, Inc. owned approximately 56.7% of Virtu Financial, creating noncontrolling interests and dependence on distributions from the operating subsidiary.
- Legal and regulatory matters include ongoing reviews and investigations, litigation related to the KCG acquisition and volatility-related ETF trading, and a fully reserved €3.0 million AMF fine expected to be paid in 2019. Management believes the currently known matters are not expected to have a material adverse effect overall, but individual periods could be affected.
- On March 1, 2019, after year-end, Virtu completed the approximately $1.0 billion acquisition of Investment Technology Group. The transaction was financed through a new $1.5 billion first-lien term loan and a $50.0 million revolving facility, materially changing the company’s post-year-end leverage and integration risk.
- The company adopted the new lease standard on January 1, 2019 and estimated recognition of approximately $334.0 million to $369.2 million of lease liabilities and $303.8 million to $335.7 million of right-of-use assets.
Most important facts for an investor to verify
- Reconcile reported earnings and margins excluding the approximately $329.0 million net BondPoint gain and other unusual items.
- Assess recurring Adjusted Net Trading Income, particularly the dependence on Americas Equities and market volumes and volatility.
- Update leverage, interest expense, maturities, covenants, and liquidity for the March 2019 ITG acquisition financing.
- Review the sustainability of the dividend and repurchase program after debt service, regulatory capital needs, tax receivable agreement payments, and ITG integration costs.
- Evaluate noncontrolling interests, the 56.7% ownership structure, and the effect of distributions from Virtu Financial on parent-company liquidity.
- Monitor regulatory investigations, litigation, the AMF payment, cybersecurity and technology controls, and any potential changes to market structure or payment-for-order-flow economics.
- Confirm post-adoption lease liabilities and right-of-use assets and their effect on reported leverage and operating metrics.