Virtu Financial, Inc. — 2016 Q2 Form 10-Q Summary
Business context and reporting period
Virtu is a technology-enabled market maker and liquidity provider operating in one reportable segment. It provides liquidity across more than 12,000 securities and financial instruments on more than 235 exchanges, markets and liquidity pools in 36 countries. The filing covers the three and six months ended June 30, 2016, compared primarily with the corresponding 2015 periods.
Comparability with 2015 is limited because the IPO and related reorganization occurred in April 2015. The 2015 financial statements include the consolidated operations of Virtu Financial only from April 16, 2015, and do not reflect the full-period effects of corporate taxes, noncontrolling interests, the IPO or the secondary offering.
Key financial metrics
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015 | Six months ended June 30, 2016 | Six months ended June 30, 2015 |
|---|---|---|---|---|
| Total revenue | $174.2 million | $182.0 million | $366.8 million | $403.5 million |
| Trading income, net | $166.5 million | $169.8 million | $352.8 million | $383.7 million |
| Adjusted Net Trading Income | $102.3 million | $105.9 million | $219.6 million | $254.3 million |
| Income before taxes and noncontrolling interest | $44.4 million | $9.6 million | $103.1 million | $89.7 million |
| Net income | $39.3 million | $7.6 million | $90.6 million | $85.0 million |
| Net income available to common stockholders | $8.4 million | $0.5 million | $18.7 million | $0.5 million |
| Diluted EPS | $0.21 | $0.01 | $0.48 | $0.01 |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $85.5 million | $182.9 million |
Trading income represented approximately 96% of total revenue in both 2016 periods. The filing reports second-quarter net income margin of 37.6%, Adjusted Net Income margin of 43.8%, EBITDA margin of 56.8% and Adjusted EBITDA margin of 63.0%. For the six-month period, the corresponding margins were 40.5%, 46.8%, 59.6% and 65.6%. These are management-defined margins based on Adjusted Net Trading Income plus technology services revenue, rather than total GAAP revenue.
Material changes versus the prior comparable period
- Second-quarter revenue declined 4.3%, while six-month revenue declined 9.1%.
- Second-quarter Adjusted Net Trading Income decreased 3.4%; the six-month decrease was 13.6%. Lower performance in global currencies, global commodities and EMEA equities more than offset gains in Americas equities, APAC equities and options, fixed income and other securities.
- Adjusted Net Trading Income per trading day declined to $1.6 million from $1.7 million in the quarter and to $1.76 million from $2.1 million for the six-month period.
- Operating expenses decreased 24.7% in the quarter and 16.0% for the six months, primarily because IPO-related share-based compensation charges fell from $44.2 million in the 2015 quarter and six-month period to $0.5 million and $1.1 million, respectively.
- Employee compensation increased 36.8% in the quarter, partly reflecting lower incentive compensation accruals in the 2015 period. Six-month employee compensation increased 3.1%, including compensation expense for IPO-related stock options.
- Net income available to common stockholders increased substantially, but the 2015 comparison was affected by the IPO-related compensation charge and the post-IPO ownership structure.
- Cash and cash equivalents declined to $149.4 million from $163.2 million at December 31, 2015. Total assets increased to $4.7 billion from $3.4 billion, largely reflecting higher broker-dealer receivables and trading assets and liabilities.
Cash flow, debt and liquidity
- Six-month operating cash flow was $85.5 million, down from $182.9 million, primarily because of changes in cash and securities positions held at prime brokers and clearing organizations and lower profitability after noncash adjustments.
- Investing cash outflow was $9.8 million, including $4.2 million for capitalized software and $5.6 million for property and equipment.
- Financing cash outflow was $90.8 million, including $91.5 million distributed to noncontrolling interest holders and $18.7 million of dividends, partially offset by $23.0 million of net short-term borrowings.
- Short-term credit facilities had $265.7 million outstanding against $493 million of aggregate availability. Broker-dealer facilities had $68.0 million outstanding, while the $100 million revolving facility had no borrowings.
- The senior secured credit facility had $497.3 million of principal outstanding, recorded at a net carrying amount of $491.9 million, with a stated rate of 5.25% at June 30, 2016. The filing states that it matures in November 2019 and that the company was in compliance with all covenants.
- Domestic broker-dealer subsidiaries maintained regulatory capital of $42.8 million and $7.2 million against reported requirements of $1.0 million and $2.9 million, respectively.
- Management believes cash flows from operations, available cash and available borrowings will meet liquidity needs for more than the next twelve months. Primary anticipated needs include higher margin requirements associated with increased trading activity and expansion.
Guidance, outlook, commentary, risks and unusual items
- The filing does not provide formal quantitative earnings or revenue guidance.
- Management stated that revenue is driven primarily by trading volume and volatility. Lower volume and volatility in currencies, commodities and European equities weighed on 2016 results, while increased Americas and APAC equity volumes provided partial offsets.
- Technology services revenue declined because the upfront component of a prior three-year arrangement had been fully recognized. The company renewed one arrangement in January 2016 and entered into a separate three-year arrangement in June 2016.
- The company disclosed the United Kingdom’s Brexit referendum. It expects no immediate impact on access to European Union markets through its Irish regulated subsidiary, but stated that the ultimate effects could materially affect its business, financial condition and results.
- The company accrued a €5.0 million, approximately $5.4 million, AMF fine related to alleged price manipulation and violations of French and Euronext rules by a European subsidiary acquired from MTH. The company disputes the allegations and is pursuing an appeal.
- The company remains subject to regulatory inquiries and potential enforcement actions, including matters involving Regulation NMS, Regulation SHO, capital requirements, the SEC and the New York Attorney General. Management states that the ultimate effect of pending matters is unknown, although it does not currently expect a material adverse effect on financial position.
- Principal business risks include reduced trading activity, counterparty and clearing-house risk, technology and cybersecurity failures, competition, dependence on liquidity and trading venues, regulatory capital requirements, litigation, international operations, foreign exchange movements and the loss of key personnel.
- The tax receivable agreement liability was $218.4 million, with expected payments of approximately $8.1 million to $16.8 million annually over the next 15 years, subject to realization of tax benefits. The first payment was expected after the extended September 15, 2016 tax-return deadline.
- Subsequent events included a July 2016 minority investment in SBI Japannext financed through bonds issued by VFH, $20.0 million of distributions by Virtu Financial to its members between July 1 and August 12, and a declared $0.24 per-share dividend payable September 15, 2016.
Most important facts for investors to verify
- Confirm the effect of the post-IPO ownership structure and noncontrolling interests on reported net income, EPS and distributions to Virtu Financial, Inc. stockholders.
- Assess the sustainability of trading results as currencies, commodities and European equities normalize from unusually favorable or unfavorable volume and volatility conditions.
- Review liquidity and collateral requirements, including $265.7 million of short-term credit-facility borrowings, $497.3 million of senior secured debt and the company’s reliance on prime-broker financing.
- Monitor senior secured credit-facility maturity, covenant compliance and restrictions on dividends, investments, acquisitions and subsidiary distributions.
- Evaluate the cash burden and potential acceleration of the $218.4 million tax receivable agreement obligation.
- Follow the AMF appeal, SEC and NYAG information requests, and other regulatory matters for possible fines, penalties, restrictions or reputational effects.
- Distinguish GAAP results from management’s non-GAAP measures, particularly Adjusted Net Trading Income, Adjusted EBITDA and Normalized Adjusted EPS.