Virtu Financial, Inc. — Form 10-Q Summary
Business context and reporting period
Virtu Financial is a technology-enabled global market maker and execution-services provider operating through Market Making, Execution Services and Corporate segments. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, with comparisons to the corresponding 2017 periods. Results include the KCG business for the full comparable periods following its July 2017 acquisition.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenue | $295.1 million | $271.3 million | $1.438 billion | $563.5 million |
| Adjusted Net Trading Income | $177.9 million | $159.8 million | $721.1 million | $319.0 million |
| Operating expenses | $265.7 million | $317.8 million | $890.7 million | $580.9 million |
| Income before taxes and noncontrolling interest | $29.4 million | $(46.5) million | $547.6 million | $(17.4) million |
| Net income | $15.6 million | $(40.0) million | $472.3 million | $(14.5) million |
| Net income available to common stockholders | $8.6 million | $(13.5) million | $208.6 million | $(8.0) million |
| Diluted EPS | $0.08 | $(0.17) | $2.04 | $(0.17) |
| Adjusted EBITDA | $88.3 million | $58.9 million | $423.4 million | $146.9 million |
| Adjusted EBITDA margin | 49.6% | 36.8% | 58.7% | 46.0% |
Q3 2018 revenue increased 8.8% year over year, while Adjusted Net Trading Income increased 11.3%. Q3 net income margin was approximately 5.3% of revenue; nine-month net income margin was approximately 32.8%, substantially affected by the BondPoint sale gain. Trading income represented 79.9% of Q3 revenue and 62.6% of nine-month revenue.
Market Making generated Q3 revenue of $264.4 million and pre-tax income of $39.7 million. Execution Services generated Q3 revenue of $34.2 million and pre-tax income of $0.1 million. For the nine-month period, Market Making generated $984.6 million of revenue and $262.9 million of pre-tax income, while Execution Services generated $458.8 million of revenue and $331.7 million of pre-tax income, including the BondPoint sale gain.
Cash flow, balance sheet, debt and liquidity
- Cash and cash equivalents were $415.9 million at September 30, 2018, compared with $532.9 million at December 31, 2017.
- Operating cash flow was $313.5 million for the first nine months, versus $215.8 million in the prior-year period.
- Investing cash flow was $363.6 million, including $400.2 million of gross proceeds from the BondPoint sale.
- Financing cash flow was $(790.4) million, including a $500.0 million repayment of long-term debt, $196.1 million distributed to noncontrolling interest and $74.3 million of dividends.
- Long-term debt principal was approximately $930.8 million, with $904.0 million reported net of discounts and issuance costs. The debt comprised a $400.0 million term loan, $500.0 million of 6.75% senior secured second-lien notes due 2022 and approximately $30.8 million of SBI bonds due 2020.
- Short-term borrowings included $17.0 million under broker-dealer facilities and approximately $144.7 million under other short-term credit facilities. Available broker-dealer facilities totaled $700.0 million.
- Management stated that operating cash flow, cash on hand and available borrowing capacity should meet liquidity needs for more than the next twelve months. Principal liquidity requirements include trading-related margin needs, debt service, dividends, tax receivable agreement payments and potential acquisition funding.
- Domestic broker-dealer subsidiaries had aggregate regulatory capital requirements of approximately $6.1 million and significant excess regulatory capital at September 30, 2018. The company reported compliance with applicable debt covenants.
Material changes versus the prior comparable period
- The KCG acquisition drove substantial increases in Market Making revenue, particularly Americas Equities, and contributed to higher brokerage, communications, compensation, order-flow and interest expenses.
- Q3 Market Making Adjusted Net Trading Income rose 20.3% to $158.9 million, led by a 27.7% increase in Americas Equities. Execution Services Adjusted Net Trading Income declined 32.6% to $19.0 million, primarily reflecting the BondPoint disposition.
- Nine-month Adjusted Net Trading Income increased 126.0% to $721.1 million. Market Making increased 127.4% and Execution Services increased 111.1%.
- Operating expenses declined 16.4% in Q3 due primarily to expense-reduction initiatives, lower compensation, communications and administrative costs, and lower transaction fees. For the nine-month period, expenses increased 53.3% because of the KCG acquisition and related operating costs.
- The company completed the sale of BondPoint on January 2, 2018 for gross cash proceeds of $400.2 million and recognized a gain of approximately $337.6 million, or $329.0 million net of transaction costs.
- The company prepaid $500.0 million of term debt during the first nine months and repriced the term loan in September 2018 to LIBOR plus 2.75%.
- The company repurchased approximately 2.37 million shares and common units for approximately $61.9 million since February 2018, leaving approximately $38.1 million of authorized capacity.
Outlook, commentary, risks and unusual items
- Management emphasized that results depend heavily on trading volumes, realized volatility, bid-ask spreads, market structure, competition and access to liquidity. No formal earnings guidance was provided in the filing.
- On November 6, 2018, after quarter-end, the company declared a $0.24 per-share dividend payable December 14, 2018.
- Also after quarter-end, Virtu agreed to acquire Investment Technology Group for approximately $1.0 billion in cash, subject to shareholder and regulatory approvals, with closing expected in the first half of 2019. The company obtained commitments for $1.5 billion of gross new debt to fund the transaction, related fees and refinancing of the existing first-lien term loan.
- The ITG transaction introduces execution, integration, regulatory-approval, financing, leverage, litigation and synergy-realization risks. The filing states that up to approximately $1.55 billion of new indebtedness could be incurred.
- Other unusual items included the BondPoint gain, $23.3 million of office-lease termination expense, $11.7 million of accelerated debt-issuance-cost amortization, and $20.0 million of purchased-intangible amortization for the nine-month period.
- The company faces ongoing regulatory reviews and investigations involving market structure, best execution, high-frequency trading, payment for order flow, anti-money-laundering and sanctions compliance. An AMF penalty of approximately $3.9 million was fully reserved and expected to be paid in 2018.
- A Delaware shareholder action related to the KCG acquisition remains pending; no damages amount was stated. Management believes current legal matters are not expected to have a material adverse effect overall, but acknowledges that individual periods could be materially affected.
- Core risks include lower trading activity or volatility, technology and cybersecurity failures, counterparty and clearing-house exposures, regulatory capital requirements, competition, leverage, foreign exchange movements, integration of KCG and ITG, and potential restrictions on distributions under debt agreements and tax receivable agreements.
Important facts for investors to verify
- Separate recurring operating performance from the nonrecurring BondPoint gain and assess normalized earnings measures alongside GAAP results.
- Reconcile the effects of KCG acquisition accounting, including acquired-intangible amortization, integration costs and changes in segment comparability.
- Review the financing plan, covenant headroom and pro forma leverage associated with the proposed ITG acquisition and $1.5 billion debt commitment.
- Monitor trading volumes, volatility, Americas Equities performance, payment-for-order-flow economics and Execution Services revenue after the BondPoint sale.
- Evaluate liquidity after dividends, share repurchases, tax receivable agreement payments, debt service and trading-margin requirements.
- Review regulatory investigations, the AMF penalty, the KCG-related litigation and any ITG-related litigation or approval conditions.
- Confirm the effect of noncontrolling interests: Virtu Financial, Inc. owned approximately 56.6% of Virtu Financial at September 30, 2018, so consolidated net income differs materially from income available to common stockholders.