Virtu Financial, Inc. — Q1 2017 Form 10-Q Summary
Business context and reporting period
Virtu is a technology-enabled global market maker and liquidity provider operating as one reportable segment. It provides liquidity across equities, commodities, currencies, options, fixed income and other securities through a proprietary platform covering more than 12,000 instruments, 235 markets and 36 countries. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016.
Financial performance and condition
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $147.3 million | $192.6 million | Down 23.5% |
| Trading income, net | $139.6 million | $186.3 million | Down 25.1% |
| Adjusted Net Trading Income | $79.4 million | $117.3 million | Down 32.3% |
| Total operating expenses | $123.4 million | $133.9 million | Down 7.8% |
| Income before taxes and noncontrolling interest | $23.9 million | $58.7 million | Down 59.3% |
| Net income | $21.1 million | $51.4 million | Down 59.0% |
| Net income attributable to common stockholders | $4.6 million | $10.3 million | Down 55.7% |
| Diluted EPS | $0.10 | $0.26 | Down $0.16 |
| Net cash provided by operating activities | $32.1 million | $51.5 million | Down $19.4 million |
- Interest and dividends income increased 14.0% to $4.9 million, while technology services revenue increased to $2.8 million from $2.1 million.
- Adjusted EBITDA was $47.7 million versus $81.1 million; the corresponding Adjusted EBITDA margin was 58.0% versus 67.9%. EBITDA was $37.5 million versus $73.6 million, with a 45.7% margin versus 61.6%.
- Net income margin, as defined by management using Adjusted Net Trading Income plus technology services revenue, was 25.6% versus 43.0%.
- Cash and cash equivalents were $165.0 million at March 31, 2017, down from $181.4 million at December 31, 2016. Total assets were $4.1 billion and total equity was $530.0 million.
- Long-term borrowings were $565.3 million carrying value, including approximately $538.7 million of senior secured term debt and approximately $31.4 million of SBI bonds. Short-term credit facilities had $241.3 million outstanding against $493.0 million of available capacity, and broker-dealer facilities had $22.0 million outstanding against $200.0 million available.
- Operating cash flow was reduced by working-capital movements in securities borrowed, broker receivables and trading assets. Investing cash use was $5.9 million, primarily for capitalized software and property and equipment. Financing cash use was $43.5 million, including $21.0 million distributed to noncontrolling interests, $10.1 million of dividends and a $7.0 million tax receivable agreement payment.
- U.S. broker-dealer subsidiaries remained above regulatory capital requirements, with reported excess capital of approximately $56.0 million and $9.0 million, respectively.
Material changes versus the prior comparable period
- Management attributed the revenue and Adjusted Net Trading Income declines primarily to lower market volume and volatility across major asset classes.
- Adjusted Net Trading Income per trading day declined to approximately $1.3 million from $1.9 million; both periods had 64 trading days.
- Adjusted Net Trading Income declined across Americas equities, EMEA equities, APAC equities, global commodities, global currencies, and options, fixed income and other securities.
- Operating expenses declined less rapidly than revenue, reflecting the business’s operating leverage. Brokerage, exchange and clearance fees fell 11.6%, while communication and data processing expense increased 2.8%.
- Employee compensation declined 5.8% to $21.3 million, partly in response to lower Adjusted Net Trading Income. Share-based compensation expense increased, including $7.6 million of total share-based compensation used in the Adjusted EBITDA reconciliation.
- The company began pricing certain trading instruments using theoretical prices supported by market inputs and classified the instruments as Level 2 fair value measurements; management treated this as a change in accounting estimate with no retrospective adjustment.
- In February 2017, employees exchanged 683,762 Virtu Financial units for an equal number of Class A shares, reducing Class C shares and increasing Class A shares.
Guidance, outlook, commentary, risks and unusual items
- The company did not provide quantitative operating guidance in the filing. Management stated that cash flows from operations, available cash and available borrowings were expected to satisfy liquidity needs for more than the next twelve months under its current operating assumptions.
- Liquidity needs are expected to be driven primarily by margin requirements associated with trading activity and expansion into new markets. Management monitors margin and liquidity needs on an intra-day and inter-day basis.
- On April 20, 2017, Virtu agreed to acquire KCG Holdings for approximately $1.4 billion in cash, subject to regulatory and shareholder approvals and expected to close in the third quarter of 2017. The proposed financing included $1.65 billion of new debt and $750 million of Class A equity financing.
- The KCG transaction presents material execution, integration, financing, leverage, regulatory approval, retention and synergy risks. The filing also warns that failure to complete the transaction could result in additional costs, litigation, termination payments and adverse effects on the stock price and financial results.
- Virtu completed the acquisition of select strategic telecommunications assets from Teza Technologies on May 3, 2017, after the quarter ended.
- The company has accrued a €5.0 million, approximately $5.4 million, fine imposed by France’s AMF relating to alleged price manipulation and market-rule violations by a European subsidiary. Virtu is appealing and states that the relevant trading complied with applicable law.
- Other key risks include lower trading volumes or volatility, counterparty and clearing-house exposure, technology and cybersecurity failures, competition, dependence on liquidity sources and trading venues, regulatory capital requirements, litigation, foreign-exchange movements, international operations and the ability to access capital markets.
- The company’s tax receivable agreement liabilities were approximately $229.4 million at March 31, 2017. Future payments are generally equal to 85% of realized cash tax savings and may be accelerated upon certain change-of-control events.
- The filing states that disclosure controls were effective as of March 31, 2017 and that no material change in internal control over financial reporting occurred during the quarter.
Most important facts for investors to verify
- Whether the proposed KCG acquisition closed on the expected timetable, the final financing mix and the resulting leverage and integration costs.
- Subsequent trading volumes, volatility and Adjusted Net Trading Income, given the significant Q1 deterioration and high sensitivity to market conditions.
- Actual cash generation after dividends, noncontrolling-interest distributions, tax receivable agreement payments and increased margin requirements.
- Compliance with senior secured credit facility covenants and broker-dealer regulatory capital requirements, particularly after the KCG financing.
- Status and ultimate cost of the AMF appeal and any SEC, NYAG or other regulatory inquiries.
- Realization of expected tax benefits and the timing and potential acceleration of tax receivable agreement payments.
- Reconciliations and definitions of the company’s non-GAAP measures, including Adjusted Net Trading Income, Adjusted EBITDA and Normalized Adjusted EPS, before comparing them with other market makers.