Virtu Financial, Inc. Q3 FY2021 Earnings Call

Good morning, and welcome to the Virtu Financial 2021 Third Quarter Results Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this is being recorded. I would now like to turn the conference over to Andrew Smith, Head of Investor Relations. Please go ahead.

Thank you, Anthony, and good morning, everyone. Thanks for joining us. Our third quarter results were released this morning and are available on our website. This morning’s call, we have Mr. Douglas Cifu, our Chief Executive Officer; Mr. Joseph Molluso, our Co-President and Chief Operating Officer; and Mr. Sean Galvin, our Chief Financial Officer. They will begin with prepared remarks and then take your questions. First, a few reminders. Today’s call may include forward-looking statements, which represent Virtu’s current beliefs regarding future events and are therefore subject to risks, assumptions and uncertainties, which may be outside the company’s control. Please note that our actual results and financial conditions may differ materially from what is indicated in these forward-looking statements. It is important to note that any forward-looking statements made on this call are based upon information presently available to the company, and we do not undertake to update or revise any forward-looking statements as new information becomes available. We refer you to disclaimers in our press release and encourage you to review the description of risk factors contained in our annual report and Form 10-K and other public filings. During today’s call, in addition to GAAP results, we may refer to certain non-GAAP measures, including adjusted net trading income, adjusted net income, adjusted EBITDA and adjusted EBITDA margin. Non-GAAP measures should be considered as supplemental to and not as superior to financial measures prepared in accordance with GAAP. Direct listeners to consult the Investor portion of our website, where you’ll find supplemental information referred to on this call as well as a reconciliation of non-GAAP measures to the equivalent GAAP terms in the earnings materials with an explanation of why we deem this information to be meaningful as well as how management uses these measures. And with that, I’d like to turn the call over to Doug.

Good morning, and thank you, Andrew. This morning, we reported our third quarter results, which reflect an 11% increase in adjusted EPS in a market environment that was slightly softer than the second quarter. For the quarter ended September 30, we generated $0.70 of adjusted EPS with $5.5 million per day of adjusted net trading income, bringing our results for the first three quarters of 2021 to $3.38 per share and an average adjusted net trading income of $7.6 million per day. Our performance in the quarter highlights the success of our organic business growth plan, which aims to increase our overall baseline performance in two ways. First, by expanding our addressable market by pursuing new opportunities such as options, market making, crypto, and Virtu capital markets. And second, by increasing the competitiveness and profitability in our existing offerings through the hard work of integrating Virtu’s best-in-class technology with the businesses we have acquired, evidenced by Virtu’s Algo technology, legacy KCG quant-style strategies, and our customer-facing ETF block desk. I’ll point out some important highlights for this quarter. Our growth initiatives generated over $350,000 of daily trading per day, which represents 6% of our net growth in the third quarter. Since 2018, we have grown these initiatives by a 61% CAGR and have leveraged our existing technology infrastructure to build these businesses from scratch. In particular, I would highlight that our options market making business continues to expand. While we do not expect this business to grow in a straight line, we continue to evolve our capabilities, connectivity, and expand the amount of symbols and venues we trade. In the latest quarter, this business saw strong results despite options volumes being down 15% from a recent peak in early 2021. We continue to make select key hires to expand the geographic footprint of this business and accelerate our growth. I also want to provide an update on cryptocurrency. We have formed a dedicated team of traders and technologists and plan to add additional resources in the near term. With the launch of crypto ETFs globally, we now trade approximately 20 products across the U.S., Canada, and Europe. We are connected to the principal spot venues to source liquidity and have meaningfully increased the number of venues and markets we can access. Given our historical expertise in market making across a diverse range of products, combined with our global connectivity with institutions and retail clients, we believe Virtu is uniquely positioned to provide liquidity to our customers and crypto products. Our ETF block desk continues to make meaningful progress, and we are now a top 5 liquidity provider as measured by the winning hit rate in total notional volume dealt in U.S. ETFs. I also want to note the progress we have made in our commitment to return capital to our shareholders. Our Board of Directors has previously authorized $470 million in share repurchases. Through the end of October, we have repurchased 13.4 million shares at an average price of $26.95 for a total of $361 million, consistent with our previously announced targets for share repurchases. In the third quarter alone, we repurchased 5.4 million shares at an average price of $25.71, for a total of approximately $139 million. As we look out in the next 12 to 24 months, we want to reiterate our commitment to returning capital to shareholders, and I’m announcing that Virtu’s Board of Directors has approved an additional repurchase authorization of $750 million over the next two years. This level is consistent with our expectations for cash flows generated by the business and will target a time to complete the buyback. As we stated previously, we remain committed to returning capital to investors and have prioritized share repurchases for the foreseeable future. Our baseline performance is enhanced by incremental from our organic business growth plan and the effect of returning capital to our shareholders through share buybacks. We believe that over the long term, this combination will be a powerful driver of growth. The steady growth of these initiatives, as well as the continued less volatile performance of our Execution Services segment, coupled with the culmination of our multi-year integration of KCG and ITG, has led us to provide clear detail around where Virtu’s results should settle at various levels of adjusted net trading income over a given period. We believe our performance this quarter is consistent with that guidance and value creation for shareholders. I’d like to take a few minutes to provide an update on the recent industry discussions around market structure, payment for order flow, and wholesale market mix. I provided a detailed update on our last public earnings call and there has been no shortage of activity since then. As I have said many times, we welcome the dialogue, and we are here to engage in data-driven discussions with regulators, customers, and other constituents as we do on a regular basis. Since I last spoke to you, it is clearer than ever that our markets, especially concerning retail order flow remains fair, transparent, and resilient. Study after study and empirical analysis after empirical analysis continue to show that the U.S. equity markets are more accessible than ever, and the U.S. retail investor experience is unprecedented and decidedly better than any market in the world. As such, we and many other market participants remain concerned that calls for reform are based on false narratives and factually unsupportable conclusions and innuendo. Today, we have a robust regulatory framework that has been developed and maintained by the SEC, FINRA, and others, designed to foster competition and has always been transparent, fact and data-driven and mostly free of the politics of the day. In an effort to further enhance transparency, we recently petitioned the SEC for specific regulatory reforms to enhance the measurement and objective disclosure of the enormous benefits that U.S. retail investors receive today. We believe reforms centered on enhancing transparency and competition will deliver tangible market-led benefits to retail investors. Despite the noise in the non-political environment, we are confident that the facts, data, and the desire to continue to put retail investors first will win the day. When regulators, politicians, and critics look at the data, they will see the massive benefits of today’s competitive ecosystem, which regulation and transparency have created for retail investors. Now I would like to turn the call over to Joe Molluso. Joe?

Thanks, Doug. Sean and I will have some brief comments, and then we will turn to questions. After several quarters of elevated market activity, realized volatility dropped to 11.1%, which is the lowest we have seen in several years and 10% below the 2019 average. As you know, 2019 was a historically low point for volatility. Further, U.S. equity volumes were down 8% overall, and retail equity volume in the United States was down 6.6%. Despite the market conditions that were softer than the second quarter and meaningfully below the market activity of 2020 and the first quarter of this year, our Market Making business outperformed, realizing $249 million and adjusted trading income of $3.9 million per day, or 5% better than the second quarter. Our Execution Services business also performed better than the market opportunity this quarter, realizing $106 million and adjusted net trading income of $1.66 million per day. This is 5% less than the second quarter. However, BDS is a global business, and market volumes were down a larger percent quarter-over-quarter in most regions. For example, the U.S. was down 8%, Canada was down 21%, and Europe down 6%, with only APAC seeing a slight 3% increase in volumes. Our Execution Services business continues to contribute to our global scale and reduce the quarter-to-quarter variability of our firm-wide results. I will review some thoughts on Virtu’s ability to generate growth through both organic initiatives and through the excess cash flow we generate, and how this all translates into revenue and earnings growth rates. Last quarter, we reviewed a slide that showed Virtu’s ability to generate earnings at various levels of adjusted net trading income, coupled with our share repurchase capabilities. Our results year-to-date and this quarter are consistent with prior indications and demonstrate the earnings and growth potential of our baseline level of earnings power combined with our growth initiatives and return of cash to shareholders. Since the inception of our share repurchase program less than a year ago, we have repurchased approximately 7% of the company on a gross basis. Compounding this effect over a number of years should meaningfully elevate our earnings power regardless of the environment. With our current overall debt levels now well within a long-term sustainable nominal amount, our quarterly dividend of $0.24 is more than secure, and we have no immediate plans for any major acquisitions. Our ability to devote most of the substantial cash flow to repurchases will continue. The announced $750 million incremental repurchase authorization will target a two-year period and is a recognition that over a sufficiently long period, Virtu will generate significant cash flows, however episodic. Finally, our growth initiatives, while themselves volatile quarter-to-quarter, are real and accrue to our bottom line with significant runway to grow. It’s worth noting that while many of the initiatives included in our growth slide began only a few years ago, they will not grow in a straight line as volumes and volatility fluctuate. In the most recent quarter, we witnessed continued strength in some areas such as options, crypto in Virtu capital markets and experienced a slight slowdown in others like Rocket. We remain bullish on these initiatives and their potential to contribute meaningfully towards growing our baseline performance in any environment. These organic initiatives, together with the substantial cash flow and appropriate levels of debt going forward, demonstrate Virtu’s ability to thrive in any environment while producing significant returns to shareholders. And now on to Sean to conclude.

Thank you, Joe. In the third quarter, our adjusted net trading income, which represents our trading gains and direct trading expenses, totaled $354 million or $5.5 million per day, which is 2% lower than the third quarter of 2020 and 2% higher than the second quarter of 2021. Market Making adjusted net trading income was $249 million or $3.9 million per day, 3% lower than the year-ago quarter and 5% higher than the second quarter 2021. Execution Services adjusted net trading income was $106 million or $1.65 million per day, which is a 1% increase year-over-year and 5% decrease in the second quarter. Our adjusted EPS was $0.70 for the third quarter, 11% higher than the second quarter of 2021. For the third quarter, our overall compensation expense was $4.6 million, which is basically flat from Q2. Our compensation and overall compensation ratios were 20% and 23.7% of adjusted net trading income, respectively, which is also consistent with the second quarter. As previously stated about our compensation ratio, consistent with past practice, we approved year-end incentive compensation to a range of percentages earlier in the year. Depending upon how the remainder of the year unfolds, this may result in adjustments to our compensation later in the quarter as we refine our specific compensation targets. We will update guidance for 2022 expenses with our fourth quarter report early in 2022. Overall, we believe our cost results going forward are consistent with the specific cost guidance and actual performance for 2021. Adjusted EBITDA was $210.8 million for Q3, up from $196.8 million in Q2 and compared to prior year quarter. Our adjusted EBITDA margin was 59.5% for the third quarter, which is an approximately two-point increase from the second quarter and continues to reflect our efficient cost structure and disciplined expense management. Our capitalization remains adequate, and our long-term debt was $1.6 billion at quarter-end. Finance interest expense was $20 million for the third quarter, which is flat from both the second quarter as well as prior year third quarter. We remain committed to our 24% quarterly dividend, which is consistent with over 25 quarters in every environment since our IPO, and our approximately $139 million share repurchase in the third quarter demonstrates our continued commitment to returning capital to our shareholders. With that, I’ll turn the question over to the operator for the Q&A.

We will now begin the question-and-answer session. Our first question comes from Rich Repetto with Piper Sandler. You may go ahead.

Hey, good morning, Doug. Good morning, Joe, and Sean. Congrats on a good quarter, and thanks for your candid remarks on equity market strength. We’re trying to understand, one of your peers had very dismal results and blamed it on the lower volatility. You yourself recognize that volumes were down and volatility metrics were slightly down quarter-to-quarter. So I’m just trying to see where the outperformance came from. If you could just highlight any of the areas, whether it’s geographical or asset class or in retail marketing. Just trying to understand how you guys outperformed in the market making segment.

Yes. Thank you, Rich, and I appreciate the question. I think what you’ve seen in this quarter, and we’ve been attempting to describe it quarter-by-quarter, is the strength of a scaled global franchise. Obviously, I know the competitor you’re referring to, which is a great company, but they are much more of a specialized market-making firm in that they derive the majority of their revenue from global ETFs, which is a great business. But that’s a small part of what we do globally. The philosophy behind Virtu has always been to be the best bid and offer in every marketplace we can electronically access around the world in every asset class. Through the year, we built this scaled franchise. While ETF block market-making in the U.S. was a little bit down this quarter, it gets lost in the launch of other results that we have. In particular, we’ve grown our options business. We’ve achieved great internalization between our market-making businesses. Our ETF business is now internalizing off our single-object market-making business, and our options group doesn’t have to worry about hedging their delta risk because they can hand it off to our single-object market-making business. We’re able to leverage everything we do globally to really improve our market-making capabilities. Retail had a nice quarter. Obviously, we don’t break anything out independently because we view this all as a single franchise and a single firm. A lot of the investments we’ve made over the years in technology and internalization continue to pay off. This quarter represents what we’ve been talking about over the last several quarters, which is that we will continue to put our heads down, work on the blocking and tackling, integrate the firm, and manage our expenses. Even though retail equity volumes were down 5% to 6% this quarter, we performed better in retail market-making than we did last quarter because we worked hard, and our strategy has performed better.

Okay. That’s helpful, Doug. And my related follow-up would be you outlined the crypto and option opportunities, which look like great opportunities for an electronic market maker like yourself. But just trying to see where you see the bigger opportunity. Did the ETF approval of futures ETFs jump out to you, or where do you see more opportunities between crypto and options?

Yes. I think that’s a great question. Sitting here today, options to me represent a large, compelling, well-known opportunity. We can all look at what the total addressable market is. You know what the volumes are; everything is published by the OCC. Internationally, you can look at the Nikkei or the DAX. There’s significant index options in Europe as well. So all of that plays into Virtu’s strengths, which I just outlined in terms of being a scaled global electronic market-making firm. As I’ve reiterated, our options business has been a bit of a slog as we reorient our technology and infrastructure to ensure that we can be the captive options market-maker. We’ve done a lot of work, and there’s still more to do, but we think it’s exciting because we can really position ourselves as a strong market maker in this area. There’s a great customer segment here, and we have already made a considerable investment in our options market-making capabilities. With respect to crypto, it’s obviously a newer asset class. We’ve kept an eye on this space closely. But again, we’ve strategically decided this fits nicely into what we do as a firm. Clearly, with the SEC approving a futures-based ETF that has widened the number of participants in the marketplace. We’re a market maker and capable of interacting with various asset classes, whether they are expressed as a spot, future, or ETF, exactly what has happened with crypto products. Being one of the leading market makers on the NYSE gives us a strong advantage. So we’re excited to continue to be involved here.

Great job, guys.

Thank you, Rich.

Our next question comes from Chris Allen with Compass Point. You may go ahead.

Hey, good morning, guys. Nice quarter. Just kind of a follow-up on Rich’s question regarding the outperformance in market-making. Maybe digging a little bit on the competitive environment in wholesale market-making, looking at Bloomberg reports that provide payment for order flow data. It looks like you guys are picking up share. Coincidentally, Citadel has seen a decent amount of share since they made comments around concentration risk. Could you provide some commentary on what the competitive environment looks like? Have there been changes in response to the regulatory pressures? Any commentary there would be appreciated.

Yes. It’s a good question. I think the chair made some comments which I thought were off-target regarding the competitive nature of the environment. It’s always been a highly competitive marketplace. The notion that it has been dominated by a single firm is a myth. While Citadel has significant market share, we have always been competing for market share alongside them. Three years ago, we effectively had zero market share with Robinhood, who is one of the largest participants, but we made a concerted effort to ensure we could handle their flow due to its volume. Now, we are approximately capturing around 37% to 38% of their marketable flow. A number of other firms have announced that they’re entering the wholesale business. These are great firms, and we welcome the competition because it keeps us sharp and demonstrates that this is a very competitive marketplace. It also indicates that retail brokers have a business-driven decision that outsourcing this business to wholesalers and market makers benefits both parties. Our retail broker clients are outsourcing to us rather than attempting to internalize their flow, which saves on expense and provides better execution for their customers. Ultimately, this wholesaling ecosystem benefits retail investors.

And the competitive environment is stable? Is that an accurate assessment?

We haven’t seen much of a change. New entrants are emerging, but we do not worry about competition. We maintain a constant dialogue with our broker-dealer clients and understand the targets they aim to achieve regarding price improvement. We continue improving our operations, and we have always been the scaled low-cost provider, which has been key to our growth.

Thanks, guys. I’ll get back in the queue.

Thank you.

Our next question comes from Ken Worthington with JPMorgan. You may go ahead.

Hi, good morning. I’d love to hear how FX and commodity market making performed this quarter. Was there growth in those markets from Q2 to Q3? I know you don’t break it out, but when looking at the U.S. equity business, given the flattish volatility and lower volumes, how did revenue capture fare in that business? And directionally, was it up, down, or flat?

Yes, sure. We’ve gotten away from looking at the various sub-segments of our market-making business, as they have become smaller parts of what we do. We view the firm as a mosaic of market-making and the scaled opportunity to continue to grow. FX has been under pressure the last couple of quarters due to volatility statistics and overall market conditions. I would say that, regardless of internal metrics that we utilize, both segments performed well, particularly in commodities where we’ve seen good growth in our Metals segment and in natural gas during the quarter due to spikes that occurred in natural gas heading into September and October. In relation to current revenue capture for the equity side, it was up this quarter, which has aided our results. We would characterize it more as same-store sales growth. While some moments of volatility did occur, nothing really sticks out significantly from the quarter.

And for a follow-up, I’d love to get more in-depth on the crypto rollout. Could you discuss the evolution of the business through the quarter? I see in the prepared remarks that you’ve broadened the resources in crypto. Are you market making at this point in spot tokens or futures? If so, what tokens are you working with? Or is the focus still primarily on the crypto ETFs?

Yes. Good question. To be more specific, we are connected and trading on four major spot venues and plan to add four to five additional ones. Our trading includes platforms like Coinbase and Kraken. We’ve done our due diligence regarding counter-party risks because, right now, the market does not have prime brokerage and centralized clearing mechanisms. We are connected to the futures market and serve as a market maker for the U.S. ETF as well as all of the ETFs in Canada and Europe. The analogy here is to our commodities business, where we could have spot, futures, and ETFs, facilitating our services. Additionally, we are working towards becoming a market maker for additional tokens. We need to be judicious about what we add to avoid undue risk. Still, we're confident we can cover around 85% to 90% of the addressable market as we expand our connections. We’re currently deploying a lot of resources to cryptocurrencies, and we’re conducting those engagements securely. Collaboration with firms who are involved in crypto liquidity is essential, and we plan to continue expanding our operations as it matures.

Thank you.

Thank you.

Our next question comes from Dan Fannon with Jefferies. You may go ahead.

Thanks. Good morning. Doug, I wanted to follow up on options market making. You talked about increased symbol and venue coverage in the prepared remarks. Could you provide an update on that? What percentage of the market are you interacting with? What would you determine to be the goal or time period for achieving full coverage?

Yes. It’s a great question. I recognize the interest in this area. To use a baseball analogy, we’re definitely out of the dugout. I’m not quite sure if it's the first or second inning, but it’s still relatively early. The marketplace is significantly different from what we are accustomed to. We are now trading complex instruments. I’m pleased to report that we have achieved market making in index options in the U.S. and are expanding into Asia. We've brought in individuals experienced with options trading to support this evolution. When you understand how to internalize hedging, Virtu's exceptional trading infrastructure supports our capabilities. From a standpoint of where we’d like to be, we fully intend to be active in the payment-for-order flow business early in 2022, whether this is in Q1 or Q2 is dependent upon performance. Moreover, by participating now in options, we are effectively learning our way into retail options market making.

Great. Thank you. And Sean, just to clarify, I think you reiterated the previously stated expense guidance for this year. But I understand it is early for next year. It’s still fair to think about a general inflationary increase for 2022?

Yes. I’d say yes. While there are still some synergies to work on, most of that has been realized already.

Our next question comes from Alex Blostein with Goldman Sachs. You may go ahead.

Good morning. A quick follow-up on Slide 5 regarding some of the new initiatives. Could you break down how various initiatives contribute to the organic growth numbers? And also, I haven’t heard much about credit. What aspirations and initiatives do you have for credit? I believe you had a partnership with MarketAxess previously.

Yes, thank you. Regarding credit, yes, we do believe it is an important opportunity. It has gained electronification. We are connected to MarketAxess and are actively trading corporates. We’ve also onboarded for basket trading in credit. We have seen some growth and are well-prepared to operate in this segment. We maintain a strong role in providing liquidity for fixed income ETFs, which has facilitated our growth in this area. The credit market is relatively nascent for us, so it does not yet have a significant effect on our performance. However, strategically, it is very important. As for the organic initiatives, we've continued to present those as they fluctuate quarter-to-quarter. Some areas have become transformative, while we are also actively pursuing execution services, which has outperformed this quarter as well.

Got you. Thank you very much.

Our next question comes from Michael Cyprys with Morgan Stanley. You may go ahead.

Good morning. Thanks for taking the question. I wanted to circle back on crypto. It seems you’re beginning to make markets in underlying crypto coins as well. What do you think it’ll take to succeed in crypto market making? How do you see it differing from other asset classes, and how do you determine which coins to add?

Yes, great question. As I mentioned earlier, it feels like our commodities market making. We treat trading gold as a spot instrument and futures, similar to the avenues of ETF trading. The strategies we execute in crypto are akin to how we operate when dealing with commodities. However, we do need to remain cautious as we monitor counterparty risk in this space, particularly since traditional financial services haven’t embraced it as a typical financial service offering. We're focused on the infrastructure around crypto as it evolves; we believe it can be a beneficial asset class for us as a market maker. We're excited about it and will expand once the market stabilizes.

Thanks again.

Our next question comes from Chris Allen with Compass Point. You may go ahead.

Maybe a quick follow-up regarding crypto. Can you give color on the capital you’re deploying in this opportunity versus how much you might allocate for something like commodities?

Yes, great question. While we don’t break out segment capital, what we allocate to crypto isn’t considered material overall in terms of capital. The market has matured, and visibility to that capital led us to become more comfortable with the aspects of the business. We monitor exposure carefully.

Understood. And getting investor questions on the expense guidance side, confirming that there are no changes implies a cash comp of about $40 million to $50 million in Q4. Is that an accurate frame?

When you look at our full-year guidance, we will be at the high end, possibly a touch higher. To date, cash compensation and total compensation ratios were at 16% and 19%, respectively, and we’ll remain around 20% for the total comp ratio.

Thank you, guys. I appreciate it.

Thank you, Chris, and I’d like to thank everybody for participating today. We look forward to talking with you sometime in 2022. Everybody, enjoy the rest of the year. Thank you.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.