Virtu Financial, Inc. Q2 FY2023 Earnings Call

Hello and welcome to the Virtu Financial 2023 Quarterly Results Conference Call. My name is Harry and I'll be your operator today. It's now my pleasure to hand you over to Andrew Smith, Head of Investor Relations, for Virtu Financial to begin. Andrew, please go ahead when you're ready.

Thank you, Harry and good morning, everyone. Thank you for joining us. Our second quarter results were released this morning and are available on our website. With us today on this morning's call, we have Mr. Douglas Cifu, our Chief Executive Officer; Mr. Joseph Molluso, our Co-President and Co-Chief Operating Officer; Ms. Cindy Lee, our Deputy Chief Financial Officer; and Mr. Sean Galvin, our Chief Financial Officer. We 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 belief regarding future events and are therefore subject to risks, assumptions, and uncertainties, which may be outside of the company's control. Please note that our actual results and financial conditions may differ materially from what is included in these forward-looking statements. It is important to note that any forward-looking statements made on this call are based on 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, Form 10-K, and other public filings. During today's call, in addition to GAAP measures, we may refer to certain non-GAAP measures, including adjusted net trading income, adjusted net income, adjusted EBITDA, and adjusted EBITDA margin. These non-GAAP measures should be considered as supplemental to and not as superior to financial measures as reported in accordance with GAAP. We direct listeners to consult the Investor portion of our website, where you'll find additional supplemental information referred to on this call as well as a reconciliation of non-GAAP measures to the equivalent GAAP term 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 all that, I'd like to turn the call over to Doug.

Thank you, Andrew and good morning everyone. Thank you for joining us this morning. In my remarks today, I will focus on Virtu's second quarter 2023 financial and business performance and strategic initiatives. Following my remarks, Joe and Cindy will provide additional details on our performance. Looking at our year-to-date and second quarter results, which are summarized on slide two of the supplemental material, we generated $4.5 million of adjusted trading net income per day in the quarter and normalized adjusted EPS of $0.37. Slide three highlights that our Market Making segment earned an average of $3.1 million per day of adjusted net trading income, outperforming the public market metrics for the quarter, and our Execution Services businesses delivered $1.4 million per day. In the second quarter, our customer Market Making saw decreased opportunity as the overall bid-offer spread and retail participation levels declined relative to the prior quarter. Although these factors led to decreased opportunities for our customer Market Making business, we performed in line with our own internal performance projections. As we've said previously, Market Making share alone is limited as a gauge of performance, but it's worth noting that our market share in the wholesale Market Making business remains within historic ranges. Our non-customer Market Making business, which provides liquidity across asset classes globally, performed well in the quarter, although its opportunity was also impacted by the muted volumes and volatility environment. Our organic growth initiatives, including our expansion into options Market Making, continue to perform well and make meaningful progress. We remain excited and optimistic about our growing abilities to address the global opportunities that await, especially in option ETF block and fixed income. On the Execution Services side, our adjusted net trading income averaged $1.4 million per day in the second quarter. Much like the last two quarters, institutional activity remained muted as our clients continue to look for more clarity from the macroeconomic environment. Most pronounced, pan-European volumes were 16% lighter in the second quarter with institutionally sized large and scale volumes down over 20%. Despite these challenging markets, VES performed in line with this opportunity quarter-over-quarter as well as year-to-year. Our multi-year focus on efficiency and new business development has yielded a scale multi-asset class global business that is laser-focused on our clients. As I've mentioned in the past, we are particularly excited about the expansion to new asset classes. We're seeing increased uptake of our automation analytics, especially in fixed income markets, which continues to drive new opportunities for growth and enhances our current business. While the overall environment in the second quarter was softer, especially characterized by a very slow start in April, we were encouraged by improving performance in the latter part of the quarter. In these very early days of the third quarter, we are seeing some modest enhanced opportunities, in particular, in our customer Market Making business. While we are generally pleased with how we performed against the addressable opportunities in the second quarter and how we continue to deploy these new businesses, we continue to focus on ways to improve in any environment and seek out new opportunities. It is important to note that we continue to invest in recruiting talent in any market environment. While Virtu's headcount has remained relatively stable after years of ups and downs due to integration, the steady headcount total masked the significant investments that we have made in people and talent in strategic areas of focus. Since January 2021, we have hired almost 300 full-time employees, including quants and developers in options, ETF blocks, fixed income, or asset money market business and other growth areas. We have also invested in hiring the right team of client-facing folks to continue to grow our VES business. Most recently, we hired Keith Casuccio, a respected industry veteran, to lead client engagement and product efforts within VES. As always, we remain relentlessly focused on cost and realized a 44% adjusted EBITDA margin during the period. Coming off a record 2023, our options business has performed well against declining opportunities set in the quarter. We continue to expand across venues and geographies. However, in the US, market-wide customer index options volumes were down 11% in Q2, impacting results in the quarter. We continue to build out our block ETF debt by improving our competitive edge and expanding our offering to cover more products and more regions, including fixed income, both in credit and rates. The operating scale we enjoy from our standardized global technology platform allows multi-tool players to immediately contribute to the growing business in any region or asset class as we reallocate personnel to focus on the biggest opportunities. However, this quarter was slower in ETF block as you may have seen from other announcements from our competitors recently. I will now turn it over to Joe who will provide additional details about the quarter.

Okay. Quickly turning to expenses and capital. We focus on cash OpEx. We ended the first half of the year with cash operating expenses that were $322 million, about 3% ahead of where we ended the full year 2022 annualized. We continue to manage expenses aggressively, especially in the soft environment during inflationary times. Our cash comp ratio is at 25% for the first half of the year, which is at the upper end of our historical range. So, consistent with Virtu's history, we will manage the discretionary compensation and headcount to drive profitability for our shareholders while retaining and recruiting world-class talent as Doug mentioned. Other expenses were up slightly in line with our expectations. Communications and data processing expenses were essentially flat versus the prior year and up 2% year-over-year due to some investment in building out new businesses in the global inflationary environment, and other expenses on an annualized basis are up slightly due to some favorable FX adjustments in the prior year and some increased professional fees. In terms of guidance for 2023, we would expect our cash operating expenses to come in on an annualized basis equal to the first half of 2023. On capital and debt, you can see our trading capital remained relatively constant throughout the year on slide six of the supplemental material. We've maintained our public $0.96 annual dividend, which we have now paid steadily since we've been public for eight years. You can see there that our payout has remained steady despite our variable results over the long-term. This consistency demonstrates our commitment to returning capital to shareholders and our ability to generate robust results over the long term. Additionally, we repurchased 2.3 million shares this quarter for approximately $42 million. Our period-end share count is now 167.9 million shares, and we have repurchased net of compensation-related new issuances almost 15% of our company in the two-plus years since the beginning of our share repurchase program. Since the inception of our share repurchase program, we have repurchased a total of 38.5 million shares for a little over $1 billion. Again, please refer to the outcomes at various performance levels on slide eight to see that our year-to-date share repurchases of $118 million are ahead of the guidance on an annualized basis. And with that, I will turn it over to Cindy Lee to review the financial details before we turn the call over to questions.

Thank you, Joe. Good morning everyone. On slide three of our supplemental materials, we provided a summary of our quarterly performance. For the second quarter of 2023, our adjusted net trading income, or NT, which represents our trading gains, net of direct trading expenses, totaled $279 million or $4.5 million per day. Market Making adjusted net trading income was $193 million or $3.1 million per day. Execution Services adjusted net trading income was $85 million or $1.4 million per day. Our second quarter 2023 normalized adjusted EPS was $0.37. Adjusted EBITDA was $122 million for the second quarter of 2023, and the adjusted EBITDA margin was 44%. On slide nine, we provided a summary of our operating expense results. For the second quarter of 2023, we recorded $173 million in adjusted operating expenses. We continue to maintain an efficient cost structure and disciplined expense management, which has helped us to control our operating expenses during the inflationary environment. Financing interest expense was $25 million for the second quarter, with the benefit of the interest rate swap contracts that we entered in prior years. Our blended interest rate was around 5% for long-term debt in aggregate. Our capitalization remains as is. We remain committed to our $0.24 per quarter dividend. The combination of the dividend payout and the share repurchase program demonstrates our continued commitment to return capital to our shareholders. Now, I would like to turn the call over to the operator for the Q&A.

Thank you. For our first question, we will go to the line of Daniel Fannon of Jefferies. Daniel, your line is now open.

Thanks. Good morning. Doug, I appreciate the commentary on the environment. I was hoping you could expand a bit. It seems like April was kind of below and then you saw improvement throughout and it appears to be continuing a bit in July. Maybe just bifurcate or expand a bit upon kind of what the asset classes or areas, geographies that maybe really have seen both kind of the more improvement and also kind of where the biggest levels of change have been?

Yes. Thank you, Dan. You're under a lot of pressure because you've now replaced Repetto as the lead-off questionnaire. So, we all miss Rich and thank him for all of his efforts over the years. But anyhow, getting back to your question. Yes, April, just anecdotally in talking to competitors, particularly on the institutional side, was one of the slowest months that people have seen in over a decade. I think a lot of that had to do with macro issues, had to do with some of the regional bank catastrophes, for lack of a better word, that were happening here in the United States. So, it was just very, very slow. The big banks saw that in April as well. And certainly, we saw it on the market-making side. The performance then progressed throughout the quarter and picked up through and including June, obviously, and allowed us to report the quarter that we're reporting. As I noted in my comments, we have seen an improvement. It's only 15, 16, or whatever 17, 18 trading days in July, and that trend has continued. I would say most particularly in US equities, which is our largest asset class, and that obviously drives a lot of our performance certainly on the Market Making side. I did highlight in my remarks that Europe, in particular, was very, very slow in the second quarter. There's a public company called Flow Traders and they reported and they obviously had a difficult second quarter, so you can kind of see what the metrics are in terms of Europe and whatnot. We've seen somewhat of an improvement of that in June and July as well. So, I would say, really, US equities, in particular, was very surprisingly slow in April, and we've seen an improvement.

Great, that's helpful. You mentioned fixed income. I think in the commentary around some of your data for the quarter. One of your domestic peers had an announcement this quarter about getting more active within corporate fixed income on the market-making side. Can you maybe talk about your presence in that market and how you're thinking about that opportunity going forward?

Yes, I believe it was encouraging news. Citadel Securities is indeed a competitor and a respected firm, and their actions reinforce our belief that we've been actively participating as a market maker in credit. We're approaching our second full year of fully engaging in various Virtu initiatives, which includes onboarding counterparties and honing our trading expertise primarily in investment-grade debt. We've established ourselves as a market maker on MarketAxess and collaborated with MarketAxess, TradeWeb, Bloomberg, and other platforms to enhance our distribution capabilities. The positive aspect is that we've seen an increase in our win rates and our credibility, positioning us as a reliable source of liquidity for buy-side counterparties, whether directly or through distribution partners like MarketAxess and TradeWeb. Additionally, we've broadened our capabilities in both on-the-run and off-the-run rates, enabling trading with over 50 firms, mainly utilizing Bloomberg and TradeWeb. We remain flexible regarding distribution mechanisms since both firms provide us with significant scale and credibility. Currently, we are only witnessing about 5% to 10% of our volume from clients on these platforms, but I'm personally focused on this area because I believe we can contribute value here. There is substantial potential, and historically we've performed well in our market segment by leveraging our approach. Therefore, in both credit and rates markets, we see opportunities to create value, and Citadel's recent announcement confirms the strategic decisions we've made in the past couple of years to reallocate resources, capital, and talent in these areas.

Thank you.

And for our next question, we will go to the line of Ken Worthington from JPMorgan. Ken, your line is now open.

Hi, good morning. Thanks for taking the question. I would love an update in terms of where you are in the single stock option Market Making rollout roadmap. Is the 605, 606 type of business still the end goal for you in options? And maybe how far along is Virtu in terms of being able to effectively participate in that single stock options business the way you do for equities for client business?

Yes, that's a great question. Reaching that end goal is certainly our aim. However, I wouldn't say we've lost focus on it. The opportunities in index market making, both for customers and non-customers, have significantly overshadowed that focus. You're likely aware of the metrics regarding the SPI and SPX volumes compared to single options, which have shown a notable change. Whether this is due to zero day options or other factors is up for discussion with experts like CBOE. Our choice to prioritize the index family has proven to be the right move, as there's been a remarkable increase in interest from both institutional and retail sides, where you can differentiate between customer options and non-customer options in many venues. While it remains part of our roadmap, its significance has diminished because the potential market in the index sector in the U.S. is so vast. Additionally, we currently have an operational index business in Asia, focusing mainly on the Indian and Japanese markets. I hesitate to set a specific date for the rollout, as we've often had to extend timelines due to the extensive opportunities in the index family. With developments like MEMEX and various options venues coming online, there’s a lot more potential for enhancing our index market making capabilities in the United States.

Great. Thank you.

Our next question today is from the line of Chris Allen of Citi. Chris, your line is open if you would like to proceed.

Yes, morning everyone. I wanted to follow-up on Dan's question on the rates. Historically, you've talked about market structure impediments to getting bigger in the rates business. What's the outlook there? There's a lot of talk around moving to centralized clearing, improvement on settlement times. And then in terms of your penetration level right now, less than 5% of volume, is this just because you're kind of just getting up to speed right now, just starting to slowly build the business? What's the longer-term opportunity set do you see there?

I'm going to take a moment to commend the chair of the SEC for advancements in centralized clearing of treasury products and real-time reporting. These changes are positive for the marketplace, and we have been supportive of these initiatives as they promote competition. The marketplace has evolved; a decade ago, it was primarily controlled by major dealers, but now the buy side has become more savvy in seeking alternative liquidity providers, which number in the dozens. We have established credibility with key distributors like TradeWeb and Bloomberg, who are valuable partners. MarketAxess, which acquired LiquidityEdge, is also part of our network, and we rely on these partners to enhance our distribution and build trust. Competing for buy-side visibility is always challenging, as they cannot support more than a limited number of liquidity providers. Understanding the main players, gaining trust with distribution channels, and providing accurate real-time pricing are critical. Recently, we engaged with senior personnel at TradeWeb to identify key clients and improve our service responsiveness. We're proficient at market making, but the competition is fierce with many players and an extensive array of counterparties. Our objective is to develop an optimal offering and deliver value to the market. Currently, we're ranked among the top 20 on TradeWeb, which is promising, although we aspire to break into the top 10 and ideally the top five, though that depends on the competitive landscape. Our scale is an advantage, particularly as we operate across multiple asset classes. Should rates products evolve into futures or ETFs, we will be positioned to access those markets. We take pride in being an efficient provider, managing our expenses to offer competitive pricing. This outlines how we approach building the business, distinguishing ourselves from others in US equities while focusing on an addressable marketplace for our products.

Thanks a lot, guys.

Thank you. Our next question comes from Michael Cyprys of Morgan Stanley. Michael, you may go ahead.

Great. Thank you. Good morning. I want to circle back to your commentary on the index options volumes where you guys have been quite active. It sounds like you're excited about the opportunity set there. But I was hoping you might be able to elaborate on what you're seeing across the marketplace that's driving the strength in index options? And how sustainable do you think this activity is, particularly if we go into different types of market environments over the next year or two? And if you could maybe provide any sort of color on what sort of customers you're trading with on the other side? We hear a lot of it is retail, but maybe how would you characterize that retail activity? And to what extent do you see or think institutions could start to come in?

That's a great question, Michael. I give credit to the teams at the options exchanges driving these products. Our understanding is that the daily exploration product is trading more because it serves as a better and cheaper hedging instrument compared to others available. This increases trading volumes and attracts interest from both professional and institutional traders. While we acknowledge that there will be fluctuations due to macro conditions and market volumes, we don't anticipate a shift in this trend in the near future. We commend the efforts of the CBOE and other organizations for creating a hedgable instrument that offers efficiency and scalability. We're enthusiastic about this because it aligns with how markets operate, and we are validated in our approach. I owe a lot to our options team; they insisted that this market direction was where we should be heading a couple of years back, and they were correct. Our ability to be competitive in these products has greatly benefited our business. Regarding customer flow, I wouldn't describe it as mom-and-pop retail, mainly due to suitability concerns. I believe it's primarily smaller trading firms and others using options aggregators. Our focus has been on engaging with these aggregator firms, such as DASH, which serve as a front end for professional or smaller trading firm options flow. This sector has made up about 40% of the flow from customer accounts in the SPX index complex, which is significant. You can categorize this flow as either customer or non-customer, making it easier to assess interest. This presents a very appealing addressable market, and that is where we've concentrated our efforts.

Great. Thank you.

Thank you. Our next question today is from Patrick Moley of Piper Sandler. Patrick, your line is now open.

Yes, good morning. Thanks for taking my call. So, just, Doug, I had a question on internalization opportunities. I was wondering if you could maybe compare and contrast the opportunities you saw in the second quarter relative to the first quarter? And then just given the lower volatility environment we're in, maybe what that means for those opportunities going forward? And maybe what that means for the normalized earnings power of the firm overall? Thanks.

Yes. Good question and welcome to the call. As Rich's successor, you have very large shoes to fill. Good luck to you, and we look forward to working with you. To answer your question, we do not disclose our internalization rates by our various groups, but it has historically been a key competitive advantage for this firm. Our rates aligned with the opportunities we saw during the quarter, and we were very pleased with our performance. The examples I've shared previously about options hedging and our ETF desk managing risk on our single-stock desk continue to progress well. This is integral to Virtu's culture and its technological setup, as we do not have distinct desks which allows us to operate effectively. Notably, our at-the-money offering for Virtu Capital Markets has internalization capabilities that are at least double what we believe competitors can achieve regarding crossing with internal flow. This is a significant advantage for us. While we do not have research, capital, or a calendar, we provide prompt execution capabilities on both a technological level and in terms of internalizing and offering significant flow. Based on our observations of what other desks and institutions do, we think our internalization rate in our ATM business is at least twice that of our competitors, which has resonated with clients and we hope will attract more issuers in the future. We remain very enthusiastic about this particular business, Patrick.

All right. Thanks a lot.

Our next question today is from the line of Alex Blostein of Goldman Sachs. Alex, your line is now open.

Hey good morning guys. Thanks for the question. I was hoping we could spend a minute on balance sheet strategy from sort of two angles. I guess, on the one hand, hear you on opportunities in fixed income. So, to what extent do you think that might impact? How much capital you need to run the business with and what that means for sort of capital return framework down the road? And then secondly, if we look at the balance sheet leverage, that's obviously been picking up with EBITDA coming down. So, just maybe a reminder of what level of debt to EBITDA do you feel comfortable running with? And again, with higher leverage today, does that impact your capital return framework at all?

No, Alex, it's Joe. I'll take that. There's no change in that view. Naturally, with a softer environment and reduced profitability, our returns are going to look lower on a trailing basis. However, regarding our capital needs for running the firm, prudent buffers, and regulatory obligations, there is no change. The fixed income business is accounted for within the current amount of capital we use. In a softer environment, we deploy less capital than we do in a more expansive environment. Looking at those trailing invested capital numbers along with our EBITDA and returns, it includes planning for fixed income, which requires more capital. We use prime brokers and do not self-clear, but we are appropriately accounted for in the numbers we deploy. Regarding the overall leverage, we were fortunate in terms of timing and managing leverage through swaps to mitigate the impact of higher rates. We are pleased with our overall debt level, which enables us to buy back shares and maintain our dividend. We refinanced in early 2022 and eliminated most of the punitive cash flow sweeps and amortizations. We don't focus on whether our leverage is two and a half times or three times; instead, we concentrate on the notional level of debt, and we are very comfortable with its current status.

Okay. Thank you.

Thank you.

Thank you. We have no further questions in the queue today. So, this will conclude the Virtu Financial 2023 second quarter results conference call. Thank you all for joining. You may now disconnect your lines, and please have a lovely rest of your day.