Virtu Financial, Inc. Q3 FY2024 Earnings Call

Good day, and thank you for standing by. Welcome to the Virtu Financial 2024 Third Quarter Results Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Andrew Smith, Head of Investor Relations. Please go ahead.

Thank you, Anton, and good morning, everyone. Thank you for joining us. Our third quarter results were released this morning and are available on our website. With us 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; and Ms. Cindy Lee, 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 the company's control. Please note that our actual results and financial condition may differ materially from what is indicated in these forward-looking statements. It is important to note that any forward-looking statements made on the 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 reconciliation of non-GAAP measures to the equivalent GAAP term in the earnings materials and 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. For the quarter ended September 30, Virtu earned $0.82 of adjusted EPS on $6.1 million per day of adjusted net trading income. We generated a 55% EBITDA margin and $215 million of EBITDA both on an adjusted basis. We delivered strong performance this quarter in both our customer and noncustomer market making businesses. We continue to progress our growth initiatives with strong performance in crypto options and ETF block. Our businesses performed well against headline volatility and volume metrics across the globe. Our Virtu Execution Services business was flat quarter-over-quarter, which we count as a solid performance given the muted environment for institutional volumes. We will talk more about VES in a minute. Overall, these results are especially impressive considering that global volumes remain quite low. U.S. equity share volume and notional turnover were down 4% and 1%, respectively, versus the second quarter. Volumes in notional in Europe were down 20% and 9% versus the second quarter, while volumes in Asia Pacific were up about 4%. Beginning this quarter, again, with Virtu Execution Services, our business performed very well. Adjusted net trading income was essentially flat from the second quarter, delivering $100 million of ANTI or $1.6 million per day. This performance, combined with a similar result in the second quarter represents the highest levels of daily adjusted net trading income since the second quarter of 2022 when volumes were 10% higher and volatility was 61% higher. I spoke last quarter about how Virtu's scaled operations afford us the unique ability to continually invest in our global multi-asset class platform to meet clients' needs. We have evidence that our multiyear investments are yielding positive results as demonstrated through third-party validation and recent client successes. A major contributor to this is what we are calling Virtu Technology Solutions, a trading and data analytics infrastructure offering for growing midsized and/or major regional broker-dealers. VTS allows us to distribute our scale technology efficiently and strategically to other brokers, empowering them with leading technology to better serve their clients in a cost-effective manner. Along with our global suite of multi-asset class enabled products and solutions, we expect to continue growing our VES business long term. In addition to our VTS offering, we expect our growth to be fueled by our flagship products and solutions, including our industry-standard data analytics platform, global workflow and execution management systems or Triton, and our world-class trading algos. Our multi-asset class EMS platform, Triton, covers equities, fixed income, FX, and derivatives and our next-generation algos integrate machine learning techniques to further align our clients' investment decisions with their implementation results. Additionally, we are focused on increasing our reach in regions and markets previously underpenetrated by Virtu, such as the Middle East, India, and Japan, as well as expanding into new client segments in existing markets to efficiently address opportunities to offer technology solutions. In the past few months, we've seen several client wins in VES as we increase and expand our client relations. These wins include the adoption of our new switcher algo developed with machine learning and allows Virtu to increase its position on broker trade rankings across global clients. We've seen increasing adoption of VTS, as I mentioned earlier. And while it is still early days, our new agency fixed income, RFQ offering is in production and growing. The senior hires made to help us address this important opportunity have been in place for most of 2024 now and are leading key efforts to broaden the distribution of our offerings. I have mentioned before, we are as excited about the future of this business as ever. As always, our VES business is anchored in long-term partnerships, and our revolving offerings are driven by client demand and built on our global multi-asset class scalable technology. Turning to Market Making, our business performed very well in the third quarter with our customer and noncustomer market making businesses both delivering a solid quarter. We continue to improve our team's cross-desk internalization enhancements to help us manage risk and to explore ways to reduce our trading costs and address more of the opportunities we see in the market. Our Asia and U.S. equity segments showed particularly strong performance this quarter. For our customer Market Making business, the market opportunities, as measured through July and August, indicate an elevated opportunity of about 9% compared to the second quarter. However, based on preliminary reports for September, the opportunity declined significantly in September, reducing the quarter-over-quarter increase in quoted spread to a low single-digit percentage. As we expand the products and markets we trade, we remain very well positioned to capitalize on future volatility and opportunities. We continue to deliver success in new areas where we had no presence only a short few years ago. Our organic growth initiatives generated $632,000 per day in adjusted net trading income this quarter contributing about 10% of our ANTI. I will highlight results from the standout performance this quarter. Building our global options capabilities continues to be a top priority. Our growing options business delivered a strong performance in the quarter. In addition to our U.S. cash equity options, we are leveraging our growing capabilities and options to target global opportunities by optimizing the brokers we're using, increasing our local data center footprint, and streamlining our technical integrations within local markets. We continue to grow in ETF block by onboarding new clients and broadening our distribution. In addition, our growing symbol and underlier coverage capabilities have opened the door for broader relationships with ETF issuers and fund managers, enabling us to service their regular trading and rebalance execution needs. Our crypto market-making business continues to pace. Spot Bitcoin ETF volumes were up about 2% compared to Q2. And the new spot Ethereum ETFs are trading about 50% to 60% as many shares as the spot Bitcoin ETFs. U.S. options on crypto ETFs are getting closer to launching and it is a natural extension of our crypto and options market making abilities to support these exciting products. We continue to expand our crypto market-making efforts by supporting new listed products and thoughtfully adding new exchanges and tokens. As we grow, we continue to build out our cross-product internalization capabilities which allow us to be more competitive, keep more of the spread, and reduce trading fees. With that, I will turn it over to Jeff.

Thank you, Doug. I'll just pick up on the market environment this quarter, which was mixed and very similar to the prior quarter. Compared to the lows of the second quarter, realized volatility of the S&P 500 was up about 52%. However, it's important to note, it's only up about half as much if you exclude the significant volatility in the first week of August. U.S. equity volumes were down 4%, and U.S. option volumes were up almost 7%. Retail activity indicators in the U.S. were also mixed. The IBKR equity share volume was down 6% versus the second quarter, and the spread opportunity through August was up 9%. But as Doug noted, the preliminary report for September suggests that the full quarter-over-quarter change will be in the low single digits. Global equity volume was also mixed with the realized volatility of EURO STOXX Index up 28%; and then Nikkei up 168%. In fixed income markets, FX volumes were mixed. Energy volumes were up 5%, while high-yield credit volumes were down 3% versus the second quarter. At September 30, 2024, our total trading capital, which is on Slide 14 and the supplement stood at $1.8 billion. Our incremental returns on capital, as you can see, remain excellent over a long-term basis, demonstrating our service-oriented ability to use our capital effectively. To that end, in the third quarter, we used a portion of our free cash flow to repurchase 1.7 million shares at an average price of $20.80 per share. To date, we have repurchased 49 million shares at an average price of $25.24 per share. The quarter-end share count was 161 million shares outstanding bringing our buybacks on target to fit within the range we have set forth publicly. Since we initiated our share repurchase program, we have repurchased 18.8% of the fully diluted shares of Virtu net after new issuances. Our share repurchase program year-to-date is within the guidelines we've published. Results from the market-related businesses like ours will always vary with volumes and volatility, but the slides illustrate the sustained earnings power of our business and the positive operating leverage we enjoy from prudent capital management, as well as our growth initiatives and the cumulative impact of the share repurchases. On the expense side, our adjusted cash operating expenses were $173 million in the third quarter. Our run rate cash OpEx is up about 5% year-over-year, consistent with the prior guidance. Our cash compensation ratio was 23%, and our total compensation ratio was 28% for the quarter compared to 26% and 32%, respectively, for the full year of 2023. We expect cash operating expenses to remain within the recent historical range, and we expect the cash compensation ratio to also remain within historical marks. Regarding our total cash operating expenses going forward, we continue to assume low single-digit overall increases in non-compensation expense. And with that, to conclude the prepared remarks, I will turn it over to our Chief Financial Officer, Cindy Lee. Cindy?

Thank you, Joe. Good morning, everyone. On Slide 3 of our supplemental materials, we provided a summary of our quarterly performance. For the third quarter of 2024, our adjusted net trading income or ANTI, which represents our trading gains, net of direct trading expenses, totaled $388 million or $6.1 million per day. Market Making adjusted net trading income was $288 million, or $4.5 million per day. Execution Services adjusted net trading income was $100 million, or $1.6 million per day. Our third quarter 2024 normalized adjusted EPS was $0.82. Adjusted EBITDA was $215 million for the third quarter of 2024, and our adjusted EBITDA margin was 55.4%. On Slide 11, we provided a summary of our operating expense results. For the third quarter of 2024, we recorded $190 million of 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 $24 million per day for the third quarter 2024. With the benefit of our recent refinance and the interest rate swap contracts that we entered in prior years, our blended interest rate was approximately 7.3% for our long-term debt in aggregate. We remain committed to our $0.24 per quarter dividend. Combined with our share repurchase program, this demonstrates our continued commitment to return capital to our shareholders. And now I would like to turn the call over to the operator for Q&A.

Our first question comes from Patrick Moley from Piper Sandler. We will now move to our next question, which is from Ken Worthington from JPMorgan.

Maybe first, we're seeing a proliferation of brokers offering retail investors access to options and now futures. This seems to play directly into the business model of Virtu. Are futures products developing the same payment for order process that we see in equities? And how is the attractiveness of futures trading for Virtu versus, say, options and equities just based on a profitability basis?

Yes. Thanks, Ken. It's a keen observation. Obviously, we've been following that closely. And I think as you suggest that it's an exciting opportunity for us. I mean I think it's very complementary to what we do in our existing cash equities wholesale business in that we have connectivity and relationships with all of the aforementioned retail broker dealers. We've been in the prior night and now Virtu have been doing business with these firms for, in some cases, 20, 30 years, and they're very, very confident in our ability to provide efficient two-sided liquidity to these clients' needs. I think, certainly, if you have active day traders that are looking for more intraday leverage perhaps the futures products and derivative products are more attractive. We see that with our retail offerings and our retail clients in Asia, in particular, I would say in Japan, in particular, where there's a very active CFD market. So we think it's complementary. We're excited about it. We don't think it's going to cannibalize the cash equities business it's probably a different sleeve, if you will, of retail investor that's more of an active day trader as opposed to a more casual retail trader for lack of a better description. So it's an exciting opportunity for us to continue to partner with these great retail firms that we've had great long-term relationships with. And I think it's underappreciated that, that really is a customer service business in part. Obviously, price matters a lot. But we get scored by all of our retail brokers on uptime and customer service and all of those things. And so it is very much a white glove business for us, and that goes back the 20, 30 years, the folks that we inherited from Knight Capital that continue to provide that service to these customers. So as they expand offerings, that's great for Virtu.

Just modeling question, brokerage costs were at the highest level since COVID. We've definitely seen some bigger activity quarters since then with low brokerage costs. So, was there anything about the mix of business that caused brokerage costs to be higher this quarter? And how do we think about the go-forward?

Yes, that’s a great point and a valid question. Regarding the Section 31 fees, they function like a transaction tax, though they shouldn't really be called that. They tend to vary and are reported in arrears as mandated by statute, with the intention to fund the FCC. Ironically, we're supporting the agency that sometimes takes actions detrimental to the market. These rates are adjusted twice a year, which causes them to be somewhat inconsistent. If we could reflect on historical data and establish a normalized Section 31 fee, it might reduce the fluctuations we see in our adjusted net trading P&L. Additionally, we've started incurring some cash fees, which, while not very substantial this quarter, began in earnest in September. So those are the two key factors.

Our next question comes from Craig Siegenthaler from Bank of America.

Hope everyone is doing well. Our question is on your organic growth businesses. So in the quarter, we monitored three big positive drivers: The Ethereum ETF launches, strong ETF volumes, and also record index options activity. So we were a little surprised to see a sequential decline in ANTI, so I was wondering if you could talk about what drove this?

Yes. It's a good question. Thank you, Craig. I think the biggest driver was probably within crypto, where we saw a pretty significant drop off in Bitcoin ETF ADV. Andrew is telling me it was down about 11% quarter-over-quarter. So there's that. And I think within the index options family, obviously, volume is important, but we internally measure spread of those products and spread was down quarter-over-quarter as well. So that's the opportunity set for a market maker, as you know. So it's not just FX times wide, and in this instance, the wide decrease. So those are the two big drivers of it. Again, nothing alarming from our perspective. We continue to perform and continue to grow. And certainly, we're optimistic as we continue to expand those businesses, particularly in options where we now have a meaningful Asian options business, which is now contributing daily adjusted net trading income. And we're guardedly optimistic as we continue to grow that business, particularly in Japan, in India and the investments that we've made in those areas will pay off in future quarters.

And just for my follow-up, we now have a final SEC equity market structure proposal, so I wanted to see if you could give us your updated view on the Reg NMS amendments on the market at large and how it will impact Virtu? And then can you give us a sense of how big your on-exchange market making business is to help us size up the risk? Specifically, we're roughly looking for how much income you're receiving from on-exchange rebates.

Yes, that's a great question. We've been closely monitoring the filed comment letters. Overall, we believe the final rule may not be fully established yet, as there's only been one litigation filed. We'll have to see how it unfolds in the courts. However, we see this as a negative outcome for the market. I've mentioned several times that we are not a rebate trading firm but rather a net payer of exchange holding fees. Therefore, the reduction of the rebate will not affect our adjusted net trading income. I often wonder why some people assume that we just collect rebates; that's not the case, and we haven't figured out how to operate as a net rebate trading firm in our role as a market maker. There is an implication that the quoted spread will significantly narrow for many stocks. But with liquidity incentives, such as the rebates being reduced to $10 million, we believe some spreads might tighten while many will actually widen because the importance of those rebates to the marketplace is often underestimated. Therefore, while certain stocks may show narrower spreads, institutional investors seeking substantial liquidity will likely need to transact at multiple price levels. This could lead to more trades happening across various price levels, resulting in increased volatility, and we expect that larger orders will incur higher transaction costs. Although there are some advantages for us on the retail wholesale side, where we do not internalize all orders and still have to improve pricing and pay for order flow, this overall proposal will be detrimental for our institutional clients. If the objective was to move more liquidity to exchanges and away from dark pools, we believe it will ultimately backfire and lead to less liquidity on exchanges. This reflects a pattern similar to MiFID II, where regulators attempted to favor particular market participants but ended up causing the opposite effect.

Our next question comes from Chris Allen from Citi.

I wanted to dig in a little bit on options. Just wondering, obviously, you talked about the APAC opportunity. Just wondering, how is the progress going in the U.S. options market specifically, which is obviously a competitive marketplace? And then how would you frame the opportunity set moving forward in terms of international versus U.S.? Is it a great opportunity set in international?

Thank you for the question, Chris. The significant focus for us is becoming a retail options wholesaler, which remains part of our medium- to long-term strategy. We have made investments and increased our trading on various exchanges. Unlike cash equities, all transactions occur on options exchanges. There has been notable growth in our presence on these exchanges, possibly reaching 18 or 19 of them. We view this as an opportunity and have expanded our range of symbols. There are regions, especially in Asia like India, Korea, and Japan, along with some smaller markets such as Malaysia, where we are establishing small options operations as well. We believe this is a significant opportunity, and we’ve developed the necessary capabilities. This includes understanding the market, partnering with local brokers, setting up data centers, and fine-tuning our connectivity to exchanges, as every market has its unique characteristics. Having personnel on the ground in cities like Mumbai who understand the technology and operations of various exchanges is crucial. We have been doing this successfully for the past 16 years. At Virtu, we excel in this aspect of the market. While our quarterly results may vary, we are committed for the long term and have seen success, with profits aligning with our other proprietary trading sectors. We are very pleased with the outcomes, which reflect the advantages of our global scale and extensive trading infrastructure. Overall, we are optimistic about our future in this area. Yes. The index offerings are truly exciting for us because they align perfectly with our expertise. Robinhood is a fantastic company and a valuable partner, and we engage in many innovative initiatives with them. Futures present a different scenario since they require execution in a marketplace like the CME or other futures exchanges. We do not see this as a competitive threat. As I mentioned earlier in response to Ken's question, we view this as a distinct subgroup within their client base, consisting of active traders seeking more leverage. Overall, anything that broadens our reach and attracts more attention to our retail broker partners is beneficial for the firm.

Our next question comes from Patrick Moley from Piper Sandler.

Sorry about the disconnect earlier. I just had one on a regulatory question. The latest implementation or phase of the OCC intraday margin rule, that they proposed the same, addressing some of the perceived risks around zero DTE. Just wondering if this is something that's on your radar at all and what impact you expected to have on trading volumes, not only zero DTE, but possibly across other asset classes as well if margin goes up across the industry?

Wow, Patrick, you're really trying to dive deep here and get me on one. I love it. Good thing, the guys prepare me for all this stuff. Look, we've looked at it. We think it's very unlikely to have any direct impact on Virtu, and the FINRA capital rules already stipulate that members maintain capital adequacy to settle all positions and based on our understanding. The new margin changes for the zero dated options are effectively just moving up delivery times. It's really just a timing difference. We don't think it's an overall capital difference. I mean, Joe, you've looked at this more closely. Would you agree with that?

Yes. We are not direct members; we clear through a third party. So we believe it's manageable.

Our next question comes from Dan Fannon from Jefferies.

Question on Slide 8. I understand you have had this framework for some time. Given that you've achieved strong results for three consecutive quarters, do you consider valuation when thinking about buybacks, or is it mainly based on ANTI's performance?

I believe this is primarily an incremental investment question. I recognize that our stock price has increased, which means we are repurchasing fewer shares at each target amount. We made a strategic choice when we initiated this process in the fourth quarter of 2020 to establish targets and approach stock buybacks through dollar-cost averaging, considering its volatility. We view this as an investment. Currently, our stock is in the low 30s, and we've repurchased nearly 20% of the company at $25. As shareholders, our aim is to create value. We regard this as a value creation initiative. If we encounter an incremental opportunity, whether organic or inorganic, where we believe the value surpasses the advantage of buying back shares at $30, we would adjust our strategy. However, for the near and midterm future, we will maintain our current direction and continue executing our plan. This doesn't diminish our enthusiasm for growth opportunities; we are adequately capitalized and resourced. We will persist at these levels to meet our targets. I anticipate that by the end of 2024, depending on our net trading income, we will likely be at the high end of our guidance based on current run rates of net trading income.

Great. That's helpful. And then just also on expenses. You guys have been pretty consistent in your messaging there, just thinking given, again, a good backdrop for you year-to-date. As we think about the fourth quarter, the cash comp versus comp ratio dynamic? Just a little bit of color there and any other seasonal expenses that we should be thinking of?

Yes, compensation is not seasonal, and we strive to accrue it appropriately. Improving compensation is a significant priority for us, and we've always aimed to stay within our compensation ratio. In less robust markets, we focus on taking care of our employees and ensuring they are compensated well, even during downturns. This approach has helped us maintain our position. Over the past three years, we have hired a substantial number of people and upgraded our talent significantly, and we intend to continue this trend. While there is constant pressure on costs, we actively manage our market data, infrastructure, and overhead. Our guidance has remained consistent for a long time, and we expect to continue adhering to it.

Thank you. The question-and-answer session is now closed. I will now turn it over to Doug Cifu for closing remarks.

Thank you, Anton, and thank you, everyone, for joining us today. We hope you all enjoy the holidays and the end of the year. We look forward to speaking with you early in 2025. Have a great day.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.