Earnings Call Transcript - VIRT Q1 2024

Andrew Smith, Investor Relations

Thank you, Michelle, and good morning, everyone. Thank you for joining us. Our first 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-Financing and Co-Chief Operating 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 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 on being 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 reports, 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 in the earnings material 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.

Douglas Cifu, CEO

Good morning, and thank you, Andrew. This morning, we reported our first quarter results. For the quarter ended March 31, Virtu earned $0.76 in adjusted EPS on $6 million per day of adjusted net trading income. We generated a 55% EBITDA margin and $203 million of EBITDA, both on an adjusted basis. We outperformed headline volume and volatility statistics in the quarter as a result of our organic growth initiatives as well as the solid performance in both our customer and noncustomer market making businesses. In particular, we had record performance in both our crypto and ETF market making operations, which I will discuss further in a moment. Overall, the environment was mixed compared to the prior quarter. Realized volatility was down about 10%, but volumes were elevated across global equities and commodities, while options volumes were flat and retail volumes were up modestly. Our core business generally performed well against this backdrop. Our customer market making operations saw a modest uptick in retail volume and an increase in the attractiveness of the flow we received offset by reduced volatility. Our market share of Rule 605 volumes remained within historical ranges, and we saw increases in executed shares and quoted spread values compared to the fourth quarter of 2023. Growth initiatives generated $1 million per day in adjusted net trading income, contributing 17% of our ANTI. I will highlight our performance in digital assets as well as ETF block, which were the standout performers this quarter. In crypto, we had a record quarter. The principal catalyst was the launch of 11 Spot Bitcoin ETFs in the United States, which were approved by the SEC on January 10. If you recall, for several years, we have discussed how our disciplined approach to counterparty risk management and commitment to capital efficiency has intentionally limited our presence in crypto. In fact, it was only a year ago when we announced that we had resumed limited market-making in crypto, which we had paused around the collapse of FTX. Since then, our crypto initiatives were focused on market making in top cryptocurrencies on a limited basis until January. The introduction of spot crypto ETF has transformed Virtu's role in the crypto ecosystem. The introduction of the ETF has played to Virtu's strength and enabled us to leverage our scale capabilities to service clients and the markets. In advance of the ETF launch, Virtu was approved as an ETF authorized participant, and we were there on day 1 of trading, making the market and facilitating flows. After normalizing for the appreciation of Bitcoin this year, the flows into these securities have been meaningful – over $14 billion of net new inflows into spot Bitcoin ETFs and the gross flows have been over $56 billion. Our ability to create tight prices in like instruments, in this case, the ETFs and spot Bitcoin is very similar to how we make markets in a plethora of equity and multi-asset class ETF products across the globe. We are very encouraged by the persistent opportunities in these products, which have continued into the second quarter. Further, we remain confident that the inherent underlying volatility of crypto as an asset class will drive sustained elevated opportunities in crypto ETFs and contribute to heightened levels of broader investor engagement and awareness across equities and options. The market is anticipating the launch of new crypto products across ETFs, options and futures, both in the U.S. and abroad, which will further expand the addressable market for Virtu. We look forward to more products coming online and for the market's continued evolution, bringing greater transparency in the efficiency that comes with centralized clearing and settlement. Turning now to ETF block. Our global ETF block initiatives also contributed meaningfully to our results and had one of its best quarters since 2020. While global ETF volumes were up across the board, our robust performance was further enabled by our efforts to broaden our distribution and our increased competitive capabilities in both equity ETFs and fixed income ETFs combined with the depth and breadth of our global client franchises. Finally, our options market making expansion continues at pace. Despite total OCC volumes being up only 2% compared to the prior quarter and muted volatility, our performance was solid, improving quarter-over-quarter. Over the last year, our market share in index options has more than doubled, and our share of ETF options remains strong despite fluctuations in market volumes. We expect our options business to continue to grow as we incrementally expand our symbol universe and look forward to another record year, building on what we have achieved since beginning this business from scratch in 2019. To summarize our market-making performance, we believe that our established businesses executed well against our internal benchmarks, yet we remain focused on our efforts to improve our yield on every opportunity and to address more of the significant opportunities available in both new and existing markets, including the ones I just mentioned. We are very excited about the continued real progress in these areas, which we had no presence in only a few years ago. Execution Services was up 3% over the fourth quarter, delivering $93 million of ANTI or $1.53 million per day. While institutional activity remains muted, there were pockets of increased activity as clients adjusted their portfolios in light of evolving global monetary policy expectations. Our ongoing efforts globally and across the BES products have continued to bear fruit. We saw outsized trading volumes in Japan and in Asia overall this quarter as we invested resources in those regions and we reached a high watermark in EMEA equity market share, an uptick in adoption of our EMS Triton has led to further cross-selling opportunities in our brokerage and analytics businesses as well. We are nearing the end of a multiyear technological transformation to create a platform focused on providing clients seamless automation of their multi-asset workflows through the life cycle of a trade in all regions globally, making us a one-stop shop for all clients' market activity. We believe these investments focused on technology and infrastructure are producing a uniquely valuable platform, which reduces many of the frictions traders encounter on a daily basis. Our clients in search of efficiencies have asked for multi-asset class full life cycle capabilities. And because of our extensive technology replatform, we will be able to deliver new products quickly. In addition, we continue to enhance our existing flagship equity products. Our new system of algorithms provides smart automation where based on current market conditions for a given stock, we help the client choose the best algorithm to execute its objective. Our new alert block crossing client interface streamlines the client's ability to cross blocks of stock, saving time and money. Our data analytics platform provides clients more choices with pre-trade decision-making and post-trade review of those decisions. In addition to adding multi-asset class capabilities to existing products, we're expanding our potential client base by offering our products to new client segments through redistribution partnerships, or what we call Virtu Technology Services. Offering our technology via new additional strategic channels allows us to accelerate the distribution of our global multi-asset class offerings in a scalable manner to help us realize these important opportunities in BES. We have made a number of senior hires who are attracted to Virtu by our broad suite of cutting-edge projects. We are excited about the future of this business as ever. As always, our offerings are based on client demand and built around long-term partnerships. Overall, our businesses continue to grow and demonstrated an impressive yield this quarter in a market environment that was mixed in terms of the opportunity set afforded by the market. Finally, you will note in our press release that effective August 1, Cindy Lee, a long time Virtuian, will become the Chief Financial Officer of Virtu succeeding my friend, Sean Galvin in that position. Cindy joined Virtu in 2011, and she will be an extraordinary CFO, given her knowledge of Virtu and has been instrumental in our success over the years. I am very happy and pleased to report that Sean is remaining with Virtu in a senior capacity. Sean's contributions to Virtu and Knight KCG over his 22 years here have been very meaningful, and we expect to continue to benefit from Sean's professionalism and experience. Thank you, Sean and Cindy. Now I'll turn the call over to Joe Molluso.

Joseph Molluso, Co-COO

Good morning. I'll speak a bit about our growth levers from our new initiatives as well as our buyback program. At March 31, total trading capital was $1.7 billion. Our scaled business is not limited by our capital base, as evidenced by the impressive results generated in the first quarter without the need for material incremental trading capital. Our capital base remains more than adequate to support our ongoing and growing businesses. In Q1, we used a portion of our free cash flow to repurchase 2 million shares at an average price of $18.31 per share. To date, we have repurchased 45.9 million shares at an average price of $25.10 per share. Our quarter-end share count was 163 million shares outstanding, bringing our buybacks on target within the range as we have set forth publicly. Since we initiated our share repurchase program, we have repurchased over 17% of the fully diluted shares of Virtu, net after new issuances. Consistent with our continued commitment to returning capital to shareholders, our Board of Directors has authorized an additional $500 million in share repurchases. We are often asked about future non-organic growth opportunities, including acquisitions. The answer to this is that we evaluate any opportunity presented versus the relative attractiveness of buying back our shares and investing in our businesses, including our growth initiatives. So it is a high bar in our opinion. You can see the demonstrated earnings leverage in our business from both capital management and our growth initiatives. While we understand our business is volatile, we believe our long-term earnings power as a result of both organic growth initiatives and the cumulative impact of share repurchases.

Sean Galvin, CFO

Thank you, Joe. Good morning, everyone. On Slide 3 of our supplemental materials, we provided a summary of our quarterly performance. For the first quarter of 2024, our adjusted net trading income, which represents our trading gains, net of direct trading expenses, totaled $367 million or $6 million per day. Market Making adjusted net trading income was $274 million or $4.5 million per day. Execution Services adjusted net trading income was $93 million or $1.5 million per day. Our first quarter 2024 normalized adjusted EPS was $0.76. Adjusted EBITDA was $203 million for the first quarter of 2024, and our adjusted EBITDA margin was 55%. On Slide 11, we provide a summary of our operating expense results. For the first quarter of 2024, we recorded $180 million of adjusted operating expenses. We continue to maintain an efficient cost structure and disciplined expense management, which helped us control our operating expenses during the inflationary environment. Financing interest expense was $23 million for the first quarter of 2024. With the benefit of the interest rate swap contracts that we introduced in prior years, our blended interest rate was around 7.6% for our long-term debt in aggregate. We remain committed to our $0.24 per share quarterly dividend, and combined with our share repurchase program, this demonstrates our commitment to return capital to our shareholders. Now I would like to return the call over to our operator for the Q&A.

Patrick Moley, Analyst

So I was hoping we could just dig a little deeper into the impact crypto market making had in the quarter. Doug, is there any chance you could quantify what the overall contribution was to ANTI judging by the organic growth initiatives? And it seems like maybe it was a couple of hundred thousand dollars a day. So any color you can give us there would be great. And then second, could you speak to just kind of the distribution of revenues you're seeing in that business? Is it fairly steady day-to-day? Or are there any outlier days where you're seeing the bulk of the revenues?

Douglas Cifu, CEO

Yes. Thank you. Good question. Yes, I think you are in the right range; it has been a couple of hundred thousand dollars a day contribution. In fact, I can say that like the block ETF contribution in the quarter was greater than the crypto contribution in the quarter, which is kind of interesting, right? So it wasn't like we had a day or two of extraordinary results. I mean certainly on January 11 or 12 when the ETFs were launched, there was a huge reshuffling between the closed-end fund into the ETFs. And so you had an uptick in performance those couple of days, but that was maybe like 10% of the overall crypto P&L for the quarter, if that. So it hasn't been that we made millions of dollars on a day or two. So it has been a nice steady contributor. The way I would look at it is, if you look at the VPMM business, our noncustomer market-making business, it's now like a new asset class within VPMM. It really has established itself as a consistent asset class in the same way that we look at like FX and commodities. We now have a separate line for digital assets or crypto in all of our internal reports. And we think that the success that the marketplace has seen with massive inflows and massive ETFs created will just encourage any additional instruments to be introduced. You've already seen that the United Kingdom and Hong Kong have announced that they have approved versions of spot Bitcoin ETFs. You're going to see leveraged products. When the CFTC and the SEC can get their act together, you're going to see options on those ETF products, and hopefully when the SEC can get it together in the next month on the same products, you'll see a suite of those launch. It's not at all dissimilar from what you see in the world of FX, where you have major payers and then you see options on FX, ETFs, and you see smaller payers, and whatnot. So we're very excited that this is a new asset class within our noncustomer market making business. The other thing I'd point out is that it's a perfect Virtu-style business because it incorporates Bitcoin and these other digital assets in the form of Spot and ETFs and futures; it's cross-border. So it's kind of Virtu 101 in terms of market making and our operational discipline and then we're very good at partnering with the issuers and becoming an authorized participant. All the things that we have talked about for the last 16 years around the Virtu noncustomer market-making business. This asset class fits quite well into. I'm happy that we got engaged in this asset class 3 or 4 years ago. Obviously, it took longer than we had thought in terms of regulation and approval of this Spot Bitcoin ETF, but we're very excited that this asset class will continue to grow, and we will continue to be in the middle of helping grow it. And I think the important thing is that it's not a niche product. $14 billion of inflows didn't just come from retail investors that are interested in trading in and out of Bitcoin. There have to have been real high net worth providers looking at the asset class and saying, okay, should there be a slimmer allocated to that? And I think the answer in some cases is certainly yes. And so that's the result of that in terms of the inflows into the product. And again, this is kind of Virtu 101. We want to be in the middle of that ecosystem, providing really tight prices and efficiency to the market because efficiency then just begets more liquidity, which begets more interest and begets more growth of the asset class, and we want to be part of that.

Patrick Moley, Analyst

Okay. Great. And then just as a follow-up, as we think about that few hundred thousand of ANTI a day, can you help us understand what amount of that is coming from trading in the ETFs versus the money that you're making trading the Spot Bitcoin and kind of like selling that back to the ETF issuers?

Douglas Cifu, CEO

Yes. I mean it's all we look at as one big integrated pot. I mean obviously, the strategies that we run in market making in the ETFs work in concert with what we do in futures and the Spot market. And it's like what we do in gold. We look at GLD, we look at spot gold, we look at gold futures, and all of those strategies are integrated, Patrick. So I'm not trying to dodge your question, but it certainly is a universe, if you will, of products that all integrate and work together. And frankly, we don't break it down in that regard. And so as I said in the answer to your first part of your question, as that universe continues to grow and expand, we're very confident that we'll be in the middle of it. The market makers will continue to provide competitive prices, whether it's in an ETF, a Spot or a future. And frankly, whether it's cross-border, I mean you can throw currency on top of that, right? There's going to be products that will be yen-denominated Bitcoin ETFs that people will be interested in, and that's right in our wheelhouse.

Kenneth Worthington, Analyst

Maybe first for Joe. In terms of capital management, you purchased $36 million of stock this quarter. That was lower than the level of repurchases we've seen over the last year. And if you look at Q1 '23, you spent roughly double on buybacks last year despite Q1 '24 having a lower stock price and a lower average stock price. Any reasons for the more modest buybacks this quarter? Was it just sort of truing up relative to ANTI or something else philosophical?

Joseph Molluso, Co-COO

No, it's nothing philosophical. We have these ranges that we posted that at different levels of net trading income. This is what you should expect in terms of the ranges. The amount of free cash flow we have doesn't necessarily line up precisely with those ranges every quarter. So there's ebbs and flows. When we embarked on our share repurchase program, we made a decision that we're just going to use the proceeds and apply them to the stock price as it is. And looking back over 3-plus years that we've done this, I think we're satisfied with where it came out. And you should fully expect we would be within those ranges that we published. And the first quarter is even if you just annualize it, it's right there in the range that we've posted for a $6 million day. So I wouldn't read anything into that.

Kenneth Worthington, Analyst

Cool. And then just a follow-up on the Bitcoin ETFs. Bitcoin ETFs have moved from strong inflows in Q1 '24 to closer to breakeven so far in Q2 '24. If flat Bitcoin ETF flows were to persist, does that impact the revenue opportunity for you in Bitcoin or crypto broadly?

Douglas Cifu, CEO

It's a good question. I think we really more look at kind of gross flows as opposed to net. There are portfolio reallocations and opportunities. I mean certainly, look, I mean when the Spot Bitcoin ETFs were approved, as I said earlier, that was massive, and you follow and I track your metrics that you put out every day, there were massive reshuffling from the closed-end fund to these ETFs. And certainly, that was episodic and that's not going to happen again. But there has been a consistent nice pattern. Again, I think the best analogy is looking at another commodities market, and the most analogous one would be gold. In that marketplace, every day, there are people that are getting in and out of ETF positions and getting in and out of the Spot or reallocating from a different asset class. So if you look at digital assets and Bitcoin specifically, as just a slice of a pie that wealth managers are now looking at, the institutions are looking at as an investable asset over some time period. That's compelling. It's no longer in my view a novelty asset that people are trading and has a somewhat nefarious tinge to it. It is now an investable asset on a meaningful number of platforms that are certainly being advocated for or allocated by gatekeepers. That means there's going to be volume. You'll have spikes when products are approved, when options come on and as more jurisdictions mention their own regulations. The theme here is that you now have a large investable asset class; there'll be volatility opportunities.

Christopher Allen, Analyst

Nice quarter and again, a nice one by the Panthers last night. Maybe just on block ETFs. You noticed a greater contribution than crypto this quarter. Can you help us think about how that business breaks down between equities and fixed income? What the drivers have been? I think you talked about efforts to broaden distribution. Maybe give us some color on that front because that, to me, seems like a more sustainable business from a longer term relative to crypto where we are seeing a little bit lower flows in the near term. So any color there would be great.

Joseph Molluso, Co-COO

Yes. Great. I mean I think from a metric standpoint, what we saw in the quarter was roughly double what we saw in 2021 in terms of ANTI performance. So that's a significant result. In terms of the breakdown, what we've built over the last couple of years is you have to kind of be in everything, Chris. And you have to be global. We're very proficient in equities, as that's the essence of the firm. But you have to be competitive in fixed income and commodity products. Certainly, there's more margin, there's more risk, and there are more challenges associated with being in fixed income and indeed in crypto. The fact is we are providing two-sided prices in all of those products. The fact that we now have a global offering with a credible desk in Europe for the first time is important. The fact that we have the same thing in Asia is important. We're not nearly as scaled as some of our competitors but we do have significant customer relationships and are leveraging the old ITG infrastructure in terms of customer relationships in Europe and in Asia, particularly.

Christopher Allen, Analyst

Appreciate all the color there. And just a follow-up on that business. Is there a good indicator for us to look at here? Is it ETF flows from a fixed equity perspective, ETF trading activity? Or is it because of the block nature, will it just have to attempt to triangulate off of different things?

Joseph Molluso, Co-COO

Yes. Overall ETF volumes are a good thing to look at globally. It is a little bit lumpy, because within that, you will see there will be huge blocks that come through periodically. We have clients that are sending in smaller clips that will be done through RFQ. If it's a larger block of a transition of an RIA, we may be putting competition with two or three other market makers and we try to price that as tightly as we can. A lot of folks will do that once a year or four times a year. The key is to provide great customer service so that you're in the wheel, and you can be competitive. Our capital base, while being smaller than some of our competitors', still allows us to provide excellent service and value. And we've built a solid global brand reputation and extensive network relationships that strengthen our market presence.

Craig Siegenthaler, Analyst

It's hard for me to congratulate you on the Panthers win last night because I'm sadly a Flyers fan.

Sean Galvin, CFO

Well, we all have our crosses to bear.

Craig Siegenthaler, Analyst

Well, back to business here. We're hoping you could spend a little more time on the effective spreads. So it seems you've been developing in the 605 data in January and February. I was hoping you could walk us through the underlying factors that drove this, especially with realized volatility lower?

Douglas Cifu, CEO

Yes. It's actually a great question because for years, people have looked at realized volatility overall at Virtu and the strong correlations between what our P&L should and shouldn't be. And I think we're still true. As I said in my prepared remarks, I'm very pleased with the overall performance, particularly in VPMM, given the fact we had a mixed environment in volumes slightly up and realized volatility materially down. I mean, as a side note, it is surprising to me to see the VIX remaining steady despite various global conflicts and monetary policy changes. In terms of our VPMM business, we have always tried to indicate that you must look at the 605 reports as important, and we do that internally here at Virtu as sort of a sub-business within our customer market-making business because we are dependent on the flows from retail clients. Retail volumes are important because if you're not getting the widgets, you can't make money on them.

Daniel Fannon, Analyst

I was hoping to get an update on options market making where you are in terms of the number of single names as well as kind of index. Trying to get a sense of what percentage of the market you are interacting with at this point?

Douglas Cifu, CEO

Yes, it's a great question, and I guess I get it every quarter. We continue to chug along. We have expanded the single names that we are trading. We're capable of quoting in 10% to 20% of the overall universe. The guys on the desk are very keenly aware kind of where they should focus their energies. I want to get into options because there's been a lot of news. We're not directly taking flow from clients, and that is a strategic decision we've made. We're very pleased with the progress. Our market share in the index family has continued to grow, and we are active on all of the 17 or 18 options venues that are out there. There's plenty of opportunity both here and abroad, and we will continue to grow. With regards to the regulatory calendar, there has been an increase in litigation against the SEC by business groups and industry participants regarding various rules. While there are ongoing proposals that could impact Virtu, I think a timeline of three to six months could provide clarity on these regulations. Depending on the outcomes, we may see significant changes, especially concerning auction proposals. In general, we expect these rulings to have no real impact on Virtu or the marketplace at large.

Michael Cyprys, Analyst

I wanted to come back to options market making. Doug, you mentioned that you're quoting in 10% to 20% of the universe today. Just curious what takes you to 50% or higher over time and what that timeframe could look like?

Douglas Cifu, CEO

Yes, it's a great question. It's really about balancing the opportunities. I think I don't know which one of you put all this great data together, but in terms of the shift toward SPX and the broader index families, we kind of go where the opportunities are. The guys in the desk are aware of where they should focus their energies. I'm letting them lead rather than imposing a specific target. I want to focus on our bottom line, how much money we're making, and so far, we're doing well. So I believe our market share will continue to expand in index products and internationally, especially in Asia, as that's a significant growth area.

Joseph Molluso, Co-COO

The pro forma EPS viewpoint is based on a three-year timeframe with expectations on growth initiatives and capital management efforts enhancing our earnings capacity. We have a firm belief in our ability to sustain performance and continue growing even amidst volatility, focusing on maintaining cash flow and managing our costs. The idea is to target a compounded growth rate while being prudent in our investments to ensure we can aim for pro forma EPS ranges in the coming years.

Douglas Cifu, CEO

I want to thank everybody for participating in this call and for all the great questions, and we look forward to speaking with you all in July. Thank you.

Operator, Operator

This does conclude the conference call for today. We would like to thank you for your participation. You may now disconnect.