Virtu Financial - Q3 2023

Transcript

Operator (participant)

Hello, and welcome to the Virtu Financial 2023 Third Quarter Results. My name is Terry, and I'll be the conference operator for today. There will be an opportunity to ask questions today, and you can do this by pressing star followed by one on your telephone keypads. I would now like to hand the call over to Andrew Smith, with Investor Relations to begin. Please go ahead.

Andrew Smith (Head of Investor Relations)

Thank you, Terry, 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 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, and Mr. Sean Galvin, our Chief Financial Officer. We'll 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 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 material, and with an explanation of why we deem this information to be meaningful, as well as how as management uses these measures. With that, I'll turn the call over to Doug.

Douglas Cifu (CEO)

Good morning, and thank you, Andrew. Thank you for joining us this morning. In my remarks today, I will focus on Virtu's third quarter, 2023 financial and business performance and strategic initiatives. Following my remarks, Joe and Sean will provide additional details on our performance. Looking at our year-to-date and third quarter results, which are summarized on slide two of the supplemental material, we generated $4.7 million of Adjusted Net Trading Income per day, up 5% per day from the prior quarter, and Normalized Adjusted EPS of $0.45 per share, up 22% from the prior quarter.

Slide three highlights that our Market Making segment earned an average of $3.3 million per day of Adjusted Net Trading Income in the quarter, rising 6% compared to the prior quarter, and our Execution Services business delivered $1.4 million per day, an increase of 4% per day over the prior quarter. The overall market environment that underlies Virtu's performance this quarter was not dissimilar to what we have seen at times in the past, and most recently in the second quarter. Periods like these are characterized primarily by reduced opportunity, and while we typically see reversion, we remain focused on our growth initiatives as well as enhancing our spread capture rates in any environment, thanks to our global scale and diversity.

As we've said previously, market 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 solidly within historic ranges, even up slightly recently. Our non-customer Market Making business, which provides liquidity across asset classes globally, performed well in the quarter relative to the opportunity set. Our organic growth initiatives, including our expansion into options, Options Market Making, continue to perform well and make meaningful progress. Our $488,000 per day from organic growth was 10% of Adjusted net trading income in the quarter. Our ETF Block business, including our fixed income business, had an excellent quarter, as did our ATM Virtu Capital Markets business. We remain very optimistic about the opportunities across all our growth initiatives.

On the Execution Services side, our Adjusted Net Trading Income averaged $1.4 million per day in the third quarter, about 4% per day above the prior quarter. Impressive results, given the general decline in market opportunity. For much of 2023, institutional activity remained slow as institutional investors have become less active in the higher rate environment. Despite these challenging markets, thanks to our continued investments, VES performed in line with its opportunity quarter-over-quarter as well as year-to-date. Taking a step back, I look at our third quarter and year-to-date results and see the success of our long-term, disciplined overall strategy.

We continued to hire and make investments in our business, remaining disciplined around costs which enabled us to realize a 47% EBITDA margin and report a respectable $0.45 per share in a challenging environment. Our focus on enhancing our core businesses and the continued success of our growth initiatives positions us well for any macro environment, including significant spikes in volatility and volumes, an increase in global tensions, and economic uncertainty. Touching briefly on our growth initiatives. In options, coming off a record 2022, our options business has performed well against a declining opportunity set in the quarter. We continue to expand across venues and geographies, including single names in addition to the index complex. Our ETF Block business was up meaningfully in the third quarter.

We continue to expand our offering to cover more products in more regions, including fixed income, both in credit and rates. We are also seeing an uptick in our Crypto Market Making business in the last 30 days as the SEC moves closer to what we think will be the inevitable approval of spot crypto ETFs in the United States. In addition, our Virtu Capital Markets business had an excellent quarter, as financing activity began to return to the market, and a number of issuers used our service to raise primary capital. Finally, you all likely noticed the litigation brought by the SEC related to Virtu's historical internal information barriers. I do not have much to add that is not in the detailed materials and supplemental information that we have already published.

Suffice to say, this is a civil litigation, and we reject completely the SEC's allegations. The SEC does not assert that any customer information was ever inappropriately accessed, and the period in focus ended four and a half years ago, predating Virtu's integration with any of the ITG businesses. We have engaged with many of our clients about the news, and we have not observed any impact to client engagement. As a general rule, we try to avoid litigation, and given the facts in this case, and the relevant legal precedents, a proportionate commercial settlement could certainly have been achieved under different circumstances.

However, it seems to be the sad and unfortunate trend, whether it involves equally serious matters such as crypto ETFs, market structure reform, private equity fee disclosures, or the funding of the Consolidated Audit Trail, or other issues, that the commission seems increasingly litigious, and their approach and actions are inviting further litigation. So Virtu is not alone in this unfortunate trend. I'll now turn it over to Joe and Sean, who will provide some additional details about the quarter. Joseph?

Joseph Molluso (Co-President and Co-COO)

Thank you, Doug. Turning to expenses and capital. On expenses, we ended the first nine months of the year with Cash Operating Expenses of $481 million, 4.6% ahead of last year. We think this is a solid performance in this inflationary environment. Our cash compensation ratio is 26% for the first nine months of 2023, which is at the upper end of our historical range. Consistent with Virtu's history, we will manage discretionary compensation and headcount to drive profitability for our shareholders while retaining and recruiting world-class talent. Other non-compensation expenses were up slightly in line with our expectations. Communications and data processing expenses were up 3.9% versus last year, owing to investment in building out new businesses and price increases for infrastructure and market data.

Other expenses on an annualized basis are up a bit, primarily due to favorable foreign exchange adjustments in the prior year. Turning to capital management, on slide 11, you can see that our invested capital has remained within a range of $1.8 billion-$2 billion for this year. We remain very well capitalized from a trading capital and long-term debt standpoint. We also remain well-positioned from a liquidity standpoint and will be able to capitalize on more volatile markets as and when they appear. We maintained our public $0.96 annual dividend, which we have paid steadily now for eight years, and you can see that our payout has remained steady despite our variable results over the long term. In addition, we repurchased 2.7 million shares for approximately $49 million in the third quarter.

Our period-end share count is now 165.2 million shares, and including repurchases through October, we have repurchased, net of new issuances, 17% of our company in the three years since beginning our share repurchase program. This brings our total repurchases to 42.2 million shares for over $1 billion. With that, I'll turn it over to Sean to review the financial details before we open the call to your questions.

Sean Galvin (CFO)

Thank you, Joe, and good morning, everyone. On slide three of our supplemental materials, we've provided a summary of our quarterly performance. For the third quarter of 2023, our Adjusted Net Trading Income, which represents our trading gains, net of direct trading expenses, totaled $298 million or $4.7 million per day. Market Making Adjusted Net Trading Income was $208 million or $3.3 million per day, and Execution Services Adjusted Net Trading Income was $90 million or $1.4 million per day. Our third quarter, 2023 Normalized Adjusted EPS was $0.45. Adjusted EBITDA was $140 million for the third quarter of 2023, and our Adjusted EBITDA margin was 47%. On slide nine, we provide a summary of our operating expense results.

For the third quarter of 2023, we recorded $174 million of Adjusted Operating Expenses. We continued 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 third quarter of 2023. With the benefit of the interest rate swap contracts that we entered into in the prior years, our blended interest rate was around 5% for our long-term debt in aggregate. We remain committed to our $0.24 per quarter dividend, and combined with our share repurchase program, this 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.

Operator (participant)

Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad now. We do ask that all participants limit themselves and only ask one question at a time. When you're preparing to speak, please ensure that your line is unmuted locally. The first question on the line comes from Ken Worthington of J.P. Morgan. Please go ahead. Your line is open.

Ken Worthington (Senior Equity Research Analyst)

Hi, good morning. Thanks for taking the question. I wanted to dig into product expansion, particularly ETF Block, options, market making, and crypto. So I guess three parts to hopefully one question. So for ETF Block, you mentioned you added a new region and new products. What new regions did you add this year? And maybe how many new products have been added? For options, where do single names stand right now, and where would you expect this to be a year from now? And then lastly, on crypto, is it possible to size the Bitcoin ETF opportunity? My understanding is as you add new overlapping opportunities in an asset class, the potential to profit increases exponentially, not linearly. So could you walk us through that as well? Thank you.

Douglas Cifu (CEO)

Yeah, great. So, let me try to handle those in reverse order since I'll remember them better. But, let me talk first about crypto, which, you know, we had started talking about maybe two years ago, and then unfortunately, you had a lot of disruption in the market, to put it mildly, with FTX and some of the other bad actors in the marketplace, and so volumes dramatically declined, as you are aware. There is still significant interest in the asset class. You can look at, like, you know, the closed-end fund Grayscale and the amount of volume, if you will, that it does and the amount of Bitcoin in its corpus.

And so if you assume that sometime between today and January tenth, which I understand is sort of the drop-dead date with respect to SEC approval, given what happened in the District Court, you know, the loss by the SEC, there's gonna be, I would think, a significant influx of interest in the ETFs that are kind of queued up. I think there's 10-12 of them. Some of the big names, BlackRock, et cetera, have proposals on the table, Schwab, and we are an AP with each of those, Ken, and I think there's gonna be, you know, a significant amount of trading from the closed-end fund that will be that will migrate, if you will, to these other funds. It's just kind of the natural fluidity. People will move to lower fee.

ETFs will move because it's part of another portfolio, or they get an offset, whatever it is. I think there'll be, you know, kind of almost letting the air out of the balloon kind of effect of all of that. But once people can look at a price on a screen and say, "Okay, I know that that is, one, the price of a Bitcoin or Ethereum or whatever the product is within an ETF, and it's traded in a product that's listed on a national securities exchange that's centrally cleared, and I know there's not gonna be any shenanigans because we have a proper regulatory environment. People are gonna get a closing price, et cetera." We think then you can see a significant increase in real retail and even institutional volumes, and that's what we're setting up for.

In addition, you know, as you know, we've partnered with Citadel, Schwab, and some, and Fidelity and some others to create a platform called EDX, which would be a front through back, you know, custody and clearing solution and execution. So there will be spot venues that will emerge in addition to that, ErisX, which is now owned by Cboe, has a great platform. So there'll be, you know, real volumes, and we'll see a marketplace that we all kind of know and understand, unlike, as Gensler says, a little bit of the Wild West that we have dealt with historically. So that's why we're... You know, I'm very happy we made the investments that we did a couple of years ago, and I think we're very well-positioned to be a significant market maker in this asset class.

With regard to ETF Block, you know, again, this is something we've been talking about for the last couple of years. We've, in terms of regions, we've really focused this year on Europe in particular. We think there's significant opportunities. Obviously, there's a number of large competitors there, Flow Traders and others. We've done all the hard work in terms of pricing, the products, both domestic and international products, which we've gotten better at, and fixed income products in that region. We have distribution in that region because of the ITG acquisition, right? So we have connectivity to both the RFQ platforms, but more importantly, end users in that marketplace know who we are because of the ITG, Virtu relationships, both in the U.K. and on the continent. So we have distribution there as well.

So we're very excited about that. As we've also talked about, the synergy between what we are doing in credit and rates, like being a maker for the first time in those products, enables us to be, we think, a significant contributor to being a market maker in ETF fixed income products. Obviously, there's a lot of incumbents there, Jane, Flow, et cetera, Citadel, that do an excellent job, but we do think there's room for Virtu. And then finally, with respect to options, you know, I think we've been somewhat validated, if you will, with regard to our approach to attack the big index family. I saw some information just the last day or two about the explosion of growth in index volumes, and you know, that's really been our big focus.

You know, single name index options volumes have significantly dropped off. Again, we are trading single name options. We'll continue to do so. Whether in 2024, we start taking directive flow from retail brokers or not, is still an open question in my mind. It's probably, you know, not... Given what's happened with the shift of volumes, it's probably not a significant priority at this point, but something we will get to.

Ken Worthington (Senior Equity Research Analyst)

Thank you very much.

Operator (participant)

... The next question on the line comes from Chris Allen of Citi. Please go ahead. Your line is open.

Chris Allen (Managing Director, Senior Equity Research Analyst)

Hey, morning, everyone. I've got some follow-ups on Ken questions. This is only going to be a two-parter. Just on the build-out and the rate side in particular, last quarter, you noted it was very early days. You were dealing with some 5% of volume, 5%-10% of clients on the platform. Any update on that front? And then on options, you talked about a declining opportunity set during the quarter. And while volumes overall were not great, index volumes where your focus were pretty strong. Was that just a function of realized volatility declining? And how are you thinking about the options environment specifically right now?

Douglas Cifu (CEO)

Yeah, that's a great question. Let me take them again in reverse order. I think you nailed it. Index volumes were up, but in terms of realized volatility, and if you will, like, rate per contract to kind of be more specific in what we were expecting in terms of opportunity, that did decline during the quarter. That being said, we outperformed, and our market share has grown considerably in SPX and the big options family. We are like a meaningful single-digit player now in options, which is a statement that I would have been reluctant to make two years ago. So I'm very, very pleased with the growth there.

We are now generating, you know, decent P&L, like, you know, not material in a Virtu sense, but individually in Asia, both in India and in Japan, which again, things I would not have thought to mention two years ago. So I'm very, very pleased with the progress we have made there. And again, I'm not, like, the greatest macro predictor, Chris. We just kind of, like, build it and we hope that it'll come. But I do see a continued interest in, like, you know, single-day options and in the index family, so that will continue to be our focus. Again, I think with increased volatility and uncertainty and, you know, macro events around the world between, you know, global conflict and central banks having to deal with interest rates, I think we'll continue to see an increase in options activity.

You can kind of see the shift that's gone from, like, the VIX family, if you will, to, like, single-day options and other products that enable traders to, you know, expose themselves to intra-day and over week and month volatilities and things like that. You had another question. What was the second part? I forgot already. I got so excited about it.

Chris Allen (Managing Director, Senior Equity Research Analyst)

Just an update on the-

Douglas Cifu (CEO)

Thank you. Thank you. Yeah, so-

Chris Allen (Managing Director, Senior Equity Research Analyst)

Great.

Douglas Cifu (CEO)

Yeah. Yeah, yeah, rates is an interesting market, right? Obviously, it's the one market that today doesn't have centralized clearing. There is an SEC proposal that we have been supportive of, one of the few things we think the SEC is actually right about. And so we would love to see centralized clearing of Treasury products. That is a typical Virtu-style build-out. We've got, obviously, connectivity. We've got strategies going in now. It's really a question of distribution. So we have significant... We've established, this year, significant connectivity or substantial connectivity to top clients, and we've grown reasonable amounts of market share, again, doing it methodically.

There's a lot of counterparties we can now go to with a credible product, and that's kind of the game plan, which is, build the technology, have a great team, come up with a product that you feel good about, i.e., prices that are competitive, and then figure out what the distribution mechanism is. Obviously, we go to ECNs, but also this is a marketplace that we think, you know, where clients will take direct feeds or go through large dealers, and that's, we've made a lot of progress on that in 2023.

Chris Allen (Managing Director, Senior Equity Research Analyst)

Thanks, Chris.

Douglas Cifu (CEO)

Thank you.

Operator (participant)

Thank you. Our next question comes from Dan Fannon of Jefferies. Please go ahead.

Dan Fannon (Managing Director, Senior Research Analyst)

Thanks. Good morning. My question is on expenses. So as we think about the environment, which is, you know, still somewhat subdued, you know, how should we think about the fourth quarter and the, you know, true up and, or, you know, comp allocation associated with cash in this revenue environment? And then also just looking at next year, should we just think about inflation as a reasonable framework for both comp and non-comp expense or any other framework that you could help us with that would be great.

Joseph Molluso (Co-President and Co-COO)

Hey, Dan, it's Joe. Good morning. Look, I think that I'll take them in reverse order as well. I mean, the non-comp expenses, I think we've always said that they're gonna grow at kind of a low single-digit rate. You know, maybe we're a touch higher than that this year. You know, we do a lot of work every day, especially on our connectivity, our infrastructure plan, our market data. You know, we monitor everything, you know, down to the—down to everyone's, you know, Bloombergs and everything, and all the other market data subscriptions. You know, I think you look at that line item, up a few million dollars in this kind of environment, where there's been price increases.

You know, I think that's a pretty good outcome, and I would expect much of the same next year, right? All things equal. On the other expenses, you know, where, you know, it's just kind of you're keeping the lights on type of expenses. Again, we were, you know, fortunate last year, 2022, we had some favorable foreign exchange adjustments. So the year-over-year increase, you know, is a lot less than it looks on a, on a, you know, constant dollar basis. And again, more of the same, I would anticipate, you know, a couple percent. And again, we monitor those very closely, you know, whether it's space or whether it's professional fees. You know, professional fees are up slightly this year, in addition to the, to the, you know, foreign exchange adjustments.

Then on comp, you know, I think...

... You know, we are, you know, we have emerged in the past year or two from multi-year integrations, you know, of large acquisitions. Our headcount has remained, you know, relatively steady. And, you know, what that masks is, you know, we have really restocked the talent pool over the past two years. We really, you know, I think, upgraded, you know, our employee base in terms of talent, in terms of capabilities. And, you know, we've always held ourselves out as not, you know, a payout shop, and that's the way it's going to remain, right? So I would say, you know, our comp ratio coming in, you know, in the mid-20s this year, from a cash standpoint, we're very comfortable with that, right?

We think it's what we need to do to adequately pay people. You know, I think we did hire quite a lot of people in the past couple of years. I think we were, you know, we did it in a disciplined way, so I think we're in a fortunate position to continue recruiting. And, you know, again, I have no issue with our comp ratio where it is. If you look back a couple of years, it was in the mid-teens, right?

So I think we're gonna be, you know, if you wanna look at that as kind of the pendulum from, you know, boom times to, you know, more, you know, less subdued markets, then I think that's kind of, you know, we're very happy with that. Great.

Dan Fannon (Managing Director, Senior Research Analyst)

Thank you.

Joseph Molluso (Co-President and Co-COO)

Thank you, Dan.

Operator (participant)

The next question comes from Alex Blostein of Goldman Sachs. Please go ahead, your line is open.

Alex Blostein (Managing Director, Senior Equity Analyst)

Hey. Hey, guys. Good morning. A quick financial question for you. So the leverage ratio is back at around 3x and 3x debt to EBITDA. So, you know, obviously, it's been not the best trading environment for the business, so that will bounce around. But how are you feeling about this creeping back up here with respect to your ability to continue share purchases at this kind of pace, if the environment can kind of continues to be what it's been?

Joseph Molluso (Co-President and Co-COO)

Look, I think we provide a pretty detailed analysis of, you know, our ability to repurchase shares at different levels of trading income. So I think there's really two separate questions there, right? You know, we are going to use our excess cash to repurchase our shares, you know, absent any, you know, other alternative for them, right? And, you know, people ask us all the time, are we looking at, you know, other acquisitions? Well, the answer is, we look at everything, but we haven't come across anything that represents close to the value of repurchasing our shares at this level.

So I think, you know, to the extent we have the dollar of excess cash, that's how it's going to be deployed, and that's after, as I say, after we pay our expenses, pay our people, you know, invest in our growth initiatives, et cetera. So I think that's kind of, you know, one part of the question. On the leverage ratio, you know, I don't really feel like, right, we are, you know, worried about whether it's 3x, 3.25x, you know, 2.5x. You know, we reset our debt. We were, you know, very fortunate and very happy, you know, that we, you know, we did this in early 2022, when we had, you know, we're in a different interest rate environment, obviously.

We've got swaps on our debt, and we always look at it, you know, and try to keep that quantum as cheap as possible. We wanna optimize that from a cost standpoint. But, you know, the question is that we ask ourselves is, you know, "Does the rate environment, you know, change the quantum of debt that we're comfortable with?" And the answer is, not really. I mean, we'll always look to, you know, make it as cheap as possible. But, you know, we're pretty comfortable with that total level.

Alex Blostein (Managing Director, Senior Equity Analyst)

Gotcha. Great. That makes sense.

Joseph Molluso (Co-President and Co-COO)

Yep. Thank you.

Operator (participant)

Thank you. The next question comes from Michael Cyprys of Morgan Stanley. Please go ahead. Your line is open.

Michael Cyprys (Managing Director, Equity Research Analyst)

Good morning. Thanks for taking the question. Wanted to drill down on index options to some of your earlier commentary. Just curious how you see the evolution of the index option marketplace here, the evolution of the different customer types that are emerging, use cases, and to what extent do you view this as sustainable, just in terms of this level of activity? And then also related to that, to what extent are you seeing these index options, like SPX, being used as a replacement for, say, E-mini futures, E-mini options on futures? Just curious how you're seeing that all evolve.

Joseph Molluso (Co-President and Co-COO)

Yeah, it's a great question. It's been sort of fascinating to watch, and I think you kinda nailed it, which is... And again, I don't, you know, we get along great with all exchanges, and people are creating products, so I'm not trying to disparage anyone's product or whatnot, 'cause we're sort of the Switzerland of liquidity provisioning, so we encourage innovation and whatnot. But, I think people have looked at that product and said, "Look, it's a really good way to manage volatility, and a good way if you wanna be speculative on volatility." It provides you the innate leverage, if you will, of the options market, and it's affordable, and it's very accessible. So just...

It is a complementary product, if you will, to what you see in futures and equities, or SPY products, et cetera, and I think it complements them very well. So it has really resonated with the marketplace. I think it adds, you know, flexibility to all stripes of traders, investors. So clearly, institutional investors are now using it as a product. There's a huge debate going on between J.P. Morgan and Goldman Sachs as to, you know, whether it's retail or not. I'm not gonna get involved in that. Let the big guys fight that out. At the end of the day, again, we don't care because-

Douglas Cifu (CEO)

... You know, we service both, all sides of the continuum of the spectrum of traders and users of that product. So we like the product a lot. We think it expands the market and provides access, you know, to all, you know, to investors that wanna engage and express an interest in either volatility or use it to hedge the rest of a portfolio. So I think it's been a really healthy development for the marketplace, and obviously, the options market is incredibly competitive from a venue perspective. At last count, I believe we have 17 options exchanges. I could be wrong. Maybe I missed the 18th. So there is a need for market makers to provide interconnectivity, if you will, between those various venues.

Joseph Molluso (Co-President and Co-COO)

That's not the easiest circus trick in the world to pull off because of the difference in technology, but that's fantastic for Virtu. That's kinda like Virtu 101, which is understanding products, understanding how they interact and relate to related products, understanding the DNA, if you will. We call that market structure, 101, of how all these venues work, making that work within our technology plant, and then providing a service in the form of an attractive price that we can distribute through these various venues. So we continue to be very excited about how that has evolved in the United States. And as I mentioned earlier, there are similar, similar, like, global index products in other countries that we have found attractive as well, that we can approach and provide value to with our scope and scale, namely India, right now, namely India and Japan.

But, good observation. Thank you for the question, Michael.

Great. Thanks.

Operator (participant)

Thank you. We currently have no further questions, so this concludes today's conference call. Thank you all for joining. You may now disconnect your lines.

Douglas Cifu (CEO)

Thank you, everyone.