Virtu Financial Inc
NASDAQ:VIRT
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Virtu Financial Inc
Earnings Call Analysis
Q3-2023 Analysis
Virtu Financial Inc
The company showcased resilience with a significant increase in adjusted net trading income, reaching $4.7 million per day, marking a 5% rise from the previous quarter, and normalized adjusted EPS grew notably by 22% from the previous quarter to $0.45 per share.
Two primary segments exhibited growth, with the Market Making segment earning a commendable $3.3 million per day, a 6% increase, and the Execution Services business contributing $1.4 million per day, up 4% compared to the last quarter.
Despite economic headwinds, the company maintained discipline in cost management, achieving an impressive 47% EBITDA margin. This is consistent with their approach to making strategic hires and investments while still being cost-disciplined.
Cash operating expenses rose to $481 million, which is 4.6% higher than last year. This can be attributed to the company's growth, which continued to scale operations effectively in a competitive market.
The talent pool has been restocked over the last two years, with the company holding a stable headcount, leading to an upgraded workforce. Despite a cash compensation ratio at the higher end of their historical range, at 26%, management is satisfied with the investment in talent, indicating a strategically managed growth in their employee base.
The leadership reaffirmed its commitment to a $0.24 quarterly dividend, highlighting a balance between consistency in payouts and the ongoing share repurchase program. The company has impressively repurchased 17% of its shares in the past three years, reflecting a strong focus on delivering shareholder value and confidence in the company's financial health.
Invested capital has been managed effectively, staying within the $1.8 billion to $2 billion range, with the company buying back 2.7 million shares for approximately $49 million in the third quarter. Further, management is comfortable with the company's leverage ratio and has no major concerns whether it fluctuates slightly around the current level.
The company is positioned well in Asia, including in India and Japan, and is adjusting its offerings to meet changing market preferences, such as the shift towards single day options and products that cater to varying volatility exposures. Additionally, the company supports initiatives like centralized clearing of treasury products, which aligns with its strategic growth plans in the evolving financial markets.
Looking forward, non-compensation expenses are expected to grow at a low-single digit rate, which is slightly higher than usual due to price increases in market data and infrastructure. However, the company appears to handle these additional costs well and anticipates a similar trend in the coming year.
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Hello and welcome to Virtu Financial 2023 Third Quarter Results. My name is Kerry, and I'll be the conference operator for today. [Operator Instructions] I would now like to hand the call over to Andrew Smith from Investor Relations to begin. Please go ahead.
Thank you, Kerry, 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 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 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.
And with that, I'll turn the call over to Doug.
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 2 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 3 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 noncustomer 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 Market Making continued 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 remains 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 continue to hire and make investments in our business, remaining disciplined around cost, which enabled us to realize a 47% EBITDA margin and report 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 in volumes and increasing 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 use our service to raise primary capital.
Finally, you'll likely notice 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 assure that any customer information was ever inappropriately accessed and the period focused ended 4.5 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 precedence, 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?
Thank you, Doug. Turning to expenses and capital. On expenses, we ended the first 9 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 9 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 noncompensation 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 could see that our invested capital has remained within a range of $1.8 billion to $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 we'll 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 8 years, and you could 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 3 years since beginning our share repurchase program. This brings our total repurchases to 42.2 million shares for over $1 billion. And with that, I'll turn it over to Sean to review the financial details before we open the call to your questions.
Thank you, Joe, and good morning, everyone. On Slide 3 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 9, we provide a summary of our operating expense results. For the third quarter of 2023, we recorded $174 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 $25 million for the third quarter of 2023. With the benefit of the interest rate swap contracts that we entered into in the prior year, 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 Instructions] The first question on the line comes from Ken Worthington of JPMorgan.
I wanted to dig into product expansion, particularly ETF Block Options Market Making in crypto. So I guess, 3 parts to hopefully 1 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?
Yes. 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 we had started talking about maybe 2 years ago. And then unfortunately, 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 the closed-end fund rate scale and the amount of volume, if you will, that it does in the amount of bitcoin in its corpus and so if you assume that sometime between today and January 10, which I understand is sort of the drop dead date with respect to SEC approval, given what happened in the District Court, the loss by the SEC, there's going to be, I would think, a significant influx of interest in the ETFs that are kind of queued up.
I think there's 10 to 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 10. And I think there's going to be a significant amount of trading from the closed-end fund 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 were moved because it's part of another portfolio or they get an offset. Whatever it is, I think they'll be 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 security exchange that is centrally cleared.
And I know there's not going to be a shenanigans because we have a proper regulatory environment, people are going to 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, as you know, we've partnered with Citadel, Schwab and Fidelity and some others to create a platform called [ EDX ] which would be a front through back 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, that is a great platform. So there will be real volumes, and we'll see a marketplace that we will kind of know and understand unlike as [indiscernible] said, a little bit of the Wild West that we have dealt with historically.
So that's why 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, again, this is something we've been talking about for the last couple of years. 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, flow traders and others. We've done all of 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 market 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, 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 in the last day or 2 about the explosion of growth in index volumes. And that's really been our big focus and single name index options have -- volumes have significantly dropped off.
Again, we are trading single name options, we'll continue to do so. Whether in 2024, we start taking directed flow from retail brokers or not is still an open question in my mind. It's probably 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.
The next question on the line comes from Chris Allen of Citi.
I've got some follow-ups on Ken question. It's only going to be a 2-quarter. Just on the build-out on the rate side in particular, last quarter, you noted it was very early days. You're doing a lot of 5% volume for 5% to 10% of clients on the platform. Any update on that front? And then on Options, you talked about a declining rev 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?
Yes. That's a great question. We 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 2 years ago. So I'm very, very pleased with the growth there. We are now generating decent P&L like not material in the Virtu sense but individually in Asia, both in India and in Japan, which again, things I would not have thought to mention 2 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 will come. But I do see a continued interest in like 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 macro events around the world between 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 expose themselves to intraday and over week and month volatilities and things like that. You had another question? What was the second part? I forgot it.
Yes, rates is an interesting market, right? Obviously, it's the 1 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 [ ECM ] but also this is a marketplace that we think 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.
Our next question comes from Dan Fannon of Jefferies.
My question is on expenses. So as we think about the environment, which is still somewhat subdued, how should we think about the fourth quarter and the true-up and/or 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 noncomp expense or any other framework that you could help us with that would be great.
Dan, it's Joe. 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 going to grow at kind of a low single-digit rate. Maybe we were a touch higher than that this year. We do a lot of work every day, especially on our connectivity, our infrastructure plan, our market data. We monitor everything down to everyone's Bloombergs and everything and all the other market data subscriptions. And I think if you look at that line item, up a few million dollars in this kind of environment where there's been price increases, 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, where it's just kind of keeping the lights on type of expenses. Again, we were fortunate last year 2022. We had some favorable foreign exchange adjustments.
So the year-over-year increase is a lot less than it looks on a constant dollar basis. And again, more of the same, I would anticipate a couple of percents. And again, we monitor those very closely, whether it's space or whether it's professional fees, professional fees are up slightly this year in addition to the foreign exchange adjustments. And then on comp, look, I think -- we have emerged in the past year or two from multiyear integrations of large acquisitions. Our headcount has remained relatively steady and what that masks is we have really restocked the talent pool over the past 2 years.
We really, I think, upgraded our employee base in terms of talent, in terms of capabilities. And we've always held ourselves out as not a payout shop, and that's the way it's going to -- and that's the way it's going to remain. So I would say our comp ratio coming in, 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. I think we did hire quite a lot of people in the past couple of years. I think we did it in a disciplined way. So I think we're in a fortunate position to continue recruiting and 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 going to be -- if you want to look at that as kind of the pendulum from boom times to more less subdued markets, then I think that's kind of -- we're very happy with that.
The next question comes from Alex Blostein of Goldman Sachs.
Quick financial question for you. So the leverage ratio is back at around 3x debt to EBITDA. So 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 repurchases at this kind of pace if the environment kind of continues to be what it's been.
Look, I think we provide a pretty detailed analysis of our ability to repurchase shares at different levels of trading income. So I think there's really 2 separate questions there, right, is we are going to use our excess cash to repurchase our shares, absent any other alternative for them, right? And people ask us all the time, are we looking at other acquisitions? 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 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 said, after we pay our expenses, pay our people, invest in our growth initiatives, et cetera. So I think that's kind of one part of the question. On the leverage ratio, I don't really feel like we are worried about whether it's 3x, 3.25x, 2.5x.
We reset our debt. We were very fortunate and very happy that we did this in early 2022 when we had -- we're in a different interest rate environment, obviously. We've got swaps on our debt. And we always look at it and try to keep that quantum as cheap as possible. We want to optimize that from a cost standpoint. But the question that we ask ourselves is, does the rate environment change the quantum of debt that we're comfortable with. And the answer is not really. I mean, we'll always look to make it as cheap as possible. But we're pretty comfortable with that total level.
The next question comes from Michael Cyprys of Morgan Stanley.
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 the future? Just curious how you're seeing that all evolve.
Yes, it's a great question. It's been sort of fascinating to watch. And I think you kind of nailed it which is -- and again, I don't -- we get along right with all exchanges and people are creating products, I'm not trying to disparage any of the product or whatnot -- because 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 in a good way, if you want to 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 acceptable. So just it is a complementary product, if you will, to what you see in futures and equities [ world's ] byproducts, et cetera. And I think it complements them very well. So it has really resonated with the marketplace.
I think it adds 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 JPMorgan and Goldman Sachs as to whether it's retail or not, I'm not going to get involved in that, let the big guys fight that out. At the end of the day, again, we don't care because 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 to investors that want to engage and express an interest in either volatility or use it to hedge the rest of the 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 inter-connectivity, if you will, between those various venues. That's not the easiest circus trick in the world to pull off because of the difference in technologies, but that's fantastic for Virtu. That's kind of 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 plan 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 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.
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.
Thank you, everyone.