Virtu Financial Inc
NASDAQ:VIRT
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Virtu Financial Inc
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Good morning. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the Virtu Financial Q4 and Full Year 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you.
Andrew Smith, Head of Investor Relations, you may begin your conference.
Thank you, Chris. Good morning and welcome, everyone. As you know, our fourth quarter and full year 2017 results and earnings presentation were released this morning and are available on our Web site.
Please note that 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 maybe outside the company's control, and our actual results and financial condition may differ materially from what is indicated in these forward-looking statements.
It is important to note that any forward-looking statements made on 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 may become available. We refer you to disclaimers in our press release and encourage you to review the description of risk factors contained in our 10-K and other filings with the SEC.
In addition to GAAP results, we may refer to certain non-GAAP measures including adjusted net trading income, adjusted net income, adjusted EBITDA and adjusted EBITDA margin. You will find a reconciliation of these non-GAAP measures to GAAP terms included in the earnings materials with an explanation of how management uses these measures.
When used on this call, adjusted net trading income refers to our trading income net of all interest and dividend income and expenses, and all brokerage, clearing and exchange fees. This will be the first full quarter where we report on the combined results of Virtu and KCG.
Speaking and answering your questions today are Mr. Douglas Cifu, our Chief Executive Officer; and Mr. Joseph Molluso, our Chief Financial Officer. They will begin with prepared remarks and then take your questions.
Now, I would like to turn the call over to Doug.
Thank you, Andrew. Good morning everyone and thank you for joining us today. On today’s call, I will review our fourth quarter results, provide an update on the integration of KCG into Virtu and make some remarks on the global outlook for Virtu in 2018. Joe will then provide more details on our quarter and we will open up the call for your questions.
I am pleased to report that in our first full quarter that reflects the combined results of operations of Virtu and KCG, we have exceeded our expectations for the combined company. The $237.3 million of adjusted net trading income we report today reflects the strong performance across the board for the firm, particularly when measured against the backdrop of limited volume and volatility that persisted during the quarter.
This result equates to approximately $3.8 million of adjusted net trading income per trading day, an increase of 38% from the third quarter despite conditions of persistently depressed volume and volatility in the fourth quarter. Specifically, during the fourth quarter, the average daily realized volatility in U.S. equities was 5.7 as compared to 7.1 during Q3, a decrease of 20%.
The important takeaway from these results is that as a firm, we improved during the fourth quarter relative to the opportunities in the market and this was particularly the case in Americas equities, our largest asset class. We also saw improvements on our other asset classes and geographies, including our rest of the world equities category, which increased its adjusted net trading income 67% quarter-over-quarter.
As I described on our last call, this demonstrates the power and strength of the combination of Virtu and KCG. The fourth quarter’s results reflect the revenue benefits of combining KCG’s first-rate customer franchises and quantitative processes with Virtu’s superior financial technology and order routing capabilities. We believed in the ability of this combination to drive Market Making revenue each quarter when we entered into the transaction and the fourth quarter results are further validation of our thesis.
In addition, we reported today adjusted EPS of $0.22 per share, a 175% increase from the third quarter. This meaningful increase in our EPS is the result of the enhanced revenue performance I just mentioned as well as our relentless focus on costs and the achievement of our expense guidance and synergy targets ahead of schedule. The efficiency and scale of the Virtu technology infrastructure in global operations will continue to drive down our combined costs.
To take a step back, these results demonstrate that Virtu can and will generate profitable results in less than ideal market operating environments of the type we experienced in the fourth quarter and any return to periods of enhanced volumes of volatility such as that experienced this week should result in superior returns as our fixed cost business model scales exceptionally well.
The increases in revenue during the quarter came from both meaningful growth in legacy Virtu and KCG’s trading P&L, driven by revenue synergies across the firm. In particular, we had a strong quarter in our rest of the world equities category and we saw improvements to the Market Making results from our strong customer franchise in U.S. equities.
We continue to be excited by the real revenue synergy opportunities arriving out of the combination of both firms, some of which we outlined on our last earnings call. These new opportunities were significant contributors to our revenue growth in the fourth quarter. In short, our conviction that the two firms Market Making styles and cultures are remarkably complementary has been proven correct and we believe that there are ample opportunities in front of us to grow revenue further.
We remain excited about the identified and yet to be identified revenue upside from this combination. We also remain confident that the expense and efficiency discipline that is the hallmark of Virtu is being applied to the legacy KCG business and the synergy results reported today and expense guidance we have provided demonstrate this discipline.
We have generated efficiencies throughout the organization, from eliminating duplicative market data to consolidating post trade infrastructures and access office space. Our progress is demonstrated further by the fact that as of today, global headcount stands at approximately 560 people, which is down from approximately 1,200 for the combined firms only a year ago.
The fourth quarter was also eventful for us on the capital management side as we entered into an agreement with the Intercontinental Exchange to sell BondPoint for $400 million which consummated in early January 2018. After tax proceeds amounted to $276 million, which was used to pre-pay our existing term loan. We are thrilled with this outcome and think ICE is the perfect home for BondPoint and its employees.
We also repriced our existing term loan put in place at the time of the KCG acquisition and lowered our interest rate spread by 50 basis points resulting in $3 million of annual pre-tax savings. To-date, we have repaid $526 million in debt since the KCG acquisition closed in July 2017. This represents approximately 32% of the debt incurred at the time of the acquisition and puts us well ahead of schedule to achieve our target capital structure that we outlined when we assumed the transaction.
As a consequence of this rapid delevering of our balance sheet, our confidence in the combined business and the new federal tax rate, our Board has approved a quarterly dividend of $0.24 as well as a $50 million share repurchase program. As we have said repeatedly, we believe that as a service business, we can run Virtu with a steady state of between $750 million and $850 million of trading capital and any excess should and will be returned to our investors. This new share buyback program is a further manifestation of this philosophy and a sign of how confident we are about the future ability to generate free cash flow.
So barely six months into the acquisition, we have validated many of the key assumptions we outlined to you when we announced the transaction. First, the customer Market Making business of legacy KCG is a thriving service business with enormous potential and consistent operating results. Managed properly and stripping away all the volatile capital-intensive hedge fund style activities it previously undertook, this business will achieve predictable revenues based on longstanding relationships and the opportunities presented.
Second, the cost synergy guidance we provided for the combined companies of approximately $300 million is very achievable and we are well underway towards achieving that target. Further, as we noted on the last call and reiterate today, there has been no impact to the revenues of the existing business as a result of the expense synergies realized. In fact, these efficiencies have made it easier for us to capitalize on a more favorable volatility environment.
Let me briefly review the results of our operating segments in more detail. Our core Market Making business performed exceedingly well in Q4 generating approximately $3.24 million of adjusted net trading income per day. This outperformance is the result of several factors. As I said on our last call, legacy KCG and Virtu Market Making businesses are extremely complementary and symbiotic.
We continue to migrate some of the legacy KCG Market Making strategies onto the Virtu platform increasing efficiency and execution performance and rolling out legacy KCG’s strategies across Virtu’s global Market Making platform. We continue to migrate the functionality inherent in KCG’s more quantitative strategies to legacy Virtu making the Virtu strategies more competitive and profitable globally.
We continue to enable additional opportunities for internalization across both firms, thereby being more efficient and intelligent about our hedging activities. We are only beginning to achieve trading efficiencies and harmonize the strengths of both legacy firms and we believe there’s a lot of growth ahead for the combined firms as we continue to implement more combined Virtu/KCG style strategies.
The Virtu Execution Services segment generated approximately $400,000 per day in Q4 2017 after removing the BondPoint revenues. We continue to view Virtu Execution Services as an attractive business and have initiated efforts to streamline and rationalize the various offerings to our institutional clients.
As you know, prior to KCG’s acquisition, Virtu has started to provide Execution Services to several clients leveraging its core technology. This work continues only now with a global client franchise that we inherited with the KCG acquisition. Importantly, we are the only firm that has significant retail and institutional flows and we are beginning to offer access to our central book of retail orders as an attractive new product to our institutional customer base.
The broad integration goals outlined at the time in the merger and in our last call have not changed. We are marrying front office trading platforms and back office post-trading systems and integrating trading, risks and operations to the entire firm so that we are one firm and have a single firm culture.
To-date, the response from our customer base has been uniformly positive as they appreciate the benefits of an efficient and streamline service provider. In terms of specifics, we’ve provided detailed expense guidance that totaled over $300 million of gross annualized expense synergies to be achieved by 2019.
The Q4 2017 results were squarely within or better than the ranges forecast for Q4 2017 and we remain confident in our ability to achieve our goals in 2018. Also, consolidating and streamlining technology allows Virtu to capitalize on upswings in volatility and volume. So the actions we have taken to achieve these synergies, including rolling out legacy KCG’s strategies and legacy Virtu global’s infrastructure has benefitted the company recently, especially in conditions like what we have seen over the past week.
When we look at the fourth quarter as a whole, we are struck with several strong positives that we wanted to highlight. The wholesale Market Making business is resilient, stable and a consistent service business. The power and scalability of the combined company is evident in our ability to achieve outsized results even in an environment with limited opportunities.
The EBITDA and profitability generated are indicative of a strong cash flow profile of our business. These strong cash flow characteristics combined with a reduction in long-term debt, the impact of the new tax law and continued strong capital position allow us to continue to pay our $0.24 quarterly dividend for the foreseeable future and as authorized by our Board of Directors, opportunistically seek to repurchase up to $50 million of our common stock and units in the future.
Looking forward, we remain very upbeat for 2018 regardless of the environment. The passage of the new tax law at the end of 2017 has sparked an uptick in retail interest, primarily in U.S. equities, which is a positive for our U.S. equities business. The operating environment in January was generally consistent with the environment we experienced in the fourth quarter of 2017 and obviously the first week of February has seen a meaningful uptick in volatility and is favorable to a scaled global market maker like Virtu.
Now, I will turn the call over to our CFO, Joseph Molluso, to walk you through the financials. Joe?
Thank you and good morning. Virtu reported this morning $0.28 of earnings per share on U.S. GAAP basis on net income of 47.8 million, our normalized adjusted EPS assuming all common units are exchanged into the public company and adjusting for one-time and other non-operating and non-recurring items was $0.22 for the quarter, a normalized adjusted net income of 41.4 million.
Adjusted EBITDA was 107.8 million resulting in a 45.4% adjusted EBITDA margin. This is important as it demonstrates the power of our fixed cost business model to generate best-in-class margins. Total revenues for the quarter were 460.4 million and adjusted net trading income, including technology and Execution Services, was 237.3 million, up 38% from the full Q3 2017.
You can see on Slide 4 of the supplemental materials, total adjusted net trading income, excluding BondPoint, which was part of Virtu for the full fourth quarter, was 229 million, up 39% from the full third quarter 2017. Market Making adjusted net trading income was 204 million, up 50% from the third quarter of 2017, assuming the two companies were combined for the full third quarter.
Execution Services fourth quarter revenues were 33 million, down 12% from the full Q3 2017. Excluding BondPoint, Execution Services adjusted net trading income was 25 million, down 15% versus the prior quarter. As you can see, our overall performance was against the backdrop of a poor volume and volatility environment in Q4 of 2017.
Average U.S. equity volumes went up about 5% compared to Q3, however, volatility indicators such as VIX and realized volatility fell 6% and 20% in Q4, respectively, and have remained at cyclical levels until this last week.
Reviewing results at the segment level on Slide 5, you can see that Americas equities came in at 141 million of adjusted net trading income driven by continued revenue synergies and strong underlying performance in core wholesale Market Making operations.
Doug outlined many of the reasons for this performance. As a reminder, this business is comprised of the legacy Virtu Market Making business in Americas equities as well as the KCG Americas wholesale Market Making operations.
Rest of world equities were similarly strong with 35 million in adjusted net trading income driven by particularly strong outperformance in the APAC region as well as improving results in Europe.
Adjusted net trading income from global FICC options and other outperformed the opportunity given the lower volumes and muted volatility in global foreign exchange and energy.
Finally, Execution Services adjusted net trading income was 33 million. Excluding BondPoint, the adjusted net trading income was 25 million compared to 29.7 million in the third quarter.
Separately, our Corporate segment includes other revenues of 89.7 million, the majority of which is attributable to a reduction in the tax receivable agreement liability as a result of recent tax legislation.
Turning now to expenses on Slide 6, which we’ll review in some detail. On the prior quarterly call, we provided supplemental materials with detailed expense guidance for this quarter, Q4, and the first and second half of 2018 and then a long-term run rate into 2019.
We have provided this guidance for several reasons. Given the detailed integration plan around all aspects of operations, we have confidence in our ability to project a phase in of cost savings resulting from the merger and our overall ability to manage expenses.
Further, given the complexity of the combination of Virtu and KCG, we wanted to provide the street with an anchor on the expense side so we can focus on the benefits of the integration on the revenue side, which is more dynamic.
Here you can see that actual Q4 2017 adjusted operating expenses were within the range that we forecasted on our last earnings call. Total adjusted cash operating expenses were 129 million for the quarter. Depreciation and amortization came in at 18 million, actually below the range we guided to last quarter.
Total adjusted operating expenses, excluding interest, taxes and non-recurring, non-operating expenses, were 147 million. So when you calculate where we are in synergies, you can see if you annualize these actual 4Q figures and compare them to the 2016 combined expense base of both companies, we have achieved 177 million in annualized expense synergies on this basis.
Looking to the right on Page 6, you can see as expenses come in line with the guidance provided for full year 2019, we expect total gross annualized synergies of 305 million to 315 million. You will recall when we announced the KCG acquisition in April 2017, we were expecting 250 million of gross annualized synergies.
Turning to some of the individual expense items, employee compensation excluding stock-based comp and non-recurring expenses was 56 million in Q4. The driver of this line item is obviously headcount which as of today stands at approximately 560.
As we stated before, we have managed our headcount to be efficient and eliminate the redundancies from the merger. We continue to proceed with this optimization while ensuring exceptional client service. Legacy KCG had an excellent reputation for client service and we believe we have maintained and enhanced the client experience at Virtu.
On the Q3 call, I outlined the historical impact of the GQS business and the resulting revenue dis-synergies were approximately 7 million. As we move further and further away from the closing and the integration of these two companies continues, we do not see any material dis-synergies as a result of the headcount reductions or any other actions taken. In fact, we believe the actions we have taken establish a firmer platform to realize the benefits of increased volatility and volumes.
Communications and data processing expenses were 48 million in Q4. This line item consists of all of our direct and wireless connections globally among the various data centers and the exchanges we connect to. The realization of synergy [ph] continues and we believe will be ahead of our targets.
Occupancy, corporate and other expenses were 25 million in this quarter. The legacy KCG operation in addition to the new headquarters built out in Lower Manhattan and a substantial footprint in Chicago, the West Coast, London, Mumbai and Singapore as well as satellite offices across the U.S. Legacy Virtu had space in New York, Austin, Dublin and Singapore.
Since the merger, we have consolidated and significantly downsized our headquarters in New York to those Lower Manhattan offices as well as downsized while maintaining a presence in Chicago and London and closed Mumbai and consolidated Singapore with Virtu’s offices.
We expect to continue to realize occupancy synergies as we condense space and rationalize other operations. We expect other expenses to continue to come down as we rationalize operations and reduce the dependency on consultants and reduce professional fees.
We had a number of non-recurring and non-operating expenses for the quarter as detailed in our press release and in our GAAP reconciliations in the supplemental materials in this quarter. We had two largely offsetting write-offs or a reduction in our deferred tax assets and a reduction in our tax receivable agreement liability as a result of the change in the tax low which I will talk about in a moment.
Apart from this, we had 4.7 million of severance paid in the quarter as a result of headcount reductions. Also, we had a one-time gain associated with an increase in fair value in our Japan investment and increase in a legal settlement reserve by 2.8 million in the quarter as well as other small items.
Turning to taxes for a moment. Our pro forma effective tax rate for the quarter was 37%. As you can see on Slide 7, we noticed some of the impacts of the Tax Cuts and Jobs Act which was signed in law just before the New Year. Going forward, we will anticipate Virtu’s effective tax rate to be reduced to approximately 23% from the current levels.
As a result of the Tax Act, Virtu is taking a one-time charge of approximately 75 million resulting from the reduction in the value of the deferred tax assets. This estimated charge is similar to what other reporting companies have seen due to this tax law change. Given Virtu’s upside structure, the charge resulting in the write-down of the deferred tax asset is offset through a reduction in the tax receivable agreement or TRA liability for approximately 85 million.
Now let me turn to our capital position and discuss our overall capital management strategy. As you can see on Slide 8, our trading capital position at December 31st was 1.3 billion. As we noted in the past, we estimate approximately 750 million to 850 million of trading capital is sufficient to operate our Market Making and Execution Services businesses.
This amount takes into account required regulatory capital amounts and sufficient buffers for stresses in liquidity. We have earmarked an additional 190 million of this excess for debt reduction through the end of 2018.
When we closed the acquisition of KCG, we had total funded debt of 1.68 billion. As Doug mentioned, including voluntary prepayments and the BondPoint proceeds, we have repaid 526 million. Our total debt load in the approximately five months – we will pay this off in the five months from closing until January 2, 2018.
As you can see on this slide, given expected repayments, we would anticipate our total debt position be just over 900 million at the end of 2018. Given the cash flow and profitability trajectory as evidenced by this most recent quarter, we would expect that our long-term debt to EBITDA targets of between 2x to 2.5x will be met by year-end, which has been our goal.
So given our excess capital position, our strong cash generation and profitability profile and our existing commitment to return capital through our dividend, we have determined we are in a position to put in place a share repurchase program and our Board of Directors has authorized a $50 million share and unit buyback program.
At a minimum, we expect to be able to repurchase shares in connection with vesting of prior year’s stock awards which will prevent share count from increasing. We are careful stewards of capital and we’ll continue to monitor capital usage and capital returns very carefully.
As always, we seek to return excess capital to our shareholders. Also, our Board of Directors declared a $0.24 quarterly dividend payable to shareholders of record as of March 1, 2018 on March 15, 2018. We are naturally pleased with the significant progress we achieved this quarter as reflected in the results. We look forward to the significant work that remains.
Now, we are happy to take your questions.
[Operator Instructions]. Your first question comes from Rich Repetto of Sandler O’Neil. Your line is open.
First, congrats Doug and Joe and team on an upside quarter here. So I guess the very first question, Doug, is we don’t even have to recite the numbers but the volatility, extreme upticks, I think people have mentioned how many times the market’s gone to the plus side, to the negative side, this sort of up and down volatility that at least we’ve come to understand is very friendly to the Market Making environment. So I guess the question is, can you give us – we haven’t been able to quantify that because we don’t have any historical results of the combined company. So is there any way to help us quantify like what this past week you might have experienced as far as net trading income per day? Was it Swiss franc or August 24 type environment?
Thanks, Rich. Thanks for the nice words. Look, it’s a lot better to talk about upswings in volatility. The last two plus years I’ve been answering questions like what happened to volatility, is it ever coming back? So it came back with a bang this week and everybody’s been obviously watching the TV. And you’re right. Look, the environment where you have a lot of price changes during the day is the ideal environment for a market maker and that’s really the ultimate measure of our service that we’re providing, because we’re transferring risk, if you will, on all those price level changes. And so when you see the Dow over S&P or whatever index or the Nikkei or the DAX whipping back and forth, that’s obviously a situation where a market maker has to step up and perform its service. And as I’ve said before that was the idea in forming Virtu was to have a technologically evolved firm that was very nimble around managing risk. And so these are obviously better environments than we saw in the fourth quarter where realized volatility actually declined and our results went up. And so it’s been a really good test for our combined firm. We’ve performed very well. I’m not going to get into specifics because I’ve learned a lot time ago that trying to provide guidance forward or even updates is a slippery slope because things can change day-by-day and week-by-week. But clearly, it’s a very, very favorable environment for a market maker. So we’re real upbeat and excited here. The firm performed very well this past week. I’m very proud of all the individuals here, very proud of our financial technology. We didn’t have any, as I said on TV, there were no outs, there were no self-helps, there was no breaks, there was no trade adjustments. We had ample of capital. And so this is the type of environment where we really can step up and provide service to our retail customers and to our institutional customers which we did very well. In terms of is it like an August or a Swiss franc type of environment, I think we’ll have to see. What I’ve always said to you guys is volatility can be episodic or it could be sustained. Obviously, as a market maker we prefer the latter, the sustained type. And so what will be interesting to see, Rich, is over the next couple of weeks whether or not the volumes and volatility continue at this level or near these levels or whether we return to single-digit volatility. That will be an interesting observation.
Got it. And then just a question on your prepared remarks, Doug. You said that January looked similar to 4Q and I’m just trying to understand that. If we look on the retail side, darks were up 30% versus the prior quarter, volumes are up, volatility was up. So are you just being a little conservative there or how can you compare January – more color on the comparison to January versus 4Q?
Yes, that’s a good question. Look, again, I’m not going to give forward-looking guidance and we don’t do monthly and all that kind of stuff. But the firm performed very well in January. I was very happy with the results. There were certainly more retail interest, as I said in my prepared remarks, because of the tax law change, maybe there were some interest because of all the phenomena around cryptocurrencies and so there were certainly more trading. And as you said, when darks go up, that’s generally a good thing for us. So it was a very solid month for us in January. It obviously didn’t have the extreme volatility that we saw this past week, but it was a very, very solid month. I think the fourth quarter is probably like a good baseline kind of going forward as to what the firm should look like and we’re obviously going to continue to try to grow that. You’re right. The ADVs were up in January, the VIX was up somewhat but it’s certainly not the type of environment that we saw this past week. So it was a solid month. The thing that I’m most excited about, Rich, is that we’re really creating new revenue opportunities by combining the firms. That’s really the story of the fourth quarter. In a declining market, we outperformed not because we had a single day or because we did this or we did that, but because the thesis of the transaction that if you combine what historically has been a great customer franchise and terrific people and wonderful quantitative abilities of KCG with the efficiency, operating scale and financial technology at Virtu, you would have the true modern market maker and that’s really what we’re trying to build here and I’m really proud of the team and how we pulled together in the fourth quarter.
Congrats. Nice Job. I’ll get back in the queue. Thanks.
Thanks, Rich.
Your next question comes from Alex Kramm of UBS. Your line is open.
Maybe you can just touch a little bit more on the cost guidance going forward in the synergy realization? I think last quarter was helpful that to get a fourth quarter guidance number, maybe you want to give us a little bit color on the first quarter or is it just fair to assume if things trickle consistently lower from here, Joe, or any sort of milestones we should be thinking about? Any sort of color you can give us as we model our '18 will be helpful on the cost side?
Yes, we gave a lot of detail on the last call. I know we broke out Q4 and then we gave – I’m looking at last quarter’s supplemental materials. On Page 10, we gave you – that was the historical results, I’m sorry. We broke out first half of 2018 and second half of 2018 guidance in the supplemental materials. So I think that – Alex, I think that amount of detail we felt was sufficient. It won’t be a 50/50 kind of thing. It will be more of a slope coming in. And I guess it was Page 12 of the product materials. But if you look at that first half guidance for 2018 and second half guidance for 2018, you can look at those numbers and then start where we are today and kind of phase those in. But the detail that we provided there is something that we’re sticking by and obviously we were right on target for Q4, so we’re pretty comfortable with it.
Right. So said differently, even though you realize a little bit more as in your prepared remarks today, we shouldn’t really be thinking any differently than what you’ve said before?
Correct.
Okay, that’s fair. And then maybe just switching gears to the revenue synergy side, I think you gave some detail already about some of the things that you have done and the success you’ve had. Any more detail you can give will be helpful, but in particular if you could put any numbers around in which you’ve done less the last quarter i.e., how has the incremental use of KCG quant strategies or some of the other things – people or things you have learned helped in terms of numbers would be great? And any expectation going forward as you still uncover new opportunities hopefully?
Yes, it’s a great question. Thank you, Alex. I think as the firms have – now we’ve been together for six months, it’s starting to blur a little bit what’s KCG and Virtu and that’s one of the reasons why it’s almost impossible to say, well, this is a new revenue opportunity and this is that, because the firms have really come together and we’ve integrated personnel. We’ve moved personnel down from New York to Austin and whatnot and around the world. And so it’s no longer Virtu and KCG, it’s just Virtu. And so it’s hard, Alex, to kind of separate out and say, okay, well, this is purely just a legacy Virtu thing, this is purely KCG. The firms really have kind of come together and that’s really the story I wanted to impress in my prepared remarks and the response I’ll give you. So it’s hard to quantify and say, okay, well, X millions of dollars was from just new strategies, if you will. I think the way to think of it going forward is that you had two Market Making firms that really came at a problem from very different perspectives. Virtu didn’t have a customer base franchise, had to deal with Making Markets in public markets and in dark pools, never had the benefit of customer non-correlated order flow. And so it was really good around financial technology, understanding market structure and was really good at managing cost because we had to. We had to be the most efficient bid and offer otherwise we weren’t going to get interacted with. KCG thanks to some brilliant guys that started this firm a long time ago have the bounty of customer workflow providing great service, world-class franchise, terrific people and developed quantitative models that were able to monetize their flow in ways that frankly pre-merger I couldn’t even comprehend. And the excellence here was outstanding. You take that and you combine those two and you’ve got the ultimate Market Making firm. That was the theory of the merger. And as I frankly exceeded my very rosy and upbeat and optimistic I’m a glass is half full kind of guy expectation. So I’m not trying to avoid the question. I can’t really quantify and say, X millions of dollars was from new stuff. Virtu and KCG are now blended. We’re not going to start – we’re going to stop talking about legacy Virtu and legacy KCG, but a lot of the growth as you can see was from the excellence of the two firms coming together. When you have an environment where market volumes are not going up and realized volatility is down 20% and our revenue is up in U.S. equities 38%-ish and outside the United States 67%-ish in equities, obviously something transformative and exciting is happening. Everybody here feels it. We’re really pumped up about it. And I think there’s a lot more opportunity as we go forward. I’m a sports guy, so everyone always says where are you in the integration and how much upside do you have to go? Usually I would do hockey but it’s easy to do baseball. We’re in the second or third inning and it’s at least a nine inning game.
All right, good. I’ll jump back in the queue. Thank you.
Your next question comes from Alex Blostein of Goldman Sachs. Your line is open.
Hi. Good morning, guys. Two questions, the first one again around the revenue backdrop and the second is more about the environment. So on the first one, is there any way you guys can help us unpack a little bit more what happened in Q4? So obviously 3.8 million trading a day in a low vol environment. I think in October you guys said the run rate was kind of 3.2, so obviously implies material improvement in November, December. Is it fair to assume that almost all of that upside came from the integration, because the environment really hasn’t improved all that much over the course of November, December? And I know there is like one or two days that were good, so i.e. maybe like how concentrated the upside of revenue was or was it fairly spread out I guess is a way to ask the question?
Yes, that’s a good question. The only day that I recall was there was the ABC News Fake Tuesday – not to get political but remember there was some tweet or something from ABC news report and the market went crazy. But that was one day of the quarter. Otherwise your question or your thesis is exactly correct, Alex. It was really just an upslope of improvement day-by-day. And obviously you could do the math. November and December were materially better than October and obviously you can see the July and September numbers. And so we definitely had an upward trajectory. And so sure, I would say that the vast majority of that was from improved excellence between combining the two firms and replatforming KCG’s strategies onto Virtu, making Virtu strategies more quantitative, internalizing more balance flow so as to not route it to exchanges, just putting two great firms together and realizing the upside which at the time of the merger we were excited about but had a hard time modeling. And we think the fourth quarter really is a great starting point and representative of what the new baseline of the firm looks like.
Yes, that makes sense. Thanks. And the second question just around the environment. So clearly there’s a lot of interest on what’s been happening in the VIX complex over the last week. You guys are a meaningful player in this space. Any way to size how much Virtu trades in VIX products that is related to the ETP complex I guess both in the long and short ETP product? And when we think about the products, obviously the VIX futures is the most relevant one, but any spillover effect that that might have on the VIX’s option market as well? Again, just kind of your participation in the market in light of what happened.
Yes, that’s a good question. Obviously, we were a market maker in the VIX complex both ETP product and the futures. It is immaterial to our business. It’s in the FICC option other category, so you can track it over time. It’s less than 1% of our revenue kind of thing. So sure, we like it. It’s a nice product. The guys at Cboe – my friend Chris Concannon, Ed Tilly do a great job. We work with all the ProShares and all the other volatility sponsors and we’re a significant market maker. But it’s a small part – small segment of the market. So our big volume is not going to decline because there is dozens and dozens of products. Candidly I’ve never heard of SVXY or XIV before Monday. It had never been on my radar screen. No offense to my friends at Credit Suisse or ProShares but there were not products that ever had reached my level of interest and therefore weren’t material. We make markets in 2,000-ish ETP products around the world and if a small handful of them are having issues, it really has no impact at all on our performance going forward.
Great. Thanks for that color.
Thank you.
Your next question comes from Chris Allen from Rosenblatt. Your line is open.
Good morning, guys.
Good morning, Chris.
Just wanted to ask – nice quarter and it was real nice positive to see the share repurchase authorization. I guess what would it take for you guys to increase the dividend – do we have to kind of think about waiting until the debt is fully repaid and maybe a more sustained volatility environment? What are the kind of triggers that would – the Board focuses on I guess is the way I’m kind of thinking about it?
Joe?
We have excess capital, right, and there are only a handful of things you can do with excess capital. You can keep it, you can pay a dividend, you can buy back shares. We have a debt to EBITDA target. We want to realize that target and we’re on track to do it by the end of this year. When we went public, we put some guidance out about what our payout ratio would be. And I think again hoping that that performance continues the way it has here in this quarter, we should be within that range in terms of our dividend payout, we’ll have met our leverage targets, we will be within what we’ve historically guided in terms of dividend payout. And the share buyback program that we put in place is a portion of the excess capital and will be opportunistic. It will sterilize some of the vesting of restrictive stock as companies typically do. So I think at the end of the year, once we’ve realized all these targets that we’ve guided to, then we’ll reevaluate and we’ll always reevaluate what to do with excess capital. But I think we’ll be very cautious and keep the payout within the range that we’ve guided to historically.
Yes. Chris, I think the headline is, look, we’ve paid $0.96 a year since we went public. Obviously we feel great about that. Our Board in kind of weighing the pros and cons thought that a share repurchase made sense, share and unit repurchase made sense. And as Joe said to kind of keep the share count, we pay a portion of our compensation in shares, so we wanted to make sure we kept the share count consistent. And we’ve always been really good stewards of shareholder capital. Myself and my partner Vincent Viola are significant shareholders, so obviously our interest are 100% aligned in terms of making distributions to investors. So I think our Board will consider that at the end of the year once we see how the rest of the year shakes out. As Joe said, obviously we’ve got a significant debt burden we want to get that back down to a level that we feel comfortable that we’ve guided you. So we’ll cross that bridge when we cross it.
Sounds good. And then maybe just give some commentary on kind of the FICC businesses. We’ve been obviously easily focused on equities but it seems like things are getting better there too just from energy trading and FX trading volume and volatility perspective. So are you seeing and basically benefits this past year or even in January relative for where it’s been over the past couple of months?
Yes, that’s a good question. It was a business that was kind of flat, if you will, in the fourth quarter. And obviously we’re making improvements because of the transaction and the merger. KCG has some futures trading businesses and so we’re integrating that into the legacy Virtu stack as well, so we’ll see improvements from that. A much smaller part of their business obviously than U.S. equities. But again, volatility in those markets was muted in the fourth quarter, so the opportunity set was lower. I would point out that the volatility this past week has been sort of limited, if you will, to the equities markets. It has not rippled as much through the FICC markets. One thing that obviously we always try to keep an eye on obviously. We’ve seen improvements to the P&L in 2018 in both those businesses. And so we’re obviously focused and excited and continue to be optimistic about the growth potentials of those businesses. But when the market is trading 11 billion shares and realized volatility spikes up, it’s going to get dwarfed by the opportunities in U.S. equities. But it’s still a very important part of what we do and I think there’s a lot of growth there as a result of the combination.
Great. Thanks a lot, guys.
Thank you.
Your next question is from Ken Worthington of JPMorgan. Your line is open.
Hi. Good morning. Thank you for taking my questions. Going to sort of G&A and comp and the variability of the expenses, if 2008 is a particularly strong year, it would kind of feel like it seem to have started this way. Walk us through how the results – maybe much better results in the top line flow through expenses? Like KCG definitely had a variable cost base. Maybe how confident do you feel that you fixed KCG cost by the cost cutting that you’ve done and maybe the changes in the way that you’re managing the business that have previously been variable? And maybe it’s just simple to answer it or ask it this way like Joe, if we look at comp or I look at G&A, what portion of it is now fixed versus variable?
Look, I would – we haven’t broken out fixed versus variable comp. The way we look at this, Ken, is that it is pretty much a fixed cost. I would say to you how I answered the first question is that the expense guidance we’ve given is the expense guidance we’ve given and we don’t see that changing. So I don’t sit here having any concern at all that there’s a hold over culture that is going to cause expenses to spike. This is not a comp to net revenue shop. This is not a variable payout shop at all. So I would say again, we’ve guided expenses and we’ll stand by those expenses. And that’s it. I don’t have any concerns about --
Yes, let me amplify that and be very clear. Virtu as you know can – we were not a trader culture. There was no guarantees, there was no percentages, there was no payout, there was none of that. And this is Virtu. I run this firm and that’s how it’s going to continue going forward. So there should be no doubt that – if you look at the legacy KCG results, there are kind of candidly meaningless as compared to how Virtu is run going forward. Look at what Virtu has done historically. We’ve always managed compensation more like a technology firm and that’s what we’re going to do going forward.
Okay, great. Thank you. In terms of capital return, the 50 million you announced is great. You’ve got a tremendous amount of excess cash in the balance sheet. It seems like the authorization could have been much bigger. There’s changes in tax code, so your tax rate is going down. How did the Board settle on the $50 million? Why wasn’t it $100 million or it feels like there was a lot of capacity to put in a bigger authorization? Thanks.
Look, again I think it’s just part of a capital management framework, Ken. We want to keep some powder dry. We want to achieve our goals. We’ve got a lot of guidance out there. We’re doing well against that guidance but we want to actually deliver before we decide we’re doing a much larger repurchase program or any other kind of capital return. So this was modest enough that it allowed us to kind of be conservative and maintain our targets but meaningful enough that it allows us to go out and manage the share count and be opportunistic if the opportunity to buy back some stock at a good price is there.
All right. And then maybe just lastly, since you guys are sort of experts in trading, VIX blew up. We sort of have the flash crash of VIX and strategies are liquidating. Do you guys think that the VIX concept is strengthened by what happened or has it been weakened? And I know that you said it was a tiny – teeny tiny part of your business but your expertise that would be appreciated there. And then there’s gaps in pricing. How did Virtu risk management hold up? It seems like it held up pretty well, but given the gaps, I thought I’d bring that up too?
Yes, and that’s a great question. I think the products that you were referring to – there were two inverse products which are trying to obviously track the inverse, so the opposite of what VIX is doing on a certain day. And I think they were probably not well understood by some of the media and frankly some of the “expert commentary” that I saw on CNBC and others and it was one of the reasons why I wanted to go on TV. The markets functioned just fine. There were no outages. There was no blowup. I object to the use of the word flash crash because I think it’s got a majority [ph] of notion to it. So these were inverse products that were attempting to track the opposite of what the VIX didn’t. The VIX spiked to 115%. The opposite of 115% is zero. And so therefore if you were an investor in these products, as I said on CNBC, [indiscernible] we don’t make value judgments to products. We’re just a market maker. So obviously FINRA and others will look at suitability with respect to those products. Should an RIA be putting those into some high net worth investment account, I don’t know. That’s certainly not – it’s above my pay grade, if you will. I think what we saw was a lot of professional institutional investors that for a long period of time were along those products. And if you track how they did over the last frankly five, six years, the returns were exceptional. And there was always going to be the possibility that the VIX would spike dramatically in one day and that you were going to get wiped out. And that’s indeed what happened. The prospectus was very clear on that. So whether or not that leads to some type of suitability concerns as to how these products are sold and who they’re sold obviously makes some sense to me. But in terms of did the market function and did the products price themselves correctly, I think they did. And we manage risk perfectly. We obviously hedge ourselves during the day and it wasn’t an issue for Virtu because we’re not making a dispositional bet one way or the other on VIX. We’re just trying to keep a two-sided quote in the ETP products and the futures at all times which we did this entire week.
Okay. And then risk management?
It worked as designed. That was one of the reasons I’m so proud of this firm is that we have spent years and hundreds of millions of dollars on robust risk management systems. I think I’ve given credit and kudos to the legacy KCG folks for doing the same after they had their well known trading in 2012. So the market traded 11 billion-ish shares and our market share actually went up and we traded north of 2 billion shares on – I guess that was on Monday or Tuesday, I can’t remember. The week’s been a bit of a blur, Ken. And so we profit – traded profits, reconciled and settled over 2 billion shares without any hiccup, without any incident and as of [ph] the entire market. So I think from a risk management perspective the firm performed as it was designed to do in times of volatility and stress.
Thank you very much.
Thank you.
Your next question comes from Kaimon Chung of Evercore ISI. Your line is open.
Hi. Most of my questions have been answered, but I had a big picture question. Now that MiFID has guidance effects, just want to get an update of what you’re seeing in terms of related volumes for your business, what are you seeing in terms of volumes in Europe and do you still expect a big shift in landscape once we get past the [indiscernible] delays? And are you still confident that you’d be a big beneficiary of that?
It’s a good question. We’ve seen some benefits from unbundling already. Our institutional business in Europe is a small part of what we do, but we’ve seen some improvements there. Our SI is up in quoting. As you mentioned, the double cap problem or SNAFU, if you will, that we had already in Europe has made it a little hard to sit here and prognosticate exactly where this all plays out. But I know we’re a meaningful player in the SI regime. We’re quoting large size and getting very good feedback from the broker-dealer partners that we’re streaming to. So I think it’s very early to kind of – and there’s very limited data right now, so it’s hard to get too excited one way or the other. I think directionally, as I’ve always said, I think it’s a good thing when you unbundle, you allow the most efficient technologically enabled transparent counterparties have the better advantage. We don’t right research, right, so it obviously helps us. And in terms of the SI regime, I always thought that that was a benefit, single dealer platform streaming quotes is kind of Virtu 101. So we remain very upbeat. But I can’t give you more color than that because it’s early days and as you had mentioned, the double cap SNAFU has made is sort of difficult to really dig into the data and reach any reasonable conclusions.
Thank you.
Your next question comes from Ben Herbert of Citi. Your line is open.
Hi. Good morning, guys. Thanks for taking the questions. Most of my questions have been answered but maybe just a follow up on MiFID and Systematic Internaliser. Do you see any sort of change and shift in market share going through that given the last three or four days and bouts of volatility, or what might you expect?
Again, I still think it’s too early to get a sense of volatility and obviously our European business has benefitted in the same way as our Asia and U.S. businesses benefitted. Don’t forget, we used to be very active in the broker crossing networks which were lowered [ph] on the MiFID II. And so as a result a lot of the volume has just shifted from the BCN world to the SI world. So there hasn’t been a meaningful change yet. I think as this all kind of plays out and once the double caps are in effect, we’ll see how it all – we’ll see where it shakes out. I like our positioning because a single dealer platform as I said of technologically enabled and can stream quotes in thousands of securities is kind of Virtu 101. I think our brand name, if you will, over there is solid and so the broker-dealers that we’ve partnered with, [indiscernible] and others of the world have been very positive about their experiences with Virtu so far and the feedback’s been good. So again, I remain optimistic about it. But I just think it’s a little early to reach conclusions.
That’s fair. Thank you.
Thank you.
Your next question comes from Rich Repetto of Sandler O’Neil. Your line is open.
Hi, guys. I think most of my follow ups have been asked as well on MiFID II. But I guess one last cut on the revenue synergies, last quarter you did, Doug, break out – you said there was 14 million and you were semi-specific in talking about some coming from FX, some coming from non-U.S. equities, the KCG strategies. And I guess just the alone question would be, have these revenue synergies scaled with volatility and scaled with your results in the last couple of weeks? And I totally respect if you want to take the one firm sort of perspective at it as well.
Yes, it’s a good fair question and obviously I believe in the one firm and everyone’s Virtu here, right. We don’t refer to us against them because we’ve created a regular one culture dynamic here. But I will say, look, a lot of the growth that you see is taking some really great KCG strategies that for reasons that are not clear to me hadn’t been scaled globally and that’s obviously one of the benefits of having a very nimble, scaled global firm like Virtu is you can try things in Asia that you always thought might work in Asia but hadn’t for reasons that are irrelevant hadn’t been tried in Asia. So that’s an important part of what we do. I do think it’s really important that people realize that a lot of the benefit also is to the legacy Virtu business. Legacy Virtu business grew significantly in the fourth quarter because of some of the benefits we learned from our new colleagues at legacy KCG in terms of being more quantitative and smarter around how we traded. And so this is a two-way street. The legacy KCG firm was a fantastic, wonderful client franchise with really, really talented employees and an unbelievable quantitative research and simulation environment that legacy Virtu just didn’t have. So it’s hard to understate the benefits of assimilating with a group of folks like that. It’s been really, really powerful.
Got it. Thank you.
Your next question is from Alex Kramm of UBS. Your line is open.
Hi. Thanks for taking me again. Not a lot of follow ups left but just very quickly, obviously now that we are all focused about a great environment again, but prior to that and still in the fourth quarter as you mentioned, it was pretty tough and we’ve seen a little bit more M&A with your peers. Obviously you participated yourself. So just wondering as the marketplace has consolidated, have you felt any sort of easier markets to transact in? I guess what I’m saying is, is the market share opportunity been better because of the tough environment or has it barely been unchanged?
Good question. Our share did improve in the fourth quarter. I think again that comes from the excellence of combining very, very symbiotic firms and internalizing more and being smarter working together. In terms of other firms kind of going away and whatnot and some of the M&A that you’ve referred to, we don’t really feel that as much because all that volume just kind of gets absorbed by the ecosystem. So it’s hard for me to point to and say, well, this firm got sold; this firm went out of business; this happened and our market share went up 30 basis points. It doesn’t really work that way that volume just kind of dissipates and gets absorbed by others. So I don’t think that that’s had a meaningful impact on our market share. The only way we improve our market share is by us digging in, making our strategies better and frankly allowing us to offer more liquidity in the form of bids and offers to the marketplace.
Okay, great. And just last one also very quick, prior to KCG you obviously – and you mentioned yourself, Doug, your velvet rope execution service that you had launched, not sure if you’re still measuring that and how much of a focus it is now that it’s a combined business. But is that still something you’re actively out there planning [ph] the table on or is it just absorbed in the full organization, anything you could share and measure would be helpful? I know it’s small.
Thank you for asking the question. The velvet rope just got a hell of a lot longer. That’s really what has happened. I love the Virtu execution product. The guys here that have been selling the KCG are fired up about it, because it’s a new product. It’s unbelievably efficient in terms of [indiscernible]. It’s opportunistic. It’s very, very transparent. We’ve got a post trade system that is second to none in terms of actually understanding where your orders got routed, so it answers all the silliness around conflicted brokers routing orders. And so it really is a game-changer to our product. And one of the things we’re most excited about was having an educated sales force of the type that we have here and in London that can really sell and disseminate that product to smart institutional investors. The other thing which is even more exciting which I mentioned in my prepared remarks and I think because of the excitement I probably got a little bit glossed over is we are the only firm that has a central risk book of retail orders and institutional orders. If we can get the trust and the confidence of institutional investors and we’re already doing this. We’ve got half a dozen investors already opted into this where we can expose institutional orders to our central risk book of retail orders and effectively cross institutional’s retail, to me that’s a game changing product as well. That’s what the institutional investors have always [Technical Difficulty] large size, non-core related retail orders where there’s not significant market impact. And so those are the two products that we’re rolling out. The guys here have embraced it. They’re excited because it’s something new. That’s a business that we think is core to what we do. It’s strategic and we’re going to really focus in terms of growing it out both here and in Europe.
And so to just follow up on that point you made, I think KCG back in the day had probably talked about this too but I think it was always a little bit of a dream that never came true. So you’re actually are crossing some of that stuff already and I guess the issue is just that you need to convince clients to participate. But other than that there’s no issues on the regulatory perspective or so forth, so you could theoretically roll this out to everyone if you wanted to, right?
Alex, you’ve known me for a long time. One thing I am not is a dreamer. So we are actively doing this. We’re crossing millions of shares a day. There’s no regulatory issue with it whatsoever. And both sides of the equation get really what they want which is a fill that doesn’t impact the market at a price that’s attractive to them. So it’s a unique product. We’re excited about it. The guys on the desk here and in London are excited about it. So to us that’s a significant growth opportunity that candidly no other firm in the world has that level of retail orders in-house and the trust in the transparency of great institutional clients. You’re right. They need to be convinced. They need to opt in. But I think having spend a lot of time with the legacy Virtu firm, they understand how we roll and how we can be very trustful and transparent to them. And so they’ve been very excited about the product and are opting in.
Great. Thanks again for that.
Thank you.
There are no further questions at this time. I would now like to turn the call to Chief Executive Officer, Douglas Cifu.
Thank you everybody for participating in our first quarter where these two firms had complete operations and we look forward to talking to you all at the end of our first quarter. And thank you all for your continuing interest in Virtu. Have a great day.
This concludes today’s conference call. You may now disconnect.