Virtu Financial(VIRT) - 2022 Q4 - Annual Report

PART I Business Virtu Financial is a technology-driven financial firm providing liquidity and trading solutions across global markets through its Market Making and Execution Services segments - The company operates through two primary segments: Market Making and Execution Services, supplemented by a non-operating Corporate segment - Virtu's business model leverages a proprietary, multi-asset technology platform to provide liquidity and trading solutions across over 50 countries and multiple asset classes, including equities, ETFs, options, foreign exchange, futures, fixed income, and cryptocurrencies - The Market Making segment generates revenue by earning small bid/ask spreads on large volumes of securities, with performance heavily influenced by market volumes and volatility - The Execution Services segment earns commissions by providing agency-based trading, workflow technology (like Triton EMS and RFQ-hub), and analytics tools to institutional clients - The company is heavily regulated by numerous domestic and international bodies, including the SEC, FINRA, CBI, and FCA. It faces risks from potential market structure reforms, particularly recent SEC proposals that could impact off-exchange trading and payment for order flow Market Making The Market Making segment is Virtu's core business, providing liquidity across global asset classes by profiting from bid-ask spreads on high-volume trades - The segment provides liquidity in cash, futures, and options markets across global equities, fixed income, currencies, cryptocurrencies, and commodities[22] - Revenue is generated by buying and selling large volumes of financial instruments and earning small bid/ask spreads, with profitability influenced by market volumes, volatility, and retail participation[25][26] - The company makes markets in over 25,000 securities on numerous exchanges and venues worldwide, including NYSE, Nasdaq, Cboe, and international exchanges[35] - Asset classes covered include U.S. Treasuries, corporate bonds, over 80 currencies (including digital), energy products, precious metals, and options on all U.S. options exchanges[38][39][40] Execution Services The Execution Services segment offers agency execution, workflow technology, and analytics to institutional clients, earning commissions on transactions - This segment offers agency-based execution, workflow technology, and trading analytics to institutional clients, earning commissions on transactions[42][44] - Key products include algorithmic trading, order routing, and access to non-displayed liquidity through ATSs like Virtu MatchIt and POSIT[45][46] - Workflow technology offerings include the Triton EMS, a multi-asset and broker-neutral platform, and RFQ-hub for negotiated trades in various instruments[47][49] - The Analytics suite provides tools for transaction cost analysis (TCA) to help clients manage trading costs and improve execution performance across multiple asset classes[52] Human Capital and Corporate History Virtu had 993 employees as of February 2023, emphasizing DE&I, with key milestones including its 2015 IPO and acquisitions of KCG and ITG - As of February 3, 2023, the company had approximately 993 full-time employees, with 71% in the Americas, 19% in EMEA, and 10% in APAC[65] - The company has a Diversity, Equity, and Inclusion (DE&I) Committee and hosts an annual Women's Winternship program to promote diversity in financial services[67] - Key corporate milestones include the April 2015 IPO, the acquisition of KCG Holdings in July 2017, and the acquisition of Investment Technology Group (ITG) in March 2019[85][88][89] Risk Factors The company faces significant risks from market volatility, intense competition, regulatory changes, its holding company structure, and substantial indebtedness Risks Related to Our Business and Operations Virtu's revenues are highly dependent on market volume and volatility, facing risks from competition, platform failures, and substantial indebtedness of $1.83 billion - Revenues and profitability are highly dependent on trading volume, volatility, and retail participation, which are subject to factors beyond the company's control and prone to significant fluctuations[100] - The company faces substantial competition from other market makers and trading firms, some of which have greater financial resources, potentially compressing bid/ask spreads and reducing profitability[109][111] - As of December 31, 2022, the company had $1.827 billion in outstanding long-term borrowings, which imposes significant operating and financial restrictions and exposes it to interest rate risk[120][127] - The business relies heavily on its proprietary technology and computer systems, making it vulnerable to system disruptions, software failures, and significant cyber-attacks that could result in material financial and reputational harm[129][130][131] Legal and Regulatory Risks The company faces significant legal and regulatory risks from ongoing scrutiny, potential SEC market structure reforms, and non-compliance penalties - The business is subject to extensive regulatory scrutiny, with ongoing attention on practices like payment for order flow, wholesale market making, and off-exchange trading[162][163] - Recent SEC proposals focused on equity market structure reform, including Proposed Rule 615 (order competition rule), Regulation Best Execution, and changes to tick sizes and access fees, could dramatically alter the market and adversely affect the company's operations and profitability[168] - Failure to comply with regulations from numerous authorities (SEC, FINRA, CFTC, ESMA, CBI, FCA, etc.) could result in fines, penalties, suspension, or revocation of licenses[170][171] - Proposed financial transaction taxes in the European Union, the U.S., and other jurisdictions could materially increase the cost of doing business and reduce trading volumes[177][179][180] Risks Related to Our Organization and Structure Virtu Financial, Inc. is a holding company dependent on subsidiary distributions, controlled by the Founder Post-IPO Member, and obligated to substantial tax receivable agreement payments - As a holding company, Virtu Financial, Inc. is dependent on distributions from its subsidiary, Virtu Financial LLC, to pay dividends, taxes, and other expenses. As of December 31, 2022, it held a 59.7% interest in the subsidiary[186] - The Founder Post-IPO Member controls approximately 85.2% of the combined voting power, allowing substantial control over corporate actions, which may create interests that differ from those of other stockholders[189][190] - The company is required to pay pre-IPO members 85% of the cash tax savings it realizes from certain tax benefits. These payments under the tax receivable agreements could be substantial and negatively impact liquidity[198][200] - Future payments under the tax receivable agreements are estimated to range from approximately $36.4 thousand to $22.0 million per year over the next 15 years, excluding payments related to subsequent exchanges[202] Properties Virtu's headquarters are in leased office space in New York, with additional leased facilities globally, deemed adequate for current needs - Virtu's headquarters are in leased office space in New York, NY, with additional leased facilities in the U.S., Canada, Europe, Asia, and Australia[222] Legal Proceedings Information on legal proceedings is incorporated by reference from Note 15 in the Consolidated Financial Statements - Details on legal proceedings are located in Note 15 of the Consolidated Financial Statements[223] PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Virtu's Class A Common Stock trades on Nasdaq, with a policy of returning cash to stockholders through dividends and a $1.22 billion share repurchase program - The company paid quarterly cash dividends of $0.24 per share during the years ended December 31, 2022, 2021, and 2020[228] - The Board of Directors has authorized a share repurchase program totaling $1.22 billion, extending through November 3, 2023[234] - From the program's inception through December 31, 2022, the company has repurchased approximately 32.3 million shares of Class A Common Stock and Virtu Financial Units for about $899.6 million, with $320.4 million remaining capacity[235] Share Repurchases in Q4 2022 | Period | Total Shares Purchased | Average Price Paid per Share | | :--- | :--- | :--- | | Oct 1 - Oct 31, 2022 | 833,650 | $21.66 | | Nov 1 - Nov 30, 2022 | 637,671 | $22.41 | | Dec 1 - Dec 31, 2022 | 649,873 | $21.12 | | Total Q4 2022 | 2,121,194 | $21.72 | Management's Discussion and Analysis of Financial Condition and Results of Operations In 2022, total revenues decreased by 15.9% to $2.36 billion, and net income fell to $468.3 million, primarily due to lower trading income Consolidated Results of Operations (2022 vs 2021) | Metric (in millions) | 2022 | 2021 | % Change | | :--- | :--- | :--- | :--- | | Total Revenue | $2,364.8 | $2,811.5 | (15.9)% | | Total Operating Expenses | $1,808.0 | $1,814.6 | (0.4)% | | Net Income | $468.3 | $827.2 | (43.4)% | | Adjusted Net Trading Income | $1,467.6 | $1,909.9 | (23.2)% | | Adjusted EBITDA | $859.1 | $1,301.2 | (33.9)% | - The decrease in total revenues was primarily driven by a $476.3 million (22.6%) decline in Trading income, net, resulting from lower spread opportunities and decreased quality of order flow[298][300] - Operating expenses decreased slightly, mainly due to a $126.3 million reduction in brokerage, exchange, and clearance fees, which was partially offset by a $91.4 million increase in interest and dividends expense and a $14.7 million increase in employee compensation[306][307][309] - In January 2022, the company refinanced its long-term debt, entering into a new credit agreement for a $1.8 billion term loan maturing in 2029 and a $250 million revolving facility[257][336] Results of Operations In 2022, total revenues decreased by 15.9% to $2.36 billion, driven by a 22.6% drop in Trading income, net, despite increased interest income Revenue Breakdown (2022 vs 2021) | Revenue Component (in millions) | 2022 | 2021 | % Change | | :--- | :--- | :--- | :--- | | Trading income, net | $1,628.9 | $2,105.2 | (22.6)% | | Interest and dividends income | $159.1 | $75.4 | 111.1% | | Commissions, net and technology services | $529.8 | $614.5 | (13.8)% | | Other, net | $46.9 | $16.4 | 186.0% | | Total revenues | $2,364.8 | $2,811.5 | (15.9)% | Key Operating Expenses (2022 vs 2021) | Expense Component (in millions) | 2022 | 2021 | % Change | | :--- | :--- | :--- | :--- | | Brokerage, exchange, clearance fees, net | $619.2 | $745.4 | (16.9)% | | Employee compensation and payroll taxes | $390.9 | $376.3 | 3.9% | | Interest and dividends expense | $231.1 | $139.7 | 65.4% | | Financing interest expense on long-term borrowings | $92.0 | $80.0 | 15.1% | - The provision for income taxes was $88.5 million, resulting in an effective tax rate of 15.9% for 2022, compared to a provision of $169.7 million and a rate of 17.0% for 2021[319] Liquidity and Capital Resources As of December 31, 2022, Virtu had $981.6 million in cash, with liquidity supported by operations and a $1.8 billion term loan refinanced in January 2022 - As of December 31, 2022, the company held $981.6 million in cash and cash equivalents and had $1.827 billion in outstanding long-term debt[320] - In January 2022, the company refinanced its debt with a new Credit Agreement that includes a $1.8 billion term loan maturing in 2029 and a $250 million revolving facility[336] - The company's principal U.S. subsidiary, Virtu Americas LLC (VAL), and its foreign subsidiaries are subject to stringent regulatory capital requirements from bodies like the SEC, FINRA, and CBI[327][330] - Future payments under the Tax Receivable Agreements are expected to range from approximately $36.4 thousand to $22.0 million per year over the next 15 years[325] Critical Accounting Policies and Estimates Virtu's critical accounting policies involve significant judgment in valuing financial instruments, recognizing revenue, and assessing goodwill and intangible assets for impairment - Valuation of Financial Instruments: Substantially all financial instruments are carried at fair value, classified into a three-level hierarchy. Most instruments are classified as Level 1 (quoted prices) or Level 2 (observable inputs)[358][359] - Revenue Recognition: Trading income is recorded on a trade-date basis. Commissions and technology services revenues are recognized as performance obligations are satisfied, which can be at a point in time (e.g., trade execution) or over time (e.g., connectivity services)[360][362][363] - Goodwill and Intangible Assets: Goodwill ($1.15 billion) is not amortized but is tested for impairment annually as of July 1st. No impairment was identified in the 2022 assessment. Finite-lived intangible assets are amortized over their useful lives[375][380][381] - Tax Receivable Agreements: The company estimates and records obligations under TRAs, which requires complex judgments regarding the computation of tax basis and the timing and realizability of future tax savings[374] Quantitative and Qualitative Disclosures About Market Risk Virtu manages market risk from price, interest rate, and currency fluctuations through market-neutral strategies, hedging, and proprietary risk management tools - The company's primary market risks relate to changes in market prices, interest rates, and currency rates[384] - Market making activities are designed to minimize directional risk by capturing spreads and hedging positions. Risk is managed through proprietary tools, preset limits, and stress testing[385][387][390] - Interest rate risk on long-term borrowings is managed using floating-to-fixed interest rate swap agreements, which are designated as cash flow hedges[393] - Approximately 19.1% of total revenues for 2022 were denominated in non-U.S. dollar currencies. The company estimates a hypothetical 10% adverse change in the U.S. dollar would have decreased total revenues by $45.1 million[397] Financial Statements and Supplementary Data This section presents the audited consolidated financial statements for 2022, including the independent auditor's report and detailed financial notes - The independent auditor, PricewaterhouseCoopers LLP, issued an unqualified opinion on the consolidated financial statements and the effectiveness of internal control over financial reporting as of December 31, 2022[406] Consolidated Statement of Financial Condition Highlights (as of Dec 31, 2022) | Account (in millions) | Amount | | :--- | :--- | | Assets | | | Cash and cash equivalents | $981.6 | | Trading assets, at fair value | $4,630.6 | | Goodwill | $1,148.9 | | Total Assets | $10,583.2 | | Liabilities & Equity | | | Trading liabilities, at fair value | $4,197.0 | | Long-term borrowings | $1,796.0 | | Total Liabilities | $8,931.8 | | Total Equity | $1,651.4 | Consolidated Statement of Comprehensive Income Highlights (Year Ended Dec 31, 2022) | Account (in millions) | Amount | | :--- | :--- | | Total Revenue | $2,364.8 | | Total Operating Expenses | $1,808.0 | | Income before income taxes | $556.8 | | Net Income | $468.3 | | Net Income available for common stockholders | $265.0 | | Diluted Earnings Per Share | $2.44 | Controls and Procedures Management and the independent auditor concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2022 - Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of December 31, 2022[686] - Management assessed internal control over financial reporting based on the COSO framework and determined it was effective as of December 31, 2022[692][693] - No changes in internal control over financial reporting occurred during the fourth quarter of 2022 that materially affected, or are reasonably likely to materially affect, these controls[694] PART III Directors, Executive Officers, Corporate Governance, Executive Compensation, and Other Matters Information for Items 10-14, including directors, executive compensation, and corporate governance, is incorporated by reference from the 2023 proxy statement - Information regarding Directors, Executive Officers, and Corporate Governance (Item 10) will be provided in the 2023 Proxy Statement[698] - Details on Executive Compensation (Item 11) are incorporated by reference from the 2023 Proxy Statement[700] - Information on Security Ownership (Item 12), Certain Relationships and Related Transactions (Item 13), and Principal Accountant Fees (Item 14) will also be set forth in the 2023 Proxy Statement[702][704][706] PART IV Exhibits and Financial Statement Schedules This section lists exhibits filed with the Form 10-K, including corporate documents, agreements, and required Sarbanes-Oxley certifications - Lists key corporate documents filed as exhibits, including the Amended and Restated Certificate of Incorporation (Exhibit 3.1) and By-laws (3.2)[708] - Includes the Credit Agreement dated January 13, 2022 (Exhibit 10.9) and various Tax Receivable Agreements (Exhibits 10.12, 10.13, 10.14)[709] - Contains required CEO and CFO certifications pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act (Exhibits 31.1, 31.2, 32.1, 32.2)[711]