Virtu Financial, Inc. - Quarter Report: 2015 June (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

For the quarterly period ended June 30, 2015

 

or

 

 

For the transition period from        to        

 

Commission file number:  001-37352

 

Virtu Financial, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

(212) 418-0100

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o     No x

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o    Accelerated filer o    Non-accelerated filer x   Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

Class of Stock		Shares Outstanding as of August 14, 2015
Class A common stock, par value $0.00001 per share		34,305,052
Class C common stock, par value $0.00001 per share		24,531,817
Class D common stock, par value $0.00001 per share		79,610,490

 

 

Table of Contents

 

VIRTU FINANCIAL, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2015

 

		PAGE NUMBER
PART I -	FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Statements of Financial Condition	2 – 3
	Condensed Consolidated Statements of Comprehensive Income	4
	Condensed Consolidated Statements of Changes in Equity	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements (Unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	55
Item 4.	Controls and Procedures	56
PART II -	OTHER INFORMATION
Item 1.	Legal Proceedings	56
Item 1A.	Risk Factors	57
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	57
Item 3.	Defaults Upon Senior Securities	58
Item 4.	Mine Safety Disclosures	58
Item 5.	Other Information	58
Item 6.	Exhibits	58
	SIGNATURES	59

 

Table of Contents

 

PART I - FINANCIAL INFORMATION

 

Financial Statements Introductory Note

 

The unaudited condensed consolidated financial statements and other disclosures contained in this report include those of Virtu Financial, Inc. (“we”, the “Company” or the “Registrant”), which is the registrant, and those of Virtu Financial LLC (“Virtu Financial”), in which the registrant became the managing member and the owner of approximately 24.8% of the outstanding membership interests through a series of reorganization transactions that were completed on April 15, 2015 (the “Reorganization Transactions”) in connection with our initial public offering (“IPO”), which was completed on April 21, 2015. For more information regarding the transactions described above, see Note 13, “Capital Structure,” to our unaudited condensed consolidated financial statements contained in this quarterly report on Form 10-Q.

 

The unaudited condensed consolidated financial statements reflect the historical results of operations and financial position of the Company, including consolidation of its investment in Virtu Financial, since April 16, 2015.  Prior to April 16, 2015, the date of the IPO, the unaudited condensed consolidated financial statements included herein represent the financial statements of Virtu Financial and subsidiaries (the “Group”). The historical unaudited condensed consolidated financial statements do not reflect what the financial position, results of operations or cash flows of the Company or the Group would have been had these companies been stand-alone public companies for the periods presented. Specifically, the historical financial statements of the Group do not give effect to the following matters:

 

·                  Reorganization Transactions;

·                  U.S. corporate federal income taxes; and

·                  Noncontrolling interest held by other members of Virtu Financial.

 

As a consequence, earnings per share information reported in the unaudited condensed consolidated statements of comprehensive income for the three months and six months ended June 30, 2015 reflect only the net income available for common stockholders for the period from April 16, 2015 through June 30, 2015, as detailed in Note 3, “Earnings per share”, to our unaudited condensed consolidated financial statements contained in this quarterly report on Form 10-Q.

 

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Virtu Financial, Inc. and Subsidiaries

Condensed Consolidated Statements of Financial Condition

(Unaudited)

 

		As of
		June 30,			December 31,
(in thousands, except share and interest data)		2015			2014
Assets
Cash and cash equivalents		$	126,978		$	75,864
Securities borrowed		667,970			484,934
Securities purchased under agreements to resell		31,050			31,463
Receivables from broker dealers and clearing organizations		691,163			387,652
Trading assets, at fair value:
Financial instruments owned		1,658,086			1,307,933
Financial instruments owned and pledged		399,306			236,375
Property, equipment and capitalized software (net of accumulated depreciation of $107,605 and $84,579 as of June 30, 2015 and December 31, 2014, respectively)		47,113			44,644
Goodwill		715,379			715,379
Intangibles (net of accumulated amortization)		1,308			1,414
Deferred tax asset		163,423			977
Other assets ($9,162 and $8,205, at fair value, as of June 30, 2015 and December 31, 2014, respectively)		34,944			32,823
Total assets		$	4,536,720		$	3,319,458
Liabilities, redeemable membership interest and equity
Liabilities
Securities loaned		$	876,782		$	497,862
Securities sold under agreements to repurchase		246			2,006
Payables to broker dealers and clearing organizations		568,459			686,203
Trading liabilities, at fair value:
Financial instruments sold, not yet purchased		1,785,628			1,037,634
Tax receivable agreement obligations		184,679			—
Accounts payable and accrued expenses and other liabilities		120,950			93,331
Senior secured credit facility		495,312			495,724
Total liabilities		$	4,032,056		$	2,812,760

 

(Continued on next page)

 

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Virtu Financial, Inc. and Subsidiaries

Condensed Consolidated Statements of Financial Condition

(Unaudited)

 

		As of
		June 30,			December 31,
(in thousands, except share and interest data)		2015			2014
Class A-1 redeemable membership interest		—			294,433
Stockholders’ / Members’ equity
Class A-1 - Authorized and Issued - 0 and 1,964,826 interests, Outstanding - 0 and 1,964,826 interests at June 30, 2015 and December 31, 2014, respectively		—			19,648
Class A-2 - Authorized and Issued - 0 and 101,381,332 interests, Outstanding - 0 and 99,855,666 interests at June 30, 2015 and December 31, 2014, respectively		—			287,705
Class A common stock (par value $0.00001), Authorized - 1,000,000,000 and 0 shares, Issued and Outstanding - 34,305,052 and 0 shares at June 30, 2015 and December 31, 2014, respectively		—			—
Class B common stock (par value $0.00001), Authorized - 175,000,000 and 0 shares, Issued and Outstanding - 0 and 0 shares at June 30, 2015 and December 31, 2014, respectively		—			—
Class C common stock (par value $0.00001), Authorized - 90,000,000 and 0 shares, Issued and Outstanding - 24,531,817 and 0 shares at June 30, 2015 and December 31, 2014, respectively		—			—
Class D common stock (par value $0.00001), Authorized - 175,000,000 and 0 shares, Issued and Outstanding - 79,610,490 and 0 shares at June 30, 2015 and December 31, 2014, respectively		1			—
Additional paid-in capital		115,274			—
Retained Earnings (Accumulated deficit)		474			(91,383		)
Accumulated other comprehensive income (loss)		412			(3,705		)
Total stockholders’ / members’ equity		$	116,161		$	212,265
Noncontrolling interest		388,503			—
Total equity		$	504,664		$	212,265
Total liabilities, redeemable membership interest and equity		$	4,536,720		$	3,319,458

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

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Virtu Financial, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
(in thousands, except share and per share data)		2015			2014			2015			2014
Revenues:
Trading income, net		$	169,792		$	153,376		$	383,722		$	318,539
Interest and dividends income		9,415			7,214			14,597			12,769
Technology services		2,772			2,386			5,188			4,963
Total revenue		181,979			162,976			403,507			336,271
Operating Expenses:
Brokerage, exchange and clearance fees, net		56,501			53,837			117,639			108,271
Communication and data processing		17,549			17,505			35,492			33,312
Employee compensation and payroll taxes		15,165			17,255			42,065			38,868
Interest and dividends expense		16,841			12,247			26,407			22,710
Operations and administrative		6,669			6,354			12,431			12,125
Depreciation and amortization		8,186			7,480			17,849			13,962
Amortization of purchased intangibles and acquired capitalized software		53			53			106			106
Acquisition related retention bonus		—			1,221			—			2,487
Termination of office leases		—			849			2,729			849
Initial public offering fees and expenses		—			8,901			—			8,901
Charges related to share based compensation at IPO		44,194			—			44,194			—
Financing interest expense on senior secured credit facility		7,259			7,748			14,861			15,299
Total operating expenses		172,417			133,450			313,773			256,890
Income before income taxes and noncontrolling interest		9,562			29,526			89,734			79,381
Provision for (benefit from) income taxes		1,997			(1,316		)	4,725			(350		)
Net income		7,565			$	30,842		85,009			$	79,731
Noncontrolling interest		(7,091		)				(84,535		)
Net income available for common stockholders		$	474					$	474
Earnings per share
Basic		$	0.01					$	0.01
Diluted		$	0.01					$	0.01
Weighted average common shares outstanding
Basic		34,305,052						34,305,052
Diluted		34,529,349						34,529,349
Net income		$	7,565		$	30,842		$	85,009		$	79,731
Other comprehensive income (loss)
Foreign exchange translation adjustment, net of taxes		1,632			(211		)	(3,001		)	(163		)
Comprehensive income		9,197			$	30,631		82,008			$	79,568
Less: Comprehensive income attributable to noncontrolling interests		(8,311		)				(81,122		)
Comprehensive income attributable to common stockholders		$	886					$	886

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

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Virtu Financial, Inc. and Subsidiaries

Condensed Consolidated Statements of Changes in Equity

for the Six Months Ended June 30, 2015

(Unaudited)

 

		Class A Common Stock					Class C Common Stock					Class D Common Stock					Additional Paid-in Capital			Class A-1					Class A-2					Retained Earnings (Accumulated			Accumulated Other Comprehensive			Total Stockholders’ / Members’			Non- controlling			Total			Class A-1 Redeemable
(in thousands, except per share and interest data)		Shares		Amounts			Shares		Amounts			Shares		Amounts			Amounts			Interests		Amounts			Interests		Amounts			Deficit)			Income (Loss)			Equity			Interest			Equity			Interest
Balance at December 31, 2014		—		$	—		—		$	—		—		$	—		$	—		1,964,826		$	19,648		99,855,666		$	287,705		$	(91,383	)	$	(3,705	)	$	212,265		$	—		$	212,265		$	294,433
Share based compensation through April 15, 2015		—		—			—		—			—		—			—			—		—			6,418		438			—			—			438			—			438			—
Repurchase of Class A-2 interests		—		—			—		—			—		—			—			—		—			(13,495	)	(97		)	—			—			(97		)	—			(97		)	—
Distribution to members through April 15, 2015		—		—			—		—			—		—			—			—		—					—			(130,000		)				(130,000		)	—			(130,000		)	—
Comprehensive income through April 15, 2015:
Net income		—		—			—		—			—		—			—			—		—			—		—			83,147			—			83,147			—			83,147			—
Foreign exchange translation adjustment		—		—			—		—			—		—			—			—		—			—		—			—			(4,633		)	(4,633		)	—			(4,633		)	—
Reorganization of equity structure		18,763,664		—			36,746,041		—			79,610,490		1			63,261			(1,964,826	)	(19,648		)	(99,848,589	)	(288,046		)	138,236			8,338			(97,858		)	392,291			294,433			(294,433		)
Balance post-reorganization		18,763,664		—			36,746,041		—			79,610,490		1			63,261			—		—			—		—			—			—			63,262			392,291			455,553			—
Issuance of Common Stock, net of offering costs		19,012,112		—			—		—			—		—			327,366			—		—			—		—			—			—			327,366			—			327,366			—
Repurchase of Virtu Financial Units and corresponding number of Class A and C Common Stock		(3,470,724	)	—			(12,214,224	)	—			—		—			(277,153		)	—		—			—		—			—			—			(277,153		)	—			(277,153		)	—
Share based compensation vested upon the IPO		—		—			—		—			—		—			45,677			—		—			—		—			—			—			45,677			—			45,677			—
Adjustments for changes in proportionate ownership in Virtu Financial		—		—			—		—			—		—			(22,513		)	—		—			—		—			—			—			(22,513		)	22,513			—			—
Issuance of tax receivable agreements		—		—			—		—			—		—			(23,041		)	—		—			—		—			—			—			(23,041		)	—			(23,041		)	—
Share based compensation after April 15, 2015		—		—			—		—			—		—			1,677			—		—			—		—			—			—			1,677			—			1,677			—
Comprehensive income, after April 15, 2015:
Net income		—		—			—		—			—		—			—			—		—			—		—			474			—			474			1,388			1,862			—
Foreign exchange translation adjustment		—		—			—		—			—		—			—			—		—			—		—			—			412			412			1,220			1,632			—
Distribution from Virtu Financial to non-controlling interest, after April 15, 2015		—		—			—		—			—		—						—		—			—		—			—			—			—			(28,909		)	(28,909		)	—
Balance at June 30, 2015		34,305,052		$	—		24,531,817		$	—		79,610,490		$	1		$	115,274		—		$	—		—		$	—		$	474		$	412		$	116,161		$	388,503		$	504,664		$	—

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

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Virtu Financial, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

		For the Six Months Ended June 30,
(in thousands)		2015			2014
Cash flows from operating activities
Net Income		$	85,009		$	79,731
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		17,849			13,962
Amortization of purchased intangibles and acquired capitalized software		106			106
Amortization of debt issuance costs and deferred financing fees		823			704
Termination of office leases		2,729			849
Share based compensation		53,529			5,520
Other		2,441			612
Changes in operating assets and liabilities:
Securities borrowed		(183,036		)	91,178
Securities purchased under agreements to resell		413			109,408
Receivables from broker dealers and clearing organizations		(303,511		)	(204,079		)
Trading assets, at fair value		(513,084		)	(45,116		)
Other assets ($9,162 and $8,205, at fair value, as of June 30, 2015 and December 31, 2014, respectively)		(2,126		)	5,528
Securities loaned		378,920			830
Securities sold under agreements to repurchase		(1,760		)	(10,883		)
Payables to broker dealers and clearing organizations		(117,744		)	(170,645		)
Trading liabilities, at fair value		747,994			216,563
Accounts payable and accrued expenses and other liabilities		14,369			11,368
Net cash provided by operating activities		182,921			105,636
Cash flows from investing activities
Development of capitalized software		(4,207		)	(4,113		)
Acquisition of property and equipment		(13,571		)	(10,595		)
Net cash used in investing activities		(17,778		)	(14,708		)
Cash flows from financing activities
Distribution to members through April 15, 2015		(130,000		)	(90,652		)
Distribution from Virtu Financial to non-controlling interest, after April 15, 2015		(28,909		)	—
Repurchase of Class A-2 interests		(1,097		)	(44		)
Repayment of short term borrowings		—			(12,800		)
Repayment of senior secured credit facility		(364		)	(2,550		)
Debt issuance costs		(871		)	—
Issuance of Common Stock, net of offering costs		327,366			—
Repurchase of Virtu Financial Units and corresponding number of Class A and C Common Stock		(277,153		)	—
Net cash used in financing activities		(111,028		)	(106,046		)
Effect of exchange rate changes on Cash and cash equivalents		(3,001		)	(163		)
Net increase (decrease) in Cash and cash equivalents		51,114			(15,281		)
Cash and cash equivalents, beginning of period		75,864			66,010
Cash and cash equivalents, end of period		$	126,978		$	50,729
Supplementary disclosure of cash flow information
Cash paid for interest		$	32,837		$	32,224
Cash paid for taxes		$	2,006		$	529
Non-cash investing activities
Compensation to developers subject to capitalization of software (of which $10,565 and $903 were capitalized for the six months ended June 30, 2015 and 2014, respectively)		23,927			2,549
Non-cash financing activities
Tax receivable agreement (Note 4)		—			—

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

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Virtu Financial, Inc. and Subsidiaries

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. Organization and Basis of Presentation

 

Organization

 

Virtu Financial, Inc. (“VFI” or, collectively with its wholly owned subsidiaries, the ‘‘Company’’) is a Delaware holding company whose primary asset is its ownership of approximately 24.8% of the membership interests of Virtu Financial LLC (“Virtu Financial”).  The Company was formed on October 16, 2013 for the purpose of completing certain reorganization transactions (the “Reorganization Transactions”), in order to carry on the business of Virtu Financial LLC (“Virtu Financial”) and to conduct a public offering. The Company is the sole managing member of Virtu Financial and operates and controls all of the businesses and affairs of Virtu Financial and, through Virtu Financial and its subsidiaries (the “Group”), continues to conduct the business now conducted by such subsidiaries. Virtu Financial was formed as a Delaware limited liability company on April 8, 2011 in connection with a corporate reorganization and acquisition of the outstanding equity interests of Madison Tyler Holdings, LLC (“MTH”), an electronic trading firm and market maker. In connection with the reorganization, the members of Virtu Financial’s predecessor entity, Virtu Financial Operating LLC (“VFO”), a Delaware limited liability company formed on March 19, 2008, exchanged their interests in VFO for interests in Virtu Financial and the members of MTH exchanged their interests in MTH for cash and/or interests in Virtu Financial. Virtu Financial’s principal subsidiaries include Virtu Financial BD LLC (“VFBD”), a self-clearing US broker-dealer, Virtu Financial Capital Markets LLC (“VFCM”), a self-clearing US broker-dealer and designated market maker on the New York Stock Exchange (“NYSE”) and the NYSE MKT (formerly NYSE Amex), Virtu Financial Global Markets LLC (“VFGM”), a US trading entity focused on futures and currencies, Virtu Financial Ireland Limited (“VFIL”), formed in Ireland, Virtu Financial Asia Pty Ltd (“VFAP”), formed in Australia, and Virtu Financial Singapore Pte. Ltd. (“VFSing”), formed in Singapore.

 

The Company is a technology-enabled market maker and liquidity provider. The Company has developed a single, proprietary, multi-asset, multi-currency technology platform through which it provides quotations to buyers and sellers in equities, commodities, currencies, options, fixed income and other securities on numerous exchanges, markets and liquidity pools in numerous countries around the world.

 

The Company is managed and operated as one business. Accordingly, the Company operates under one reportable segment.

 

Basis of Presentation

 

These condensed consolidated financial statements are presented in U.S. dollars and have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding financial reporting with respect to Form 10-Q and accounting standards generally accepted in the United States of America (“U.S. GAAP”) promulgated in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC” or the “Codification”). These condensed consolidated financial statements are unaudited and include all adjustments of a normal, recurring nature necessary to present fairly the financial condition as of June 30, 2015 and December 31, 2014, the results of operations and comprehensive income for the three and six months ended June 30, 2015 and 2014 and cash flows for the six months ended June 30, 2015 and 2014. The condensed consolidated financial statement information as of December 31, 2014 has been derived from the 2014 audited consolidated financial statements. The results of operations for interim periods are not necessarily indicative of results for the entire year. The condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s final prospectus filed with the SEC on April 16, 2015 (the “Prospectus”) for the offering of Class A common stock, par value $0.00001 per share (the “Class A common stock”). See Note 13 to the condensed consolidated financial statements for information regarding the Reorganization Transactions (as defined in Note 13) and the Company’s IPO.

 

Principles of Consolidation, including Noncontrolling Interests

 

The unaudited condensed consolidated financial statements include the accounts of VFI and its majority and wholly owned subsidiaries. As sole managing member of Virtu Financial, VFI exerts control over the Group’s operations. In accordance with ASC 810, Consolidation, the Company consolidates Virtu Financial and its subsidiaries’ consolidated financial statements and records the interests in Virtu Financial that VFI does not own as noncontrolling interests. All intercompany accounts and transactions have been eliminated in consolidation.

 

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2. Summary of Significant Accounting Policies

 

Use of Estimates

 

The Company’s condensed consolidated financial statements are prepared in conformity with US GAAP, which require management to make estimates and assumptions regarding fair value measurements including trading assets and liabilities, goodwill and intangibles, compensation accruals, capitalized software, and other matters that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Accordingly, actual results could differ materially from those estimates.

 

Earnings Per Share

 

Earnings per share (“EPS”) is computed in accordance with ASC 260, Earnings per Share. Basic EPS is computed by dividing the net income available for common stockholders by the weighted average number of shares outstanding for that period. Diluted EPS is calculated by dividing the net income available for common stockholders by the diluted weighted average shares outstanding for that period. Diluted EPS includes the determinants of the basic EPS and, in addition, reflects the dilutive effect of shares of common stock estimated to be distributed in the future under the Company’s share based compensation plans, with no adjustments to net income available for common stockholders for dilutive potential common shares.

 

Cash and Cash Equivalents

 

The Company considers cash equivalents as highly liquid investments with original maturities of less than three months when acquired. The Company maintains cash in bank deposit accounts that, at times, may exceed federally insured limits.

 

Securities Borrowed and Securities Loaned

 

The Company conducts securities borrowing and lending activities with external counterparties. In connection with these transactions, the Company receives or posts collateral. These transactions are collateralized by cash or securities. In accordance with substantially all of its stock borrow agreements, the Company is permitted to sell or repledge the securities received. Securities borrowed or loaned are recorded based on the amount of cash collateral advanced or received. The initial collateral advanced or received generally approximates or is greater than 102% of the fair value of the underlying securities borrowed or loaned. The Company monitors the fair value of securities borrowed and loaned, and delivers or obtains additional collateral as appropriate. Receivables and payables with the same counterparty are not offset in the condensed consolidated statements of financial condition. For these transactions, the interest received or paid by the Company is recorded gross on an accrual basis under interest and dividends income or interest and dividends expense in the condensed consolidated statements of comprehensive income.

 

Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase

 

In a repurchase agreement, securities sold under agreements to repurchase are treated as collateralized financing transactions and are recorded at contract value, plus accrued interest, which approximates fair value. It is the Company’s policy that its custodian takes possession of the underlying collateral securities, the fair value of which exceeds the principal amount of the repurchase transaction, including accrued interest. For reverse repurchase agreements, the Company typically requires delivery of collateral with a fair value approximately equal to the carrying value of the relevant assets in the condensed consolidated statements of financial condition. To ensure that the fair value of the underlying collateral remains sufficient, the collateral is valued daily with additional collateral obtained or excess collateral returned, as permitted under contractual provisions.

 

The Company does not net securities purchased under agreements to resell transactions with securities sold under agreements to repurchase transactions entered into with the same counterparty.

 

Receivables from/Payables to Broker-dealers and Clearing Organizations

 

Amounts receivable from broker-dealers and clearing organizations may be restricted to the extent that they serve as deposits for securities sold, not yet purchased. At June 30, 2015 and December 31, 2014, receivables from and payables to broker-dealers and clearing organizations primarily represent amounts due for unsettled trades, open equity in futures transactions, securities failed to deliver or failed to receive, deposits with clearing organizations or exchanges and balances due from or due to prime brokers in relation to the Company’s trading. The Company also offsets the outstanding principal balances on all short term credit facilities against amounts receivable from and payable to broker-dealers and clearing organizations when the criteria for offsetting are met.

 

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In the normal course of business, substantially all of the Company’s securities transactions, money balances, and security positions are transacted with several brokers. The Company is subject to credit risk to the extent any broker with whom it conducts business is unable to fulfill contractual obligations on its behalf. The Company’s management monitors the financial condition of such brokers and does not anticipate any losses from these counterparties.

 

Financial Instruments Owned Including Those Pledged as Collateral and Financial Instruments Sold, Not Yet Purchased

 

The Company carries financial instruments owned, including those pledged as collateral, and financial instruments sold, not yet purchased at fair value. Gains and losses arising from financial instrument transactions are recorded net on a trade-date basis in trading income on the condensed consolidated statements of comprehensive income.

 

Fair Value Measurements

 

At June 30, 2015 and December 31, 2014, substantially all of Company’s financial assets and liabilities, except for long-term borrowings and certain exchange memberships, were carried at fair value based on published market prices and are marked to market daily or were short-term in nature and were carried at amounts that approximate fair value.

 

The Company’s assets and liabilities have been categorized based upon a fair value hierarchy in accordance with ASC 820-10, Fair Value Measurements and Disclosures. ASC 820-10 defines fair value as the price that would be received to sell an asset or would be paid to transfer a liability (i.e., the exit price) in an orderly transaction between market participants at the measurement date. Fair value measurements are not adjusted for transaction costs. The recognition of ‘‘block discounts’’ for large holdings of unrestricted financial instruments where quoted prices are readily and regularly available in an active market is prohibited. ASC 820-10 requires a three level hierarchy which prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy level assigned to each financial instrument is based on the assessment of the transparency and reliability of the inputs used in the valuation of such financial instruments at the measurement date based on the lowest level of input that is significant to the fair value measurement. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurements).

 

Financial instruments measured and reported at fair value are classified and disclosed in one of the following categories based on inputs:

 

Level 1 — Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

 

Level 2 — Quoted prices in markets that are not active and financial instruments for which all significant inputs are observable, either directly or indirectly;

 

Level 3 — Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

 

Transfers in or out are recognized based on the beginning fair value of the period in which they occurred. There were no transfers of financial instruments between levels during the three and six months ended June 30, 2015 and 2014.

 

Derivative Instruments

 

Derivative instruments used for trading purposes, including economic hedges of trading instruments, are carried at fair value. Fair values for exchange-traded derivatives, principally futures, are based on quoted market prices. Fair values for over-the-counter derivative instruments, principally forward contracts, are based on the values of the underlying financial instruments within the contract. The underlying derivative instruments are currencies which are actively traded.

 

Derivative instruments used for economic hedging purposes include futures, forward contracts, and options. Unrealized gains or losses on these derivative instruments are recognized currently in the condensed consolidated statements of comprehensive income as trading income, net. The Company does not apply hedge accounting as defined in ASC 815, Derivatives and Hedging; accordingly all derivative instruments are recorded at fair value with changes in fair values reflected in earnings.

 

Property and Equipment

 

Property and equipment are carried at cost, less accumulated depreciation, except for the assets acquired in connection with the acquisition of MTH which were recorded at fair value on the date of acquisition. Depreciation is provided using the straight-line

 

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method over estimated useful lives of the underlying asset. Routine maintenance, repairs and replacement costs are expensed as incurred and improvements that appreciably extend the useful life of the assets are capitalized. When property and equipment are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in income. Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the related carrying amount may not be recoverable.

 

The useful lives of furniture and fixtures are as follows:

 

Furniture, fixtures and equipment		3 to 7 years
Leasehold improvements		7 years or length of lease term, whichever is shorter

 

Capitalized Software

 

The Company accounts for the costs of computer software developed or obtained for internal use in accordance with ASC 350-40, Internal-Use Software. The Company capitalizes costs of materials, consultants, and payroll and payroll related costs for employees incurred in developing internal-use software. Costs incurred during the preliminary project and post-implementation stages are charged to expense.

 

Management’s judgment is required in determining the point at which various projects enter the stages at which costs may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the estimated useful lives over which the costs are amortized.

 

The Company’s capitalized software development costs were approximately $2.8 million and $2.0 million for the three months ended June 30, 2015 and 2014, respectively, and $5.5 million and $5.0 million for the six months ended June 30, 2015 and 2014, respectively.  The related amortization expense was approximately $2.7 million and $2.4 million for the three months ended June 30, 2015 and 2014, respectively, and $5.2 million and $5.0 million for the six months ended June 30, 2015 and 2014, respectively. Additionally, in connection with the compensation charge related to Class B and East MIP interests recognized upon the IPO (Note 13), the Company capitalized and amortized $9.5 million and $8.0 million of the costs, respectively, which were included within charges related to share based compensation at IPO, net, in the condensed consolidated statements of comprehensive income.  Capitalized software development costs and related accumulated amortization are included in property, equipment and capitalized software on the accompanying condensed consolidated statements of financial condition and are amortized over a period of 1.4 to 2.5 years, which represents the estimated useful lives of the underlying software.

 

Goodwill

 

Goodwill represents the excess of the purchase price over the underlying net tangible and intangible assets of our acquisitions. Goodwill is not amortized but is tested for impairment on an annual basis and between annual tests whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Goodwill is tested at the reporting unit level, which is defined as an operating segment or one level below the operating segment. We operate in one operating segment, which is our only reporting unit.

 

The goodwill impairment test is a two-step process. The first step is used to identify potential impairment and compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test must be performed. The second step is used to measure the amount of impairment loss, if any, and compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss must be recognized in an amount equal to that excess.

 

The primary valuation methods we use to estimate the fair value of our reporting unit are the income and market approaches. In applying the income approach, projected available cash flows and the terminal value are discounted to present value to derive an indication of fair value of the business enterprise. The market approach compares the reporting unit to selected reasonably similar publicly-traded companies.

 

The Company tests goodwill for impairment on an annual basis on July 1 and on an interim basis when certain events or circumstances exist. There were no triggering events that would have caused the Company to assess goodwill for impairment during the three and six months ended June 30, 2015 and 2014, respectively.

 

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Intangible Assets

 

The Company amortizes finite-lived intangible assets over their estimated useful lives. Finite-lived intangible assets are tested for impairment annually or when impairment indicators are present, and if impaired, written down to fair value.

 

Exchange Memberships and Stock

 

Exchange memberships are recorded at cost or, if any other than temporary impairment in value has occurred, at a value that reflects management’s estimate of fair value, in accordance with ASC 940-340, Financial Services — Broker and Dealers. Exchange stock includes shares that entitles the Company to certain trading privileges. The shares are marked to market with the corresponding gain or loss recorded in the condensed consolidated statements of comprehensive income. The Company’s exchange memberships and stock are included in other assets on the condensed consolidated statements of financial condition.

 

Trading Income

 

Trading income is comprised of changes in the fair value of trading assets and liabilities (i.e., unrealized gains and losses) and realized gains and losses on trading assets and liabilities. Trading gains and losses on financial instruments owned and financial instruments sold, not yet purchased are recorded on the trade date and reported on a net basis in the condensed consolidated statements of comprehensive income.

 

Interest and Dividends Income/Interest and Dividends Expense

 

Interest income and interest expense are accrued in accordance with contractual rates. Interest income consists of interest earned on collateralized financing arrangements and on cash held by brokers. Interest expense includes interest expense from collateralized transactions, margin and related lines of credit. Dividends on financial instruments owned including those pledged as collateral and financial instruments sold, not yet purchased are recorded on the ex-dividend date and interest is recognized on the accrual basis.

 

Technology Services

 

Technology services revenues consist of fees paid by third parties for licensing of our proprietary risk management and trading infrastructure technology and provision of associated management and hosting services. These fees include both upfront and annual recurring fees. Revenue from technology services is recognized once persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is probable. Revenue is recognized ratably over the contractual service period.

 

Rebates

 

Rebates consist of volume discounts, credits or payments received from exchanges or other market places related to the placement and/or removal of liquidity from the order flow in the marketplace. Rebates are recorded on an accrual basis and included net within brokerage, exchange and clearance fees in the accompanying condensed consolidated statements of comprehensive income.

 

Income Taxes

 

Virtu Financial is a limited liability company and is treated as a pass-through entity for United States federal, state, and local income tax purposes. Accordingly, no provision for United States federal, state, and local income tax was required prior to the consummation of the Reorganization Transactions and the IPO.  Subsequent to consummation of the Reorganization Transactions and the IPO, the Company is subject to U.S. federal, state and local income taxes on its taxable income, which is proportional to the percentage of Virtu Financial owned by the Company. The Company’s subsidiaries are subject to income taxes in the respective jurisdictions in which they operate.

 

Certain of the Company’s wholly owned subsidiaries are subject to income taxes in foreign jurisdictions. The provision for income tax is comprised of current tax and deferred tax. Current tax represents the tax on current year tax returns, using tax rates enacted at the balance sheet date. A deferred tax asset is recognized only to the extent that it is probable that future taxable income will be available against which the asset can be utilized.

 

The Company recognizes the tax benefit from an uncertain tax position, in accordance with ASC 740, Income Taxes only if it is more likely than not that the tax position will be sustained on examination by the applicable taxing authority, including resolution of the appeals or litigation processes, based on the technical merits of the position. The tax benefits recognized in the condensed

 

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consolidated financial statements from such a position are measured based on the largest benefit for each such position that has a greater than fifty percent likelihood of being realized upon ultimate resolution. Many factors are considered when evaluating and estimating the tax positions and tax benefits. Such estimates involve interpretations of regulations, rulings, case law, etc. and are inherently complex. The Company’s estimates may require periodic adjustments and may not accurately anticipate actual outcomes as resolution of income tax treatments in individual jurisdictions typically would not be known for several years after completion of any fiscal year. The Company has determined that there are no uncertain tax positions that would have a material impact on the Company’s financial position as of June 30, 2015 and December 31, 2014 or the results of operations for the three and six months ended June 30, 2015 and 2014.

 

Comprehensive Income and Foreign Currency Translation

 

The Company’s operating results are reported in the condensed consolidated statements of comprehensive income pursuant to Accounting Standards Update 2011-05, Comprehensive Income.

 

Comprehensive income consists of two components: net income and other comprehensive income (“OCI”). OCI is comprised of revenues, expenses, gains and losses that are reported in the comprehensive income section of the consolidated statements of comprehensive income, but are excluded from reported net income. The Company’s OCI is comprised of foreign currency translation adjustments. Assets and liabilities of operations having non-U.S. dollar functional currencies are translated at period-end exchange rates, and income statement accounts are translated at weighted average exchange rates for the period. Gains and losses resulting from translating foreign currency financial statements, net of related tax effects, are reflected in other comprehensive income, a separate component of members’ equity.

 

Share-Based Compensation

 

The Company accounts for share-based compensation transactions with employees under the provisions of ASC 718, Compensation: Stock Compensation. ASC 718 requires a share-based payment transaction with employees to be measured based on the fair value of equity instruments issued. The fair value of awards issued for compensation prior to the Reorganization Transactions and the IPO was determined by management, with the assistance of an independent third party valuation firm, using a projected annual forfeiture rate, where applicable, on the date of grant. With respect to equity awards issued for compensation in connection with or subsequent to the Reorganization Transaction and the IPO pursuant to the 2015 Management Incentive Plan, the fair value of the stock option grants are determined through the application of the Black-Scholes-Merton model.  Similarly, the fair value of the restricted stock units is determined based on the IPO per share price or the market price at the time of grant. The fair value of share based awards granted to employees is expensed based on the vesting conditions.

 

Recent Accounting Pronouncements

 

Revenue - In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for annual reporting periods, and interim periods within that period, beginning after December 15, 2016 (fiscal year 2018 for the Company) and early adoption is not permitted. Companies may use either a full retrospective or a modified retrospective approach to adopt ASU 2014-09. The Company has not yet determined the potential effects of the adoption of ASU 2014-09 on its condensed consolidated financial statements

 

Repurchase Agreements - In June, 2014, the FASB released ASU No. 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.  The amendment changes the accounting for repurchase financing transactions and for repurchase-to-maturity transactions to secured borrowing accounting.  The accounting changes are effective for the Company beginning in the first quarter of 2015.  The effect of the accounting changes on transactions outstanding as of the effective date are required to be presented as a cumulative effect adjustment to retained earnings as January 1, 2015.  The Company currently does not enter into these types of repurchase transactions.  The amendment also requires additional disclosures for repurchase agreements and securities lending transactions regarding the class of collateral pledged and the remaining contractual tenor of the agreements, as well as a discussion of the potential risks associated with the agreements and the related collateral pledged, and how those risks are managed.  Additional disclosures are required for repurchase agreements, securities lending transactions, sales with a total return swap, and other similar transfers of financial assets that are accounted for as a sale.

 

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Compensation — In June 2014, the Emerging Issues Task Force (the ‘‘EITF’’) of the FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The amendment requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015 (fiscal year 2016 for the Company). Earlier adoption is permitted. The Company is currently evaluating the impact of this ASU on its condensed consolidated financial statements.

 

Going Concern — In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The guidance will explicitly require management to assess an entity’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. The new standard will be effective in the first annual period ending after December 15, 2016 (fiscal year 2017 for the Company). Earlier adoption is permitted. The Company will implement this new standard on the required effective date.

 

Hybrid Financial Instruments — In November 2014, the EITF of the FASB issued ASU 2014-16, Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or to Equity. The ASU requires that for hybrid financial instruments issued in the form of a share, an entity should determine the nature of the host contract by considering all stated and implied substantive terms and features of the hybrid financial instrument, weighing each term and feature on the basis of relevant facts and circumstances. An entity should use judgment based on an evaluation of all the relevant terms and features, and should consider the economic characteristics and risks of the entire hybrid financial instrument, including the embedded derivative feature that is being evaluated for separate accounting from the host contract. The ASU is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. For all other entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2015 (fiscal year 2016 for the Company) and interim periods within fiscal years beginning after December 15, 2016. Early adoption, including adoption in an interim period, is permitted. The Company is currently evaluating the impact of this ASU on its condensed consolidated financial statements.

 

Debt Issuance Costs — In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs.  The ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts, rather than as a deferred charge asset. The ASU is effective for financial statements issued for fiscal years beginning after December 15, 2015 (fiscal year 2016 for the Company), and interim periods within those fiscal years.  Early adoption of the amendment is permitted and the Company has elected to early adopt this ASU effective as of June 30, 2015. The new guidance has been applied on a retrospective basis, wherein the accompanying condensed consolidated statements of financial condition have been adjusted to reflect the period-specific effects of applying the new guidance.  Refer to Note 8 for additional information regarding the impact of this guidance on the Company’s condensed consolidated financial statements.

 

3. Earnings per Share

 

Historical earnings per share information is not applicable for reporting periods prior to the consummation of the IPO. Net income available for common stockholders of $0.5 million is the net income earned by VFI. on its approximate 24.8% interest in Virtu Financial for the period from April 16, 2015 through June 30, 2015, net of the provision for income taxes for the period.

 

The below table contains a reconciliation of net income before noncontrolling interest to net income available for common stockholders:

 

		Three Months Ended,			Six Months Ended
		June 30, 2015			June 30, 2015
(in thousands)
Income before income taxes and noncontrolling interest		$	9,562		$	89,734
Provision for (benefit from) income taxes		1,997			4,725
Net income		7,565			85,009
Net income allocable to members of Virtu Financial LLC (for the period January 1, 2015 through April 15, 2015)		(5,703		)	(83,147		)
Noncontrolling interest subsequent to April 15, 2015		(1,388		)	(1,388		)
Net income available for common stockholders		$	474		$	474

 

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The calculation of basic and diluted earnings per share is described below:

 

Basic earnings per share are calculated utilizing net income available for common stockholders from April 16, 2015 through June 30, 2015 divided by the weighted average number of shares of common stock outstanding during the same period:

 

		Period from
		April 16, 2015 through
(in thousands, except for shares or per share amounts)		June 30, 2015
Basic earnings per share:
Net income available for common stockholders		$	474
Weighted average shares of common stock outstanding:
Class A		34,305,052
Basic Earnings per share		$	0.01

 

Diluted earnings per share are calculated utilizing net income available for common stockholders commencing on April 16, 2015, divided by the weighted average total number of shares of common stock outstanding during the period from April 16, 2015 through June 30, 2015 plus additional shares of common stock issued and issuable pursuant to the 2015 Management Incentive Plan (Note 13).

 

		Period from
		April 16, 2015 through
(in thousands, except for shares or per share amounts)		June 30, 2015
Diluted earnings per share:
Net income available for common stockholders		$	474
Weighted average shares of common stock outstanding:
Class A
Issued and outstanding		34,305,052
Issuable pursuant to 2015 Management Incentive Plan		224,297
		34,529,349
Diluted Earnings per share		$	0.01

 

4. Tax Receivable Agreements

 

In connection with the IPO, on April 15, 2015, the Company entered into Tax Receivable Agreements (“TRAs”) to make payments to the Virtu Post-IPO Members, as defined in Note 13, and the Investor Post-IPO Stockholders, as defined in Note 13, that are generally equal to 85% of the applicable cash tax savings, if any, realized as a result of favorable tax attributes that will be available to the Company as a result of the Reorganization Transactions, exchanges of Virtu Financial interests for Class A common stock or Class B common stock and payments made under the TRAs. Payments will occur only after the filing of the U.S. federal and state income tax returns and realized the cash tax savings from the favorable tax attributes. The first payment is due 120 days after the filing of the Company’s tax return for the year ended December 31, 2015, which is due March 15, 2016, but the due date can be extended until September 15, 2016. Future payments under the TRAs in respect of subsequent exchanges would be in addition to these amounts.

 

As a result of the exchange of units of Virtu Financial, the Company recorded a deferred tax asset of $161.6 million associated with the increase in tax basis. Payments to the Virtu Post-IPO Members and the Investor Post-IPO Stockholders in respect of the purchases, the exchanges and the Mergers described in the Registration Statement and Note 15 of the condensed consolidated financial statements of Virtu Financial included herein will aggregate to approximately $184.7 million in the aggregate, ranging from

 

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