Virtu Financial, Inc.
Q2 2017 Earnings Call Transcript

Published: 8 Aug 2017

[Operator:]

Good morning. My name is Leandra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Virtu Financial Conference Call announcing 2017 Second Quarter Results. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Mr. Andrew Smith, Head of Investor Relations, you may begin your conference.

[Andrew Smith:]

Thank you, Leandra. Good morning. Our second quarter results were released this morning and are available on our website. Today’s call may include forward-looking statements, which represents 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 result 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 becomes 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 Securities and Exchange Commission. 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 and clearing expenses. This will be the last quarter where we report on Virtu’s standalone results. Since the KCG acquisition closed on July 20th our third-quarter results will incorporate KCG’s results from July 20 until September 30, 2017. 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. I would now like to turn the call over to Doug.

[Douglas Cifu:]

Thank you, Andrew. Good morning and thank you for joining our call this morning to discuss Virtu’s second quarter results. I will begin the call by discussing briefly the results of our business, and then reporting some important progress on the KCG acquisition. Following that Joe will walk you through the financial results for the quarter, and finally we will address any questions that you may have. For Virtu, the second quarter was impacted adversely by the well-documented global slowdown in volatility. As has been widely reported, volatility is at or near historic lows in major global assets classes including US equities, currencies and commodities. While it is not our business to try and forecast macro global trends and volatility or market direction, we believe the continued near zero global interest-rate policy by central banks and the uncertain regulatory environment for large financial institutions has contributed to this lack of volatility. While we are disappointed at the persistence of this trend in volatility, and are hopeful that this may represent a trough for volatility we echo the views of various market commentators that this condition is a cyclical and not a secular feature of the global markets. Volatility is important to a market maker as it impacts the opportunity to profitably provide two sided prices and earn a bit off a spread. To cite some examples of this diminished volatility, intraday volatility of the S&P 500 Index averaged just 55 basis points during the quarter, a 41% drop year-over-year and a 2% decline compared to the prior quarter. Average daily consolidated U.S. equity share volume declined year-over-year. If you look at the charts we provided in the press release, you will note that these levels of volatility are unprecedented. These levels of volatility are not isolated to the United States, as both our European and Asian equities businesses similarly experienced meaningful declines in volatility during the quarter. Outside of equities the environment is similar. For example, in commodities, average daily realized volatility of the JP Morgan Commodity Volatility Index declined over 18% and 8% year-over-year and versus the prior quarter, respectively. The average daily CBOE / COMEX Gold Volatility Index declined 32% and 15%, year-over-year and compared to the prior quarter, respectively. Average daily CME Energy and ICE Energy contract volumes increased 5.4% and 1.6%, year-over-year and versus the prior quarter, respectively. In Currencies, the average Deutsche Bank FX Volatility Index declined 29% and 21%, year-over-year and versus the prior quarter, respectively. The JP Morgan FX G7 Volatility Index declined 28% and 21%, year-over-year and versus the prior quarter, respectively. Average daily volumes on Spot venues were down compared to the prior quarter with EBS and Hotspot posting the largest drops of 8% and 5%, respectively. Comparisons to the 2016 second quarter are naturally unfavorable due to the impact of Brexit on the global financial markets. However, our businesses saw a relative strength in European equities, which were up 27% versus the first quarter, outperforming the volume benchmarks that was up 7% for the same period. Our Asian equities performance was strong as the results were up 9% versus the prior quarter, in particular while benchmark volumes were down 5%, and volatility was at extreme lows. Results in Americas equities and global [FIC] were equally challenged given the environment as I noted earlier. During the second quarter, our global commodities business underperformed some of the benchmark metrics. Global commodities results were down 27% versus the prior quarter. Energy volumes on exchanges were up slightly and the volatility environment remained muted. Global currencies were down 19%, but outperformed declines in the benchmark volatility indices, which fell almost 30% to multiyear lows. Despite this we remain confident that the core results are a consequence of the terrible environment for a market maker. While we are not happy with the results, we are proactively managing our business to grow and to continue to earn an acceptable return in this environment. We can control expenses, and we continue to aggressively manage all aspects of our business in a way that will sustain exceptional margin. We achieved a 53% adjusted EBITDA margin in the quarter. Again, while this is low by historical standards, our continued profitability in the worst of all environments demonstrates the importance of a business built on scale. As we have continually said, we built Virtu from periods of feast and from periods of famine, and while we are unhappily in a prolonged famine period, Virtu remains profitable and remained well poised to capture opportunities as global markets recover from their slumber. Virtu’s multi-asset class, broad geographic presence coupled with our world-class technology and scale will continue to allow us to compete in any environment. In fact, these challenging environments create opportunities for firms like Virtu to build further scale and increase our participation in a period of record low opportunity. Indeed, the underlying rationale for the KCG acquisition was to leverage our scale and platform to consolidate at a time when volatility is low, while adding a premier customer franchise to the Virtu mix. Our most proactive action to date to create shareholder value is the acquisition of KCG. We completed the acquisition on July 20. I'm happy to report that we are well on our way to achieve our stated synergy target, and are in fact ahead of schedule. I wanted to share with you some thoughts on the progress we have made to date. At December 31, 2016 the headcount of legacy KCG was 952 people. As I speak, the headcount is 610 people. Together with Virtu, the total headcount of the combined firm is 755 people. At December 31, 2016 the combined headcount of both firms would have been 1,100 people. Equally significant, we have achieved these reductions in force without any meaningful impact on revenues and without the loss of any key personnel. In addition, we have taken the following actions. Offices in Singapore and India have been closed. In London, we have closed unprofitable trading operations and focused the business on the significant opportunity in Europe with regard to Mifid 2017. We are committed to a strong European client franchise with a robust client facing operation in London. Joel will provide more details, but suffice to say we will meet or exceed the synergy targets we presented to you on April 20 when we announced the transaction. Actions taken to date, barely three weeks after the closing, along with further actions will result in at least $125 million of annual run rate savings by the end of the third quarter of 2017, which is 50% of our stated growth synergy target of $250 million. In terms of capital management, we are proceeding with the plan outlined on April 20 and expect to achieve capital savings over the period of 12 to 18 months of at least $440 million which we earmarked for debt reduction. In fact, we have already made a $100 million prepayment of the $1.15 billion term loan we incurred to finance the transaction as a result of the excess capital in the legacy KCG businesses. I am more excited than ever about the prospects for the combined businesses. In the short time since the transaction closed we have identified myriad revenue opportunities, optimizations and efficiencies to cite a few. We are extremely impressed with the long-standing, deep and loyal client relationships that KCG has. Relationships that KCG built represent a true franchise. We have not lost any clients due to the merger and the response from clients has been overwhelmingly positive. The retail market making business of legacy KCG is more impressive and sustainable than we believed as outside observers. In addition to the retail order flow business, we are committed to growing and enhancing the customer trading and facilitation businesses of KCG, particularly the block trading ETF and OTC businesses. We believe these steps will benefit greatly from Virtu’s market structure and technological capabilities. KCG’s institutional agency business is a strong franchise, which we are committed to. We believe that we will be able to incorporate Virtu’s market structure knowledge, scalable technology and analytical tools to provide customers with unprecedented transparency into their orders, and most importantly better execution quality. We will integrate KCG’s more quantitative trading capabilities into Virtu’s core market making business, while moving to a single, global technology platform. This will increase our trading P&L and reduce overall cost. In summary, while market conditions have not helped either legacy Virtu or legacy KCG’s results recently, we are very focused on improving results on a standalone basis, and we are very excited about the value creation opportunity from synergies both on the expense and the revenue side. Finally our board decided on a $0.24 per-share dividend payable to shareholders of record on September 1, 2017. As I have repeatedly said, our board and management team remain committed to returning capital to our shareholders. I will now turn the call to our CFO, Joe Molluso, to review our financial results for the second quarter and provide more details on the integration. Joe?

[Joseph Molluso:]

Thank you, Doug. Good morning. In the second quarter, net revenues, which includes technology services revenues and adjusted net trading income was $77 million. These results compare to $82.2 million in the first quarter. GAAP EPS was $0.01 per share in Q2. Assuming more common units on our exchange for common shares, our normalized adjusted EPS was $0.13 per share compared to $0.16 in Q1. In our press release and supplemental materials, we detail nonoperating items that are in GAAP results for the second quarter of 2017. Most prominent of which are advisory expense transactions and debt issue costs related to the KCG transaction. Reviewing briefly the six categories of adjusted net trading income and with all comparisons to Q1. Americas equities adjusted net trading income was $24 million, down 15% from Q1; European equities was $9.2 million, up 27%; Asian equities was $12.5 million, up 9%; global commodities was $12.8 million, down 27%; global currencies was $10.7 million, down 19%. Doug reviewed some of the industry statistics on market volatility impacting these results. We provide additional details on volume and volatility statistics in the supplemental materials. Technology services revenues were up $3.1 million this quarter, from $2.8 million [indiscernible]. This business will obviously be integrated into legacy KCG’s much larger client franchise. Total core expenses, slide 4 in the supplemental materials, were $49.7 million in the second quarter. Compensation was down from $19 million in Q1 to $16 million in Q2. Underlying this is a decline in year-end incentive reserve compensation, which is in line with the decline in our revenues. Our other core expense categories of communications and data processing, depreciation and amortization and operations and administrative expenses have remained within historical norms. Now I will turn to some of the information regarding the merger of Virtu and KCG. We closed the transaction on July 20. So we have been one company for less than three weeks. I want to first review some of the synergy projections we put forth on April 20 when we announced the transaction and report our progress made against those projections. On April 20, we assumed there would be $208 million of net expense synergies, pre-tax, consisting of $70 million of technology, communication and data processing expenses and $180 million of occupancy, overhead and headcount redundancies. We offset these amounts by an estimated $42 million in revenue dis-synergies to arrive at the $208 million. Although it has been less than three weeks since closing, we have already identified at least $125 million of expense synergies to be achieved on an annualized basis by September 30 of this year. Barely three weeks in, we have taken actions to realize over $125 million in synergies, or half of the gross $250 million we originally identified. So we are confident we will meet or exceed the forecasted amount of expense synergies. Importantly, we cannot identify material revenue dis-synergies associated with the expense reductions to date. Turning to capital and our capital structure. On June 30, we completed a refinancing transaction, where Virtu raised a total of $1.65 billion in funding. The proceeds of the transaction were dispersed at closing and were used to refinance Virtu’s existing $540 million term loans and legacy KCG’s $465 million bond, as well as to fund the acquisition. During marketing, the transaction financing was very successful. The amount of the first lien term loan was upsized from $825 million to $1.15 billion and the second lien notes due 2022 was set at $500 million. A term loan priced at LIBOR plus 375 basis points that matures on December 31, 2021. The $500 million bond was priced at 6.75% and matures in 2022. On April 20 as well we announced that we expect $440 million of capital releases related to capital synergies. We are well on our way to achieving this goal, evidenced by the fact that we have already made a repayment of $100 million of our prepayable term loan. In the supplemental materials, we have provided a reconciliation of Virtu’s trading capital position and cash position as of June 30. As we have mentioned on these calls in the past, the $361 million of trading capital is well in excess of what Virtu requires to meet its trading obligations. In future quarters, we will provide consolidated reconciliation incorporating legacy KCG’s positions. For illustrative purposes, we have included a combined trading capital conciliation for Virtu plus KCG as of March 31, 2017 on Page 10 [indiscernible] for which public information is available. You can see that we began with a trading capital base of $1.85 billion. Of this amount, we have identified $440 million as available for lease over 12 to 18 months. Because of the total amount of trading capital and the nature of both firms trading, we believe we can derive the aforementioned $440 million of capital synergies. Further, there are additional equity sources that are not stated in the capital position synergies, including contractual tax receivables, $50 million resulting from the [indiscernible]. In this comfortable capital and leverage position, we intend to maintain the current plan to use excess capital to reduce debt and to the extent required by any shortfall in earnings continue the current dividend policy. Now I will turn the discussion back to the operator for Q&A.

[Operator:]

[Operator Instructions] And your first question comes from the line of Richard Repetto with Sandler O'Neill. Your line is open.

[Richard Repetto:]

Yes. Good morning Doug. Good morning Joe. And congrats on the quick start out of the gate on the KCG integration. So I guess the first question is I heard you mentioned Joe that you haven't experienced any revenue dis-synergies. I know though there was a negative $42 million in original guidance. So, I guess, are we – first, are we revising the revenue dis-synergies – can we get more color on that, and then given the quick start, this was a two-year timeframe that you initially outlined, and can we – what is sort of the timetable with further cost reductions beyond the 125, and I guess, you already said you have great potential to exceed it I guess.

[Joseph Molluso:]

I think, on the first part of your question on the revenue dis-synergies, Richard it is – a portion of the answer is that some of the businesses that we have closed like the prop trading business in Europe, we are really not producing much and a lot of that 42 million was off of a baseline of 2016. So I think the combination of a falloff in 2017, and the fact that we have just gotten that quicker as you say and have been able to identify where we can move things onto the Virtu platform has allowed me to make that statement that there is very little revenue dis-synergies in the actions taken to date. We are not revising anything at this point, and as I said we have been closed a couple of days short of three weeks. So we will wait a little bit and before we [indiscernible] anything, but as you say, we are well on our way to the gross number of 250. We are well on our way to the net number of 208, and I am optimistic about our ability to achieve that sooner than the 24 months that we gave you in April.

[Richard Repetto:]

Okay, and then also on KCG, Doug, is there anyway you can give us a feel, I think everyone is aware of the low volatility environment, but give us a feel on KCG results because I don't think I have seen them anywhere – the results for the second quarter, how they did?

[Douglas Cifu:]

Sure. I mean, obviously they didn't report because they deregistered in [34], so we are not going to publish those, but I mean, I think their quarter was not dissimilar to ours in the sense that they experienced the same level of low volatility that we did in the second quarter. So, order of magnitude it was in the same zip code. I think just looking at the combination, Rich, it is hard to overstate my excitement and enthusiasm – the team’s excitement and enthusiasm as to how well these two firms are clicking, one, from a cultural perspective, but two, the nature and the style in which we trade are very, very complementary. I always thought as an outsider that that would be the case that you could combine Virtu, which is really as I have always described it, a financial technology company that understands market structure and order routing exceptionally well, and its bid offer style capture market making firm that is connected to a lot of different venues and has built great scale. That is Virtu in a nutshell. And KCG has built this fantastic client facing franchise, and has really exceptional quantitative style trading skills that frankly Virtu lacks, and combining those core competencies is really something that is obviously not reflected in the synergy numbers right, because those are revenue numbers and we didn’t put any of those in then forecast and are hard to put opinion. But the teams have really smart folks on each side who are very excited about meshing those strategies together. And to me that's if there's one takeaway from this call, in addition to the obvious expense synergy number which we worked hard to accomplish is the potential upside of combining two firms that were competitors but really approached the market in a very different way. Combining those two, I think we're going to create a very powerful financial services firm for the future.

[Richard Repetto:]

Okay. And one last one for me. The low volatility environment, it is what it is. And but I guess the last thing you have to do is what you just covered. The potential for revenue synergies and this combined firm leveraging the abilities of each, when do we expect to see that to actually impact results. Is that something that will take six months, the expenses you're out of the gate super-fast but on the revenue synergy side where you're using some of your market structure, both market structure expertise? When do you expect that to actually impact results?

[Douglas Cifu:]

I mean, some of it you'll see right away because obviously there will be some benefits which again we didn’t put in the model with regard to being at higher tiers and things along those lines. So, that's going to enhance net trading revenue capture or adjusted net trading income because our exchange in broker fees will as a percentage of volume traded will decline naturally because we're going to be in the highest. We're close to the highest tiers and obviously with equity venues and what not. So, that's immediate. You're asking a great question in terms of how do we actually integrate strategies to enhance what we're doing. And there are a multitude of projects going on in each of our offices and each of our trading groups, some of which we've raising and some fruit being born. But it's going to take obviously a period of months before we really row boat that in earnest. So, I think the remainder of this year you'll see some of it but I do think it will kick in significantly 2018. It's hard to understate how much benefit the Virtu's side can get. For example, from understanding in a more predictive manner where we think markets are headed. The signal power and the strength, the legacy KCG franchise is really very significant and they built it over a couple of decades here as you well know. And so, we had always thought that would be a unique thing to add to Virtu and it turns out that it certainly will be. And then on the opposite coin outside the coin, both on the customer market making but also on the institutional sales front, our understanding of market structure and technology which is kind of all we're really about at legacy Virtu, really will add to the servings offerings. For example, we're already offering an integrated algo solution to legacy KCG customers that they can have access to the Virtu algorithms on the legacy side. So, within three weeks we're already accomplished that technology integration. So, we're moving very quickly. We do think that Virtu's speed the folks here certainly get that and are really adjusting the way in which they operate and the way which they communicate. So, culturally I couldn’t be happier where we sit and now that I have really dug into the weaves of what legacy KCG was all about, we are all as a team very excited about where we're going to take this combined firm.

[Richard Repetto:]

Got it. Thanks for taking my questions.

[Douglas Cifu:]

No problem. Thank you, Rich.

[Operator:]

Your next question comes from the line of Alex Blostein with Goldman Sachs. Your line is open.

[Alex Blostein:]

Right. Hi, good morning everybody. A couple of clarification I guess around the capital discussion. So, Joe, the pay down of debt the $100 million you guys mentioned, was that part of the 440 that you expected to be released over time or I guess was this just excess cash that you guys thought you could quickly redeploy, that was because just kind of sitting of KCG's balance sheet.

[Joseph Molluso:]

It's going to 440.

[Alex Blostein:]

Got it, clear. On the second question, just I guess a follow-up around the KCG operating dynamic. So, the revenue picture sounds like similar to you guys but can you help us I guess with expenses and more importantly looking into third quarter which are the pro forma run rate expense they should be given kind of the faster pace of synergy realizations you guys are seeing?

[Joseph Molluso:]

Yes. I mean, we haven’t broken out the numbers between the expense categories but I can tell you the expense synergies that we've achieved are weighted given the headcount numbers that sided, they're weighted towards the employee comp in benefits line. Those are the ones that are kind of most ratable over the four quarters. So, if there is a headcount reduction and there is a reduction employee comp, you kind of realize that equally over the next four quarters. And the rest of it is tend to be won't be depending on when contracts run off. But I would say most of that number, Alex, should bleed in over the following four quarters in a pretty equal way.

[Alex Blostein:]

Got it, okay. And then just a last one. Again, come back to the capital dividend discussion. So, clearly faster synergy realization on the cost front will help the cash flows and help the dividend coverage. But it feels like if this environment continues on the revenue side, there's still be a bit of a gap to the $0.24 number that you guys are still paying out. So, as you're thinking about just the timing of the capital release and pay down of debt, can you help us bridge I guess the gap ultimately how much could you guys feel comfortable using off the balance sheet to cover the dividend versus the need to pay down that?

[Douglas Cifu:]

Yes. This sounds like a good question. One that we spend a lot of time here looking at. I mean, I will say and I'm going to be intentionally vague here because it really does depend as you said Alex in terms of what the environment looks like and how we choose and choose and therefore what the operating cash flow that we're generating is. As Joe mentioned, just using the March 31 balance sheet which is the last thing that we have publicly available. They're probably directionally accurate. We had an aggregate capital balance if you will a 1.85 billion. And that as we said we were comfortable at 440 million of that is capital release. I will say that they were incremental things that we've done here in a way that we've managed capital and that with prime brokers and industry that candidly legacy KCG did not undertake. So, there is going to be ample opportunity for us to extract additional capital savings from the combined legacy Virtu and legacy KCG balance sheets. Which means that there is a significant amount of excess capital kind of floating around the systems. So, whether a short fall from a dividend perspective, if you just take the $0.96 run rate multiplied by the share count and look at what that cash requirement is, subtracting obviously the actual cash flow that we're generating. It will vary quarter-by-quarter. Obviously we've disclosed and these supplemental materials, some of the access that we've had historically trying to reconcile cash to GAAP and what not. What I'm trying to say is I think there's enough cash here to sustain the dividend for the foreseeable future. That's certainly what the direction organic from the board and the guys were giving to the board. Whether that obviously I'm never going to say never because that would be a responsible but we're very comfortable where the dividend is set right now. Joe, I don’t know if you want to?

[Joseph Molluso:]

No. I think and again we're very comfortable with the capital position of the combined firm. So, we're going to take it step-by-step, see how these quarters develop. But as Doug said, we put the most 31st number in here because it's the latest, that number is naturally going to be different in June. But as we use both the transaction, et cetera. But I think we feel that it's more than enough to as Doug said maintain the dividend for the foreseeable future, meet the 440 million of capital, we'd draw a plan and still have a more than acceptable buffer to operate.

[Douglas Cifu:]

I mean, yes just for example and you guys could do the math as well as we could. But like a $125 million of run rate synergy if you just take that number and divide it by the share count pretax almost $0.70 a share. So, it provides you a significant opportunity to generate additional cash.

[Alex Blostein:]

Yes, agreed. That all makes sense. Thanks.

[Douglas Cifu:]

Thank you, Alex.

[Operator:]

Your next question comes from the line of Alex Kramm with UBS. Your line is open.

[Alex Kramm:]

Yes. Hi, good morning everyone. Maybe to just continue the conversation you just had, I mean you threw a lot of numbers around here and obviously we'll come back into the math after all said has done here. But thinking about the current environment, you think about the synergies that you realized and kind of like the rough numbers you gave us about the 2Q results for KCG. I mean, basically if this persists this environment, are you covering the dividend right now with the cash flow that you're is you're getting or is that still a little bit of a shortfall. And again we can do the math ourselves but just wondering what you're seeing right now.

[Joseph Molluso:]

Alright. Obviously on a standalone basis, the second quarter versus not. And as Doug said on the third quarter we'll have KCG's results incorporated from July 20th on. So, well third quarters not over yet so we'll see, Alex. I mean, in this environment it's a touch environment but as we said the foreseeable future certainly includes this quarter next quarter through the beginning of the year.

[Alex Kramm:]

Alright, okay. We'll do the math. I guess I was just thinking you see the money coming in and out every day. So, obviously you're watching that closely, so just wondering where we're running but I guess we'll leave it at that. Secondly, just obviously just coming back to the standalone results here for Virtu. Tough quarter obviously and I hear you on the realized volatility and obviously we're checking the same things. But I think as always, when we can really see from the inside, there is always the wondering that people have that the model is broken. So, just wondering what you can give us to make us feel a little bit more comfortable like in terms of how the quarter progressed, how it's running so far on the third quarter in terms of the volume volatility environment but also there were probably a couple of days in the quarter that volatility was a little bit better. They were one of event. So, just wondering how you did like so it'll give us more comfort that the system is not broken. For example, pre-IPO you said you like at one day where you lost money. Like any updates to make us feel like hey these guys are still refining the models and are still making money and it's really just the environment. Sorry for the load of question.

[Douglas Cifu:]

Yes. Yes, no like it's a very important than I get the question and I promised I would never talk about that histogram because I talked about a lot and then up ultimately backfiring on us because people read a lot more into it than they intended, than we intended obviously. But we're market making from the models, don’t break because they're not quantitative models. They are let's capture a bit offer spread, let's try to post it in offers, and as the bid offer spread, expense and volumes go up, you make more money. So, absolutely during the quarter where their days where they would increase and very isolated. Relative high volatility? Yes. Do we make more money on those day? Yes. Did we have any significant drawdowns or losing days during the quarter? I'm going to wave my ruler right now and tell you no we did, we made money every day in the second quarter at legacy Virtu just the same way that we always did. We made lots of money every day than we did in for example 2014 and periods of 2015 where there were more volatility and more volume. The opportunity set just has declined as that spread is being paid to the market. I read all these things about the depth of HFT and all that other kind of stuff. And I get outside as people look at it and don’t really understand what it is we do. We are not a quantitative predictive trading firm at Virtu, we're a market making firm. There will always be a need for people to provide bid and offers to the market. Despite what people might thing, natural buyers and sellers don’t meet mystically in some room somewhere without the market having to pay bid offer spread. So, there will always be a need for firms that provide that service. The key to our firm is that we can provide that service and that bid offer spread more efficiently and cheaper and at better scale than anybody else. So, that's the model. So, that model was not broken, it's never going to be broken and we're going to apply that efficiency in that scale to KCG which takes a different view of the world and is a little more quantitative. But legacy Virtu continues to chug along. Am I happy with the results? No. Do I blame it largely on the environment? I do. Are the things that we could do better? Absolutely. Do we as a management team continually look at what we do in terms of trying to capture bid offer spread to get better? Absolutely. You got initiatives all over legacy Virtu to make the firm better. But as a construct as a business model, I absolutely reject the proposition that electronic market making is somehow going by the way side. We built this from when he sat down with me in 2007 ironically in the building that I'm sitting in now, the old nine and said this is what we're going to do. We built this firm for a cease in for a famine. As I said in my prepared remarks unhappily, we're in a prolonged famine period. But a 53% adjusted EBITDA margin is not something I'm happy with but it's still a pretty nice profitable business.

[Alex Kramm:]

Great. And then just maybe just lastly and to stay on the same kind of theme here. Clearly have your hands with KCG but when I look at your press release today and then other is just a placeholder but you talk about the 235 markets and 36 countries 12,000 securities, you're making market then. And I remember at the IPO, there was this whole discussion, there still a Greenfield opportunity to grow this business. We really haven’t heard much about this in the last several quarters here. So, you talk about the EBITDA margins and yes you're very profitable but at the same time you could make the argument that maybe this should be the time where you're also investing. Some of your competitors are talking about investing right now. So, just wondering if you're maybe standing still a little bit much, focused too much on KCG and the base business is not really looking for, that next opportunity is set around them also. Maybe anything you can share with us would be great.

[Douglas Cifu:]

I don’t know, we just spend a 1.8 billion buying a company. So, I think that's a pretty piece in size investment. I mean that the whole idea behind buying KCG, putting aside all the expense and synergies and all that type of thing. And what we were trying to do in Virtu was effectively go up stream. If you will get closer to the natural buyers and sellers because there is a universe of bid offer spread that buyers and sellers are paying. And there are friction points in the system. So, some of that the market make or some with big change, some of with the broker that's sending that order. The closer you can get to that order the more bid offer spread you can capture. That's moving upstream getting closer to the natural buyer and natural seller. As I talked about many times, we didn’t have the customer franchise nor the salesforce to do that. We look very closely on ourselves and said "How can we grow our FX business, our fixed income business or equities business. How do we get closer to the end user in a way where we're not just posting bids and offers and these things called exchanges and dark pools?" And the conclusion we have is rather than try to build it, given the opportunity to buy KCG and we thought was a very fair value. Let's acquire that client franchise by through acquisition. And so, we are investing if you will in growing the legacy Virtu business because we now have this peppery if you will of clients around the world in every different asset class that we can attack. So, for example, we announced a relationship in Europe with Instinet to bring Virtu prices directly to end users. That's the way to grow your European equities business without having to rely on posting bids and offers in exchanges and what are the equivalent of dark pools in Europe. We're going directly to end users using the services of Instinet. We can do that and we are doing that now in the United States through our own salesforce. So, we're now making prices directly at legacy Virtu through the combination of KCG. Can users of it that want to buy and sell blocks of EPS, that's exciting. That's the market that we never had at legacy Virtu. So, the idea was to combine the core strength of Virtu, efficiency technology understanding of market structure making it two sided price and bringing it to the end user. KCG has been doing this for two decades. So, rather than trying to beat our heads against the wall and hire a bunch of sales folks at Virtu, we made the judgment that it was better for us to combine with KCG. So, I don’t know how we could have invested in the business and grown it in a more efficient one stop solution than combining with the firm that is exceedingly complementary to what we do and what we needed.

[Alex Kramm:]

Thanks, that points. Thank you, very much.

[Operator:]

Your next question comes from the line of Ken Wilmington with JP Morgan. Your line is open.

[Ken Wilmington:]

Hi, good morning. So, on NTI. So, first I guess maybe in American equities, I think realized far was up sequentially, volume in today wall was essentially flat. That's just a big decline in NTI in 2Q versus 1Q and then I flip it around and talk about Asia or as per Asia. Debt business is held up particularly well. It looks like realized and implied wall has really collapsed. So, I think you've got in a little bit closer to the end customers in Asia. So, why is American equities maybe not holding up particularly well, the metrics seems to be bad but not horrific? In Asia, the metric seem to be, we're thinking that business is doing great. Why the divergent?

[Douglas Cifu:]

Yes. It's a great question and good observation and then the point you made at the end actually you kind of help back to the question which is one of the initiatives we made in Asia as you remember about a year ago, so was some of our strategic relationships, put it that way. I'll run Asia with retail brokers like SPI and others that we haven’t named. And so, we have in that market place that the structure if you will for wholesale market making in that in Japan for example. And so, in those markets in both the equities and the future side, we've got in closer to the end user and so helped, it's helped our overall performance by giving us access to natural bids and offers or natural interests if you will that could be serviced by our bids and offers without having to necessarily compete in an open exchange for that pull out. And so, that's helped our Asian business both on the equity side and then the equity future side. In the U.S. again not to be the dead horse, one of the reasons why we wanted to do the acquisition obviously was to get at the significant business that KCG has had for a number of decades now in the retail with retail broker dealers and providing market making services to their ultimate, to their rent users. And that's to say they were most excited about. And so yes, and our America's equities business continues to suffer and we're fighting in the nice side if you will kind of the exchanges in the dark pool and that's just has become in the quarter it was more comparative. Joe, I don’t know if you have the statistics in terms of realized volatility. But that volumes were down actually that.

[Joseph Molluso:]

Yes. What I mean you can you know when, when you're looking at realized inter day volatility of 55 basis points, it's just very hard to look at that as in any way that's kind of an uptick. It's just a continued poor environment. And when I look at Q2 versus Q1, I see the SP implied volatility is down slightly. The realized volatility was up slightly, the inter day volatility was again was down meaningfully. So, again it's just a continued poor environment.

[Ken Wilmington:]

Okay. I was hoping to get revenue for KCG in 2Q. It sounds like you don’t really want to provide it. If you will, will you help us at lease frame it, we obviously know it was a terrible quarter, they're going through a merger, so probably not all that productive. But if we look at 2Q for Virtu, it was the worst quarter we've seen or the lowest NTI that we have seen since the beginning of '14. If you look at KCG, 1Q was lousy, but they've actually had quarters that were worse than 1Q. So, again if we can get the number directly, was KCG's 2Q the lowest trading income they've seen or was it just lower than 1Q?

[Douglas Cifu:]

Ken, there is not going to be filing. I would say that the results quarter-on-quarter are similar to Virtu.

[Ken Wilmington:]

Okay, tried. And then --.

[Joseph Molluso:]

In terms of free to decrease directly in terms of percentage or percentage down.

[Ken Wilmington:]

Okay, that helps. Thank you. And then just lastly, on headcount. Boy, you guys took out a lot of hedge and I think the question was asking and you answered that you haven’t seen an impact revenue. Maybe help us understand where these employees were focused, were they just all back office and technology and you're able to provide all that yourselves or was it that the people that you fired didn’t necessarily have any impact on net income but they did have an impact on revenue. So, I'm sorry, we're just trying to clarify that because the headcount reduction seems so big.

[Joseph Molluso:]

Yes. No, it's a great question. It' a little bit of both. I mean, even before the closing the prior management team were obviously with our equity essence and encouragement had closed. For example, the Singapore and the Mumbai office which was and you can look at this from some of the legacy KCG filings, Ken was generating very little just on net trading income at all and clearly was grossly unprofitable. Same with what they were doing in London. I think they had at the end of the year something in the zip quote of 220 to 230 employees outside the United States and the businesses were grossly unprofitable on generating not that much adjusting net trading the prop business is that institutional sales business in London had always been a shining jewel of what KCG has done in Europe and we're excited to maintain and make that business better. But in terms of what I'll call prop market making opportunities outside the United States, it was we don’t want an abject failure and we took the necessary action to shut it down, even some of the preclosing subsequently we've done other things. So, there were certainly that and that was just a different style of running a firm here to put it bluntly in terms of nonrevenue producing folks. As you guys know we're pretty lean in mean here. As I always say, it is only one person at Virtu that doesn't really have a day job and that's myself, everybody else is actually on the line producing something. So, we don’t have that kind of management layer. So, we eliminated that and a lot of the good share mass if you will of having a big firm that just didn’t really reconcile with our style of running a business have been eliminated. So, it is a large number of people, obviously you've seen great people that are going to move on and do other things and we wish them well. And we don’t take, we don’t relish if you will changing people's lives in that manner. But we think that the folks that will be left here and remain here will see that we're trying to build a truly successful sustainable business that can operate for years and years and be profitable. I told everybody that we don’t have unprofitable offices, sure have to put out this question before, I'm happy to invest in things but we have to make money. That's what Virtu is all about. We have to return money to our shareholders. So, we're not going to have unprofitable offices, we're not going to have overseas offices that we invest in for years that don’t make money. That just doesn't make any sense to me. We got to make money everywhere and we're going to do that.

[Douglas Cifu:]

Ken, when we announced the acquisition, we said we were not going to impact any of the client facing businesses and from a client standpoint nothing should change. And we think even with this reduction we have not done anything that would impact anything that's --.

[Ken Wilmington:]

Okay, great. Thank you, very much.

[Operator:]

Your next question comes from the line of Ben Herbert with Citi. Your line is open.

[Ben Herbert:]

Hi, good morning. Thanks for taking the question.

[Douglas Cifu:]

Good morning.

[Joseph Molluso:]

Good morning.

[Ben Herbert:]

Good morning. Could you just provide an update on integration costs and what portion of that is cash versus noncash?

[Joseph Molluso:]

There's two answer to that question. One is that both of other integration cost for in terms of cash and noncash related charges. That means writing off the plans in these ones or office that where moving out of will not appear in Virtu's financial statements because they were undertaken prior to close. The amount that will actually be on Virtu's financial statements then is just the minimus. So, you're talking right now single digit millions.

[Ben Herbert:]

Okay, thank you. And then, maybe I missed in the prepared remarks, but the 2 million reserve for legal matter, could you just share some color on that?

[Joseph Molluso:]

Yes. This is the AMF judgement that is not final yet but the fine was reduced.

[Douglas Cifu:]

Yes. We had originally got fined €5 million. We appeal that I mean it was in my view is a formal lawyer holding without any basis in fact or in law. But putting that aside for a second, we appealed it and the PL in the French traditional system it was reduced to €3 million. So, we reversed the €2 million as a result of that. And we have further revenue to appeal, which we will because to me it was just an absolute political railroading by the French system had absolutely no basis of French law. And so, we're going to fight it and not fight it.

[Ben Herbert:]

Thanks. And then, maybe lastly just an update on missed and preparations there if you're seeing any impact from efforts around last minute changes.

[Douglas Cifu:]

Yes, great question. Obviously, it's great to have been there for a while and be in Ireland and I have to worry about Brexit and another we've got London, we got to deal with that but putting that aside for a second. I mean, this to me is one of the most exciting tailwind type of regulatory changes I could impact Virtu. As I talked about before, this notion of the systemic internalizer and Virtu III publicly announced that we're going to be a major player in that. It really fits directly into our wheelhouse and it fits exceptionally well with the combination with KCG on the prop, making a price market making side. Additionally, as we have talked about on prior calls and the legacy KCG management team also noted, having a strong execution only institutional sales business in Europe and then obviously in the United States, in a post Mifid unbundled world, it's exceedingly exciting. We think one of the great strength that Virtu had on the agency side with our offering was superior execution quality but also transparency into how orders were routed and what not. So, now taking that product if you will and offering that to all the great legacy KCG customers a lot of whom I've already met and are meeting more both in Europe and the United States is a significant opportunity for us. And then lastly, I don’t think this has been as reported as much as it should have been in under Mifid II and ETF will be due to the covered instrument or a covered security no longer it's a derivative. And so, we think that'll drive more efficiency and more screen trading which really plays into the Virtu model. We've got a very strong screen based electronic ETF market making business in Europe. We don’t have a salesforce, now actually we have a salesforce and we got block trading capabilities here in the United States. So, those three things really combine to we thing create hopefully will create a lot of value for our combined firm. In terms of preparation at legacy Virtu, we already Mifid II compliant and the KCG legacy business was well on its way. So, we won't have any problems meeting the January 3rd dead line.

[Ben Herbert:]

Thanks. And then just lastly, are there any capital requirements related to that or your preparations there?

[Douglas Cifu:]

Now, I mean we're at steady state capital already in Europe. So, there won't be in fact there will be capital synergies because we reduced all the prop trading businesses in the legacy KCG entity. We're all being moved to the Irish entity. So, as a result you'll have capital efficiencies if you will for the combined businesses.

[Ben Herbert:]

Great, thank you.

[Douglas Cifu:]

Thank you.

[Operator:]

And we'd now like to turn the call over to Douglas Cifu for closing remarks.

[Douglas Cifu:]

Okay, you don’t have the question?

[Joseph Molluso:]

No.

[Douglas Cifu:]

Okay. Just wanted to make sure there are no other questions. Thank you, everybody. Obviously we're very excited about the integration. A lot of stuff going on here in Virtu. It's only been three weeks. I would like to emphasize again that the cultural similarities between these firms and acceptance of kind of the Virtu style of doing business has been exemplary. I really want to credit all the legacy KCG employees. Senior folks and junior folks have been here for a long time. We came in and that's a great unknown and they've really embraced our firm and it really is already feeling like we're one combined firm. So, I'm really very excited about the future as I think the 100s of great employee around this firm are and we will continue to do our very best to generate P&L and drive returns to our shareholders. So, thank you all for your questions. And I look forward to talking to you in late October or early November. Thank you.

[Operator:]

This concludes today's conference call. You may now disconnect.