Virtu Financial Inc (VIRT) 2017 Q2 法說會逐字稿

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. (Operator Instructions)

Mr. Andrew Smith, Head of Investor Relations, you may begin your conference.

Thank you, Leandra. Good morning. As you know, our second quarter results were released this morning and are available on our website. Today's call may include forward-looking statements, which represent Virtu's current belief regarding future events and are therefore subject to risks, assumptions and uncertainties which may be outside the company's control and our actual results and financial condition may differ materially from what is indicated in these forward-looking statements. It is important to note that any forward-looking statements made on this call are based on information presently available to the company, and we do not undertake to update or revise any forward-looking statements as new information 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'll find a reconciliation from 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 20, 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.

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 following -- 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 and volatility. As has been widely reported, volatility is at or near historical lows in major global asset classes, including U.S. 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 numerous market commentators that this condition is a cyclical and not a secular future of the global markets.

Volatility is important to a market maker as it impacts the opportunity to profitably provide 2-sided prices in earn bid offer 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 6% 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 for 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 JPMorgan 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 year, 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 JPMorgan 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 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 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. As you know, 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 for periods of feast and for periods of famine. And while we are unhappily in a prolonged famine period, Virtu remains profitable and 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 targets and in -- 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. 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 significant opportunity in Europe with regard to MiFID II. We are committed to a strong European client franchise with a robust client-facing operation in London. Joe 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 3 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 gross 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, optimization 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 desks 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 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 costs.

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 over to our CFO, Joe Molluso, to review our financial results for the second quarter and provide more details on the integration. Joe?

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 all common units are exchanged 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 transactions -- our advisory expense transactions and debt issue costs related to the KCG transaction.

Reviewing briefly the 6 categories of adjusted net trading income and 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. We continue to onboard clients (inaudible). 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. Employee 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 a 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. As you know, we closed the transaction on July 20. So we have been 1 company for less than 3 weeks. I want to first review some of the synergy projections we've put forth on April 20, when we announced the transaction and report on progress made against those projections. On April 20, we assumed there would be $208 million of net expense pretax, consisting of $70 million of technology communications and data processing expenses, and $180 million of occupancy overhead and headcount redundancy. Offset these amounts by an estimated $42 million in revenue dis-synergies to arrive at the $208 million. Although, it has been less than 3 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. We're barely 3 weeks in, we've taken actions to realize over $125 million in synergies or half of the gross $250 million we originally identified, that 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. Proceeds of the transaction were disbursed at closing and were used to refinance Virtu's existing $540 million term loan and legacy KCG's $465 million bond, as well as to fund the acquisitions. 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. Our 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 and cash position on -- 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. Future quarters, we will provide a consolidated reconciliation incorporating legacy KCG positions. For illustrative purposes, we have included a combined trading capital reconciliation for Virtu plus KCG as of March 31, 2017, on Page 10, the latest date for which public information is available. You can see that, we began with the trading capital base of $1.85 billion. Of this amount, we have identified $440 million as available for release 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 liquidity sources that are not stated in the capital position synergies, including a contractual tax receivable of $50 million resulting from the (inaudible) comfortable capital leverage position, we intend to maintain the current plan to use excess capital to produce that 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 Instructions) And your first question comes from the line of Richard Repetto with Sandler O'Neill.

Congrats on the quick start out of the gate on the KCG integration. So I guess, the first question is, I heard you mention, Joe, that, you haven't experienced any revenue dis-synergies. I know there was a negative $42 million in original guidance. So I guess, are we -- well, first, are we revising the revenue dis-synergies? Or can we get more color on that? And then given the quick start, this was a 2-year time frame that you initially outlaid -- outlined. And can we -- what's the sort of the timetable with further cost reductions beyond the $125 million? And I guess, you've already said, you have great potential to exceed it, I guess.

Right. So I think on the first part on your question on the revenue dis-synergies, Rich, I mean, it's -- a portion of the answer is that, some of the businesses that we've closed like the prop trading business in Europe, where we're really not producing much and lot of that $42 million was off of a baseline of 2016. So I think the combination of the falloff in 2017 and the fact that we've just gotten added quicker, as you say, and being able to identify where we can move things off to the Virtu platform has allowed us to -- has allowed me to make that statement that, there is very little revenue dis-synergies the actions taken to date. We're not revising anything at this point. I mean, as I said, we've been closed couple of days short of 3 weeks. So we'll wait a little bit and -- before we revise that anything, but as you say, we're well on our way to the gross number of $250 million. We're very well on our way to the net number of $208 million, and I'm optimistic about our ability to achieve that sooner that 24 months that we gave you before.

Okay. And then also on KCG, Doug, is there anyway so 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've seen them anywhere for -- the results for the second quarter, how they did?

Yes, sure. I mean, obviously, they didn't report, because they deregistered in the '34 Act, so we're not going to publish those. But I mean their quarter was not too similar like 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's hard to overstate my excitement and enthusiasm and the team's excitement and enthusiasm as to how well these 2 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've always described it, a financial technology company that understands market structure and order routing exceptionally well and as a bid offer style capture market-making firm that's connected to a lot of different venues and has built great scale, that's Virtu in a nutshell. And KCG has built this fantastic client-facing franchise and has really exceptional quantitative style trading skills that frankly, Virtu lacked. And combining those core competencies is really something that's obviously not reflected in the synergy numbers, right, because those are revenue numbers and we didn't put any of those in the forecast and hard to put a pin in, but the teams of really smart folks on each side 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've worked hard to accomplish, it's the potential upside of combining 2 firms that were competitors but really approached the market in a very, very different way. Combining those 2, I think will -- we're going to create a very, very powerful financial services firm for the future.

Okay. And one last one from me. The low volatility environment, it is what it is. And -- but I guess, the last thing has to do with what you just covered. The potential for revenue synergies in this combined firm leverage and the abilities of each, when do we expect to see that to actually impact results? Is that something that will take 6 months? The expenses, you're out of the gate superfast, but on the revenue synergy side, where you're using some of your market structure -- Virtu's market structure expertise, when do you expect that to actually impact results?

Well, 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, right. So that's going to enhance net trading revenue capture, adjusted net trading income, because our exchange and broker fees will -- as a percentage of volume traded will decline naturally, because we're going to be in the highest or close to the highest tiers in all these U.S. equities 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, in each of our trading groups, some of which we've already seen and some fruit being borne, but it's going to take obviously a period of months before we really roll those out in earnest. So I think the remainder of this year, you'll see some of it, but I do think it'll kick in significantly in 2018. It's hard to understate how much benefit the Virtu side can get, for example, from understanding in a more predictive manner where we think markets are headed. The signal power and the strength of the legacy KCG franchise is really very, very significant, and they've built it over a couple decades here, as you well know. And so we had always thought that, 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 -- side of 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 were really about at legacy Virtu, really will add to the service offering. So for example, we're already offering an integrated algo solution to legacy KCG customers that they can have access to the Virtu algorithms on a legacy side. So within 3 weeks, we've already accomplished that technology integration. So we're moving very quickly. We do things at Virtu speed. The folks here certainly get that and are really adjusting the way in which they operate, the way in which they communicate. So culturally, I couldn't be happier where we sit. And now that I've really dug into the weeds 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.

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

Couple of clarifications, I guess around the capital discussion. So Joe, the pay down of debt, the $100 million that you guys mentioned, was that part of the $440 million 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 just kind of sitting off KCG's balance sheet?

It's part of the $440 million.

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 the third quarter, which are the pro forma run rate expense base should be, given kind of the faster pace of synergy realizations you guys are seeing?

Yes. I mean, we haven't broken out the numbers between the expense categories. But I'll -- I can tell you the expense synergies that we've achieved are weighted -- given the headcount numbers that Doug cited, they're weighted towards the employee comp and benefits line. Those are the ones that are kind of most ratable over the 4 quarters. So if there is a headcount reduction and there is a reduction in employee comp, you've kind of realize that equally over the next 4 quarters. And the rest of it is -- tends to be lumpy depending on when contracts run off. But I would say, most of that number, Alex, should bleed in over the following 4 quarters in a pretty equal way.

Got it. Okay. And then just a last one, again coming 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'll 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 a 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 debt?

Yes, this is obviously a good question, and 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, right, because it really does depend as you said, Alex, in terms of what the environment looks like and how we achieve synergies 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, of $1.85 billion. And that -- as we said, we were comfortable with $440 million of that as capital release. I will say that, there are incremental things that we've done here in a way that we've managed capital and dealt with prime brokers and the Street 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 system. So whether the shortfall 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 we're generating, it'll vary quarter-by-quarter. Obviously, we've disclosed in some of the supplemental materials some of the excess that we've had historically trying to reconcile cash to GAAP and whatnot. What I'm trying to say is, I think there is enough cash here to sustain the dividend for the foreseeable future. That's certainly what the direction we're getting from the Board and the guidance we're giving to the Board. Whether that -- obviously, I'm never going to say never, because that would be irresponsible, but we're very comfortable where the dividend is set right now. And Joe, I don't know if you want to...

No, and again, we're very comfortable with the capital position of the combined firm, right. So we're going to take it step-by-step, see how these quarters develop. But as Doug said, we put the March 31 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 is more than enough to, as Doug said, maintain the dividend for the foreseeable future, meet the $440 million of capital withdrawal plan and still have a more than acceptable buffer to operate the business.

I mean, just for example, and you guys can do the math as well as we could, but like $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.

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

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 and do the math after all is said and done here. But if you think about the current environment, if 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 are getting? Or is there still a little bit of a shortfall? And again, we can do the math ourselves, but just wondering what you're seeing right now?

Look, obviously, on a standalone basis, in the second quarter Virtu did not. And as Doug said, in the third quarter, we'll have KCG's results incorporated from July 20 on. So third quarter is not over yet, so we'll see, Alex. So I mean, in this environment, it's a tough environment, right. As we said, the foreseeable future certainly includes this quarter, next quarter through the beginning of the year.

All right. Okay, good. We'll do the math. I guess, I was just thinking you see 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 there's always the -- when we can't really see it from the inside, there's always the wondering that people have that the model is broken. So just wondering what you can give us to make us we feel little bit more comfortable like in terms of how the quarter progressed? How it's running so far in 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 or there were one-off events. So just wondering how you did like to give us a little more comfort that the system is not broken. For example, pre-IPO, you said you -- like you had 1 day where you lost money like any updates to make us feel like, "Hey, these guys are still refining their models and are still making money and it's really just the environment." Sorry for the loaded question.

Yes. No, look, it's a very, very important than I get the question. And I promised I would never talk about that histogram, because I talked about it a lot and it ended up ultimately backfiring on us, because people read a lot more into it than I intended -- than we intended, obviously. But we're a market-making firm. The models don't break, because they're not quantitative models, all right. They are -- let's capture bid offer spread, let's try to post bids and offers, and as the bid offer spread expands and volumes go up, you make more money. So absolutely during the quarter where there are days where there was increase and very isolated relative high volatility? Yes. Did we make more money on those days? Yes. Did we have any significant drawdowns or losing days during the quarter? I'm going to waive my rule right now and tell you, no, we didn't. We made money every day in the second quarter at legacy Virtu just the same way that we always did. We made less money every day than we did in, for example, 2014 and periods of 2015 where there was more volatility and more volume. The opportunity set just has declined as less spread is being paid to the market. I read all these things about the death of HFT and all that other kind of stuff. And I guess, as outsiders, 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 think, 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 a firm -- 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 and that's the model. So that model is not broken. It's never going to be broken, and we're going to apply that efficiency and 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 there things that we could do better? Absolutely. We a management team continually look at what we do in terms of trying to capture bid offer spread to get better, absolutely. We've 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 wayside. We've built this firm. When Vinny sat down with me in 2007, ironically, in building that I'm sitting at now, the old NYMEX and said, this is what we're going to do. We built this firm for a feast and 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.

Great. And then just -- maybe just lastly and to stay on the same kind of theme here. Clearly, you have your hands full with KCG, but when I look at your press release today and I know this is just a placeholder, but you talk about 235 markets and 36 countries, 12,000 securities you're making markets in. And I remember at the IPO, there was this whole discussion, there is still a greenfield opportunity to grow this business. We really haven't heard much about this in the last couple -- 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 are 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 set around the world. So maybe anything you can share with us will be great.

I don't know. We just spent a $1.8 billion buying a company, so I think that's a pretty decent size investment. I mean, just the whole idea behind buying KCG, putting aside all the expense synergies and all that type of things is, what we were trying to do at Virtu was effectively go upstream. If you will, get closer to the natural buyers and sellers, because there is a universe of bid offer spreads that buyers and sellers are paying and there are friction points in the system. So some of that that's the market maker, some of it's the exchange, some of it's the broker that sending that order. The closer you can get to that order, the more bid offer spread you can capture, right. 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 sales force to do that. We looked very closely at ourselves and said, how can we grow our FX business, our fixed income business, our equities business? How do we get closer to the end user in a way where we're not just posting bids and offers in these things called exchanges and dark pools? And the conclusion we had was rather than try to build it, given the opportunity to buy KCG at what we thought was a very fair value, let's acquired 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 potpourri, 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, right. That's a way to grow your European equities business without having to rely on posting bids and offers in exchanges and in one of 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 sales force. So we're now making prices directly at legacy Virtu through the combination of KCG to end users of -- that want to buy and sell blocks of ETF. That's exciting to us. That's a 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 a 2-sided price and bringing it to the end user. KCG has been doing this for 2 decades. So rather than try to be beat our heads against the walls 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 a firm that is exceedingly complementary to what we do and what we needed.

Your next question comes from the line of Ken Worthington with JPMorgan.

So on NTI, so first, I guess, maybe American equities, I think realized fall was up sequentially, volume and intraday fall was essentially flat. Why such a big decline in NTI in 2Q versus 1Q? And then I'll flip it around and talk about Asia, or as per Asia, that business has held up particular well. It looks like realized and implied vol has really collapsed. So I think you've gotten a little bit closer to the end customers in Asia. So why is American equities maybe not holding up particularly well. The metrics seem to be bad but not horrific. In Asia, the metrics seems to be horrific and that business is doing great. Why the divergence?

Yes. It's a great question and good observation, and the point you made at the end actually -- well, you kind of helped us through the question, which is, one of the initiatives we made in Asia, as you remember about a year ago or so was, some of our strategic relationships put it that way over in Asia with retail brokers like SBI and others that we haven't named. And so we have in that marketplace, that's 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 futures side, we've gotten closer to the end user. And so helped -- it's helped our overall performance by giving us access to natural bids and offers that were – or natural interest, if you will, that could be serviced by our bids and offers without having to necessarily compete in an open exchange for that flow. And so that's helped our Asian business, both on the equities side and then equity futures side. In the U.S., again, not to beat a dead horse, one of the reasons why we wanted to do the acquisition obviously was to get the significant business that KCG has had for a number of decades now in the retail -- with retail broker dealers in providing market-making services to their -- ultimately, to their end users and that's thing that we're most excited about. And so yes, our Americas equities business continues to suffer as we're fighting in the knife fight, if you will, kind of the exchanges and the dark pools. And that just has become -- in the quarter, it was more competitive. Joe, I don't if you have the statistics in terms of realized volatility...

Yes, I mean...

But our volumes were down actually though.

Well, I mean, Ken, when you're looking at realized intraday 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 the -- at Q2 versus Q1, I see the SP implied volatility down slightly, the realized volatility was up slightly, the intraday volatility was again -- was down meaningfully. So again, it's a just a continued poor environment.

Okay. I was hoping to get revenue for KCG in 2Q. It sounds like you don't really want to provide it. If you won't, will you help us at least frame it. We obviously know it was a terrible quarter, you'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't get the number directly, was KCG's 2Q the lowest trading income they've seen? Or was it just lower than 1Q?

Ken, again, they're not going to be filing. I would say that the results are -- the results quarter-on-quarter are similar to Virtu.

Okay. That's right. And then...

In terms of increase or decrease, directionally. In terms of percentage up, percentage down.

Okay. That helps. And then just lastly, on headcount, boy, you guys took out a lot of heads and I think the question was asked and you answered that you haven't seen impact to 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 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.

Yes -- no, it's a great question. It's a little bit of both. I mean, even before the closing, the prior management team obviously with our acquiescence and encouragement had closed, for example, the Singapore and the Mumbai office, which was -- you can look at this from some of the legacy KCG filings, Ken, was generating very, very little adjusted 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 code of 220 and 230 employees outside the United States and the business was grossly unprofitable and generating not that much adjusted net trading and the profits. Their institutional sales business has in London has always been a shining jewel of what KCG's done in Europe, and we're excited to maintain and make that business better. But in terms of, what I'll call market-making opportunities outside the United States, it was, to be blunt and abject, failure, and we took the necessary actions to shut it down even some of the pre-closing and subsequent we've done other things. So there was certainly that. And then it was just a different style of running a firm here to put it bluntly, in terms of non-revenue producing folks. As you guys know, we're pretty lean and mean here. It's -- as I always say, there's only one person at Virtu that doesn't really have a day job and that's myself. So 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 accoutrements, 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, great people that are going to move on and do other things, and we wish them well. 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, to put Alex's question before, I'm happy to invest in things. But we have to make money. That's what Virtu is all about, and 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.

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 client-facing.

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

Could you just provide an update on integration costs? And then what portion of that is cash versus noncash?

Well, there's 2 answers to that question. One is that (inaudible) most of the integration costs so far in terms of cash and noncash related charges, severance, writing off rents and leaseholds for offices that we're moving out of will not appear in Virtu's financial statements, because they were undertaken prior to close. The amount that will actually be our Virtu Financial statements are Ben is de minimis. So you're talking right now, single-digit millions.

Okay. 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?

Yes. The -- this is the AMF judgment that was – that is not final yet, but the fine was reduced.

Yes. We had originally been fined EUR 5 million. We appealed it. I mean, it was in my view as a former lawyer, wholly without any basis in fact or in law. But putting that aside for a second, we appealed it on appeal in the French Judicial System, it was reduced to EUR 3 million, so we reversed the EUR 2 million as a result of that. And we have further avenue to appeal, which we will, because to me it was just a absolute political railroading by the French system, it had absolutely no basis in French law, so we're going to fight it and not pay it.

And just maybe lastly just an update on MiFID preparation there, if you're seeing any impact from efforts around last-minute changes.

Yes, great question. Obviously, it's great to have been there for a while and be in Ireland and not to worry about Brexit. Now that we've got London, we're going to deal with that. But putting that aside for a second, MiFID to me is one of the most exciting tailwind type of regulatory changes that could impact Virtu. As I talked about before, this notion of the systemic internalizer and Virtu has already 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 -- 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 in -- obviously in Unites States in a post-MiFID unbundled world is exceedingly exciting. We think one of the great strengths that Virtu had on the agency side with our offering was superior execution quality but also transparency into how orders were routed and whatnot. 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, and I don't think this has been as reported as much as it should have been in under MiFID II and ETF will be viewed as a covered instrument or covered security, no longer as 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 sales force. Now actually, we have a sales force and we've got block trading capabilities here in the United States. So those 3 things really combine to, we think, create -- hopefully will create a lot of value for our combined firm. In terms of preparation, at legacy Virtu, we're already MiFID II compliant and the KCG legacy business was well on its way. So we won't have any problems meeting the January 3 deadline.

And then just lastly, are there any capital requirements related to that? Or are your preparation's there?

No, I mean, we're at steady-state capital already in Europe. So there won't be -- in fact, there'll be capital synergies, right, because we've 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.

I would now like to turn the call over to Douglas Cifu for closing remarks.

Okay. Is there any other questions?

No.

Okay. Just wanted to make sure there are no other questions. Thank you, everybody, Obviously, we're excited about the integration. A lot of stuff going on here in Virtu. It's only been 3 weeks. I would like to emphasize again that the cultural similarities between these firms and the 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 that have been here for long time, we came in and as a great unknown and they've really embraced our firm and it really is already feeling like we are 1 combined firm. So I'm really very, very excited about the future as I think the hundreds of great employees 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 in late October, early November. Thank you.

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