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Edited Transcript of VIRT earnings conference call or presentation 5-Nov-19 1:30pm GMT

Q3 2019 Virtu Financial Inc Earnings Call

NEW YORK Nov 17, 2019 (Thomson StreetEvents) -- Edited Transcript of Virtu Financial Inc earnings conference call or presentation Tuesday, November 5, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexander M. Ioffe

Virtu Financial, Inc. - CFO

* Andrew Smith

Virtu Financial, Inc. - SVP, Head of IR & Corporate Strategy

* Douglas A. Cifu

Virtu Financial, Inc. - CEO & Director

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Conference Call Participants

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* Alexander Blostein

Goldman Sachs Group Inc., Research Division - Lead Capital Markets Analyst

* Christopher John Allen

Compass Point Research & Trading, LLC, Research Division - Analyst

* Daniel Thomas Fannon

Jefferies LLC, Research Division - Senior Equity Research Analyst

* Kenneth Brooks Worthington

JP Morgan Chase & Co, Research Division - MD

* Kenneth William Hill

Rosenblatt Securities Inc., Research Division - Senior Research Analyst

* Michael J. Cyprys

Morgan Stanley, Research Division - Executive Director and Senior Research Analyst

* Richard Henry Repetto

Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to Virtu Financial 2019 Third Quarter Results Conference Call. (Operator Instructions) Thank you.

I would now like to turn the conference over to your speaker today, Andrew Smith, Senior Vice President, Head of Investor Relations and Corporate Strategy. Please go ahead, sir.

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Andrew Smith, Virtu Financial, Inc. - SVP, Head of IR & Corporate Strategy [2]

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Thank you, Jacqueline. Good morning, everyone. As you know, our third 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. 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 upon 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 annual report and Form 10-K and other public filings.

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. Non-GAAP measures should be considered as supplemental to, and not as superior to financial measures prepared in accordance with GAAP. You'll find a reconciliation of these non-GAAP measures to the equivalent GAAP term in the earnings materials, with an explanation of why we deem this information to be meaningful as well as 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 expense, and all brokerage clearing and exchange rebates and/or fees.

Speaking and answering your questions today are Mr. Douglas Cifu, our Chief Executive Officer; and Mr. Alex Ioffe, our Chief Financial Officer. They will begin with prepared remarks and then take your questions.

I'd like to turn the call over to Doug.

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [3]

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Good morning. Thank you, Andrew. Thank you also for joining us today. Today, I'm very pleased to report our financial results for the third quarter of 2019. While the third quarter was punctuated with periods of volatility and uncertainty across the global markets, on the whole, the market environment was similar to the second quarter. Despite this backdrop, both our Market Making and Execution service segments, were able to capitalize on some episodic volatility and otherwise performed in line with our expectations. In short, our results reflect our continued disciplined focus on achieving and executing on our strategic and sustainable growth initiatives across both our business segments.

In my remarks today, I will highlight the exciting progress we've made in the short 8 months since we closed the ITG transaction on March 1, and discuss our strong performance in spite of the muted opportunity in the quarter.

Looking first at the integration and product enhancements. While much runway lies ahead, let me tell you about the distances we've come. Most importantly, client feedback has been overwhelmingly positive and constructive. We continue to receive support and constructive feedback from our global institutional client base, as we invest in our global-scaled platform to accelerate our sustainable growth and offshore opportunities. These opportunities include initiatives that we previously discussed, like re-platforming and improving the latency of our alert block crossing product, re-platforming and enhancing our global EMS, Triton, and bringing true multi-asset class capabilities to the new Triton platform as well as new initiatives like our new FX and fixed income modules for our analytics toolkit and our recently announced execution, concierge service outsourced trading offering.

I'm pleased to tell you that in the 3 months since our last call, we have begun to deliver on each of these initiatives. Alert is a better functioning and less latent platform. Clients are seeing the benefits from the Triton enhancements we discussed on the last call. With over a dozen clients already migrated to the new Triton Valor platform, and our first FX trades recently completed from a Triton EMS.

Although it is still early days, client feedback is highly complementary. Our recently announced FX and fixed income analytics modules and our entry into the outsourced trading business with our Execution Concierge Service are both great examples of leveraging our unique position and capabilities to find incremental ways to deliver value to our clients and generate sustainable organic growth.

Keeping with that theme, today, we are announcing the launch of Virtu Capital Markets, which will provide select capital market services, including at-the-market offerings and corporate buybacks to issuers. I'll discuss the details further in a moment, but the idea is consistent with our strategy of leveraging our core market structure expertise, global technology platform and distribution network to deliver efficient and transparent products and solutions to the market.

Now turning to our specific results. Looking at our Execution service business segment, our average daily adjusted net trading income increased 1% versus the prior quarter, which is reflective of the growth we have been focused on achieving. This growth is especially impressive given the relatively challenging environment.

Specifically, noting that global equity volumes were flat to negative compared to the prior quarter and considering the global commission wallet trends, the outperformance of our Execution service business segment is a strong testament to the value our clients place on the product and services we provide.

As a reminder, our Execution Services segment includes our execution brokerage, workflow and technology and our analytics business. As we outlined on our previous quarterly updates, we have identified $25 million to $50 million of opportunities from leveraging Virtu's best-in-class technology and operational expertise to enhance and expand the legacy ITG products, and we're already seeing some of those benefits in Q3.

As you know, the third quarter represents only the second full quarter of our operations as a combined Virtu and ITG organization. However, we have made significant progress integrating our businesses as well as identifying and capturing meaningful revenue synergy opportunities.

Building our leadership position and workflow automation products continues to be a priority at the forefront for Virtu. Specifically, our multi-broker and multi-asset class EMS, Triton, is the engine at the nexus across our complete suite of products and services. We are encouraged with the growth we've seen from new and existing clients choosing to integrate more of our products into their daily operations.

In today's supplemental materials, we have highlighted how clients have embraced the launch of analytics portal, our [FX] and Fixed Analytics modules and are beginning to migrate to Triton Valor.

As I've mentioned briefly, we are launching today Virtue Capital Markets to provide select capital market services for issuers, including at-the-money offerings -- at-the-market, excuse me, offerings and corporate buybacks.

In the same way that our entry into the outsourced trading space was a natural extension of our native capabilities to provide more services to our client base, Virtu Capital Markets, likewise, leverages our unique position and core market structure expertise, technology platform and our broad global distribution network to deliver efficient and transparent products and solutions to the market.

ATM offerings are a useful tool for a public company in any sector that is looking to raise equity capital. As with other parts of the financial services ecosystem, there has been an increased focus on the cost and efficiencies of the capital raising function of the marketplace, as witnessed by the recent increased focus on direct listings as a more efficient alternative avenue for initial public offerings. An ATM offering provides efficiency at scale to an existing public company seeking to raise equity capital.

As with other new initiatives, we are applying Virtu efficiencies and expertise to enable us to engage with a growing sector in the capital markets. As the leader in providing trading technology and liquidity to the buy side and sell-side, the new Virtu Capital Markets business will allow us to offer those same core strengths to public companies through the ATM structure. Virtu Capital Markets is led by Jeff Lumby and Joshua Feldman, both of whom have extensive records in the ATM space over the last 2 decades and were attracted to Virtu's global execution platform, distribution and capabilities.

Looking at our Market Making segment, this quarter is a great example of how the strength and sustainability of Virtu's global diversified financial technology-driven market making operations continues to perform in any environment.

Overall, while realized volatility of major indices was mostly up, global equity volumes were flat to down, and retail engagement indicators, like OTC volume, lagged or flat. In short, this quarter presented a mix of challenges and reduced opportunities for market-making.

However, despite these conditions, we outperformed, largely enabled by 2 factors: first, our efforts to increase our global reach has helped us grow our addressable opportunities; and second, our efforts to improve our capture rates have helped improve our yield on existing opportunities. This is largely driven by continued deployment of, and integration with, Virtu trading technology of ex-KCG and ex-Getco quant strategies, continued success of our ETF block desk and our early wins from our growing options market making presence.

We are constantly working to increase the addressable opportunities across the firm. This is especially true with our market-making business segment, where we are uniquely able to scale existing strategies to previously untraded products and markets as well as develop new strategies, building on our knowledge and experience with global markets.

This quarter's market-making results reflect meaningful contribution from strategies both derived from legacy Knight and legacy Getco strategies and brought to new markets using Virtu technology and new strategies that combine the best of Virtu Getco and Knight.

Revenue synergies that we have previously discussed on the call are exactly these strategies, and we estimate that the 2019 adjusted net trading income run rate of these revenue synergies is approximately $40 million.

Since the Knight acquisition in mid-2017, we have been working to grow our capture rates through improving our internalization. Internalization is an essential function of competitive market making as it creates opportunities to retain the bid-ask spread and reduce transaction costs. To this end, we've recently merged the legacy Virtu broker-dealer with the legacy Knight broker-dealer. Not only was this 1 of the last major hurdles, limiting how much we could interact within our firm, but merging broker-dealers has allowed us to free up approximately $100 million, $50 million of which we used to repay our term loan just last week.

This quarter's performance also demonstrates how quickly Virtu teams can mobilize. On our last call, we mentioned our efforts to organically grow our options market making and customer-facing ETF block desk. Our ETF block desk results for 2019 year-to-date already 31% above our full year 2018 results. Our options market making is off to a very strong start as well, earning several million dollars more in the third quarter of 2019 than we did in all of 2018.

In today's supplemental materials, you can see how the technological advancements we've made have allowed us to grow our options market-making presence. Our customer-facing market-making unit continues to deliver essential liquidity and price improvement to customers. We, of course, have been keen observers around the recent announcements by some of our valued clients of their move to 0 commissions for their clients in U.S. equities. These cost reductions speak volumes about the efficiency and transparency our retail partners and Virtu, together with the other great market making firms, have brought to the U.S. equities market for retail investors.

We are proud of the role we have played in this ecosystem and the value we provide to U.S. retail investors in partnership with over 200 retail partners. For example, in the third quarter, Virtu provided over $80 million in price improvement better than could be obtained on any exchange to the end investor. Retail investors have never had it so good, and we should all be proud of this ecosystem.

Before I introduce our new CFO, Alex Ioffe, I'd like to comment on how very proud I am of the enhancements and integration progress we've made to date, and I am very optimistic for the future. Our teams of new and veteran Virtuans have come together to make meaningful progress towards our strategic initiatives to leverage our global scale technology platform and deploying advancements to our clients across our suite of products and services.

Now I am pleased to introduce our new Chief Financial Officer, Alex Ioffe, who many of you already know. Alex is a 25-year veteran in the electronic brokerage industry, previously serving as a senior executive at Interactive Brokers, and we look forward to benefiting from his deep experience and leadership.

Now let me turn the call over to Alex. Alex?

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [4]

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Thank you, Doug. Good morning, everyone. It's good to be here. Our GAAP results for the third quarter revenues of $385 million, net loss of $4.1 million and diluted loss per share of $0.04. Normalized adjusted EPS, removing onetime integration costs and noncash items, was $0.21 compared to $0.16 in the prior quarter. The prior quarter was the first full quarter after the ITG acquisition and a relevant basis for comparison.

We closed the ITG transaction on March 1 of this year, and I will provide details on the financial progress of this integration in a few minutes. Adjusted net trading income, which is our trading gains, net of direct trading expenses, was $250 million in the third quarter. That is 4.5% better than the last quarter, driven by a 3% increase in the average adjusted daily net trading income, which rose to $3.9 million and 1 additional trading day in the third quarter. Within that, our Execution Services segment was 43% of the adjusted net trading income and market-making was 57%.

The addition of ITG helps improve the consistency of our results. A substantial part of the Execution Services trading income, which has recurring subscription income components, came from the business lines acquired from ITG. As Doug described in detail, we are enhancing legacy ITG products by leveraging existing Virtu capabilities to modernize the underlying technology. Improving latency for Alert products, adding multi-asset capabilities for the Triton EMS and new features to put analytics products.

We are also extending our product set to field the needs of institutional clients by: one, utilizing our existing capabilities with what we call Execution Concierge Services, which is outsourced trading desk; and two, adding new capabilities with Virtue Capital Markets.

Our goal is to leverage our technology and market knowledge to bring together complete offerings to our institutional customers, growing the agency and recurring revenue streams.

Switching over to debt. At the end of the third quarter, we refinanced $500 million of our outstanding notes to take advantage of a favorable interest rate environment. This transaction closed on October 9. The interest rate was reduced from 6.75% to 4.8% or 195 basis points lower, fixed for 5 years, and we extended the maturity of this debt from 2022 to 2026. This will reduce our interest expense by approximately $8.6 [billion] per year.

The interest rate environment continues to be favorable. And attention bankers, we are evaluating options for additional optimization of the $1.5 billion in floating rate term debt maturing in 2026.

As Doug mentioned, after the end of the third quarter, we prepaid $50 million of outstanding debt. However, we included $10 million of accrued interest in the refinancing of the $500 million notes. Consequently, the net debt paydown since the third quarter was $40 million.

Adjusted EBITDA for the third quarter was $104 million. Net interest expense was $34 million. Debt to trailing 12 months EBITDA stood at 3.4x.

Integration with ITG is proceeding well. Through the third quarter, we realized $96 million of synergies or 72% of the original target $133 million. For the full year, we expect to realize $134 million in expense synergies or 101% of the original target.

To be fair, on the last quarterly call, we raised total synergies target from $133 million to $167 million, a 25% increase. We are on track to achieve total synergies of $167 million, midpoint of the higher second quarter guidance, or better by the end of 2020.

As we are working through the integration, we think $10 million better or $177 million in savings is reasonable. This would put us on an operating expense run rate of $156 million for the quarter compared to a premerger combined run rate for Virtu and ITG of $200 million per quarter.

I would like to point out that the $200 million quarterly expense run rate was already reduced for Virtu as a result of synergies from the KCG acquisition.

We continue to be within the expense guidance range for 2019, but we are at the higher end of the range. This is mostly due to do with timing and does not impact 2020 projected savings. The 2 main components for the timing were: sub leases for the space that is no longer needed, and the timing of staff reductions, which reduced the expense run rate in future periods.

Finally, we declared a customary $0.24 dividend for the quarter, which will be paid on December 16. Now I would like to turn the call over to the operator for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Rich Repetto from Sandler O'Neill.

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Richard Henry Repetto, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [2]

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I guess, my question is on the global FICC options and other. I mean, strong outperformance, it was up 39% quarter-over-quarter. And I guess, could you go -- give us a little bit more specific details on the outperformance in that segment?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [3]

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Yes. Thanks for participating, Rich. Yes, a couple of things. One is, during the quarter, I mentioned in my remarks that there was periods of episodic volatility. So we had, during the quarter, a spike in energy volumes and energy volatility, for example, thanks to some upheaval in the Middle East. And so there were events like that.

On the organic front, I mentioned in my remarks as well that like our options, market making business has started to perform. There were some good opportunities in the quarter. And as well on the ETF side, there's significant opportunity traditionally in fixed income. And so that gets classified in that area. So we've become, as I mentioned on the last call, we are now a participant -- excuse me, in credit in 2019. So we're seeing opportunities, both on the fixed income ETF side, but also on the credit side. So it's really a combination of those.

If you look at the volatility on energy, for example, in the quarter, I think it was up something like 280%, although the CME volume was down. There was that brief period of time, I think it was in September, when you really saw WTI and CL spike in terms of volatility. And that's kind of the virtue story, right? We're there to capture volatility and provide two-sided prices. During times of stress, we continue to trade during that very serious geopolitical event and it resulted in some nice P&L pickup.

But also, I would stress the organic growth of our options business and our block ETF business as well, Rich.

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Richard Henry Repetto, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [4]

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Got it. So it seems like you're pretty positive on -- I should have -- I'm remiss in not asking a sort of the outlook. But I do want to do my 1 follow-up on a different topic, but it's a 0 commissions. And just trying to get a feel for the communications with the ebrokers, I know some have expected that did -- the -- some efforts to try to increase payment for order flow -- excuse me, versus price improvement, et cetera. And I know your margins are very thin now. And then what you're seeing since these -- the cuts went into effect in the beginning of October?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [5]

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Yes. I mean, I'll speak very generally. I never talk about a specific customer publicly. And obviously, I'm not going to do that here. But I think generally, here's what I would say. I view this move towards 0 commissions as just part of a larger mosaic that we're seeing in the financial services market around efficiency and scale. And this is what we -- Vinnie and I preached this from when we started Virtu in 2008, and we are still seeing from the same sheet of music, which is if you are scaled and efficient, you will do well. And customers, whether they're retail or institutional or otherwise, are going to demand efficiency and scale to your business. And so this is just a natural to me evolution of the market, and it is made possible by the good services of Virtu Financial. And to give them credit, Citadel, Susquehanna, Two Sigma or other great firms that our wholesalers or market makers, in what we refer to as the 605 space.

So I think -- and you know this, but the lion share of what we provide, and I mentioned it in the script, is price improvement. So that means that we are actually providing a price that is better than the national best bid or best offer back to the retail end user of the 200 or so retail brokers that we do business with.

We provide price improvement to every retail broker that we do business with, period, end of story. There are some of them that, in addition to that, will take a rebate from us, right, as part of our interaction with them.

Everything is fully disclosed. Everything is fully transparent. We don't have customers that are sending us orders based on the size of the rebate. We are competing with those aforementioned market-making firms based on our ability to provide price improvement.

So I look at this move towards 0 commissions as further support, if you will, for the efficiency and the service that Virtu, and our competitors are providing in this ecosystem, and this ecosystem works incredibly well.

So for me, it really sort of buttresses our belief in that business. But obviously, Rich, there's only -- we run a great business here. We provide a lot of value back, but there's only so many eggs in the basket. And so if our customers want to engage in the discussion about how those eggs should be allocated, we're obviously open to that discussion. But certainly, we're not creating more eggs at any time. And so at the end of the day, I think this is ultimately a strong positive for the value that we bring and our competitors bring to the ecosystem.

As I said in the script, I think it is amazing. The benefits that have been brought to a retail investor to think that in 2019, you can go on a terminal or a handheld and literally for $0.00, get a price in a large-cap or medium-cap or small-cap name that's better than you could get on any exchange is just an incredible endorsement for the ecosystem that we've all created. I'm very proud of our role in that ecosystem.

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Operator [6]

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Your next question comes from Alex Blostein from Goldman Sachs.

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Alexander Blostein, Goldman Sachs Group Inc., Research Division - Lead Capital Markets Analyst [7]

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So Doug, maybe building on that last point, you talk about efficiencies and scale becoming increasingly important. And we can debate whether or not payment order flow, pricing will go up because the brokers need to make money somewhere. But if they do -- if that happens, how does it change your M&A opportunity set? Because it feels like there will be other small players that could feel incremental more pressure. So as you kind of evaluate the landscape over the next couple of years, how big of a driver do you anticipate M&A to be for Virtu?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [8]

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Yes. Thank you, Alex. I mean, I think, first of all, just a follow-up on the 605 theme, and these are all public statistics. And since I'm saying now they're (inaudible) public, but our market share in 605 land, particularly with regard to marketable orders in September, was up over 200 basis points, right? So obviously, we're doing something right in terms of providing both a good service and a good price to, as I said, the 200-odd retail partners that we do business with. So we're committed to that business. We think it's a great business. It's a long-standing night business that we've been privileged to inherit. And I think we've made it better and more streamlined.

There's a larger theme here, Alex, which is -- and it's -- you see it on the institutional side, I'm not going to name names, but you know the large institutions that have either gotten out of the equities business or scaled back their infrastructure in the equities business because commission rates aren't going up, the pool is going down, right? And so there's these large seismic shifts that are going on in the marketplace. And all the big, small, medium-sized broker dealers are trying to deal with it.

I think the most important theme, and this is what we've been stressing, frankly, since we started Virtu, but this was the theme behind the acquisitions of Knight and ITG is that we're going to build a truly scaled and we have the ability to build a truly scaled, really efficient firm that can provide prices. We can provide those prices as a principal, we can provide those as an institution. And on top of that, we can provide really a adroit-skilled -- scaled, excuse me, financial technology products like Triton, like analytics, like Alert, like RFQ Hub, et cetera, et cetera.

And so too, the efficient firms are going to survive, firms that have legacy costs and aren't scaled and aren't asset class and can't provide principal prices and institutional prices, I don't think are going to survive, right? They're going to be forced to do something different. They're going to be forced to take more risks. They're going to be forced to combine. And so we're going to be a natural landing place for a lot of those firms.

One of the reasons I brought my friend, Marc Rosenthal into the firm, was because we were being inundated by opportunities, and I needed a smart guy to help us navigate that path as to where the firm can find opportunity. And so what I have said before, I will restate is the continuum of pre-trade to post-trade is now available to Virtu, right?

We provide pre-trade analytics, we provide post-trade analytics, settlement and clearing, everything in between, other than being an exchange is something that we have skill in, we have financial technology that can address, and we think we can provide a service offering.

So to the extent there are firms that we think can supplement that, right, or add to that either geographically or through a product or something they develop, sure, we're willing to take a look at it. But this is not just an M&A machine, right? There's a lot of great organic opportunities happening around here.

One of the things we'd highlighted today was our Capital Markets initiative. 2 great guys came to me. I candidly had no idea what the ATM business was. I thought it was a cash machine to begin with. And when Jeff educated, Jeff Lumby educated me on it, and I said this is a natural fit to Virtue.

He saw it as an outsider. Give Jeff all the credit in the world. He's a brilliant guy. He's a pioneer in this business. He said, "I want to come to your firm, because your scale, because you've got your own liquidity, you've got tools, you've got -- you're not conflicted in the sense you don't have research, and you don't have brokers, you can really provide great service to these corporate issuers.".

I'm not the smartest guy in the world. When a smart guy like that comes to you, the lightbulb went off and said, boom, this is a natural for our firm. So that's the -- I know I've kind of meandered, Alex, but I wanted to give you a sense strategically where this firm is positioned in the middle of all that and how we're going to grow.

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Alexander Blostein, Goldman Sachs Group Inc., Research Division - Lead Capital Markets Analyst [9]

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Got it. And my follow-up, and I guess, speaking of cash. So the Capital Markets business that you guys have announced today and the initiatives that are kind of taking place there. How meaningful a revenue contributor do you expect these to be over the course of the next, call it, 12 to 18 months? And does that at all impact the balance sheet intensity or sort of capital utilization of the business that might impact your deleveraging plans and buybacks, et cetera?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [10]

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Yes, that's a great question. Thank you. Look, the answer is, each of these things individually are nice businesses. In the aggregate, they're significant, right? That's really what we're talking about. So our ETF block business has grown 31%. We're now a meaningful options market maker. I've said that the revenue synergies, I said today, are on a run rate for $40 million this year, right?

The ATM business, we have it in our supplemental materials on Page 8, we're showing you the size of the opportunity, right? I'm not suggesting we're going to have double-digit market share, there's a lot of great competitors in this business. But again, it can be a meaningful business. Jeff and Josh, have done this for a long time, right? So all of these things are additive to the opportunity set.

The key point is that the -- we have all the infrastructure, right? So we -- sure, we had to bring Jeff and Josh and a couple of other talented folks into the firm because they had subject matter expertise that we did not have, but all of the accouterments that they needed are here, they're here. So there's no incremental investment that is needed.

On the capital side, we're acting as a conduit, as an agent, if you will. So there's really no incremental capital for the ATM business other than obviously having a self-clearing broker-dealer that has full distribution capability. We already have that.

So all of the things that we've talked about, Execution Concierge Services, the ATM business, even the options making on the ETF business, that's all done within the structure of our broker-dealer, which, as we announced on the call on the -- as part of the script, we've merged all of our broker-dealers. So we've brought even more capital efficiency there.

So we just paid back $50 million last week. We announced our dividend. So we're on plan for our deleveraging and maintaining our dividend, while at the same time, trying to grow the firm.

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Operator [11]

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Your next question comes from Ken Worthington from JPMorgan.

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Kenneth Brooks Worthington, JP Morgan Chase & Co, Research Division - MD [12]

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Maybe first, and along those lines, you mentioned the merger of the KCG and Virtu broker-dealers. You paid down the $50 million of debt. What are you considering for the other $50 million? Are there more capital efficiencies that can be freed up from the ITG acquisition? And then with this merger of the broker-dealers, are there any other benefits that you expect to see, either on the trading side or expense side that come from the integration?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [13]

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Yes. No, it's a good question. So you're correct. We are migrating clients from the ITG broker dealer, whose name I forgot, into this large Virtu broker-dealer. So at the end of the day, we will have, in the United States, one large-scale broker-dealer that acts as both as a principal and agent with different [ag] units and all that stuff that you know very well.

So we are bringing efficiency. With regard to the other $50 million, it's in the broker-dealer today, right? So we're going to...

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [14]

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You're absolutely right, Ken. It freed up a little over $100 million altogether. And we're keeping the other $50 million in the broker-dealer.

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [15]

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Yes, for the time being and just to see kind of -- yes, to see how it kind of plays out. So our capital needs, Ken, haven't changed dramatically, right? So if we put on a larger position here and there. You know the business. We explained it to you. We have flexes where we need to have flex funds effectively available to satisfy those.

But in terms of getting into some new business lines, where there's a dramatic need for incremental capital, that's not in my DNA, right? We're not changing the DNA of what the firm is about. We're just trying to create as much internal efficiencies. And having 2 or 3 broker-dealers with separate RBH and with separate compliance and audit requirements just didn't make a lot of sense from our perspective. And so that's why we're doing -- we're mushing it all together.

You're going to see that globally. The most important thing, though, operationally, from the convergence of these broker-dealers is internalization. I don't think people understand how important that is and how candidly good at legacy Virtu was at that. We built our firm and our financial technology on the basis that everything can and should be internalized, applying that financial technology and that DNA and that rigor now to the Knight and even the ITG business is monumentally important.

It's not just exposing the order or the intention to the marketplace, it's the friction and the cost of doing that. So if we can internalize more flow, we're going to reduce our brokerage commission and exchange line, which we never talk about, right, because we always talk about everything in terms of net trading, right? But we make a lot of gross P&L, and we pay a lot of it back to exchanges and to brokers. If we can reduce that, that just creates more net trading opportunities for the firm.

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Kenneth Brooks Worthington, JP Morgan Chase & Co, Research Division - MD [16]

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Okay, great. And then on the net trading revenue, net capture were both under pressure this quarter. I know there's a lot of moving pieces, some things are better, some things were worse. What I was hoping to do is dig a layer deeper on the 1 or 2 factors that may be helped for the quarter. And 1 or 2 factors that may have hurt for the quarter.

You had mentioned volatility being better, but OTC volume being lower. Could you go a step further or a layer deeper to help us better understand maybe 1 or 2 of the positive things, and maybe 1 of the 2 of the negative things that had the impact this quarter?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [17]

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Yes, I'll give you the positives. And when we talked about -- I mentioned in the script already or answered to Rich's first question, which is there were some opportunities in the energy complex this quarter where you saw a big spike in volatility. That just, by definition, is going to enhance your capture rate. And then there were some China volatility, some Trump Tweet-related volatility. Those are always going to be positives.

I would say the ETF block business, as a capture rate, Ken, particularly globally, is a positive to our overall capture rate because it's more segmentation and bespoke liquidity we're providing directly to counter-parties, right? So you're going to, by definition, you're taking more risk and you're providing a better service, so your capture rate is going to go up. So those are the positives.

I would say the pressures and these change quarter-by-quarter is when you have the U.S. equities volume that is flat, and it was coming off a quarter that was not a great quarter. And you have -- volatility goes up, but you really -- you went from an $11 and change realized volatility to a $15 and change realized volatility, although on a percentage basis, that's meaningful as an absolute matter, it's really not that meaningful, right? So you continue to see pressures there.

And then as you mentioned, the two indicia that we look for is interactive brokers numbers because they give you a per share number, but also the OTC number that you alluded to. I think it was down like 10-ish percent in the quarter.

So just the addressable opportunity is going to contract when you see those types of metrics. And so those are the positives weight against to the negatives. And I think the wash here was a directionally positive quarter in that we performed better. But obviously, we think there's enhancements in organic growth, and we continue on.

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Operator [18]

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Your next question comes from Ken Hill from Rosenblatt.

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Kenneth William Hill, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [19]

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First question, I guess, is on the dividend. You talked about some of the capital gives and takes during the quarter. But 5% to 6% dividend yield is still really attractive. Just curious, despite that really attractive dividend yield, you don't tend to get a lot of credit for that in the stability of the shares. Do you guys ever kind of reconsider that given the ownership structure as far as maybe reallocating to other areas via repurchases? Or other kind of growth areas that might add to the revenue kind of enhancement over time? Just curious to get your thoughts there.

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [20]

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Yes. No, it's a good question. I mean, obviously, you could probably answer better and your colleagues that are asking me these questions could probably answer better why we don't get that credit. I have -- we've paid a dividend, you can have (inaudible) to verify this since 2009, right? And I'm a very large shareholder, and we will continue to pay a dividend as long as I have anything to do with it. I've told people I would sell this lovely table that I'm sitting at before I would cut the dividend. That's how impassioned I am about it because I think it's my job.

My job is to return capital to my investors, my partners that I started the firm with and now the public shareholders, and that's what we do here. We do not need to add incremental capital for our growth initiatives. That's one of the core strengths of Virtu. That's one of the continuing themes that I'm always going to hammer on, which is we've built this fixed cost plant that scales exceptionally well. We can add the Capital Markets business, Execution Concierge Services. We have chosen not to go after the spectrum of risk, which requires more capital because that's not in our DNA.

Ultimately, we're a market-making firm, we're not a hedge fund. There's nothing wrong with being a hedge fund, but that's not our business. If you want to run a hedge fund, you need billions of dollars of capital. If you want to run a market maker, you need billion dollars of capital. It's not risk capital, it's facilitation capital. That's the most important distinction that I've always tried to make.

So all of the income investors out there, yes, they should buy a Virtu. It doesn't make any sense to me. When the Fed's reducing interest rates and you can get a 5.5%, 6% return from what I think is a growth stock, it makes a lot of sense. But again, I'm not great at apparently convincing public investors because you're right, that narrative seems to have been lost in the weeds.

There was a second part to your question, which I got excited about the answer that I've forgotten. Did I answer your question, Ken?

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Kenneth William Hill, Rosenblatt Securities Inc., Research Division - Senior Research Analyst [21]

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Yes, you answered as far as where you're allocating capital and dividend strength there. The second question, I guess, I have is on Execution Concierge Service. You just recently launched it in October. I was hoping to get an update on what kind of indications of interest you're hearing from folks? And just anything more broadly about the October environment that you care to share?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [22]

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Yes, that's a great question. Yes, look, I mean, we've -- subsequent to the announcement, there was a nice press release, and we got some good press on it, which was great. We were inundated with inbound. And Jack Polina, who runs the business long term of ITG, fellow's been here over 20 years, has been out and about. We have signed our first customer. We announced that last week, right? And so the profile of a customer runs the gamut of your small to midsized firm that is thinking about outsourcing, either the entirety or a substantial portion of the trading desk because of cost concerns, right, that's a natural, we're all feeling it, right?

Again, the theme of efficiency and scale. If you're an asset manager, what are you great at? Well, you're great at hopefully generating alpha and distribution of that product. You don't need to be a subject matter expert in trading. Let the subject matter experts, i.e., Virtu do that for you. And as well, larger institutions that are looking to outsource perhaps part of what they do internationally.

Let's not -- I trade, 20% of my book in Asia, I don't want to set up a Hong Kong office. Virtu, can you do this for, of course, that's a solution. So I think, again, from our perspective, the incremental cost of Virtu getting into that business was effectively 0, right?

We had a commission management business that's been led by a great project for the last 20 years. We, obviously, know how to trade and we got algos and we've got connectivity. We own ITG nets so we're connected to all the brokers. We're completely non-conflicted. So you don't have to use a Virtu algo. You don't have to sell a Virtu product. This isn't about research or investment banking, it's about giving you the opportunity to execute through whoever you want at a low-cost and the most adroitly that you possibly can globally. And we think we can provide that service at a per unit cost that is competitive with anything on the street because our incremental cost of providing that service is effectively 0. That's the theme.

Using our assets, using our scale, using our technology to provide really good products and services that individually may not move the dial, but collectively, they're going to start pushing this dial to the right.

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Operator [23]

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Your next question comes from Dan Fannon from Jefferies.

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Daniel Thomas Fannon, Jefferies LLC, Research Division - Senior Equity Research Analyst [24]

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My question is on the regulatory front. Last year, the kind of exchange market data, kind of was a focus of Virtu. If you think about the next kind of 12, 18 months. I guess, can you talk about the 1 or 2 areas you're most focused on?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [25]

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Yes, good question. Yes, I mean, I think the -- and I haven't mentioned this before on calls. But I think one of the offshoots Dan of this race to 0 around commission is 605 reform.

We've been -- I've been beating the drum probably a little too quietly, and I'm generally not a shy guy, so we're going to start beating the drum a little bit louder. In terms of really when a market maker can provide best service to an end user is when the end user is willing to segment flow in a way that makes sense, right?

So not all retail flow is the same, not surprising. A 200 share order for mid-cap stock is very different from a 9,000 share order for Amazon, right? Everybody would agree, and it's a lot more challenging for a market maker to handle that 9,000 share order.

Under Rule 605, which was created before there was an Amazon, before the company even existed, right? That's how antiquated it is, if you will, right? Those 2 orders are kind of handled the same way. And we provide price improvements to each of those.

I don't think that, that makes a lot of sense. Like I was a little bit of a newcomer to this industry, as you guys know. And looking at that, I say, that doesn't make a lot of sense. So we have been quietly working with our partners in terms of trying to create a more sensible way to segment flow. And I think there's a regulatory solution and Virtu is going to go public with some of our thoughts around that because we want to be a thought leader there. I think that's an important way to make the industry better and ultimately, send that price improvement to an end user that is probably a little more akin to a retail investor than to an institutional investor. I think that's 1 area of intense focus.

In terms of some of the other regulatory items around Market Data and Connectivity, I think that's -- obviously, there's litigation going on in Washington. So that's kind of grind to a halt. Same with the access fee pilot because there's such animus right now.

Obviously, we've been at the center of a little bit of that maelstrom, and we did that for the right reasons. But I think ultimately, our main priorities are going to be around 605 reform for the next 6 to 12 months.

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [26]

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And 0 commissions with additional incentives for that to go forward.

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [27]

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Yes.

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Daniel Thomas Fannon, Jefferies LLC, Research Division - Senior Equity Research Analyst [28]

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And then just to follow-up on expenses. Alex, you mentioned some of the moving parts with regards to kind of the synergy expectation of the lower half for this year versus next. I guess, as we think about a revenue environment that continues to be not as constructive, what are the levers that you have to kind of pull forward or reduce kind of expenses, particularly as we think about kind of 2020 in that baseline level of kind of investment or trajectory of expenses that you might have?

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [29]

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Well, the biggest levers we have is really continuing to consolidate companies. The ITG integration continues and should be in very good shape towards the end of 2020 to get the most bank in terms of synergies and reduction in expenses.

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Daniel Thomas Fannon, Jefferies LLC, Research Division - Senior Equity Research Analyst [30]

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Okay. I guess, just -- is there anything in specific? You talked about, I think, some duplicate rent or sub sublease stuff like, is that we should -- is that just timing associated with the end of this year? Or anything else?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [31]

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Yes. I mean, I think, I mean, I've been here long enough. So I'll take the blame for it. I mean, some of the sub -- we have a lot of real estate. I used to kid with Joe Molluso, our former CFO, it feels like sometimes I'm running a REIT, right? Because we bought these 2 companies, and they were very long offices.

And so we had a lot of space here in New York, our building, at 300 Vesey, if anybody's interested, we'd be happy to sublet one of the floors. They've been hard to sublet. And under the GAAP rules, you can't take some of these write-offs until you actually have a sublet. And so part of that's been my issue or the marketplaces issue in terms of how that happens. We just need a dance partner for some of these, Dan. And then some of it is once you get in here and look at what the runoff is from technology licenses and data centers and things like that, it sometimes can take longer.

So to Alex's point, which I will let them finish in a second, is that ultimately, at the end of this -- in 2020, we come out the backside, a very scaled firm, the timing of it was a little bit nuanced and some of it has slipped slightly.

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [32]

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Yes, Doug is absolutely right. And also, practically, if you think about acquisitions, your first set of improvement is -- comes quickly. And then you have a bit of a lull in the middle as you're lining up the next set of big things, right? So that's why the timing is shifting a little bit. It's not a linear, straight line thing.

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Operator [33]

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Your next question comes from Chris Allen from Compass Point.

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Christopher John Allen, Compass Point Research & Trading, LLC, Research Division - Analyst [34]

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I wanted to kind of revisit the leverage targets you guys talked about still on the path to achieving those. Does that contemplate an improvement in the environment? Because, obviously, you have a very good fourth quarter of '18 rolling off, and we're turning kind of in the wrong direction at present.

And obviously, you get some benefits from synergies moving forward. But if we see a continued kind of challenging environment, is the 2 to 2.5 year-end of 2020, realistic? And maybe you could also tell us, let us know where -- what level of excess cash you have on hand, if you needed to trying to tap into that to pay down the debt?

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Unidentified Company Representative, [35]

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Yes. Look, I still think it's realistic. Obviously, I'm going to state the obvious. It helps to have more EBITDA when you're doing the multiple, right? So like having a nice quarter is not a negative. And you're right, the fourth quarter of 2018 was a nice quarter. That all kind of kicked into gear in mid- to late November, December. So who knows, we could have a similar event here as well. But we have a lot of free cash. We don't disclose separately what's free and what we actually use for trading, but it's a significant amount. It obviously oscillates every day, depending upon opportunities. We also have credit lines at our broker-dealer and at our holding company. So the firm is very well capitalized.

We've already paid down $100 million in aggregate. From when we acquired ITG, we did $50 million in May or June, and we just did $50 million last week. So in 8 months, we paid down $100 million. And I think our target was 200-ish or something like that or? Yes. Yes, so we're halfway there in less than 8 months. So we're executing according to plan. You do make the right point also, Chris, which is that these synergies continue to roll off. And so as our expense base goes down, that obviously is generating more free cash flow. And a lot of that is, as we just articulated, is back-ended to 2020.

So I don't -- we're not sitting here praying to the volatility gods for an influx of EBITDA. There's a lot of levers that we can push to get there, and we're still reasonably confident that we'll get there. And at the end of the day, the firm is very well capitalized, paying its dividend, we're not missing out on any growth or trading opportunities based on what we have.

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [36]

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And Chris, to your point, we keep reasonable amount of free cash on hand to be able to take advantage of volatility when it emerges.

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Christopher John Allen, Compass Point Research & Trading, LLC, Research Division - Analyst [37]

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Understood. And then I guess, one follow-up. I just wanted to ask about the communications and data processing line. Increased a decent amount sequentially. Just, A, could you give us any color in terms of what's driving that, how we're thinking about that moving forward and kind of hitting the targets because we probably do see a pretty big move down in the fourth quarter to hit the 2019 guidance? Just trying to think about 2020 as well.

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [38]

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Yes. Chris, can you please repeat the question?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [39]

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The question was the colo and -- I'm sorry, technology and communication was higher than he thought. And I think a lot of it has -- yes, go ahead.

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [40]

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Yes. That's right. And part of it is timing and part of it is rationalizing some of the expenses between categories.

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Christopher John Allen, Compass Point Research & Trading, LLC, Research Division - Analyst [41]

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Okay. Any incremental color in terms of what kind of categories we're talking about here? Is this just...

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [42]

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I think we're just a reclassification -- I mean, Alex, if correct if I'm wrong here, but there was a reclassification that we did from when we bought ITG, right? There were some things that they put in that they had an occupancy like data centers and things like that, that we thought more properly fit in technology and communications, right?

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [43]

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That's right. There was...

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [44]

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And that was meaningful.

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Alexander M. Ioffe, Virtu Financial, Inc. - CFO [45]

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For data center of about $3.1 million that we move from occupancy to communications and data processing.

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [46]

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Right. It was just, Chris, a methodology that ITG employed that we thought was different than ours. I don't want to say incorrect, but it was just a different way of, ultimately, the expense number was the same. It's just a question of how to classify it. There's not like some new technology or some new data center or anything like that. I mean, we are wickedly focused on, obviously, you could tell my public positions on market data and colo. And so it's not any ongoing expense that has moved the dial here. That's the important takeaway.

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Christopher John Allen, Compass Point Research & Trading, LLC, Research Division - Analyst [47]

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Got it. That makes more sense just to think about total adjusted OpEx guide versus that specific line.

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [48]

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Yes, we should have been clearer about that. Sorry. Yes, we should have been clearer. Thank you for the clarification.

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Operator [49]

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Your next question comes from Michael Cyprys from Morgan Stanley.

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Michael J. Cyprys, Morgan Stanley, Research Division - Executive Director and Senior Research Analyst [50]

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I was just hoping we could dive in a little bit more on the equity market making revenues in the quarter, about $102.5 million. Just hoping you could provide some additional color around the cadence of how that progressed during the quarter in July, August and September? How things are shaping up on October? Will we see volatilities up sharply in October? Just curious if that's coming through in terms of the opportunity set for market-making as well?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [51]

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Yes. Yes, it's a good question. I mean, I think, look, the -- as I said in my remarks, the third quarter, although there were some periods of volatility, it felt a lot like the second quarter. I think it was more balanced in terms of the monthly distribution, although in September, there was some rumblings out of the Middle East, as I've mentioned a few times that were significant.

In terms of what the fourth quarter looks like. I think you guys can look -- I always point you first to the volume numbers, which we track fairly religiously here. I think the October and to date November volume numbers, you haven't seen any real material increases at all. It's mixed.

Europe continues to be pretty muted, I'll say, nicely. It used to be a $30 billion notional day in Europe was a little bit like a white rhino, and now it's just like a regular rhino, you see it a lot, not that I've ever seen a rhino, but you get my point. So I think, look, the market continues to be challenging. And that's why we don't -- obviously, we focus on the market every day, and that's how we run the firm. But there's a bigger story here in terms of efficiency and scale. And the firm continues to chug along even in these more challenging marketplaces.

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Michael J. Cyprys, Morgan Stanley, Research Division - Executive Director and Senior Research Analyst [52]

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Okay. And maybe just as a follow-up on the regulatory theme. There's been a proposal for a transaction fee tax out there, 0.1% of value on stocks and bonds at 0.1% on payments on derivative contracts. Just curious your latest thinking on that, on how you could see that impacting the ecosystem and how that would impact Virtu's revenue base?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [53]

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Yes. Yes. I tried very hard not to be political, so I will do my best not to insult anybody. Sometimes I fail at that pretty miserably. But this is obviously a disaster, not just for the financial markets, but for the United States. I guess, that was pretty political.

It's really a tax on pensions and the middle class and the 401(k). That's ultimately who would pay it. We've seen very direct evidence of that in Europe, in particular, where they put in place an FTT actually exempted at market makers to keep the efficiency of the mark going along. And ultimately, it's the pensions -- the pension schemes that go along with it, which is why I always scratch my head when the unions are in favor of this because you would think their members, if they really understood who ends up paying a transaction tax, they would be violently against. It really is a tax on the middle class. I would point out that Vice President Biden just this week, and his staff, put out a statement to that effect.

So this is not a left or right issue. It's not a political issue, this is really a common sense and what's good for the markets and what's good for America kind of issue.

It's an absolute disaster. I think the empirical evidence is very clear that marketplaces that have done this have just seen liquidity flee to other marketplaces. Sweden did this in 1994, on a Friday, on Monday, the derivatives business moved to London, and Sweden has never recovered.

So again, this is, to me, not a political issue, it's just what's the empirical evidence show? And what are you trying to accomplish? If you're trying to ruin parts of the American financial system and put a tax on the middle class and on pension, then you're accomplishing it.

If you're trying to celebrate the greatest financial market in the world, then you're not doing a good job. So at the end of the day, I think, obviously, you can tell by my remarks, it is catastrophically a bad idea. We're very vocal on that.

I think the U.S. Chamber of commerce put out a great study on this very recently. And I think reasonable people, I guess, can differ on a lot of issues. But the empirical evidence here globally suggests that there -- that this just doesn't make any sense. So I'm very optimistic that when level-headed people look at this on both sides of the aisle, they will realize that we should be celebrating our capital markets, not trying to destroy them.

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Operator [54]

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Your next question comes from Rich Repetto from Sandler O'Neill.

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Richard Henry Repetto, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [55]

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Yes. One last quick question. Retail priority from the CBOE? Just trying to see -- I know market makers have taken more market share of the limit orders from the ebrokers. Is this a pass through? Or how would it impact you, Doug?

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [56]

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Yes. Look -- I'm -- look, I always commend folks for trying to be innovative and responsive and whatnot. I mean -- look, I mean, we have -- we run a noncustomer, customer business. We have institutional retail customers. I think there are a lot of folks that are unhappy about this on the institutional side because, again, you're in a public marketplace. You're creating a priority mechanism, which seems unfair to them.

I think we do a very good job servicing our retail customers. It's early days, but there has not been an avalanche of orders being posted there.

I mean, candidly, Richard, will have no impact on what we do and no impact on our business. I think it's -- the CBOE give them credit. They're good people, we work very closely with them. Obviously, I disagree with this initiative, because I don't think it makes a lot of sense. And I think they're trying to solve a problem candidly that doesn't exist. But give them credit for trying to be competitive.

Ultimately, it has no impact on what we do day-to-day.

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Operator [57]

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There are no further questions at this time. Mr. Doug Cifu, I turn the call back over to you.

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Douglas A. Cifu, Virtu Financial, Inc. - CEO & Director [58]

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Thank you very much, Jacqueline, and thank you, everybody, for participating today. We look forward to speaking with you again in February when we announce our year-end results. Have a great day.

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Operator [59]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.