3. Merger of Virtu Financial, Inc. and KCG Holdings, Inc.

Background

As of the Closing Date of the Acquisition, each of KCG’s issued and outstanding shares of Class A common stock, par value $0.01 per share were cancelled and extinguished and converted into the right to receive $20.00 in cash, without interest, less any applicable withholding taxes. The acquisition of KCG is being accounted for as a business combination, subject to the provisions of ASC 805, Business Combinations.

As discussed in further detail in Note 9 “Borrowings”, on June 30, 2017, Virtu Financial and VFH entered into a fourth amended and restated credit agreement (the “Fourth Amended and Restated Credit Agreement”) with the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent, sole lead arranger and bookrunner, which amended and restated in its entirety the existing Credit Agreement. The Fourth Amended and Restated Credit Agreement provided for a $540.0 million first lien secured term loan, drawn in its entirety on June 30, 2017, and continued VFH’s existing $100.0 million first lien senior secured revolving credit facility. Also on June 30, 2017, Orchestra Borrower LLC (the “Escrow Issuer”), a wholly owned subsidiary of the Company, entered into an escrow credit agreement (the “Escrow Credit Agreement”) with the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent, sole lead arranger and bookrunner, which provided for a $610.0 million term loan (the “Escrow Term Loan”), the proceeds of which were deposited into escrow pending the closing of the Acquisition.

Upon the closing of the Acquisition, the proceeds of the Escrow Term Loan were released to fund in part the Acquisition consideration, the obligations of the Escrow Issuer in respect of the Escrow Term Loan were assumed by VFH Parent and the Escrow Term Loan was deemed to be outstanding under the Fourth Amended and Restated Credit Agreement and the Escrow Credit Agreement and related credit documents automatically terminated and were superseded by the provisions of the Fourth Amended and Restated Credit Agreement. In addition, the revolving credit facility under the Fourth Amended and Restated Credit Agreement terminated.

On June 16, 2017, the Escrow Issuer and Orchestra Co-Issuer, Inc. (the “Co-Issuer”) completed the offering of $500 million aggregate principal amount of 6.750% Senior Secured Second Lien Notes due 2022 (the “Notes”). The Notes were issued under an Indenture, dated June 16, 2017 (the “Indenture”), among the Escrow Issuer, the Co-Issuer and U.S. Bank National Association, as trustee and collateral agent. The Notes mature on June 15, 2022. Interest on the Notes accrues at 6.750% per annum, payable every six months through maturity on each June 15 and December 15, beginning on December 15, 2017.

On July 20, 2017, VFH assumed all of the obligations of the Escrow Issuer under the Indenture and the Notes. The Notes are guaranteed by Virtu Financial and each of Virtu Financial’s wholly-owned domestic restricted subsidiaries that guarantees the Fourth Amended and Restated Credit Agreement, including KCG and certain of its subsidiaries and the Escrow Issuer. We refer to VFH and the Co-Issuer together as, the “Issuers.”

On the Closing Date, the Escrow Credit Agreement and related credit documents automatically ceased to be of force or effect and were superseded by the provisions of the Fourth Amended and Restated Credit Agreement and the first lien senior secured revolving credit facility matured. A total of $1,119.4 million restricted cash in escrow was released to the Company.

On the Closing Date, and in connection with the financing of the Acquisition, the Company issued to Aranda Investments Pte. Ltd. (“Aranda”), an affiliate of Temasek Holdings (Private) Limited (“Temasek”), 6,346,155 shares of the Company’s Class A common stock, pursuant to the investment agreement with Aranda (as amended, the “Aranda Investment Agreement”) in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), pursuant to Section 4(a)(2) of the Securities Act for an aggregate purchase price of approximately $99.0 million. On August 10, 2017, the Company issued an additional 1,666,666 shares of its Class A common stock for an aggregate purchase price of $26.0 million (collectively, the “Temasek Investment”).

On the Closing Date, and in connection with the financing of the Acquisition, the Company issued to North Island Holdings I, LP (“NIH”) 39,725,979 shares of the Company’s Class A pursuant to the investment agreement with NIH (as amended, the “NIH Investment Agreement”) in a private placement exempt from the registration requirements of the Securities Act pursuant to Section 4(a) (2) of the Securities Act for an aggregate purchase price of approximately $613.5 million. On August 10, 2017 the Company issued an additional 338,124 shares of its Class A common stock for an aggregate purchase price of $5.2 million (collectively, the “NIH Investment”). In connection with the Temasek Investment and NIH Investment, the Company incurred approximately $7.8 million in fees which were recorded as a reduction to additional paid-in capital.

On July 21, 2017, the outstanding 6.875% Senior Secured Notes due 2020 issued by KCG were redeemed at a redemption price equal to 103.438% of the principal amount, plus accrued and unpaid interest, pursuant to the indenture, dated as of March 13, 2015 (as amended, restated, supplemented or otherwise modified), by and among KCG, the subsidiary guarantors party thereto and The Bank of New York Mellon, as trustee and collateral agent.

In accordance with the terms of the Fourth Amended and Restated Credit Agreement, VFH made voluntary prepayments of principal under the Term Loan Facility in the amount of $100.0 million each, on August 8, 2017 and September 29, 2017, respectively. The outstanding principal amount under the Term Loan Facility was $950.0 million as of September 30, 2017.

Accounting treatment of the Acquisition

The Acquisition is accounted for as a purchase of KCG by the Company. Under the acquisition method of accounting, the assets and liabilities of KCG, as of July 20, 2017, were recorded at their respective fair values and added to the carrying value of the Company's existing assets and liabilities. These fair values were determined with the assistance of third party valuation professionals. The reported financial condition and results of operations of the Company for the periods following the Merger reflect KCG's and the Company's balances and reflect the impact of purchase accounting adjustments. As the Company is the accounting acquirer, the financial results for the three and nine months ended September 30, 2017 comprise the results of the Company for the entire applicable period and the results of KCG from Closing Date through September 30, 2017. All periods prior to 2017 comprise solely the results of the Company.

Certain former KCG management employees were terminated upon the Merger, and as a result were paid an aggregate of $6.4 million pursuant to their existing employment contracts. This amount has been recognized as an expense by the Company and is included in Employee compensation and payroll taxes in the condensed consolidated statements of comprehensive income (loss) for the three and nine month periods ending September 30, 2017. The Company also expects to make annual incentive compensation payments to former KCG employees who became employees of the Company following the Merger, and accrued related compensation expense of approximately $23.0 million during the three and nine months ended September 30, 2017, which is included in Employee compensation and payroll taxes in the condensed consolidated statements of comprehensive income (loss).

Purchase price and goodwill

The aggregate cash purchase price of $1.40 billion was determined as the sum of the fair value, at $20.00 per share, of KCG shares and warrants outstanding to former KCG stockholders at closing and the fair value of KCG employee stock based awards that were outstanding, and which vested at the Closing Date.

The purchase price has been allocated to the assets acquired and liabilities assumed using their estimated fair values at July 20, 2017, the closing date of the Acquisition. The Company has not yet completed all of its analyses to finalize the allocation of the purchase price to the KCG acquired assets and liabilities. The allocation of the purchase price may be modified over the measurement period, as more information is obtained about the fair values of assets acquired and liabilities assumed. The Company has engaged third party specialists for the purchase price allocation.

The amounts in the table below represent the allocation of the purchase price and are subject to revision during the remainder of the measurement period, a period not to exceed twelve months from the Acquisition date. Adjustments to the provisional values during the measurement period will be recorded in the reporting period in which the adjustment amounts are determined. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the Acquisition date:


(in thousands)
Cash and equivalents	$	592,993
Cash and securities segregated under federal regulations		3,000
Securities borrowed		1,406,444
Securities purchased under agreements to resell		16,894
Receivables from broker dealers and clearing organizations		553,031
Financial instruments owned, at fair value		2,095,339
Property, equipment and capitalized software (net)		112,204
Intangibles		156,300
Deferred taxes		22,928
Other assets		331,820
Total Assets	$	5,290,953

Securities loaned	$	166,189
Securities sold under agreements to repurchase		841,606
Payables to broker dealers and clearing organizations		536,653
Payables to customers		17,583
Financial instruments sold, not yet purchased, at fair value		1,756,647
Accounts payable and accrued expenses and other liabilities		239,004
Debt		480,987
Total Liabilities	$	4,038,669

Total identified assets acquired, net of assumed liabilities	$	1,252,284

Goodwill	$	143,012

Total Purchase Price	$	1,395,296

Amounts preliminarily allocated to intangible assets, the amortization period and goodwill were as follows


			Amortization
		Amount	Years
Technology	$	67,800	1-6 years
Customer relationships		77,100	13 - 17 years
Trade names		5,000	10 years
Exchange memberships		6,400	Indefinite
Intangible assets	$	156,300
Goodwill		143,012
Total	$	299,312

Of the total Goodwill of $143.0 million, $107.2 million has been assigned to the Market Making segment and $35.8 million has been assigned to the Execution Services segment. Such goodwill is attributable to the expansion of products offerings and expected synergies of the combined workforce, products and technologies of the Company and KCG.

Tax treatment of the Merger

The Company believes that the Acquisition will be treated as a tax-free transaction as described in Section 351 of the Internal Revenue Code, and both KCG and the Company have received tax opinions from external legal counsel to that effect. KCG’s tax basis in its assets and liabilities therefore generally carries over to the Company following the Acquisition. None of the goodwill is expected to be deductible for tax purposes.

The Company recorded net deferred tax assets of $22.9 million with respect to recording KCG’s assets and liabilities under the purchase method of accounting as described above as well as recording the value of other tax attributes acquired as a result of the Acquisition, as described in Note 12.

Pro forma results

Included in the Company’s results for the three months ended September 30, 2017 are results from the business acquired as a result of the Acquisition, from the date of Acquisition, July 20, 2017 through September 30, 2017 as follows:



(in thousands)
Revenues	$	149,327
Income (loss) before income taxes		(12,578)

The financial information in the table below summarizes the combined pro forma results of operations of the Company and KCG, based on adding the pre-tax historical results of KCG and the Company, and adjusting primarily for amortization of intangibles created in the Acquisition, debt raised in conjunction with the Acquisition and nonrecurring costs associated with the Acquisition, which comprise advisory and other professional fees incurred by Virtu and KCG of $24.2 and $22.5 million, respectively. The pro forma data assumes all of KCG’s issued and outstanding shares of Class A common stock, par value $0.01 per share were cancelled and extinguished and converted into the right to receive $20.00 in cash, without interest, less any applicable withholding taxes on January 1, 2016 and does not include adjustments to reflect the Company's operating costs or expected differences in the way funds generated by the Company are invested.

This pro forma financial information is based on estimates and assumptions that have been made solely for purposes of developing such pro forma information, including, without limitation, preliminary purchase accounting adjustments. The pro forma financial information does not reflect any synergies or operating cost reductions that may be achieved from the combined operations. The pro forma financial information combines the historical results for the Company and KCG for the three and nine month periods ended September 30, 2017 and 2016 (in millions, except per share amounts):


	For the Three Months Ended				For the Nine Months Ended
(in thousands, except per share amounts)		2017		2016		2017		2016
Revenue	$	304,020	$	373,338	$	1,068,164	$	1,401,819

Net income (loss)		(82,520)		1,783		(117,169)		163,146

Net income (loss) attributable to common stockholders		(30,432)		658		(43,210)		60,165

Diluted earnings (loss) per share	$	(0.35)	$	0.01	$	(0.48)	$	0.67