Virtus Investment Partners, Inc. — Q3 2018 Form 10-Q
Business context and period: Virtus provides investment management and related services to retail and institutional clients. This unaudited quarterly report covers the three and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless noted. Virtus completed its acquisition of a 70% interest in Sustainable Growth Advisers (SGA) on July 1, 2018.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $152.2 million | $123.7 million | $414.2 million | $297.6 million |
| Operating income | $33.9 million | $16.8 million | $83.9 million | $30.0 million |
| Net income attributable to common stockholders | $24.9 million | $16.7 million | $67.1 million | $25.3 million |
| Diluted EPS | $3.19 | $2.21 | $8.67 | $3.52 |
- Q3 revenue grew 23.1%; investment management fees increased 25.1%. Nine-month revenue grew 39.2%, with investment management fees up 41.1%.
- Calculated operating margin was approximately 22.3% in Q3 2018 versus 13.6% in Q3 2017, and 20.3% for the first nine months of 2018 versus 10.1% in 2017.
- Q3 net income attributable to stockholders rose 43.7%; nine-month net income attributable to common stockholders increased 165.7%.
- For the first nine months, total sales inflows were $18.3 billion, outflows were $17.3 billion, and net flows were positive $1.1 billion. Q3 net flows were positive $493 million.
- At September 30, total AUM was $105.6 billion, up 16.6% year over year; long-term AUM was $103.9 billion. Growth reflected the acquisitions and market performance. Average long-term AUM for the nine-month period increased 45.0%.
- Operating cash flow was negative $101.7 million for the first nine months, versus negative $104.0 million in 2017. Investing cash flow was negative $111.9 million, including $127.0 million of net cash used for SGA. Financing cash flow was positive $199.5 million.
- Cash and cash equivalents were $169.0 million, and investments were $85.1 million at September 30. Debt on the balance sheet was $338.9 million; the term loan principal outstanding was $351.5 million. No borrowings were outstanding on the $100 million revolving facility.
- Total equity was $659.2 million. Common dividends declared were $0.55 per share for Q3, compared with $0.45 in Q3 2017.
Material changes and management commentary
- Management attributed revenue and operating income growth primarily to SGA, increased average AUM from acquisitions and market appreciation, positive net flows, and a higher average fee rate. Q3 2017 included $4.9 million of RidgeWorth acquisition and integration costs.
- SGA purchase consideration was $129.5 million, funded with balance-sheet resources and $105 million of additional term debt. The acquisition added $120.2 million of goodwill and $62.0 million of intangible assets; purchase-price allocation remained subject to final assessment.
- Expenses rose, including employment costs (up 16.8% in Q3) and amortization. The nine-month effective tax rate declined to 23.2% from 31.7%, primarily reflecting the federal corporate tax-rate reduction.
- ASC 606 increased reported distribution and service revenue and distribution expenses by the same $2.1 million in Q3 and $5.4 million for the first nine months; management said the adoption had no material overall financial-statement impact.
- Consolidated investment products (CIPs), including CLOs, substantially increase reported assets, liabilities, revenues, and expenses. The company says its risk in these products is limited to its beneficial interests and fees; CIP cash flows therefore should not be read as equivalent to corporate operating cash generation.
Outlook, risks and contingencies
- The filing provides no specific earnings or AUM guidance. Management cautions that nine-month results are not necessarily indicative of full-year results.
- Key stated risks include AUM declines or client withdrawals, market and interest-rate volatility, competition, distribution relationships, regulation and litigation, debt service and covenant compliance, key-personnel retention, investment losses, and failure to realize acquisition benefits or impairment of goodwill and intangibles.
- The company reported a 2.50:1.00 maximum total net leverage covenant, applicable only when revolver loans and letters of credit exceed 30% of revolving commitments. Term debt matures June 1, 2024 and is subject to scheduled amortization and potential excess-cash-flow repayments.
- A securities class action relating to funds formerly subadvised by F-Squared had a final-approval hearing on October 24, 2018; the court reserved its decision. The company considered final approval likely and expected no material financial impact if approved, while noting litigation outcomes remain uncertain.
- Management concluded disclosure controls were effective. Its assessment excluded SGA’s internal controls following the July acquisition; Virtus was reviewing SGA’s controls. A new general ledger and accounts-payable system was implemented during the quarter.
Investor verification priorities
- Separate organic flows and market-driven AUM changes from acquisition-related growth, particularly the large “Other” AUM movements disclosed in the flow tables.
- Reconcile balance-sheet debt of $338.9 million with the $351.5 million term-loan principal, and review leverage, interest-rate exposure, and covenant headroom.
- Assess recurring corporate cash generation separately from cash flows and debt reported for consolidated investment products.
- Review SGA’s final purchase-price allocation, integration progress, and the expected contribution to fee revenue and earnings.
- Track the court’s final decision on the securities-litigation settlement and any material developments in regulatory or other legal matters.