Virtus Investment Partners, Inc. — Q1 2018 Form 10-Q
Business context and period. This unaudited quarterly report covers the three months ended March 31, 2018, compared with Q1 2017. Virtus provides investment management and related services to retail and institutional investors. Growth comparisons are substantially affected by the June 2017 RidgeWorth acquisition.
Financial performance and key metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $129.0 million | $79.8 million | +61.7% |
| Operating income | $22.6 million | $10.0 million | +125.1% |
| Operating margin | 17.5% | 12.6% | +4.9 percentage points |
| Net income | $23.8 million | $13.7 million | +73.4% |
| Net income attributable to common stockholders | $21.2 million | $10.9 million | +93.9% |
| Diluted EPS | $2.77 | $1.62 | Up |
Investment management fees were $100.5 million, up 69.5%, largely reflecting RidgeWorth and higher average assets. Total operating expenses rose 52.6% to $106.4 million; increases included employment costs, acquired-business costs, and $5.0 million of acquired-intangible amortization. Q1 operating income included $3.1 million of acquisition and integration costs. The reported effective tax rate was 21.5%, versus 24.4%, primarily reflecting the lower federal corporate tax rate following the Tax Cuts and Jobs Act.
Long-term assets under management (AUM) were $87.4 billion at quarter-end, up 82.1% year over year; total AUM, including liquidity strategies, was $89.1 billion. Q1 long-term inflows were $5.4 billion and outflows $6.2 billion, for net outflows of $730.6 million, versus net inflows of $519.5 million a year earlier. Institutional accounts had $1.23 billion of net outflows. Market performance reduced long-term AUM by $387.9 million. Average long-term AUM increased 91.6% to $88.9 billion, while the average long-term fee rate fell 5.3 basis points to 46.0 basis points.
Operating cash flow was negative $61.8 million, compared with negative $15.2 million in Q1 2017. The company attributed the outflow primarily to increased net purchases of consolidated investment product (CIP) investments; annual incentive compensation payments were $74.1 million, versus $39.7 million. Investing cash flow was negative $21.6 million, including $20.3 million for unconsolidated CLO investments. Financing cash flow was negative $14.5 million. Cash and cash equivalents attributable to the company were $80.8 million at March 31, down from $132.2 million at year-end; cash including CIP balances was $136.5 million.
At March 31, reported balance-sheet debt was $245.4 million; management separately reported $258.7 million outstanding under the term loan and no revolver borrowings. The company reported net debt of $127.2 million and a 0.99:1.0 net leverage ratio. The $100 million revolver’s 2.5:1.0 leverage covenant applies only when revolving loans and letters of credit exceed 30% of commitments. CIP notes payable of $1.46 billion relate to consolidated investment products, are recourse only to their respective assets, and should be distinguished from corporate borrowings.
Material changes, outlook, and risks
- Revenue and earnings increased substantially, principally due to RidgeWorth, acquired in June 2017. Virtus said RidgeWorth contributed approximately 24% of consolidated revenue in Q1 2018. The acquisition also increased expenses and intangible amortization.
- Net flows turned negative despite higher sales: total inflows were $5.4 billion, up 66.3%, but outflows resulted in $730.6 million of net long-term outflows.
- Adoption of ASC 606 increased reported distribution and service revenue and distribution expenses by $1.236 million each in Q1 2018; management said adoption did not materially affect the financial statements. Comparative periods were not restated.
- Virtus agreed to acquire a majority interest in Sustainable Growth Advisers (SGA) for a stated purchase price of $129.5 million, subject to adjustments, customary conditions, and client approvals. Closing was expected in mid-2018, but was not assured. The credit agreement provides $105 million in additional term-loan commitments conditional on the transaction.
- The credit amendment removed the term-loan maximum leverage maintenance covenant and revised the revolving-credit covenant. The additional loan commitments carry a delayed-draw fee until funded or terminated.
- Virtus declared a $0.45 quarterly common dividend and a $1.8125 quarterly preferred dividend. No common shares were repurchased during the quarter.
- No formal earnings or AUM guidance is provided in the supplied filing text. Management cautioned that actual results may differ materially from forward-looking statements; key risks include AUM declines and client withdrawals, market volatility, competition, regulatory or litigation outcomes, leverage and liquidity, key-personnel retention, and acquisition-related risks.
- A securities class action related to funds formerly subadvised by F-Squared remained subject to court approval of a settlement agreement in principle. The company said an approved resolution was not expected to materially affect results, cash flows, or financial condition. The filing also describes ordinary-course regulatory and legal matters, with outcomes inherently uncertain.
- Management concluded disclosure controls were effective, but excluded RidgeWorth internal controls from the evaluation; RidgeWorth accounted for approximately 24% of quarterly consolidated revenue. The company was reviewing its internal-control structure following the acquisition.
Investor verification priorities
- Assess whether the acquisition-driven revenue and AUM expansion translates into durable organic growth, given the quarter’s net outflows and institutional withdrawals.
- Review fee-rate trends, product mix, and expense growth, including acquisition integration costs, compensation, and intangible amortization.
- Reconcile operating cash use with reported earnings, separating CIP investment activity and incentive-compensation timing from core corporate cash generation.
- Confirm corporate debt, net-debt calculations, covenant definitions, and the funding and cost of the SGA acquisition commitments; distinguish these from non-recourse CIP debt.
- Check the status and financial terms of the SGA transaction and court approval of the securities-litigation settlement, neither of which was completed in this filing.