Virtus Investment Partners, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports fourth-quarter results. Virtus is an asset manager whose revenue is primarily earned from fees tied to assets under management (AUM).
Business context and reporting period
Virtus uses a multi-manager, multi-style model serving retail and institutional clients through mutual funds, closed-end funds, ETFs, separate accounts and structured products. On June 1, 2017, it acquired RidgeWorth Investments, which had approximately $40.1 billion in AUM at acquisition. The acquisition materially changed the scale and composition of the business; 2017 results include RidgeWorth only from the closing date.
Year-end AUM was $91.0 billion, including $88.8 billion in long-term assets and $2.1 billion in liquidity strategies. Average long-term AUM was $72.3 billion for 2017.
Key financial metrics
| Metric | 2017 | 2016 | Change / context |
|---|---|---|---|
| Revenue | $425.6 million | $322.6 million | Up 31.9%; acquisition contributed approximately $77.1 million of investment-management fee revenue from June through December. |
| Operating income | $58.0 million | $50.8 million | Up 14.2%; operating margin was approximately 13.6%, versus 15.8%. |
| Net income | $39.9 million | $48.8 million | Down 18.1%. |
| Net income attributable to common stockholders | $28.7 million | $48.5 million | Down 40.9%; 2017 includes preferred dividends. |
| Diluted EPS | $3.96 | $6.20 | Down 36.1%. |
| Operating cash flow | $(182.7) million | $30.5 million | Decline primarily reflected investment purchases by consolidated investment products (CIPs); these flows do not directly represent cash flow attributable to shareholders. |
| Investing cash flow | $(417.0) million | $3.1 million | Primarily included $393.4 million of net cash used for the RidgeWorth acquisition. |
| Financing cash flow | $750.5 million | $(48.3) million | Included company borrowings and equity issuance, as well as financing flows of CIPs. |
| Cash and cash equivalents | $132.2 million | $64.6 million | Company balance-sheet cash; excludes separately presented CIP cash. |
| Debt | $259.4 million gross Term Loan outstanding | $30.0 million | Balance-sheet debt was $248.3 million net of financing costs; no revolving-credit borrowings at year-end. |
Virtus had $100.0 million of unused revolving-credit capacity at year-end. It reported $127.2 million of net debt and a 0.74:1.0 net leverage ratio. The balance sheet also included $1.46 billion of CIP notes payable; the filing states that this debt is recourse only to the relevant investment products, not to Virtus’s general assets.
Long-term AUM rose 95.8% year over year, mainly due to RidgeWorth and $9.0 billion of market appreciation, partly offset by $218 million of net outflows. Total long-term inflows were $15.4 billion and outflows were $15.6 billion. The average fee rate across long-term products declined to 46.9 basis points from 50.9 basis points, primarily because acquired assets carried a lower blended fee rate.
Fourth quarter: Revenue was $128.0 million versus $79.9 million in Q4 2016; operating income was $28.0 million versus $12.8 million. Net income attributable to common stockholders was $3.4 million versus $12.4 million, and diluted EPS was $0.46 versus $1.87.
Material changes versus the prior comparable period
- RidgeWorth drove substantial AUM and revenue growth, but acquisition-related costs, higher amortization and financing expense limited operating-income growth.
- Operating expenses rose 35.3% to $367.6 million. 2017 included $26.3 million of acquisition and integration costs, including restructuring and severance; amortization expense increased following acquired intangible assets.
- The effective tax rate increased to 50.3% from 30.1%. The Tax Cuts and Jobs Act generated an estimated $13.1 million 2017 tax expense, mainly from revaluing deferred tax assets.
- Virtus issued common and mandatory convertible preferred stock in February 2017, raising $220.5 million net in total, and borrowed under a new credit agreement to help fund RidgeWorth. Preferred-stock dividends reduced earnings available to common stockholders.
Outlook, management commentary, risks and unusual items
- Outlook: The filing provides no quantified earnings or revenue guidance. Management notes that market movements, investment performance and client flows affect AUM and fee revenue.
- Planned acquisition: In February 2018, Virtus agreed to acquire a majority interest in Sustainable Growth Advisers for $129.5 million, subject to adjustments, customary closing conditions and client approvals; closing was expected in mid-2018. The amended credit agreement provided $105.0 million of additional term-loan commitments intended to help fund the transaction.
- Debt and distributions: Term-loan amortization and mandatory excess-cash-flow repayments may constrain cash available for other uses. The credit agreement restricts certain actions, including dividends and share repurchases. Common dividends were $1.80 per share in 2017; the board declared another $0.45 quarterly common dividend in February 2018. Future distributions are not assured.
- Legal matters: In a securities class action relating to funds formerly subadvised by F-Squared, Virtus reached a settlement agreement in principle on February 6, 2018, subject to court approval; the company expected no material financial impact upon approval. A separate related action was dismissed with prejudice in December 2017. Virtus says other legal and regulatory matters are not expected to have a material adverse effect based on information available, while noting outcomes remain uncertain.
- Principal business risks: AUM and earnings depend on market levels, investment performance and client flows. Other material risks include fee pressure and competition, termination of advisory agreements, dependence on key personnel and distribution partners, regulatory and litigation exposure, cybersecurity and service-provider disruptions, and volatility in seed and other investments.
- Reporting and controls: The auditor issued an unqualified opinion on the financial statements and internal control over financial reporting. Management and the auditor excluded RidgeWorth from their 2017 internal-control assessments because it was recently acquired; RidgeWorth represented 18.1% of consolidated revenue.
Most important facts for investors to verify
- How much of revenue, operating income and AUM growth is sustainable after separating RidgeWorth’s contribution, market appreciation and net flows.
- Whether net flows improve, particularly in open-end funds and institutional accounts, and whether investment performance supports asset retention.
- Whether the lower blended fee rate persists and how expense levels, integration savings and acquired-intangible amortization affect margins.
- The cash-flow impact of CIPs versus Virtus’s own operating cash generation; consolidated investment-product balances should not be treated as ordinary corporate liquidity or debt.
- Debt repayment capacity, covenant terms, preferred dividends and dilution upon mandatory preferred-stock conversion in 2020.
- Completion, financing and expected economics of the proposed SGA acquisition, and court approval and final terms of the securities-litigation settlement.
- Integration of RidgeWorth controls, and exposure to market, regulatory, cyber, key-person and distribution-partner risks.