Virtus Investment Partners, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011; comparisons are with the same 2010 periods. Virtus is a multi-manager investment firm serving retail and institutional clients. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Financial performance and liquidity
- Revenue: Q3 revenue was $55.5 million, up 55.9% year over year; nine-month revenue was $148.5 million, up 43.0%. Q3 investment management fees rose 57.8% to $37.1 million, primarily reflecting higher average fee-earning assets and the Newfleet team contribution.
- Profitability: Q3 operating loss was $2.2 million versus $2.9 million operating income a year earlier; Q3 net loss attributable to common stockholders was $3.5 million, or $0.56 per diluted share, versus income of $2.4 million, or $0.37 per diluted share. The quarter included $9.6 million of DPG closed-end fund structuring costs and $1.2 million of related sales compensation, as well as a $1.6 million loss on trading securities. For the first nine months, operating income was $5.7 million versus $4.8 million, and common-stockholder income was $2.2 million versus $2.1 million.
- Margins: Operating margin was approximately negative 4.0% in Q3 2011 versus 8.1% in Q3 2010; nine-month operating margin was 3.8% versus 4.6%.
- Cash flow: Nine-month operating cash flow was $6.7 million, down from $12.8 million. Investing used $0.8 million and financing used $10.6 million, including $7.9 million for share repurchases. Cash declined $4.7 million to $39.2 million.
- Liquidity and debt: Working capital was $43.4 million, compared with $44.2 million at year-end 2010. Long-term debt was $15.0 million under a $30.0 million revolving facility maturing September 2013; $15.0 million remained available to draw at quarter-end. The company reported compliance with all financial covenants.
- Other balance-sheet items: Total assets were $151.4 million and total liabilities were $67.9 million. Marketable securities were $11.7 million. Series B preferred stock was reported at $35.9 million before the subsequent conversion agreement.
Business trends and changes from prior periods
- Assets under management were $33.1 billion at September 30, up 22.0% from $27.1 billion a year earlier and 12.2% from year-end 2010. Average AUM for the first nine months rose 26.6% to $32.6 billion.
- Q3 total sales were $3.3 billion, up 111.6%; nine-month sales were $8.6 billion, up 109.6%. Net flows were $1.6 billion in Q3 and $4.4 billion for nine months, offset in part by market depreciation of $2.4 billion and $0.9 billion, respectively.
- Q3 AUM declined 0.6% from June 30, as strong net flows were outweighed by market depreciation. Management attributed higher redemptions to industry trends amid late-quarter market weakness. Long-term open-end mutual fund sales increased substantially, while money-market assets declined over the nine-month period.
- The Q3 launch of the Duff & Phelps Global Utility Income Fund (DPG) added approximately $1.0 billion in assets, but caused significant structuring and sales costs. Higher compensation, distribution costs and variable insurance fund expenses also weighed on results.
Outlook, risks and unusual items
- Outlook: The filing provides no specific revenue or earnings guidance. Management expected available cash, marketable securities and operating cash generation to cover anticipated operating and capital needs for the next 12 months, while noting that future cash needs depend on operating performance, AUM and market conditions.
- Preferred-stock agreement after quarter-end: On October 27, Virtus agreed with BMO Bankcorp to convert all 35,217 Series B preferred shares into 1,349,300 common shares, subject to regulatory approval. Virtus paid $8.1 million for accrued and certain future preferred dividends. Preferred dividends and the preferred director-election right ended effective October 31, 2011, subject to completion of the conversion.
- Tax matter: An IRS private letter ruling allowed a loss related to an inactive subsidiary to be treated as ordinary rather than capital, subject to stated facts and representations. Virtus maintained a full valuation allowance against deferred tax assets, citing cumulative losses in the preceding three-year period; management said continued income could support a future release. The ruling’s assumptions and the realizability of tax assets remain relevant uncertainties.
- Risks and contingencies: Key risks include market volatility and falling AUM, investment underperformance and resulting outflows, dependence on distribution channels and key personnel, competition and fee pressure, regulatory or legal matters, goodwill or intangible impairment, financing availability, and compliance with debt covenants. The company said known legal and regulatory matters were not expected to materially harm consolidated financial condition, but adverse outcomes could affect particular periods.
- Market-risk sensitivity: a 10% change in the fair value of marketable securities would have changed net income by approximately $1.0 million and comprehensive income by $1.2 million. A hypothetical 300-basis-point interest-rate change would have changed interest expense by approximately $0.1 million for the reported periods.
Important facts for investors to verify
- Whether strong sales and net flows persist and offset market-driven AUM declines and increased redemptions.
- DPG’s ongoing costs, asset retention and contribution to fee revenue after its launch-period expenses.
- Completion and regulatory approval of the BMO preferred-stock conversion, including the effect of the $8.1 million payment and common-share dilution.
- The terms and covenant headroom of the revolving facility, and the company’s ability to sustain cash generation amid compensation, distribution and working-capital needs.
- The continuing validity of the tax ruling’s factual assumptions and the evidence required to release any deferred-tax valuation allowance.