Invesco Ltd. — Q3 2010 Form 10-Q
Business context and reporting period. Invesco is a global investment manager. This unaudited quarterly report covers the three and nine months ended September 30, 2010; amounts are in U.S. dollars unless noted. Results include Morgan Stanley’s retail asset management business, including Van Kampen, from its June 1 acquisition. Period comparisons are affected by the acquisition and a new consolidation accounting rule for certain collateralized loan obligations (CLOs).
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Operating revenue | $953.1m | $705.8m | $2,459.2m | $1,879.5m |
| Net revenue (non-GAAP) | $707.1m | $537.1m | $1,840.5m | $1,418.8m |
| Operating income | $182.9m | $151.6m | $391.2m | $323.8m |
| Operating margin | 19.2% | 21.5% | 15.9% | 17.2% |
| Net income attributable to common shareholders | $154.7m | $105.2m | $290.5m | $211.6m |
| Diluted EPS | $0.32 | $0.24 | $0.63 | $0.51 |
| Adjusted operating margin (non-GAAP) | 34.8% | 32.1% | 33.6% | 26.6% |
| Adjusted EPS (non-GAAP) | $0.39 | $0.27 | $0.94 | $0.59 |
- Revenue and margins: Q3 operating revenue increased 35.0%; nine-month revenue rose 30.8%. Growth reflected the acquisition, higher average assets under management (AUM) and market gains, partly offset by lower performance fees and foreign exchange effects. Q3 operating expenses grew 39.0%, faster than revenue, and reported operating margin declined. Nine-month operating expenses increased 32.9% and included $123.3m of transaction and integration charges. Adjusted measures exclude specified acquisition, amortization, deferred-compensation and other items; they are non-GAAP and are not substitutes for GAAP results.
- AUM and flows: Period-end AUM was $604.5bn, versus $446.9bn a year earlier; the acquisition added $114.6bn. Q3 AUM benefited from $34.4bn of market gains and $8.2bn of currency translation, with $4.9bn of long-term net inflows and $2.4bn of institutional money-market outflows. Nine-month long-term net inflows were $22.5bn, while institutional money-market funds had $13.8bn of net outflows.
- Cash flow: Nine-month operating cash flow was $375.5m, versus $161.4m in 2009. Investing cash outflow was $644.4m, including the acquisition; financing cash inflow was $169.5m. Cash and cash equivalents declined from $762.0m at year-end 2009 to $664.1m. Reported cash flows include consolidated investment products; their cash is not available for general corporate use.
- Debt and liquidity: Corporate long-term debt was $1,394.2m at September 30, up from $745.7m at year-end, principally reflecting $648.5m drawn under a new $1.25bn credit facility to help fund the acquisition. The facility expires in May 2013; the company reported $601.5m of remaining capacity. Leverage covenant ratio was 1.52x against a 3.25x maximum; interest coverage was 16.43x against a 4.00x minimum. Invesco reported compliance with its covenants and regulatory capital requirements. Some cash is subject to jurisdictional restrictions; $459.3m was held by the European sub-group.
- Balance sheet: Total assets were $19.94bn and equity $8.85bn. Goodwill was $6.88bn and net intangible assets $1.34bn. CLO consolidation materially increased reported assets and liabilities; $5.64bn of CLO debt is non-recourse to Invesco and is backed by CLO assets unavailable to the company’s general creditors.
Material changes and unusual items
- Morgan Stanley / Van Kampen acquisition: Completed June 1 for $770.0m cash and shares valued at $569.2m, with total consideration of approximately $1.342bn. The acquired business contributed an estimated $272m of revenue from closing through September 30; this is an incremental estimate, not stand-alone earnings. Integration costs were $123.3m for the first nine months. Management said expected synergies had been achieved; possible U.S. fund mergers were expected in six to nine months and could yield about $10m of additional savings in the second year after acquisition.
- Other acquisition: Concord Capital was acquired in August for $14.5m cash plus initially estimated contingent consideration of $32.4m payable over five years.
- CLO accounting change: Adoption of FASB Statement No. 167 from January 1 required consolidation of certain CLOs, adding about $6.5bn of assets and $5.7bn of debt at quarter-end. Consolidated CLO gains and losses largely offset through noncontrolling interests and had a reported net impact of $1.8m in Q3 and $5.6m for nine months. Prior periods were not restated. In Q3, CLO-related fair-value gains and losses included a $148.3m net loss; this substantially affected GAAP income before noncontrolling interests.
- Reporting and accounting: Invesco broadened its AUM definition in 2010 to include certain ETF, UIT and passive assets, including assets that do not earn investment-management fees. This affects comparability of AUM and yield measures. Management reported effective disclosure controls and no material change in internal control over financial reporting during the nine months.
Outlook, risks and contingencies
- The filing gives no specific revenue, earnings or AUM forecast. Management described continued economic and political uncertainty, while noting positive market returns in most major markets during Q3. Revenue remains sensitive to market levels, asset mix, client flows, investment performance and currency movements.
- Management cited generally strong relative performance in several investment capabilities but noted challenged areas, including near-term U.S. Core equity performance. Past performance is not indicative of future results.
- Regulatory risk is significant: the Dodd-Frank Act and potential changes affecting money-market funds, fund distribution, compensation, capital and compliance could increase costs or affect products and AUM. Invesco said the eventual impact was uncertain. The company also warns that adverse investment performance, client withdrawals, or loss of confidence could reduce AUM and revenue.
- Contingencies include $82.0m in undrawn capital commitments and $36.0m of committed support for two investment trusts, with an option to raise support to $66.0m. The recorded fair value of the support guarantee was $4.0m; no payment had been made. A Canadian tax authority assessment of $21.8m is being contested; no provision was recorded, and management said it expects to contest it successfully.
- New litigation relates to auction-rate preferred securities redemptions by certain acquired closed-end funds. Invesco has acquisition-agreement obligations concerning defense costs and potential damages; outcomes and potential exposure are not quantified clearly in the filing. Separately, previously disclosed market-timing settlements were approved by the court on October 21, subject to appeal. Management did not believe outstanding litigation was probable to have a material adverse effect, while acknowledging uncertainty.
- Q3 included a $10.1m net tax benefit from expiration of the statute of limitations for certain tax positions. Nine-month results also included $6.5m of seed-investment impairment charges and $8.9m of fund reimbursement costs related to correcting historical foreign-exchange allocations.
Important facts for investors to verify
- Reconcile GAAP and non-GAAP results, especially the effect of acquisition costs, CLO consolidation and noncontrolling interests on reported earnings and margins.
- Assess the acquired business’s sustainable revenue, costs, integration progress, fund-merger approvals and realized synergies; the filing does not provide separate post-integration earnings.
- Track AUM flows by channel and product, performance-fee eligibility, asset mix and fee yields, taking account of the revised AUM definition.
- Review corporate debt, facility availability, covenant headroom, restricted cash and acquisition-related financing needs.
- Monitor CLO valuation assumptions and market liquidity, the trust-support commitments, ARPS litigation and the Canadian tax dispute.
- Note that the filing’s summary table reports nine-month operating margin of 15.9%, while the MD&A narrative elsewhere states 19.2% for the nine-month period; the values are inconsistent, and the filing text does not provide a clear resolution.