Virtus Investment Partners, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unaudited results; comparisons are with the corresponding 2018 periods unless noted. Amounts are in U.S. dollars.
Business context
Virtus provides investment management and related services to retail and institutional clients across funds, separate accounts and structured products. Revenue is primarily asset-based. The July 2018 acquisition of a 70% interest in Sustainable Growth Advisers (SGA) contributed to year-over-year growth in assets and fees.
Financial and operating performance
- Q2 revenue: $140.5 million, up 5.7%; investment management fees rose 11.1% to $114.6 million. Distribution and service fees declined 21.6% to $10.6 million.
- Q2 operating income and margin: $30.1 million, up 10.3%; operating margin was approximately 21.4%, versus 20.5% in Q2 2018. Higher revenue was partly offset by higher operating costs, including acquisition-related amortization.
- Q2 earnings: Net income attributable to common stockholders was $24.8 million, up 18.4%; diluted EPS was $3.26, versus $2.75. Q2 net income was also affected by $12.5 million of other income, including gains associated with consolidated investment products (CIPs).
- First-half results: Revenue was $271.2 million, up 3.5%; operating income was $51.1 million, up 2.4%; net income attributable to common stockholders was $44.5 million, up 5.5%. Diluted EPS was $5.87, versus $5.52.
- Assets and flows: Assets under management (AUM) totaled $105.0 billion at June 30, up 14.6% year over year. Long-term AUM was $103.3 billion. Q2 long-term net flows were $60.9 million, down from $1.29 billion a year earlier; total sales/inflows were $5.1 billion versus $6.6 billion. Management attributed AUM growth mainly to SGA and market performance. Open-end funds had Q2 net outflows of $704 million.
- Fees and mix: Average long-term AUM increased 9.8% in the first half, while the average long-term fee rate declined 0.5 basis points to 45.8, principally reflecting SGA’s lower blended fee rates and lower structured-product incentive fees.
- Cash flow: First-half operating cash flow was negative $143.7 million, compared with negative $154.5 million. Investing cash flow was negative $5.6 million; financing cash flow was positive $145.9 million. These consolidated cash-flow totals include substantial CIP activity and should not be read as the company’s stand-alone cash generation.
- Liquidity and debt: Corporate cash and cash equivalents were $166.0 million and investments were $73.4 million at June 30. The company had $315.7 million outstanding on its term loan and no revolver borrowings against its $100 million facility. The balance-sheet debt figure was $306.1 million, net of $9.6 million of debt issuance costs. The term loan matures in June 2024; the revolver in June 2022.
- Capital returns: First-half common dividends declared were $1.10 per share, versus $0.90. The company repurchased 215,671 shares for $22.5 million in the first half; 409,132 shares remained authorized for repurchase at June 30.
Changes, outlook and risks
- Growth in investment management fees was strongest in institutional accounts and retail separate accounts; open-end fund fees were slightly lower. Lower distribution and administration fees reflected weaker open-end fund assets and sales.
- Operating expenses rose 3.8% in the first half. Amortization expense increased 50.3% to $15.1 million, primarily due to SGA-related intangible assets. First-half restructuring and severance costs were $1.5 million.
- Reported CIP assets and liabilities are large: CIP investments were $2.0 billion and CIP notes payable were $1.8 billion at June 30. CLO obligations are generally recourse only to the related CLO assets; Virtus states its exposure is limited to its beneficial interests and accrued management fees.
- The filing provides no quantified earnings or AUM guidance. Management identifies AUM declines, client withdrawals or contract terminations, market volatility, competition, regulatory and legal matters, personnel retention, technology disruption, debt covenant capacity and acquisition execution as risks. Legal and regulatory matters are described as not likely to have a material adverse effect based on information currently available, but outcomes remain uncertain.
- Other notable items: Virtus adopted lease accounting in January 2019, recording a $20.5 million right-of-use asset and $28.6 million lease liability at adoption. Management reported effective disclosure controls; its assessment excluded SGA’s internal controls.
Important facts for investors to verify
- Whether AUM and net-flow trends, particularly open-end fund outflows, persist; distinguish market gains and the SGA acquisition from organic growth.
- The contribution and future integration, fee profile, amortization and performance of SGA.
- Underlying earnings excluding volatile CIP and investment gains, and the effect of rising amortization and interest costs.
- Debt repayment capacity and covenant headroom, while separating Virtus corporate debt and cash from nonrecourse CIP balances and cash.
- Developments in legal or regulatory matters, client mandates, and any changes to the company’s capital-return plans or preferred-stock conversion obligations.