Virtus Investment Partners, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Virtus provides investment management and related services; revenues are primarily asset-based fees. Financial statements are unaudited.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $82.3 million | $92.4 million | $242.7 million | $295.9 million |
| Operating income | $16.5 million | $23.1 million | $38.0 million | $63.9 million |
| Net income attributable to common stockholders | $15.6 million | $(0.6) million | $36.1 million | $28.5 million |
| Diluted EPS | $1.99 | $(0.07) | $4.39 | $3.15 |
| Operating margin | 20.1% | 25.0% | 15.7% | 21.6% |
Q3 revenue fell 10.9% and operating income fell 28.5%; lower average assets under management (AUM) drove the decline, partly offset by lower expenses. Q3 net income turned positive largely alongside a $25.2 million year-over-year improvement in other income, including investment gains at consolidated sponsored products; operating income still declined. Nine-month revenue decreased 18.0%, while net income attributable to common stockholders rose 26.7%, supported by improved investment results and a lower estimated effective tax rate.
- AUM and flows: Period-end AUM was $46.5 billion, down 2.9% from September 2015 and 1.9% from December 2015. Average AUM for the first nine months was $45.3 billion, down 14.2% year over year. Nine-month net outflows were $4.3 billion, partly offset by $3.8 billion of market appreciation. Q3 net inflows were $0.5 billion, compared with $1.6 billion of net outflows in Q3 2015.
- Cash and liquidity: Company cash and cash equivalents were $165.4 million at September 30, versus $87.6 million at year-end 2015; marketable securities were $81.5 million. Nine-month operating cash flow was a use of $1.1 million, versus a use of $57.0 million in 2015. Investing activities provided $4.6 million; financing activities provided $78.4 million.
- Debt: Virtus had no borrowings under its corporate revolving facility at September 30. A new five-year unsecured facility provides up to $150 million (potentially $200 million with lender approval). The consolidated CLO had $323.9 million of notes payable; these are obligations of the CLO, secured only by its assets, and are not recourse to Virtus’s general assets.
- Capital returns: Virtus repurchased shares for $72.2 million during the first nine months, including a $47.2 million tender offer, and declared dividends of $0.45 per share each quarter. Shares outstanding were 7.61 million at September 30.
Material changes and unusual items
- Open-end fund AUM declined 15.0% year over year. The Emerging Markets Opportunities fund accounted for about $3.1 billion, or 72%, of nine-month net outflows, following an organizational change at its subadvisor; it had positive Q3 net flows.
- On June 9, 2016, Virtus issued a CLO with $356.3 million par value, including $320.0 million of senior notes and $36.3 million of subordinated notes. CLO consolidation materially affects reported balance-sheet and cash-flow totals, but Virtus says its exposure is limited to its beneficial interests and fees.
- Nine-month results included $4.3 million of restructuring and severance expense, chiefly staff reductions and related office costs. The comparable 2015 period included a $16.5 million loss contingency that was settled and paid.
- On October 27, after quarter-end, Virtus bought BMO’s 1,727,746 shares (about 22.7% of September-end shares) for $161.5 million at $93.50 per share. It used $131.5 million of cash and borrowed $30.0 million under the facility. Following the transaction, Virtus reported $120.0 million of unused facility capacity.
Outlook, risks, and contingencies
The filing gives no specific financial guidance. Management identifies AUM levels, net flows, market performance, distribution relationships, and fee mix as important drivers. It expects cash uses to include investment in growth and infrastructure, product seeding, dividends, and share repurchases. The company cautions that interim results are not necessarily indicative of full-year results.
Key risks include market declines or client withdrawals reducing fee-bearing AUM, loss or renegotiation of advisory relationships, competition, key-personnel retention, regulatory developments, and inability to meet credit-facility covenants. The facility requires a maximum leverage ratio of 3.00:1.00 and minimum interest coverage of 4.00:1.00; Virtus reported compliance at September 30. Securities class actions concerning funds formerly subadvised by F-Squared remain pending. The company disputes the claims and said it did not consider a material loss probable and reasonably estimable; adverse outcomes could nevertheless affect particular periods.
Important facts for investors to verify
- Whether AUM outflows—especially in open-end funds and the Emerging Markets Opportunities fund—continue or improve, and how they affect fees and margins.
- The source and repeatability of investment gains supporting reported net income, versus the ongoing decline in operating income.
- The post-quarter BMO share purchase’s impact on cash, leverage, share count, interest expense, and future capital returns.
- The CLO’s credit performance, floating-rate exposure, and the distinction between its nonrecourse liabilities and Virtus’s own liquidity.
- Developments in the F-Squared-related litigation and any resulting financial exposure.