Virtus Investment Partners, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Unaudited financial statements are prepared under U.S. GAAP. Unless stated otherwise, financial amounts below are in millions of dollars.
Business context and reporting period
Virtus provides investment management and related services to retail and institutional clients through mutual funds, closed-end funds, ETFs, separately managed accounts and other products. Revenue is primarily asset-based. Reported consolidated statements include certain sponsored investment products; their assets and results are not wholly available to Virtus shareholders.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $99.7 | $112.7 | $203.5 | $220.6 |
| Operating income | $16.2 | $22.5 | $40.8 | $55.1 |
| Operating margin | 16.3% | 20.0% | 20.0% | 25.0% |
| Net income attributable to common stockholders | $9.8 | $19.5 | $29.1 | $41.5 |
| Diluted EPS | $1.08 | $2.10 | $3.20 | $4.44 |
- Q2 investment management fees fell 7.6% to $68.9 million; distribution and service fees fell 26.3% to $17.6 million. Average AUM declined 7.8% year over year to $54.4 billion, while the average fee rate was unchanged at 50.7 basis points.
- Q2 operating expenses decreased 7.5% to $83.4 million. A $15.5 million reduction in distribution and asset-based expenses was partly offset by a $10.5 million increase in other operating expenses, principally reflecting the regulatory loss contingency.
- Operating cash flow was $1.6 million for the first half, versus cash used of $91.1 million in the prior-year period. Investing cash flow was negative $4.6 million and financing cash flow negative $4.6 million. The filing attributes the operating cash-flow improvement mainly to lower investment purchases by consolidated sponsored products; cash flow therefore is affected by those products’ activity.
- At June 30, cash and cash equivalents were $194.3 million and investments were $59.3 million. Total assets were $722.0 million; total liabilities were $107.5 million. Virtus had no debt outstanding and reported no borrowings under its $75 million secured credit facility, with capacity to draw the full amount. The facility may increase by $50 million subject to lender approval; the company reported compliance with covenants.
- Cash dividends declared were $0.45 per share in Q2 and $0.90 per share for the first half. Virtus repurchased 212,588 shares for $28.0 million during the first half; 411,971 shares remained authorized for repurchase at June 30.
Material changes and AUM
- Assets under management were $52.4 billion at June 30, down $4.3 billion, or 7.6%, from December 31, 2014. The filing reports a 12.8% year-over-year decrease excluding money market assets; including money market assets, AUM fell 14.6% from $61.4 billion to $52.4 billion. Virtus’s money market funds were liquidated in October 2014.
- First-half net outflows were $3.5 billion, mainly from $5.0 billion of outflows from the former AlphaSector funds; excluding those funds, Virtus reported $1.5 billion of net inflows. In Q2, total net flows were negative $1.35 billion versus positive $968 million a year earlier. Management served notice in May to terminate the unaffiliated subadviser to five AlphaSector funds; those funds had $4.5 billion of AUM at June 30.
- Alternatives AUM declined 40.2% year over year to $4.0 billion. Separately managed account AUM rose 1.3% to $7.0 billion and institutional AUM rose 11.1% to $5.1 billion.
- On April 10, Virtus acquired a majority interest in ETF Issuer Solutions, renamed Virtus ETF Solutions, for approximately $4.8 million. The transaction added $1.4 million of goodwill and $2.4 million of intangible assets and was described as immaterial to the financial statements.
Outlook, risks and unusual items
- The filing provides no numeric earnings or revenue guidance. Management identifies market performance, AUM flows, client withdrawals, investment results, distribution relationships, competition, personnel, regulation and litigation as factors that could affect results and liquidity.
- Virtus recorded a $16.5 million pretax loss contingency related to the SEC inquiry into historical performance information associated with former subadviser F-Squared, including an $11.3 million increase in Q2. A related potential tax benefit was $5.5 million, for a net impact of $11.0 million. SEC discussions were ongoing; the company cautioned that any eventual loss could exceed the recorded amount.
- Two putative securities class actions relate to the F-Squared/AlphaSector matter. The company said no material loss was probable and reasonably estimable for either claim and intends to defend them. It stated that other legal and regulatory matters were not expected to have a material adverse effect, while noting outcomes remain uncertain.
- On July 20, 2015, after quarter-end, Virtus used $50 million of cash to seed a new Multi-Strategy Target Return Fund. Market-risk disclosures estimate that a 10% change in the fair value of marketable securities would change six-month net income attributable to common stockholders by approximately $15.6 million; a 1% interest-rate change could alter the fair value of fixed-income sponsored-fund investments by an estimated $3.6 million.
Important facts for investors to verify
- Progress and final cost of the SEC/F-Squared matter, including whether settlement exceeds the $16.5 million pretax reserve and the effect on cash and earnings.
- Subsequent flows and performance in the former AlphaSector funds, the subadviser transition, and whether inflows outside those funds continue.
- Whether the sharp year-over-year revenue and earnings declines stabilize as AUM and fee-earning asset levels change.
- Liquidity after the $50 million post-quarter fund seed, and the distinction between Virtus’s own cash/investments and assets of consolidated sponsored products.
- Any developments in the two class actions and the company’s stated assessment of their potential losses.