Victory Capital Holdings, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Financial statements are unaudited. The USAA asset management and transfer agency acquisition closed July 1, 2019, so its results are included only from that date.
Business context and key metrics
Victory is an investment manager whose revenue primarily depends on fees tied to assets under management (AUM). At September 30, 2019, AUM was $145.8 billion, including $81.1 billion added through the USAA acquisition. The company reported $0.7 billion of net inflows for the quarter and $3.2 billion for the nine-month period.
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $215.0 million | $108.1 million | $393.8 million | $317.4 million |
| Income from operations | $55.6 million | $31.8 million | $100.4 million | $88.8 million |
| Net income | $26.0 million | $20.6 million | $54.9 million | $49.8 million |
| Diluted EPS | $0.35 | $0.29 | $0.75 | $0.71 |
| Adjusted EBITDA and margin | $96.3 million; 44.8% | $43.3 million; 40.1% | $166.5 million; 42.3% | $123.8 million; 39.0% |
| Adjusted net income | $60.5 million | $29.0 million | $106.8 million | $78.6 million |
Adjusted EBITDA and adjusted net income are non-GAAP measures; the company presents them as measures of ongoing operations and excludes items including acquisition, restructuring, financing and share-based compensation costs.
Financial position, cash flow and liquidity
- Cash and liquidity: Cash and cash equivalents were $79.0 million at quarter-end, compared with $51.5 million at December 31, 2018. Receivables were $86.4 million; the $100 million revolving facility was undrawn. Accounts and other payables were $146.7 million.
- Debt: Long-term debt carrying value was $1.006 billion, against $1.037 billion of term-loan principal. The new seven-year loan bears interest at LIBOR plus 3.25% or an alternate base rate plus 2.25%; the reported term-loan rate at September 30 was 5.57%. The company reported compliance with its financial covenant.
- Subsequent debt payments: Victory repaid $63 million during Q3 and a further $40 million after quarter-end through October 31, for $103 million of principal reduction since the July 1 financing.
- Cash flow, nine months: Operating activities provided $167.7 million, investing activities used $845.9 million, and financing activities provided $705.7 million. Operating cash flow included a $74.7 million source from accounts payable and accrued expenses; receivables used $11.4 million. The acquisition accounted for $851.3 million of investing outflow.
Material changes and unusual items
- Q3 revenue increased about 99% year over year, while nine-month revenue increased about 24%. Net income rose about 26% for Q3 and 10% for the nine-month period. Comparisons reflect the USAA business being consolidated only after its July 1 acquisition; acquired-company revenue for Q3 was $121.3 million.
- Quarterly investment management fees rose to $155.4 million from $92.5 million, primarily reflecting higher average AUM, partly offset by a lower realized fee rate from asset mix. Revenue yield on average AUM fell to 58.5 basis points from 67.6 basis points.
- The $954.1 million USAA transaction consideration comprised $851.3 million cash and $102.8 million contingent consideration. Additional contingent payments may total up to $150 million over four years, subject to revenue-related conditions. Purchase accounting, including acquired intangible values and tax position, remained preliminary.
- Q3 included $16.4 million of acquisition-related costs, $4.8 million of restructuring and integration costs, and a $7.4 million loss on debt extinguishment. Interest expense and other financing costs increased to $16.9 million from $4.5 million.
- The company sold its Cerebellum Capital investment for $10.6 million and recorded a $2.9 million gain. It began a quarterly dividend of $0.05 per share; the board declared another $0.05 dividend payable December 26, 2019.
Outlook, commentary and risks
The filing provides no specific financial guidance. Management describes the acquisition as expanding and diversifying the platform, particularly in fixed income and solutions, and creating access to USAA members through a direct channel. Integration brings additional personnel, distribution, transfer-service and other operating costs.
Results remain sensitive to investment performance, client flows, market movements, asset mix and fee rates. Management estimates that a 10% change in AUM, proportionately across strategies, would change annualized revenue by approximately $85.3 million at the quarter’s weighted-average fee rate. Other disclosed risks include substantial indebtedness, acquisition integration, key-person and technology/cybersecurity risks, competition, regulation and potential litigation. New retail-investor rules are due to be implemented by June 30, 2020 and may increase compliance and operating costs. The company reported no material legal proceedings, no material changes to its previously disclosed risk factors other than the dividend, and effective disclosure controls.
Most important facts for investors to verify
- How much revenue, earnings and AUM growth are attributable to the acquisition versus organic flows and market performance.
- Whether USAA integration costs and expected synergies develop as planned, and whether preliminary purchase accounting changes.
- The sustainability of the lower realized fee rate and the composition and persistence of net flows by asset class and channel.
- Debt repayment capacity, floating-rate interest exposure, covenant headroom and the contingent acquisition payments.
- The quality of operating cash generation, given the significant working-capital contribution from accrued expenses and payables.
- The continuing affordability and terms of dividends and share repurchases amid acquisition-related leverage and cash needs.