Victory Capital Holdings, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited consolidated results; dollar figures below are in millions unless noted. Victory is an investment manager whose revenue is primarily asset-based fees. It reported $63.6 billion of AUM at quarter-end.
Financial performance and key metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $108.1 | $102.4 | $317.4 | $304.0 |
| Operating income | $31.8 | $24.2 | $88.8 | $63.2 |
| Net income | $20.6 | $7.9 | $49.8 | $14.6 |
| Diluted EPS | $0.29 | $0.13 | $0.71 | $0.25 |
| Adjusted EBITDA (non-GAAP) | $43.3 | $39.3 | $123.8 | $109.0 |
| Adjusted EBITDA margin (non-GAAP) | 40.1% | 38.3% | 39.0% | 35.9% |
| Adjusted net income (non-GAAP) | $29.0 | $17.1 | $78.6 | $44.0 |
- Q3 revenue rose 6%; investment management fees increased 8% to $92.5 million as average AUM grew, partly offset by lower realized fee rates from asset mix. Fund administration and distribution fees fell 5%, mainly due to lower distribution fees and a shift toward lower 12b-1-paying share classes.
- Q3 operating margin was approximately 29.4%, versus 23.7% a year earlier. Nine-month operating margin was approximately 28.0%, versus 20.8%.
- Q3 AUM increased 2% from June 30, primarily from $2.1 billion of market appreciation, partly offset by $672 million net outflows. Nine-month AUM rose 3% from December 31, with $3.3 billion of market appreciation partly offset by $1.4 billion net outflows. Q3 outflows were concentrated in U.S. mid-cap equity; Solutions, fixed income and global/non-U.S. equity had inflows.
- Operating cash flow was $99.9 million for the first nine months, compared with $59.4 million in 2017. Investing activities used $7.7 million; financing activities used $80.0 million. Cash increased to $25.1 million from $12.9 million at year-end.
- Long-term debt carrying value was $268.4 million at September 30; principal outstanding was $280.0 million. The term loan rate was 5.14%. The $100 million revolving facility was undrawn. Cash less gross debt principal was approximately negative $254.9 million.
- Q3 interest and financing costs declined 62% to $4.5 million; nine-month costs declined 57% to $16.3 million, reflecting refinancing and debt repayments. Nine-month results included a $6.1 million debt-extinguishment loss from refinancing.
- Income tax rates were 24.2% for Q3 and 24.8% for the first nine months, down from 39.5% and 38.9%, respectively, mainly following the federal rate reduction under the Tax Act.
Material changes and notable items
- Net income increased substantially year over year, supported by higher operating income and lower interest costs and effective tax rates. Nine-month GAAP results also reflect the $6.1 million refinancing loss; non-GAAP measures exclude specified items and should be considered alongside GAAP results.
- Operating expenses declined 2% in Q3 and 5% year to date. Lower general and administrative costs and amortization contributed; personnel compensation increased with incentive compensation. Year-to-date restructuring costs fell from $4.9 million to $0.7 million.
- The February 2018 IPO generated $156.5 million net proceeds. In connection with the IPO, Victory refinanced its prior credit agreement and repaid $499.7 million of prior term loans. It repaid a further $80 million under the new term loans through September 30.
- Victory repurchased 357,697 Class A shares for $3.5 million through September 30; $11.5 million remained under its $15 million authorization. No dividend per share was declared in the periods shown for 2018; the 2017 nine-month figure was $2.19 per share.
Outlook, transactions and risks
- The filing provides no numerical earnings or revenue guidance. Management notes that interim results are not necessarily indicative of full-year results.
- Harvest acquisition: agreed September 21, with closing expected around the end of Q1 2019, subject to conditions including client consents. Consideration includes $255 million cash and $15 million of Class B shares at closing, additional Class B shares in installments, and performance-based earnouts of up to $100 million for each of 2021–2023. A committed incremental term facility of up to $265 million was planned; financing is not a closing condition.
- Subsequent event: on November 6, 2018, Victory agreed to acquire USAA Asset Management Company and related businesses for $850 million cash plus contingent payments of up to $150 million over four years. Closing was expected around the end of Q2 2019, subject to conditions and required fund/client approvals. Lenders committed up to $1.395 billion of term loans and a $100 million revolver to refinance existing debt and fund the acquisitions and related costs.
- Management identifies market-driven AUM declines, client withdrawals, fee-rate and asset-mix changes, investment performance, talent retention, technology and cybersecurity, regulation, litigation, acquisition integration and substantial indebtedness as key risks. The pending acquisitions bring additional financing, dilution, integration, client-consent and execution risks; the USAA transaction could materially increase leverage. The USAA acquisition was expected to accelerate the date Victory ceases to qualify as an emerging growth company.
- Market sensitivity: management estimates a 10% change in AUM, proportionately across strategies, would change annualized revenue by approximately $43.3 million at the Q3 weighted-average fee rate. Revenue is also exposed to foreign-exchange and interest-rate movements.
- Management concluded disclosure controls and procedures were effective at September 30, 2018, and reported no material change in internal control over financial reporting during the quarter. The company reported no material legal proceedings.
Important facts for investors to verify
- Whether AUM outflows persist, especially in U.S. mid-cap equity, and whether market appreciation or net flows drive subsequent AUM and fee revenue.
- Fee-rate trends and the effects of asset and share-class mix on investment-management and distribution revenue.
- Cash generation, debt repayments, floating-rate interest exposure, covenant headroom and the eventual financing terms and leverage for both acquisitions.
- Harvest and USAA closing conditions, client and fund approvals, consent-related purchase-price adjustments, earnout obligations and integration costs.
- Comparability of GAAP and non-GAAP earnings, including adjustments for stock compensation, acquisition costs, amortization, debt costs and other excluded items.