Virtus Investment Partners, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited results. Virtus provides investment management and related services; it completed its acquisition of RidgeWorth Investments on June 1, 2017, so reported Q2 results include only one month of RidgeWorth operations.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $94.1 million | $80.1 million | $173.9 million | $160.4 million |
| Operating income | $3.2 million | $8.7 million | $13.2 million | $21.5 million |
| Net income attributable to stockholders | $(0.3) million | $8.1 million | $12.7 million | $20.5 million |
| Net income attributable to common stockholders | $(2.4) million | $8.1 million | $8.6 million | $20.5 million |
| Diluted EPS | $(0.34) | $0.97 | $1.22 | $2.43 |
| Operating margin | 3.4% | 10.9% | 7.6% | 13.4% |
- Q2 revenue rose 17.5%, led by investment management fees, up 27.3% to $74.1 million. The quarter included $11.3 million of RidgeWorth revenue for June.
- Operating expenses increased 27.5% in Q2 to $90.9 million. Key drivers included $8.9 million of restructuring and severance, acquisition and integration costs, higher employment expenses, and added amortization.
- At June 30, total AUM was $88.6 billion, up 96.1% from a year earlier; long-term AUM was $85.0 billion. The acquisition contributed approximately $40.1 billion of AUM. Q2 long-term net flows were $(0.2) billion, versus $(2.2) billion in Q2 2016; Q2 total sales were $3.5 billion.
- Average fee yield for all products was 47.5 basis points in Q2 versus 51.1 basis points a year earlier. Management attributed the decline mainly to acquired assets’ lower average fee rate.
- Six-month operating cash flow was $54.6 million, versus $51.9 million in 2016. Investing cash outflow was $389.1 million, mainly reflecting the acquisition; financing cash inflow was $430.8 million. Cash and cash equivalents were $127.6 million at June 30, excluding cash held by consolidated investment products.
- Balance-sheet debt was $248.1 million; cash was $127.6 million and investments were $93.4 million. The company reported net debt of $184.1 million after adjusting for $51.7 million of contingent consideration, and a 1.1:1 net leverage ratio. The revolving facility had no borrowings; $100 million was available.
Material changes, outlook and risks
- RidgeWorth acquisition: Total consideration was $547.1 million, including $471.4 million cash paid at closing, Virtus shares valued at $21.7 million, $51.7 million contingent consideration, and $2.3 million deferred cash consideration. The contingent payment conditions were met and payment was expected in Q4 2017. Purchase accounting and working-capital adjustments remained preliminary.
- The acquisition was funded in part with a new $260 million, seven-year term loan and public offerings that generated $220.5 million net proceeds from common and mandatory convertible preferred stock. The preferred stock carries a 7.25% dividend and is scheduled to convert in February 2020.
- The new credit agreement includes a $100 million, five-year revolving facility, secured debt, customary restrictions, and a maximum leverage covenant set at 2.5:1 as of June 30, with scheduled reductions to 1.75:1 over the following 18 months. The term loan bears floating-rate interest and has scheduled amortization and potential excess-cash-flow repayments.
- Management provided no specific earnings or revenue guidance in the supplied filing text. It noted that results depend on AUM, market performance, net flows, fee rates, and acquisition integration and synergies.
- Key risks include market declines or client withdrawals reducing fee-generating AUM, loss of advisory mandates or distribution relationships, competition, regulatory and litigation matters, retention of personnel, variable-rate debt and covenant compliance, and failure to realize acquisition benefits. Management said legal matters were not expected to materially affect the company, but outcomes remain uncertain; securities class actions remained pending.
- One securities class action had been certified, with expert discovery ongoing. A second action’s class-certification motion was denied; plaintiffs later sought leave to amend. The company stated it believed neither matter had a material loss that was probable and reasonably estimable.
- Disclosure controls were deemed effective, but RidgeWorth internal controls were excluded from the assessment because the acquisition was recent. Management was reviewing RidgeWorth’s controls for integration.
Important facts for investors to verify
- Whether RidgeWorth’s acquired assets and client relationships remain stable, and whether integration costs and expected synergies develop as anticipated.
- Final acquisition purchase-price allocation, working-capital settlement, and timing and funding of the $51.7 million contingent payment.
- Subsequent AUM flows, average fee yields, and the contribution of acquired assets to recurring earnings.
- Ability to maintain covenant headroom as leverage limits tighten, including exposure to floating interest rates and scheduled debt repayments.
- Progress and potential outcomes of the disclosed securities litigation and any changes in legal contingencies.
- Distinction between Virtus corporate debt and approximately $1.1 billion of consolidated CLO notes, which the filing says are nonrecourse to Virtus’s general assets.