Victory Capital Holdings, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Victory Capital is an investment manager whose revenue is primarily driven by fees on assets under management (AUM). Figures are unaudited; dollar amounts are in millions unless noted.
Financial performance and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $104.4 | $100.9 | $209.4 | $201.6 |
| Operating income | $29.7 | $19.4 | $57.0 | $39.0 |
| Net income | $18.7 | $2.4 | $29.2 | $6.8 |
| Diluted EPS | $0.26 | $0.04 | $0.42 | $0.11 |
| Adjusted EBITDA (non-GAAP) | $40.7 | $36.2 | $80.5 | $69.8 |
| Adjusted EBITDA margin (non-GAAP) | 39.0% | 35.9% | 38.4% | 34.6% |
- Q2 revenue rose 3%; investment management fees increased 5% on higher average AUM, partly offset by a lower realized fee rate from asset mix. Fund administration and distribution fees declined 6%, including lower distribution fees as assets shifted to lower 12b-1-paying share classes.
- Operating expenses declined 8% in Q2. Lower distribution, general and administrative, depreciation and amortization, and restructuring costs more than offset higher personnel costs. GAAP operating margin was approximately 28.4%, versus 19.3% in Q2 2017.
- Q2 net income increased substantially year over year, while the six-month result includes a $6.1 million debt-extinguishment loss tied to refinancing. Interest and financing costs fell to $4.7 million in Q2 from $13.8 million, and to $11.8 million for six months from $26.5 million.
- Effective tax rates were 25.3% for both the quarter and six-month period, versus 36.1% and 38.3%, respectively, in 2017. The filing attributes the lower 2018 rate primarily to the Tax Act’s reduction in the federal corporate rate, with share-based compensation also affecting the rate.
- Six-month operating cash flow was $59.6 million, compared with $27.1 million. Investing activities used $5.3 million; financing activities used $52.0 million. Cash ended at $15.2 million, compared with $12.9 million at year-end 2017.
- At June 30, cash was $15.2 million, receivables $51.8 million, and the $100 million revolving facility was undrawn. Long-term debt carried on the balance sheet was $287.9 million, against $300 million principal outstanding. The term loan rate was 5.08% (5.71% effective yield). Subsequent repayments reduced principal to $280 million by August 3.
Business trends and changes versus prior periods
- AUM was $62.3 billion at June 30, up 2% from March 31 and 9% year over year. The quarterly increase reflected $1.5 billion of market appreciation, partly offset by $0.1 billion of net outflows. Six-month AUM rose $0.5 billion, as $1.2 billion of market appreciation was partly offset by $0.7 billion of net outflows.
- Q2 gross flows were $3.5 billion and net flows were negative $0.1 billion, compared with $4.0 billion and negative $0.6 billion a year earlier. Quarterly inflows in global/non-U.S. equity, Solutions and U.S. small-cap were offset by outflows, particularly in fixed income and U.S. mid-cap. Six-month outflows were concentrated in U.S. mid-cap and fixed income; Solutions and global/non-U.S. equity had inflows.
- Average AUM increased year over year, but revenue yield on average AUM declined to 68 basis points in Q2 from 71 basis points and to 68 basis points for six months from 72 basis points.
- The February 2018 IPO generated $156.5 million net proceeds. Proceeds, new term debt and cash were used to repay the prior credit agreement. The new agreement has seven-year term loans and a five-year revolver, increased to $100 million in May.
- The company authorized a $15 million Class A share repurchase program in May and had repurchased 66,112 shares for $0.7 million by June 30; $14.3 million remained available.
Outlook, commentary, risks and unusual items
- No specific earnings or revenue guidance was provided. Management emphasized that results depend on AUM levels and mix, investment performance, client flows and fee rates; interim results are not necessarily indicative of full-year results.
- Management reported strong investment performance: 83% of strategies by AUM exceeded benchmarks over one year and 69% over three years; 69% of fund AUM received four- or five-star Morningstar ratings.
- Key risks include market-driven AUM declines and client withdrawals, fee-rate pressure from asset mix, investment performance, retention of investment professionals, competition, regulatory and litigation exposure, cybersecurity and third-party operational reliance, and substantial indebtedness. A 10% broad-based AUM change was estimated to change annualized revenue by approximately $42.3 million at the quarter’s weighted-average fee rate.
- Other notable items: $1.9 million of non-capitalizable refinancing costs were included in six-month general and administrative expense; restructuring costs fell substantially as 2017 RS Investments integration costs subsided. The company also had a $2 million commitment for additional Cerebellum Capital investment, with the second installment paid just after quarter-end and the final installment scheduled for October.
- The filing reports no material legal proceedings or material changes to previously disclosed risk factors. Management concluded disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether AUM flows improve and whether market appreciation, rather than sustained client inflows, remains the main driver of AUM growth.
- Whether the declining fee yield and changing mutual-fund share-class mix continue to pressure revenue despite higher average AUM.
- Debt balances, floating-rate exposure, required repayments and covenant headroom under the new credit agreement; confirm the subsequent repayments and interest terms.
- The composition and sustainability of adjusted EBITDA and adjusted net income, which are non-GAAP measures and exclude specified costs.
- Execution of the Cerebellum investment commitment, share-repurchase activity, and any material developments in the risks referenced in the company’s 2017 Form 10-K.