Virtus Investment Partners, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. The company provides investment management and related services to retail and institutional clients. Unless stated otherwise, amounts below are in U.S. dollars; financial statement amounts are in millions.
Financial performance and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $132.9 | $94.1 | $262.0 | $173.9 |
| Operating income | $27.3 | $3.2 | $49.9 | $13.2 |
| Net income attributable to common stockholders | $21.0 | $(2.4) | $42.2 | $8.6 |
| Diluted EPS | $2.75 | $(0.34) | $5.52 | $1.22 |
| Operating margin | 20.5% | 3.4% | 19.1% | 7.6% |
Revenue growth was driven primarily by the June 2017 RidgeWorth acquisition and higher average assets under management (AUM). Operating income also benefited from the absence of $8.9 million in Q2 2017 restructuring and severance charges. Q2 2018 net income included $5.8 million of net interest income, compared with $1.2 million of net interest expense in Q2 2017; this includes substantial offsetting income and interest expense within consolidated investment products (CIPs).
- AUM: Total AUM was $91.6 billion at June 30, up 3.4% year over year. Long-term AUM was $89.8 billion, up 5.7%. Q2 long-term net flows were positive $1.3 billion versus negative $0.2 billion a year earlier; first-half net flows were positive $0.6 billion.
- Fees and margins: Average long-term AUM grew 65.9% in the first half, largely from RidgeWorth. Average long-term fee rates declined 3.3 basis points year over year to 46.3 basis points, primarily reflecting the acquired business’s lower blended fee rate.
- Cash flow: First-half operating cash flow was negative $154.5 million, versus positive $54.5 million in 2017, primarily because of increased net purchases of CIP investments and working-capital movements. Investing activities provided $15.3 million, compared with $389.1 million used in 2017, which included the RidgeWorth acquisition. Financing activities provided $85.4 million.
- Liquidity and debt: At June 30, corporate cash and cash equivalents were $138.8 million, marketable investments were $61.4 million, and corporate debt on the balance sheet was $245.1 million. The credit agreement reported $258.1 million outstanding under the term loan and no borrowings under the $100 million revolver; reported net debt was $119.2 million and net leverage was 0.66:1. Consolidated CIPs also carried $1.57 billion of notes payable, generally recourse only to the related CIP assets, not the company.
- Balance sheet: Total assets were $2.69 billion and total equity was $640.4 million. Reported cash includes $40.8 million held by CIPs and $0.9 million of CIP cash pledged or on deposit; these are distinct from corporate cash.
- Dividends and repurchases: Common dividends declared were $0.45 per share for Q2. The company repurchased 60,622 shares during the first half for $7.5 million at a weighted-average $123.69 per share.
Material changes versus the prior comparable period
- Q2 revenue increased 41.2%; first-half revenue increased 50.6%. Investment management fees rose 39.3% and 52.7%, respectively, chiefly reflecting RidgeWorth and higher AUM.
- Q2 operating income rose to $27.3 million from $3.2 million, while first-half operating income increased to $49.9 million from $13.2 million. Higher employment, distribution, and amortization expenses partly offset revenue growth.
- First-half common-stockholder earnings increased to $42.2 million from $8.6 million. The prior-year comparison included RidgeWorth acquisition-related restructuring costs and acquisition financing and issuance activity.
- First-half average fee rates declined despite substantial AUM growth. The filing also reports lower closed-end fund and institutional AUM year over year, partly offset by growth in open-end funds, retail separate accounts, and structured products.
- Adoption of ASC 606 increased reported distribution and service revenue and distribution expense by $2.1 million in Q2 and $3.3 million in the first half, with no corresponding change to operating income. Prior-year figures were not restated.
Outlook, risks, contingencies, and unusual items
- Acquisition: The company closed its majority investment in Sustainable Growth Advisers (SGA) on July 1, 2018; SGA had $11.3 billion of AUM at June 30. The transaction was funded with balance-sheet resources and $105 million of additional term loans, borrowed July 2. The acquisition is subsequent to the reporting date.
- Guidance: The filing provides no specific earnings, revenue, or AUM guidance. Management identifies AUM levels, net flows, market performance, borrowing capacity, and acquisition benefits as important uncertainties.
- Debt terms: The term-loan maintenance covenant was removed. A 2.50:1.00 leverage covenant applies to the revolving facility only when revolving loans and letters of credit exceed 30% of commitments. The term loan includes excess-cash-flow and certain asset-sale repayment provisions.
- Legal matter: A securities class action related to funds formerly subadvised by F-Squared reached a settlement agreement; the court preliminarily approved it on June 28, 2018, with a final-approval hearing scheduled for October 24. The company believed final approval likely and expected no material financial impact if approved. The filing cautions that legal and regulatory matters remain inherently uncertain.
- Principal risks: AUM declines or client withdrawals, market volatility and investment losses, competition, loss of key personnel or distribution relationships, regulatory or litigation outcomes, debt and liquidity constraints, technology disruptions, tax changes, and failure to realize acquisition benefits. Management reported no material change in market-risk disclosures and concluded disclosure controls were effective.
- Accounting and unusual items: Tax accounting under the Tax Cuts and Jobs Act remained provisional for certain effects. The company expects lease-accounting adoption to add right-of-use assets and lease liabilities. Amortization of acquired intangibles increased materially following RidgeWorth.
Important facts for investors to verify
- Whether positive sales and net flows continue, and how AUM changes from market performance, acquisitions, redemptions, and client mandates.
- Whether the lower blended fee rate and elevated employment, distribution, and intangible-amortization costs affect future operating margins.
- The SGA transaction’s final funding, integration, contribution to earnings, and impact on leverage and liquidity after the reporting date.
- How much of reported cash and debt relates to CIPs; CIP assets and liabilities should not be confused with corporate liquidity and recourse debt.
- Final court approval and any ultimate cost of the securities litigation settlement, along with developments in other legal or regulatory matters.
- Whether operating cash flow normalizes, given the large first-half use of cash and the investment activity of consolidated products.