Virtus Investment Partners, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014; filed November 6, 2014. Virtus provides investment management and related services to retail and institutional clients. Results are unaudited.
Financial performance and key metrics
- Q3 revenue: $117.8 million, up 17.4% year over year. Investment management fees rose 17.6%, primarily from higher average AUM and a higher average fee rate.
- Q3 operating income: $38.9 million, up 23.1%; operating margin was approximately 33.0%, compared with 31.5% a year earlier. Q3 net income attributable to common stockholders was $37.3 million versus $21.1 million; diluted EPS was $4.02 versus $2.56.
- Nine-month results: Revenue of $338.5 million, up 19.7%; operating income of $94.1 million, up 18.1%; common-stockholder net income of $78.8 million versus $50.4 million; diluted EPS of $8.46 versus $6.21. Operating margin was approximately 27.8%, versus 28.2%.
- Taxes and unusual earnings item: Q3 included a $15.5 million net tax benefit from settlement of the 2011 federal tax audit, including recognition of uncertain-tax-position benefits offset partly by a deferred-tax-asset reduction. The nine-month effective tax rate was 23.6%, compared with 37.6% in 2013. A separate $25.1 million stock-compensation windfall tax benefit was recorded in equity, not earnings.
- AUM: $60.9 billion at September 30, up 10.7% from a year earlier; long-term AUM was $59.5 billion. Average AUM for the first nine months was $59.3 billion, up 14.6%. Alternatives AUM rose 49.2% year over year, while institutional AUM fell 5.6%.
- Flows: Q3 total net flows were $492 million, compared with $1.25 billion in Q3 2013. Long-term open-end mutual funds had $652 million of Q3 net inflows; separately managed accounts and institutional accounts had net outflows. Nine-month total net flows were $1.0 billion versus $7.5 billion in 2013.
- Cash flow and liquidity: Operating cash flow was negative $102.3 million for the first nine months, versus positive $26.1 million in 2013, largely reflecting purchases of investments held by consolidated sponsored products, tax payments and structuring fees. Investing cash flow was negative $7.4 million; financing cash flow was positive $11.9 million. Cash and cash equivalents were $172.7 million at September 30, down from $271.0 million at year-end.
- Debt and capital: No debt was outstanding; the company reported $75 million of available borrowing capacity under its credit facility, which expires in September 2017. Total equity was $560.4 million. The company repurchased $26.3 million of shares and paid $4.1 million in dividends during the nine-month period; a further $0.45-per-share dividend was declared for payment in November.
Material changes and management commentary
- Management attributed revenue and operating-income growth mainly to higher average AUM; average fees also increased as equity and alternative strategies made up a larger share of AUM.
- Expenses increased 14.7% in Q3 and 20.3% for the nine months. Nine-month distribution and administrative expense included $9.6 million of structuring costs for the new DSE closed-end fund. Other operating costs also rose with research, new-fund costs, professional fees and a middle- and back-office service-provider transition.
- Q3 other non-operating expense was $6.1 million, versus $1.7 million of income in the prior-year quarter, reflecting investment losses. This limited pretax-income growth to 3.9% despite higher operating income.
- Five sponsored investment products were consolidated and one deconsolidated during the first nine months; 12 were consolidated at quarter-end. Their assets and liabilities affect reported totals, but management states its exposure is limited to its investment and fees, and consolidation changes do not affect net income attributable to stockholders.
- Three money market funds, with $1.2 billion of AUM at September 30, were liquidated on October 20. Management expected no impact on operating results.
- No specific financial guidance or quantified forward outlook is provided. Management identified AUM levels, net flows, operating cash flows and credit availability as uncertainties in forward-looking statements.
Risks, contingencies and controls
- Fee revenue and income are sensitive to market values and client withdrawals. Other disclosed risks include competition, key-person retention, distribution relationships, regulation and litigation, service-provider interruptions, deferred tax assets, and goodwill or intangible-asset impairment.
- The company reported a material weakness in controls over assessing and continuously reassessing whether certain variable-interest entities should be consolidated. Disclosure controls were deemed ineffective at quarter-end. New controls and staff training were implemented, but had not operated long enough to establish remediation; management stated the weakness had not caused a material misstatement in the reported financial statements.
- Virtus is involved in litigation, arbitration and regulatory matters. Management did not believe the matters were likely to materially affect consolidated financial condition, but noted adverse outcomes could affect results or cash flows in particular periods.
- The broker-dealer subsidiary was above required minimum net capital and within its permitted indebtedness ratio; the company reported compliance with credit-facility covenants.
Most important facts for investors to verify
- How much of earnings growth reflects recurring operating performance versus the $15.5 million tax-audit benefit.
- Whether AUM growth and net flows remain durable, particularly given weaker Q3 flows, institutional and separately managed account outflows, and the money-market fund liquidations.
- Whether negative operating cash flow is primarily attributable to sponsored-product investment activity and how company-level liquidity evolves.
- Whether the material weakness in VIE-consolidation controls is remediated and whether future filings identify any consolidation adjustments.
- Whether expense growth, including fund-launch and systems-transition costs, moderates as revenue expands.