Virtus Investment Partners, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited results; dollar amounts below are in millions unless stated otherwise.
Business context
Virtus operates a multi-manager investment management business serving retail and institutional clients. Revenue is primarily asset-based. Assets under management (AUM) were $33.3 billion at June 30, up 32.7% year over year; average AUM was $31.8 billion. Second-quarter net flows were $1.5 billion and first-half net flows were $2.9 billion, primarily reflecting long-term open-end mutual fund sales. Market appreciation added $0.5 billion in Q2 and $1.4 billion in the first half.
Financial performance and liquidity
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Revenue | $48.9 | $34.8 | $93.0 | $68.2 |
| Operating income | $3.5 | $1.2 | $7.9 | $1.9 |
| Net income | $3.2 | $0.4 | $7.5 | $1.5 |
| Net income (loss) attributable to common stockholders | $2.0 | $(0.5) | $5.0 | $(0.3) |
| Diluted EPS | $0.30 | $(0.08) | $0.73 | $(0.06) |
| Operating margin, approximate | 7.1% | 3.5% | 8.5% | 2.8% |
- Q2 revenue increased 40.5% year over year; first-half revenue increased 36.3%. Higher investment management fees reflected increased average fee-earning assets, while distribution and administration fees also rose.
- Expense growth partly offset revenue gains: Q2 operating expenses were $45.4 million, up $11.9 million year over year. Employment expense rose with variable compensation and the addition of the Newfleet Multi-Sector team; distribution costs increased with asset-based commissions and variable insurance fund activity.
- First-half cash provided by operating activities was only $0.1 million, down from $4.5 million. Investing activities used $0.7 million and financing activities used $6.7 million. Cash declined $7.3 million to $36.6 million.
- At June 30, cash was $36.6 million, marketable securities $15.4 million, working capital $47.4 million, and long-term debt $15.0 million. The $30 million revolving credit facility matures in September 2013; $15 million was drawn and the company reported compliance with its financial covenants. Total liabilities were $62.7 million.
Material changes, outlook and risks
- Long-term open-end fund sales were $2.4 billion in Q2, up 150.5% year over year; first-half sales were $4.8 billion, up 138.7%. Money-market assets declined amid historically low interest rates.
- Virtus established Newfleet Multi-Sector as an affiliated manager for $5.2 billion of fixed-income assets. On July 27, it launched the Duff & Phelps Global Utility Income Fund, which raised $0.7 billion. The company reported $9.6 million of related launch costs funded in July.
- Management expected available cash, marketable securities and operating cash generation to cover expected operating and capital needs over the next 12 months. The filing provides no specific earnings or revenue guidance. Management cautioned that weaker markets, investment performance or client outflows could reduce AUM, revenue, income and cash flow.
- Market risk is material because fees depend on AUM. A hypothetical 10% change in marketable securities fair value would change net income by an estimated $1.3 million and comprehensive income by $1.5 million. A 300-basis-point interest-rate change was estimated to change quarterly and six-month interest expense by approximately $0.1 million.
- Deferred tax assets remained fully offset by a valuation allowance, reflecting cumulative recent losses. Virtus had requested an IRS private letter ruling concerning a potential $93 million capital loss; success was not assured, and any release of the valuation allowance depended on future evidence of taxable income.
- The company reported routine litigation, arbitration and regulatory examinations; it did not expect them to materially affect consolidated financial condition, but adverse outcomes could affect results or cash flows in particular periods. It reported no significant changes to previously disclosed risk factors.
- Series B preferred stock totaled $35.9 million and carries cumulative dividends at 8% annually. Virtus paid $1.4 million in preferred dividends in the first half. The company repurchased 85,000 common shares for $4.8 million during that period.
Key facts for investors to verify
- Whether strong mutual fund sales and net flows persisted after quarter-end, and how market movements affected AUM and fee-earning asset mix.
- Whether higher compensation, distribution costs and Newfleet-related expenses remain proportionate to revenue growth and support sustained margin improvement.
- Why first-half operating cash flow was nearly zero and whether receivables, commission payments and other working-capital movements normalize.
- Credit-facility covenant headroom, preferred dividend obligations and the liquidity impact of the July fund launch costs and continued share repurchases.
- Outcome of the IRS ruling request and the evidence required before any deferred-tax valuation allowance could be released.