Victory Capital Holdings, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Victory is an investment manager whose revenues are primarily asset-based fees. It reported $60.9 billion in AUM at quarter-end. The quarter included the company’s February IPO and refinancing.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $105.0 million | $100.7 million | +4% |
| Operating income | $27.3 million | $19.6 million | +39% |
| Net income | $10.5 million | $4.4 million | +138% |
| Diluted EPS | $0.16 | $0.08 | +100% |
| Adjusted EBITDA | $39.8 million | $33.6 million | +18% |
| Adjusted EBITDA margin | 37.9% | 33.4% | +4.5 percentage points |
| Adjusted net income | $23.1 million | $13.0 million | +78% |
| Operating cash flow | $25.9 million | $9.7 million | +$16.2 million |
Investment management fees rose 6% to $89.1 million, reflecting higher year-over-year AUM, partly offset by a lower realized fee rate. Fund administration and distribution fees declined 4% to $15.8 million, including distribution fees of $10.1 million versus $11.2 million as assets shifted toward lower 12b-1-fee share classes. Revenue yield on average AUM fell to 69 basis points from 73 basis points. GAAP operating margin was approximately 26.0%, compared with 19.4%.
Balance sheet, liquidity and cash flow
- At March 31, cash was $12.3 million; total assets were $785.1 million; and stockholders’ equity was $398.8 million.
- Gross term-loan principal was $323.0 million and debt’s balance-sheet carrying value was $310.4 million. The new seven-year term loans carried a 5.05% rate at quarter-end (LIBOR plus 2.75%); the reported effective yield was 5.57%.
- The company had $50 million undrawn under its revolving facility at March 31. On May 3, 2018, it amended the facility to increase commitments to $100 million.
- Investing activities used $2.7 million, including a $1.0 million Cerebellum investment. Financing activities used $23.8 million; cash declined $0.6 million to $12.3 million.
- After quarter-end, Victory repaid a further $18 million of term loans, bringing principal outstanding to $305 million as of May 3, 2018.
Material changes versus the prior period
- Quarter-end AUM was $60.9 billion, down 1% from $61.8 billion at December 31, 2017, but up from $56.6 billion at March 31, 2017. Q1 2018 AUM declined by $0.3 billion from market depreciation and $0.6 billion in net outflows.
- Gross flows were $3.7 billion, down from $4.7 billion. Net outflows were $633 million; U.S. mid-cap equity was the largest source of outflows. Solutions and global/non-U.S. equity recorded inflows.
- The February IPO raised $156.5 million net. Combined with new term loans and cash on hand, proceeds refinanced and repaid the prior $499.7 million credit-agreement term loans. Debt principal fell to $323.0 million by quarter-end.
- Interest expense and financing costs decreased to $7.1 million from $12.6 million, while the refinancing generated a one-time $6.1 million debt-extinguishment loss. Operating expenses declined 4%, partly because amortization and restructuring costs were lower.
- The federal corporate tax rate reduction contributed to a lower effective tax rate: 25.3% versus 39.4%. The company also recorded a $1.3 million retained-earnings adjustment upon adopting share-based-payment guidance.
Outlook, commentary and risks
- The filing provides no specific earnings, revenue, AUM or margin guidance. Management cautions that interim results are not necessarily indicative of full-year results.
- Management cited strong investment performance: 69% of fund AUM had four- or five-star Morningstar ratings; by AUM, 87% of strategies outperformed benchmarks over one year and 71% over three years. Past performance is not a guarantee of future results.
- Key business risks include market declines and client withdrawals affecting AUM and fees, investment performance, fee-rate and asset-mix pressure, competition, retaining key personnel, reliance on third parties and technology, cybersecurity, regulation, acquisitions, litigation, and substantial indebtedness. A 10% change in AUM, proportionately across strategies, was estimated to change annualized revenue by about $42 million at the quarter’s weighted-average fee rate.
- The credit agreement is secured by substantially all company and guarantor assets and includes customary restrictions and a leverage covenant that applies when revolver borrowings exceed specified utilization. Term loans bear variable-rate interest.
- Victory committed to invest an additional $3.0 million in Cerebellum preferred units in three installments; the first $1.0 million was funded April 1, 2018. The filing reports no material legal proceedings and no material changes to previously disclosed risk factors.
- The dual-class structure gives Class B shares ten votes each versus one vote per Class A share. The filing also describes voting proxies granted by many employee shareholders to a committee comprising senior executives.
Key facts for investors to verify
- Whether net outflows and fee-rate compression continue, particularly in U.S. mid-cap strategies and lower-fee share classes.
- How much reported earnings growth reflects recurring operations versus refinancing costs, tax changes and non-GAAP adjustments; review the company’s Adjusted EBITDA and Adjusted Net Income reconciliations.
- Current debt principal, variable interest costs, revolver availability and compliance with credit-agreement covenants.
- Progress and remaining obligations under the Cerebellum investment commitment, and any material developments affecting the investment.
- Voting control and potential dilution under the dual-class shares, equity awards and employee voting arrangements.