Virtus Investment Partners, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. The interim financial statements are unaudited. Virtus provides investment management and related services to individual and institutional investors; revenues are primarily asset-based fees.
Key financial results
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Revenue | $80.1 million | $99.7 million | $160.4 million | $203.5 million |
| Operating income | $8.7 million | $16.2 million | $21.5 million | $40.8 million |
| Net income attributable to common stockholders | $8.1 million | $9.8 million | $20.5 million | $29.1 million |
| Diluted EPS | $0.97 | $1.08 | $2.43 | $3.20 |
| Operating margin | 10.9% | 16.3% | 13.4% | 20.0% |
- Revenue and earnings: Q2 revenue fell 19.6% year over year and first-half revenue fell 21.2%. Operating income declined 46.1% in Q2 and 47.3% for the half. Lower average assets under management (AUM) were the principal driver. Q2 common-stockholder earnings fell 17.3%; first-half earnings fell 29.8%.
- Cash flow and liquidity: Reported operating cash flow was $51.9 million for the first half, versus $1.6 million in 2015. Cash and cash equivalents attributable to the company were $155.5 million at June 30, up from $87.6 million at year-end; investments were $91.7 million, including $80.2 million in marketable securities. The cash-flow statement’s ending cash total of $247.7 million includes cash held by consolidated investment products and is not equivalent to company cash alone.
- Debt: Virtus reported no company borrowings under its $75 million credit facility, with the full capacity available and covenants satisfied. The consolidated CLO had $319.7 million of notes payable outstanding; these are obligations of the consolidated investment product, not general corporate debt.
- Capital returns: The company paid $7.6 million in dividends during the first half and declared dividends of $0.45 per share in each quarter. It spent approximately $62.1 million on share repurchases, including a $47.1 million tender offer for 556,509 shares.
Material changes and business trends
- AUM was $45.2 billion at June 30, down 13.8% from a year earlier and 4.7% from December 31, 2015. Average AUM for the first half fell 17.8% year over year to $45.2 billion.
- First-half net outflows were $4.8 billion, compared with $3.5 billion in the prior-year period. About $3.2 billion of 2016 outflows came from the Virtus Emerging Markets Opportunities Fund following an organizational change at its subadviser. Q2 net outflows were $2.2 billion, versus $1.3 billion in Q2 2015.
- Open-end funds were the main pressure point: first-half net outflows were $5.0 billion, and open-end fund AUM fell 25.6% year over year. Positive net flows in separately managed accounts, ETFs and institutional accounts partly offset the decline. First-half market performance added $2.8 billion to AUM.
- Lower AUM also reduced distribution and service fees and administration and transfer-agent fees. First-half average fees earned declined 0.7 basis point year over year, primarily because of lower open-end fund fee rates.
Outlook, commentary, risks and unusual items
- The filing gives no specific financial guidance or numerical forecast. Management notes that results depend on AUM, market performance and net flows and cautions that first-half results are not necessarily indicative of full-year results.
- Q2 2016 included $2.4 million of restructuring and severance costs, mainly from headcount reductions and vacated office space; $2.1 million remained unpaid at quarter-end. Q2 2015 included an $11.3 million regulatory loss-contingency expense, and the first half of 2015 included $16.5 million of such expense; the matter was settled and paid in 2015.
- Other income benefited from an approximately $2.9 million gain on the sale of a minority interest in a subadviser during Q2. Reported CLO interest expense included $3.7 million of discount amortization in Q2.
- The company identified market-driven AUM declines, client withdrawals, advisory-contract terminations, competition, distribution relationships, regulatory matters and litigation among its risks. Two securities class actions concerning funds formerly subadvised by F-Squared survived motions to dismiss in part. Virtus said it intends to defend the cases and did not consider a material loss probable and reasonably estimable. It cautioned that adverse outcomes could still affect results or cash flows in particular periods.
- The CLO launched in June 2016, issuing $356.3 million of notes and replacing warehouse financing. Its portfolio included $344.9 million of bank loans; no collateral assets were in default at June 30. The company’s exposure is described as limited to its investment and management fees, but the consolidated product’s floating-rate assets and liabilities remain relevant to performance and risk.
Investor verification points
- Track AUM and net flows, especially open-end funds and the Emerging Markets Opportunities Fund, and assess whether outflows persist.
- Reconcile reported operating cash flow and ending cash to the effects of consolidated sponsored products and the CLO; the MD&A contains a description calling operating cash flow “used” despite the cash-flow statement reporting $51.9 million provided.
- Distinguish the CLO’s $319.7 million of consolidated notes payable from Virtus’s own corporate debt, and review CLO credit quality, refinancing and interest-rate exposure.
- Monitor whether restructuring savings offset lower revenues, and whether fee rates and expenses stabilize as AUM changes.
- Follow the F-Squared-related litigation and any developments that could change the company’s loss assessment or lead to material payments.