Virtus Investment Partners, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Unaudited results are prepared under U.S. GAAP. Virtus provides investment management and related services to retail and institutional clients; revenue is primarily asset-based.
Financial performance
Amounts below are in millions of dollars, except per-share data and where noted.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $112.7 | $96.1 | $220.6 | $182.3 |
| Operating income | $22.5 | $26.9 | $55.1 | $48.0 |
| Operating margin | 20.0% | 28.0% | 25.0% | 26.3% |
| Net income attributable to common stockholders | $19.5 | $15.4 | $41.5 | $29.3 |
| Diluted EPS | $2.10 | $1.91 | $4.44 | $3.64 |
- Revenue and assets: Q2 revenue grew 17.3% year over year; six-month revenue rose 21.0%. Management attributed growth mainly to higher average assets under management (AUM) and higher average fees. Q2 average AUM was $59.0 billion, up 11.2%; six-month average AUM was $58.1 billion, up 14.6%. Period-end AUM was $61.4 billion, up 16.6% from June 2013.
- Profitability: Q2 operating income fell 16.3%, despite revenue growth, as operating expenses increased 30.3%. Six-month operating income rose 14.9%. Q2 net income attributable to common stockholders increased 27.0%, with gains in investment-related other income contributing to pretax results.
- Expenses and margins: Q2 distribution and administration expense increased $15.0 million, or 61.7%, including $9.6 million in structuring costs for the new DSE closed-end fund. Management cited total DSE launch-related costs of approximately $10.1 million, including sales and other costs. Other expense increases included compensation, research, professional fees, new-fund start-up costs, and transition of middle- and back-office systems.
- Cash flow and liquidity: Six-month operating cash flow was negative $91.1 million, compared with positive $22.2 million in 2013; investing cash flow was negative $2.0 million and financing cash flow negative $7.7 million. Cash and cash equivalents on the balance sheet were $170.4 million at June 30, down from $271.0 million at year-end; investments were $65.1 million. Management cited investment purchases, including activity in consolidated sponsored products, and $129.9 million invested to seed three mutual funds in April as significant cash uses. Consolidated sponsored-product cash and investments are not generally available to Virtus or its creditors beyond Virtus’s direct interests.
- Debt: No debt was outstanding at June 30. The company had $75 million available under its credit facility, expiring September 2017, and reported compliance with its covenants.
- Capital returns: Virtus repurchased 66,913 shares for approximately $12.5 million during the first half. It declared a $0.45-per-share dividend, payable August 14, 2014, with approximately $4.2 million recorded as payable at quarter-end.
Material changes and business drivers
- Long-term open-end mutual fund net flows were $750.5 million in Q2, versus $2.6 billion in Q2 2013; first-half net flows were $1.0 billion, versus $6.2 billion. AUM growth also reflected market appreciation and the launch of DSE, which added $463.3 million.
- Equity and alternative assets represented a larger share of AUM, contributing to a higher average fee rate. The company reported a 51-basis-point average fee rate for all products in the first half, versus 49 basis points a year earlier.
- Four additional sponsored investment products were consolidated during the first half and one was deconsolidated. Consolidation increased reported balance-sheet assets and investment-related gains and losses; management said it does not affect net income attributable to stockholders. The company’s exposure to these products is generally limited to its investments and fees.
Outlook, risks and unusual items
- The filing provides no specific financial guidance or quantified forecast. Management’s discussion emphasizes that results depend on AUM, flows, market conditions, and fees; it cautions that actual results may differ materially from forward-looking statements.
- Management identified the DSE launch costs as a key reason Q2 operating income and margin declined despite revenue growth. Investment-related gains also increased year-over-year and supported pretax income; these amounts can fluctuate with markets.
- Key stated risks include AUM declines and client withdrawals, competition, reputation and personnel risks, regulatory or legal developments, distribution or subadvisory relationship changes, service-provider interruptions, and impairment of goodwill or intangible assets. Management reported no material changes to previously disclosed risk factors.
- Virtus is regularly involved in litigation, arbitration, and regulatory examinations or investigations. Management did not believe their outcomes were likely to materially affect consolidated financial condition, but said adverse outcomes could affect results or cash flows in particular periods; potential losses are not clearly quantifiable in the filing.
- Market-risk disclosure: Virtus estimated that a 10% change in the fair value of marketable securities would change six-month net income attributable to common stockholders by $15.4 million and comprehensive income by $15.6 million. A 1% interest-rate change was estimated to change the fair value of its fixed-income investments by $2.9 million.
Important facts for investors to verify
- Whether AUM growth and positive market performance persist, and how weaker long-term mutual fund flows affect fee revenue.
- Actual and remaining DSE launch-related costs, and whether operating margins recover after the launch period.
- The drivers and sustainability of investment gains, particularly gains and cash-flow effects associated with consolidated sponsored investment products.
- The composition and accessibility of reported cash and investments, including cash held within sponsored products, and the cause and persistence of negative operating cash flow.
- Developments in legal or regulatory matters, credit-facility availability and covenants, and the expected impact of the new revenue-recognition standard, which the company was still evaluating.