Virtus Investment Partners Inc (NASDAQ:VRTS)
Q2 2016 Earnings Conference Call
July 29, 2016 10:00 AM ET
Jeanne Hess - IR
George Aylward - President and CEO
Mike Angerthal - EVP and CFO
Adam Beatty - Bank of America Merrill Lynch
Good morning, my name is Cat, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners quarterly conference call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com.
This call is also being recorded, and will be available for replay on the Virtus website. At this time all participants are in a listen-only mode. After the speakers' remarks there will be a question and answer period, and instructions will follow at that time.
I will now turn the conference to your host, Jeanne Hess. Thank you
Thank you. Good morning everyone on behalf of Virtus Investment Partners I would like to welcome you to the discussion of our operating and financial results for the second quarter of 2016.
Before we begin, I direct your attention to the important disclosures on page two of the slide presentation that accompanies this webcast. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance, and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in this statement. These statements may be identified by such words as expect, anticipate, believe, outlook, may, and similar terms.
For a discussion of these risks and uncertainties, please view the Risk Factors and Management Discussion and Analysis sections of our periodic reports that are filed with the SEC, as well as our other recent filings, which are available in the Investor Relations section of our website, Virtus.com. We do not undertake any obligation to update forward-looking statements.
In addition to results presented on a GAAP basis, Virtus uses certain non-GAAP measures to evaluate its financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results, and should be read in conjunction with GAAP results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our earnings press release, which is available on our website. For this call we have a presentation including an Appendix that is accessible with the webcast through the Investor Relations section of Cirtus.com. Now I would like to turn the call over to our President and CEO, George Aylward. George.
Thank you, Jeanne. Good morning everyone. I will start today by providing an overview of the quarter including the assets, flows, capital, before turning it over to Mike for more detail on financial results.
So let's begin with assets under management and flows, we ended the quarter assets under management of 45.2 billion, which represents a sequential quarter decline of 1%, as net outflows offset market appreciation, total sales were 2.4 billion declined from 2.8 billion in the sequential quarter, due to lower sales in mutual funds, that offset higher sales in both institutional and SMAs. Mutual fund sales of 1.4 billion were down from 2.2 billion sequentially, reflecting lower sales of the emerging market opportunities. Excluding the Emerging Markets fund, mutual fund sales were 0.9 billion, compared with 1.0 billion in the first quarter. Mutual fund net outflows improved modestly to 2.4 billion from 2.6 billion in the sequential quarter, reflecting improved net flows in domestic equity and fixed income funds.
The Emerging Markets fund excluding model related redemptions, net flows in the quarter tracked with the improvement in the asset class, and our funds flows improved in each month of the quarter. The fund which remains our best selling fund, continues to generate strong relative performance, at June 30 it was in the top quartile on a year-to-date basis, and top decile on a one year basis, and the longer term performance also remained strong, in the top quartile on a three year basis, and top decile on a five and ten year basis. Relative investment performance continued to be very strong across our funds with 19 of our rated funds representing 83% of our rated fund AUM, having four and five stars at June 30th, that is up 14 four and five star funds, representing 73% of our fund AUM at June 30th, 2015.
We are pleased to see that several of these strong performing funds are beginning to gain traction with financial advisors. These include Kayne Anderson Rudnick's high quality Small Cap Cord Small cap sustainable growth strategies, Duff & Phelps Differentiated REIT Strategies, and Newfleet's research-driven Fixed Income offerings, particularly the low duration funds. We believe these funds are well-positioned for the current environment, and that they represent the type of actively managed strategies financial advisors should be attracted to. Turning to our other products, we have positive flows in SMAs, Institutional, and ETFs in the quarter, estimated sales increased sequentially by 11%, and net flows were up more than 100%.
As Kayne's Small Cap core strategy was added to a preferred list at a major distribution partner. Institutional sales and flows were also solid in the quarter, and included the issuance of the Newfleet Managed CLO, which is a product category where we see additional opportunities. In the traditional business we also have Small Cap Equity mandates fund to Kayne, we are pleased with the increased demand that we are seeing for institutional strategies. In terms of flows for July, mutual fund net outflows are tracking to a level that would be significant improvement to June, with better flows in each of our five largest funds. Combining the improved net flows from mutual funds with what we've seen for SMAs in institutional, July is tracking to be our best month in total net flows since September 2014.
Turning to the financial results, revenues as adjusted were flat compared to the prior quarter at 62.6 million, while operating expenses as adjusted declined 3% on lower employment expenses, primarily reflecting lower payroll taxes. Separately in June, we implemented select staff reductions primarily in our business support areas, for which you will see the benefit in coming quarters. Second quarter operating income as adjusted which included discrete items was 16.7 million, compared with 15.2 million in the prior quarter, with related margins of 27%, 24% respectively. As a reminder the first quarter did include higher payroll taxes and the impact from the variable incentive fee that has since been eliminated.
Turning to capital, in the quarter we returned 51.2 million of capital through share repurchases and dividend payments. As a result of continued repurchases, our ending shares outstanding have declined by 6.6% from March 31st and 12.5% from June 30th of 2015. The primary driver of the high level of repurchases in the quarter was a tender offer for up to 75 million of our common stock, within the price range of $73 to $82.50. This resulted in the repurchase of approximately 557,000 shares at $82.50, for a total of 47.1 million, including expenses related to the transaction.
The under subscription of the tender offer reflects that there were not a sufficient number of shareholders willing to participate at the high end of the price range. In terms of our capital management strategy we remain focused on balancing between maintaining adequate working capital, investing in the business, and providing a meaningful return to shareholders. As we've always done, we will evaluate these elements and determine what is the best use of capital at any point in time.
With that, I will turn it over to Mike. Mike.
Thank you, George. Good morning everyone. As you may have noted, we made some changes to our earnings release format, to make it more focused and concise, and it continues to present both GAAP and non-GAAP information.
As always, my comments will be primarily focused on the non-GAAP results, as the GAAP results are described in the earnings release. There have not been any changes to our non-GAAP measures, or the earnings presentation that accompanies this call.
Starting on slide seven, Assets Under Management, we ended the quarter with assets of $45.2 billion, which represents a decrease of $0.5 billion, or 1% from the prior quarter. The sequential AUM decline is primarily attributable to new outflows of $2.2 billion, that were partially offset by market appreciation of $1.8 billion. The $7.2 billion year over year decrease in AUM is primarily attributable to $7.6 billion of net outflows and $0.5 billion of dividend distributions, which were partially offset by $1.1 billion of market appreciation.
Total AUM was diversified with 37% in domestic equity, 21% in international equity, 34% in fixed income, and 8% in alternatives and other. By product open end fund assets were 56% of total AUM, separately managed accounts were 17%, closed end funds were 15%, and institutional was 12%.
Turning to slide eight, Asset Flows, total sales decreased sequentially by $0.4 billion, or 16% to $2.4 billion, reflecting $0.8 billion of lower mutual fund sales, that were partially offset by higher institutional sales of $0.4 billion. Additionally, we had higher sales in separately managed accounts.
Gross sales and open end mutual funds were $1.4 billion, a decrease of $0.8 billion from the first quarter, primarily attributable to lower sales in emerging markets. Second quarter total net outflows of $2.2 billion were primarily attributable to $1.7 billion of net outflows in emerging market opportunities fund, excluding this fund, total net outflows were $0.5 billion, which was an improvement from $1.1 billion in the first quarter.
Mutual fund flows by asset class were as follows. Fixed income strategies had net outflows of $0.2 billion, an improvement from $0.3 billion in the prior quarter. Domestic equity fund net outflows also improved in the quarter to $0.3 billion, an improvement from $0.5 billion in the prior quarter.
Sales of domestic equity funds increased to $0.2 billion, primarily due to higher sales in three five star Small Cap Equity strategies managed by Kayne Anderson Rudnick. International Equity net outflows of $1.8 billion, were primarily attributable to $2.1 billion of redemptions in the Emerging Markets fund, down from $2.7 billion of redemptions in the first quarter.
Model redemptions which increased an organizational change at the subadvisor in the first quarter declined to $0.7 billion from $1.3 billion. As we look at July's results of the EM fund, model flows continue to improve. Additionally, sales from traditional FA driven business increased 30% over June, and corresponding redemptions have declined by more than 50%. As such, overall net outflows are only slightly negative for the month a significant improvement from June.
Given the improving flows in the fund combined with favorable market performance, net assets are tracking to increase in July compared to June. In separately managed accounts flows are positive $129.6 million, due to higher sales in Kayne's small cap strategies. Kayne was designated as the replacement manager for small cap SMA mandate in May, while some of these assets flowed through in June. We saw the remaining flows from that assignment in July. Institutional had positive net flows of 235.7 million, due primarily to the issuance of the CLO managed by Newfleet.
In addition, Kayne Anderson contributed to positive net flows in this category, due to new mandates as funded in the quarter. ETFs had positive net flows as we continue to leverage the capabilities of the team at Virtus ETF Solutions. For our closed end funds in the second quarter, two funds completed tender offers totaling 103.3 million, which is included in outflows. Separately, our closed end fund AUM benefited from 135.7 million increase in the use of leverage in the quarter, which more than offset the outflows. Changes in leverage are reporting in the Other row.
Turning to slide nine, Investment Management fees as adjusted of 58.1 million increased 1% on a sequential quarter basis, and declined 17% from the prior year quarter. The components of the change in Investment Management fees are average assets and fee rates. The 1% sequential increase was due to a higher net fee rate that was partially offset by lower average assets under management. The average fee rate increased sequentially to 51.1 basis points from 49.7, due to a higher open end fund fee rate, which included a 2.1 basis point increase from the elimination of the negative variable incentive fee in the first quarter. Average assets under management of 44.8 billion decreased 2% sequentially, due to a 6% decline in open end assets that offset increases in all other product categories.
Slide 10 shows the five quarter trend in employment expenses. Total employment expenses as adjusted were 33.1 million, a decrease of 2.9 million, and 0.5 million from the prior quarter and prior year respectively. The decrease from the first quarter reflects 2.2 million of lower payroll taxes, reflecting the first quarter payment of annual incentive compensation. And lower variable incentive compensation. The 0.5 million decreased over the prior year reflects lower variable incentive compensation. During the quarter, we eliminated some staff positions, primarily in the business support areas of the Company.
As the reduction took place near the end of the quarter, there was little to no impact on employment expenses as adjusted in this quarter. The annual base salary and benefit costs associated with this reduction totaled more than 3 million. The trend in other operating expenses as adjusted reflects the timing of product distribution and operational activities. Other operating expenses as adjusted of $12.1 million in the second quarter, increased $1.7 million, or 17% on a sequential quarter basis, and $0.5 million, or 4% compared to prior year. The current quarter included $1.1 million of discrete items, the annual board grant of $0.6 million, and $0.5 million of business initiative costs. Excluding these items other operating expenses would have been $11 million, an increase of $0.6 million, or 6% from the prior quarter, primarily due to higher sales and marketing expenses.
We continue to focus on managing other operating expenses and reiterate our range of $10.5 million to $11.5 million per quarter, with variability driven by the level of distribution activity, portfolio management costs, and professional fees.
Slide 12 illustrates the trend of adjusted results. In the second quarter operating income as adjusted was $16.7 million, an increase of $1.5 million, or 10% from the prior quarter. The increase primarily reflects lower employment expenses, partially offset by higher other operating expenses.
Operating margin as adjusted for the second quarter was 27%, an increase from 24% in the first quarter, which included higher payroll taxes, and the impact from the variable incentive fee. Earnings per share as adjusted were $1.24 in the quarter, an increase of $0.12, or 11% sequentially, and included a partial quarter benefit of a lower share count following the tender offer.
GAAP net income attributable to common stockholders was $8.1 million, or $0.97 per diluted share. The quarter included $1.7 million, or $0.20 per share related to unrealized gains on the Company's investments, and $1.8 million, or $0.21 per share gain on the sale of a minority interest in a subadvisor. These items more than offset by $4.6 million, or $0.56 per share of CLO launch related expenses, reflecting both issuance costs, as well as other costs related to the sale of the CLO notes, and $1.5 million, or $0.18 per share of restructuring and severance costs.
The effective tax rate of 41% was impacted by consolidated investment products, and a valuation allowance related to the Company's investments. We ended the quarter with strong cash and investments, no outstanding debt, and $75 million of unused capacity on our credit facility.
Cash and investments remain strong at $368 million, or $48 per share at June 30th, compared with $383 million, or $46 per share at March 31st. During the quarter, we returned $51.2 million of capital, an increase from $19.9 million in the first quarter. Over the last 12 months, we have returned $131 million, which is well above our target payout ratio, as we focused on returning a meaningful level of capital to shareholders, primarily through opportunistic repurchases. As a result of our share repurchases, basic shares outstanding have declined 6.6% to 7.7 million in the quarter, and 12.5% from a year ago. We have approximately 1.3 million shares remaining on our existing share repurchase authorization.
We ended the quarter with working capital of 152 million, which represents 53% of our annual spend, as we have mentioned our targeted our working capital to spend ratio at the 50% to 75% level, to ensure adequate levels of financial flexibility for investing in the business. Our seed program at June 30th was 174 million, a decline of 107 million, or 38% from the prior quarter, primarily due to the liquidation of three mutual funds. The near term target range for our seed program remains 125 million to 175 million, as we believe having appropriate levels of seed capital is critical to the long term growth prospects of the Company and our affiliates.
With that, let me turn the call back over to George.
Thanks Mike. That concludes our prepared remarks. Now, we will take your questions. Cat, would you open up the lines, please?
Thank you. [Operator Instructions] Our first question comes from the line of Michael Carrier with Bank of America Merrill Lynch, your line is open.
Thank you this is Adam Beatty in for Mike. First just a question on products. Interested in some of the differences in new product areas, and what your plans might be there? Specifically ETFs, you have had good traction with the ones so far. And alternatives, given the liquidation, are you planning on backfill that with anything, also multistrategy, if you could comment on that? Thank you.
Sure. I'll start with ETFs. And as you indicated, that is an area where we had acquired a majority interest in an ETF platform last year. We've been very focused on adding product capabilities, and giving effect to their business model in that space. We've had several funds that we've been working on, in terms of those opportunities, one or two of them have already been launched, but that's an area we're spending a lot of time on, in terms of what are the right product offerings there.
ETFs will absolutely continue to be an important part of the book of business of the financial advisors that we do business with. and looking to see how we can offer either some differentiated actively managed capabilities, either from our current affiliates, or through other subadvisory relationships, as well as are there those smart data types of opportunities, that we also think would be differentiated and work better in ETF, than they would work in an open end mutual fund.
Obviously, a lot of people are doing a lot of work in ETFs, and it takes a lot of time to get all of those things through the regulatory filings, et cetera, and appreciative of the volume that people are dealing with. We are still very optimistic about the opportunity set that is in that space, and we do think that we have some compelling differentiators, in terms of the types of things that we can do in that space. So I think that's great.
In terms of ALTs, and even though we did liquidate some of the alternative funds that we had, we do still do believe in the space, and whether you want to call it alternatives, or multiasset class, or non-correlated types of strategies, we currently have the Aviva offering, which currently is a multistrat offering that we do feel very strongly about. This is an interesting environment, for those types of non correlated non benchmark type of product because the indices just keep going up and up and up. Our view is that this is a time that people should be investing in those types of strategies, but it's really not as easy to get people to be compelling to buy those types of strategies where right now the indice seems to be doing well.
We'll continue to do more products in that area. But the stuff that we have currently from our active managers in the traditional space, we've hit a very good spot, in terms of the mix of having good performance in funds, and then actually having the matching demand. And I've pulled out a couple of things in terms of Kayne Anderson Rudnick and Duff & Phelps, and I always refer to Newfleet. But for some of those strategies, particularly like the small cap side, or even on the REIT side, it's great to have performance, it's better to have performance when people are actually looking for those strategies. So we're very pleased that on this call we were able to call out in a couple of categories where some of our high performing strategies started to gain traction, and you're starting to see some of the flows come through.
Thanks. Appreciate the detail there. And then just in terms of distribution, and you've talked a little bit about allocation models and some of the redemptions, etcetera, partly driven by Vontobel, how are discussions going in that space? Firstly, are you aware of any potentially lumpy pending redemptions, and then looking forward, are folks that you're talking to in the intermediary channel, concerned about affiliate risk management or anything of that nature, and what does the pipeline look like? Thank you.
No. In terms of the EM models which I guess is what you're focusing in on, there was an organizational change in March, early March as we highlighted on the first quarter call, we focus here. There were some of those models that drove some of the elevated redemptions. As we said in the first quarter call, we did not see any type of elevation of redemptions from financial advisors, so non model driven, so those, where a financial advisor did not have concern about, as much concern about the organizational change.
And as we've indicated, we saw those outflows in the first quarter. They occurred in the second quarter but they diminished significantly from $1.3 billion to $0.7 billion. So as you're this far away from that organizational change right now, our view would be you should expect to see our EM flows trend in relation to how good is their performance, and how is the asset class doing.
In terms of the asset class because even a lot what you've seen in terms of our fund, you sort of have to take a step back and look at what's going on in the categories. So for intermediary sold Emerging Market funds, March was actually a very negative month overall for those funds, and then was flat in April, got positive again in May, was positive again in June, but a little slightly less positive.
So, as I indicated in some of my comments, so our flows will always track that type of trend, so an emerging market is out of favor, and it net flows into category, we would generally have similar experience. Models are always lumpy, and we'll have some money in and we'll have some money out. We actually did in July have money in on a model for EM, and we had a little bit of money out on an EM. They actually offset each other effectively. So we'll always have a little bit of lumpiness with flows in terms of the models, but as Mike had pointed out, we're seeing a decrease of the redemptions in the FA driven business, which were never that elevated. They were elevated but not by much, and we're seeing an increase in sales related to that. But really the challenge in our flows for the quarter is really isolated to the EM Fund.
Thank you this concludes the question and answer session. I would like to turn the call back over to Mr. Aylward for closing remarks.
Okay, as always, I want to thank everyone for joining us today, and we certainly encourage you to give us a call if you have any other further questions.
That concludes today's teleconference. Thank you for participating. You may now disconnect.
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