Virtus Investment Partners, Inc. (NASDAQ:VRTS) Q4 2017 Earnings Conference Call February 2, 2018 10:00 AM ET
Jeanne Hess - Vice President, Director of Investor Relations
George Aylward - President and Chief Executive Officer
Mike Angerthal - EVP and CFO
Ari Ghosh - Credit-Suisse
Sameer Murukutla - Bank of America
Surinder Thind - Jefferies
Good morning. My name is Andrew, 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 Web site, www.virtus.com. This call is also being recorded and will be available for replay on the Virtus Web site. At this time, all participants are in a listen-only mode. After the speakers’ remarks, there’ll be a question-and-answer period and instructions will follow at that time.
I will now turn the conference to your host, Jeanne Hess. Please go ahead.
Thank you, and 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 fourth quarter of 2017. 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, and as such are subject to known and unknown risks and uncertainties, including, but not limited to, those factors set forth in today's earnings release and discussed in our annual report on Form 10-K and quarterly report on Form 10-Q and other SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the 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 Web site.
Now I would like to turn the call over to our President and CEO, George Aylward. George?
Thank you, Jeanne, and good morning, everyone. I’ll start today by discussing the results for the quarter, including assets, flows, earnings before turning it over to Mike for more detail on the financial results. Before taking your questions, I will make some comments on our agreement with Sustainable Growth Advisers or SGA that was announced earlier this morning.
Now let me begin with assets under management and flows. Long-term AUM increased 1.9% sequentially to $88.8 billion, as strong market appreciation more than offset net outflows. Total assets, which include liquidity strategies, ended the period at $91 billion.
Total sales were $4.1 billion compared with $4.6 billion in the third quarter, which included a CLO issuance of $0.5 billion. Total net flows were negative $0.8 billion in the quarter compared with positive $0.2 billion sequentially as net inflows and retail separate accounts and ETFs were more than offsets by net outflows in institutional and open ended funds.
Retail separate account net flows continued to be positive in the quarter due primarily to the quality oriented equity strategies offered by Kayne Anderson Rudnick. We have had positive flows in retail separate accounts for the past eight quarter and continue to believe that the growth outlook in this category remains strong.
ETFs also continue to generate positive flows in the quarter, reflecting higher sales. Institutional net flows were negative $0.4 billion as increased sales were offset by higher redemptions. Insititutional flows are generally lumpy and there were no notable flows or inflows in any single strategy in the quarter.
Mutual fund net flows were negative $0.6 billion compared to flat in the third quarter due primarily to outflows in bank loan strategy consistent with the industry trend for that asset class. Mutual funds have generated positive net flows in the quarter, including Kayne's small cap growth. small cap core funds, and international small cap funds. Emerging market opportunities fund managed by Vontobel and the Multi-Sector Short Term Bond Fund from Newfleet.
Our relative investment performance continued to be solid as of December 31st with 81% of rated fund to AUM having four and five starts and approximately 90% of the institutional assets meeting their benchmarks on a three and five year basis.
In terms of January flows, mutual fund net flows were positive across asset classes and retail growth sales, which include retail separate accounts were the strong as we have seen in almost five years. As for other product categories, the one thing of note is that as we previously announced, we issued a new $400 million CLO managed by Seix in January.
Moving onto financial results. Revenue as adjusted increased 5% in the quarter due to higher average assets and higher fee rates that more than offset 2% increase in operating expenses, which included $0.9 million of transaction costs with the SGA agreement. The higher revenues as adjusted, as well as the realization of all expected synergies from the RidgeWorth transaction resulted in 11% sequential quarter increase in operating income as adjusted.
Operating margin as adjusted increased to 35.7% from 33.8% in the prior quarter and 28.4% in the prior year quarter. Fourth quarter earnings per share as adjusted increased 13% to $2.50 from $2.30 in the prior quarter on higher operating income as adjusted.
Turning to the balance sheet. During the quarter, we see that a new fixed income as part of our strategy to expand our product offerings for offshore investors. In addition, we facilitated a reset transaction on one of our existing CLOs, thereby extending its reinvestment period and maturity date.
Now, I'll turn it over to Mike to provide a more detailed view of financial results and the balance sheet. Mike?
Thank you, George. Good morning, everyone. Starting on slide seven, assets under management. We ended the quarter with long-term assets of $88.8 billion, which reflects increases of 1.9% and 96% from the prior quarter and prior-year quarter, respectively. The sequential increase reflects market appreciation of $2.7 billion, partially offset by net outflows of $0.8 billion, and other activity of negative $0.3 billion, which primarily includes dividend distributions.
The change from the prior year reflects the assets from the RidgeWorth acquisition, market appreciation of $9 billion, and net outflows of $0.2 billion.
Our long-term AUM continues to be well diversified by product type with $43.1 billion in open-end funds, $20.8 billion in institutional, $13.9 billion of retail separate accounts, $6.7 billion in closed-end funds, $3.3 billion of structured products and $1 billion in ETS. At December 31st, our assets remained balanced between fixed income and equity, with equity increasing slightly in the quarter to 52% of total assets.
Turning to slide eight, asset flows. Total sales were $4.1 billion, a sequential quarter decrease of $0.5 billion or 10%, primarily due to the launch of a CLO in the prior quarter. Total sales increased from the prior-year quarter by 56% or $1.5 billion on higher sales in institutional, retail separate accounts and open-end funds. Net outflows for the quarter were $0.8 billion as the combined net inflows from retail separate accounts and ETFs of $0.3 billion were more than offset by net outflows in open-end funds and institutional.
I would note that for the year, retail separate accounts and ETFs generated $1.6 billion of positive flows, an increase of 69% from 2016.
With respect to mutual funds, net outflows for the quarter were $0.6 billion as positive flows and equities were more than offset by negative flows in fixed income. The flows by asset class were as follows. International equity funds had net inflows of $0.2 billion in the quarter, an increase from $0.1 billion in the prior quarter. The increase is due to higher net inflows in the emerging markets opportunities fund and the international small cap fund.
Domestic equity funds had net flows of $0.1 billion as net inflows and small cap strategies were more than offset by net outflows in mid and large cap strategies. Fixed income funds had net outflows of $0.5 billion compared to flat flows in the third quarter as inflows into multi-sector strategies were offset by outflows in bank loan strategies, consistent with market trends in this investment category.
Turning to slide nine. Investment management fees as adjusted of $102.1 million increased by $3.7 million from the prior quarter. The sequential quarter increase of 4% was due to higher average assets under management and a higher net fee rate. The average fee rate on long-term assets for the quarter was 45.4 basis points compared with 44.8 basis points for the third quarter. The increase in the blended fee rate reflects lower mutual fund expense reimbursements, partially offset by lower incentive fees on structured products.
The fourth quarter open-end fund fee rate increased to 50 basis points from 48 in the prior quarter due to the impact of lower fund expense reimbursements as a result of the consolidation of service providers and an increase in average assets and higher fee equity products due to market appreciation.
Incentive fees on structured products decreased to $0.1 million from $0.8 million in the prior quarter. I would also note that the ETF fee rate decreased sequentially to 16 basis points from 27 basis points due to higher expense reimbursements on newly launched funds. For modeling purposes, we believe the 50 basis points for the open end fund fee rate and 23 basis points for the ETF fee rate are reasonable assumptions, all else being equal.
Slide 10 shows the five quarter trend in employment expenses. Total employment expenses as adjusted of $52.6 million increased 1% from the prior quarter. The increase was due to higher profit based incentive compensation. As a percentage of revenues as adjusted, employment expenses were 48% compared with 50% in the third quarter.
As a reminder, in the first quarter of each year, we incur higher levels of payroll taxes and other benefits that amounted to $3.4 million in the first quarter of 2017. Of this amount, $3 million was attributable to incremental payroll taxes and retirement eligible employee stock-based compensation. We expect these costs to increase by approximately 35% in the first quarter in line with higher staffing that resulted from the RidgeWorth transaction.
The remaining $0.4 million of the first quarter 2017 seasonal items was related to benefit costs, primarily the timing of the 401(k) match, which we expect to increase to approximately $2 million due to the higher staffing levels as well as planned modifications.
The trend in other operating expenses has adjusted reflects the timing of product, distribution and operational activities. Other operating expenses as adjusted were $16.7 million, an increase of $0.6 million or 4% sequentially. The current quarter includes $0.9 million of transaction cost associated with the SGA agreement. Excluding those costs, other operating expense as adjusted were $15.8 million.
Slide 12 illustrates the trend of financial results. In terms of the non-GAAP results, operating income as adjusted was $39.1 million, an increase of $3.9 million or 11% compared to the prior quarter. Operating margin as adjusted was 35.7%, an increase of 190 basis points from the prior quarter and 730 basis points from the prior year. The fourth quarter margin reflects the impact of $25 million in synergies related to the RidgeWorth transaction.
Earnings per share as adjusted were $2.60 in the quarter, an increase of $0.30 or 13% sequentially. Weighted average shares outstanding as adjusted declined 1% sequentially as the higher common stock price in the quarter resulted in the preferred shares hypostatically converting to 55,000 fewer common share than in the third quarter.
The fourth quarter effective tax rate as adjusted increased sequentially by 70 basis points to 39%, reflecting changes in the 2017 state tax apportionment factors. Notably, the fourth quarter rate was not impacted by the Tax Cuts and Job Act.
In terms of our effective rate going forward, our preliminary analysis of the impact of the new federal tax rates indicate an effective rate as adjusted of approximately 28% compared with the 39%. The decrease reflects the decline in the federal rate, partially offset by certain federal tax limitations on deductions and the impact of the lower federal rate on state tax deductions.
Regarding GAAP results. Fourth quarter net income per share was $0.46 compared to $2.21 per share in the third quarter. Fourth quarter GAAP earnings included the following items. A non-cash tax charge of $13.1 million or $1.76 per share, reflecting the impact of the new tax legislation that resulted in the remeasurement of our deferred tax assets at the new lower corporate tax rates. Acquisition and integration costs of $3.3 million or $0.28 per share, which decreased from $4.9 million or $0.36 per share in the third quarter, and 12% decrease in weighted average diluted shares outstanding due primarily to this quarter's calculation of the if-converted method.
As we mentioned previously, each quarter under GAAP we calculate whether it's more dilutive to deduct the preferred dividend from net income or treat the preferred shares as if converted into common shares. For the fourth quarter deducting the dividend was more dilutive given lower income that included the impact of the tax charge. In the third quarter, it was more dilutive to treat the shares as converted given the higher level of net income.
Slide 13 shows the trend of our capital position and relative liquidity metrics. At December 31st, C capital investments were $118.4 million and within the targeted range of $100 million to $150 million, which will fluctuate based on our specific product and distribution needs. In the quarter, we recycled certain existing seed investments to launch the multisector income UCIT managed by Newfleet.
CLO investments were $108.3 million, an increase of $19.6 million from September 30th due to the Company’s investment in the reset transaction of 2013 vintage CLO managed by Siex. The benefits of the reset transaction include the expansion of the maturity date and reinvestment period for the $425 million CLO, as well as lower CLO liability costs.
In the quarter, our seed capital in CLO investments generated $2.9 million of dividend and interest income, which represents the yield on those investments compared with $4.1 million in the prior quarter. It’s important to note that while this is not included in our non-GAAP measure and income as adjusted, it provides a significant economic benefit to the company.
Net debt at December 31st was $127.2 million that resulted in a net debt to bank EBITDA ratio of 0.7 times, a decrease from 0.9 times at September 30th, reflecting cash generated by the business. As a reminder, bank EBITDA is calculated in accordance with our credit agreement and is generally defined as operating income as adjusted plus stock-based compensation, dividend and interest income on investments and fully phased in synergies.
With that, let me turn the call back over to George. George?
Thanks, Mike. The last item I want to discuss before taking your questions is our announcement this morning of our agreement to purchase the majority interest in SGA, a boutique-manager with $11.6 billion in assets under management as of December 31st. SGA manages distinctive high conviction U.S. and global growth equity portfolios, primarily for institutional clients.
The addition of SGA into our family of affiliated managers would further diversify our offerings for our strategies, product lines and clients. They would add the distinctive growth equity capability to our current offerings and significantly expand our institutional and the international client base. Their assets are primarily in U.S. and global large cap growth equity strategies with $7.1 billion and $4.5 billion in AUM respectively. They manage their strategies with a research focused approach that invest in differentiated global businesses that they believe will offer predictable and sustainable growth.
Their distinctive high conviction approach to growth equity investing and attract investment performance has generated strong demand for their strategies, particularly global equity in the institutional market. They've grown significantly since their founding in 2003. Their AUM has nearly doubled over the past three years and in 2017, they generated approximately $2.4 billion in positive net flows. This clearly illustrates how well positioned they are in an environment that has generally favored passive investing.
Essentially all of their assets are managed for institutional clients and separate accounts or sub-advisory mandates. SGA would increase our institutional AUM from 23% of total assets at December 31st to approximately 31% on a pro forma basis. They would also add a meaningful international presence to our business. They currently manage about $4 billion or so for institutional clients in Australia, Canada, Europe, Japan and Middle-East.
We are optimistic about the growth outlook for SGA. They've strong relationships with consultants and a solid pipeline, which should present opportunities for further growth in the institutional channel. In addition, as we do with our other affiliates, we will look to make their strategies available to other product structures and another channels. We believe there are opportunities to expand their presence in a retail markets, leveraging our U.S. retail distribution resources. We will also selectively make their strategies available to other product structure, including retail separate accounts, mutual fund ETFs for usage.
We will acquire 70% interest in the company consisting of the minority position held by a private equity investor, and a portion of the equity held by SGA’s partners. The purchase price at closing would be $129.5 million, pending any purchase adjustments tied to client consents. All of the partners, including the three co-founders, have entered into long-term employment agreements. They will also retain equity in the firm, which aligns interest for shareholders and invest a significant portion of the transaction proceeds into their strategies, which aligns interest with their clients.
Like our other affiliated managers SGA will continue to operate as an individual boutique retaining autonomy over its investment process, maintaining its independent structure, culture brand and control over day-to-day activities. We expect to finance the transaction using balance sheet resources and debt from our existing credit capacity of $100 million or new financing depending upon market conditions. Our expectation is that our net leverage will remain below 2x debt to EBITDA.
The transaction is financially attractive and is expected to deliver an IRR for approximately 20% and be immediately accretive to non-GAAP earnings. We expect EPS as adjusted accretion of approximately 6% on a pro forma run rate basis of fourth quarter of 2017 earnings, excluding transaction costs.
In addition, purchase intangibles will reduce tax obligations. As would be expected with the acquisition of a smaller focus boutique firm, there is no significant duplication of costs. We expect the transaction to close by the middle of 2018. The addition of SGA as our news boutique affiliate illustrates an important component of our growth strategy and a key element of our value preposition. We have often said and we’ll continue to say that our long-term growth is not dependent on an M&A strategy. However, a key element of our multi-boutique model is that it provides us with opportunities to selectively partner with distinctive boutiques and support their growth by offering their strategies in different product structures and providing access to our distribution resources.
Our model allows us to partner with the right firm for particular capability by having a flexible approach to partnering, thereby not limiting our opportunity set. We have successfully leveraged our multi-boutique model over the years to expand our affiliated mangers with the establishment of new fleet in 2011 and a Rampart in 2012, whereas ETF solutions in 2015 and Seix, Ceredex and Silvant through the RidgeWorth acquisition in 2017.
We believe our value preposition is attractive to boutique managers, because they can focus on providing their investment strategies to their clients while benefiting from the scale distribution and other resources of a larger organization. We're excited about this opportunity. SGA is a quality investment management firm offering a distinctive approach to growth investing, which is additive to our current investment offerings and provides an important part of an investor’s well diversified portfolio.
With that, let us open up to the questions. Andrew, can you open up the lines please.
Certainly [Operator Instructions]. Our first question comes from the line of Ari Ghosh with Credit-Suisse. Your line is now open.
So on the SGA deal, could you firstly talk a little bit about the fee rate and how that compares to your existing institutional blend. Maybe then touch on what performances looked like recently. And then of the $2.4 billion of inflows that you called out in 2017, is that in line with what the company is doing, has been doing in prior years? And looking forward, what -- if you could size up that pipeline that would be pretty helpful as well. Thank you.
I’ll see what I can do to answer some of those questions. So on the first part you're asking about their institutional business and we're very pleased to be expanding our assets in that channel as we look to diversify little bit away from more from retail. So I think Mike their institutional fee profile…
It’s generally consistent with the blended institutional rate that we reported around 31 basis points, I think its fair to use that in your assumption on their AUM, Ari.
And then in terms of just the reference I made to some of their flows. As I indicated, they started in 2003, they’re at $11.6 billion, in last three years they more than doubled and last year about $2 billion plus number that I gave you, I think that gives you an indication of what that net flow profiles looked like over those years. And I missed the second part of the beginning of that first question, Ari, you broke up a little bit.
I know there were a lot of question embedded, but if you could just touch on may be what the pipeline looked like, either the magnitude of it or compared to prior year. Just want to get a sense of the pipeline that we’re looking at over the next 12 months from SGA.
And as I assume you, you can understand. We're not going to give any kind of insight into there pipeline. At the time, we’re announcing a transaction that we haven't yet completed. But again we feel very good about the opportunity set that they’ve had and the types of relationships they have, and if we can continue to see that they’ll have those opportunities going forward. And down the line, we’ll start talking more little bit about specifics on pipeline.
And then just a quick follow up, following the deal, how should we think about capital deployment for 2018 and '19? Does this transaction change either magnitude or timing of the plans that you had over the next 12 months? Or should we still continue to expect probably buyback keeping the share count where it is right now around these levels, and then maybe even came down some of your debt every year? Thank you.
Again, Mike and I have both repeatedly said, we really -- it's important for us to maintain flexibility, because we really do look at a primary goal of organic growth in the business. And as you know, we’ve set aside portions of our capital structure that we utilize and recycle for the organic development of new products and investments now increasingly in CLOs. We’ve been very aggressive at the appropriate times on stock repurchases when we believe it’s highest and the best use of shareholders capital.
And the same is true on the M&A side where we spent a lot of time looking a lot of things over the years. We’ve actually been very selective and there we happen to have now done the big RidgeWorth transaction in SGA, it really was as a result of its really being very comfortable that these were very good opportunities at that time. So I think we will continue to maintain with flexibility. As we said very clearly, we’re going to be using the debt and the balance sheet side to finance this transaction, keeping our leverage at 2x number. But we’re going to continue to generate significant cash flow and obviously post the transaction with SGA, that’s a cash flow positive type of business.
So we’ll continue to evaluate, at any point and time, the different uses of the capital to things we’ve done in the past. Mike, do you want to add anything to that?
And Ari just to point out from a specific standpoint. As you know, the existing term loan has an excess cash flow suite feature in it, which we’ll calculate based on 2018 calendar year and there will be a required pay down based on that calculation in Q1 '19. So certainly, thinking through the priorities, that’s a contractual covenant that we’ll follow. And after that, I think as George outlined, we’ll evaluate capital go forward.
And our next question comes from the line of Michael Carrier with Bank of America. Your line is now open.
This is actually Sameer Murukutla on for Michael Carrier. A quick question on the tax rate, I know you gave us the 28%. It seems a little high versus your peers. So can you just give us any more detail on why it’s ending up 20 versus lower 20s?
I haven’t seen the peers. But certainly, when we look at it the 39 and we’re certainly pleased to be a beneficiary of the Tax Cuts and Jobs Act. There are certain federal deductions that will have limitations under the new rules, so that will certainly be something that goes into our rate. So you have the 35% and the 21% plus the state tax will have some limitations on the deductions and then the state tax deductions are further limited by the reduction in the federal rate. So I think 28% is a good estimate and to the extent that changes, we’ll true it up.
I guess just as a follow-up just a question on your margin outlook going forward. You did 35.7 in the quarter and then you announced SGA deal. Looking forward, where do you think this margin could maybe top out at?
One of the bigger drivers of any fluctuation in our margin will really be how are the markets doing and what are our assets levels. So January obviously having equity markets that were strong but as a reminder, only half of our assets are in equities 52% and 48% is in fixed income. So we're pleased where the margin came in. We highlighted one or two small items, specifically the transaction cost related to that. And as you think about SGA, it's an equity shop large cap growth, so it's not a highly cost expensive way to manage money. So we’re not going to give any specifics in terms of the margin. But again, that would be a transaction that you should think of would be accretive to our margin as opposed to dilutive to our margin.
We've also talked about incremental margins or tax ratios in the 50% to 55% range. And I think that is always a caveat of where the AUM growth or revenue growth comes from. But I think that's -- it's a good assumption going forward.
[Operator Instructions] And we have a question from the line of [Michael Sypris]. Your line is now open.
Just wanted to circle back on the SGA transaction just on the operational organizational structure, just if you could elaborate a bit on how this affiliates going to bit within your overall organization relative to the other affiliates that you have. It seems you centralized a little bit more operations. In some cases, it didn’t quite get the sense that you’re going to pull as much the center with this one relative to others. Maybe I am misinterpreting them a little bit, also the 70% stake. Why 70? How you’re thinking about that? I think you some of the other affiliates you have little bit of a larger stake there and the others of revenue shares. How is this one going to work as well?
Couple of things, just to be very clear, for all affiliates they operate as their own firms or own identities, their own locations, their own culture, total control over their investment process and were in their day to day business. And it is correct to say that we do have the ability to offer different types of infrastructure or systems or data that could be shared in a multi-affiliate basis when it allows for economies of scale and all that. But each of our affiliates they do operate as very distinct separate and individual of businesses.
SGA is a large cap growth equity manager; approximately 25 people who are managing the $12 billion; they’ll continue to do exactly what they do now; and our job is to do what we can to support them or to make things easier for them; and to help them in their opportunities in terms of managing their business; and executing their business plan. So that’s way I would describe both SGA and our multi-boutiques.
I forgot the second part of your question, 70%, you're current in saying that our structures include the 100%. We also include some or less than 100%. And that was the point I was making when I talked about the flexibility of our business model, because for us it was really important, it’s finding the right partner for the right strategy. So whether it’s an ETF business or whether it’s a very distinctive differentiated high conviction growth equity manager. We're not going to limit our opportunity set to any kind of cookie cutter structure.
So the only thing that’s consistent amongst our affiliates is that they stay who they are, they are independently, they manage money and they take care of their clients. But whether its 70% or whether its 100%, each of that -- that structural will really depend on each individual opportunity.
And just as a follow up, could you talk to what you view as the compelling strategic rationale for this transaction. It doesn’t seem like it’s a cost synergy play here. And if you could just give a little bit of history recap in terms how long you’ve been in discussion with them and any color around?
And great point, this is not about synergies. Now, this is a product capability, right. So as we look through the myriad of different types of transactions that we’ve looked at and I’ll use actual illustrations right. So the RidgeWorth transaction was really a twofer. It was three great affiliates to add to the family and capabilities, as well as an opportunity to unlock great synergies in terms of duplications of costs and effectively almost double size of the company. So that was within many, many elements.
This is a product division capability as was Rampart where we brought in differentiated portable yield/optional related strategy. And then ETF solutions, which was really more about the product expansion and how do we effectively accelerate our ability to enter into the ETF business. And as you may remember, when we made our investment with $70 million and they’re now $1.1 billion, which we're happy with that.
So each of those will be looked at through the filter of either adding a great capability, expanding our product opportunity set or if we can coupled that with synergies; and synergies are great; they are gravy; but really what’s core in the transaction is getting really good managers that can grow. So we look through the whole continuum of those. And again as I’ve said, we have done one of each and we’ll continue to look for those things that fit going forward.
So it’s about the product capability here that you’re picking up that you have international portfolio that’s there. If I can just sneak another follow up question, if that’s okay. Just on alignment of interest, just curious how you're thinking about aligning interest with this affiliate and how that may defer at all from some of the other affiliates and just probably you're thinking on that.
I don’t think it defers materially. I mean, the alignment of interest by maintaining the minority interest, they have an significant alignment of interest with us to grow that business. And to grow it in terms of its overall profitability, which is how we're generally judged and elevated in value. So I think that’s a great alignment of interest and that’s on consistent with our other affiliates where really the miles we have which were all profit based, I can’t remember before what you said, you thought there were revenue or not. But our models are really more profit contribution based. So for every dollar of profit that is contributed by the affiliates to the shareholders of Virtus, a percentage of that is really utilized to provide for incentive compensation to the affiliate.
So we’ve always thought that that was great clear line of sight from the affiliates into our shareholders. And then generally as we’ve said, we do use for as equity in certain components to further align those structures. So for us, alignment from those affiliates and those investment professionals to Virtus shareholders is very important and we feel pretty good about the structure we have.
And our next question comes from the line of Surinder Thind with Jefferies. Your line is now open.
Just following up earlier on the question about just the use of capital and how you’re thinking about it. I just wanted to clarify one or two things. First is, did I hear correctly that the leverage ratio is going to, after the SGA acquisition, will approach to two times net debt to EBITDA? And if so, that’s about the maximum level that you’re comfortable with at this point? Was that correct?
No, just to clarify, I think we were alluding to gross debt to EBITDA post the transaction. And I don’t think we gave a specific level of what we’d be comfortable with just that would be the level that would be on a pro forma basis assuming utilization of the credit facility that’s $100 million of capacity on it, would result in that type of leverage.
Can you provide some color around where -- what levels you would be comfortable with, or is it much more situational in the sense that obviously as the leverage ratio goes up, your ability -- you talked about being flexible in your approach to the ways that you wanted to be able to grow the firm while maintaining flexibility. So as your leverage ratio goes up, the ability to grow inorganically obviously decreases. And so at what point does debt pay down become a priority over other needs of whether its share repurchases and stuff?
We look at a lot of factors as we think about that and refer back to some of the comments we made around the time of the RidgeWorth transaction. So as we think about leverage, we always run the business very conservatively and for most of our existence, did not utilize leverage. In part, it was because of our size and it’s really the risk profile of the equity exposure that we had. And as we’ve grown and developed and expand and diversified the business, we’ve got a little bit more comfortable with certain levels of leverage.
And now I presume with the SGA addition of another manager of different strategy, diversified into retail that will influence. So we think about how we diverse our business, how large the business is and how we can manage the leverage. And then we couple that with what I was addressing earlier, which is our job is very simple. What is the best was to create value for shareholders. So we do like to make sure that we have that flexibility so keeping within very comfortable range of leverage while at the same time evaluating considering opportunities to create value.
And as you are aware, we do maintain on our balance sheet, significant other resources in terms of our seed capital, as well as now in terms of other investments, primarily in the CLO. So we do -- we have a balance sheet that we evaluate for different types of opportunities. So Mike?
And I'll just reiterate the point on the debt pay downs, the facility requirement of the excess cash flow sweep. So certainly that will be a priority to service the debt and those pay downs.
I mean, the question was more around obviously more than just what the requirements, but yes. And then I guess in terms of the other thing I would like to touch base on is just kind of how you guys are thinking about expenses. We've kind of touched on this a little bit in the past, and we've talked about generally industry spend being a little bit higher than maybe in years prior. And then as we've gone through this earnings season, one of the themes that's been emerging is that most have reported thus far, their expense outlook is perhaps been higher than what the analyst community was thinking about going into the earnings call. How should we think about where you guys are in terms of -- because the theme is basically been that now it's still the time to invest. Things are changing and so they are going to continue to invest and elevate investment. How should we think about where your guys as model given that everybody operates so autonomously? And if there are risks where that you guys begin to fall behind given that everybody is autonomous versus trying to force everybody that say no, we need to really think about a more centralized approach to some of the things that we’re doing.
So let me clarify a whole bunch of things. So each of our affiliates as autonomy of managing their client assets and running their business, we do provided the benefits of scale for a whole variety of different cost elements right. So whether it's trading systems that are multi-affiliate, whether it’s outsource middle and back office. So don’t confuse the language I'm using about how they operate autonomously in terms of managing money in servicing clients that they are not benefitting tremendously from the scale of the combined business and many of the services and contracts and cost of managing money, we’re able to do within multi affiliate structure. So there are no -- so if you’re thinking that somehow duplication of cost and cost of affiliate that's really is not a correct way to think about us.
It wasn’t so much that it was -- it's more around where maybe some of the incremental spend is occurring in terms of enhancing capabilities, as the back office part I guess I'm comfortable within the sense that obviously that is one of the big advantages of boutique becoming part of the Vertus model is a lot of these, the core technical things that you need to do to run your systems or your operations, you guys do take care of all that. And my question was more about where a lot of the -- some of the incremental investment tends to be is in -- obviously there was a technology component. But there was also just trying to enhance the capabilities, whether it's -- or the decision making processes whether it's trying to go through new sources of data or those kinds of things.
What I'll add to that is if you’re talking about industry wide and what's going on with cost structures, I think all of us will say costs are going up not down. And whether its distribution costs whether to your point, it's enhancements to investment processes with either data or AI types of capabilities, those are all things that will cost more money not less. So again, I think in those areas by having retail as a good example, by having a shared retail cost so where a lot of us have to invest in retail, having to share it amongst multi-boutiques is very helpful, adding a new affiliate doesn’t mean we have to add anything on the retail distribution side, we have the work of course, we have the capabilities, we have the relationship in place.
But for those other things you’re referring to again as appropriate, if we can utilize a single source service provider to tell multiple affiliates we would look to do that. But really for particularly in our area of affiliates focused on their investment process, where they support that may make it easier for them to do that, and that’s really we’ll align them for.
And this concludes our question-and-answer session for today. I'd like to turn the conference back over to Mr. Aylward.
Great. And I want to thank everyone for joining us today and we certainly encourage you to call us if you have any other further questions. Thank you very much.
That concludes today's conference. Thank you for participating. You may now disconnect. Everyone, have a wonderful day.