Q3 2019 Earnings Call
Ladies and gentlemen, please standby your conference call would be good momentarily once again, ladies and gentlemen switch them along.
Good morning, My name is covered and I'll be your conference operator today I would like to welcome everyone to Virtus investment partners quarterly conference call. The slide presentation for this call is available on the Investor Relations section of the first website Www Dot Virtus Dot Com. This call is also being recorded and will be available for replay on the Virtus website.
At this time all participants are in listen only mode. After the speaker's remarks, there will be a question and answer period instructions will follow at that time I will now turn the call up to your host Sean work.
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 third quarter of 29 team.
Our speakers today, or George Aylward, President and CEO of Virtus, and Mike Ingersoll Chief Financial Officer.
Following their prepared remarks, we will have a Q in a period.
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 were subject to known and unknown risks and uncertainties, including but not limited to those factors set forth in today's news release.
As discussed in our FCC 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, we use certain non-GAAP measures to evaluate your financial results.
non-GAAP financial measures are not substitutes forget financial results and should be read in conjunction with I guess.
Reconciliations of these non-GAAP financial measures.
The applicable GAAP measures are included in today's news release, which is available on our website.
Now I'd like to turn the call over to George George.
Thank you Sean good morning, everyone.
We're pleased with our third quarter financial result in operating performance, which were characterized by our highest level of earnings per share as adjusted an increase in our operating margin meaningful growth in revenue.
Continued excellent investment performance and consistent stock repurchases and debt reduction.
And well overall net flows were negative primarily due to an institutional redemption each of our other products delivered improved net flows on a sequential basis with positive net flows from seven retail separate accounts in each yes, and open end funds improving to their business flow results in a year.
Regarding the net outflows as I indicated they were largely in institutional primarily due to a point $9 billion redemption by single client not only invest in a bank loans as we said previously institutional isn't uneven business, but we like the momentum we see building and continue to invest in growing the business.
Let me turn into our results for the quarter.
Long term assets under management of 102.8 billion, we down modestly on a sequential basis as market depreciation was offset by net outflows.
Total assets, which include liquidity strategies ended the period at 104.1 billion.
Total sales of 4.8 billion decreased 7% from the second quarter, which included a large institutional sub advisory mandate, excluding that when in the prior period sales were up 13% due to higher sales of retail separate accounts and open end funds, which included the model wins and Reallocations, We mentioned on the second quarter pool.
Net outflows of 1.1 billion compared with modestly positive flows in the prior quarter.
Other than institutional each of our product areas generated a sequential improvement in net flows with significant improvement in funds and positive net flows in retail separate accounts in each yes.
Looking at each product we kill separate accounts had positive net flows a point 4 billion due to organic growth in both intermediary sold and private client.
King Smith strategies continue to be key contributors to net flows in the intermediary sold channel, which is now generated 15 consecutive quarters of positive net flows.
Bts had positive net flows for the third consecutive quarter.
Open infant net outflows were modestly negative.
But as I noted improved significantly from the prior quarter.
Flows of funds were primarily due to bank loan strategies.
Institutional net flows were negative 1.4 billion compared with net inflows of point 5 billion in the prior quarter due to the large client redemption.
In terms, what we're seeing so far in October the trend to mutual fund net flows is generally consistent with the third quarter with positive equity net flows more than offset by bank loan outflows.
Institutional we're pleased with the pipeline I've seen some smaller wins across our affiliates and there is nothing new to report since last quarter in terms of notification of meaningful redemptions.
Regarding other product initiatives, we are in the process of whereas in a new see a low for early 2020 issuance.
We also recently launched a new fund employment gains International Smid strategy.
Moving to the financial results operating income as adjusted in the related margin were $47.7 million, 30% up from $43.7 million, 36% in the prior quarter due to strong revenue growth lower other operating expenses and the inherent leverage ability of the business.
Earnings per share as adjusted afford Allison three cents were up 11% in second quarter with the increased due to higher revenues as adjusted and lower other operating expenses as adjusted.
To the prior quarter, which included the annual equity grants to the board of directors compared to the prior year period third quarter earnings per share suggested increased 3%.
Turning to the capital on the balance sheet, we continued to maintain a balanced approach to capital management across the priorities of investing in the business returning capital to shareholders and managing our leverage.
During the quarter, we raised our quarterly common dividend by 22% the second consecutive annual increase.
Repurchased or net settled approximately 72000 common shares are about 1% of shares outstanding and continue paying down debt on our term loan ending the quarter with net debt to bank EBITDA of point Fivex with that I'll turn the call over it might provide more detail on the results Mike.
Thank you George good morning, everyone.
Starting with our results on slide seven assets under management.
At September Thirtyth long term assets were 102.8 billion down modestly from 103.3 billion at June Thirtyth.
The sequential decline reflected 1 billion of market appreciation that was more than offset by net outflows.
Primarily in institutional accounts.
So total assets were relatively flat with the prior quarter.
Domestic midcap strategies demonstrated solid growth up point 7 billion or 7% during the period, partially offsetting the impact of continued negative sentiment and leveraged finance strategies.
Which declined 1.2 billion.
Or 9%.
Domestic midcap value and increased 29% over the past year and now represents 20% of domestic equity win.
Up from 16% at September Thirtyth 2018.
Despite several funds being soft closed domestic smallcap assets have grown modestly due to strong investment performance.
Our asset mix by product type remains diversified and essentially stable with the prior quarter.
Turning to slide eight asset flows.
Net outflows of 1.1 billion in the third quarter were due almost entirely to the loss of one institutional client.
Compared with modestly positive inflows in the second quarter.
Open end fund flows were negative due to bank loans, but improved meaningfully to point 2 billion.
Point 7 billion in the second quarter.
Due to an increase in emerging market flows.
Recast separate accounts and EPS continued to generate positive flows.
Total sales were 4.8 billion a sequential decline of 7% as stronger open end funds and retail separate account sales were more than offset by a decline in institutional.
Fund sales of 3 billion increase point 5 billion or 19% due to higher sales of emerging markets and domestic mid cap funds.
Primarily due to model flows.
Retail separate account sales at point 8 billion were up 12% sequentially with growth in both the private client.
Intermediary sold channels.
Institutional sales declined by 8.9 billion from the second quarter, which included a point 9 billion.
Global real estate sub advisory mandate.
Looking at mutual fund flows by asset class.
Equity funds had positive net flows of point Threebillion, an improvement from point 1 billion in the prior quarter.
Domestic equity net flows are modestly positive.
Similar to last quarter strong net flows from mid cap strategies or partially offset by net outflows in both small and large cap.
Mid cap funds, which we offer and growth value and core strategies.
Generated point 3 billion and positive flows in the quarter, reflecting an annualized organic growth rate of 30%.
This continues a strong trend for our mid cap products.
International equity funds had positive net flows of point $3 billion in the quarter, a meaningful improvement from breakeven net flows in the prior quarter.
Inflows into emerging market equities, which included a model reallocation drove the improvement.
So developed markets also generated positive flows.
For fixed income funds bank loan strategies with the primary driver net outflows of point 5 billion for the quarter.
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Our managers continue to deliver strong relative investment performance across our strategies as of September Thirtyth 25 of our 54 rated retail mutual funds.
Representing 81% at retail rated fund assets.
Had four or five stars.
And 94% of rated retail fund day you win.
Three four or five star funds.
Each of our five largest mutual funds is a five or forestar phoned, representing a diverse set of strategies from five different managers.
In addition to this very strong fund performance, 93% of institutional assets are beating their benchmarks on a five year basis as of September thirtyth.
And 86% of assets were exceeding the median performance of their peer groups on the same five year basis.
Turning to slide nine investment management fees as adjusted at 122.1 million.
Increased 5.6 million four or 5% sequentially.
Due to a 2% increase in long term average assets under management.
At a higher average fee rate.
Fees for the quarter include 1.2 million in performance related fees on institutional accounts.
Compared with negligible amounts in the prior quarter.
On average we have generated approximately 2 million in performance related fees annually.
The average fee rate on long term assets for the quarter increased to 46.6 basis points.
Up <unk> 0.6 basis points from 46 in the prior quarter continuing the trend we have seen of late.
With respect to open end funds the fee rate increased to 56.3 basis points from 55.4 in the second quarter, reflecting the impact of favorable equity returns on the level of equity assets.
And the ongoing positive fee rate differential between sales and redemptions.
This quarter the blended fee rate on mutual fund sales was 58 basis points, while the rate on redemptions was 52 basis points.
Slide 10 shows the five quarter trend in employment expenses total employment expenses as adjusted of 16.1 million increased 5% sequentially from the second quarter.
The increase largely reflects higher profit based incentive compensation in the third quarter.
Employment expenses represented 47.2% of revenues essentially flat sequentially.
And down 1.8 points from the prior year, given revenue growth primarily attributable to market appreciation.
For modeling purposes, we believe this level isn't appropriate expectation for the fourth quarter.
Okay.
The trend in other operating expenses as adjusted reflects the timing of product distribution and operational activities. Other operating expenses as adjusted were 18.1 million a decrease at point 9 million or 5% from the prior quarter.
The decrease was primarily due to the point 8 million annual equity grants to the board of directors last quarter.
Okay.
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Slide 12 illustrates the trend in earnings operating income as adjusted of 47.7 million increased 4 million or 9% sequentially, primarily due to higher revenues as adjusted as well as lower other operating expenses as adjusted compared with the second quarter, which included the annual forward Grant.
The operating margin as adjusted for the quarter was 37.5% an increase of 140 basis points sequentially and unchanged from the prior year period.
Adjusting for performance fees in both periods the margin increased by 120 basis points to 36.9%.
Net income as adjusted up $4 in three cents per diluted share increased 40 cents or 11% sequentially.
Interest and dividend income as adjusted which includes income generated on seed in CLL investments.
Was 3.5 million or 31 cents per share.
A decrease from 3.8 million or 34 cents per share last quarter due to lower celo interest income.
I would note that our investment in the CLL. We issued early in 2019 will pay its first dividend in the fourth quarter and I would remind you that there will be variability from quarter to quarter in interest and dividend income based on market values and timing of distributions.
The effective tax rate as adjusted for the quarter was 27% stable with the prior quarter at a reasonable run rate for modeling purposes.
Regarding GAAP results third quarter net income per share was $2.95.
Compared with $3.26 in the second quarter.
Third quarter net of tax GAAP earnings per share included the following items.
67 cents of net unrealized losses on investments.
59 cents of amortization of intangible assets.
17 cents of other costs, including acquisition integration restructuring and severance.
At a four cents benefit from net realized gains on investments.
Slide 13 shows the trend of our capital position and related liquidity metrics.
Working capital at September Thirtyth of 158 million increased 9 million or 6% sequentially, primarily reflecting operating earnings partially offset by debt repayments and return of capital to shareholders.
Gross debt outstanding at September Thirtyth was 301 million as we repaid 15 million of debt.
The net debt to EBITDA ratio of 0.5 times at September Thirtyth was down from 0.7 times at June Thirtyth.
And from 0.9 times a year ago.
Due to continued cash generation and consistent debt pay down.
Gross debt to EBITDA was 1.5 times at the ended the quarter.
Down from 1.7 times in the prior year.
Regarding return of capital to shareholders, we raised our quarterly common dividend by 22% to 67 cents per share.
We repurchased 7.5 million or 70949 shares of common stock, which represented approximately 1% of beginning of quarter total outstanding common shares.
Over the past year, we have repurchased 446767 shares.
Representing 6% of September Thirtyth 2018 common shares outstanding.
And on a net basis shares outstanding have declined 4% over the past year.
On February Onest 2020 are mandatorily convertible preferred shares will convert to comment.
While the conversion will not impact the shares used to calculate EPS as adjusted.
It will increase the market flowed in our common shares by approximately 1 million or 15% depending on the conversion price.
The conversion will also had the effect of increasing our annual free available cash flow.
By five to 6 million.
Finally, as a reminder, we have intangible assets that will continue to provide a cash tax benefit of approximately 10 million per year at current tax rates over the next 14 years.
With that let me turn the call back over to George George Thanks, Mike. So now take your questions. Kevin can you open up the lines. Please.
Ladies and gentlemen, if you have a question or comment at this time. Please press star than the one key on your Touchtone telephone. If your question has been answered you wish to move yourself from the Q. Please press the pound cake.
First question comes from Jeremy Campbell with Barclays.
Hey, thanks.
Just a question about the open end funds I mean, you guys still have nearly like 5 billion and a leveraged finance funds or the open an area. Obviously it remains out of favor I think you guys called it out as a key driver of your your drag on your flow profile on the opening costs. So I'm just hoping you could help us with the year to date cadence of outflows in that bucket in the bank loans.
Is it kind of slowed as it accelerating anything that might help us think through how much of a drag this asset class will be on the flow profile going forward be helpful.
Yeah, I mean, generally a and that asset class bank loans are either you know they vary greatly with expectations on interest rates and whether they are increasing or decreasing so with the expectations at incur interest rates will not be going up.
That sector that asset class and then add a favor since pretty much the fourth quarter last year, maybe a little before that.
But in terms of the cadence I would say generally flat in terms of the level on the open end fund side and again I think ultimately there'll be a conclusion by the market of sort of how it feels about that asset class because they still generate very good returns and they fit well into a diversified portfolio.
Got it and then I guess, just one on the capital side as a follow up I mean, you guys have successfully de Levered here, you have dry powder and flexible balance sheet at this point.
Just kind of wondering what the M&A landscape looks like right now and whether there might be something accretive out there that might be more public share friendly than than using capital the repurchase or stock when an already I was kind of a pretty limited float here at this point.
Yeah, no. It's a it's a good question I mean, we continue to evaluate all sorts of opportunities you know the activity in the M&A market. There is no activity going on I think our model lends itself.
In many ways to that type of activity, while though we've always said our long term growth strategies not contingent upon M&A. So to the extent that we identify opportunities that we think are the highest and best use of capital absolutely.
Do consider those we're very disciplined about how we approach. It so we haven't announced anything since the SDMA transaction, but continue to look at that as one of the many opportunities we have because as you point out we're generating consistent strong cash flows where we're at a lower leverage were below one turn where half a turn.
Of net debt in terms of that and simultaneously we've been consistently be buying back our shares even though as you correctly pointed out that float.
He is not optimal it will improve in February of 2020, which we look forward to.
But we certainly do consider any of those alternatives that could be accretive unhelpful in terms of the return to shareholders.
All right. Thanks, a lot guys.
Thank you.
Our next question comes from Michael Carrier with Bank of America.
Hi, good morning, Thanks for taking the questions.
Maybe first one just on the yeah, I guess from a product or flow outlook. It seems like the close end fund market has gotten a bit more active so just more curious just given that you have some presence in that part of the market.
Yeah. If you are seeing more dialogue for for some potential product launches.
Yeah, no we like the product line of close end fund and as you point out we have multiple closed end funds managed with several of our affiliates and there was a prolonged period where that.
Product structure was sort of out of favor, we're very happy to see the increase activities. We look very closely at all of the issuances, we have several strategies that clearly lend themselves to that structure.
So we do view that once again as a great opportunity and certainly we will evaluate if there is an appropriate.
Structure for us to to introduce we've followed closely the evolution of what the restructuring is on the newer term trust types of structures et cetera, and again, we feel.
Between several of our affiliates we have.
Strategies that would be attractive and we maintain a very active dialogue with the issuers in underwriters of those products.
Okay. That's helpful. And then just as a follow up on the on the fee rate side, you guys have done a good job in sort of maintaining or even increasing just given some of the products that you offering where you're seeing the demand for inflows rest outflows.
Yes, I recently, you've had some of the distribution platforms.
You change some of the pricing dynamics.
Most recently with one of the platforms looking at estimate and changing that.
Pricing dynamic so just more curious in terms of how your products are lining up what you're seeing from the distribution platforms.
Anything changing meaningfully and how you think your products stack up.
On the platforms.
Sure so.
So some background. So we have actually had a trend period of increasing average fee rate rather than a decreasing fee rate, which is much more common industry and really what drives that is our view is is being driven a lot by just consistently strong performance and particularly in areas that are more capacity constrained and less except.
The ball to competition from passive types of strategies. So our fee rate is going up because some of our very strong performing product that is less challenged by passive challenges has been raising assets and includes capacity constrained.
Products as well as those that are a little less capacity constrained so.
That has been driving and that is really where a lot of our core strengths are on some of the.
More capacity constrained or at least less.
Less likely to be competed with passive strategies, so more complex strategies, multisector strategies et cetera, and in terms of the.
Some of the.
Stuff you've been seeing in terms of the press in terms of where some of the intermediaries, maybe going with their fee levels again, we we have a very diverse business with a lot of our managers that that do.
Make themselves available through those intermediaries again, a lot of those strategies or some of our more capacity constrain strategies, where we currently have more demand that we actually have capacity and we feel very good about how they're priced and what the opportunity set is for those products. So we actually feel very positive from a product positioning standpoint that.
At our set of products and their relative performance.
Gives us a good opportunity in in this environment and the environment that may emerge.
Okay. Thanks, a lot.
Thank you.
Our next question comes from multi with Sandler O'neill.
Thanks. Good morning, one from me just I guess stepping back on a high level looking at the strategy medium to long term I mean, how do you feel.
The kind of got geographical maybe channel mix, maybe asset class next other certain areas. It look appealing that you feel your honor Underpenetrated, maybe emerging markets alternatives do you have any plans for the mechanism for growth within those those asset classes as well.
Sure well I see the area that we.
We focus a lot in terms of the diversification of our business and continue to look in opportunities to increase that diversification right. So you've seen that manifests itself through our expansion into EPS. Our expansion on the usage side, we had been over the last few years investing and building out the institutional channel.
And particularly the non U.S. institutional channel. So we continue to think that those are great opportunities for us while there's still a lot of opportunities here in the in the us market.
Our managers have not as as much penetration outside the U.S. as they're incredibly compelling investment performance would allow so we see that as an area you recall from the second quarter, we referred to a a European sub advisory mandate.
So we think there's great opportunity so that our focus really has been on growing the institutional growing these two channel in the non us we have solely build out a product suite of usage I think we're up to five now at this point all of whom have great performance in our at the three and five year record. So we see those is opportunities for us.
US too to leverage those strong capabilities and further diversify our business, which doesn't mean will spend less time and effort in the us retail space of the use institutional space. It's just another opportunity and where we're putting our efforts in terms of future growth.
Great. Thanks.
Well.
Our next question comes from Alex Prosumer Goldman Sachs.
Hi, how are you just check printing products.
A question on the.
On the Sir on the effort accounts kinda give us some cardona school, what's driving the inflows over here and rich product are you seeing I come mascoma separate accounts business.
Sure you're and we've been very happy with the retail separate accounts as I noted in his remarks 15 consecutive quarters of positive flows in that category and I think you're seeing that in terms of the industry is one of the opportunities for active managers to really add a lot of value in terms of a well diversified portfolio. So were please.
These to partner with a multitude of the intermediaries that we partner with to offer a variety of strategies a lot of our growth has been as we sort of noted in the mid and the.
It is small cap area, but we do offer other capabilities as well and in addition to the areas that I mentioned on the previous question in terms of areas of growth. We continue we've seen retail separate accounts is a big area of growth and that is continues to be one where we think we have many compelling investment strategies.
In terms of continuing to grow in that channel.
Understood and I'm, just a follow up on the expenses.
Any color on the 2020 outlook for defense and I mean, my gave a good guidance far over the next quarter, but if I can just provide as to how you're thinking now for the 2020 expenses.
Michael Us.
Yes.
Thanks, and we typically.
We will update you as appropriate win win.
Elements of the portfolio the business change, we talked about the fourth quarter and.
Both the employment expense ratio sort of tracking using a third quarter level as appropriate.
Physician for modeling all else being equal other operating expenses, we've talked about.
The last couple of quarters, 18, 18.1, being appropriate and certainly those levels will.
Be dictated by market condition.
One of the things we've seen.
It is.
Incremental margins in the 50% type of range and that's something we continue to believe is an appropriate expectation.
On one thing for modeling that you'll recall first quarter does have seasonal items we have.
I have the.
Payroll tax items and that come through in the first quarter that'll be an expectation.
For modeling as well.
So hopefully that's enough to kind of frame the beginnings of 2020.
Thank you and that's helpful.
Our next question comes from Michael Cyprys with Morgan Stanley .
Hey, good morning, Thanks for taking my question.
Just on the debt pay down it was really nice to see another solid quarter.
Continual debt pay down here also seems like it stepped up a bit so just curious how you're thinking about.
Hi, how are you guys are approaching and is it sort of like a 4% paid on a quarter you guys are targeting our certain percent of of EBITDA. Just curious how you how you're approaching at and how you're thinking about the velocity of a pay down from here, what we should be expecting.
Sure well couple of things.
We're pleased with the level of cash flow that we're currently generating and as we always say we want to balance it amongst the various priorities of the business in terms of investing in the growth returning the capital and managing our leverage and so again the growth in the in a cash generation in this quarter. So.
We continue the balance that we'd like to have certain set of consistency as balance with.
Those opportunities that we have to make investments we do view debt as something that is a tool to be use going forward.
So Mike you want to just give a little color on.
Yeah, I think you've kind of framed it as we think about it and we've been consistent in our pay downs over the last four or five quarters.
And at certainly at 0.5 times, what we do have financial and operating flexibility, which we think is is important going forward.
And.
As we talked about the there'll be a little pickup in the free cash flow that we retain in the first quarter when the Mandatorily convertible preferred.
Do convert to comment so thats another consideration for us as we think through.
Balancing investing in the business.
Paying down debt and returning capital to shareholders. So we feel really well positioned as we head into 2020.
Great. Thank you and just another question maybe just on performance fees. It looked like you had.
I think it was about a 1.2 million or so come through in the quarter can you just remind us of the laminates, earning performance fees, how that's maybe change over the past year or two and how we should be thinking about performance fee revenues.
Over the next 12 24 months.
Yeah, we did in the prepared remarks talk about.
Experiencing approximately 2 million of annual performance fees has been historical levels over the last couple of years and that comes through in two ways really on the.
COO structured products we.
Experienced performance fees on their at certain periods of time, and then we have hybrid fees on certain institutional accounts that are measured with a base fee and a performance fee on a.
Actual results first benchmark and.
That's really what you saw contribute in to the performance fee and the third quarter 2019, So it will vary.
But again I think.
That 2 million per year is as good a benchmark as as any and to the extent there are more products that come through with these type of hybrid fees lead.
Make you aware of them for for modeling purposes and otherwise.
Great. Thank you.
Thank you.
This concludes our question answer session I would like turn the conference over to Mr. Award.
Thanks, and I want to thank everyone as always for joining us today and we certainly encourage you to call reach out if you have any other further questions. Thank you very much.
That concludes today's call. Thank you for your thank you for participating you may now disconnect.