Virtus Investment Partners Inc (VRTS) 2010 Q2 法說會逐字稿

Good morning. My name is Lenia, 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 on the Virtus website, www.Virtus.com, in the Investor Relations section. 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 would now like to turn the conference over to your host, Joe Fazzino.

Thank you, Lenia. On behalf of Virtus Investment Partners, I would like to welcome you to our call to discuss the operating results for the second quarter of 2010.

Before we begin, I direct your attention to the important disclosures on page 2 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 the statements.

For a discussion of these risks and uncertainties, please see the Risk Factors and Management Discussion & Analysis Sections of our periodic reports that are filed with the SEC, as well as our other recent filings.

In addition to results presented on a GAAP basis, Virtus uses certain non-GAAP financial measures to evaluate its financial 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, along with copies of our filings with the SEC, at www.Virtus.com, under the Investor Relations section.

For this call, we have a presentation that is accessible with the webcast through the Investor Relations section of the website. The presentation, including the appendix, will be available on the website following this call.

This morning's call will begin with remarks from George Aylward, our President and Chief Executive Officer, who will provide an overview of the quarter and review some of our accomplishments. Mike Angerthal, Executive Vice President and Chief Financial Officer, will discuss our financial results. Then we will open the call to questions. Now I would like to turn the call over to George.

Thanks, Joe and good morning, everyone. We appreciate your joining us this morning, and as always, Mike and I welcome the opportunity to discuss the results for the quarter and answer your questions. We have a lot to talk about today, so I will begin by providing a high-level review of the quarter and give some thoughts on some of our recent actions in the area of growth and capital management that we believe will benefit the business going forward. Mike will review the details of the financial results and then we will conclude with a question-and-answer session. Let's start with a recap of the quarter and a discussion of recent activities.

Overall, we're pleased to deliver positive results in terms of flows, operating income, and margin, all of which show continued improvement. It's also helpful that this was a relatively clean quarter with respect to our non-GAAP performance measures, which provide some solid data points around the current rate of revenues and operating expenses.

As I mentioned in the news release, there are a few items in particular that stand out for me as I review the quarter. Our sales and flows held up quite well in spite of what happened in the markets. The declines in the markets impacted us like all managers, and also created nervousness among investors. But in spite of that, we maintained mutual fund sales at the level of the last quarter. We also maintained our positive net flow position for the fifth consecutive quarter, which is a solid achievement in light of the uncertainty of investors.

This quarter's results also demonstrate the leveragability of our business. We demonstrated continued progress towards our goals with increased revenue and stable expenses, which resulted in bottom-line growth and margin expansion.

We've also been active in other areas of the business, specifically growth opportunities and our continued efforts to enhance our capital position and flexibility, so we will talk about these recent developments as well.

Let me highlight some of our key achievements during the quarter. We delivered a 46% increase in operating income as adjusted to $5.3 million from $3.6 million in the first quarter, and also delivered another quarter of improved positive GAAP net income.

Operating margin, as adjusted, was 20% in the second quarter, an improvement from 14% in the first quarter.

Sales in the second quarter were solid, particularly in light of the choppy equity markets during the quarter. Gross sales were $1.1 billion compared with $1.4 billion in the prior quarter. I would note that the decrease is primarily the impact of lower institutional product sales compared with the first quarter, which were high compared to previous quarters.

Long-term mutual fund sales remained strong at $1 billion, and we had a fourth consecutive quarter of double-digit organic growth in long-term funds. Given the environment, we also maintained a good balance in sales between equity and fixed income products.

We also delivered a fifth consecutive quarter of positive net flows for both long-term funds and all products. In terms of AUM, the positive net flows were more than offset by market depreciation this quarter, resulting in an AUM that was down about 2% from March 31.

Revenue as adjusted increased 3% from the first quarter, a result of the impact of improved scale and increased mutual fund revenue.

Expenses were relatively flat from the prior period, reflecting the scalability of the business [call].

Moving beyond the financial results, we also had several developments in the areas of distribution and products. Our distribution access and capabilities are important elements of our potential for long-term growth. We took an important step to further strengthen these efforts when Jeff Cerutti joined Virtus as Head of Retail Distribution on June 1. Jeff has more than 15 years of sales management and leadership experience, and I think he is the right person to build on our recent sales momentum, particularly as we look to improve the productivity of our sales force and the diversity of our sales.

We continue to manage our product offerings, and we made several changes in our mutual fund lineup in the second quarter. So, for example, we merged three Small Cap funds with approximately $250 million of assets into funds managed by our affiliated manager, Kayne Anderson Rudnick.

We appointed HIM Monegy, a subsidiary of Harris Investment Management, as sub-advisor to our high-yield income fund. And we expanded our offering of products based on the Alpha sector quantitative strategy by introducing the Premium Alpha Sector Fund.

Last week, we also announced the scale and growth initiative related to the variable insurance trust market. I will give some additional detail on the VIT transaction in a few minutes.

But now I'd like to review some of the actions we have taken as part of our long-term capital management plan. We continue to manage our capital structure to enhance flexibility for our business needs, and we have taken some important steps recently. The shelf registration statement that we filed in April was declared effective in June. This is a fairly standard and important capital tool for a public company, which gives us great flexibility. As we have noted, it was also a requirement under the investment agreement with Harris.

In July, we amended the credit agreement to give us the flexibility to retire approximately $10 million of convertible preferred stock. And yesterday afternoon, we executed a comprehensive amendment to our credit facility to give us additional long-term financial flexibility. Mike will got over this in more detail, but this amendment extends the maturity and enhances other critical terms of the agreement. This is a very important development as we have viewed the extension of the facility as a key factor in making other decisions around the next steps in our capital management strategies.

One of those steps occurred yesterday as well, when we issued notice that we will be exercising our option to call a portion of the 8% convertible preferred stock held by Harris Bankcorp. Under the terms of the investment agreement, Virtus has the right to call 9,783 shares of the 45,000 shares outstanding of preferred stock at a call price of $1,000 per share, plus any unpaid accrued dividends. Harris [said] its options may convert the preferred shares into approximately 375,000 shares of common, representing conversion price of $26.10 per share.

I think you will agree that these are significant developments for the Company. We have had questions for many investors about our capital management plans, and as you can see from these actions, we have taken the appropriate steps to put in place the elements of a flexible, long-range capital management profile that is appropriate for a company of our size in our industry.

So what are our next steps? Once the call option is settled, we will be in an even better position to evaluate other long-term capital management initiatives. We will evaluate all the various alternatives as appropriate. And while we're not ready to discuss what the next steps will be, let me give you some idea of how we will evaluate our options.

As we think through the potential next steps and the various alternatives, whether they be stock, dividend or debt related, we will continue to consider such items as our operating results, our cash balances, working capital levels, debt servicing requirements, and the provisions of both our debt facility and preferred securities, both of which impact any decisions we may make, as Mike will review later on. As you can see from the steps we've already taken, we have a thoughtful approach to enhancing the flexibility and efficiency of our capital structure and intend to continue doing so.

The one last item I want to cover before Mike discusses the results of the quarter, and that is the growth initiative we announced last week. We signed an agreement that allows us to become the adviser and distributor of the Phoenix Edge Series Fund. The Edge series is a variable insurance trust that provides investment options inside variable life insurance policies and annuities. Currently, it is only available in Phoenix products. After this adoption transaction is completed, we will be marketing these products to other insurance and annuity companies.

As we said in the release, Edge has approximately $1.6 billion in assets and is comprised of 17 series or funds. We are currently the fund administrator for the funds and have been for many years. We also sub-advised three of the funds with about $300 million in assets under management.

When the transaction closes, we will be the adviser to all the funds included in the transaction, adding an estimated $1.2 billion at June 30 levels to the $300 million of assets we already reflect as institutional assets. Four funds with $100 million of assets are not included in this transaction.

As part of the transaction, the Edge series shareholders are being asked to approve proposals that would merge or modify some of the existing funds. Those proposed changes include appointing our affiliated managers to sub-advise an additional $500 million of AUM. Unaffiliated managers will continue to manage about $700 million under sub-advisory relationships with us.

These figures again are all based on assets under management as of June 30 and could change by the time the deal closes, which is expected in the fourth quarter.

We will be renaming the existing trust the Virtus Variable Insurance Trust and market current and new investment strategies to other insurance and annuity companies. We think insurance companies will find an external VIT attractive because it gives them access to a wider range of investment strategies and lets them outsource certain non-core investment functions. The new Virtus VIT will help us expand our distribution into this market.

The transaction supports several key elements of our strategy. First, it will bring additional assets to our affiliated managers and allow us to leverage the capacity we have in existing strategies.

Second, it will add a new product to our already broad base of open-end and closed-end retail funds, SMAs and institutional business.

And third, it leverages our current capabilities, including our fund administration capabilities, our understanding of the insurance market, and our strength in retail distribution.

I should also note that this transaction helps preserve the current economics from our role as fundamental administrator and sub-advisor, and in addition, the deal is structured to be variable in nature in order to align the interests of both Phoenix and Virtus. We both benefit as assets grow, which is the way we like to structure a deal like this.

Now I will turn the call over to Mike, who will give some additional details on the financial results for the second quarter and the capital initiatives that we have taken. Then we will open it up for Q&A. Mike?

Thanks, George, and good morning, everyone, and thank you for joining us today. As usual, I will review the key drivers of the business, and then I will review the recent capital activities.

Let's start right in on slide 8, assets under management. AUM ended the quarter at $25.1 billion, down $0.5 billion or 2% from the prior quarter. Long-term assets, which exclude money market funds, ended the quarter at $22.3 billion, down $0.3 billion or 1% on a sequential basis.

The largest driver and the sequential change in AUM was the impact from the difficult financial market environment in the second quarter. Specifically, the impact was market depreciation of $795.4 million this quarter, which equates to 3% of beginning AUM. With broader equity markets down more than 11%, that was relatively solid performance, where we benefited from our balance of asset classes as only approximately 45% of our assets move with equity markets.

As to be expected with the activity in the financial markets this quarter, our mix of assets shifted slightly and ended the quarter nearly evenly split between fixed income and equity alternative assets.

Our money funds, which are sub-advised and earn a relatively low fee, have represented a declining portion of our total AUM over the past year. And at the end of the second quarter, they were down for just a bit over 11% of total assets.

AUM for mutual funds, excluding money market funds, was down 3% sequentially and up 22% of the prior-year period. AUM for institutional was up from the prior quarter, primarily because of higher levels of low-fee cash management products. AUM for separately managed accounts was down about 5% sequentially.

AUM has increased 12% from the second quarter 2009 as the strength of our positive net flows over the past year, combined with market appreciation for three of the four quarters, have more than offset the $1.2 billion decline in money market funds during that period.

Slide 9 provides additional detail on our flow results. We were pleased to deliver a fifth consecutive quarter of positive net flows, particularly with the choppy markets during the quarter. Let's step through the chart and highlight the key indicators. Gross flows, which are shown on the chart at the top left, were $1.1 billion for the quarter, our fourth consecutive quarter of sales greater than $1 billion. As a reminder, institutional sales in the prior quarter included several fixed income mandates that funded. As we highlighted on last quarter's earnings call, institutional activity is, by its nature, lumpy and did not repeat at the same level this quarter. When adjusting for institutional activities, gross flows were down slightly at 1%, or $14.6 million.

This change is driven by long-term mutual fund sales that were $975.4 million in the second quarter of 2010, down only slightly by $13 million or 1% from the prior quarter. Importantly, the long-term, open-end mutual fund organic growth rate was 11.1%, representing our fourth consecutive quarter of double-digit growth for these assets.

As a reminder, we define the organic growth rate for the fund business as annualized net sales divided by beginning open-end fund long-term assets under management.

We delivered positive net flows of $168.1 million. It's important to note that we have positive flows in both domestic equity and fixed income mutual funds in the quarter. That demonstrates we have a broad range of products contributing to the strong sales effort. In addition, we continue to benefit from the diversity of our mutual fund distribution relationships. In the second quarter, no single firm accounted for more than 21% of our total mutual fund sales volume.

Finally, it is worth noting the consistency in the redemption rates. We remained in a tight range during the trend period, as you see at the lower left on the slide. The ability to retain assets is an important factor in continued delivery of positive net flows.

Moving on to slide 10 and the operating results, in the second quarter, we delivered significant improvements in our operating results on a comparative basis to both the sequential quarter and prior year. Operating income as adjusted of $5.3 million in the second quarter improved $1.7 million or 46% compared to the prior quarter, and improved $4.5 million or greater than 5 times when compared to the prior-year quarter.

Also, of particular note, our operating margin, as adjusted, of 20% reflects a 6-point increase from the prior quarter. Achieving a 20% margin demonstrates the leveragability of our business and represents solid and consistent progress towards achieving higher margin levels. George and I and the entire management team remain committed to focusing our efforts on asset growth and expense discipline to continue to expand margins and increase profitability.

In terms of specific drivers in the quarter, increased mutual fund revenue, particularly in fund administration and transfer agent fees, were partially offset by higher expense waivers, which are a component of investment management fees, and are influenced by a variety of factors. These changes, combined with slightly higher average AUM and continued expense discipline, provide the factors for sequential quarterly improvement.

Compared to the prior-year quarter, the same drivers as the sequential quarter improvement apply. In addition, average AUM growth of 17% over that period drove management fees higher by approximately $5.2 million, excluding structured products.

This increase was partially offset by higher variable compensation costs as both sales and profits have increased markedly from the prior-year period.

I would point out one other item not included in our non-GAAP operating metric, which was $1.1 million of restructuring and severance charges incurred during the quarter.

Turning to investment management fees, you will notice in the bar chart we spiked out the fee recapture related to the two subordinated fee recoveries recorded in the prior two quarters. We expect this will assist investors in analyzing the trend in this top-line growth metric. As I describe the sequential changes, I will discuss the results excluding these items.

Second-quarter investment management fees were $23.4 million, an increase of $0.3 million or 1% from the prior quarter, and $5.2 million or 29% from the prior-year second quarter. The increase from the prior quarter reflects a 4% increase in average assets, excluding money markets. Offsetting the increase in average assets is a reduction in investment management fees from increased expense waivers related to the mutual fund business.

We have expense waivers in many of our mutual funds, and we record investment management fees net of these expense waivers, which have increased from the prior period after the changes.

The increase in expense waivers also slightly impacted the blended fee rate, which was 36.4 basis points for the second quarter, representing a decline of 2.5 basis points from the prior quarter. The impact of the subordinate fee recapture I alluded to earlier was approximately 2 basis points, so the blended fee rate declined approximately 0.5 of a basis point on a normalized basis. This decline is primarily attributable to additional mutual fund expense waivers.

On a year-over-year basis, our blended fee rate increased 3.1 basis points, which primarily reflects lower money market assets, which have declined from 18% of our total assets in the prior year to 11% of assets at June 30, 2010.

Another item I would like to highlight. Fees earned on our managed account business are based on quarter-end asset levels. Given the decline in the markets in the second quarter, we are anticipating approximately $0.3 million of lower fees from this aspect of our business, looking ahead to the third quarter.

Moving to operating expenses, I will start with employment expense. Employment expenses were $15.5 million for the second quarter, down $0.9 million, or 5%, on a sequential basis. This decrease from the prior quarter is primarily driven by the seasonal impact of payroll tax payments.

On a year-over-year basis, the $2.3 million, or 17% increase, is primarily due to the impact of higher variable-based incentive compensation, which reflects the variable nature of our compensation plans.

The variability of the compensation line is evident in the analysis at the bottom of the slide. Employment expense as a percentage of revenues as adjusted for the second quarter was 57.3%, an improvement of 540 basis points from the prior quarter.

That change is expected due to the higher payroll taxes in the first quarter. However, after adjusting for that item, this quarter's results yield an improvement of 190 basis points from the prior quarter's 59.2%. This is a key metric as it demonstrates the variable nature of compensation, which will generally track with profit and sales from quarter to quarter.

In addition, it helps us evaluate the scalability of our business model, and as we have said previously, our ability to leverage our current capabilities will help us further improve our margins.

Moving to slide 13, we show the trend of other operating expenses for the past five quarters. As a reminder, this line item includes sales-related activities, including travel and entertainment, promotional meetings, marketing and printing. Marketing and selling costs are tied to sales and flows and will tend to increase when sales move up.

For the analysis in the bar charts, we have again pointed out an item to assist investors with analyzing the quarter's financial results, and the business's operating trends.

The item identified is the non-cash stock-based compensation that we adjust in the performance measure of our non-GAAP results. Although the service period for these grants is one year, accounting standards require us to record the entire amount in the period it was granted. Again, as I describe the results, I will exclude this item.

For the second quarter of 2010, other operating expenses were at $7 million, which was essentially flat for the prior quarter. Importantly, the ratio of other operating expenses as a percentage of revenues adjusted decreased from 26.8% to 26.1% or 70 basis points.

Further, other operating expenses as a percentage of net revenue as adjusted have declined 660 basis points since the second quarter of 2009, once again demonstrating the scalability of our fixed cost structure.

Transitioning over to the capital structure activity that was announced yesterday and highlighted earlier by George, I want to describe the activities around both the senior secured financing and the convertible preferred securities, and specifically, how these actions have given us greater operating flexibility and have enhanced the efficiency of the capital structure.

First, concerning the amended credit facility. This amendment concluded a key initiative for the Company this year, as the original loan was scheduled to mature in September 2011, and therefore, would have become a current obligation in the third quarter 2010. Extending the maturity for an additional 2-plus years to September 2013 allows the business to operate with a relatively modest level of debt while moving to retire much higher-cost financing.

The new facility also provides additional financing capacity. The credit available under the facility remains at $30 million for the term of the loan rather than reducing to $18 million as of September 1, 2010. And the amendment reduces the variable interest rate, which is benchmarked to standard market indices by up to 50 basis points, further driving down the cost of capital to the Company. Of note, the annualized variable interest rate on our debt in the second quarter was 3.19%.

And finally, the amended facility revises our covenant profile. As we have noted, certain covenants have been modified to provide additional operating flexibility.

Two key covenants to highlight -- the asset coverage ratio was reduced, providing additional borrowing ability. Under the new terms, given our current profile, we have the flexibility to draw down on the entire amount of the facility. As we have stated, there is no current intent to use additional debt capacity, but securing additional flexibility continues to be a key initiative for management.

The other item is a restricted payment clause, which imposes a limit of up to 75% of quarterly free cash flow. This must be considered in any capital management decisions that management and the Board may undertake, including common stock dividends and common share repurchases, for example.

The second item we announced yesterday, which was made possible by completing the amendment we just reviewed, was the action on a portion of the 8% convertible preferred shares. Yesterday, we issued the call notice for 9,783, or approximately 22%, of the 45,000 outstanding convertible preferred shares. This significant step improves the overall efficiency and cost of the capital structure.

The notice effectively will retire these convertible shares, and at this time, there are two potential outcomes on those shares that are described on the right-hand side of the slide, showing our actual June 30 capital structure on a pro forma basis with each of the potential alternatives. It is worth reiterating that the election is at the discretion of the convertible holder.

The first scenario is full redemption of the convertible shares. This would have the effect of using existing cash balances to retire [9.8] of convertible shares plus accrued interest and dividends. Importantly, under this scenario, the common shares outstanding remain the same, cash and working capital are reduced, and the Company would have lower dividend payments of approximately $800,000 per year.

The second scenario is for the preferred stockholder to convert the preferred shares into common stock of Virtus. The conversion is a non-cash transaction and would have the effect of increasing the common shares outstanding while similarly reducing the convertible preferred balance by $9.8 million, and also lowering annual dividend payments by $800,000.

Under either outcome, there would be no change in Board representation or other governance rights of the preferred stockholder, which includes approval rights for certain capital transactions such as stock repurchases. We retain our belief that Harris Bankcorp represents a solid investor and a strong business partner as Virtus continues to progress as an independent asset management company. With that, let me turn the call back over to George.

Thank you, Mike. We're now ready to respond to your questions. I'm going to ask our operator to open up the lines. We ask that you limit your questions to two at a time as a courtesy to your fellow listeners on the call who want to pose questions.

If you have more questions, please feel free to get back into the queue. Lenia, can you open up please?

(Operator Instructions). [Justin Evans], [Sonoma] Capital.

Fantastic quarter. Great flows and the Phoenix deal is a big entrepreneurial surprise. You guys are really magicians with this giant leap in the distribution in admin profits. So, I guess in breaking down all the recently announced fund mergers, the VIT transaction and the other potential product management opportunities, it looks like these deals could net you about another $2.5 million per quarter of future EBITDA.

This syncs up fairly well with what your past comments were about getting the industry average margins. Is that a fair way to think about what lies ahead for you?

Well I think it's fair to say that one of our primary focus is on improving our margins to industry levels. And what we've said before about what really drives that is really within our individual investment management capabilities to have a certain level of scale of assets in order to reach those levels. So all of the actions that you sort of described have certain things in common. And it's basically continuing to drive growth in assets through sales, and more importantly, positive that was. It is, where appropriate, in terms of investment performance, combining funds so that there are more assets managed by individual investment management teams. And then there are opportunities such as the VIT transaction that we announced, where we will, again, have additional assets to be managed in the same strategies by the same teams and with the same fixed cost structure as assets that we currently manage. So all of those things are part of the plans that we have in place in order to improve margins.

And we complement that with also dealing with the market rates of our various services that we provide to clients and customers, and those are all just part and parcel of the types of things that we are doing to achieve, again, margins that are more in line with the industry.

Okay. And I guess another question is, in terms of industry standard EBITDA calculations, is it fair to say that perhaps I should back out your stock option expense on the one hand, but maybe gross up your EBITDA to equalize for the fact that you've got this giant tax asset that will offset somewhere around $400 million of future GAAP net income?

Well, there's several ways that you can look at that. The stock-based compensation -- and it's a good question -- that is non-cash. So from the perspective that we illustrate some of the non-GAAP disclosures, it's really being included from a non-GAAP prospective. But certain other analytics might say, well, that's in lieu of other types of compensation, which, to some extent, might be true, but there are various uses and causes of some of our equity compensation. So I'm not sure if I would necessarily recommend that that be the absolute best treatment, which is to reverse that.

In terms of taxes, different people have different views in terms of how to provide thought on the economic value of taxes. As we've discussed on previous calls and as you can see our filings, we do have certain tax attributes that effectively keep us at a relatively low effective tax rate in terms of primarily federal types of taxes. I do think that that is something that should be acknowledged as a potential value for a firm like ours, particularly as we continue to now demonstrate, we can generate taxable income and that the shields that we have in place that are appropriate under tax regulations absolutely do enhance shareholder value. Mike, I'm not sure -- was there anything you wanted to add around the tax side?

No, I think you're right. You will see state taxes flow through on the tax line. As George mentioned, from a federal perspective, those tax attributes will come into play and keep our effective interest -- effective tax rate at relatively modest levels.

Well, I guess, if you guys were in our shoes or this use of an acquirer, let's say, how would you calculate EBITDA and ultimate fair value of this Company? Would you back out stock comp? Would you also gross up the earnings number with the tax asset to add some kind of -- would you gross it up or would you add some kind of present value of the tax asset to your enterprise value calculation? If it was you, on the other end of it, how would you think about it?

Well, there's two things. One, in terms of our non-GAAP disclosures, really the purpose of that is to really sort of illustrate an ongoing cash generating ability of the Company. It is not meant to be specifically a valuation determinate metric. And, different people will do valuations in different ways, as you well know. And I think generally, when people look at valuation, they are going to look primarily in an asset manager from cash earnings, making some adjustments for what they believe any value there is in a net balance sheet. And, I do think that to the extent that tax attributes are realizable, either by that entity or through a transaction, some value will be given to that.

But I'm not going to speak to the specifics of how I would value us or how other people would value us because, as you know, there's a continuum of how different individuals will sort of view that exercise, and some could approach it on a DCF and a revenue run rate.

We're focused on really creating shareholder value so that the methodology for valuation is not really our primary focus. It's just continuing to improve the result of the Company, so under any calculation, value is being increased for shareholders.

Okay. Thanks, guys. I've got a few more questions, but I will jump back in the queue so I leave some oxygen in the room for some other investors.

Okay, Justin. Thank you.

(Operator Instructions). Lee Matheson, Broadview Capital Management.

Thanks. My first question, again, congratulations on the quarter. It looks very good. On the Phoenix Edge transaction, could you -- you alluded to there being maybe some sort of fee split with Phoenix on this. Can you give us some idea of the economics around the deal in terms of how -- what the economics look like for you guys on it?

Sure. We're not giving specifics on the transaction, and so what we have sort of said is to the extent that there's an economic construct within the transaction, this is sort of structured on a variable basis so that there is an alignment for both of the parties over a period of time. So you should think about that in terms of assets under management over time and probably basis points related to that. (multiple speakers). Yes, were not going into the specifics of what that is, but I think it's a good structure for us, and my view is it's a good structure for all.

So maybe it looks like the Insight Fund purchase and the same sort of idea? (multiple speakers)

There was a variable structure built into the Insight Fund, so again, that's a concept that we think is very helpful in certain types of deals and certain types of structures. Again, it's from the perspective -- from our perspective, it's not a capital-intensive structure. And again, we do think there's good alignment because if assets go up, the other party participates well in that transaction.

Okay. And then on the calling of the press, how much time does the prep holder have to respond and make a decision on that?

It's a relatively short period of time, so you should expect that there will be clarity in a very short period of time. There's some complications in terms of how you count the days, etc., but it will be a relatively short period of time.

Okay. And then my last one, just you mentioned 21% of sales volume coming through I believe to -- referring to a specific broker-dealer. Who was that broker dealer? Can you disclose that?

No, we don't give the specific broker-dealer. The point that Mike was trying to make is one of the things that we are very focused on is the diversity of our sales. We don't ever like to be too concentrated in any single distribution relationship, so he cited that none was greater than 21%, and that's a pretty good number. We would not like to see it any higher than that.

Just so -- in terms of our distribution footprint, we have distribution relationships with -- everywhere; with all of the major wire houses, the regionals, or in DCIO, etc., which again, is why no one accounts for more than 21%.

Is it safe to assume that the 21% is a major wireline house?

We've had times where major wire houses have been our number one distributor, and we've had times where it hasn't been that. So again, it's part I think of the benefit of our legacy of having a broad set of distributions.

What I will say is, a firm that is number one, one year, is not necessarily number one the next year or the next year. We've seen a great rotation between one firm being our biggest sales source and then the next year it could be a totally different firm. But I'm not going to name the specific firm. We have good relationships with all of them.

Thanks, guys. I'm going to jump back in the queue.

Justin Evans, Sonoma Capital.

Hi, Justin, long time no talk.

I was going to say, well, if nobody else wants to ask questions, I will pick your ear. So, I guess, kind of going back to a tougher question than the previous ones, you guys uttered the term share repurchases for the first time on a conference call today. I want to thank you for that, first of all. And I wanted to see if you could clarify the debt covenant that you mentioned about the 75% of free cash flow quarterly. What's the situation with that?

For Mike that would be just -- what Mike referred to was basically pretty standard and reasonable covenant in debt. Mike, do you want to go through how ours works?

Yes, and this is a clause that was in the original agreement, and remains in the facility, and the senior lender has a clause that has a restriction on levels of free cash flow that can be used for certain corporate and capital activities, including share repurchases and/or dividend payments, anything really junior to the senior debt holder. So, it's a free cash flow calculation as defined in our credit facility. It tracks along the lines of EBITDA and also adjusts for any capital expenditures and some other cash items that the Company makes. But it's a pretty standard definition and clause and tracks on a quarterly basis.

So, it's 75%, is what you can spend or that you must retain?

You have up to 75% that you can use and make payments to other capital areas. (technical difficulty). For example, the convertible preferred dividend that we make on a quarterly basis falls under that calculation.

Got you, got you. Okay. And then I guess along the same lines, can you guys talk about the odd lot program? What did you end up buying back, or sorry, what did you end up retiring from the odd lots out there? And, Mike, maybe you could talk about if you can potentially execute a forward reverse split cash out to retire the remaining odd lots that are out there, without having much impact on the flowed or the stock price?

We're not going to go into the specifics of what we saw in the odd lot. What we'll say is it was a mechanism that we employed for clearly stated reasons. That period has now expired. I think any implications for that have rung out of the system.

But, again, I think generally what I would say about if it is it did sort of meet what our objectives were, and sort of what we thought it would achieve in consultation with a service provider that we employed.

And to your second part, in terms of what we might do in the future -- we're obviously aware of the different alternatives and different ways that you could approach accomplishing those types of things. We will think and evaluate all those, but I'm not going to give any specifics about any exact plan or mechanism that we would use going forward.

Got you. Okay. Fair enough. Thanks, guys. Great quarter.

(Operator Instructions). Lee Matheson, Broadview Capital Management.

Can you talk a little bit about the expense waivers you mentioned in the mutual funds? Is that largely coming from the money market side? And can you quantify that?

In terms of expense waivers, for a lot of our open-end funds, and I would ignore the money markets for a moment, in order to make sure that our expense ratios for our funds are competitive with our competitors, we have in place actually a large number of expense caps, which basically says that to the extent that the operating expenses of a fund exceed a certain pre-established ratio, that we will "waive management fees" to hold it at that level. So Mike was sort of alluding to some changes in expense caps and the implications that has on the investment management fee line.

It's net in investment management fees, again, because it is effectively a waiver of management fees. We do not give the specifics of what that is, but generally what drives expense waiver costs are, it's really a fund by fund cap, and it basically will be influenced by the level of assets in that fund, and the fee rates in place, and the other variable costs related to that fund. So it does sort of fluctuate, and it is highly influenced by a fund by fund sort of asset level.

So with the collapsing of these three Small Cap funds into one mandate or sorry, three -- I wasn't clear. Is it three into one or is it three into a different three? Will those help increase the average AUM in the funds and hopefully help kick you over the hump on some of those expense waivers?

Yes, we did. And to be clear, it was three into three. And again, anytime that you increase the level of assets within a given fund, assuming its fixed costs obviously stay constant, and you have a larger amount of assets to spread those costs over, other than your variable costs, the expense ratio will reduce, so one of the benefits of consolidating assets in funds is, again, you have the same manager just managing more assets, but you also have more assets in a fund that will help with that expense ratio, so, yes.

And on the Phoenix Edge stuff, you mentioned there's I think $700 million still being sub-advised by third parties. In the -- are those assets there because you went through and you like the sub-advisor and you wanted to use a capability you didn't have? Or are they essentially a sub-advisor because you had a contract and you couldn't get out of that contract for a while? And is there a possibility that more AUM will work its way over to your own sub-advisors over time from this series of funds?

Well, the primary driver for who manages the assets is really who is the best manager for driving those assets within the capabilities that either we offer or offer through our partnerships.

We mention those two -- the two sub-advisors in the release, is Goodwin which is the fixed income subsidiary of Phoenix, who also manages one of our most successful funds, so obviously, that is a strategic partner of ours. And having that team manage assets, in a fashion similar to what they do in the open-end fund makes sense for us.

The other manager is actually -- it's for a capability we don't have, which is international, and it is Aberdeen, which is actually a very long-standing relationship of both Phoenix as well as obviously us as part of Phoenix. And it's a very strong performing product and fund, and we're actually very excited about having that capability to sort of offer in the market because it has very good performance track records.

Okay, great. And then final question would just be where AUM sits today. Are you guys going to disclose that? Or just go off of the June 30 numbers, because obviously the market has come back since the end of the quarter of that year.

Yes, for now, we're just releasing the assets on the quarter end, so that will be the only permission that you would need to have for modeling purposes.

Okay, great. I appreciate the questions, guys.

Okay. Thank you very much.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Aylward for any closing remarks.

Thank you. I want to thank everyone for participating this morning. I hope we gave you a look at our Company. And if you have any further questions, please give us a call at any time. Thank you very much.

Thank you, sir. That does conclude today's teleconference. Thank you for participating. You may now disconnect your line.