Virtus Investment Partners Inc (VRTS) 2010 Q3 法說會逐字稿

Good morning. My name is Amy, 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 Virtus website.

At this time, all participants are in a listen-only mode. After the speakers' remarks, there will be a question-and-answer period and instructions will follow at that time.

I will now turn the conference over to your host, Mr. Joe Fazzino. Please go ahead, sir.

Thank you, Amy. On behalf of Virtus Investment Partners, I would like to welcome you to our call to discuss operating results for the third 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.

These statements may be identified by such words as expect, anticipate, believe, outlook, may, and similar terms or variations. For a discussion of these risks and uncertainties, please see the risk factors and management discussion and analysis sections of our periodic reports that are filed with the SEC, as well as our other recent filings which are available on our website under Investor Relations at www.virtus.com.

In addition to results presented on a GAAP basis, Virtus uses certain non-GAAP financial measures to evaluate its financial results. Reconciliation 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 our website under the Investor Relations section.

For this call, we have a presentation that is accessible with the webcast through the Investor Relations section of our 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, and then we will open the call to questions.

Now I will like I would like to turn the call over to George.

Thank you, Joe. Good morning, everyone. We appreciate your taking the time to join us today. I will begin by giving some perspective on the results for the quarter, as well as on several of our recent initiatives. Mike will review the financial results in more depth, and then we will conclude with the question-and-answer session.

I am sure you have read our news release and have seen that the third quarter was a solid one for us. We delivered continued growth in our already strong sales and demonstrated an ability to increase earnings and operating margin despite the expense impact of increased sales of higher fee products in markets that were relatively flat on average.

Slide 5 provides some of the highlights that stand out in the quarter. Sales in the third quarter were very strong with gross sales of $1.6 billion, up 40% sequentially, driven by the strongest quarter of mutual fund and institutional sales since we became a public company. As a reminder, institutional sales tend to be volatile, and this quarter's activity should not be seen as any indication of future trends.

Our mutual fund sales continue to be an area of great strength, with total sales of $1.1 billion, up 14% from the previous quarter. This was our highest quarter of mutual fund sales since becoming a public company and also the fifth consecutive quarter of double-digit organic growth for the funds at 19.6% percent this quarter.

We have a lot of traction from several equity products, particularly the Emerging Markets Opportunities Fund and our new AlphaSector product. These sales were additive to the continued strength in our other products, like the Multi-Sector Short Term Bond Fund.

Overall, 56% of fund sales in the quarter came from equity products and as compared to 42% in the second quarter. We are pleased to see the increase in equity products as they provide balance in our asset mix and earn higher fee.

Thanks to the strong sales, this was our sixth consecutive quarter of positive net flows. We had a $300 million increase in positive net flows from the prior quarter, $200 million of which came from mutual funds. The positive net flows, combined with $1.6 billion of market appreciation this quarter, resulted in an 8% increase in assets from June 30.

Revenue, and revenue as adjusted, were up modestly from the second quarter. While the markets were up from the start to the end of the quarter. They were down on average for the quarter, but with our positive flows and an increased mutual fund revenue, we did see a modest increase in overall revenue.

Importantly, while revenue was up slightly, expenses were down in virtually every category, except for employment expenses, which, as you would expect, increased because of the impact of having an increase in sales, particularly of higher fee products which have a higher payout.

Operating income, as adjusted, grew by 8% to $5.7 million from $5.3 million in second quarter, in spite of markets that were down on average and the expense pressure from increased sales. Operating margin, as adjusted, was 21% in the third quarter, up from 20% in the second quarter. The increases in both operating income, as adjusted, and operating margin, as adjusted, were affected by the higher compensation expense related to the increased sales, particularly of higher fee products.

I would also point out that we delivered another quarter of improved GAAP net income, which came in at $3.7 million for the quarter, compared with $400,000 in the second quarter of the year.

Moving beyond the financial results, we also had several product developments as shown on slide 6. We introduced two funds this quarter -- the Premium AlphaSector Fund and the International Equity Fund.

While we usually talk about a three-year incubation period for new funds so that they can generate a performance track record, the Premium AlphaSector Fund has been an exception to the rule. We have had tremendous response to this new AlphaSector strategy, in part based on the success of the strategy offered in the AlphaSector Rotation Fund that we introduced last October. After just one quarter in the market, the new Premium AlphaSector Fund had nearly $140 million in assets.

The International Equity Fund is a new offering, so we expect to see a more typical ramp-up period for sales for this fund. The fund is managed by Pyrford International, which is a new outside subadviser for us. The offering from Pyrford brings a value approach to international investing, compared with the growth orientation of Vontobel, which manages our other international equity strategies.

Also, in September, we announced a secondary rights offering for the Zweig Total Return Fund. Closed-end funds are an attractive product and the market conditions have opened up a bit, providing an opportunity to raise additional assets based on the capabilities we have available.

There were several other initiatives that we announced last quarter that I want to update you on. We announced the scale and growth initiative related to the Phoenix Edge Series Trust, which provides the investment options inside variable annuities and life insurance products. The trust had $1.6 billion in assets, and we have been the subadviser for about $300 million of those assets. When the transaction closes, we will be the adviser to all of the funds included in the transaction, adding approximately $1.2 billion to AUM. An additional $500 million of those assets will be managed by our affiliates.

This transaction gives us a product that provides access to another distribution channel since we can market our investment capabilities to other insurance and annuity companies. We expect to close the transaction this quarter, the full benefit of which won't be reflected until the first quarter of next year.

During the quarter, we also executed several previously announced steps in our capital management plan. Shortly after our last call in August, we converted 9783 of the 45,000 outstanding shares of our 8% preferred stock into approximately 378,000 shares of common stock, thus reducing our dividend payment on the preferred shares by approximately $800,000 a year.

In October, we announced that our Board had authorized a program to repurchase up to 350,000 shares of our common stock. The buyback provides a means to return capital to shareholders, and would generally offset solution from shares issued under equity-based plans.

Mike will go into more detail on the repurchase program in a few minutes, but anticipation of questions on the buyback, let me say at the outset that we will not be providing specifics on the initiation or timing of the program, although you will see the results on a quarterly basis.

In addition to the capital initiatives we completed in the second quarter, the conversion and the buyback were the next two steps in our strategy to develop a flexible, long-range capital management profile that is appropriate for a company our size. We continue to evaluate the additional steps and alternatives, and we are always considering the best ways to manage our capital for the benefit of our shareholders. And we will continue to update you as appropriate.

Before I turn the call over to Mike, I would like to spend a few minutes on one other topic, that being our strategy to build long-term value. At the time the decision was made to spin the Company off in the fourth quarter of 2007, we had plans in place to restructure and then grow the Company. As you recall, 2007 was a very different period in the markets, and our operating earnings and margins were much higher.

As we are closer to the spin, the economic environment changed substantially, as did our focus and priorities. So when we became a public company on January 1, 2009, while we did execute on many of the plans to adjust our cost structure, we had to defer plans to execute on growth initiatives.

As we moved through the past 18 months, we have taken significant foundational actions to put the Company in a strong position. As you have seen over the past several quarters, with the backdrop of a more constructive environment, the strength of our products and sales efforts have translated into consistent positive flows, and we have continued to demonstrate our expense management discipline, which has resulted in improved profitability. All of these actions have brought us to the point where our strategic priorities now include balancing the requirements to improve our profitability with driving long-term growth.

We have spent considerable time over the past year on our three-to-five-year strategic plans and priorities that we believe will enable the Company to reach our profitability targets, allow for growth and build long-term shareholder value.

The primary focus of the management and the Board over the next three to five years is to work towards this successful execution of our long-term strategic plan. We intend to provide more specifics on strategic goals, priorities and plans in future discussions, particularly one where we'll review the full-year results in our investor call early next year.

Now I will turn it over to Mike who will give some details on the financial result and activities for the third quarter, and then we will open up for questions and answers. Mike?

Thank you, George, and good morning, everyone. This morning, I will start out by discussing our operating results, then I will review each of the key drivers of the business, and finally, the recent capital initiatives and our balance sheet.

Let's begin with slide 8, an overview of operating income, as adjusted. In the third quarter, we demonstrated improved operating results, compared with both the second quarter of 2010 and the third quarter of 2009. Operating income, as adjusted, of $5.7 million in the third quarter, improved $0.4 million or 8% from the prior quarter, and $2.5 million or 77% from the prior-year quarter.

For the nine months of 2010, we generated $14.6 million of operating income, as adjusted, compared with $2.6 million in the first nine months of 2009.

In comparing results with the prior quarter, there are some important items of note that continue to demonstrate the positive operating trends of the last several quarters. Specifically, revenues have been affected by strong sales and net flows, as well as a more stable market environment.

Our employment expenses reflect the increasing sales levels and the result of pressure from sales expense, resulting from the variable nature of our incentive compensation programs. And we continue to actively manage our other operating expenses within a relatively narrow range, further reflecting the leveragability of the business.

These factors contributed to expanding the operating margin, as adjusted, to 21% for the third quarter, an improvement of 130 basis points from the prior quarter and up 680 basis points from the prior year third quarter.

In addition, for the nine-month period ending September 30, 2010, the margin was 18%, compared with 4% for the first nine months of 2009. We believe we are demonstrating the continued progress towards higher margin levels that we expect in the Company.

I would also point out several earnings items of note reflected in our GAAP income statement in the period, which you will find in the financial appendix to this morning's presentation.

GAAP earnings this quarter increased to $3.7 million from $400,000 last quarter. This resulted from the continued improved operating results, as well as a contribution of $1.5 million from the mark-to-market gains on investments in our mutual funds that are classified as trading securities on our balance sheet.

Let's look at the key elements that drive our profitability, assets under management and asset flows.

First, AUM on slide 9. Assets ended the quarter at $27.1 billion, an increase of $2 billion or 8% from the prior quarter. Long-term assets, which exclude money market funds, ended the quarter at $24.4 billion, up $2.1 billion or 10% on a sequential basis.

The two drivers of the sequential change in AUM were the positive net flows of $455.2 million, which we will review in more detail on slide 10, and market appreciation, which was $1.6 billion in the third quarter.

Given our diversified mix of assets, the market appreciation of our assets will not fully track the broader equity markets. So while the S&P 500 was up approximately 11% in the third quarter, our market appreciation was about 6%.

There are a few other points to highlight about the change in assets. First, as a result of the equity market appreciation and strong open-end equity fund sales, the percentage of equity assets shifted by 110 basis points from 44.2% to 45.3% of all assets.

Fixed income assets ended the period at 44.8%, up 30 basis points from the second quarter. Finally, our money funds, which are subadvised and earn a relatively low fee, continue to represent the declining portion of our total assets, and at the end of the third quarter were less than 10% of all assets.

Slide 10 provides detail on our asset flows. This was our best quarter for gross sales and net flows since we became a public company. Gross sales, which are shown on the chart at the top left, were $1.6 billion for the quarter, our fifth consecutive quarter of sales greater than $1 billion, an improvement of 41% over sales of $1.1 billion in the second quarter. This improvement was driven by long-term open-end mutual fund sales that were $1.1 billion in the third quarter, up 14% from $975.4 million in the second quarter, as well as a strong quarter for institutional sales.

A few highlights about mutual fund sales. First, the sales mix shifted significantly during the quarter, with 56% of sales from equity products, compared with 42% in the prior quarter. That shift reflects our marketing and distribution efforts during the quarter, as well as several attractive products, particularly the Emerging Markets Opportunities Fund and the new Premium AlphaSector Fund. These equity product sales added to the continued strong sales from our other mutual funds, including the Multi-Sector Short Term Bond Fund.

The increased sales of equity funds also resulted in higher average net fee rates of new sales in the quarter. The net fee rate for third-quarter mutual fund sales was approximately eight bits higher than the average net fee rate for sales in the previous quarter. Increasing fee rates on new sales results in higher revenue, which is an important factor in expanding our margins and increasing profitability.

For the quarter, long-term open-end mutual funds had an organic growth rate of 19.6%, representing the fifth consecutive quarter of double-digit growth. As a reminder, we defined the organic growth rate as annualized net sales divided by beginning of period assets under management. We also continue to have good diversification in our mutual fund distribution efforts, and on a year-to-date basis, no single firm has accounted for more than 19% of total mutual fund sales volume.

Institutional products also contributed to this quarter's total sales, with $385.5 million of inflows, compared with $31.5 million in the prior quarter. The sales were primarily in fixed income mandates at our Duff & Phelps affiliate. As always, I will remind you that institutional activity is by its nature lumpy, as demonstrated by the significant swings in sales over the past five quarters.

Finally, as noted on the lower left of this slide, the annualized sales rate of 25% is higher in the past several quarters, and our annualized redemption rate of 18% ticked up a bit, but both are primarily due to sales and redemptions of lower fee institutional assets.

Moving on to investment management fees on slide 11, investment management fees of $23.5 million in the third quarter were relatively unchanged from the prior quarter, as increases in mutual fund fees were substantially offset by lower fees from separately managed accounts and expense cap reimbursements on our mutual funds. When compared with the prior-year period, investment management fees increased by 14%.

It is important to look at the change in revenue in the context of the market activity during the quarter. Broad indices like the S&P 500 were up more than 11% for the quarter, but that is a point-to-point comparison from June 30 to September 30. As we know, the financial markets did not move in a straight line during the quarter. In fact, the average equity markets were down about 2% for the third quarter. As a result, while ending assets were up 8% for the quarter, average assets were up just 1%, in part from positive flows. Thus, the change in investment management fees corresponds more closely to the change in average assets for the quarter.

As I mentioned on the call last quarter, we anticipated lower fees on our managed account business in the third quarter, as fees in the quarter are based on assets at the start of a quarter, which were down from the second quarter. Conversely, we expect higher fees from the SMA assets in the fourth quarter, as a result of higher assets at the beginning of the period.

And finally, the blended fee rate was 35.7 basis points for the third quarter, representing a slight decline of 0.7 basis points from the second quarter. This decline is primarily related to the impact of lower fee institutional business.

Moving to expenses. Total non-GAAP operating expenses were flat to the prior period, as a result of two main elements that we will review on slides 12 and 13. Employment expenses were up due to the variable nature of incentive compensation and other operating expenses were down, reflecting the leveragability of the business.

Let's begin on slide 12 with employment expenses, which were $15.9 million for the third quarter, up $0.4 million or 3% on a sequential basis. On a year-over-year basis, employment expenses were up $1.8 million or 13%. On both the sequential and year-over-year basis, the increase was primarily driven by the impact of higher variable incentive compensation from significantly higher sales. Sales of all products were up 41% from the prior quarter and mutual funds were up 14%, contributing to this increase in employment expenses during the quarter.

As a reminder, compensation expense related to retail sales are recorded at the time sales are made. It is important to note that sales this quarter were on higher fee equity products, which as you would expect, have a higher payout rate.

We also evaluate employment expenses as a percentage of net revenues, as shown in the box at the lower portion on slide 12. This metric demonstrates the variable nature of compensation, which will generally track with profit and sales from quarter to quarter.

Employment expenses as a percentage of revenue, as adjusted, was 58.2% for the third quarter, compared with 57.3% in the prior quarter, reflecting the higher sales-based compensation from higher sales in the quarter.

Importantly, on a year-to-date basis, this metric decreased 780 basis points to 59.3%, further reflecting the scalability of our business. This metric also benefited from the fact that our employee count is virtually flat from the prior year.

On to slide 13, other operating expenses. We have continued to actively manage other operating expenses even as we have grown topline sales. Other operating expenses include sales-related activities such as travel, promotional meetings, marketing, and printing.

For the third quarter, other operating expenses were at $6.7 million, a decrease of $0.7 million, up 9% from $7.4 million in the prior quarter. For ease of comparison between the quarters, we spike out the non-cash stock-based compensation that we adjust for in the performance measure in our non-GAAP results. Excluding stock-based compensation in the second quarter, other operating expenses declined $0.3 million or 4%.

The ratio of other operating expenses as a percentage of revenue, as adjusted, decreased from the prior quarter and from the prior-year period, an important metric that demonstrates our ability to leverage our fixed cost structure.

Other operating expenses were 24.6% of revenue, as adjusted, in the third quarter, an improvement of 150 basis points from 26.1% in the second quarter, excluding stock-based compensation. On a year-over-year basis, the ratio of other operating expenses to revenue has decreased by 650 basis points.

Finally, I want to discuss our balance sheet and the capital management initiatives that we recently announced. Working capital at September 30, 2010 increased 28% from December 31, 2009 and 10% from the prior quarter. While cash is also up, as you know, we generally build cash throughout the year prior to the payment of incentive compensation in the first quarter. Thus, we believe working capital is a better measure of our financial position, as it includes the incentive compensation accrual.

The improvement of working capital reflects the improved operating results and cash generation of the business. An important contributor to the growth of our cash position is the benefit from our favorable tax attributes. The benefit of those tax assets is reflected in the Company's year-to-date effective tax rate of 0.8%. As a reminder, our deferred tax assets are fully allowed on our balance sheet under US GAAP.

In terms of capital management, as we previously mentioned, we had an important change in our capital structure profile in August with the conversion of the portion of Harris Bankcorp's 8% convertible preferred shares. As a result of the conversion, Harris' overall investment in Virtus remains unchanged at approximately 22% on a fully diluted basis. However, the composition of their holdings changed, so they now hold $35.9 million in preferred equity, compared with $46.8 million at the end of the second quarter. Harris now holds 378,446 shares of our common stock.

As a result of the conversion, going forward, we have reduced dividend payments on the preferred shares by approximately $800,000 per year. Also, after the quarter ended, we announced that our board of directors had approved a repurchase of up to 350,000 shares of common stock. There are a few items in particular to note with the repurchase program.

First, the repurchase program required a consent of Harris Bankcorp as the Series B Convertible Preferred holder . Secondly, it is subject to covenant limitations within our credit facility. Under the terms of the credit facility, there is a quarterly restriction on certain capital payments of up to 75% of the prior quarter's free cash flow.

The types of payments that are restricted include the preferred dividend payments, as well as any common share buyback activity that we may undertake in a quarter. As George indicated earlier, we will not provide specifics on what actions we will take relative to the program or when we will take them. However, we will provide details on repurchase activity in connection with our quarterly SEC filings as required under US GAAP.

The Board and the management team are focused on continuing to enhance shareholder value, and we feel that conversion and repurchase program are two important steps toward that goal.

We are now ready to respond to your questions. I am 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.

Amy, can you please open it up?

Certainly. We will now begin the question-and-answer session. (Operator Instructions).

Our first question is from Mr. Justin Evans with Sonoma Capital. Please go ahead.

Looks like a great quarter. Two quick questions for you. First, it looks like your stock is still very much undervalued by most industry metrics. It's great to see the first buyback announced. Do you intend to repurchase shares at these levels or do you think the buyback -- do you think that the buyback is only a tool in case of a significant drop in the stock price?

Well, I think in terms of the recent announcement was that the Board had approved a program to be put in place at this point, and I think we were probably trading at 30, 35 or 36 at that time, so obviously, that is an indication that we think a couple of things that a stock repurchase at this point is a good opportunity and use of shareholder capital.

Obviously, we have consider the value of the stock at the time that the decision was made, and as we alluded to both, I think my comments as well as probably Mike's, we also acknowledged as part of that program that we are in an industry that uses equity and that equity plans, you create some dilution, and that we believe it's a good thing for shareholders to make sure that there are structures in place to help offset that. So with all those factors, and again, obviously, we are believers in the stock, that this is an appropriate time and step to do the repurchase. Does that answer?

Yes, thank you. And the second question is there has been a bunch of speculation about what BMO will do when their standstill agreement expires next year. Do you plan to stay in front of that event by retaining an adviser for strategic alternatives? As large shareholders, we'd like to see a robust and complete process in the event of a buyout proposal.

Right now, I mean, just in our focus in -- as I specifically stated in my comments, we have a strategic plan in place to grow the Company, and I think we have done a very respectable job over the last six quarters. So that is where we will focus, and we believe that the best opportunity of creating shareholder value is to continue to do what we have been doing, and now that we have some of the foundational steps behind us and some of the distractions behind us, we have an opportunity to really focus more, hence, my comment about the strategic plan that is in front of us and where the Board and management will focus for the next three to five years.

Obviously, we are very aware of the BMO transaction. As you recall, I was the one who was involved in that transaction, so there is nothing related to that that we are not aware of, and obviously, we have to be prepared for anything that happens. But as a recently spun company, with the types of results that we are generating, I don't really think that there are many external constituencies that sort of think there is any other probability other than for us to keep doing what we are doing in generating double-digit organic growth and having tripled the stock price in about a year and a half.

So we will absolutely be prepared for anything that a public company should be prepared for, but our focus is on continuing to do what we have been doing, which is creating shareholder value.

Perfect. Thanks, guys. Great quarter.

Thank you.

Austin Hopper, AWH Capital.

Good morning, guys. Austin Hopper, AWH capital. No worries. Thanks for taking the questions and great quarter, and also truly a great job since the spin.

You mentioned that the success you've had with the Emerging Markets Opportunities Fund, and by my math, I think it's up -- the AUM about $400 million in the last four months or so. I just was curious to get some color in that, in terms of it being an example of the way you are able to grow a particular fund, how you have been able to do that. Is it sort of concentration with a particular wire house and customer or something or just kind of how that has worked?

Sure. That is a good question. And it points to one of the things that we always refer to, is that we have a broad set of products that can be attractive in different environments, both equity-type products and fixed income-type products. And we have been in an industry that has really seen significant interest, primarily in fixed income funds, and because we've had a very strong performing fund, we've had flows in that category.

We've sort of been slightly unusual in that we have also had some flows in equity products, primarily the original AlphaSector strategy that we introduced, which has a conservative bent to it in that it can go on to cash.

To your specific question of how to think about the opportunity and what happened with emerging markets was our Emerging Markets Fund which is managed by Vontobel, who manages the majority -- in fact, all right now of our international assets, was a very high-performing fund, has a little bit of a quality orientation, and based upon the successful execution of their investment oversight, it's having incredibly strong numbers. And as we always monitor all of our different funds, we are continuously looking at our funds, what's performing well, and sort of comparing that to what is in demand in the market.

So as Mike stated in his comments, it was really a combination of having a high-performing product in the category and then understanding that the interest in our distribution channels was strong and doing a very effective job, at least in our view, of doing the appropriate marketing and distribution efforts and making the appropriate adjustments to have our wholesalers focus on that product that we were able to do what you have already sort of noticed, which is that the fund has increased substantially over the last three, and I would even say four months.

So I think that is an example of sort of what we've tried to do on a day-to-day basis, is really monitor the market for opportunities for our strong product and then focus our distribution efforts on that. And our view is in our stable of products, there are always interesting opportunities, and we believe we actually have a lot of other funds that we hope in the right markets will also be attractive. Did that answer your --

Great. Yes, very much so. Final question. It relates to BMO. Can you just remind me what share price does the remaining convert automatically get converted and how does that work?

When you say remaining convert, remember, the call that -- are you referring to the call that we already did?

No, no, I am sorry. What is the remaining, the remaining holdings, the convert that they still hold? Isn't there some sort of provision that it automatically converts at some share price?

There are some provisions that refer to that, the additional things could happen at 175%, all of the [2610] but I don't know if I would interpret that as a specific mandatory convert. So there is a provision at 175%, which I believe would be about $45.68 approximately, but there are other provisions related to that.

Great. Again, thanks for taking my questions and super job.

Great. Thank you very much, Austin.

(Operator Instructions). Brian Gonick, Senvest.

Hi, good morning.

Hi, Brian.

Can you quantify for us the impact of the Phoenix deal and the $1.2 billion of assets coming in Q1 from a fee perspective and an expense perspective?

Sure. And that's a helpful question because if you think about what we've discussed, there's really two metrics. Well, there are actually probably three. The trust is $1.6 billion, and we have always been the fund administrator for the whole complex, and our sub -- our affiliated managers have been the managers of about $300 million. And after the transaction, we will now be the adviser for the whole, all of the funds that come with the trust, which we said will add $1.2 billion. And more importantly, we will -- our affiliates will manage subject to shareholder approval about $500 million.

So thinking about the economics, obviously, our primary driver of economics are those assets which we actually manage directly through affiliates, hence the $500 million number, I believe, being an important number.

Obviously, being the primary adviser of the whole $1.2 billion has value in it of itself, but the difference between those two numbers is effectively there is an amount of fixed income assets that will continue to be subadvised by Goodwin, which is part of Phoenix and is obviously also the manager of our Multi-Sector Short Term Bond Fund, and there's actually a piece of international equities that will be subadvised by an external subadviser.

So I focus on the $500 million, and the fact that our affiliates will manage that as being something as you think through modeling.

The other thing I've tried to point out, the VIT business is not the same as the fund business, and so the nature of it is, we are really providing somebody with a vehicle to make available in their annuity, which is not the same as selling your own fund and having upfront sales costs. So the concepts that we would start talking about when and if we are successful in starting to sell the variable insurance trust is rev share. So it will be less about upfront sales costs, which are obviously a big driver on funds. It will be more about what is the industry average revenue share that is in place when you make your assets available to insurance company, so probably to repeat again.

So we will not be "necessarily" wholesaling our products within insurance companies. So we will make our wholesalers as available, and they can add value. The primary thing is for us to get placement in an insurance company, they put it in their product, and then their wholesalers will effectively sell it. So for us, it is really just having a market-based rev share.

And this being to your next question is how does that sort of compare to mutual funds? If you think about it, if I did nothing but VIT and I didn't have to do the same level of wholesaling, and that would mean I probably wouldn't have the same level of fixed costs or variable costs. So you might think that all things being equal that the rev share types of costs on a VIT would be sort of higher than what you see on the fund side because you do not necessarily have to have the same infrastructure. Does that help?

Yes, a little bit. So just so I understand, is the $500 million of -- is that incremental AUM in addition to the $300 million you are already subadvising?

Yes, it is. So the $300 million is in certain existing strategies. The $500 million subject to shareholder approval will be additional, so for a total of $800 million.

And so if I wanted to translate this and understand it in terms of revenue dollars, on the $500 million, what kind of fees would you make? And then on the $700 million, I guess, of stuff we are not advising, what kind of fees would you make?

Well, again, I would focus on the $500 million obviously moreso than the latter. So the $500 million and in terms of what types of assets they are is probably more equity than fixed. The management fee rates for those products are not necessarily different so much than mutual funds, so you wouldn't be wrong if you were thinking the 55 to 65 basis point-type of range. That is the gross fee.

Then what you have to sort of think about then is, okay, well, how much is revenue share for something like that? And again, as I have indicated before, it is not the same type of revenue share that you have on the fund business. It would be significantly higher. But you should also assume we would probably want to do things that have an incremental margin that is above the target margin that we would want, so that might help you back into sort of what would be an acceptable level of incremental profitability for us to help drive our margin up.

Got it. Okay. There were a number of fee increases recently on a couple of funds, and I am wondering if those -- the impact of those fee increases what was felt in this third quarter or if it they will be felt going forward in Q4. And I guess tied into that, there were some expense caps. I'm wondering if you might be able to quantify the impact of those in the quarter and if those are -- if you've gone through those thresholds now so that you're not going to have to be reimbursing on expenses?

Right, and when you talk about the fee changes, the fee changes that were made -- and actually, we disclosed in the second quarter that there were some fee changes to some of the ancillary services we provide to the funds, and there's two sides to the equation.

The first is what is the fee rate, and our goal is to have a market fee rate for the types of services we provide to our fund company compared to others. But at the same time, we have to balance that with the expense ratios of the funds and making sure that fund shareholders are not harmed, so hence comes in the concept of expense caps.

So there were some changes in fees, and at the same time, we put in certain expense caps. The full effect of that was not in place in the second quarter, I think, as we specifically disclosed. So in the third quarter, both structures are up in place, that being the new market rate fees that are in place for certain services, as well as the caps that are in place to get to this -- the latter part of the question is where are we with the expense caps?

Expense caps are really driven by the adviser agreeing to maintain expenses at a medium level of expense ratios and what will drive it are assets and costs. So in rising markets and as you're increasing assets, that is a good thing if you think about expense caps. And as we have always done, we continue to work not only on the Company's expense structure but also on the funds expense structure. So all things being equal as markets go up and if you can continue to raise assets, the hope would be that the expense caps will become less necessary in the future, but there is just a lot of factors that come into those calculations, in terms of, at any point in time, what they are.

Mike did allude to the fact that they had increased. We don't give specifics on exactly what the number is, but in the third quarter, they did increase, but again, you should think about that as really part of the fact that the fees have also changed. Net/net it was still an accretive or positive thing, but both of those things did have a full quarter in the third quarter.

Okay. So the important thing is that net/net, the fee increase relative to the expense reimbursement was a gain. And as we enter fourth quarter, given the change in AUM due to appreciation, are we now in a position where we are not going to be writing checks for expense reimbursement?

Well, I am not going to give any specific guidance on any element, but again, as assets go up and if the expenses of the funds don't go up or preferably go down, that will create opportunities. But expense caps are sort of -- follow the industry because you really, as a smaller fund complex we have to put in expense caps for either new funds or make sure that our funds are competitive at an expense ratio, so they are not something that's necessarily always set in stone. But again, all things being equal, being positive net flows and markets being up, will have a positive rather than a negative impact on (multiple speakers)-- .

Okay, okay. On the institutional business, you mentioned that the fees are basically coming in on a quarterly basis and so that as you end the quarter with a higher amount of AUMs institutionally, that the fees will be higher. Can you quantify then what the revenue impact might be in Q4, all things being equal, based on the asset level that we started with at the beginning of the quarter?

Well, again, for separately managed accounts, which is on the retail side, for the managed accounts that we either do directly to high net worth clients or through wrap programs, those do get locked in at the end of a quarter. So at any point, at any quarter, the revenue you are seeing is based upon the asset value at the beginning of the quarter plus whatever little activity had happened during the quarter to true things up. Mike, do you want to give any --?

Yes, I mean, we have not really framed the impact of that on a quarterly basis, but as we are looking here today, we could probably forecast that it would add approximately $200,000 to $300,000 on the topline.

And again, that's on the topline.

Got it. And are there any incremental expenses associated with that?

The expenses again are -- we'd like to have a variable cost structure, so generally, when you see topline growth in revenue, incrementally, it should only be the variable cost of compensation because again, our compensation plans are very, very variable. So when revenue goes up, it will go up, and if revenue went down, it goes down.

Okay. Given the fact that you have been solidly profitable now for a few quarters and particularly in this quarter, and this is a run rate business, and based on all the AUM we know is coming in, what is the chance that we might see at least some change in the valuation allowance on the tax assets?

Good question. Yes, as you correctly state, our tax assets are fully allowed for, and the concept under GAAP there is unless you can demonstrate that you can absolutely utilize certain tax attributes, you generally do the appropriate thing, you are conservative and you fully allow for them. So as things get better, you have to reevaluate that. Mike, do you want to give any --?

Yes, it's a good question. When you look at our GAAP earnings, recognize that about $1.5 million of those earnings were based on the mark-to-market, and you really have to evaluate taxable income when you are assessing the adequacy for that allowance. But clearly, we are on the right track, and it is something we look at.

I probably think there would be a longer history of earnings before you'd see that, any impact on the balance sheet. What you see now is you see an effective tax rate that's in the low-single digits, which is really contributing to our ability to generate cash internally and drive our working capital balances, which are increasing, and really improve our financial position. So you clearly do see the benefit of those attributes in our results that we are reporting.

Right. My last question is, you indicated that you were going to talk a little bit more about some of the longer term or medium-term strategic goals at the end of the year or at the beginning of next year, based on the full-year's numbers. Do you expect at that point in time you will be in a position to provide guidance?

We will evaluate -- I mean, that will allow us one more set of data points in terms of making a decision, in terms of giving guidance, so we always consider the concept of when it is appropriate to give guidance and a couple of things. I think we have now demonstrated after a series of quarters that our results and earnings are generally pretty predictable. I think it's a compliment probably to some of you on the phone that you really have been able to now -- to sort of model our earnings out pretty well, and I think we have demonstrated stability in expenses and predictability of how much you capture from revenue.

So it is something we will consider. Guidance is a lot of factors that you consider when you make the decision to give guidance, including what is going on in the markets and what you expect going forward. But at the time we make any decision to do that, obviously, we would announce that. But a lot of things have occurred that would be considered as we made that decision.

Very well. I think it's been a good quarter, and you are on a very good track here, and I would suggest that based on the run rate you are at today and the things you are doing to grow the AUM, you would be better served to buyback stock as soon as possible while it's at this level versus where the stock might be in the future based on the progress you are making.

Sure.

Good to know, and I appreciate that point.

Thank you.

Thank you.

Steve White, RMB Capital Management.

Hey, guys. How are you doing?

Steve, how are you?

Good, thanks. I would just like to echo Brian's last comment there on the buyback. But I had two questions, and they were related to the management fee.

The first was about the institutional that has a little bit lower margin. Mike, you talked a little bit about it. And I was just wondering if you could talk a little bit more about the nature of those assets and the nature of that relationship. And also, let's see. In the long-term mutual fund, I see that the fee has gone down the last couple of quarters, and I am a little surprised by that, given the shift towards equity products. And I was just wondering is there something that I am not thinking about correctly there?

Well, let me -- I will give you a quick high-level answer, then Mike will go into it. For institutional, I just want to be clear. It's lower fees, not necessarily lower margin. The lower fee -- and generally for larger blocks of institutional assets, they generally will go for a lower fee because if someone is going to give you hundreds of millions of dollars or $50 million or $80 million, your cost structure is a little different. So it is lower fee, not necessarily lower margin.

And on the fund side, remember the lag that you see in terms of sales and when it shows up in our results. So when you see the basis points going down, the average fee rate and mutual funds, you should think about the fact that in the past four quarters, we have been selling a lot of Multi-Sector Short Term Bond, which is a lower fee. Now you are seeing that we are selling an Emerging Markets Fund, which has a higher fee. But you are not going to see that for a bit. But, Mike, do you want to --?

Yes, there are a couple other points on the long-term mutual fund fee change, and one we alluded to on the call is the average equity market change was actually down Q2 to Q3, which impacts our fee rates. And the other is we talked a bit about the increase in funds under reimbursement, which does offset the investment management fees, and you would see that on that line item, as well. But when you look at where ending AUM landed at the end of the quarter as well as the mix shift of sales being driven primarily by equity product in the quarter, we are pretty optimistic about the fact that we increase the sales by approximately [8 bits] this quarter on our new sales, and what impact that will have on the blended [bit] on that line item going forward.

Okay. Sounds good. Now that does it for me. Thanks a lot. And good quarter.

Okay. Thanks, Steve.

Thanks, Steve.

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

Great, thank you very much. And I just want to thank everyone for participating this morning. I hope this update gave you a better understanding of the Company and our results. And obviously, if anyone has any questions please give us a call at any time. Thank you.

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