Virtus Investment Partners Inc (VRTS) 2011 Q1 法說會逐字稿

Good morning. My name is Towanda, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners Quarterly Conference Call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com. This call is also being recorded and will be available for replay on the Virtus website.

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

I will now turn the conference to your host, Joe Fazzino. Please proceed, sir.

Thank you, Towanda. On behalf of Virtus Investment Partners, I would like to welcome you this morning to the discussion of our operating results for the first quarter of 2011.

Before we begin, I direct your attention to the important disclosures on page two of the slide presentation that accompanies this webcast. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements. These statements may be identified by such words as expect, anticipate, believe, may and similar terms.

For a discussion of these risk and uncertainties, please see the risk factors and management discussion and analysis sections of our period reports that are filed with the SEC as well as our other recent filings, which are available in the Investor Relations section of our website, www.virtus.com.

In addition to results presented on a GAAP basis, Virtus uses certain non-GAAP 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. For this call we have a presentation, including an appendix that is accessible with the webcast through the Investor Relations section of virtus.com.

This morning's call will begin with remarks from President and Chief Executive Officer, George Aylward, who will review some of our accomplishments during the quarter; Mike Angerthal, Executive Vice President and Chief Financial Officer, will then discuss our financial results before we open the call to questions.

Now, I would like to turn the call over the George Aylward. George?

Thank you, Joe. Good morning, everyone. We appreciate all of you joining us today, and Mike and I look forward to reviewing our results and taking your questions.

I will start this morning by putting the quarter into perspective and giving you highlights of the financial results. Mike will provide a more detailed review of the results before we open up the call to questions.

Let me begin by reviewing some of the accomplishments in the first quarter. As was clear in our news release, the first quarter of 2011 was a very strong quarter, driven by our ability to continue the sales and net flow momentum that we had throughout 2010.

If you look at our results over the past eight quarters, there are three key factors that have driven our improved profitability. First, we have grown sales significantly during this period. Second, more important than growing sales has been our ability to remain consistently in positive net flows, which is not true of all asset managers. And third, we have maintained a stable level of fixed expenses.

If you look back at our short history as an independent public company, you see that the foundational actions and growth initiatives that we've executed have put us in a position to build on the momentum we have generated in the business and deliver on our goal of growing value for shareholders.

So, let me highlight some of the key results of the fourth quarter starting with sales. I think you will agree that we generated great sales results this quarter. We are extremely pleased with the total and mutual fund sales for the quarter.

It was our third consecutive quarter with double-digit increases in total sales, mutual fund sales and positive net flows. This is also the third consecutive call that we can say that we had a quarter with record sales and net flows for the Company, and that's a statement I don't mind repeating.

Total sales were $2.6 billion in the first quarter, an increase of 86% from the first quarter of 2010 and a sequential increase of 52%. The sequential increase for mutual fund sales was even more impressive. In the first quarter, we had mutual fund sales of $2.3 billion, an increase of 61% from the prior quarter and more than double the sales of the first quarter of last year.

The reason for our strong sales this quarter are pretty basic and encompass three factors, product, performance and distribution. Sales were driven by having products that are in demand, that are attractive in terms of investment performance and that we can distribute effectively.

As I mentioned in the past, with our multi-manager, multi-style model and our distribution breadth we don't have to rely on a single product or distribution partner for our flows. Rather, we continue to demonstrate a favorable balance in the kinds of products that we can sell to a broad set of financial intermediaries.

Additionally, I want to emphasize we have a very solid line-up of products with strong relative performance. Let me give you some additional thoughts about the balance of our sales and distribution.

First, we offer a wide variety of investment capabilities that can meet very different investor demands. Our sales this quarter continue to be balanced among domestic equity, international equity and taxable and fixed income strategies, which means we have funds for different cycles and investor preferences. Among our best-selling funds this quarter, no one fund generated more than 29% of total fund sales.

Second, our investment strategies are delivering solid and relative performance across a variety of products. We had 80% of our retail fund assets in the top half of their peer group for the three years as of March 31st with 62% of those assets in the top quartile.

The relative strength and consistency of our investment performance is a key driver of sales. Our ability to consistently deliver solid investment performance for clients makes it possible to generate sales from the financial intermediaries whom we sell through. Strong products sell, and we offer strong products throughout our line-up.

Finally, we have a comparable balance in our distribution relationships. As we have said previously, we have great access inside all of the wirehouses as well as a good presence with IRAs, planners and the regional broker-dealers. That allows us to generate sales from a variety of sources.

Over the past several quarters, our sales teams have done a tremendous job of deepening the relationships within the national wirehouses, even with no meaningful increase in staff.

Looking beyond this quarter, we continue to see opportunities to further penetrate the wirehouse channel and additional opportunities to broaden and deepen our relationships in the IRA, planner and regional broker-dealer channels.

Going forward, with strong performing funds, a balance in products and effective distribution, we have a solid foundation to help us sustain the level of sales, although it will be difficult to sustain the dramatic rate of sequential increases. I would also note that we are pleased to see that the strong mutual fund sales have continued into April.

The organic growth rate for our open-end fund sales was 45% for the quarter compared with 22% in the fourth quarter. This is a very strong result and one that is significantly higher than the average organic growth rate of other fund companies that, like us, sell through financial intermediaries.

To put our sales growth rate into context, we compare it to the mutual fund organic growth -- our mutual fund organic growth rate of 45%. We compare that with some of the larger mutual fund companies, and ours was amongst the highest in that group. The average in that group was approximately 8%.

In addition to having very strong sales, I've even more pleased with the net flows generated this quarter because it is the net flows that drive higher asset levels and growth in investment management fees.

We had total positive net flows of $1.4 billion, primarily from mutual fund sales, and our assets under management grew by 25% from the first quarter of last year. In fact, our fund net flows of $1.4 billion in the first quarter of this year were nearly equal to the gross fund sales in the fourth quarter of last year.

In addition to leveraging the success we have had in distribution and investment performance in the current sales, we are continually looking for ways to sustain our growth in the future. One way we do this is with our active product management, which includes expanding our product line, particularly with new funds.

This quarter we launched three new mutual funds. Two of the funds were extensions of our AlphaSector offerings. The first new product is the Global Premium AlphaSector Fund, which leverages the domestic equity strategy utilized in our other AlphaSector products and adds a similar international component.

The other fund is the Allocator Premium AlphaSector Fund, which employs the domestic and international equity strategies of the first fund but also adds in items such as fixed income and alternatives.

The AlphaSector strategy has been well received in the marketplace, and since financial advisors already understand the story we think that there is potential for these two new funds. It certainly helps that the Premium AlphaSector Fund, which was launched less than a year ago, continues to be one of the best-selling funds in its category.

The other new fund we launched this quarter is the Global Commodities Stock Fund, which is another product that can offer investors a different investment opportunity. We can give investors exposure to commodities through the listed securities of commodity and commodity-related companies rather than direct exposure to commodities.

This approach benefits investors by giving them additional transparency, liquidity and simplicity. We're using Coxe Advisors, which specializes in commodity equities as a sub-advisor for these products.

As I said at the start, the main story of this quarter is the significant growth in sales, and the impact of our sales growth was reflected in operating income. Operating income as adjusted was $7 million for the first quarter compared with $3.6 million in the first quarter of 2010 and $7.1 million in the fourth quarter of 2010.

Operating margin as adjusted was 21% for the first quarter compared with 14% in the first quarter of 2010 and 23% in the fourth quarter of 2010. As you would expect, the significantly higher sales resulted in a corresponding increase of sales-related expenses. In our business, there is an upfront cost to growth and that affected our earnings in the quarter.

Specifically, the $800 million increase in retail sales from the already strong levels of the fourth quarter resulted in a quarterly increase of $1.2 million in variable sales costs, primarily sales comps.

With our upfront incentive compensation expenses, the significant growth in the sales had a negative impact on the current quarter but clearly is positive to the future profitability of the Company. Another factor in the quarter was just the timing of annual incentive compensation, which, as expected, resulted in a $1.2 million sequential increase in payroll taxes related to those payments.

As we have demonstrated in the past, we will remain focused on driving top line growth, continuing to manage our overall cost structure and further expanding our profitability as we move closer to industry average margins. In terms of margins, I would point out that the items that I mentioned such as sales strain and the timing of the payroll taxes do have an impact.

Before I turn the call over to Mike, I want to provide some additional perspective on capital management, specifically our level of working capital, actions we took in the past quarter and what we would focus on going forward.

Concerning our working capital position, at March 31st we had $46 million in working capital, which has grown from the $33 million we had at the time we went public. As I've said before, the $33 million at the time of the spin-off was the minimum level of working capital and represented about 30% of our annual expenditures, and that that was the figure that would reasonably allow us to navigate the difficult environment of early 2009.

Things have changed since the time of the spin-off. The economic environment is better. We've grown the business significantly. We have started to return capital in the form of share repurchases, and we now have an increased number of organic opportunities to further grow the business.

While we are not in a capital-intensive industry, we still need an appropriate level of working capital to grow the business in areas such as incubating new investment strategies, funding the cost of growing sales and making investments in organic and other growth opportunities.

To put our working capital into context relative to other public asset managers, our working capital as a percentage of annual expenditures has actually remained at about 30%, which is actually at the very low end of the industry range.

As I mentioned earlier, we completed several activities during the quarter that required capital usage. We launched three new mutual funds, which required seed capital of $3 million. The availability of capital is an important consideration for us in determining the level of new fund development we undertake.

In addition, we returned $3.5 million, or just over half the quarter's cash earnings, to shareholders in the form of stock repurchases and dividends on the preferred shares.

While we continue to improve our capital position as we generate cash earnings, the demands on our capital will increase as we consider opportunities for growth, so we consider all of the factors as we look at the adequacy of capital. We will measure our working capital not only on absolute terms but on a relative basis that evaluates operating spend, requirements of the business, growth initiatives and an appropriate return of capital to shareholders.

Now, let me ask Mike to review our results in more detail and provide additional insights into these results and our other achievements in the first quarter. Mike?

Thank you, George, and good morning. Today, I will review the slides that outline the first quarter results, starting with some additional detail about our sales, flows and assets. After that, I'll give additional perspective on our expenses, particularly the impact of the increasing sales levels. Then, I will review our GAAP and non-GAAP performance metrics. And finally, I'll provide additional thoughts on our capital position.

Let's begin with slide seven, Asset Flows. This slide provides detail on our asset flows, and I'll start by emphasizing the sales growth in the first quarter. The team at Virtus is energized by the level of gross sales and net flows and the growth we have experienced over the past several quarters and since we became a public company.

Gross sales, which are shown on the upper-left bar chart, were $2.6 billion for the quarter, the first time we reached the $2 billion mark since we became a public company. Looking at the box under the chart, you will note that we had a complex-wide annual sales rate of 35.3%, an increase of 10 percentage points from the prior quarter.

Total sales of $2.6 billion were driven by long-term, open-end mutual fund sales of $2.2 billion, an increase of 54% from the fourth quarter, reflecting an annualized sales rate of 76.1%, which improved from 54.3% in the prior quarter.

I do want to mention that the $2.3 billion of long-term mutual fund sales reported in the AUM tables in our press release includes $98 million in additional assets from the secondary rights offering completed this quarter for one of our closed-end funds. That item is excluded when we calculate our open-end fund sales rates and organic growth rates.

Our overall organic growth rate increased to 19.1% from 8.25 in the prior quarter. The organic growth rate for long-term, open-end mutual funds was 44.8% in the first quarter, again a significant sequential increase from the organic growth rate of 22.4% in the fourth quarter.

A particularly important trend to review is the sequential growth in positive net flows. Total net flows were $1.4 billion in the first quarter of 2011, an increase of 156% from the prior quarter and more than three times the first quarter of 2010 level.

This increase was primarily driven by the increased sales rate, but also by a decline in the redemption rate of 90 basis points. Our overall open-end mutual fund redemption rates improved by 70 basis points on a sequential-quarter basis.

We also continued to have a significant portion of our sales in equity funds in the quarter as they were at 62% of total mutual fund sales in the first quarter of 2011, consistent with the prior quarter at an increase from 40% in the first quarter of 2010. This had the effect of further increasing the average net fee rate on new assets by one basis point from the prior quarter from 41 to 42 bps. The average fee rate on new assets has increased by 11 bps since the first quarter of last year.

We are pleased with the balance in our sales mix, and during the quarter our strongest funds included fixed income, domestic equity and international equity strategies.

During the quarter, we had $0.6 billion in sales from the multi-sector, short-term bond fund, $0.6 billion in sales from the Premium AlphaSector Fund and $0.5 billion from the Emerging Market Funds. Total sales of all other long-term, open-end funds were $0.5 billion, which represented an increase of 29% from the prior quarter.

We continue to be well diversified in the sources of our mutual fund sales. With the balance of our distribution, we're not reliant on any one firm for a majority of our retail sales. In fact, for the first quarter no firm accounted for more than 16% of sales.

Growth in sales clearly has been a result of strong investment performance. At March 31st, 2011, 20 of our long-term, open-end funds were rated four of five stars on a load-waved basis, which is an increase from prior quarters.

Our top-rated funds included a variety of investment strategies, such as small cap domestic equity, global investor, REITs, in addition to the top-selling funds that I just mentioned.

Although current demand in the market is still weighted towards fixed income and a limited number of equity strategies, we believe that with our strong product performance across many strategies we have attractive products to offer as there are changes in market cycles and investor preferences.

Turning to slide nine, AUM, assets ended the quarter at $31.9 billion, an increase of $2.4 billion or 8% from December 31st. Long-term assets, which exclude cash management strategies and money market funds, ended the period at $28.5 billion, up $2.3 billion or 9% on a sequential basis from $26.2 billion at the end of 2010.

There were two primary drivers of the sequential change in assets under management, positive net flows of $1.4 billion, which, as I mentioned earlier, increased by 156% from the fourth quarter of 2010, and market appreciation was $0.9 billion, in line with the fourth-quarter level.

And I'd also like to point out that we enhanced the asset disclosure in our press release tables to provide more insight into our long-term assets. A footnote has been added to reflect the cash management component within all the product categories. Reviewing and analyzing these categories, excluding cash manage, should be useful as the cash products can be volatile in terms of inflows and outflows and are generally our lowest fee products.

As a result of the market appreciation and strong sales in equity mutual funds, the mix in our assets has continued to shift. The percentage of equity assets increased by 250 basis points to 51.4% of assets at March 31st from 48.9% at December 31st.

Moving on to investment management fees on slide 10, investment management fees of $28.8 million in the first quarter improved by $2.1 million, or 8%, from the prior quarter. This sequential improvement was primarily driven by two factors. Average assets are up 7% from the prior quarter, and long-term average assets increased 9% sequentially.

As a reminder, long-term AUM excludes the money market and cash management products that I just discussed and the increase of one basis point in the net fee rate earned on the assets, and that's the result of the higher percentage of equity assets. Partially offsetting these increases was the fact that there were two fewer days in the quarter compared to the prior quarter, impacting fees by $0.5 million.

The largest driver in the change of average assets that increased investment management fees from the prior quarter was, as expected, the increase in our average mutual fund assets. The represented nearly 60% of the change from the prior quarter.

The blended fee rate increased by one basis point 38.1 bps in the first quarter, primarily due to the 250 basis-point increase in the percentage of higher-fee equity assets, as we discussed earlier. This is partially offset by the decline in the variable insurance funds' blended fee rate, which declined 5.4 basis points to 39.8 basis points from 45.2 basis points in the prior quarter.

As I discussed on the last call, the blended fee rate is net of fund reimbursements, which can fluctuate from period to period. We expect the net fee rate for variable funds in the first quarter will be a better indicator of a run-rate level for management fees going forward.

As you see in the table on the lower-right, the net fee rate dropped by 0.8 basis points year-over-year because the first quarter of 2010 benefited from the recovery of subordinated fees from a structured finance product. Excluding the fee recovery, the net fee rate in the first quarter would have increased by 1.2 basis points on a year-over-year comparison. The trend of increasing net management fees earned is another indicator of the solid outlook for the business.

Moving over to the expense side and to page 11, Employment Expenses. Here, is where you will see the impact from the significant increase in sales from the prior quarter, as well as the impact of payroll taxes on our annual incentive payments.

Employment expenses of $19.6 million for the quarter were up $2.1 million, or 12%, on a sequential basis. The main driver of the sequential increase in expenses is the higher sales strain during the quarter. This is a concept that we first discussed last quarter, which reflects the upfront nature of sales-related compensation associated with this quarter's incremental sales over the prior quarter.

The $791 million in higher first-quarter, long-term, open-end mutual fund sales resulted in approximately $1.2 million of additional incentive compensation, or approximately a 15 basis-point cost on the incremental new sales.

You may recall last quarter when we first highlighted the sales strain concept the cost was closer to 20 basis points on new sales. It's worth noting that the expense is variable in nature and will fluctuate based on several factors, including products sold, distribution channel and level of sales.

It's also important to highlight the additional mutual fund sales generated in the first quarter compared to the prior quarter would be expected to deliver incremental investment management fees of $3.4 million per year.

Also, as expected, the first quarter had $1.2 million of higher payroll taxes as a result of the timing of annual incentive payments. Our non-sales incentive compensation is generally earned and accrued throughout the year and then paid in the first quarter, at which time we have a significant increase in payroll tax expense.

The impact of these higher costs are shown in the metric, employment expenses calculated as a percentage of revenues as adjust, which is shown in the box below the chart. On a sequential-quarter basis, this metric increased by 250 basis points to 59.2% from 56.7%.

However, excluding the impact of the payroll taxes, the first-quarter employment expenses as a percentage of net revenue would have declined 120 basis points to 55.5% on a sequential basis.

Onto slide 12, Other Operating Expenses. Even as we have significantly grown top line sales our other operating expenses, which include certain sales-related costs, have remained within a relatively stable range as we continue to maintain an expense discipline. For the first quarter, other operating expenses of $7.4 million increased 3%, or $300,000, from the fourth quarter. The increase was driven primarily by higher professional fees related to tax advisory services.

An additional metric to measure our ability to leverage our fixed cost structure is other operating expenses as a percentage of revenues as adjusted, which is displayed in the box at the lower portion of the slide.

Even with our significant growth, we have been able to control other operating expenses as a percentage of net revenues and continue to drive that ratio lower. In the first quarter, other operating expenses represented 22.2% of net revenues, compared with 23.1% in the previous quarter and 26.8% in the prior-year quarter.

On slide 13, we see the impact of the trends I just discussed on operating income as adjusted. Operating income as adjusted, our primary non-GAAP metric, was $7 million, an increase of $3.4 million, or 93%, from $3.6 million in the first quarter of 2010 and down modestly from $7.1 million in the fourth quarter. The year-over-year increase was driven by the 21% increase in average assets, combined with expense discipline related to our fixed cost structure.

The modest sequential decrease in operating income as adjusted of 3% shows the impact of higher mutual fund revenue being offset by the $1.2 million of higher sales-based variable compensation, and the $1.2 million of increased payroll taxes from the annual incentive compensation.

The impact of the higher sales strain and payroll taxes related to the annual incentive compensation negatively impacted our operating margin as adjusted, which was 21.1% in the first quarter.

Excluding the impact of the incremental payroll taxes related to incentive compensation, which occurs each year in the first quarter, the adjusted operating margin would have been closer to 25% for the first quarter.

When we look at the quarter internally and adjust for timing, the increasing AUM levels driven by sales and market performance are providing a catalyst for continuing to expand our profitability and deliver increasing margins.

The momentum we have from our strong product performance, rising AUM levels and increasing percentage of total AUM in equity assets has us well positioned to continue to make progress on our goal of achieving industry average margin levels.

Some items to note on our GAAP financial results, net income attributable to common stockholders was $3 million, or $0.43 per common diluted share, in that first quarter compared with $0.1 million, or $0.02 per share, in the prior-year quarter and $3.1 million, or $0.45 per share, in the sequential quarter.

A couple of items to touch on the income statement. First, our realized and unrealized gains on trading securities reflect the mark-to-market of our variable securities portfolio. In the quarter, we had approximately $561,000 in unrealized gains, compared with approximately $300,000 in the prior quarter.

Second, we show a tax expense for the period of $287,000, which is down from $433,000 in the prior quarter, reflecting an effective tax rate of approximately 6%. As you may recall, the Company is subject primarily to just state tax payments in certain jurisdictions. And, as I mentioned on the last call, we would expect the effective tax rate to remain in the mid-single-digit range.

Finally, I want to spend a moment reviewing some highlights on our balance sheet, including our capital and liquidity position, working capital and an update on our tax situation.

The bars on the left-hand side of the chart highlight the progress on our working capital position. We ended Q1 with $46.1 million, an increase of 4% sequentially from the prior quarter. As we have discussed before, working capital is one of the key metrics that we analyze internally to assess that we have adequate capital available to meet the business' operating and growth needs.

Overall, our capital position is the strongest it has been since we became an independent public company, and we believe it is at an appropriate trajectory to provide the Company with the financial flexibility we need to support the future growth of the business.

This improved cash flow generation and improved working capital position has enabled us to invest into specific business activities. During the quarter, we deployed seed capital of approximately $3 million into new products.

Working capital is also a key factor in evaluating the position of the business to return capital to our shareholders. In the first quarter, there was an increase in the return of capital to shareholders resulting in a payout ratio of approximately 58%.

This payout level includes $0.7 million of preferred dividends on our convertible securities. The ratio of capital returned to common stockholders is approximately 47% and is comprised of two forms of stock repurchases completed during the quarter.

First, we repurchased 50,000 of common stock for $2.8 million under the multi-year share repurchase program we announced in Q4 of 2010. And we have now repurchased a total of 70,000 shares, or approximately 1%, of the outstanding diluted shares in the four months ended March 31, 2011.

Second, we withheld an additional 9,300 shares to satisfy employee tax obligations related to vesting stock units using an additional $0.5 million of capital. Taken together, we returned $3.3 million, or 47% of the quarterly results, to our common shareholders.

On to debt. Our outstanding debt balance remains at $15 million, and we have an additional capacity to borrow up to $30 million on the facility. We continually evaluate how we will utilize this facility. And, as of the first quarter, we have elected to keep the balance outstanding and maintain the facility, given it is our cheapest source of financing and the first quarter is our lowest point of cash for the year.

I actively and continually review this facility and all the elements of our capital structure, to ensure we have an appropriate operating flexibility in place to adequately manage the business.

Finally, as you may have read in our 10-K filing during the fourth quarter of 2010, we recorded a capital loss carry-forward of $93 million related to the dissolution of an inactive, wholly owned subsidiary. The capital loss deferred asset, as with all of the Company's deferred tax assets, has a full valuation allowance recorded against it.

On April 1, 2011, we filed a request for a private-letter ruling from the IRS to allow for ordinary loss for this item. The receipt of a favorable ruling would have the effect of recharacterizing the loss as an ordinary loss, and could result in the generation of an additional NOL carry-forward that could be used to offset taxable income rather than capital gains. Clearly, we will update you as appropriate on this matter.

With that, let me turn the call over to George.

Thanks, Mike. We're now ready to answer your question. I'm going to ask the operator to open up the lines. We do 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.

Towanda, can you open it up, please?

Thank you.

(Operator Instructions)

Your first question comes from the line of Larry Hedden with KBW. Please, proceed.

Good morning. Could you comment on the --

Good morning, Larry.

Could you comment on the trends that you saw in the retail channel during the quarter, sort of how that changed by month, and then comment a little bit more about what you're seeing so far in April?

And -- in general, or specific to us or both?

Both.

And, again, I think they trend very closely to each other. What we had seen and what the industry had seen in the fourth quarter was really the beginning of the movement out of some of the reliable, dependable fixed income strategies as people increased -- started to feel a little more comfortable taking some risk with equity strategies.

And we were fortunate in having the AlphaSector products, which are sort of defensive, equity-type strategies, as well as the Emerging Market Fund. So, we had seen that increase in the fourth quarter.

For us, the first quarter ended up being obviously the stronger quarter than the fourth, and I think that was sort of consistent with what we had seen in the industry-wide flows. And, for us, it was interesting in that the balance sort of remained in those three funds. And Mike gave you the specific sales numbers for each of those funds.

And I also thought it was interesting -- the consistency month to month to month. Because, generally, you do see just maybe a little bit of seasonality but it is usually the -- at the beginning of a year people -- I don't -- come back from the years and fell rejuvenated and you'll sort of see a change in your sales. But, that doesn't always lead to the rest of the quarter.

But, for us, it was generally consistent throughout the three months of the quarter. And the mix of sales was generally pretty consistent as well, though I will say closer to the end of the third quarter I think people were beginning to put a little more faith into the equity side. So, I would say probably a slight uptick in the equity strategies, particularly for us the AlphaSector strategy, during the end of the quarter, but really not incredibly significant.

What we hope to see going forward is that people look to take additional opportunities in the equity market. I think the whole retail market sort of missed on the whole run of small caps and mid-caps.

I think if you look statistically, one of the best runs in any market environment has been what has happened with small caps and mid-caps from the lows of March of 2009 until now, and I do think that that was an opportunity that some retail investors missed. We like to tell that story, and we do think there's opportunity there.

Okay. And then in terms of the expense caps -- and I'm sorry if you had mentioned this, but did you recover any of the expense caps during the quarter? And going forward, particularly in Q2, do you anticipate recovering any of those expense caps? Thank you.

I won't give specific details in -- on the expense caps but, as you're pointing out, a large number of our funds do have expense caps, which are really a cap on the total expense ratio of a fund. And obviously, we do that to be competitive and to have an expense ratio for our funds that's similar to the median.

You're -- you are correct in pointing out that to the extent that our funds reach a certain scale and exceed -- and go below those caps, we do have an ability to recover. Right now, that is not necessarily a significant -- the recoveries are not a significant part of our operating results. But, if we can continue to generate sales and increase the asset base over which the expenses are spread, that is an opportunity if we are successful to raise those assets.

Your next question comes from the line of Jeffrey Thorpe with Sonoma Capital. Please, proceed.

Good morning, George, and Mike. Congratulations, on another great quarter.

Thanks, hello.

Good morning, Jeff. Thank you, very much.

Just one question, do you foresee more opportunities for additional transactions, a la VIT or rights offerings, products like the AlphaSector or personnel like your excellent hire of Mark Flynn, which might be immediately accretive to your business?

I think we continue to see opportunity. Opportunities are coming from like two places. It's really sort of what's evolving in the markets. As we look back to '09 where everyone was in a protection mode there weren't a lot of opportunities, particularly in things like secondary offerings or new closed-end funds and, even in many ways, for new open-end funds.

So, as the environment has changed and improved, we've seen additional opportunities. You've seen that with the secondary offering on one of our closed-end funds. You see that as we've sort of been able to introduce a couple of new -- newer products that we think will have demand as we go forward.

And the opportunities for us have changed as well. As we have grown and been successful, particularly in sales, we are a more attractive business partner than maybe we were three or four years ago. And success does breed interest. So, I think we continue to see a better environment for growth opportunities in terms of products in channels, as well as personnel and other additive things to the business.

I mean, it -- for us to bring in attractive talent, whether it be sales talent or investment talent, is obviously a lot easier the more successful that the Company is. And, for us, the focus is on making sure that we take advantage of those opportunities as they occur.

And as it goes to the reference of the VIT deal, fundamentally we have a large number of organic growth opportunities and that has obviously been where we have spent the majority of our times and efforts.

And I do think while you have great organic opportunities you should take advantage of them. That's not to say that inorganic opportunities shouldn't be considered because this is a scale business, and sometimes those can be very powerful.

I think, as you've seen, though, we sort of try to take a conservative approach in that we do view the VIT transaction as a very capital-friendly type of transaction. And there are not a lot of those deals necessarily out there, but we do certainly make ourselves aware of any of those things that are out there could be of benefit.

For us, one of the things that's a good driver for us is driving the level of assets under management by the teams that we have in place. So, the organic growth is great, and inorganic is another way to look at that. But, as we've always said, organic is our first priority, and for inorganic we would be very selective and particular about any of those opportunities.

Thanks, so much.

Great. Thank you, Jeff.

Your next question comes from the line of Justin Evans with Sonoma Capital. Please, proceed.

Hey, guys. Good morning.

Good morning, Justin.

Hi, Justin.

Hey, who was that last guy on the call? No, just kidding. Congratulations. Your flow numbers were staggering, and April looks like it's a continuation of that trend.

Real quick question on margins. If I add back your one-time commission strength for the quarter and your seasonal payroll expenses, you come up with kind of $9.4 million of adjusted EBITDA for Q1, which is kind of a 28.5% margin. If I look to Q2, it's clear you're going to have a much higher revenue number, maybe as high as $38.8 million -- or $35.8 million or so, just based on my model here, based on certain assumptions.

I'm going to assume your incremental margins on new AUM are fairly high. Can you give us some color on what your adjusted EBITDA margins could range to going forward? And also, how should I model incremental margins for new revenues coming in?

Sure. And I won't give specifics on exactly what are EBITDA and EBITDA margin will be in the second quarter. But to go through what you're describing, by backing out the taxes and if our sales had not grown as much as they had grown, you add back the 2.4, you get to that number.

So if you look to the second quarter, obviously, you would not expect the annual payment of annual incentive to have a tax impact. So the question will be on the expectations of -- for what the sales will be, going forward, for the second quarter.

So the sales we had in the first quarter will add -- the $1.4 billion of net flows will add to our basis of assets. And then, it'll really be a question of what is the additional sales in the second quarter and what's the costs associated with that.

To sort of talk about the incremental margin on assets, generally once you've addressed the sales costs related to acquiring the assets, there's really very minimal costs associated with it, because our -- we have a fixed cost structure in terms of the infrastructure needed to manage money. And generally, the only costs associated with it would be the variable compensation expense.

Because I think, as you know, in our compensation plans, throughout the Company, including portfolio managers, there's a direct correlation to profitability. So as profitability goes up or down, so will compensation expense.

But obviously that would be a smaller element of costs on an ongoing basis than, say, for example, our sub-advised part of our business, where we effectively pay out 50% of the fee for an outside sub-advisor, so they can cover their fixed costs and their variable comp. As I've said, I think, on a couple of instances, obviously, the non-sub-advised is a much higher number.

So it would really have to be in terms of what your view of the variable costs related to compensation could be on ongoing assets, exclusive of sales. I mean, we've given a lot of clarity on the sales number, so hopefully that's helpful on your models.

Yes, I mean, I just think of the strain issue that keeps coming up as kind of a short-term phenomenon that'll ultimately go away. And I really want to focus on kind of the long-term earnings power of the business and the asset levels that you have now?

Yes, well, I mean, obviously agree with that. Again, the -- to have the types of sales growth rates that we have -- and again, you have to fund your current sales with your existing book of business. So when you have an organic -- when you have a new -- growth rate of the 45% level, there is that upfront impact on margin.

And if you get to -- so we're significantly above average in terms of our growth rate. So, that has a significantly above average negative impact on margin. And if we were only at an average organic growth rate, there would be a -- we would have a leveling off of sales, when you would have a much lower impact on the sales costs.

So I do think, looking at the sales strain that we're illustrating is really important for people to understand what is that short-term burst of costs related to significantly higher sales. come out with their own view of what a normalized growth rate for an average company should be.

And then obviously modeling out that kind of growth, it builds towards long-term profitability. And that should be -- that should influence their valuation. As their valuation should also be influenced by their view of how great the growth opportunity is, how diverse the opportunities are, someone's tax situation. All those things should be factored in as people sort of look at trying to apply a valuation.

Okay. Got you. And just real quick -- and my next question would be, do you think your stock's still undervalued?

Would you like my specific price for our stock?

Well, I'm just -- yes, go ahead. Go ahead.

Again, I think what we like people to think about as they look at stock and how to value us, is we acknowledge that people are going to look at our multiples and our business and look at our current operating margin. I think you're pointing out one of the important things that we like to communicate, it's that you can't look at a current period margin without having a fulsome understanding of what's driving it.

And your multiples should be impacted by your operating margin, but it should also be impacted by how good your growth rate. It should also be impacted by how much risk you're taking for your growth. And again, we think with a multi-manager, multi-style type of model, that from a probability or a risk-adjusted basis, we stand in good stead.

And I also think that if you have a different tax profile than a similar company that that should be taken in consideration in two ways. One, in terms of how you look at the multiple or just by simply calculating what you think the value of the tax attributes are in a per share type of a basis.

So again, we're -- we think we have a very good company here. We think our opportunities are strong. With eight quarters of data available, I think it speaks for itself in terms of the opportunities that we've demonstrated we've been able to take advantage of, and I think all of that should be factored in, as people try to value the Company.

(Operator Instructions)

Your next question comes from the line of Brian Gonick with Senvest. Please, proceed.

Hi, good morning. Great quarter, guys. Just a quick question. If the average price you paid, it looks like it was $56 a share, what was the range in price that you paid in buying back stock during the quarter?

Hey, Brian, it's Mike Angerthal. Yes, I think the average stock price of the Virtus stock from January through the end of the quarter ranged from the low 50s and, I think, touched 60 -- $60.99 even, for a stretch. So I think we probably [fall] obviously, within that range.

So you paid -- your, I mean, the average price you paid was $56 a share. So some stock, maybe you paid $58, $59 and some stock you paid, $53, $52. I mean, is that sort of the range, roughly?

Yes, clearly the program is put in place on a quarterly basis and it's executed by a broker dealer who goes to market and tries to affect the level. And that sounds like the -- a reasonable level of the range.

Yes, remember, the way the plan works is, it's under like a 10b type of a coverage, is that prior to initiating it for a quarter, we need to make a determination of the level and then it's executed by the third-party and they execute within those parameters.

So it is not that we make a decision on a daily basis. We sort of have to make the decision in advance, thinking of two things. What is the expectation of the stock price over the quarter? And then also, remembering our limitation, that under our credit facility, that we can't exceed more than 75% of cash flow generated for a quarter.

So, we're sort of doing it in advance, without having all of the variabilities. But I think as Mike said, the third-party who executes the program will execute it at their discretion, as trader.

Mike, is there anything you want --?

Right. Is that 75% of the cash flow based on the prior quarter's cash flow?

That's right.

Right. So we -- you know what your limit is in the current quarters based on the prior quarter's cash flow and how much stock you can buy back then. Right?

Well, we know what the dollar amount is, what we don't know is what the stock price will be. So --

Well, obviously. Right.

But, Brian, I just would like to point out, there are other capital items that are underneath that restricted capital requirement under the debt facility. So, clearly, we have to factor in potential capital expenditures or other factors when we set the -- this being one of several items of capital usage in a given quarter.

Right. Right. Okay. Do you think there's an opportunity to renegotiate your credit facility and terms of the credit facility? I mean, I know we just did it and we talked about this recently, but lenders' terms certainly have been getting easier over the past few quarters. What do you think about that?

Well, I'll let Mike answer. But as you've noted, we started, in the beginning of '09, with one debt agreement. Mike renegotiated it later in '09 and then renegotiated, again, in 2010. And again, I think even as Mike explicitly said, we continue to evaluate, and he personally continues to evaluate that. And as we change and evolve and get stronger, I think, as we've shown, we update those types of numbers.

Mike?

Yes, I think, Brian, it is something we pay careful attention to. And clearly, the trajectory of sales that we spent a great deal of time talking about on the call is an important factor in terms of where the business is positioned.

And we did renegotiate, last August, but when you look at the third quarter of 2010, the fourth quarter of 2010 and the first quarter of 2011, I think there's a substantial change in the business profile. So that's one factor that we look at and we discuss with our lenders to ensure we have a facility that not only provides the Company with the operating flexibility that it needs, but is advantageous and appropriate, given its current profile.

So it's a great point, something we continue to focus on.

Your next question is a follow-up from the line of Larry Hedden with KBW. Please, proceed.

Hey, guys. Just a couple of follow-ups. Based on your commentary around other operating expenses, should we expect the run rate to go back down towards the 4Q level?

Hey, Larry, it's Mike Angerthal. Yes, I don't want to provide specific guidance. We've been managing the business in that $7 million per quarter range. This quarter we have some specific items related to the tax work on the private letter ruling that we discussed.

We are focused on the expenses. We demonstrated an ability to keep those costs in line. We are thinking and focused on growth. So at this point, I think, in the near-term quarters, that it -- that is our focus. And should that change, we'll certainly provide clarity on the drivers of those levels. But I think it's a fair assumption for at least the immediate quarter for us to focus on those levels.

Okay. Great. And then, just one last question. Could you give any size as to the headcount and relative size of the distribution-related personnel at the end of the quarter?

Well, total headcount, as we reported in our 10-K, ended the year at 273 individuals. And I think we heard on the call that we did add a general counsel this quarter, so we know it's at least 274 this quarter.

But we haven't historically given the detailed levels of sales. I think George alluded to the fact that we didn't meaningfully add distribution resources in the quarter. And our base employment expenses have really not moved materially. The change in our material expense was driven solely in part by the variable nature of our sales levels and our profitability plans as well as the payroll tax item that we talked about.

George?

Yes, I mean, I think there's no significant changes really in headcount from the end of the year. I mean, we'll report the final number in the Q, though.

And for -- our retail -- the -- our retail sales force, again, what I was alluding to there has actually not been a significant change in the sales force, not only in the quarter, but really not a noticeable change over the last many quarters. Because they -- and where we've been getting our sale is not by ramping up sales force, which is a valid strategy that a lot of people employ.

We've gotten it by having a higher productivity and effectiveness of that sales force. And we -- we're not yet giving out that specific number of the wholesalers, though we do think we have a small, but high quality sales force. We differentiate on the quality of our wholesalers, not on the quantity because we can't compete on the quantity side.

Hopefully, that's helpful.

That is. Thank you for answering my questions.

Thank you, Larry.

Thank you, Larry.

Your next question is a follow-up from the line of Justin Evans from Sonoma Capital. Please, proceed.

Hi, guys. Thanks. Just two quick follow-ups. First, it's clear you're about to have a step function up in profitability. The variance valuation metrics, such as AUM multiples, management fee multiples and EBITDA multiples should start to align with the group. Which one of these metrics do you use most often when thinking about your business? Which one kind of just pops in your head as a default valuation metric?

Well, all of them have validity in different situations. I think the -- most people commonly focus in on the multiple of a cash earnings number, whether it be an EBITDA or operating income as adjusted or another metric.

What will vary there is how do you either give credit or take away credit, based upon profitability, growth, and the risk in the long-term nature of the business.

Where revenue and AUM can become helpful is trying equalize for some of those things. So if you have two exactly identical companies, and one is in a high-growth and one is not in a high-growth, they're going to have different EBITDA, but the company's may be fundamentally worth the same.

So AUM and revenue help with that, but I do -- what we do look mostly at the cash earnings and then what multiples apply. And whenever someone looks at AUM, we always caution them to, obviously, treat cash differently than you do anything else and think about the range of multiple in terms of, again, slightly margin and growth.

And revenue, it's important just to isolate the revenue that is something that comes in the bottom line. So, it's primarily investment management fees and you would exclude those things.

And, again, you'd look at your expectations going forward on revenue. One of the questions Larry alluded to are things like expense caps and reimbursements. So as you would assume in a company that has expense caps in place, it's currently depressing its investment management fees.

And part of it will be your thought -- your thoughts going forward, on is that always going to be the case as a company ramps up scale. And with the growth rates that we're sort of demonstrating, that is something you should think about as you're doing your modeling.

So you're looking at a free cash flow variation of multiple? I mean, is that kind of how you consider yourselves compared to the world?

Well, again, I do think looking at all three of them absolutely have value.

Yes.

The reason that -- I'm leaving with the cash earnings. But, again, if you look at cash earnings, it would be, the way -- we look at all three of those numbers. When we look at cash earnings, we look at what we do internally, which is a normalized number, which does some of the math that you were sort of alluding to and sort of comes up with a run rate.

Because the view is the value of a company is the probability-weighted, risk-adjusted assumption of future earnings potential and using a time horizon. So it does incorporate what is the expectation of the profitability going forward, normalized for any noise, and normalized for any upfront negative impacts from having a significantly high growth rate.

So, the key is how do you compare one company's multiple to another company's multiple? And so, I think the underlying driver of cash is generally the better driver. Where I think we have an imperfect market, that people are always good at ascribing the right multiple to a company based upon either its current profitability, its current growth, this current tax situation, or the risk of its business, in terms of either how broad or narrow its capabilities are.

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

Okay. I want to thank everyone for participating this morning. I hope we gave you a better understanding of the Company and the results. As always, if you have any further questions, just please give us a call at any time. Thank you.

That concludes today's teleconference. Thank you for participating. You may now disconnect. Good day.