Virtus Investment Partners Inc (VRTS) 2013 Q2 法說會逐字稿

Good morning. My name is Sheena 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 session of the Virtus website at 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. Good morning, everyone. On behalf of Virtus Investment Partners, I would like to welcome you to the discussion of our operating and financial results for the second quarter of 2013. Before we begin, I direct your attention to the important disclosures on page two of the slide presentation that accompanies this web cast.

Certain matters discussed on this call may contain forward-looking statement 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.

For a discussion of these risks and uncertainties, please see the risk factors in the management discussion and analyses section of our periodic reports that are filed with the SEC, as well as our other recent filings, which are available in the Invest 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.

Our non-GAAP financial measures are not substitutes for GAAP and financial results and should be read in conjunction with GAAP results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our earnings press release which is available on our website. For this call, we have a presentation including an appendix that is accessible with the web cast through the Investor Relations section of our website.

This morning we'll begin with remarks from President and Chief Executive Officer George Aylward who will review our accomplishments and operating results for the quarter. Mike Angerthal, Executive Vice President and Chief Financial Officer, will then discuss our financial results in further detail and will also review the balance sheet and capital items.

We will conclude by opening the call to your questions. Now I would like to turn the call over to George Aylward. George?

Thank you, Joe, and good morning everyone. We appreciate your joining us on the call this morning. Mike and I are pleased to have the opportunity to talk about our results which represented another very strong quarter. There were two different market environments in the second quarter.

The quarter began with the markets continuing their upward trajectory until mid May when the Fed hinted that it might taper its quantitative easing. From then until the end of June,the markets reacted negatively and any yield-focused investment was severely punished given the uncertainty of interest rates. It was a reality check for many investors as well as for many asset management firms that were over allocated to fixed income strategies.

With that as a backdrop, we are particularly pleased with our results this quarter. Let me start by reviewing some of our accomplishments. First, we reported our highest levels of revenues in operating earnings and an increase in our operating margin. The growth in revenues reflect the cumulative benefit of our growing asset levels from continued strong net flows.

Over the past year, total assets have increased by 36% and a growth in AUM combined with higher average net fee rates allowed us to generate records levels of investment management fees for the quarter. The consistent increase in our revenue combined with the inherit leverageability of the business and our highly variable cost structure led to the growth in operating earnings and expansion of the operating market.

Second, we sustained high levels of sales in organic growth despite the challenging market environment. Our ability to offer diversified products across multiple asset classes allowed us to navigate a period when the industry experienced heavy net redemptions, particularly in fixed income strategies. The industry, in general, saw changes in investor behavior as a result of the volatile markets and the uncertain interest rate environment.

In response to the Feds comments in May, there was a period when investors began to rebalance away from fixed income products. There are arguments to be made about whether or not this is the start of, or the next step in, the great rotation out of fixed income, but we're less concerned about that because of the diversity of our product offerings.

A fundamental element of our business model is to offer investment strategies across product types and asset classes that are attractive in various market cycles and as investor preferences change. The value of that approach was demonstrated this quarter as we maintained a very high level of sales and flows.

As certain investors shifted into different strategies compared with the last quarter, we had attractive products to meet their changing needs, whether looking for downside protection, capital preservation, non-correlated strategies, et cetera. While the increased earnings in sustained high sales and flows were key accomplishments in the quarter, we also continued to expand our product offerings for the future. In June we launched a new [defensive] fund, the Low Volatility Equity Fund, which is the first Virtus mutual fund managed by our [Rampart] affiliate.

We've seen more demand for lower volatility offerings and we think Rampart's experience in managing options strategies will be attractive in a retail market. Another new offering is a product that will be available for off shore investors. We received the approval of the Central Bank of Ireland for a [usage] structure thatallows us for the first time to offer existing and new investment strategies to non-US investors.

Our first offering will be an alternative strategy, the Liquid Alpha Fund. The initial distribution for usage will be to international clients of US-based financial advisors who can be supported by our existing sales structure. Longer term we will look at expanding into non-US distribution which will provide an additional area of growth. As I mentioned wedge had very strong financial results this quarter as well as sustained high levels of sales and positive net flows.

Total sales were $5.6 billion , which was an increase of 76% from the second quarter of last year, and our second best quarter ever after the very strong results in the first quarter. We had $2.5 billion of positive net flows which is an increase of 80% from $1.4 billion in the second quarter of last year.

Our flows represented an organic growth rate of 20% and the consistency of strong flows is the key element in the 36% increase in asset [centered] management over the past year. Mutual fund sales were $5.1 billion in the quarter or 84% higher than the second quarter of last year. It was also the second best quarter after last quarter when we had exceptionally high sales related to the announcement of limits to the investment in our Emerging Markets Opportunity Fund.

For the quarter, our funds sales rate was 67% so we continue to have growth well above the average of the industry. Fund sales for the first half of the year were $10.8 billion or 87% of the sales for all of last year. With the market volatility in the quarter we did see a change in which strategies were most attractive.

In the first quarter, our fixed income in international equity strategies were the most popular and, by comparison, in the second quarter we had increased interest in our defensive domestic equity strategies and our long short equity fund that recently surpassed $1 billion in assets.

At a time when investors' appetites were rapidly changing, given the uncertainty and the speculation in the market, our broad product line have allowed us to have a range of strategies for investors as they repositioned their portfolios. In addition to the strong fund sales, we maintained positive net flows that were well above our average quarterly run rate for the past year. Even as markets fluctuated, we maintained positive net flows for each month of the quarter and had a 34% annualized organic growth rate.

We're also pleased to see that mutual fund flows in July increased from June and were significantly higher than July of last year. Operating earnings reached a reported level in the quarter as a result of higher revenues from a cumulative top line growth and generally stable fixed costs. Operating income as adjusted was $31.7 million, an increase of 66% from the second quarter of last year.

The growth in the prior year reflects the 41% increase in revenue as adjusted over the past year as a result of our growing assets, particularly in open end mutual funds where assets were up 53% over the past year. The increased profitability of the business is demonstrated by the expansion of our margin to 44% from 38% a year ago. This reflects the leverageability of the business as we benefit from higher revenue on our growing asset base, while maintaining a relatively stable fixed cost base and a high proportion of variable costs.

Earnings per diluted share were $1.91 on net income of $15.4 million, an increase of 84% from the second quarter of 2012. Net income this quarter reflected a negative $0.22 per share impact from the net unrealized mark-to-market adjustments on our marketable securities. We're pleased with these results.

The record revenue in earnings, continued high sales and flows and strong investment performance combined for a very strong quarter. With that, I'll turn the call over to Mike to provide more detail on the financial results and then we'll open up the call for questions. Mike?

Thank you, George. Good morning, everyone. In the second quarter, we continue to generate strong results across all of our key metrics and this morning I'm going to review our quarterly results starting with assets under management, sales and flows. Then I'll review key income statement line items and discuss our balance sheet and capital position.

Starting on slide eight, assets under management. We ended the quarter with total AUM of $52.7 billion, up 36% from the prior year and 3% over the prior quarter. The sequential increase in AUM reflects strong net flows of $2.5 billion, partially offset by market depreciation of $900 million as international equity and fixed income markets declined in the latter part of the quarter.

There are three elements that contributed to the year-over-year increase of $13.8 billion, strong organic growth, a solid market environment, and assets from a small acquisition. Specifically, net flows added $9.7 billion, or 70% of the increase, market appreciation added $3.2 billion and the remaining $0.9 billion is primarily attributable to assets added from the acquisition of Rampart that was completed late in 2012.

As a result of consistent strong flows, mutual fund assets are up 53% from the prior year and 6% from the prior quarter. Separately managed account assets are up 49% from the prior year primarily due to the addition of Rampart. The composition of our assets remained relatively consistent on a sequential basis with equity assets, which include alternatives at 60.4% and fixed income up slightly to 36.3%.

The percentage of combined equity and alternative assets remain consistent as net flows and domestic and International equities and alternatives were partially offset by market depreciation in international equities. The percentage of fixed income assets was up slightly as positive net flows offset market depreciation.

In a quarter of increased volatility, we maintained solid double digit organic growth which demonstrates the breath of our investment strategies, differentiated product offerings, and the continued strong investment performance across a variety of assets classes and investment styles. Total sales for the quarter were $5.6 billion, an increase of 76% from $3.2 billion in the prior year quarter.

Total net flows were $2.5 billion, which is an overall annualized growth rate of 20% compared with 15% in the prior year quarter. We have now had 17 consecutive quarters of positive net flows, as well as double digit overall organic growth for essentially the past 10 quarters. Open end fund sales were $5.1 billionin the second quarter, an 84% increase from the prior year, but 11% lower on a sequential basis.

Fund net flows increased by 87% to $2.6 billion from the second quarter of 2012. That is an organic growth rate of 34% compared with 28% in the prior year quarter and 56% in the prior quarter. Fund sales and net flows were lower on a sequential basis due to the very high sales in our Emerging Market Opportunity Fund in the first quarter related to the impact of the notification that new investments into the fund would be limited.

Even with the soft close of the fund, emerging market sales remain solid in the second quarter as existing investors and platforms continued to make investments into the fund. Sales in all other mutual funds increased 9% on a sequential basis, reflecting the diversity of our product offerings. This strong positive influence in our domestic and international equities, and alternative offerings, gave us double digit organic growth each month of the quarter, including June.

Sales in our defensive equity and long short strategies increased 69% over the first quarter, and net flows into those funds increased more than 100% on a sequential quarter basis. Finally, institutional sales increased to $189 million from $61 million in the second quarter of 2012. The increase was primarily related to sales into small cap strategies at Kayne Anderson Rudnick and Newfleet's fixed income strategies.

Slide ten illustrates the continued growth and operating income as adjusted and the associated margin. In the second quarter, operating income as adjusted was $31.7 million, an increase of 66% compared to a year ago and 27% on a sequential basis. The sequential increase in operating income as adjusted reflects continued strong growth in revenues, reflecting higher assets under management and generally stable operating expenses as adjusted, which were up 2%.

The substantial increase in operating income as adjusted over the prior year primarily reflects revenue growth from the cumulative impact of $9.5 billion of positive open end fund net flows over the past four quarters, and the benefit of a highly leverageable business and our variable expense structure.

The operating margin as adjusted was 44%, an increase of 650 basis points from the prior quarter, and 520 basis points from the sequential quarter. Our year-to-date capture ratio, which we define as incremental operating earnings divided by incremental revenues, was 57% which is within our historical range.

Concerning GAAP results, net income attributable to common stockholders was $15.4 million or $1.91 per diluted common share, representing a year-over-year increase of 84% and an increase of $0.18 per shareshare or 10% on a sequential basis. Excluding the impact of the unrealized mark-to-market adjustments on our marketable securities, net income would have increased $0.47 per share or 28% on a sequential basis.

As we discussed in our last call, approximately 50% of our seed capital portfolio is invested in an emerging market debt strategy that is bench marked to a global bond index that had a negative 5.6% return in the quarter. To provide clarity on our unrealized gains and losses, we've provided a schedule of marketable securities and related indexes in the appendix to this presentation. Finally, our effective tax rate for the quarter was 38.7%.

The increase from 37.3% in the first quarter was due to the lost attribute to redeemable non controlling interest that is included in our pre tax income, but not subject to income tax expense. As we've stated during prior calls, the Company's cash tax rate remains in the low single digits, allowing us to retain a large portion of the cash we generate from operations.

Turning to revenues on slide 11. Investment management fees increased to $64.5 million, up 12% on a sequential quarter basis, and 44% from the second quarter of last year. The two key elements in the growth of investment management fees are the increases in average long-term assets and fee rates. Average long-term assets under management grew to $51.4 billion, up 11% from the sequential quarter and 41% from the prior year due to strong mutual fund net flows.

The increase over prior year also benefited from market appreciation and the addition of Rampart. The average fee rate was 48.7 basis points, an increase of 1.5 dips from the prior year, and the increase from the prior year primarily reflects net slows into higher fee mutual funds. Over the past four quarters, more than 70% of our net flows have been into equity and alternative strategies.

Total employment expenses for the quarter were $32.9 million, an increase of $0.5 million or 1% from the prior quarter. The sequential increase is attributable to increased variable incentive comp due to higher profitability, partially offset by $1.8 million of lower payroll taxes related to annual incentive payments that occur in the first quarter.

In terms of sales related costs, as a reminder, the expense is variable in nature and will fluctuate based on several factors, including the level of sales, types of products sold, and how they are sold. In the second quarter, sales based compensation was essentially flat from the first quarter, despite the sequential decrease in mutual fund sales.

A key employment experience metric is the ratio of employment expenses to revenues as adjusted, which improved 460 basis points on a sequential quarter basis to 45.7% driven by $1.8 million of lower incremental payroll taxes and the variable nature of our compensation programs. Moving to slide 13, other operating expenses.

The trend in other operating expenses demonstrates the leverageability of the business as these expenses continue to represent a lower percentage of revenues as adjusted. Other operating expenses in the second quarter increased by $1.3 million from both the prior year quarter and the first quarter. The sequential quarter increase was due to higher sales related activities including the periodic due diligence meetings we hold for specific distribution partners as well as our support for their marketing efforts.

Due to the timing of these activities, the level of these expenses will vary each quarter. Also contributing to the sequential increase was the annual director grants that occur in the second quarter of each year. The increase over the prior year reflects the higher sales related activities as well as the addition of Rampart. Excluding the impact of the annual director grant, the ratio declined 30 basis points to 13.6%.

The ratios declined 340 basis points since the prior year quarter, reflecting our ability to leverage our cost structure and expand profitability. Touching on our balance sheet and capital position. In the second quarter, we generated strong cash flows from operations which resulted in improvements in all our key liquidity metrics.

We've included a new metric of working capital as adjusted, which we believe is the most appropriate measure to evaluate the current capital available on our balance sheet to support the operations of the business. This metric is calculated as cash plus accounts receivable plus accounts payable and accrued expenses. For the quarter, working capital as adjusted increased $18 million, or 42%, due to strong cash flows from operations.

The ratio of working capital as adjusted as a percentage of annualized operating expenses increased to 23% from 17% in the first quarter on strong operating cash flows. By comparison, industry averages are closer to 50% to 60% of annual spend.

With regard to share repurchases in the quarter, we repurchased 20,000 shares at a total cost of $4.6 million and in May the Board of Directors authorized an extension of the Share Repurchase Program. So at the end of the second quarter we have remaining repurchase capacity of $375,000.00 through May of 2016. In addition, in the second quarter we utilized $2 million to net settle [the vesting] of 8,680 restricted stock units.

As we've discussed previously, we manage our capital to provide operating flexibility and to maximize shareholder value. We will continue to strive to increase our financial flexibility to be in the position to capitalize on opportunities and maintain our growth. With that, let me turn the call back over to George.

Thanks, Mike. As I said earlier, we are very pleased with results this quarter, particularly the continue growth in earnings, margin expansions, and our ability to maintain solid sales and flows during the volatile market. Our sales success this quarter demonstrates how our broad and distinctive product set offers clients attractive investment strategies to address their needs in a variety of market conditions.

As we enter the second half of the year, we have the critical elements in place, product, investment performance, strong distribution and new opportunities to sustain our momentum. So with that, let's open up to some questions. Sheena, can you open the lines, please?

(Operator Instructions). Our first question comes from Michael Kim, Sandler. Please proceed.

Good morning. Michael Kim from Sandler. First, can you talk a little bit about the multi sector short-term bond fund in terms of how that portfolio is positioned, assuming rates continue to move higher? Do you think the knee jerk reactions to the move in rates has been a shift away from bond funds more broadly but that, ultimately, maybe the better positioned or differentiated strategies will end up recapturing at least some of those assets?

It's a good question because people sometimes group everything together in one bucket. So when you talk about fixed income, you're really talking about very different types of strategies. So, for us, if you look at the multi sector short-term bond fund, it is multi sector, so it's playing in 14 sectors and basically looking for the greatest value, and it's a short duration, it's about [2.5] is the duration on the multi sector short-term bond fund.

Over the history of 19 or 20 years, we've had the experience of how it behaves in rising interest rates and the fund has always done very well. Our view for that fund is in this type of an environment with the levers that are available for Dave and his team to pull on that fund, that is the kind of place where you're going to have the most maximum opportunity to take advantage of that.

We actually feel that fund is very well-positioned to be the type of place you want to be on a fixed income product, rather than other strategies which may, obviously, longer duration and less flexibility in terms of playing different spread sectors.

But again I think you always have to be careful when you look at a big category of either quote, unquote equity or fixed that really there's a lot of sub stories going between that. I think you've seen some other examples of some other fixed income funds that were shorter in duration, a little more flexible, generally doing better than some that are a little more focused and concentrated.

Understood. Second question, anything on the closed [end] front? Seems like some of your peers have gotten a little bit more active coming to market with new funds, so just wondering how you're thinking about that business these days and the opportunity set there?

Yes. No, again, we're still big fans of the closed end fund structure. There's been a lot of closed end funds with a little bit of dislocation in the last few months.

There's been a lot of credit deals that have been put out there. And we do, obviously, have the credit capabilities and we think there's some opportunities to serve investors with other types of equity or income products. So it's an area where we continue to be active, but for us it's very important to do the right strategy at the right time, so that's the way we sort of look at it.

Got it. And the, finally, on the M&A front. Can you talk about maybe what you're seeing terms of opportunities or competition, pricing, et cetera? And how you're thinking about potential needs or strategic acquisitions going forward?

Yes. Again, I start with that given the diversity of the capabilities that we currently have and just the broad offerings, our organic growth, again, of 20% for the quarter is high. We don't need M&A to be successful or to grow. It's not a fundamental element of our growth proposition. That being said, again, you always see cycles in the markets in the M&A front in terms of whether there's more opportunities or less opportunities.

You need to stay cognizant of those, again, as a multi manager. In some way our business is sort of built to partner. And, again, as you know, we partner through either pure sub advisory, through minority, through majority and through other structures. Our focus is always trying to find what are the investment capabilities that we would like to bring to market, and we're flexible in how we do that.

So, again, you've seen us do just sub advisory or a minority, et cetera. I think it's an interesting market and, again, I think you're seeing a little bit more activity. But we're primarily focused on our organic and really just raising the assets from that with which we currently have.

Okay, that's helpful. Thanks for taking my questions.

Thank you.

Our next question comes from Steven Schwartz, Raymond James & Associates. Please proceed.

Steve?

Maybe you can run us through, in the long 2010 term, open end mutual funds, what the flows were by month?

I'm sorry, Steve, we didn't hear the very beginning of that.

Yes. There was some static. You said flows in the long-term open end mutual funds were positive each month. I was wondering if you could walk us through what those flows were for April, May and June?

We're not going to give the specifics. Our experience was very reflective of the dynamics in the market of the quarter. So, again, I think everyone saw one experience in the April to the mid May or May 22nd type of period. Which I think for us was probably -- I would describe it as consistent with or slightly stronger than the very end of the first quarter, excluding emerging markets. Then upon the period with the comments from the Fed, I think we and the industry saw a period where particularly fixed income had a couple of very difficult days and then everything stabilized.

As I indicated in my comments, what was really interesting then was really the switch from the first quarter being very heavy in international equity and fixed and, for us, it was a switch into the downside, the defensive equity, which is our AlphaSector, the premium product. And then our dynamic AlphaSector which is the long short equity fund. So that emerged in the second part of the month. And, again, I don't think -- not all of our competitors were maintaining positive flows in those three months, in those periods. Mike, do you want to add any--

Yes. I think in -- Hi, Steven, it's Mike Angerthal. I think in my prepared remarks I indicated that we did maintain double digit organic growth in the long-term open end fund so it was a trajectory that we were pleased with and I think George reiterated in his comments that we saw that trend sort of continue into July.

Right.

Right.

That's sort of the color we'll put on the monthly basis.

Okay. I did want to just follow-up on that. Maybe a little bit more color on July. The trend of where the money goes or where the money's going, is that any different from where it was post the [caper tantrum]?

I think it's very similar. Again, I think you're seeing the same. For us, again, a lot of defensive equity, the long, short, and then a couple of periods on the fixed income where people were sort of saying, hey, this is actually a good entry. But I think that's still choppy. I think people are still trying to figure out, longer term, how they want to play their fixed income.

Anything new in the quarter on distribution efforts, on expanding distribution?

Yes. We continue to, again, I think have very good rankings in all of the firms and do well. We've been just finalizing the level of staffing that we currently have. Again, I think as we said before, we have fewer wholesalers than most of the people we actually compete against. The only real new thing is, again, I did speak about , that we now have a usage structure which we just got approval for.

So that won't be anything in the short-term on that, but as we introduce product there, we'll be able to leverage some of our existing sales force for financial advisors who have investors that would fit that profile. We continue, again -- I believe we look very closely at market share and we look very closely at how we're ranked within firms and we continue to do very well for a firm our size and that's not a well-known mutual fund company.

George, I was thinking here of -- I think that you're mostly strung in the [wire houses] and have been talking up the opportunity in IRA. I was specifically referencing that.

Yes. And, again, you're absolutely right. While we have selling agreements with everyone and we've been in most places for many, many years, in the last few years a lot of our greatest focus and penetration was in the wire houses where we achieved very high rankings. And we expanded our sales force a little over a year ago and we've seen great results.

I mean, the percentage growth is significantly high in that channel but it's coming from a smaller base. So I have to say we've been very happy that we have truly been able to translate some of the success that we've had on the traditional wire houses into the independents and the IRAs. Mike, [anything]? No?

Okay.

Okay.

Yes. And then two more if I may, quick ones. The new product offerings. Do you have to put seed money into either one of those?

You do. You do. So for the liquid alpha fund, which is the first (inaudible) seed of about $1 million. That will be in at. And it will be similar to an open end fund. We'll have to seed it, at a minimum, at a level which to execute the strategy.

So that means if it's a diversified equity kind of product, it's a lower seed, say $1 million. If it's more capacity constrained like small international small cap, it's, like, $5 million and once you do the more, the truly diversified fixed income, like we did with emerging market debt, we had to do $20 million.

$25 million.

It will be a very similar type of seed capital required in the [usage] as opposed to the regular [40 Act] US [funds].

Okay. And then one more. Mike, what was the amount of RSUs that were net settled? Did you say $860,000.00?

$8,680.00.

$8,680.00. Alright. $8,680.00. Don't know where I got that.

Alright. Thank you, guys. You're welcome.

Thank you.

Thank you for your question. (Operator Instructions). Our next question is from John Dunn, Sidoti & Co. Please proceed.

Hi, John.

Could you just talk a little bit on the institutional channel and if you have an idea of where you would like that to go as a percentage of total of AUM mix?

Yes. For our institutional business, again, we've had a very high level of growth on the retail side and the institutional side has not been anywhere near that level. It's been basically very stable and we were sort of pleased with some of the gross sales that we're seeing in that place. As a reminder for our institutional business, it's really going to be focused on our affiliated managers as opposed to [sub] [advisories]. So we don't do institutional for those strategies which are really done through sub advisories.

That's an area where we had invested some resources very early last year, I think. It's a little bit more than a year now where we invested in some resources in terms of distribution and we've sort of been pleased with the traction that they've been able to generate, which, again, you haven't seen a significant level of flows. But it certainly has increased. The pipeline has increased as well as the activity.

So, again, it's certainly not the same level of retail nor would we expect it to be. And it's a longer tailed business. I think a lot of the changes that were put into place and some of the work that has been done over the last year has started to pay out.

Great. And then just a follow-up on M&A. Could you characterize what you think the pricing environment is out there? Is it reasonable? Is it overheating?

Again, I guess it depends on which perspective [you're on]. I wouldn't say it's necessarily overheated. As I've looked through the multiples for deals, private multiples versus public multiples, which I've sort of have been looking at since the mid 1990's, it's certainly not anywhere near its high. I would actually say -- If anything I would say some of the multiples that I've been seeing are lower than some of the historicals.

But again, it's all based upon the market environment in the year end. You're not going to see the same multiples as we did 1997, 1998 and 1999. But, again, to me valuation is very property specific, right? The value is based upon each individual thing. I wouldn't consider them [frothy].

Great. Thank you very much.

Yes. No problem.

Thanks for your question. Our next question comes from Terry Lally, Spotlight Funds. Please proceed.

Good morning. I'm trying to get a little more color on July. If I heard the statements correctly, it sounds like it continued on the double digit growth. Up from June and then up over last year. What was last year as a baseline? Any further color? Because it did seem like we had a tail of two markets, right? The very strong equity market in July versus the volatile market of June. I'm trying to get an idea of what the trends and fund flows are for that.

Yes. We don't give specific month by month. We only release the flows for the total quarter. I'm not going to give you the specifics on that. But where I can helpful is, if you look at the percentage increases that we had quarter over prior year quarter you can just see the level of growth that we've been having on a year-over-year basis. We're indicating that the flows are greater than they were last July and they did increase from June.

If you were to ask me to go through a trajectory, I would say the low point -- the May 22nd and the late May period was really the biggest area where there were low sales and higher outflows and it recovered through June and then that continued through July. So if you were doing a trajectory, the lower point would have been in the June area and then moving up towards as you enter July. I don't know if that's helpful but if you're trying to get trajectory, that's what I would give you.

Okay. I think you mentioned that 70% of the flows, recent flows, have been in the equity and alternative premium products, and we've seen the very positive mixed shift with your average fee up average 150 basis points. What's the average fee on the equity and alternatives, and how can we see that continue to lift your average revenue?

Yes. No, it's a great question because the higher fee products are the equity in the alternative funds. And the two funds in particular, one, I believe, has about 110 basis point fee and the other is 150 basis point fee. Again, which those are sub [devised] products but those are obviously higher fee than, obviously, the fixed income products that we were selling a lot of last quarter.

So both of the products that we're selling more of this quarter -- So last quarter it was emerging markets, which is 100 [bips] and multi sector, which will lend at about [42] or [43]. And now we're selling these two products. Mike, do you have any more color?

Yes, I think that's right. In the quarter [hour], for new sales was about 52 basis points for new product. The other thing to keep in mind on our fee rates, is they include expense reimbursements that we pay to the fund because we net that in the revenue line and some of the recently launched funds are currently experiencing slight reimbursement. So that will be another factor that impacts our net fee rates.

Okay. But mixed shift is positive, especially if we see fund flows into the equity. The alternate, we continue that lift and there will be some timing issue on, say, the start of funds and the reimbursement. But the trend line is your mixed shift to equity and alternatives?

Yes.

Yes, that's correct. You've seen that over the past year, as you noted.

Great. The operating leverage of the business, the correlation to the asset under management growth. You can you really see in the leverage of the business model. You're up 500 basis points sequentially. You referred to some of that being related to payroll taxes.

Help us through that. Did most of the high compensation plays reach the maximum caps in Q1? Was it was sometime in Q2? Would there be more benefit as we get into the back half of the year or did we see most of the benefit of that in the quarter?

Our annual incentive comps, and we've been very clear on this, is basically in the first quarter. So you will always see for us a large number of the highly compensated people maximizing out in that first quarter. So there, we reported, was a $1.8 million higher payroll tax in the first quarter than the second quarter. So that is very thin. It's been like that every year. And in terms of the margin, Mike? It was--

Yes. It was about 290 basis points on the incremental margin quarter-over-quarter. And a good way to think about it that we pointed to is the capture ratio where we pointed to it on a year-to-date basis, which is at about 57%. And we sort of target in that 50% to 55% range for incremental margins. That's a good way to think about it going forward on revenue growth.

Okay. And then it looks like [Ex] Q1, when you have the payroll tax all [hitting], given the bonus period that, at the current AUM base, you're running close to a $2.00 run rate. And then with AUM growth, with fee lift and operating leverage, we grow off this $2.00 base and leveraging the only 8 million shares out.

Well, we don't give guidance. And I think for $2.00, you're talking about EPS?

Your EPS, your current run rate--

If you are going to look at the EPS, just recognize that there were $0.22 of unrealized mark-to-market in that line item. That's just going to fluctuate and, obviously, isn't a core part of the operating element of the business.

Right.

So that's why we pointed it out. We provide some incremental detail on our marketable security portfolio so you can get a sense on how that can trend by looking at it versus the index. But I would just factor that into your analysis when you look at the business.

That's why we've added it in the supplemental information on the marketable securities and the related indexes because, again, that did have a negative $0.22 impact based upon what those indexes and the related products did. And it could go the other way so you should be very cognizant of that as you do any kind of projections and modeling.

I just wanted to thank you guys. You're doing a great job for a shareholder that bought your stock at $5.50. Congratulations and thank you.

We're happy that you're pleased.

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

Yes. I just want to thank everyone for joining us this morning and we certainly encourage you to give us any call if you have any further questions. Thank you.

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