Virtus Investment Partners Inc (VRTS) 2016 Q4 法說會逐字稿

Good morning. My name is Michelle 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 at www.Virtus.com. The call is being recorded and will be available for replay on the Virtus website.

(Operator Instructions)

I will now turn the conference to your host, Jeanne Hess.

Thank you and good morning, everyone. On behalf of Virtus Investment Partners I would like to welcome you to the discussion of our operating and financial results for the fourth quarter of 2016.

Before we begin I'd direct your attention to the important disclosures on page 2 of the slide presentation that accompanies this webcast. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

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

For a discussion of these risks and uncertainties, please see the risk factors and management discussion and analysis sections of our periodic reports that are filed with the SEC as well as our other recent filings which are available in the investor relations section of our website, Virtus.com. We do not undertake any obligation to update forward-looking statements.

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 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.

Now I would like to turn the call over to our President and CEO George Aylward. George?

Thank you, Jeanne, and good morning, everyone. I will start today by providing an overview of the quarter including assets and flows before turning it over to Mike for more detail on the financial results. I will then provide a brief update on our pending acquisition of RidgeWorth Investments before taking your questions.

Now let me begin with assets under management and flows. Assets under management were $45.4 billion at December 31, which represented a 3% decline from September 30 due to market depreciation and modest net outflows.

Total sales were $2.6 billion compared with $3.1 billion in the prior quarter which included certain items that we noted on our last call. Mutual fund sales were $1.6 billion compared with $1.9 billion in the third quarter. As we mentioned on our last call, the third quarter included $0.3 billion of model-related inflows in the Emerging Markets Opportunities Fund. Excluding the model-related inflows, mutual fund sales increased modestly quarter to quarter.

Mutual fund net outflows were $0.7 billion compared with $0.3 billion in the prior quarter due primarily to the lower model-related sales in the Emerging Markets Fund. Relative investment performance continued to be very strong across our funds with 19 of our rated funds representing 84% of our rated fund AUM having four and five stars as of December 31.

With respect to our other products, we continue to generate positive flows in SMAs, ETFs and institutional. SMAs were solid in the quarter at $0.5 billion as Kayne's equity strategies continue to gather assets. SMA assets ended the quarter at $8.5 billion, representing a 25% increase from December 31, 2015.

We believe that this product category could have increased opportunities given some of the recent trends in the distribution landscape. Sales of ETFs increased sequentially to $201 million from $67 million, reflecting $78 million of sales related to the introduction of the Virtus Newfleet Dynamic Credit ETF. We ended the year with $0.6 billion of assets and ETFs which we continue to see as a potential area of growth.

Institutional sales were $0.3 billion compared with $0.6 billion in the third quarter which included a domestic REIT mandate at Duff & Phelps. We are pleased that institutionals gained traction and generated positive net flows in both 2015 and 2016 following our increased focus in investments in this part of the business. In terms of what we're seeing in January, overall retail sales have been flat to slightly positive with the Emerging Markets Fund being one of several funds in both equity and fixed income contributing positive flows on a month-to-date basis.

Turning to the financial results, operating income as adjusted and the related margin were $18.2 million and 28% down from $20.3 million and 31% on lower revenues, as adjusted, and higher operating expenses, as adjusted. Third-quarter revenues, as adjusted, benefited from a $0.7 million incentive fee on a CLO while other operating expenses, as adjusted, increased in the fourth quarter due to the timing of certain business activities.

Fourth-quarter earnings per share, as adjusted, increased 7% to $1.75 from $1.64 sequentially, reflecting the partial-quarter impact of the lower share count resulting from the repurchase of the 1.7 million shares held by Bank of Montreal in October. In the quarter, we returned $164 million of capital due primarily to the 162 million share repurchase from Bank of Montreal that reduced ending shares outstanding by 22.7% from September 30, 2016.

As a result of our continued repurchases, ending shares outstanding have declined by 30% from December 31, 2015. Cash and investments were $274 million or $46 on a per-share basis as of December 31, 2016.

Now I'll turn it over to Mike to provide a more detailed view of the financial results and balance sheet. Mike?

Thank you, George. Good morning, everyone.

Starting on slide 7, assets under management. We ended the quarter with assets of $45.4 billion which represents a decrease of $1.1 billion or 3% from the prior quarter. The sequential decrease in AUM is primarily attributable to market depreciation of $0.6 billion and net outflows of $0.4 billion.

The $2 billion year-over-year decrease in AUM is primarily attributable to $4.7 billion of net outflows and $0.5 billion of dividend distributions, which are partially offset by $3.2 billion of market appreciation. Total AUM at quarter end was diversified with 38% in domestic equity, 19% in international equity, 34% in fixed income and 9% in alternatives and other. By product, open-end fund assets were 52% of total AUM. Separately managed accounts were 19%, closed-end funds were 15%, institutional 13%, and ETFs 1%.

Turning to slide 8, asset flows. Total sales were $2.6 billion, a sequential quarter decrease of $0.5 billion or 15% primarily due to lower sales in institutional. Total sales also decreased from the prior-year quarter by 17% or $0.6 billion as lower sales in mutual funds offset higher sales in institutional, SMAs and ETFs.

Gross sales in open-end mutual funds were $1.6 billion, a decrease of $0.2 billion from the third quarter, primarily due to $0.3 billion of lower model-related sales in the Emerging Markets Fund. Fourth-quarter total net flows were negative $0.4 billion as net outflows from mutual funds more than offset combined net inflows from all other products of $0.4 billion.

Institutional, SMAs and ETFs have generated positive flows of $3.9 billion for the full year and have grown by 50% over the prior year.

Mutual fund flows by asset class were as follows. Fixed income strategies had net outflows of $0.1 billion compared to breakeven flows in the prior quarter. Sales increased by 19% sequentially, primarily due to increased flows into the five star Multi-Sector Bond Fund measured by Newfleet, which has delivered top decile relative performance on a 1-, 3-, 5- and 10-year basis for the periods ended December 31, 2016.

The Senior Floating Rate Bond Fund and the Multi-Sector Intermediate Bond Fund also contributed higher sales in the fourth quarter. Domestic equity net outflows of $176 million were largely consistent with the prior quarter. Within this asset class the foreign five star rated Small Cap Funds managed by Kayne Anderson Rudnick generated net inflows of $109 million.

International equity net flows were negative $0.3 billion on lower sales when compared to the third quarter which included $0.3 billion of model-related inflows in the Emerging Markets Fund. In separately managed accounts, flows were a positive $170 million due to continued strong sales in Kayne's equity strategies.

ETFs had positive net flows of $150.2 million during the quarter. In December, we launched the Newfleet Dynamic Credit ETF, which generated $78 million of net inflows. This is the second ETF we have issued for Newfleet, which is consistent with our strategy to bring selective, actively managed ETF strategies from our affiliated managers to market.

Institutional continued to generate positive net flows with $46.6 million in the quarter, primarily due to inflows into existing accounts at Newfleet and Rampart.

Turning to slide 9. Investment management fees, as adjusted, of $59.3 million decreased 2% on a sequential-quarter basis. The 2% sequential decrease was due to a lower net fee rate and lower average assets under management.

The average fee rate decreased sequentially to 51.2 basis points from 51.8 basis points, primarily due to a lower institutional fee rate. The institutional fee rate declined to 37.2 basis points from 41.5 bps in the third quarter, which included the impact of the $0.7 million CLO incentive fee.

The average ETF fee rate decreased sequentially to 24.6 basis points from 32.4 bps due to higher expense reimbursements for one of our funds in the quarter. Excluding the higher reimbursements, the ETF fee rate was consistent with the prior quarter at 32.2 basis points which we believe is an appropriate estimate for first-quarter modeling purposes. Average assets declined 1% in the quarter due to net outflows and market depreciation.

Slide 10 shows the five-quarter trend in employment expenses. Total employment expenses, as adjusted, of $33.5 million increased 1% from the prior quarter as higher variable compensation was partially offset by lower fixed employment expenses. Employment expenses decreased $0.9 million or 3% compared to the prior year due to both lower fixed and variable based employment expenses.

Employment expenses as a percentage of revenues were 52%, an increase from 51% in the prior quarter, reflecting lower revenues. The trend in other operating expenses, as adjusted, reflects the timing of product distribution and operational activities. Other operating expenses, as adjusted, of $11.7 million increased $0.8 million or 7% from the third quarter.

The key drivers of the increase included higher sales and marketing expenses of $0.4 million, $0.2 million of legal costs associated with product initiatives and $0.2 million of middle and back office outsourcing related costs.

Slide 12 illustrates the trend of adjusted results. In the fourth quarter, operating income, as adjusted, was $18.2 million compared with $20.3 million in the prior quarter, resulting in a decrease of $2.1 million or 10%. The change reflects lower revenues, as adjusted, and higher operating expenses, as adjusted.

The related margin for the fourth quarter was 28% compared with 31% in the third quarter and 29% in the prior-year quarter. Earnings per share, as adjusted, were $1.75 in the quarter. The increase of $0.11, or 7% sequentially, was primarily related to a 16% decline of average shares due to the partial-quarter benefit of the 1.7 million share repurchase that was completed during the quarter at $93.50 per share.

GAAP net income attributable to common stockholders was $12.4 million or $1.87 per diluted share. The quarter included $4.3 million or $0.65 per share due to the release of a deferred tax asset valuation allowance related to realized capital losses, $3.3 million or $0.49 per share related to unrealized losses on the Company's seed and CLO investments and $2.1 million or $0.31 per share of acquisition-related costs associated with the RidgeWorth transaction, which are excluded from our adjusted results.

We will continue to break out acquisition and integration expenses quarterly to provide transparency into the costs necessary to complete the acquisition and integrate the business. The effective tax rate of 4% reflects the release of a net valuation allowance of $4.1 million related to the certainty of the realizability of capital losses. This compares to 30% in the prior quarter that included a $1.5 million valuation allowance release.

Slide 13 shows the trend of our capital position and key financial metrics. During the quarter, we returned $164.2 million of capital. That included 161.5 million of share repurchases from Bank of Montreal and $2.7 million in common stock dividends.

As a result of the repurchase, basic shares outstanding at December 31 declined by 22.7 million to 5.9 million sequentially. When compared to the prior year, basic shares outstanding have declined 30%.

Cash and investments under the quarter at $274 million or $46 on a per-share basis, down $4 or 8% from the third quarter. Seed capital investments of $180 million are largely unchanged from the third quarter. As we have mentioned on prior calls, our targeted seed capital range has been $125 million to $175 million, which will fluctuate based on our specific product and distribution needs and capital priorities at any point in time.

Working capital, which excludes our seed capital portfolio, ended the quarter at $28 million or 10% of annual spend. Our longer-term targeted range for working capital is 50% of annual spend.

Regarding the financing of the RidgeWorth acquisition, we have $475 million of committed financing available as previously disclosed and we also have an effective shelf registration. Together, they will give us the flexibility to execute on our intended permanent financing structure.

With that let me turn the call back over to George. George?

Thanks, Mike. Since we announced the agreement to acquire RidgeWorth Investments in mid-December, we have made progress on the various work streams related to completing the transaction and integrating the businesses.

First, we have been communicating the details of the potential transaction with our distribution partners and RidgeWorth has been focused on client outreach. Second, we have begun the process of submitting the appropriate filings to affect the combination of the fund business as the mutual fund shareholders will be asked to approve the reorganization of the RidgeWorth funds into the Virtus funds. Third, we continue to work on our integration plans while accomplishing the tasks that can be completed prior to close. Lastly, as Mike mentioned, we have been taking the necessary steps to put our permanent financing in place before the close of the transaction and, as we indicated on our call in December, we will balance operating flexibility, capital efficiency and delivering meaningful accretion to our common shareholders.

In terms of the RidgeWorth business, total assets ended the quarter at $40.2 billion, an increase of $0.1 billion from September 30. Their investment performance remains strong with 83% of their rated mutual fund AUM having four and five stars at December 31. We remain excited about this transaction as it will further diversify our investment strategies and clients, enhance and expand our distribution resources, increase profitability and scale, and expand growth opportunities.

With that, we will now take your questions. Michelle, can you open up the lines, please?

(Operator Instructions) Michael Carrier, Bank of America Merrill Lynch.

Thanks, guys. First question, just on I guess cash and capital, 2016 was an active year both on buybacks and the RidgeWorth deal announcement. Just wanted to get a sense -- when you think about 2017 and going forward -- you mentioned the working capital target as a percentage of spend and you're below that. But it seems like the seed might be a little on the higher end.

And so when I think about going forward in terms of cash generation, and where the focus will be in terms of deployment, just wanted to get a sense of where the priorities are given where things stand post the buybacks and the deal.

Yes, let me get a couple of thoughts and Mike can add in. So our focus is going to be on putting together the permanent financing for the RidgeWorth transaction and, obviously, as a result of that, our profile will change significantly, right?

We've traditionally not had debt on our balance sheet. And, as we've indicated, we have fully committed financing as it relates to the transaction and ultimately we'll be putting together the balance of how we want to put that altogether.

As we look at that, we've already in terms of our seed capital -- we previously said our range had been $125 million to $175 million. We're actually at the high end of that right now. But as we indicated previously, we always think about that in relation to the other uses of capital and, obviously, we're very excited about the RidgeWorth transaction.

So we'll be looking to, as I indicated, as we put together the permanent financing using existing balance sheet resources, the debt that's available to us and flexibility around equity we will be putting all of that together to come up with the right mix. Mike, do you want to --?

Yes, I think George touched on the key points. I think we're obviously going to ensure after closing the transaction that we maintain adequate liquidity and have the ability to invest in the business.

And, as we indicated I think when we got on the phone in December, the pro forma balance sheet will have appropriate levels of cash and have a credit facility in place to provide adequate liquidity to enable us to execute on -- and balance with investing in the business and ensuring that we can continue to balance that.

Okay. That's helpful. And then just on the other expenses, I know you gave some color in the quarter on product launches and marketing spend. Just wanted to get a sense when we think about this year maybe where the level should be on a per quarter basis and maybe just based on what you guys are working on in terms of the new product side and how maybe active that portion of the spend will be?

Yes, Michael, this is Mike Angerthal. I think a good way to look at it is over the course of the year, and I think when we look at the other operating expense line on an annual basis, I think the average was slightly over $11 million, maybe $11.3 million.

So there are going to be periods where it's on the high end and there will be periods on the low end. And you kind of saw that in the last two quarters. I think last quarter, we were slightly below $11 million, and here we're above that.

So, think the best way to look at it is look at our annual level and just look at that and provide it on a quarterly basis. And we will know that some periods will be slightly above or below.

Okay. Thanks a lot.

Ari Ghosh, Credit Suisse.

Hey, good morning, guys. Just coming back to the financing of the RidgeWorth deal, just wondering if the prevailing market conditions have nudged you any closer to finalizing a mix for that? And, specifically, if you can speak to a total Company debt to EBITDA level that you are comfortable running with, either from a Company target standpoint or based on the caps that you might have on your new facilities. Thanks.

Sure, so a couple things. As Mike sort of pointed out, and as we said on our last call, we already have the committed debt financing in place, we now have an effective registration statement. So you're alluding to another factor that we have to start thinking about is the market conditions which were -- which we will evaluate the market conditions.

So in terms of putting together the optimal mix, we are very focused on those elements of making sure we have a meaningful accretion to the shareholder, as Mike is alluding to, making sure that we still have the appropriate flexibility in our balance sheet. And, as we look in terms of being a debt bearing Company, and again at this size and this level of cash flows, we're much more comfortable than we would have been previously.

I'm not going to give you any specific guidance in terms of what that might look like. But as a publicly traded asset manager in terms of our size, we'll be cognizant of what's the appropriate level to do. But ultimately it will come down to making sure the combination of all these pieces do the right things for shareholders in terms of having us achieve the accretion that we're targeting as well as putting in the right capital structure for the long term of the business.

Mike, do you want to add anything at all?

The only thing I would add with respect to the view of the market conditions, I think we've indicated that we do intend to put the capital structure in place before closing of the transaction. So, that is something that we are focused on.

Got it. And then just on the institutional SMA side, hoping that you would flush out a little bit of the demand trends, where you're seeing the most demand and how that compares to 2016 where you saw a robust uptick in levels over there.

And then also if you could just talk about RidgeWorth's institutional net flow trends. I don't think we've touched on that before, and if you expect that to be net additive when the AUM rolls over. Thanks.

Well, so on the first piece in terms of the institutional business, and as we indicated in our remarks, we are very pleased that we've had some continued traction in that area. It's still not at the levels that we ultimately want to achieve. But very pleased to see the continued progress.

As you know, in any given quarter it's been different managers and different strategies. So Duff & Phelps has had periods where they've had solid contributions -- Kayne Anderson Rudnick as well and Newfleet as well. So, again, I still think we have opportunities with each of those managers, given the relative performance that we feel is very compelling and their differentiated strategy, so we continue to see opportunities there.

And I think -- it's hard to, as I sit here today -- I'd like to think that the market is a little more constructive than we might have otherwise been expecting, because you asked me how it was compared to last year, probably than we thought in January 2015. But that could all change tomorrow, but we feel very good that we have multiple engines there. And then, I'm sorry, your second question was really related to RidgeWorth's flows?

Yes, their institutional net flow trends. If you can provide a little color on what the trailing 12s looked like or even like directionally if you expect it to be net additive when the AUM rolls over.

Well, a couple things. We did give the ending AUM number for RidgeWorth and we're very pleased with that. And again, I think as you know, some of their mutual fund information is publicly discernible from stuff that's out there. So we've been very impressed with some of the strengths of some of their great funds including their senior floating rate fund.

For institutional in terms of whether -- how we're going to see it -- I'm not going to give you specific guidance. But one of the things that attracted us to this transaction is just the quality of the managers and their presence in that institutional space where they've continued to have opportunities on both the equity side as well as the fixed income side. So we're hopeful that that will continue to be the case and, obviously, will be additive to the traction that we've been generating.

Great. Thanks, guys. That's helpful.

Surinder Thind, Jefferies.

Good morning, gentlemen. I'd like to start with just a question about the sales and marketing strategy or distribution at this point, given the change in the administration and potentially the suspension of the DOL rule. What are you guys hearing from clients and how are you guys thinking about the strategy going forward versus maybe where you guys were three months ago?

Yes, it's -- in the environment whenever there is some uncertainty, that's always a challenge. I think we, like many others, are continuing to move forward with the assumption that things that have been going down the path in terms of fiduciary rule and some of the other changes that our distribution partners are making will continue to be the case. If that changes, we can certainly adjust, as well.

But we have been very focused on being good partners with our intermediaries, working on our share classes. And again, we do what we always do on the sales level which is trying to have our wholesalers engage financial advisors in the ways that can help them solve problems for their clients' portfolios, which generally in the past has been about having good strategies and a good asset allocation in their book.

But now part of it is also solving for some of those areas of focus from the DOL, etc. So we're continuing to work along the path that we're hearing from our distribution partners in terms of moving toward some of the goals that are being outlined by some of those regulations.

Fair enough. And just related to that, obviously, as we read in the media reports, some clients are heading down full path under the assumption that, whether or not the DOL rule is suspended, they are going down the path of more fee-oriented accounts versus others are taking a bit of a pause.

Do you think if the rule is suspended, just a more general question industry-wide, would that create more uncertainty for a couple -- for, let's say it takes them two years to get the rule rationalized or consistent with maybe what the SEC might be doing?

Well, it all depends on what the communication is, right? So right now if an industry expects a rule and it understands what the rule is it can work towards addressing.

If something is just simply suspended with no indication of what may be coming, that by definition will create a little bit more uncertainty. So I think it will all be about what the communication is and is something being delayed? Is something being terminated?

And then what's the vision in terms of what may come following? So, again, we live in a world that is subject to a lot of regulations and regulations change. I think the industry has done a good job of always being nimble in terms of being responsive to changes in regulatory direction and I expect we'll continue to do so.

That's helpful. And then maybe just a really quick question on the compensation level.

Looking at the 4Q numbers, it was perhaps a little bit higher than what I was expecting. Is that fair for a run rate going forward other than seasonality? Or is there maybe some true-up embedded in there?

I think it's fair to model at the level in the fourth quarter. As I indicated, I think variable compensation was increased during the quarter. That offset decreases in the fixed level, the base salaries based on some of the restructuring and severance we had undertaken earlier in the year. So I think this quarter is a good indicator.

Understood. And can you remind me approximately what percentage is variable compensation?

We talked about a meaningful level, probably between 50% and 55% being variable in nature. And some of that is driven by profit pools and sale-based and just a reminder that our affiliates each have discrete profit pools based on their respective performances in periods where AUM changes either by third-party subadvisors or in one area or another. You do need to recall that the pools are distinct and separate for each of our affiliates.

Understood. Thanks, that's it for me.

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

I want to thank everyone today for joining us. And we certainly encourage you to give us a call if you have any other further questions. Thank you.

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