VRTS - NASDAQ

Good morning. My name is Dede, 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 being recorded and will be available for replay on the Virtus website. [Operator Instructions] I will now turn the conference to your host, Sean Rourke.

Thank you, Dede, and good morning, everyone. On behalf of Virtus Investment Partners, I'd like to welcome you to the discussion of our operating and financial results for the first quarter of 2024. Our speakers today are George Aylward, President and CEO; and Mike Angerthal, Chief Financial Officer. Following their prepared remarks, we'll have a Q&A period. Before we begin, please note the disclosures on Page 2 of the slide presentation. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and as such are subject to known and unknown risks and uncertainties including, but not limited to, those factors set forth in today's news release and discussed in our SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements. In addition to results presented on a GAAP basis, we have certain non-GAAP measures to evaluate our financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results and should be read in conjunction with them. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in today's news release and financial supplement, which are available on our website. Now I'd like to turn the call over to George. George?

Thank you, Sean, and good morning, everyone. I will start with an overview of the results we reported this morning, and then I'll turn it over to Mike to provide a little more detail. Market strength continued into the first quarter despite ongoing investor uncertainty over the path of inflation and interest rates, leading to growth in our assets under management to $179 billion. We saw meaningful increases in retail and institutional sales and improved net flows across asset classes and strategies given the diversity of our product offerings, compelling investment performance and effective distribution. We were also pleased with the recognition in Barron of our investment performance earlier this year, which identified us as a top 5 fund family for all periods under review, including for the year of 2023 as well as the longer-term 5- and 10-year periods. For the quarter, our highlights included a 22% increase in sales with strong growth in all product categories, positive net flows in retail separate accounts, ETFs and global funds, growth in operating earnings and the margin, excluding seasonal expenses, attractive investment performance across strategies and continued return of capital through share repurchases, net settlements and our dividend and we ended the quarter with reasonable levels of leverage. Turning now over to the results. Total assets under management increased 4% to $179 billion, primarily due to favorable market performance in addition to positive net flows in retail separate accounts, partly offset by net outflows in institutional and open-end funds. Sales increased 22% to $7.6 billion with double-digit growth in all product categories, including a 47% increase in sales of institutional, 18% in open-end funds and 12% in retail separate accounts as investors solely began to put some cash back to work as equity markets reach new highs. Open-end fund sales reached our highest level in 2 years with growth across most strategies and our retail separate account sales were the highest in 3 years. Net outflows were $1.2 billion, an improvement from the net outflows of $3.8 billion in the prior quarter. By product, institutional net outflows of $1.3 billion, a sequential improvement from $2.2 billion, the redemptions included the rebalancing by several accounts given the strong equity market appreciation over the past 2 quarters. Institutional is inherently variable on a quarterly basis, though we continue to see broad-based interest in our strategies. Retail separate accounts generated positive net flows of $0.7 billion, the highest level in 2 years. Demand for SMID and Mid-Cap has been strong, and we continue to introduce additional strategies to complement those offerings to drive growth over time. Open-end fund net outflows of $0.6 billion were at their best level since the second quarter of 2021 and improved from $2.0 billion in the fourth quarter with better flows in most strategies and positive net flows in Mid-Cap, global equity and fixed income. In terms of what we're seeing so far in April, many of the first quarter trends have continued, including solid momentum in retail separate accounts and ETFs, as well as generally similar retail fund flow trends with pockets of strength in certain strategies. In institutional, we have high levels of activity across both geographies and strategies that are based on known fundings and redemptions, the second quarter is tracking similarly to the first. Our first quarter financial results reflected the impact of seasonally higher employment expenses, absent which we achieved sequential improvements in both operating income and margin as we generated higher revenues and closely managed expenses. Excluding the seasonal employment expenses, the operating margin was 33.6%, up 60 basis points from the fourth quarter due to higher revenues and lower other operating expenses. Earnings per share as adjusted of $5.41 declined from the fourth quarter due to $1.11 of seasonal expenses. Excluding those expenses, EPS as adjusted increased 7% sequentially. On a more comparable year-over-year basis, earnings per share as adjusted increased 29%. Turning now to capital. During the quarter, we repurchased or net settled approximately 64,000 shares for $15 million. We continue to take a balanced approach to capital management by investing in our growth, returning capital to shareholders and maintaining appropriate levels of leverage. Over the past year, we have repurchased or net settled 296,000 of our shares for $61 million and reduced outstanding shares by 2%, raised our quarterly dividend by 15%, close on a strategic acquisition that increased our product capabilities and maintain net leverage below 0.5x. We ended the quarter with modest net debt position as the first quarter represents our highest quarter of cash utilization given the timing of annual incentives and a revenue participation payment. We continue to generate significant cash flow, providing ongoing opportunities to invest in the growth of the business and return capital to shareholders. And with that, I'd like to turn the call over to Mike. Mike?

Thank you, George. Good to be with you all this morning. Starting with our results on Slide 7, assets under management. At March 31, assets under management were $179.3 billion, up 4% from $172.3 billion at December 31 due to $8.7 billion of favorable market performance, partially offset by net outflows of $1.2 billion. Average assets under management in the quarter increased 7% to $173.4 billion, with ending assets 3% above the quarter's average. Our assets under management continue to represent a broad range of asset classes and products. Institutional was 36% of AUM. Retail separate accounts, which has delivered consistent organic growth was at 26% of assets. Global Funds and ETFs, while a relatively small portion of our AUM at a combined 4% have had consistent organic growth and their combined AUM is up 36% over the prior year period. We also continue to have compelling long-term relative investment performance across products and strategies. As of March 31, approximately 53% of institutional assets ,85% of retail separate account assets and 56% of rated mutual fund assets were outperforming their benchmarks over 5 years. For mutual funds, 62% outperformed the median of their peer groups over the 5-year period. In addition, 63% of rated fund assets had 4 or 5 stars, and 91% were in 3, 4 or 5-star funds. We have 35 funds that were rated 4 or 5 stars, including 11 with AUM of $1 billion or more. And we had 6 ETFs that were rated 4 or 5 stars as well. Turning to Slide 8, asset flows. Total sales of $7.6 billion increased 22% from $6.2 billion due to growth in all product categories. Institutional sales of $1.7 billion increased from $1.2 billion in the prior quarter. Retail separate account sales of $2.4 billion increased 12% from $2.1 billion. Open-end fund sales of $3.5 billion increased 18% from $2.9 billion due to growth across most investment strategies with strong growth in small cap where we recently reopened 2 strategies that had been soft closed. Total net outflows were $1.2 billion with marked improvement from $3.8 billion of net outflows in the prior quarter. Reviewing by product. Institutional net outflows of $1.3 billion improved from $2.2 billion in the fourth quarter. As always, institutional flows will fluctuate depending on the timing of client actions. In retail separate accounts, positive net flows of $0.7 billion increased from $0.4 billion in the prior quarter and represented our highest net flows in 2 years. Both intermediary sold and private client continued to generate positive net flows. For open-end funds, net outflows were $0.6 billion compared with $2 billion in the fourth quarter due to higher sales and lower redemptions and included positive net flows in small cap, global equity and fixed income. ETFs were again positive and have generated a 34% organic growth rate over the past year. Global Fund net flows were also positive with organic growth of 12% for the past year. Turning to Slide 9. Investment management fees as adjusted of $180.5 million increased $6.1 million or 3%, reflecting the 7% increase in average assets under management, that was partially offset by lower performance fees, which were elevated in the prior quarter. The average fee rate of 41.9 basis points compared with 42.6 basis points in the prior quarter, which included 0.8 basis points of performance fees. The first quarter average fee rate was unfavorably impacted by discrete fund reimbursement costs of 0.2 basis points. Normalizing for that as well as 0.1 basis points of performance fees, the average fee rate in the quarter was 42 basis points, modestly higher than the 41.8 basis points normalized fourth quarter average fee rate. Looking ahead, we believe the normalized first quarter average fee rate is reasonable for modeling purposes. As always, the fee rate will be impacted by markets and the mix of assets. Slide 10 shows the 5-quarter trend in employment expenses. Total employment expenses as adjusted of $111.6 million increased 15% sequentially, reflecting $10.9 million of seasonal employment expenses related to the timing of annual incentives, primarily incremental payroll taxes and benefits. Excluding the seasonal items, employment expenses increased by 4% sequentially due to higher profit and sales-based variable incentive compensation. Employment expenses were 55.7% of revenue as adjusted. And excluding the seasonal items, they were 50.3%, slightly above the prior quarter level of 50% due to higher variable incentives. Looking ahead, we believe employment expenses as a percentage of revenues in a range of 49% to 51% is reasonable. Though, as always, it will be variable based on market performance, in particular as well as profits and sales. Turning to Slide 11. Other operating expenses, as adjusted, were $30.2 million, down $1 million or 3% from the fourth quarter. We have maintained other operating expenses within a narrow range over the past 2 years despite inflationary pressure and the addition of a new affiliate last year, reflecting management of some of our longer-term contractual expenses and by limiting discretionary spending. Looking ahead, the quarterly range of $30 million to $32 million for other operating expenses as adjusted remains reasonable. For modeling purposes, keep in mind that our annual Board of Directors' equity grants occur in the second quarter. Slide 12 illustrates the trend in earnings. Operating income as adjusted of $56.4 million declined $7.4 million or 12% sequentially due to the seasonal employment expenses. Excluding those items, operating income increased 5%. Looking at the more comparable year-over-year period, operating income increased 19%. The operating margin as adjusted of 28.2% compared with 33% in the fourth quarter. Excluding the seasonal employment expenses, the operating margin was 33.6%, an improvement of 60 basis points with an incremental margin of approximately 50%. On a year-over-year basis, the operating margin improved by 140 basis points. With respect to nonoperating items, interest expense decreased by 5% sequentially, reflecting lower gross debt due to the repayment of our revolving credit line in the fourth quarter. Noncontrolling interest increased by $1 million reflecting growth in affiliate earnings. Net income as adjusted of $5.41 per diluted share, which included $1.11 of seasonal expenses compared with $6.11 in the fourth quarter and increased 29% over the prior year period. In terms of GAAP results, net income per share of $4.10 compared with $4.21 per share in the fourth quarter and included $0.69 of unfavorable fair value adjustments to affiliate minority interests and $0.11 of acquisition and integration costs. Slide 13 shows the trend of our capital liquidity and select balance sheet items. Working capital was $123.4 million at March 31, up sequentially from $109.1 million as cash generated by the business more than offset return of capital to shareholders. Cash and equivalents declined sequentially to $123.9 million from $239.6 million at December 31. Cash utilization in the quarter included the annual incentives and the revenue participation payment as well as return of capital to shareholders through the dividend, share repurchases and net settlements. As a reminder, the first quarter typically represents the low point of our cash during the year. The contingent consideration liability was reduced by a $24.2 million revenue participation payment to $66.7 million. The majority of that liability will be paid annually over the next 2 years in the first quarter. At March 31, gross debt to EBITDA was 0.9x, the same level as December 31. Net debt at March 31 was $134.2 million or 0.4x EBITDA. We generated $69 million of EBITDA in the first quarter, down sequentially due to seasonal employment items, but up 17% from the prior year level. During the quarter, we repurchased 21,108 shares of common stock for $5 million and net settled an additional 42,588 shares for $9.9 million to satisfy employee tax obligations. Over the past year, we have reduced total shares by 2.2%. With that, let me turn the call back over to George. George?

Thanks, Mike. So we will now take your questions. Dede, would you open up the lines, please?

[Operator Instructions] And our first question comes from Crispin Love of Piper Sandler.

Just looking forward on flows. Based on your -- it seems like April to date shaping up to be pretty similar to the first quarter, this first is that fair. And then do you think that's sustainable just given the -- some of the volatility we've seen in April to date in markets and rates? And have you been pleased with those flows so far enabled in this backdrop? And just if there's anything else to call out product line, that would be great.

Yes. So for -- talk about funds for a bit. So what's interesting, obviously, is the market conditions at the very end of March are not similar to some of the volatility and weakness we've had over the last few weeks. We did indicate that they're generally trending similar, I think what the difference is, and we referred to some pockets is in this quarter, you're actually -- why were you seeing continued strength in some of the SMID and the Mid, you're seeing some more interest in the less correlated strategies given that volatility in the market, which makes total sense. We did see a little bit of a rebalancing, but even with that, the trajectory is very similar to what we saw in the first quarter. If things continue the way they are now, it just may be a difference in composition whereas a lot of the first quarter was about people taking advantage of the highs of the equity markets, you may see it a little bit more in the second quarter where people are looking for lower correlation or really making different decisions in terms of their fixed income allocations. And I think that continues -- the trends for the retail separate accounts and the ETFs very similar to what we saw in the first quarter.

That's helpful, and that makes a lot of sense in the less correlated strategy for April. And then just one last question for me. Can you just give us your kind of latest views and thoughts on the potential to add additional affiliated managers? M&A was light in 2023. But we could be entering an environment where you could see some more activity here. And what are the areas where you're most interested in? And then just kind of to start the year, have conversations been picking up, stalling or kind of pretty stable with potential new managers?

Yes. So overall, I mean, conversations have always continued. So the activity probably other than a couple of recent announcements in the industry, maybe it's been a little bit low, but my view and my perspective, and I think it's shared by others, is there's been ongoing dialogues and conversations about firms looking on different ways to partner with each other. I think the interest in doing that has remained. I think people have been more thoughtful about the nature of the conversation. And again, I think they generally are getting more creative in terms of the ways that they're partnering as opposed to maybe some of the more traditional ways of doing that. So we continue to remain just as active as we've always been in our conversations. For us, it only makes sense if it meets certain strategic fits for us, either in terms of product capability, distribution access or our relative scale. So that is something we continue to evaluate. We always focus first on our organic growth, but we do look at those opportunities. And just in terms of what could be interesting, again, you never know what that may be. But in our last few transactions, they were really focused a little bit more on the less correlated types of liquid alternatives. We continue to see that as an opportunity for further expansion as we're pretty well represented in the traditional long-only categories. That's not to say that there couldn't be something that's interesting there. But generally, the less -- the noncorrelated and less liquid areas would be areas of interest.

And our next question comes from Michael Cyprys of Morgan Stanley.

I was hoping you could talk about the international distribution efforts. Maybe you could update us on how that is progressing, how much is that contributing to flows in AUM today? And talk about the progress and expansion of the team and how that's all coming together. And then more broadly, just on the institutional pipeline. If you could just maybe elaborate a bit more on some of the strengths that you're seeing puts and takes between the different strategies and different subchannels within the institutional broader channel.

Yes. So a couple of quick thoughts, and then I'll ask Mike to add to that. So we continue to be very optimistic about our opportunities on the non-U.S. institutional side. We've been pleased from the very beginning with the embracing of our capabilities by some of our newer resources and then being very effective in terms of getting us in front of potential clients and consultants that we might not otherwise previously have had access to, given we didn't have the presence outside the U.S. And over the last few years, we've highlighted on several quarters where we've had significant mandates across strategies. I think one quarter when I think we had a large cap growth equity. I think we have a fixed income, and we have a global REIT, all in one quarter, all outside the U.S. So we continue to see those levels of activity. We've commented previously. We have seen some lengthening of the decision period for that. But we continue to be optimistic in that area and see that as a good opportunity for us. Mike?

Yes. I think we talked about the sales increase sequentially all -- across all product types, certainly, we saw that on institutional as well. So we are pleased to see that tick up. And we're seeing that across our affiliates and across geographies. We've talked before about contribution across several of our managers in actual fundings as well as what we see in the pipeline. The business is inherently lumpy. We are pleased that we had improvement -- marked improvement on the net outflows sequentially. And when we look to the pipeline, there is contribution continued across our managers and across geographies, and that includes higher levels of activity. And that activity is meaningful from multiple geographies and includes meetings, RFPs and strong activities that are ongoing. So difficult to forecast flows, but we're pleased with the activities that we're seeing across the teams.

Great. And just a follow-up question on the ETF side, seeing some strength there year-on-year that you had called out. Just hoping you could update us more broadly on your overall ETF strategy. To what extent is there any sort of appetite for doing mutual fund to ETF conversions as we're seeing from some other managers and more broadly, on active ETFs? What's the sort of appetite for broadening out the offering of active ETF strategies, too?

Yes. No, great question. I think in terms of the utilization of ETFs, our perspective is that there continues to be further refinement on the utilization by specific financial advisers and how they want to access investment strategies. And I think that is leading to more of an evolution in terms of not purely utilizing the ETF as sort of lower-cost beta, but instead using it as a vehicle of choice for certain actively managed strategies. I think you particularly see that in fixed income. I think we and others have been introducing fixed income ETFs for the reason that it's become a more preferred vehicle for that. I think that is continuing. I think most of our recent product introductions have been on the ETF side and a lot of the things that we currently have in development will be to expand those ETF offerings. And again, it's really -- because our goal has always been to make our managers and strategies available and allowing potential clients to access it through different vehicles. So we increasingly see the opportunity set as some people may still want access it via the traditional open-end fund. We've obviously seen the growth in the demand on the retail separate account side. And you see that more on the actively managed side for ETFs, a little more so for fixed income right now than maybe equity and also on the less correlated, noncorrelated types of strategy. So we continue to see that as an area of growth. In terms of your questions around your conversions, and I think as you know, there's also activity around people considering the opportunity to utilize the share cash structure. We keep our mind open to those. Again, we have the ability to do open-end funds and we have the ability to do ETFs, theoretically also have the ability to do conversions. I think in terms of the conversions, and I think there was some recent article, I remember seeing where a lot of the success in the conversions has really been limited to 1 or 2 firms in that. So again, if that's something that we think is an opportunity for us, we would consider it, but we don't have anything in filing related to that.

Just on that point, if I could follow up on the conversion. Just curious what you think drives success where that is happening in the marketplace. And what sort of leads you to evolve your views on that point or sort of what holds you back from stepping into that?

Well, I think it gets to -- ultimately, I think for -- there's logical reasons for people to make the decision to do the conversions in terms of what they think is the right connection between the ultimate client and the vehicle that they're trying to access, right? So the choice is to either convert or to just introduce through a different wrapper. So I think it's very specific. I think it's specific to the nature of the type of financial advisers that utilize your vehicles as well as the channel that you sell them in. So in some of the firms that have made those conversions, they would align very easily with the specific adviser group that utilized their strategy or to the channel in which they're available. So all those things would be things that we would kind of factor in if we were to make that decision.

And our next question comes from Bradley Hays of TD Cowen.

It's Bradley Hays on for Bill Katz. Starting on the balance sheet. How should we think about the cadence of rebuilding the cash balance? And related to that, how should we think about the priorities for deployment between buyback, debt paydown, M&A, et cetera?

Yes. Bradley, it's Mike Angerthal. I think the cash balance just as we cited the first quarter is the highest use period for us for cash with the payment of annual incentives and we had our third revenue participation payment of $24 million occur in the first quarter. So just the cadence of those payments, you'll see typically the Q1 of the lowest part of the year and then you'll naturally rebuild cash as it's generated from the business through the remainder of the year. So as you saw in the fourth quarter last year, that was the highest point of capital and cash for the year. It's just the typical seasonal cash build for the business. I think in terms of capital priorities, we talked about our balanced approach to capital management. I think 2023 is a good depiction of that. We used capital in connection with the strategic acquisition during the year that closed in April of 2023, raised our dividend for the sixth consecutive year in the third quarter and bought back meaningful amount of shares while continuing to invest in the business, which included seeding new strategies and we supported one of our affiliates with the launch of a CLO. So investing in the business, paying down debt for strategic investments in the business and then returning meaningful capital to shareholders are all priorities and representative of our approach to capital management.

I know you probably saw the strategic partnership announcement from one of your peers. Is there any appetite to explore something similar?

Yes. We don't comment on other specific types of transactions. But again, our view is as we evaluate any way that we believe could potentially create long-term value for shareholders. And in terms of partnering, in my earlier comments, I kind of made reference to, I think there continues to be sort of an evolution in the ways that people approach partnering. I do think that would be a good example of other less traditional ways of doing that. So again, we would evaluate any different type of structure if we thought that there was a strategic fit and it was a value creator for shareholders.

Okay. And then if there's time for one more. Looking at fixed income, how are you thinking about your various strategies in sub-asset classes, given the higher for longer environment, we're increasingly seeing ourselves in? Is there a greater focus to develop or push more active strategies, anything opportunistic there?

Yes. Well, our strategy is from the 3 managers we have with the fixed income really across the spectrum, right? So we have -- what's kind of interesting is between the capabilities that we have at Newfleet, which has strategies in the shorter duration, which probably were less in favor of the intermediate now being much stronger. And then in -- separately we have the sites, in particular, they are alone in the high-yield capabilities as well as then Stone Harbor with their emerging market debt. So we actually think that there's lots of different opportunities as we tried to encourage fixed income investors as everyone else is, to not relying totally on treasuries given where they currently are, but sort of avail themselves. And we saw a little bit of the strength in that in some of the loan fund flows. But there are other ways to diversify their income stream, and we do think we have several managers that would be compelling in that environment, and that's one of the things that our sales force is focused on.

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

Great. Thank you so much. And I just want to thank everyone today for joining us. And obviously, as always, we encourage you to reach out if you have any other further questions. Thank you.