Virtus Investment Partners, Inc. Q4 FY2023 Earnings Call

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. 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, 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 fourth quarter of 2023. Our speakers today are George Aylward, President and CEO; and Mike Angerthal, Chief Financial Officer. Following the 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 use certain non-GAAP measures to evaluate our financial results. Our non-GAAP financial measures are not substitutes for the 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.

Thank you, Sean. Good morning, everyone. So I'll start with an overview of the results reported this morning before turning it over to Mike to provide some more detail. Though still volatile, the market has trended more favorably in the fourth quarter on views of inflation and interest rate expectations, leading to an increase in assets under management. While we had net outflows driven by open-end funds, consistent with the industry as well as specific institutional accounts, we also had strong retail sales, including the highest retail separate account sales in two years, positive net flows in retail separate accounts and ETFs, each of which had organic growth for the full year, lower total operating expenses for the quarter, with other operating expenses essentially flat for the full year, increased return of capital including $20 million of share buybacks, attractive investment performance across strategies both long term and for the one-year period, and repayment of debt, ending the quarter with low net leverage and a well-positioned balance sheet. Total assets under management increased 6% to $172 billion, primarily due to favorable market impact, in addition to positive net flows in retail separate accounts. Sales increased 7% to $6.2 billion due to a 12% increase in retail sales, with particularly strong growth in retail separate accounts, which grew 15% led by private client. Open-end fund sales increased 9%, with sequentially higher sales of domestic equity, fixed income, and alternative strategies. Net outflows were $3.8 billion, compared with net outflows of $1.5 billion last quarter. By product, institutional had net outflows of $2.2 billion compared with net outflows of $0.4 billion last quarter, which included redemptions related to repositioning by several retirement plan mandates. The institutional business is inherently variable on a quarterly basis, but has generated organic growth in three of the last four years with contributions across affiliates, strategies, and geographies. Retail separate accounts generated positive net flows of $0.4 billion and were positive for the full year. We continue to see retail separate accounts as a key growth area as we expand offerings with additional strategies to complement our strength in small, SMID, and mid-cap equities. Open-end net outflows of $2 billion compared with $1.5 billion in the third quarter due to a higher level of redemptions across strategies. Those SMID-cap and global equities continue to generate organic growth. ETFs again generated positive net flows and for the full year delivered 14% organic growth, as we've continued to broaden the product lineup with additional distinctive active strategies. In terms of what we saw in January for flows, retail and institutional net flows were each improved meaningfully. On the retail side, while it is just one month, January was the best month for net flows and open-end funds since September of 2021, with net outflows of approximately $150 million. That represents less than 25% of the average monthly net outflow in the fourth quarter, with improvement across asset classes including breakeven net flows in domestic equity and positive net flows in alternatives. Earlier this week we reopened two capacity-constrained small-cap strategies that have been closed since 2018 and have already seen a meaningful level of interest for them. For institutional, we had a large funding early in January that had been delayed from the fourth quarter. All else being equal, institutional is generally trending towards flat net flows for the first quarter based on known and expected upcoming funding and redemption activity. This business can fluctuate in the short term and we have seen a more prolonged funding cycle. However, the pipeline continues to be strong in terms of size and with broad representation across affiliates, strategies, and geographies. Our fourth quarter financial results reflected lower average AUM, largely due to the timing of market performance and net outflows, partially offset by lower total operating expenses. The operating margin was 33%, down sequentially from 33.9% due to lower investment management fees and was up 120 basis points from the prior year period. Earnings per share, as adjusted, of $6.11 compared with $6.21 in the prior quarter and were up 18% from $5.17 in the fourth quarter of 2022. During the quarter, we continued to take a balanced approach to capital management. We repurchased approximately 98,000 shares for $20 million, up from $15 million in the prior quarter. For the full year, we repurchased approximately 224,000 shares and reduced outstanding shares by 1%. In 2023, we increased our quarterly dividend by 15%, our sixth consecutive annual increase in our dividend. We also repaid the remaining $20 million outstanding on our revolving credit facility and ended the quarter in a modest net debt position and gross debt below 1 times EBITDA. We continue to generate significant cash flow, providing ongoing opportunities to invest in the growth of the business and return capital to shareholders.

Thank you, George. Good to be with you all this morning. Starting with our results on Slide 7, assets under management. At December 31st, assets under management were $172.3 billion, up 6% from $162.5 billion at September 30, due to $14.3 billion of favorable market performance, partially offset by net outflows of $3.8 billion. Average assets under management in the quarter decreased 3% to $162.7 billion with ending assets 6% above the quarter's average. Our assets under management represented a broad range of products and asset classes. Institutional, our largest product category, was 37% of AUM. Retail separate accounts have delivered consistent organic growth and are at 25% of assets, up from 16% five years ago. We also remained well diversified among and within asset classes. Alternatives and multi-asset, in which we had limited presence several years ago, totaled over 20% of our AUM, reflecting the results of our strategic efforts to expand capabilities, particularly in less correlated strategies. Non-US clients represented 18% of AUM and generated 10% organic growth in 2023. We continue to have compelling long-term relative investment performance across products and strategies. As of December 31, approximately 69% of institutional assets, 86% of retail separate account assets, and 62% of rated mutual fund assets were outperforming their benchmarks over five years. The mutual funds, 71%, outperformed the median of their peer groups over the five-year period. In addition, 69% of rated fund assets had four or five stars, and 90% were in 3, 4, or 5 star funds. We had 38 funds that were rated 4 or 5 stars, including 11 with AUM of $1 billion or more. Our managers performed well for the full year 2023, with 58% and 90% of institutional and separate accounts AUM respectively, meeting benchmarks for the period, while 55% of mutual fund AUM beat benchmarks and 70% outperformed the median performance of the peer group. Total sales of $6.2 billion increased 7% from $5.8 billion due to growth in both retail separate accounts and open-end funds. By product, institutional sales were $1.2 billion compared with $1.3 billion in the prior quarter, which included the issuance of a $300 million CLO. Retail separate account sales of $2.1 billion increased 15% from $1.8 billion, led by significant growth in private client sales. Open-end fund sales of $2.9 billion increased 9% from $2.7 billion, primarily due to higher sales in mid-cap, SMID-cap, and bank loan strategies. Total net outflows were $3.8 billion, compared with $1.5 billion of net outflows in the prior quarter. Institutional net outflows of $2.2 billion included approximately $1 billion of redemptions from several long-standing retirement plan mandates. Retail separate accounts generated positive net flows of $0.4 billion, which increased from $0.3 billion in the prior quarter. Both intermediary sold and private client continued to generate positive net flows. For open-end funds, net outflows were $2 billion compared with $1.5 billion in the third quarter due to higher redemptions across strategies. ETFs were again positive and on a full year basis generated 15% organic growth.

Turning to capital, our operating income as adjusted decreased by $3.1 million or 5% sequentially, due to the lower average assets under management, partially offset by lower total operating expenses. The operating margin as adjusted was 33% compared with 33.9% in the third quarter. With respect to non-operating items, other income as adjusted increased by $0.5 million, reflecting higher earnings on equity method investments. Total net interest income decreased modestly from the prior quarter, which included a higher level of CLO interest income from a recent issuance and reflected lower gross debt. Net income as adjusted of $6.11 per diluted share declined 2% from $6.21 in the third quarter. We ended 2023 with appropriate levels of working capital and modest leverage, providing meaningful financial flexibility to invest in the business, return capital, and repay debt. During the quarter, we repaid the remaining $20 million balance on our revolving credit facility and ended the year with net debt of $19 million, representing net leverage of 0.1 times EBITDA. We also repurchased 97,952 shares during the quarter for $20 million, up from $15 million in the prior quarter. For the full year 2023, we repurchased 223,807 shares for $45 million and reduced the share count by 1.3%. I would also note that as a reminder, our intangible assets continue to provide a cash tax benefit. At current tax rates, we estimate the tax attributes could provide a cash tax benefit of approximately $19 million per year over the next 10 years. And with that, let me turn the call back over to George. Thanks, Mike. Okay, so we'll now take your questions. Dede, would you open up the lines, please?

Certainly. And our first question comes from Crispin Love of Piper Sandler.

Thanks. Good morning, everyone. Appreciate you taking my questions. Just first, on the institutional flow side. You mentioned that the outflows in the quarter were driven by some of the repositioning by some of the large retirement plan mandates. Can you just provide a little more detail there? I heard some of the more constructive color on January in the first quarter, but is repositioning of retirement mandates something that you would expect to see more of in 2024 through the year, or can just the institutional flows here just be lumpy based on the quarter and could trend closer to more recent levels?

A couple of comments, and then Mike can add to that. So every retirement plan, pension plan has different attributes and is at different points in terms of funding cycles. What was unusual for us was to have multiple plans, each with different clients and different strategies, reaching a level of funding and giving the strength of the ending of the market share. It's not unusual for a plan or any client to reposition their risk profile and lock in returns. While the institutional business is variable by nature, it has generated organic growth in three of the last four years with contributions across affiliates, strategies, and geographies. So I would not be surprised if we see some more repositioning this year.

From our perspective, those redemption levels were sort of at the fee rate of our blended fee rate. So nothing unusual, other than for multiple plans to all rebalance in this relatively short period of time.

Which is unusual, considering what happened at the end of the year in the markets. So, you were in that environment where there was a nice pop in equity.

Great. And then just, Michael, just on the institutional fee rate increased by about 3 bps in the quarter and is at a higher level than we've seen for several quarters. Is that mix of assets or anything to call out there? Does that have anything to do with the redemptions?

No, the performance fees in the quarter were $3.3 million, which ticked up a bit and were really driven by institutional accounts. We try to normalize that in our disclosures. Looking ahead, I think 42 to 44 for our blended fee rate remains appropriate for modeling as we go forward. The adjusted fee rate on a normalized basis is a good way to think about it going forward.

We disclose the impact of the performance fees on the institutional, so it's always good to look at it with and without to observe the trend of the underlying accounts.

Perfect. That makes sense. And then just one last question for me, just on the non-controlling interest on the adjusted income statement. The dollar value here was at the lowest level for a few years. Can you discuss kind of why that was the case in the quarter and just some of the adjustments there, the GAAP to non-GAAP?

The non-controlling interest relates to the portion of sustainable growth advisors that the company does not own. You may recall last year, we did increase our ownership from 70% to about 75% in the third quarter. The change primarily reflects the change in ownership. As we look forward, a good way to model the non-controlling line is to take an average of those two quarters, third quarter and fourth quarter, as a benchmark moving forward.

Perfect. Thank you. I appreciate you taking my questions.

Thank you.

Thank you. One moment for our next question. And our next question comes from Bradley Hays of TD Cowan.

Hi. Good morning. It's Bradley Hays on for Bill Katz. How are recent takeout multiples impacting the way you're thinking about deal opportunities as well as what you're seeing in the market?

In terms of the impact from takeout multiples, we continue to evaluate the opportunities that are currently out there, and multiples will ebb and flow based on the asset class and specific opportunity sets. There has been some pull-in of some of those multiples. But there are different ranges of multiples depending on whether you're talking about a traditional opportunity versus one that is alternative. We stay cognizant of these factors as we assess our opportunities.

Okay. As your net debt to EBITDA sits quite low, how does this play into or change your thoughts around the cadence of capital return or deployment?

In terms of capital, with low levels of leverage and significant cash flow, we continually evaluate how to best deploy capital, including in growing the business, which is fundamental to generating long-term shareholder value. We continue stock buybacks and various strategies will generally vary based on how our stock is trading, interest rates, and other market factors.

Specifically, the first quarter also includes a revenue participation payment annually, which has been around the $25 million mark in the last several first quarters. I'd expect it to be somewhere around that level. So in addition to annual incentives and other cash needs in the first quarter, we will be expecting to make that payment. Over that period, we've consistently raised the dividend with a nice growth rate while also reducing the share count.

Great. Just final question for me on M&A. I was hoping maybe you could elaborate a bit on the M&A pipeline and conversations that you're having with prospective candidates in the marketplace. How would you sort of characterize those conversations today versus maybe six or 12 months ago? What are some of the properties that are coming across your desk, and where do you see some of the biggest opportunities for M&A at this point for Virtus?

The number of conversations and frequency remains pretty consistent. However, they have focused more on strategic fit and alignment of interest than merely auction processes. We're interested in many conversations, particularly in non-traditional and alternative strategies. Our last two transactions were in the liquid alt side. While we focus on organic growth strategies, we are excited about the number of opportunities that could be out there, provided they align with our capital use and growth strategy.

Great. Thanks so much.

Thank you.

Thank you.

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

Great. Thank you. I want to just thank everyone for joining us today. As always, we certainly encourage you to give us a call if you have any other further questions or need information. Thank you all. Have a great day.

That concludes today's call. Thank you for participating, and you may now disconnect.