Virtus Investment Partners, Inc.

Good morning. My name is Gigi, 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 speaker's 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 Rorick.

Thank you, 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 2021. Our speakers today are George Elward, President and CEO, and Mike Angerthal, Chief Financial Officer. Following their prepared remarks, we will have a Q&A period. Before we begin, please note the disclosures on page two 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 GAAP financial results and should be read in conjunction with the GAAP results. Reconciliations of these non-GAAP financial measures, the applicable GAAP measures are included in today's news release and financial supplement, which are available on our website. Now I would like to turn the call over to George. George?

Thank you, Sean. Good morning, everyone. I will start today with an overview of the results we reported this morning, and then Mike will provide more detail. We are pleased with the significant strategic and financial accomplishments of the past year, which presents us well to navigate what may be a challenging market environment in 2022. Over the past year, we have meaningfully increased scale with assets under management up by more than 40%, generated positive organic growth for the second consecutive year, delivered our highest levels of operating profitability and earnings per share, significantly increase cash flow, including nearly doubling EBITDA to $440 million, increase return of capital through higher share repurchases and a meaningful increase in our dividend, and finalize three strategic and highly differentiated transactions, including Stone Harbor Investment Partners on January 1st, which adds $14.7 billion of emerging markets debt and multi-asset credit strategies, and the talented team that we are excited to welcome as a new affiliate. The strategic transactions, which also include Allianz GI and Westchester Capital, added nearly $50 billion of assets under management in complementary and differentiated investment strategies and enhanced our distribution breadth and capabilities. These transactions were executed with existing balance sheet resources and meaningfully increased our cash flow generation. We ended the year in a net cash position, providing ongoing flexibility to invest in the business and continue to return capital to shareholders. For the fourth quarter specifically, we delivered very strong financial and operating results, including our highest level of earnings per share as adjusted, a 50% operating margin, continued strong investment performance, positive net flows in retail separate accounts, ETFs, and institutional, and continued return of capital, including an increase in our level of share repurchases. Turning to a review of these results, Total assets earned in management were $187.2 billion, up 14% from September 30th due to market performance and the addition of Westchester Capital, which closed on October 1st. Sales momentum increased with $8.7 billion of inflows, up sequentially from $7.6 billion, and with growth in all product categories. Net flows were essentially break-even as ongoing positive organic growth in retail separate accounts, institutional and ETFs, was offset by open-end fund net outflows. By product, retail separate accounts generated positive net flows for the 15th consecutive quarter with an 11% organic growth rate. Institutional net flows were positive for the 5th consecutive quarter with continued traction at multiple affiliates and from both existing mandates and new accounts. ETFs generated positive net flows for the 6th consecutive quarter with and open-end net flows were negative, consistent with industry trends, and largely due to outflows from emerging market and domestic growth equity strategies. In terms of the flows we saw in January, the fourth quarter trends continued, including positive flows in retail separate accounts, institutional, and ETFs. In open-end funds, international and domestic equity strategies continued to be in net outflows, and we are still seeing positive net flows into alternatives and bank loan strategies where inflows have accelerated. Our financial results for the quarter reflected AUM growth and the benefits of our variable expense structure. Operating income has adjusted and increased by 6% sequentially to $117 million, and the related margin of 50.2% was relatively consistent with the prior quarter and up nearly 10 percentage points from the prior year period. Earnings per share has adjusted and increased 7% sequentially to $10.36 and our highest reported level, primarily due to higher revenues. Turning now to capital, during the quarter we increased the level of stock buybacks, repurchasing approximately 82,000 shares for $25 million, up from $20 million in the prior quarter. Our balance sheet remains strong, and we ended the quarter in a net cash position as we continue to generate significant cash flow. With that, I'll turn the call over to Mike. Mike?

Thank you, George, and good morning, everyone. Starting with our results on slide seven, assets under management. At December 31st, assets under management were $187.2 billion, up 6% from $177.3 billion at September 30th. The sequential increase reflected $6.3 billion of market performance and $5.1 billion of assets from Westchester Capital. Assets continued to be diversified by product type with open-end funds institutional, and retail separate accounts, representing approximately 41%, 26%, and 24% of AUM, respectively. In terms of asset classes, equity assets represented 62% of long-term AUM, with 75% of that in domestic equity and 25% in international, global, or specialty. The addition of Westchester Capital increased alternatives to 6.1% of total assets from 3.2% in the prior quarter. On a pro forma basis, including Stone Harbor, which closed on January 1st, AUM of $202 billion included 29% in institutional accounts and 24% in fixed income strategies, compared with 26% and 18%, respectively, at December 31st. We continued to generate strong relative investment performance across strategies. At December 31st, approximately 66% of rated fund assets had four or five stars, and 96% were in three, four, or five-star funds. We had 14 funds with AUM of $1 billion or more that were rated four or five stars, up from nine funds a year ago, representing a diverse set of strategies from six different managers. In addition to strong fund performance, as of December 31st, 65 percent of institutional assets and 82 percent of retail separate account assets were beating their benchmarks on a three-year basis, and 65 percent of institutional assets and 88 percent of retail separate account assets were outperforming their benchmarks over five years. Also, 86 percent of institutional assets were exceeding the median performance of their peer groups on the same five-year basis. Turning to slide eight, asset flows. Net flows were essentially break-even for the quarter as retail separate accounts, institutional, and ETFs all generated positive net flows that were offset by net outflows from open-end funds. Reviewing by product, in retail separate accounts, net flows were $1.1 billion driven by core domestic equity with an annualized organic growth rate of 11%. Institutional net flows of $0.5 billion were positive for the fifth consecutive quarter, again, benefiting from mandates at multiple affiliates. ETFs had $0.1 billion of positive net flows. For open-end funds, net outflows were $1.7 billion, largely driven by emerging markets, but domestic growth equity strategies also contributed, which is consistent with industry trends in the retail channel. By asset class for all products, international equity, specialty, and fixed income flows were negative, while domestic equity, global equity, multi-asset, and alternatives each continued to generate positive net flows. Total sales were $8.7 billion, up 14% sequentially from $7.6 billion. Byproduct, fund sales of $4.1 billion increased 14% due to alternative equity and fixed income strategies. Bank loan fund sales were particularly strong, up 24%. Retail separate account sales increased 12% to $2.2 billion with particular strength in SMID cap. Institutional sales increased 16% to $2.1 billion largely due to global equity strategies. Turning to slide 9, investment management fees as adjusted of $203.4 million increased $13.4 million, or 7% sequentially, reflecting 3% growth in average assets and a higher average fee rate. Performance fees in the quarter of $0.7 million were relatively unchanged from the prior quarter level of $0.6 million. The average fee rate of 43.7 basis points up 1.7 basis points sequentially. The higher fee rate largely reflected the impact of Westchester Capital. With respect to open-end funds, the fee rate increased to 49.3 from 46.3 in the third quarter, reflecting the addition of the Westchester Capital strategies and market-driven growth in equity assets. Looking ahead, for all products, we would anticipate a fee rate in the range of 41 to 43 basis points, which takes into account the addition of Stone Harbor's primarily institutional assets. Slide 10 shows the five-quarter trend in employment expenses. Total employment expenses as adjusted of $92 million increased 6% sequentially, primarily due to higher profit and sales-based variable incentive compensation, as well as the addition of the team at Westchester Capital. As a percentage of revenues, employment expenses were 39.6%, essentially the same level as the prior quarter. Looking ahead for 2022, We believe a reasonable range for employment expenses, as adjusted, would be 40% to 42% of revenues, which is subject to variability based on markets and sales. For modeling purposes, the first quarter will include seasonal employment expenses, which are not included in this range. Turning to slide 11, other operating expenses as adjusted were $22.9 million, up 13% on a sequential basis from $20.2 million. The sequential increase of $2.7 million reflected growth in the business, including the addition of Westchester Capital, as well as a continued increase in travel and related expenses, though not yet back to pre-COVID levels. As a percentage of revenues, other operating expenses were 9.8%, up 50 basis points sequentially. From the prior year period, however, they were down 130 basis points, reflecting the leverageability of the business. Looking forward, we expect other operating expenses in a range of $25 to $29 million per quarter, reflecting the addition of Stone Harbor, selected investments in our infrastructure and technology, and our estimate of travel and related expenses, which are still uncertain. 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 $116.8 million increased $6.7 million or 6% sequentially due to higher revenues. Compared with the prior year, operating income as adjusted increased 89% due to significant growth in the business including highly accretive strategic transactions. The operating margin as adjusted of 50.2% compared with 50.6% in the third quarter and increased 9.9 percentage points from 40.3% in the prior year quarter. Net income as adjusted of $10.36 per diluted share increased by 65 cents or 7% sequentially due to higher revenues from the increase in average assets under management. Regarding gap results, Net income per share of $6.29 decreased 15% from $7.36 per share in the third quarter and included the following items. A $2.30 reduction reflecting the increase in the fair values of both the minority interest liability and the revenue participation liability. 47 cents of expense for a CLO reset transaction and $0.28 of realized and unrealized losses on investments. Slide 13 shows the trend of our capital liquidity in select balance sheet items. Working capital was $220 million at December 31st, down sequentially from $345 million as $155 million in consideration for Westchester capital and $37 million in return of capital, more than offset cash generated by the business during the quarter. Contingent consideration, which includes the estimated AGI revenue participation and Westchester capital earn-out payments, was $163 million at December 31st. This amount will vary over time, based on changes in AGI and Westchester revenues. At December 31st, gross debt to EBITDA was 0.6 times, down from 0.7 times at September 30th and from 0.9 times at December 31st, 2020, due to significant growth in operating income over that period. We generated $124 million of EBITDA in the fourth quarter, up 6% sequentially and 80% above the prior year level, as AUM growth from AGI and Westchester Capital, market appreciation, and positive net flows has meaningfully increased quarterly cash flow. On a run rate basis, EBITDA approached $500 million based on the fourth quarter, up from $440 million on a trailing 12-month basis. During the fourth quarter, we repurchased 81,866 shares of common stock for 25 million, above the prior quarter level of 20 million. We ended the quarter in a net cash position, with cash exceeding gross debt by 105 million. First quarter 2022 cash obligations include the payment of annual incentives, as well as approximately $65 million for our first revenue participation payment and the closing payment for Stone Harbor. In addition, cash outlays in the first quarter will include return of capital, including share or purchases, which remain a priority given our stock's recent trading levels, as well as other opportunities to invest in the growth of the business. With that, let me turn the call back over to George.

George? Thank you, Mike. We will now take your questions. Gigi, would you open up the lines, please?

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line to meet Modi from Piper Sandler. Your line is now open.

Hey, thanks. Good morning, George. Good morning, Mike. Good morning. Just wanted to follow up maybe on some of the commentary you had on at the beginning of your prepared remarks, George. Given the market backdrop with kind of rate increases and inflation, the kind of rotation into value we've seen thus far this year, can you remind us first what the firm-wide mix of growth versus value in the strategies is, and then Secondly, what's your view on kind of how you think Virtus performs in an environment like this throughout the year? Do you kind of view it as an opportunity to outperform the benchmarks or kind of does the growth bent sort of maybe stall out performance and can impact some flows?

Sure. Great question. I'll give you some thoughts and Mike can follow up. So I think we absolutely look at this as an opportunity. I think as As believers in active management, these are the environments where thoughtful portfolio management teams executing their strategies have that opportunity to show how they perform. And we've done that in the prior periods of volatility. If you recall the first quarter of 2020, we sort of commented on across the board how most of our managers demonstrated the value of active management. Going to the beginning part of the question, the whole strategy behind the multi-affiliate model and our collection of managers is really to have that broad offering for the changing market cycles and investor preferences. So we designed it so that we're able to participate when things like growth equity are in favor, but when they're out of favor, we have several offerings that are on the value side. And then as it relates to things like rising interest rates, I commented and I think Mike did as well on our floating rate fund opportunity set, which again, is out of favor when rates were not going up. And we've been pleased to see the increase in the fourth quarter. I think Mike said 24%. And I commented that those goals are accelerated in the first quarter. So the balance of our offerings is sort of meant to allow us to sort of navigate the changes in the market, as well as the investor preferences. But generally, overall, we look at the volatility in the markets. And I think I speak for all active managers that is a great opportunity for us to show what we have. Mike, if you want to add to that.

Yeah, I'll just add a bit on the diversity of the portfolio. We gave some stats on the overall diversity, and on a pro forma basis, adding Stone Harbor increases the institutional and the fixed income. I think looking just solely into the equity portfolio, it is well-balanced. I would think about it not just growth value, but growth value and core equity, And growth is probably slightly less than half, maybe 45% of the equity assets. And looking at core and value would be generally the remainder of that. And obviously, that's diverse across our managers, our equity managers, Kane Anderson, SGA, NFJ, and others.

Got it. Thanks, guys. That's really helpful. Just turning to Stone Harbor, I know we're only a month in. Maybe you can just update us on the institutional kind of performance and flows there thus far, how it's integrating into the platform, and then kind of what kind of impacts you expect to see from that platform this year.

Sure. Well, we're very excited to have Stone Harbor join us. And I think as I've commented previously, we've actually been having a lot of conversations with Stone Harbor over a period of time as we've reached our agreement with to bring them into the complex. So a lot of work has been done in terms of how to optimize the opportunity set as they're part of Virtus and a lot of part of your point on how to sort of integrate them into what we bring in terms of our support services and distribution. But as I've also mentioned, There's also some great capabilities and technology from their side that we're also integrating to make available to our other affiliates. So I think that has gone incredibly well. And I think a lot of that is, is just basically due to the people, but as well as the is a great opportunity.

Mike, I think you're cutting out here. I can't hear you.

Yeah, I've got it. So I think George was in the process of just finalizing the closing and bringing on the team at Stone Harbor. And certainly now that they've come on, this is the permanent home that they've joined us in the first quarter. And we look forward to continuing to bring their strategies to their clients going forward.

Got it. Thank you. And then just one last from me, you know, just on the M&A front, you know, whether it's in the non-correlated asset classes or through kind of expanded distribution, has the recent volatility opened up any new conversations there? And, you know, how are you viewing those opportunities here early in the year?

Sure. Well, I mean, talking about M&A, again, this has been part of our strategy overall for many years. We fundamentally don't want M&A to be necessary for our long-term growth strategy. That being said, I just referred to the third in the last 12 months that we've completed. The amount of activity we're seeing continues to be quite robust. We're very selective in terms of what we look at or what we'll consider. So to the extent that we find those opportunities, we will absolutely evaluate those, but there'll be through the filter of, you know, what adds the strategic value to the business in terms of either, um, select additions of capabilities to expand our offerings, um, um, access to different markets as well as general, you know, scale and increasing of the cashflow, uh, and accretion to our shareholders. So, um, We think the conversations in the industry will continue. We think it's a very active M&A environment across the board. That includes our sector. And we'll certainly be participating as others will as well.

Great. Thanks, George. Thanks, Mike.

Thank you.

Thank you. Our next question comes from the line of Michael Cypress from Morgan Stanley. Your line is now open.

Hey, good morning, George, Michael. Thanks for taking the question. Just given the increased cash generation of the business, I was hoping you could talk a little bit about how you think about deploying all of that cash flow here. It looks like the buybacks, modest amount on the quarter. Is this a good run rate to think about, or can that accelerate here? And when we look at the dividend payout ratio, think about 14% in the quarter. I guess, what do you think is the appropriate level for Virtus for dividend payout? And on the M&A side, maybe you can just give us a little bit of color around how much time are you spending on that today versus a year ago? And what sort of areas could it make the most sense? I know you spoke high level on the last question, but what sort of products or distribution areas could make the most sense? So sorry for the multi-pronged question.

No, that's fine. So I'll break them into the two pieces. So in terms of capital, as you noted, the generation of cash flow for us has significantly increased. Mike gave the stat on the run rate of our EBITDA. So significant generation of cash flow. As we've always said about our capital management strategy is we really balance all elements of it. because with the cash flow that we have and the lower level of leverage that we currently have, we have the ability to continue to return capital to the shareholder, invest in the future growth of the business on the organic side, as well as selectively evaluate and execute on M&A transactions to the extent that they make sense. So we continue to balance all of those. As we've said in the past, you know, we generally will evaluate, you know, the balancing of those opportunities in any given quarter, right? So last quarter, we did uptick our stock buybacks to a higher level, and that was reflective of our views of other opportunities as well as our stock. I think Mike actually referred to that as well as we're looking at how we trade in our available cash flow. That will evaluate into our decision. And we continue to invest in you know, the growth of the businesses. We're excited about our opportunity to continue to grow things like the institutional business, our non-U.S. business. Those are all great opportunities for us to grow the business. So we'll continue to balance that. I think on the dividend side, we had a very meaningful increase this year. So we've had multiple years of consecutive increases in our dividend. So we think that that has been the right thing to do for our shareholders. So we'll continue to evaluate those opportunities. And then I'll go to the M&A and then Mike can go back to capital after I finish on the M&A. I think like a lot of people, everyone is busy considering M&A opportunities. So we are partaking in those things that make sense for us. As we sort of look at it in the context of the types of activities we've done over the last 10 or 12 years, we look at, one, different product capabilities that are additive to what we have, complementary and differentiated. So Westchester and Stone Harbor obviously were right along those lines. So we continue to look for those things which would be complementary and not redundant with what we currently have. In that area, I also think about things that are less liquid and less correlated asset classes. So Westchester was an example of that. I think I commented at the time that we do view an opportunity for us to grow our capabilities of less correlated types of strategies, which would also then get you into less liquid types of strategies. We think those are great opportunities to add to what we have. We do view our capabilities. A client footprint being more predominantly U.S.-based than we'd like is an opportunity for us to look at things that expand that opportunity set, which we will do organically through institutional resources. But that would be another area that we look at. And, again, we're always looking at things that will, you know, generally increase the scale of the business, allowing us to generate cash flow that we can either return to shareholders or use to invest in future growth of the business. Mike, do you want to comment at all on the capital management strategy?

Yeah, I think you touched on a lot of the key components of the capital management and notably we're cognizant of the recent trading levels of the stock and share purchases do remain a significant priority for us given that both on an absolute basis of the stock and a relative basis and You know, we take that and other factors into consideration when we evaluate our return of capital strategies and approaches, and that'll be something, you know, we focus on certainly in first quarter as we're looking at that. And then we balance that as well with investing in the business. And, you know, we do have meaningful payments in the first quarter upcoming. As I noted, there's the closing payment. For Stone Harbor and the first annual revenue participation payment, all of those will be occurring in the first quarter along with annual incentives. So we're balancing that, but a meaningful priority of share purchases, we'll look closely at it, and we think that's an important component of returning capital to shareholders.

Great. Thanks so much. And maybe just a follow-up question, if I could. on expense efficiency. You guys delivered positive operating leverage in 2021 for what I think is a fifth consecutive year, if I have that right, which I don't think many other listed money managers have achieved. So I guess congratulations on that accomplishment. And maybe you could just talk a little bit about your philosophy and how you're able to deliver positive operating leverage, um, where others perhaps struggle in the industry. And as we think about the market volatility in 22 with the new deals that have come into the run rate with Westchester and Stone Harbor, to what extent does that alter your ability to generate positive operating leverage? And if markets are down a bit, maybe you could just give us a sense of how you might be able to flex that expense base.

Sure. Well, I'll give some thoughts and then Mike can add to that. So I think we are pleased that we have been able to demonstrate that leverageability and capture on the incremental basis that expansion of the margin. So, again, the markets have been helpful for that. I think the nature of some of the transactions that we've done as well have been helpful there. And as you kind of see in our sales history over the past couple of years in particular, generally been at the higher fee rate, so our fee rate, you know, generally has been countercyclical to some of our peers in that it's actually increased. You know, our expense base, we try to maintain a very flexible and variable expense base. But to your point, if markets go down and revenue goes down, there will be implications there. But again, I think generally, particularly on the compensation side, we have a particularly high percentage of compensation that is generally variable in nature and So, you know, we continue to hope to pull in at the incremental margins that we spoke to previously. And, again, the market will sort of assist us or make it a little bit more of a challenge over the next few quarters. Mike?

Yeah, I think you touched on really the key drivers of that operating leverage. And, you know, the incremental margin, I think, for the full year was a little bit above the historical range that we've talked about of 50% to 55%. And I think that the top line revenue contribution and being able to maintain the fee rate over that period has been a key contributor. We're also adding the accretive strategic transactions that we alluded to, which were at the higher end of our incremental margins, has enabled us to increase you know, the margin by nearly 1,000 basis points year over year in the fourth quarter. And, you know, just to reiterate George's point on the variability of the cost structure, you know, more than 50% of the employment expenses, you know, do vary based on different metrics, whether it be profitability or sales. And I think that's a key driver. But, you know, certainly those are factors that we took into consideration with some of the outlook that we provided and we We will be impacted if markets do shift meaningfully here.

And just a follow-up point on the expense side, just any color on what's baked in to your expense guidance in terms of equity market appreciation, what sort of market levels or changes in broader markets would kind of shift you to one end or even out of the range? Or said another way, if markets are down 20%, how would your expense sort of guide flex higher or lower and out of the range, et cetera?

Yeah, but I think we tried to capture a range that is reflective of current markets, Q4 markets. Certainly, there was a drawdown in January in the markets and then kind of a recovery of sorts so that These are obviously volatile market environments, and we tried to capture that in the range that we provided, especially on the employment side. We'll update you as those ranges might shift over time, but we tried to capture the current market environment. If markets continue to be volatile, we'll update you as appropriate. As a reminder, the first quarter will include the seasonal items So capture that in your modeling as well. But to the extent this variability continues, we'll update you as appropriate.

Great. Thanks so much.

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

Great. Well, thank you. And I want to thank everyone on the call today for joining us. And again, as always, we encourage you to Send in a message or give us a call if you have any other questions. Thank you very much.

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