Victory Capital Holdings, Inc. 10-Q

Item 1. Financial Statements Victory Capital Holdings, Inc. and Subsidiaries Condensed Consolidated Balance Sheets (U naudited) (In thousands, except shares data) September 30, 2020 December 31, 2019 Assets Cash and cash equivalents $ 56,284 $ 37,121 Receivables 79,196 95,093 Prepaid expenses 5,335 4,852 Investments 19,617 19,076 Property and equipment, net 18,741 13,240 Goodwill 404,750 404,750 Other intangible assets, net 1,165,763 1,175,471 Other assets 4,305 3,706 Total assets $ 1,753,991 $ 1,753,309 Liabilities and stockholders' equity Accounts payable and accrued expenses $ 56,313 $ 89,203 Accrued compensation and benefits 40,859 54,842 Consideration payable for acquisition of business 120,500 118,700 Deferred tax liability, net 28,117 5,486 Other liabilities 32,768 22,668 Long-term debt, net 815,877 924,539 Total liabilities 1,094,434 1,215,438 Stockholders' equity Class A common stock, $ 0.01 par value per share: 2020 - 400,000,000 shares authorized, 19,350,111 shares issued and 16,438,709 shares outstanding; 2019 - 400,000,000 shares authorized, 18,099,772 shares issued and 16,414,617 shares outstanding 193 181 Class B common stock, $ 0.01 par value per share: 2020 - 200,000,000 shares authorized, 54,400,113 shares issued and 51,165,503 shares outstanding; 2019 - 200,000,000 shares authorized, 53,937,394 shares issued and 51,281,512 shares outstanding 544 539 Additional paid-in capital 641,467 624,766 Class A treasury stock, at cost: 2020 - 2,911,402 shares; 2019 - 1,685,155 shares ( 42,488 ) ( 21,524 ) Class B treasury stock, at cost: 2020 - 3,234,610 shares; 2019 - 2,655,882 shares ( 42,576 ) ( 31,386 ) Accumulated other comprehensive loss ( 8,987 ) — Retained earnings (deficit) 111,404 ( 34,705 ) Total stockholders' equity 659,557 537,871 Total liabilities and stockholders' equity $ 1,753,991 $ 1,753,309 See the accompanying notes to the unaudited condensed consolidated financial statements. 3 Table of Contents Victory Capital Holdings, Inc. and Subsidiaries Condensed Consolidated Statements of Operations (Unaudited) (In thousands, except per share data) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Revenue Investment management fees $ 137,240 $ 155,406 $ 414,153 $ 307,859 Fund administration and distribution fees 51,416 59,574 160,810 85,960 Total revenue 188,656 214,980 574,963 393,819 Expenses Personnel compensation and benefits 47,375 55,556 144,051 125,599 Distribution and other asset-based expenses 39,123 57,202 135,613 89,151 General and administrative 13,196 17,654 38,373 31,828 Depreciation and amortization 3,936 7,768 12,152 18,253 Change in value of consideration payable for acquisition of business 2,000 — 1,800 ( 14 ) Acquisition-related costs 1,148 16,386 1,056 21,950 Restructuring and integration costs 1,285 4,841 4,888 6,629 Total operating expenses 108,063 159,407 337,933 293,396 Income from operations 80,593 55,573 237,030 100,423 Other (expense) income Interest income and other (expense) income 1,120 2,742 ( 86 ) 5,231 Interest expense and other financing costs ( 8,187 ) ( 16,856 ) ( 29,305 ) ( 26,000 ) Loss on debt extinguishment ( 758 ) ( 7,409 ) ( 1,675 ) ( 7,409 ) Total other expense, net ( 7,825 ) ( 21,523 ) ( 31,066 ) ( 28,178 ) Income before income taxes 72,768 34,050 205,964 72,245 Income tax expense ( 17,027 ) ( 8,058 ) ( 48,337 ) ( 17,343 ) Net income $ 55,741 $ 25,992 $ 157,627 $ 54,902 Earnings per share of common stock Basic $ 0.82 $ 0.38 $ 2.33 $ 0.81 Diluted $ 0.76 $ 0.35 $ 2.14 $ 0.75 Weighted average number of shares outstanding Basic 67,743 67,724 67,785 67,610 Diluted 73,437 73,671 73,703 73,300 Dividends declared per share of common stock $ 0.06 $ 0.05 $ 0.16 $ 0.05 See the accompanying notes to the unaudited condensed consolidated financial statements. 4 Table of Contents Victory Capital Holdings, Inc. and Subsidiaries Condensed Consolidated Statements of Comprehensive Income (U naudited) (In thousands) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Net income $ 55,741 $ 25,992 $ 157,627 $ 54,902 Other comprehensive loss, net of tax Net unrealized loss on cash flow hedges ( 621 ) — ( 8,970 ) — Net unrealized gain (loss) on foreign currency translation 37 ( 25 ) ( 17 ) ( 21 ) Total other comprehensive loss, net of tax ( 584 ) ( 25 ) ( 8,987 ) ( 21 ) Comprehensive income $ 55,157 $ 25,967 $ 148,640 $ 54,881 See the accompanying notes to the unaudited condensed consolidated financial statements. 5 Table of Contents Victory Capital Holdings, Inc. and Subsidiaries Condensed Consolidated Statements of Changes in Stockholders’ Equity (U naudited) (In thousands) Accumulated Additional Other Retained Common Stock Treasury Stock Paid-In Comprehensive (Deficit) Class A Class B Class A Class B Capital Loss Earnings Total Balance, December 31, 2019 $ 181 $ 539 $ ( 21,524 ) $ ( 31,386 ) $ 624,766 $ — $ ( 34,705 ) $ 537,871 Issuance of common stock — — — — 26 — — 26 Share conversion - Class B to A 4 ( 4 ) — — — — — — Repurchase of shares — — ( 4,394 ) — — — — ( 4,394 ) Shares withheld related to net settlement of equity awards — — — ( 8,787 ) — — — ( 8,787 ) Vesting of restricted share grants — 7 — — ( 7 ) — — — Exercise of options — 3 — — 1,690 — — 1,693 Other comprehensive loss — — — — — ( 4,887 ) — ( 4,887 ) Share-based compensation — — — — 5,993 — — 5,993 Dividends paid — — — — — — ( 3,601 ) ( 3,601 ) Net income — — — — — — 57,166 57,166 Balance, March 31, 2020 185 545 ( 25,918 ) ( 40,173 ) 632,468 ( 4,887 ) 18,860 581,080 Issuance of common stock — — — — 32 — — 32 Share conversion - Class B to A 2 ( 2 ) — — — — — — Repurchase of shares — — ( 7,186 ) — — — — ( 7,186 ) Shares withheld related to net settlement of equity awards — — — ( 739 ) — — — ( 739 ) Vesting of restricted share grants — 2 — — ( 2 ) — — — Exercise of options — — — — 1 — — 1 Other comprehensive loss — — — — — ( 3,516 ) — ( 3,516 ) Share-based compensation — — — — 3,887 — — 3,887 Dividends paid — — — — — — ( 3,439 ) ( 3,439 ) Net income — — — — — — 44,720 44,720 Balance, June 30, 2020 $ 187 $ 545 $ ( 33,104 ) $ ( 40,912 ) $ 636,386 $ ( 8,403 ) $ 60,141 $ 614,840 Issuance of common stock — — — — 35 — — 35 Share conversion - Class B to A 6 ( 6 ) — — — — — — Repurchase of shares — — ( 9,384 ) — — — — ( 9,384 ) Shares withheld related to net settlement of equity awards — — — ( 1,664 ) — — — ( 1,664 ) Vesting of restricted share grants — 2 ( 2 ) — — — Exercise of options — 3 — — 1,425 — — 1,428 Other comprehensive loss — — — — — ( 584 ) — ( 584 ) Share-based compensation — — — — 3,623 — — 3,623 Dividends paid — — — — — — ( 4,478 ) ( 4,478 ) Net income — — — — — — 55,741 55,741 Balance, September 30, 2020 $ 193 $ 544 $ ( 42,488 ) $ ( 42,576 ) $ 641,467 $ ( 8,987 ) $ 111,404 $ 659,557 See the accompanying notes to the unaudited condensed consolidated financial statements. 6 Table of Contents Victory Capital Holdings, Inc. and Subsidiaries Condensed Consolidated Statements of Changes in Stockholders’ Equity (U naudited) (In thousands) Accumulated Additional Other Common Stock Treasury Stock Paid-In Comprehensive Retained Class A Class B Class A Class B Capital (Loss) Income Deficit Total Balance, December 31, 2018 $ 153 $ 553 $ ( 8,045 ) $ ( 21,719 ) $ 604,401 $ ( 86 ) $ ( 119,709 ) $ 455,548 Issuance of common stock — — — — 13 — — 13 Share conversion - Class B to A 4 ( 4 ) — — — — — — Repurchase of shares — — ( 1,344 ) — — — — ( 1,344 ) Shares withheld related to net settlement of equity awards — — — ( 318 ) — — — ( 318 ) Exercise of options — 1 — — 220 — — 221 Cumulative effect of adoption of ASU 2016-01 and 2018-02 — — — — — 62 ( 62 ) — Other comprehensive income — — — — — 12 — 12 Share-based compensation — — — — 1,547 — — 1,547 Dividends paid — — — — — — ( 41 ) ( 41 ) Net income — — — — — — 14,527 14,527 Balance, March 31, 2019 157 550 ( 9,389 ) ( 22,037 ) 606,181 ( 12 ) ( 105,285 ) 470,165 Issuance of common stock — — — — 16 — — 16 Share conversion - Class B to A 8 ( 8 ) — — — — — — Repurchase of shares — — ( 1,948 ) — — — — ( 1,948 ) Shares withheld related to net settlement of equity awards — — — ( 123 ) — — — ( 123 ) Exercise of options — 2 — — 733 — — 735 Other comprehensive loss — — — — — ( 8 ) — ( 8 ) Share-based compensation — — — — 3,755 — — 3,755 Dividends paid — — — — — — ( 24 ) ( 24 ) Net income — — — — — — 14,383 14,383 Balance, June 30, 2019 $ 165 $ 544 $ ( 11,337 ) $ ( 22,160 ) $ 610,685 $ ( 20 ) $ ( 90,926 ) $ 486,951 Issuance of common stock — — — — 15 — — 15 Share conversion - Class B to A 13 ( 13 ) — — — — — — Repurchase of shares — — ( 5,103 ) — — — — ( 5,103 ) Shares withheld related to net settlement of equity awards — — — ( 4,001 ) — — — ( 4,001 ) Vesting of restricted share grants — 1 — — ( 1 ) — — Exercise of options — 5 — — 1,956 — 1,961 Other comprehensive income/(loss) — — — — — ( 25 ) — ( 25 ) Share-based compensation — — — — 4,814 — — 4,814 Dividends paid — — — — — — ( 3,919 ) ( 3,919 ) Net income — — — — — — 25,992 25,992 Balance, September 30, 2019 $ 178 $ 537 $ ( 16,440 ) $ ( 26,161 ) $ 617,469 $ ( 45 ) $ ( 68,853 ) $ 506,685 See the accompanying notes to the unaudited condensed consolidated financial statements. 7 Table of Contents Victory Capital Holdings, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (Unaudited) (In thousands) Nine Months Ended September 30, 2020 2019 Cash flows from operating activities Net income $ 157,627 $ 54,902 Adjustments to reconcile net income to net cash provided by operating activities: Provision for deferred income taxes 25,439 3,310 Depreciation and amortization 12,152 18,253 Deferred financing costs and derivative and accretion expense 3,411 2,612 Stock-based and deferred compensation 14,187 13,928 Change in fair value of contingent consideration obligations 1,800 ( 14 ) Unrealized depreciation (appreciation) on investments 1,432 ( 1,409 ) Net gain on equity method investment — ( 2,683 ) Loss on debt extinguishment 1,675 7,409 Changes in operating assets and liabilities: Receivables 15,487 ( 11,366 ) Prepaid expenses ( 483 ) ( 1,955 ) Other assets ( 11 ) ( 43 ) Accounts payable and accrued expenses ( 34,160 ) 74,713 Accrued compensation and benefits ( 13,994 ) 8,501 Other liabilities ( 1,842 ) 1,527 Net cash provided by operating activities 182,720 167,685 Cash flows from investing activities Purchases of property and equipment ( 7,046 ) ( 2,920 ) Purchases of trading securities ( 5,252 ) ( 4,606 ) Sales of trading securities 3,279 2,342 Purchases of available-for-sale securities ( 275 ) ( 104 ) Sales of available-for-sale securities 274 104 (Purchase) sale of equity method investment ( 1,500 ) 10,572 Acquisition of business — ( 851,276 ) Net cash used in investing activities ( 10,520 ) ( 845,888 ) Cash flows from financing activities Issuance of Class A common stock, net of underwriter discount 93 44 Issuance of Class B common stock from exercise of stock options 3,122 2,917 Repurchase of common stock ( 22,821 ) ( 9,342 ) Payments of taxes related to net share settlement of equity awards ( 9,145 ) ( 3,497 ) Proceeds from long-term senior debt — 1,088,503 Payment of debt financing fees — ( 19,820 ) Repayments and repurchases of long-term senior debt ( 113,387 ) ( 343,000 ) Repayment of promissory note — ( 96 ) Payment of dividends ( 11,518 ) ( 3,984 ) Receipt (payment) of consideration for acquisition 649 ( 6,017 ) Net cash (used in) provided by financing activities ( 153,007 ) 705,708 Effect of changes of foreign exchange rate on cash and cash equivalents ( 30 ) ( 33 ) Net increase in cash and cash equivalents 19,163 27,472 Cash and cash equivalents, beginning of period 37,121 51,491 Cash and cash equivalents, end of period $ 56,284 $ 78,963 Supplemental cash flow information Cash paid for interest $ 32,371 $ 8,216 Cash paid for income taxes 27,729 9,540 See the accompanying notes to the unaudited condensed consolidated financial statements. 8 Table of Contents Victory Capital Holdings, Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (Unaudited) Note 1. ORGANIZATION AND NATURE OF BUSINESS Victory Capital Holdings, Inc., a Delaware corporation (along with its wholly-owned subsidiaries, collectively referred to as the “Company,” “Victory,” or in the first-person notations of “we,” “us,” and “our”), was formed on February 13, 2013 for the purpose of acquiring Victory Capital Management Inc. (“VCM”) and Victory Capital Services, Inc. (“VCS”), formerly known as Victory Capital Advisers, Inc., on August 1, 2013. On February 12, 2018, the Company completed the initial public offering (the “IPO”) of its Class A common stock, which trades on the NASDAQ under the symbol “VCTR.” On and effective July 1, 2019, the Company completed the acquisition (the “USAA AMCO Acquisition”) of USAA Adviser and VCTA, formerly known as the USAA Transfer Agency Company d/b/a USAA Shareholder Account Services. The USAA AMCO Acquisition includes USAA’s mutual fund and ETF businesses and its 529 College Savings Plan (collectively, the “USAA Mutual Fund Business”). Refer to Note 4, Acquisitions, for further details on the acquisition. VCM is a registered investment adviser managing assets through open-end mutual funds, separately managed accounts, unified management accounts, ETFs, collective trust funds, wrap separate account programs and Undertakings Collective Investment in Transferable Securities (“UCITs”). VCM also provides mutual fund administrative services for the Victory Portfolios, Victory Variable Insurance Funds, Victory Institutional Funds and the mutual fund series of the Victory Portfolios II (collectively, the “Victory Funds”), a family of open-end mutual funds, the VictoryShares (the Company’s ETF brand), as well as the USAA Mutual Fund Business, which includes the USAA Mutual Fund Trust, a family of open-end mutual funds (the “USAA Funds”). Additionally, VCM employs all of the Company’s United States investment professionals across its Franchises and Solutions, which are not separate legal entities. VCS is registered with the SEC as an introducing broker-dealer and serves as distributor and underwriter for the Victory Funds and USAA Funds. VCTA is registered with the SEC as a transfer agent for the USAA Funds. NOTE 2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the SEC regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by GAAP for complete annual financial statements. As such, the information included in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. In the opinion of management, the consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the financial condition, results of operations, and cash flows for the interim periods presented. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. Principles of Consolidation The unaudited condensed consolidated financial statements include the operations of the Company and its wholly-owned subsidiaries, after elimination of all intercompany balances and transactions. On September 20, 2020, the Company acquired a 15 % equity interest in Alderwood Partners LLP (“Alderwood”). Alderwood’s operating entity, Alderwood Capital, is a London-based investment advisory firm focused on taking minority stakes in specialist boutique asset management businesses. The Company analyzed its investment in Alderwood under the voting interest model and determined that it would not consolidate Alderwood as it does not have a controlling financial interest. The Company’s involvement with non-consolidated variable interest entities (“VIEs”) include sponsored investment funds and, in 2019, an equity method investment. For further discussion regarding VIEs, refer to Note 2, Significant Accounting Policies, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. For further discussion regarding equity method investments, refer to Note 15, Equity Method Investment. Use of Estimates and Assumptions The preparation of the unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements and the notes. Actual results may ultimately differ materially from those estimates. 9 Table of Contents On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic. The global spread of COVID-19 has created significant volatility, uncertainty , and economic disruption. COVID-19 did not have a material adverse effect on our reported results for the three and nine months ended September 30, 2020 . New Accounting Pronouncements Accounting Standards Adopted in 2020 • Derivatives and Hedging: Effective January 1, 2020 , the Company early adopted Accounting Standards Update (“ASU”) 2017-12 (“ASU 2017-12”), Derivatives and Hedging (Topic 815) and ASU 2019-04, Codification Improvements to Topic 815, Derivatives and Hedging (“ASU 2019-04”). ASU 2017-12 improves and simplifies accounting rules for hedge accounting to better present the economic results of an entity’s risk management activities in its financial statements and improves the disclosures of hedging arrangements. Various provisions of ASU 2017-12 were subsequently clarified by the Financial Accounting Standards Board (“FASB”) in April 2019 through the issuance of ASU 2019-04. The Company did not have any existing hedging relationships at the time of adoption; therefore, the adoption of ASU 2017-12 and ASU 2019-04 had no impact on our consolidated financial statements. On March 27, 2020, the Company entered into an interest rate swap transaction (the “Swap”) to manage interest rate risk associated with a portion of its floating-rate long term debt (notional amount of $ 450 million). The Swap was designated as a cash flow hedge and the initial prospective quantitative hedge effectiveness assessment was deemed highly effective. Under ASU 2017-12, the Company has the option to perform subsequent assessments of hedge effectiveness qualitatively. The Company has elected to assess the Swap’s hedge effectiveness qualitatively and will verify and document on a quarterly basis that facts and circumstances have not changed. Recently Issued Accounting Standards • Subsequent Measurement of Goodwill: In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) (“ASU 2017-04”) which simplifies the test for goodwill impairment. ASU 2017-04 eliminates the requirement to calculate the implied fair value of goodwill (step two) to measure a goodwill impairment charge. Goodwill impairment will be based upon the results of step one of the impairment test, which is defined as the excess of the carrying amount of a reporting unit over its fair value, not to exceed the carrying amount of goodwill allocated to that reporting unit. The effective date for calendar-year public business entities was January 1, 2020. Due to the Company’s status as an emerging growth company (“EGC”), the new guidance will be effective for the Company’s fiscal year that begins on January 1, 2021 and requires a prospective approach to adoption. Early adoption is permitted for interim or annual goodwill impairment tests. The impact of this new guidance will depend upon the performance of the Company’s one reporting unit and the market conditions impacting the fair value. • Leases: In February 2016, the FASB issued ASU 2016‑02, Leases (Topic 842) (the “New Lease Standard”) which supersedes previous lease guidance, Accounting Standards Codification (“ASC”) Topic 840 (“ASC Topic 840”). The New Lease Standard requires lessees to recognize a right-of-use asset and a lease liability for all leases (with the exception of short-term leases) on their balance sheet at the commencement date and recognize expenses on their income statement similar to ASC Topic 840 guidance. In addition, the FASB issued ASU 2018-11, Leases Targeted Improvements, which provides a package of practical expedients for entities to apply upon adoption. The effective date for calendar-year public business entities was January 1, 2019. In June 2020, the FASB deferred the effective date of the New Lease Standard for private companies and other companies who had not yet been required to adopt the standard. Due to the Company’s EGC status, the New Lease Standard will be adopted on January 1, 2022. Management has assessed and evaluated the Company’s portfolio of active real estate leases and is currently surveying the business for other leases. As outlined in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, the Company has approximately $ 23 million in undiscounted, future minimum cash commitments under net operating leases. The New Lease Standard is expected to result in a gross up of assets and liabilities on the Consolidated Balance Sheets and to have no material impact on the Consolidated Statements of Operations or the Company’s liquidity or debt covenant compliance under the current credit agreement. • Expected Credit Losses: In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 creates a new model for determining current expected credit losses (“CECL”) on trade and other receivables, net investments in leases, contract assets and long-term receivables. The CECL impairment model requires companies to consider the risk of loss even if it is remote and to include forecasts of future economic conditions as well as information about past events and current conditions. The effective date for calendar-year public business entities is January 1, 2020. As an EGC, the Company currently expects to adopt ASU 2016-13 on January 1, 2023. The Company is currently reviewing the effect of this new standard on its consolidated financial statements. 10 Table of Contents NOTE 3. Revenue RECOGNITION In accordance with the new revenue recognition standard requirements, the following table disaggregates our revenue by type and product: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2020 2019 2020 2019 Investment management fees Mutual funds (Victory/USAA Funds) $ 112,983 $ 125,928 $ 337,355 $ 228,855 ETFs (VictoryShares) 2,890 3,116 8,498 7,172 Separate accounts and other vehicles 24,318 26,512 71,920 72,379 Performance-based fees Mutual funds (USAA Funds) ( 2,699 ) — ( 2,699 ) — Separate accounts and other vehicles ( 252 ) ( 150 ) ( 921 ) ( 547 ) Total investment management fees $ 137,240 $ 155,406 $ 414,153 $ 307,859 Fund administration and distribution fees Administration fees Mutual funds (Victory/USAA Funds) $ 27,605 $ 30,098 $ 83,948 $ 40,734 ETFs (VictoryShares) 370 378 1,055 924 Distribution fees Mutual funds (Victory/USAA Funds) 6,296 7,674 18,999 22,878 Transfer agent fees Mutual funds (USAA Funds) 17,145 21,424 56,808 21,424 Total fund administration and distribution fees $ 51,416 $ 59,574 $ 160,810 $ 85,960 Total revenue $ 188,656 $ 214,980 $ 574,963 $ 393,819 The following table presents balances of receivables: (in thousands) September 30, 2020 December 31, 2019 Customer receivables Mutual funds (Victory/USAA Funds) $ 55,383 $ 64,407 ETFs (VictoryShares) 1,196 1,391 Separate accounts and other vehicles 19,519 27,836 Receivables from contracts with customers 76,098 93,634 Non-customer receivables 3,098 1,459 Total receivables $ 79,196 $ 95,093 Revenue The Company’s revenue includes fees earned from providing; • investment management services, • fund administration services, • fund transfer agent services, and • fund distribution services. Revenue is recognized for each distinct performance obligation identified in customer contracts when the performance obligation has been satisfied by transferring services to a customer either over time or at the point in time when the customer obtains control of the service. Revenue is recognized in the amount of variable or fixed consideration allocated to the satisfied performance obligation that Victory expects to be entitled to in exchange for transferring services to a customer. Variable consideration is included in the transaction price only when it is probable that a significant reversal of such revenue will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Investment management, fund administration and fund distribution fees are generally considered variable consideration as they are typically calculated as a percentage of AUM. Fund transfer agent fees are also considered variable consideration as they are 11 Table of Contents calculated as a percentage of AUM or based on the number of accounts in the fund. In such cases, the amount of fees earned is subject to factors outside of the Company’s control including customer or underlying investor contributions and redemptions and financial market volatility. These fees are considered constrained and are excluded from the transaction price until the asset values or number of accounts on which the customer is billed are calculated and the value of consideration is measurable. The Company has contractual arrangements with third parties to provide certain advisory, administration, transfer agent and distribution services. Management considers whether we are acting as the principal service provider or as an agent to determine whether revenue should be recorded based on the gross amount payable by the customer or net of payments to third-party service providers, respectively. Victory is considered a principal service provider if we control the service that is transferred to the customer. We are considered an agent when we arrange for the service to be provided by another party and do not control the service. Investment Management Fees Investment management fees are received in exchange for investment management services that represent a series of distinct incremental days of investment management service. Control of investment management services is transferred to the customers over time as these customers receive and consume the benefits provided by these services. Investment management fees are calculated as a contractual percentage of AUM and are generally paid in arrears on a monthly or quarterly basis. Investment management fees are recognized as revenue using a time-based output method to measure progress. Revenue is recorded at month end or quarter end when the value of consideration is measured. The amount of investment management fee revenue varies from one reporting period to another as levels of AUM change (from inflows, outflows and market movements) and as the number of days in the reporting period change. The Company may waive certain fees for investment management services provided to the Victory Funds, USAA Funds and VictoryShares and may subsidize certain share classes of the Victory Funds, USAA Funds and VictoryShares to ensure that specified operating expenses attributable to such share classes do not exceed a specified percentage. These waivers and reimbursements reduce the transaction price allocated to investment management services and are recognized as a reduction to investment management fees revenue. The amounts due to the Victory Funds, USAA Funds and VictoryShares for waivers and expense reimbursements represent consideration payable to customers, which is recorded in accounts payable and accrued expenses in the unaudited Condensed Consolidated Balance Sheets, and no distinct services are received in exchange for these payments. Performance‑based investment management fees, which include fees under performance fee and fulcrum fee arrangements, are included in the transaction price for providing investment management services. Performance-based investment management fees are calculated as a percentage of investment performance on a client’s account versus a specified benchmark or hurdle based on the terms of the contract with the customer. Performance-based investment management fees are variable consideration and are recognized as revenue when and to the extent that it is probable that a significant reversal of the cumulative revenue for the contractual performance period will not occur. Performance-based investment management fees recognized as revenue in the current period may pertain to performance obligations satisfied in prior periods. Fulcrum fee arrangements include a base investment management fee and a performance fee adjustment to the base investment management fee depending on whether the assets being managed experienced better or worse investment performance than the index specified in the customer’s contract. The performance fee adjustment arrangement with certain equity and fixed income USAA Funds took effect on July 1, 2020 and is calculated monthly based on the investment performance of those funds relative to their specified benchmark indexes over the discrete performance period ending with that month. Fund Administration Fees The Company recognizes fund administration fees as revenue using a time-based output method to measure progress. Fund administration fees are determined based on the contractual rate applied to average daily net assets of the Victory Funds, USAA Funds and VictoryShares for which administration services are provided. Revenue is recorded on a monthly basis when the value of consideration is measured using actual average daily net assets and constraints are removed. The Company has contractual arrangements with a third party to provide certain sub-administration services. We are the primary obligor under the contracts with the Victory Funds, USAA Funds and VictoryShares and have the ability to select the service provider and establish pricing. As a result, fund administration fees and sub-administration expenses are recorded on a gross basis. Fund Transfer Agent Fees The Company recognizes fund transfer agent fees using a time-based output method to measure progress. Fund transfer agent fees are determined based on the contractual rate applied to either the average daily net assets of the USAA Funds for which transfer agent services are provided or number of accounts in the USAA Funds. Revenue is recorded on a monthly basis when the value of consideration is measured using actual average daily net assets or actual number of accounts and constraints are removed. 12 Table of Contents The Company has contractual arrangements with a third party to provide certain sub-transfer agent services. We are the primary obligor under the transfer agency contracts with the USAA Funds and have the ability to select the service provider and establish pricing. As a result, fund transfer agent fees and sub-transfer agent expenses are recorded on a gross basis. Fund Distribution Fees The Company receives compensation for sales and sales-related services promised under distribution contracts with the Victory Funds and USAA Funds. Revenue is measured in an amount that reflects the consideration to which the Company expects to be entitled in exchange for providing distribution services. Distribution fees are generally calculated as a percentage of average net assets in the Victory Funds and USAA Funds. The Company’s performance obligation is satisfied at the point in time when control of the services is transferred to customers, which is upon investor subscription or redemption. Based on the nature of the calculation, the revenue for these services is accounted for as variable consideration, the Company may recognize distribution fee revenue in the current period that pertains to performance obligations satisfied in prior periods, as it represents variable consideration and is recognized as uncertainties are resolved. The Company’s distribution fee revenue is recorded in fund administration and distribution fees in the unaudited Condensed Consolidated Statements of Operations. The Company has contractual arrangements with third parties to provide certain distribution services. The Company is the primary obligor under the contracts with the Victory Funds and USAA Funds and has the ability to select the service provider and establish pricing. Substantially all of the Company’s revenue is recorded gross of payments made to third parties. Costs Incurred to Obtain or Fulfill Customer Contracts The Company is required to capitalize certain costs directly related to the acquisition or fulfillment of a contract with a customer. Victory has not identified any sales-based compensation or similar costs that meet the definition of an incremental cost to acquire a contract and as such we have no intangible assets related to contract acquisitions. Direct costs incurred to fulfill services under the Company’s distribution contracts include sales commissions paid to third party dealers for the sale of Class C Shares. The Company may pay upfront sales commissions to dealers and institutions that sell Class C shares of the participating Victory Funds at the time of such sale. Upfront sales commission payments with respect to Class C shares equal 1.00 % of the purchase price of the Class C shares sold by the dealer or institution. When the Company makes an upfront payment to a dealer or institution for the sale of Class C shares, the Company capitalizes the cost of such payment, which is recorded in Prepaid expenses in the unaudited Condensed Consolidated Balance Sheets and amortizes the cost over a 12-month period, the estimated period of benefit. Valuation of Assets Under Management The fair value of assets under management of the Victory Funds, USAA Funds and VictoryShares is primarily determined using quoted market prices or independent third-party pricing services or broker price quotes. In limited circumstances, a quotation or price evaluation is not readily available from a pricing service. In these cases, pricing is determined by management based on a prescribed valuation process that has been approved by the directors/trustees of the sponsored products. The same prescribed valuation process is used to price securities in separate accounts and other vehicles for which a quotation or price evaluation is not readily available from a pricing service. For the periods presented, a de minimis amount of the AUM was priced in this manner. NOTE 4. ACQUISITIONS USAA AMCO Acquisition On and effective July 1, 2019, the Company completed the USAA AMCO Acquisition, acquiring 100 % of the outstanding common stock of the USAA Acquired Companies and the USAA Mutual Fund Business. The USAA AMCO Acquisition expands and diversifies the Company’s investment platform, particularly in the fixed income and solutions asset classes, and increases the Company’s size and scale. Additional products added to the Company’s investment platforms include target date and target risk strategies, managed volatility mutual funds, active fixed income ETFs, sub-advised and multi-manager equity funds. The acquisition also added to the Company’s lineup of asset allocation portfolios and smart beta equity ETFs and provided the Company the rights to offer products and services using the USAA brand and the opportunity to offer its products to USAA members through a direct distribution channel. Purchase Price During the first quarter of 2020, the Company received a post-closing purchase price adjustment of $ 0.7 million in cash from the sellers related to net working capital adjustments. No further adjustments were recorded through the end of the measurement period on June 30, 2020. There has been no change in the goodwill balance from December 31, 2019 to September 30, 2020. 13 Table of Contents Total cumulative consideration paid for the USAA AMCO Acquisition was $ 949.4 million, comprised of $ 851.3 million of cash paid at closing plus the acquisition date value of contingent payments due to sellers of $ 98.8 million less $ 0.7 million in net working capital adjustments settled in the first quarter of 2020. A maximum of $ 150.0 million ($ 37.5 million per year) in contingent payments is payable to sellers based on the annual revenue of USAA Adviser attributable to all “non-managed money”-related AUM in each of the first four years following the closing. To receive any contingent payment in respect of “non-managed money”-related assets for a given year, annual revenue from “non-managed money”-related assets must be at least 80 % of the revenue run-rate (as calculated under the Stock Purchase Agreement) of the USAA Adviser’s “non-managed money”-related assets under management as of the closing date, and to achieve the maximum contingent payment for a given year, such annual revenue must total at least 100 % of that closing date revenue run-rate. Annual contingent payments in respect of “non-managed money”-related assets are subject to certain “catch-up” provisions set forth in the USAA Stock Purchase Agreement. The Company accounted for the acquisition in accordance with ASC 805, Business Combinations. Accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values at the date of the USAA AMCO Acquisition. The Company used an independent valuation specialist to assist with the determination of fair value for certain of the acquired assets and assumed liabilities disclosed below. The excess purchase price over the estimated fair values of assets acquired and liabilities assumed of $ 120.6 million was recorded to goodwill in the unaudited Condensed Consolidated Balance Sheets, all of which is expected to be deductible for tax purposes. The goodwill arising from the acquisition primarily results from expected future earnings and cash flows, as well as the synergies created by the integration of the USAA Acquired Companies within our organization. The following table summarizes the estimated amounts of identified acquired assets and liabilities assumed as of the acquisition date: (in thousands) Cash and cash equivalents $ 17,473 Investment management fees receivable 25,353 Fund administration and distribution fees receivable 4,779 Other receivables and prepaid expenses 299 Property and equipment 1,165 Other intangible assets (1) 808,670 Goodwill 120,643 Accounts payable and accrued expenses ( 5,575 ) Accrued compensation and benefits ( 5,907 ) Payable to members and custodians ( 17,473 ) Contingent consideration payable to sellers ( 98,800 ) Total purchase price consideration $ 850,627 (1) Includes $ 750.2 million for indefinite-lived investment advisory contracts, $ 19.1 million for indefinite-lived transfer agent contracts, $ 0.8 million for indefinite-lived distribution contracts, $ 38.2 million for definite-lived trade name assets and $ 0.4 million for definite-lived lease-related assets, all of which were recorded in other intangible assets, net on the unaudited Condensed Consolidated Balance Sheets. Contingent Consideration The Company expects to pay to sellers in the fourth quarter of 2020 the maximum amount of $ 37.5 million for the first annual earnout period for the USAA AMCO Acquisition. The fair value of contingent consideration payable to sellers at September 30, 2020 was estimated to be $ 120.5 million, which includes the $37.5 million expected to be paid for the first earnout period, as compared to $ 118.7 million at December 31, 2019. The increase in the contingent consideration liability of $ 2.0 million and $ 1.8 million in the three and nine months ended September 30, 2020, respectively, was recorded in change in value of consideration payable for acquisition of business in the unaudited Condensed Consolidated Statements of Operations. The fair value of the USAA AMCO Acquisition contingent consideration payable was estimated using the real options method. Revenue related to “non-managed money” assets was simulated in a risk-neutral framework to calculate expected probability-weighted earn out payments, which were then discounted from the expected payment dates at the relevant cost of debt. Significant assumptions and inputs include the “non-managed money” revenue projected annual growth rate, the market price of risk, which adjusts the projected revenue growth rate to a risk-neutral expected growth rate, revenue volatility and discount rate. As of September 30, 2020, the projected annual growth rate for “non-managed money” revenue was approximately 3 %. The market price of risk and revenue volatility of approximately 7 % and 16 %, respectively, were based on data for comparable companies. As 14 Table of Contents the contingent consideration represents a subordinate, unsecured claim of the Company, the Company has assessed a discount rate of approximately 4.5 %, which incorporates adjustments for credit risk and the subordination of the contingent consideration. Total estimated undiscounted earn out payments ranged from $ 128 million to $ 150 million, the maximum amount payable to sellers. Actual and Pro Forma Results for USAA Acquired Companies Revenue of the USAA Acquired Companies is included in the Company’s results as from July 1, 2019. For the six months ended June 30, 2020, revenue of the USAA Acquired Companies was $ 221.3 million. Net income attributable to the USAA Acquired Companies for the six months ended June 30, 2020 is impractical to determine as the Company does not prepare discrete financial information at level. The following Unaudited Pro Forma Condensed Combined Statements of Operations are provided for illustrative purposes only and assume that the acquisition occurred on January 1, 2018. This unaudited information should not be relied upon as indicative of historical results that would have been obtained if the acquisition had occurred on that date, nor of the results that may be obtained in the future. The historical consolidated financial information of Victory and the USAA Acquired Companies have been adjusted to give effect to unaudited pro forma events that are directly attributable to the transaction, factually supportable and expected to have continuing impact on the combined results. These amounts have been calculated after adjusting the results of the USAA Acquired Companies to reflect additional interest expense, distribution costs, share-based compensation expense, income taxes and intangible asset amortization that would have been expensed assuming the fair value adjustments had been applied on January 1, 2018. In addition, Victory’s and the USAA Acquired Companies’ results were adjusted to remove incentive compensation, legal fees and mutual fund proxy costs directly attributable to the acquisition. Unaudited Nine Months Ended (in thousands, except per share amount) September 30, 2019 Revenue $ 632.9 Net income $ 76.5 Earnings per share of common stock Basic $ 1.13 Diluted $ 1.04 Weighted average number of shares outstanding Basic 67,610 Diluted 73,300 Acquisition-Related Costs Costs related to acquisitions are summarized below and include legal and filing fees, advisory services, mutual fund proxy voting costs and other one-time expenses related to the transactions. These costs are included in acquisition-related costs in the unaudited Condensed Consolidated Statements of Operations. Acquisition-related costs Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2020 2019 2020 2019 USAA AMCO Acquisition $ 776 $ 16,235 $ 664 $ 21,043 Other 372 151 392 907 Total acquisition-related costs $ 1,148 $ 16,386 $ 1,056 $ 21,950 15 Table of Contents Restructuring and Integration Costs In connection with business combinations, asset purchases and changes in business strategy, the Company incurs costs integrating investment platforms, products and personnel into existing systems, processes and service provider arrangements and restructuring the business to capture operating expense synergies. The following table presents the rollforward of restructuring and integration liabilities, which are recorded in accounts payable and accrued expenses in the unaudited Condensed Consolidated Balance Sheets, for the three and nine months ended September 30, 2020 and 2019: Three Months Ended September 30, Nine Months Ended September 30, (in millions) 2020 2019 2020 2019 Liability balance, beginning of period $ 2.8 $ 1.5 $ 3.0 $ 0.1 Severance Expense - USAA AMCO — 3.7 0.9 5.2 Integration costs - USAA AMCO 1.3 1.1 4.0 1.4 Total restructuring and integration costs 1.3 4.8 4.9 6.6 Settlement of liabilities ( 1.2 ) ( 4.4 ) ( 5.0 ) ( 4.8 ) Liability balance, end of period $ 2.9 $ 1.9 $ 2.9 $ 1.9 NOTE 5. Fair Value Measurements The Company determines the fair value of certain financial and nonfinancial assets and liabilities. Fair value is determined based on the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value determinations utilize a valuation hierarchy based upon the transparency of inputs used in the valuation of an asset or liability. Classification within the fair value hierarchy contains three levels: • Level 1—Valuation inputs are unadjusted quoted market prices for identical assets or liabilities in active markets. • Level 2—Valuation inputs are quoted prices for identical assets or liabilities in markets that are not active, quoted market prices for similar assets and liabilities in active markets and other observable inputs directly or indirectly related to the asset or liability being measured. • Level 3—Valuation inputs are unobservable and significant to the fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability. The table below shows liabilities measured at fair value on a recurring basis. As of September 30, 2020 (in thousands) Total Level 1 Level 2 Level 3 Financial Liabilities Interest Rate Swap Liability $ ( 11,772 ) $ - $ ( 11,772 ) $ - Contingent Consideration Arrangements (1) ( 120,500 ) - - ( 120,500 ) Total Financial Liabilities $ ( 132,272 ) $ - $ ( 11,772 ) $ ( 120,500 ) As of December 31, 2019 (in thousands) Total Level 1 Level 2 Level 3 Financial Liabilities Contingent Consideration Arrangements (1) $ ( 118,700 ) $ - $ - $ ( 118,700 ) Total Financial Liabilities $ ( 118,700 ) $ - $ - $ ( 118,700 ) (1) Refer to Note 4, Acquisitions, for further information regarding the Company’s contingent consideration arrangements. The Swap liability represents amounts owed as of September 30, 2020 under a floating-to-fixed interest rate swap transaction entered into by the Company on March 27, 2020. The Swap effectively fixed the interest rate at 3.465 % on $ 450 million of the outstanding Term Loan balance through the Term Loan’s maturity in July 2026. The fair value of the Swap is included in other liabilities on the unaudited Condensed Consolidated Balance Sheets at September 30, 2020. Pricing was determined based on a third party, model-derived valuation in which all significant inputs are observable in active markets (Level 2). Refer to Note 14, Derivatives, for further detail on the Swap. The contingent consideration arrangement liabilities represent the USAA AMCO Acquisition estimated earn-out payment liability, which is included in consideration payable for acquisition of business in the unaudited Condensed Consolidated Balance Sheets. 16 Table of Contents Significant unobservable inputs for the option pricing model used to determine the estimated fair value of the USAA AMCO Acquisition earn-out payment liability include the “non-managed money” revenue projected growth rate, revenue volatility, market price of risk and discount rate. An increase in market price of risk, discount rate and revenue volatility results in a lower fair value for the earn-out payment liability, while an increase in the projected growth rate for “non-managed money” revenue results in a higher fair value for the earn-out payment liability. Refer to Note 4, Acquisitions, for further details related to the valuation of contingent consideration payable related to the USAA AMCO Acquisition. Changes in the fair value of the liability, realized or unrealized, are recorded in earnings and are included in change in value of consideration payable for acquisition of business in the unaudited Condensed Consolidated Statements of Operations. The following table presents the balance of the contingent consideration arrangement liabilities at December 31, 2019 and September 30, 2020, respectively. (in thousands) Contingent Consideration Liabilities Balance, December 31, 2019 $ ( 118,700 ) USAA AMCO change in fair value measurement ( 1,800 ) Balance, September 30, 2020 $ ( 120,500 ) There were no transfers between any of the Level 1, 2 and 3 categories in the fair value measurement hierarchy from December 31, 2019 to September 30, 2020. The Company recognizes transfers at the end of the reporting period. The net carrying value of accounts receivable and accounts payable approximates fair value due to the short‑term nature of these assets and liabilities. The fair value of our long-term debt at September 30, 2020 is considered to be its carrying value as the interest rate on the bank debt is variable and approximates current market rates. As a result, Level 2 inputs are utilized to determine the fair value of our long‑term debt. The fair value of the Company’s money market investment ($ 10.1 million within cash and cash equivalents), available-for-sale investments and trading securities are measured using Level 1 inputs, which are the market prices for shares in these open-end mutual funds . NOTE 6. Related-Party Transactions The Company considers certain funds that it manages, including the Victory Funds, the USAA Funds, the VictoryShares and collective trust funds that it sponsors (the “Victory Collective Funds”), to be related parties as a result of our advisory relationship. The Company receives investment management, administrative, distribution and compliance fees in accordance with contracts that VCM and VCS have with the Victory Funds and the USAA Funds and has invested a portion of its balance sheet cash in the USAA Treasury Money Market Fund and earns interest on the amount invested in this fund. We also receive investment management fees from the VictoryShares and Victory Collective Funds under VCM’s advisory contracts with these funds and administrative fees from the VictoryShares. In addition, we receive transfer agent fees in accordance with a contract that VCTA has with the USAA Funds. The table below presents balances and transactions involving related parties included in the unaudited Condensed Consolidated Balance Sheets and unaudited Condensed Consolidated Statements of Operations. • Included in cash and cash equivalents is cash held in the USAA Treasury Money Market Fund. • Included in receivables (fund administration and distribution fees) are amounts due from the Victory Funds and USAA Funds for compliance services and amounts due from the USAA Funds for transfer agent services. • Included in revenue (fund administration and distribution fees) are amounts earned for compliance services and transfer agent services. • Realized and unrealized gains and losses and dividend income on investments in the Victory Funds and USAA Funds classified as available-for-sale securities and investments in the Victory Funds and USAA Funds classified as trading securities and dividend income on investments in the USAA Treasury Money Market Fund are recorded in interest income and other income (expense) in the unaudited Condensed Consolidated Statements of Operations. • Amounts due to the Victory Funds, USAA Funds and VictoryShares for waivers of investment management fees and reimbursements of fund operating expenses are included in accounts payable and accrued expenses in the unaudited Condensed Consolidated Balance Sheets and represent consideration payable to customers. 17 Table of Contents (in thousands) September 30, 2020 December 31, 2019 Related party assets Cash and cash equivalents $ 10,088 $ 10,060 Receivables (investment management fees) 41,008 47,872 Receivables (fund administration and distribution fees) 16,960 19,313 Investments (available-for-sale securities, fair value) 785 771 Investments (trading securities, fair value) 18,518 17,914 Total $ 87,359 $ 95,930 Related party liabilities Accounts payable and accrued expenses (fund reimbursements) $ 5,330 $ 4,316 Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2020 2019 2020 2019 Related party revenue Investment management fees $ 115,376 $ 130,361 $ 348,653 $ 239,869 Fund administration and distribution fees 51,416 59,574 160,809 85,960 Total $ 166,792 $ 189,935 $ 509,462 $ 325,829 Related party other income (expense) Interest income and other income (expense) $ 828 $ ( 342 ) $ ( 1,268 ) $ 1,473 NOTE 7. Investments As of September 30, 2020 and December 31, 2019, the Company held both available-for-sale securities and trading securities. Available-for-sale investments consist entirely of seed capital investments in certain Victory Funds and USAA Funds. Trading securities are held under a deferred compensation plan and include Victory Funds, USAA Funds and third party mutual funds. Available‑For‑Sale Securities A summary of the cost and fair value of investments classified as available-for-sale were as follows: Gross Unrealized Fair (in thousands) Cost Gains (Losses) Value As of September 30, 2020 $ 702 $ 90 $ ( 7 ) $ 785 As of December 31, 2019 696 85 ( 10 ) 771 Unrealized and realized gains and losses on available‑for‑sale investments are recognized in the accompanying unaudited Condensed Consolidated Statements of Operations as “Interest income and other income (expense).” There were no proceeds from sales and realized gains and losses from available-for-sale securities for the three months ended September 30, 2020 and 2019. For the nine month periods ended September 30, 2020 and 2019 proceeds from sales and realized gains and losses from available-for-sale securities were as follows: Sale Realized (in thousands) Proceeds Gains (Losses) For the nine months ended September 30, 2020 $ 274 $ 18 $ ( 13 ) For the nine months ended September 30, 2019 104 4 — Trading Securities A summary of the cost and fair value of investments classified as trading securities were as follows: Gross Unrealized Fair (in thousands) Cost Gains (Losses) Value As of September 30, 2020 $ 20,420 $ 449 $ ( 2,037 ) $ 18,832 As of December 31, 2019 18,670 733 ( 1,098 ) 18,305 18 Table of Contents Unrealized and realized gains and losses on trading securities are recorded in interest income and other income (expense) in the unaudited Condensed Consolidated Statements of Operations. Proceeds from sales and realized gains and losses from trading securities in the periods ended September 30, 2020 and 2019 were as follows: Sale Realized (in thousands) Proceeds Gains (Losses) For the three months ended September 30, 2020 $ 1,289 $ 48 $ ( 166 ) For the three months ended September 30, 2019 908 1 ( 29 ) Sale Realized (in thousands) Proceeds Gains (Losses) For the nine months ended September 30, 2020 $ 3,279 $ 85 $ ( 308 ) For the nine months ended September 30, 2019 2,342 15 ( 60 ) NOTE 8. Income Taxes The effective tax rate for the three and nine months ended September 30, 2020 and 2019 differs from the United States federal statutory rate primarily as a result of state and local income taxes, excess tax benefits on share-based compensation and certain non-deductible expenses and for the periods in 2019, expense related to recognizing a liability for unrecorded tax benefits. For the three months ended September 30, 2020 and 2019, the provision for income taxes was $ 17.0 million and $ 8.1 million, or 23.4 % and 23.7 %, of pre-tax income respectively. For the nine months ended September 30, 2020 and 2019, the provision for income taxes was $ 48.3 million and $ 17.3 million, or 23.5 % and 24.0 % of pre-tax income, respectively. The effective tax rate for the three and nine months ended September 30, 2020 was slightly lower than the effective tax rate for the same periods in 2019 due to the combination of decreased excess tax benefits on share-based compensation and decreased expense related to state uncertain tax positions. No valuation allowance was recorded for deferred tax assets in the periods ended September 30, 2020 and 2019. At September 30, 2020, the Company had no liability for gross unrecognized tax benefits. It had a $ 0.1 million liability for interest and penalties on previously unrecognized gross tax benefits, which is included in “Other liabilities” in the accompanying unaudited Condensed Consolidated Balance Sheets. The Company expects that the amount of unrecognized tax benefits will change in the next 12 months; however, the Company does not expect the change to have a material impact on its consolidated financial statements. The following table presents the changes in gross unrecognized tax benefits, excluding interest and penalties, for the three and nine months ended September 30, 2020 and 2019. (in thousands) 2020 2019 Beginning balance, January 1 $ 2,582 $ — Additions based on tax positions related to current period 280 — Reductions related to settlement of tax matters ( 908 ) — Ending balance, March 31 $ 1,954 $ — Additions based on tax positions related to current period — — Reductions related to settlement of tax matters ( 1,954 ) — Ending balance, June 30 $ — $ — Additions based on tax positions related to current period — — Reductions related to settlement of tax matters — — Ending balance, September 30 $ — $ — 19 Table of Contents NOTE 9. Debt 2020 Debt Repricing Concurrent with the USAA AMCO Acquisition on July 1, 2019, the Company (i) entered into the 2019 Credit Agreement, (ii) repaid all indebtedness outstanding under the previous credit agreement (dated February 2018), and (iii) terminated the previous credit agreement. On January 17, 2020, the Company entered into the First Amendment (the “First Amendment”) to the 2019 Credit Agreement with the other loan parties thereto, Barclays Bank PLC, as administrative agent, and the Royal Bank of Canada as fronting bank. Pursuant to the First Amendment, the Company repriced the existing term loans (the “Existing Term Loans”) with replacement term loans in an aggregate principal amount of $ 952.0 million (the “Repriced Term Loans”). The Repriced Term Loans provide for substantially the same terms as the Existing Term Loans, including the same maturity date of July 2026 , except that the Repriced Term Loans provide for a reduced applicable margin on LIBOR of 75 basis points. The applicable margin on LIBOR under the Repriced Term Loans is 2.50 %, compared to 3.25 % under the Existing Term Loans. The following table summarizes the components of long-term debt under the 2019 Credit Agreement in the unaudited Condensed Consolidated Balance Sheets at September 30, 2020 and December 31, 2019: (in thousands) September 30, 2020 December 31, 2019 Term loan principal outstanding $ 837,239 $ 952,000 Unamortized debt issuance costs ( 7,959 ) ( 17,230 ) Unamortized debt discount ( 13,403 ) ( 10,231 ) Long-term debt, net $ 815,877 $ 924,539 The 2019 Credit Agreement contains customary affirmative and negative covenants, including covenants that affect, among other things, the ability of the first lien leverage ratio, measured as of the last day of each fiscal quarter on which outstanding borrowings under the revolving credit facility exceed 35.0 % of the commitments thereunder (excluding certain letters of credit), of no greater than 3.80 to 1.00. As of September 30, 2020, there were no outstanding borrowings under the revolving credit facility and the Company was in compliance with its financial performance covenant. A total of $ 114.8 million of the outstanding term loans under the 2019 Credit Agreement was repaid or repurchased and retired during the first nine months of 2020. The Company repaid $ 38.0 million in outstanding term loans in the first three months of 2020 and recorded a $ 1.0 million loss on debt extinguishment. During the three months ended June 30, 2020, the Company repaid or repurchased and retired $ 33.3 million of outstanding term loans and recorded a $ 0.1 million gain on debt extinguishment. During the three months ended September 30, 2020, the Company repaid or repurchased and retired $ 43.5 million of outstanding term loans and recorded a $ 0.8 million loss on debt extinguishment. Refer to Note 16, Subsequent Events, for information related to term loan activity subsequent to September 30, 2020. 2020 Swap Transaction On March 27, 2020, the Company executed the Swap, a floating-to-fixed interest rate swap transaction, to effectively fix the interest rate at 3.465 % on $ 450 million of its outstanding term loan through the term loan maturity date of July 2026. Refer to Note 14, Derivatives, for further information on the Swap. 20 Table of Contents Interest Expense As of September 30, 2020, the term loans under the 2019 Credit Agreement had an interest period of three months and an interest rate of 2.80 %. Including the impact of amortization of debt issuance costs and original issue discount described herein, the effective yield for term loans under the 2019 Credit Agreement as of September 30, 2020 was 3.23 %. The following table summarizes the components of interest expense and other financing costs in the unaudited Condensed Consolidated Statements of Operations for the periods ended September 30, 2020 and 2019: For the Three Months Ended September 30, For the Nine Months Ended September 30, (in thousands) 2020 2019 2020 2019 Interest expense $ 6,236 $ 15,308 $ 25,260 $ 22,931 Amortization of debt issuance costs 739 920 2,275 1,650 Amortization of debt discount 367 475 1,136 768 Interest rate swap expense 724 153 205 — Other 121 — 429 651 Total $ 8,187 $ 16,856 $ 29,305 $ 26,000 NOTE 10. Equity Shares Rollforward The following tables present the changes in the number of shares of common stock issued and repurchased (in thousands): Shares of Common Stock Issued Shares of Treasury Stock Class A Class B Class A Class B Balance, December 31, 2019 18,100 53,937 ( 1,685 ) ( 2,656 ) Issuance of shares 2 — — — Share conversion - Class B to A 406 ( 406 ) — — Repurchase of shares — — ( 240 ) — Vesting of restricted share grants — 719 — — Exercise of options — 288 — — Shares withheld related to net settlement of equity awards — — — ( 445 ) Balance, March 31, 2020 18,508 54,538 ( 1,925 ) ( 3,101 ) Issuance of shares 2 — — — Share conversion - Class B to A 207 ( 207 ) — — Repurchase of shares — — ( 457 ) — Vesting of restricted share grants — 173 — — Exercise of options — — — — Shares withheld related to net settlement of equity awards — — — ( 43 ) Balance, June 30, 2020 18,717 54,504 ( 2,382 ) ( 3,144 ) Issuance of shares 2 — — — Share conversion - Class B to A 631 ( 631 ) — — Repurchase of shares — — ( 529 ) — Vesting of restricted share grants — 197 — — Exercise of options — 330 — — Shares withheld related to net settlement of equity awards — — — ( 91 ) Balance, September 30, 2020 19,350 54,400 ( 2,911 ) ( 3,235 ) 21 Table of Contents Shares of Common Stock Issued Shares of Treasury Stock Class A Class B Class A Class B Balance, December 31, 2018 15,281 55,284 ( 856 ) ( 2,147 ) Issuance of shares 1 — — — Share conversion - Class B to A 382 ( 382 ) — — Repurchase of shares — — ( 123 ) — Vesting of restricted share grants — 40 — — Exercise of options — 72 — — Shares withheld related to net settlement of equity awards — — — ( 29 ) Balance, March 31, 2019 15,664 55,014 ( 979 ) ( 2,176 ) Issuance of shares 1 — — — Share conversion - Class B to A 809 ( 809 ) — — Repurchase of shares — — ( 113 ) — Vesting of restricted share grants — 4 — — Exercise of options — 150 — — Shares withheld related to net settlement of equity awards — — — ( 8 ) Balance, June 30, 2019 16,474 54,359 ( 1,092 ) ( 2,184 ) Issuance of shares 1 — — — Share conversion - Class B to A 1,331 ( 1,331 ) — — Repurchase of shares — — ( 300 ) — Vesting of restricted share grants — 169 — — Exercise of options — 487 — — Shares withheld related to net settlement of equity awards — — — ( 216 ) Balance, September 30, 2019 17,806 53,684 ( 1,392 ) ( 2,400 ) Share Repurchase Program The share repurchase programs authorized in 2018 and 2019, each for $ 15.0 million of the Company’s Class A common stock were completed in September 2019 and June 2020, respectively. In May 2020, the Company’s Board of Directors authorized the Company to repurchase up to an additional $ 15.0 million of the Company’s Class A common stock in the open market or in privately negotiated transactions (“2020 Share Repurchase Program”). As of September 30, 2020, a total of 2,911,402 shares of Class A common stock had been repurchased under authorized share repurchase programs at a total cost of $ 42.5 million for an average price of $ 14.59 per share. As of September 30, 2020, $ 2.5 million was available for future purchases and on October 29, 2020, the 2020 Share Repurchase Program was completed. On November 2, 2020, the Company’s Board of Directors authorized the Company to repurchase up to an additional $ 15.0 million of the Company’s Class A common stock through December 31, 2022 in open market or privately negotiated transactions (“Additional 2020 Share Repurchase Program”). The amount and timing of the purchases under the 2020 Additional Share Repurchase Program will depend on a number of factors including the price and availability of the Company’s shares, trading volume, capital availability, Company performance and general economic and market conditions. The Additional 2020 Share Repurchase Program can be suspended or discontinued at any time. The Additional 2020 Share Repurchase Program expires when $ 15 million shares of Class A common stock are repurchased or on December 31, 2022. Quarterly Dividends During the three months ended September 30, 2020, the Company paid a quarterly dividend of $ 4.1 million. Dividends paid during the nine months ended September 30, 2020 totaled $ 11.5 million, comprised of $ 10.8 million in quarterly dividends and $ 0.7 million in cash bonuses and distributions related to dividends previously declared upon vesting of restricted stock and stock option awards. NOTE 11. Share‑Based Compensation Current Period Activity During the three months ended September 30, 2020, the Company issued restricted stock awards for 484,010 shares of common stock, of which awards for 11,997 shares were fully vested on the grant date, awards for 57,576 shares vest based on service over a three year period, and awards for 414,437 shares vest based on service over a thirty month period. For the nine months ended September 30, 2020, the Company issued restricted stock awards for 781,843 shares of common stock, of which awards for 30,976 shares were fully vested on the grant date, awards for 336,430 shares vest based on service over a three year period and awards for 414,437 shares vest based on service over a thirty month period. 22 Table of Contents Stock option award and restricted stock award activity during the nine months ended September 30, 2020 and 2019 was as follows: Shares Subject to Stock Option Awards Nine Months Ended September 30, 2020 2019 Avg wtd Avg wtd Avg wtd Avg wtd grant-date exercise grant-date exercise fair value price Units fair value price Units Outstanding at beginning of period $ 3.83 $ 6.27 7,880,167 $ 3.79 $ 6.12 9,070,052 Granted — — — 7.25 17.64 31,178 Forfeited 5.86 12.40 ( 8,746 ) 5.00 9.63 ( 247,403 ) Exercised 3.44 5.06 ( 617,412 ) 3.15 4.11 ( 708,949 ) Outstanding at end of the period $ 3.86 $ 6.36 7,254,009 $ 3.82 $ 6.24 8,144,878 Vested $ 3.73 $ 5.97 6,641,955 $ 3.59 $ 5.51 6,860,289 Unvested 5.30 10.67 612,054 5.06 10.12 1,284,589 Restricted Stock Awards Nine Months Ended September 30, 2020 2019 Avg wtd grant- Avg wtd grant- date fair value Units date fair value Units Unvested at beginning of period $ 14.29 3,215,619 $ 13.17 2,997,856 Granted 16.65 781,843 16.27 1,192,145 Vested 14.35 ( 1,089,780 ) 11.06 ( 212,929 ) Forfeited 15.88 ( 78,839 ) 13.49 ( 433,549 ) Unvested at end of period $ 14.98 2,828,843 $ 14.25 3,543,523 Dividend Payments At September 30, 2020 and December 31, 2019, the amount of cash bonuses and distributions related to dividends previously declared on unvested and outstanding restricted share awards and stock options totaled $ 1.0 million and $ 1.3 million, respectively, which was not recorded as a liability as of the balance sheet date. A liability will be recorded for these cash bonuses and dividends when the restricted shares and options vest. Share-Based Compensation Expense The Company recorded $ 3.6 million and $ 4.8 million of share-based compensation expense in the three months ended September 30, 2020 and 2019, respectively, and $ 13.5 million and $ 10.1 million of share-based compensation in the nine months ended September 30, 2020 and 2019, respectively, in personnel compensation and benefits in the unaudited Condensed Consolidated Statements of Operations. NOTE 12. Earnings Per Share The following table sets forth the reconciliation of basic earnings per share and diluted earnings per share from net income for the three and nine months ended September 30, 2020 and 2019: Three Months Ended September 30, Nine Months Ended September 30, (in thousands except per share amounts) 2020 2019 2020 2019 Net income $ 55,741 $ 25,992 $ 157,627 $ 54,902 Shares: Basic : Weighted average number of shares outstanding 67,743 67,724 67,785 67,610 Plus : Incremental shares from assumed conversion of dilutive instruments 5,694 5,947 5,918 5,690 Diluted : Weighted average number of shares outstanding 73,437 73,671 73,703 73,300 Earnings per share Basic: $ 0.82 $ 0.38 $ 2.33 $ 0.81 Diluted: $ 0.76 $ 0.35 $ 2.14 $ 0.75 23 Table of Contents Outstanding instruments excluded from the computation of weighted average shares for diluted earnings per share because the effect would be anti-dilutive totaled 43 thousand and 0.3 million for the three months ended September 30, 2020 and 2019, respectively, and 43 thousand and 1.3 million for the nine months ended September 30, 2020 and 2019, respectively. Holders of non-vested share-based compensation awards do not have rights to receive nonforfeitable dividends on the shares covered by the awards. NOTE 13. Accumulated Other Comprehensive Loss The following table presents changes in accumulated other comprehensive loss by component for the nine months ended September 30, 2020 and 2019. Available-for- Cumulative Sale Cash Flow Translation (in thousands) Securities Hedges Adjustment Total Balance, December 31, 2019 $ — $ — $ — $ — Other comprehensive loss before reclassification and tax — ( 11,977 ) ( 23 ) ( 12,000 ) Tax impact — 2,853 6 2,859 Reclassifications, before tax — 205 — 205 Tax impact — ( 51 ) — ( 51 ) Net current period other comprehensive loss — ( 8,970 ) ( 17 ) ( 8,987 ) Balance, September 30, 2020 $ — $ ( 8,970 ) $ ( 17 ) $ ( 8,987 ) Balance, December 31, 2018 $ ( 59 ) $ — $ ( 27 ) $ ( 86 ) Other comprehensive income before reclassification and tax — — ( 28 ) ( 28 ) Tax impact — — 7 7 Net current period other comprehensive income — — ( 21 ) ( 21 ) Cumulative effect of adoption of ASU 2016-01 and 2018-02 59 — 3 62 Balance, September 30, 2019 $ — $ — $ ( 45 ) $ ( 45 ) NOTE 14. DERIVATIVES Interest Rate Swaps On March 27, 2020, the Company entered into the Swap to manage interest rate risk associated with a portion of its floating-rate long-term debt. The Company does not purchase or hold any derivative instruments for trading or speculative purposes. Under the terms of the Swap, the Company pays interest at a fixed rate of interest and receive interest that varies with the three-month LIBOR rate. The notional value, fixed rate of interest and expiration date of the Swap as of September 30, 2020 was $ 450 million – 3.465 % – July 1, 2026 . Refer to Note 5, Fair Value Measurements, for additional disclosures regarding fair value measurements. The designation of a derivative instrument as a hedge and its ability to meet the hedge accounting criteria determine how the Company reflects the change in fair value of the derivative instrument. A derivative qualifies for hedge accounting treatment if, at inception, it meets defined correlation and effectiveness criteria. These criteria require that the anticipated cash flows and/or changes in fair value of the hedging instrument substantially offset those of the position being hedged. The Swap is assessed for effectiveness and continued qualification for hedge accounting on a quarterly basis. For the three months ended September 30, 2020 and since inception, the Swap was deemed to be highly effective. The Swap is designated as a cash flow hedge. Accordingly, the Swap is measured at fair value with mark-to-market gains or losses deferred and included in accumulated other comprehensive loss, net of tax, to the extent the hedge is determined to be effective. Gains or losses from the Swap are reclassified to interest expense in the same period during which the hedged transaction affects earnings. The amount payable to the Swap counterparty at September 30, 2020 of $ 0.7 million is recorded in other liabilities on the unaudited Condensed Consolidated Balance Sheets. The following table summarizes the classification of the Swap in the unaudited Condensed Consolidated Balance Sheets at September 30, 2020 and December 31, 2019 (in thousands): Balance Sheets Description September 30, 2020 December 31, 2019 Other liabilities Fair value of interest rate swap $ 11,772 $ — Notional amount 450,000 — 24 Table of Contents The following tables summarize the effects of the Swap in the unaudited Condensed Consolidated Statements of Operations and unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2020 and 2019 and (in thousands): Three Months Ended Nine Months Ended September 30, September 30, Statement of Operations Description 2020 2019 2020 2019 Interest expense and other financing costs Loss reclassified from AOCL $ 724 $ — $ 205 $ — Three Months Ended Nine Months Ended September 30, September 30, Statements of Comprehensive Income Description 2020 2019 2020 2019 Other comprehensive loss Loss recognized in AOCL, net of tax $ 621 $ — $ 8,970 $ — NOTE 15. EQUITY METHOD INVESTMENT On September 20, 2020, the Company acquired, through a wholly owned subsidiary, a 15 % interest voting share and income share in Alderwood. Alderwood’s operating entity, Alderwood Capital, is a London-based investment advisory firm focused on taking minority stakes in specialist boutique asset management businesses. The Company has commitments to contribute additional capital of $ 4.5 million to Alderwood and $ 50 million to a private fund to be launched by Alderwood, subject to certain terms and conditions. The Company analyzed its investment in Alderwood under the voting interest model and determined that it does not have a controlling financial interest over Alderwood and should not consolidate under the voting interest model. Given the level of ownership interest in Alderwood, which is an English limited liability partnership, and the fact that Alderwood will maintain specific ownership accounts for investors, the Company accounts for its investment in Alderwood using the equity method of accounting. For the three and nine months ended September 30, 2020, the Company recorded no gains or losses from its equity investment in Alderwood. For the three and nine months ended September 30, 2019, the Company recognized a $ 2.9 million gain on sale of its equity investment in Cerebellum Capital, LLC (“Cerebellum”). Gains and losses on equity method investments, including the gain on sale of the Cerebellum equity investment, are recorded in “Interest income and other income (expense)” in the unaudited Condensed Consolidated Statements of Operations. Equity method investments are recorded in “Other assets” in the unaudited Condensed Consolidated Balance Sheets. At September 30, 2020, the Company had a $ 1.5 million investment in Alderwood and no longer held an equity investment in Cerebellum. NOTE 16. SUBSEQUENT EVENTS Subsequent to September 30, 2020, the Company repaid $ 20.0 million in term loan principal, for a total debt reduction of $ 282.8 million since July 1, 2019. On November 4, 2020 , the Company announced that its Board of Directors declared a quarterly cash dividend of $ 0.07 per share on the Company’s common stock, an increase of 17 % and 40 %, respectively, over the third quarter 2020 and second quarter 2020 quarterly cash dividend. The dividend is payable on December 28, 2020 , to stockholders of record on December 10, 2020 . On November 4, 2020, the Company announced that its Board of Directors approved the Additional 2020 Share Repurchase Program authorizing the repurchase of up to $ 15 million of its Class A Common Stock through December 31, 2022 . Under the new program, the Company may purchase its shares from time to time in the open market or in privately negotiated transactions. The amount and timing of the purchases will depend on a number of factors including the price and availability of the Company’s shares, trading volume, capital availability, Company performance and general economic and market conditions. The share repurchase program may be suspended or discontinued at any time. On November 4, 2020, the Company announced the planned acquisition of THB Asset Management (“THB”), an investment management company headquartered in Norwalk, Connecticut. THB currently manages approximately $ 435 million in the micro-cap, small-cap and mid-cap asset classes, including U.S., global and international strategies. Aligning with the Company’s responsible 25 Table of Contents investing initiatives, all of THB’s strategies have environmental, social and governance (“ESG”) considerations fully integrated into their investment processes.