Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Unless the context otherwise requires, references in this Quarterly Report on Form 10-Q to the “Company,” “Victory,” or in the first-person notations of “we,” “us,” and “our” shall mean Victory Capital Holdings, Inc., a Delaware corporation, and its wholly-owned subsidiaries.
The following discussion is intended to assist in the understanding of our financial position at March 31, 2021 and December 31, 2020, results of operations for the three months ended March 31, 2021 and 2020, and cash flows for the three months ended March 31, 2021 and 2020, and should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our Annual Report on Form 10-K for the year ended December 31, 2020. This discussion and analysis contains forward-looking statements and should also be read in conjunction with the disclosures and information contained in “Forward-Looking Statements” included elsewhere in this Quarterly Report on Form 10-Q and in “Item 1A. Risk Factors” included in the Annual Report on Form 10-K for the year ended December 31, 2020.
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Overview
Our Business – We are a diversified global asset management firm with $154.3 billion in assets under management as of March 31, 2021. The Company operates a next-generation business model combining boutique investment qualities with the benefits of a fully integrated, centralized operating and distribution platform.
We provide specialized investment strategies to institutions, intermediaries, retirement platforms and individual investors. With 10 autonomous Investment Franchises and a Solutions Platform, Victory Capital offers a wide array of investment styles and investment vehicles including, actively managed mutual funds, institutional separate accounts, separately managed accounts, unified managed account products, collective trust funds, private funds, undertakings for the collective investment in transferrable securities, other pooled vehicles and ETFs. Our earnings are primarily driven by asset-based fees charged for services related to the investment strategies we deliver and consist of investment management, fund administration and distribution fees.
Franchises – Our Franchises are operationally integrated but are separately branded and make investment decisions independently from one another within guidelines established by their respective investment mandates. Our integrated model creates a supportive environment in which our investment professionals, largely unencumbered by administrative and operational responsibilities, can focus on their pursuit of investment excellence. VCM employs all of our U.S. investment professionals across our Franchises, which are not separate legal entities.
Solutions – Our Solutions Platform consists of multi-Franchise and customized solutions strategies that are primarily rules-based. We offer our Solutions Platform through a variety of vehicles, including separate accounts, mutual funds and VictoryShares which is our ETF brand. Like our Franchises, our Solutions Platform is operationally integrated and supported by our centralized distribution, marketing and operational support functions. Our approach to rules‑based investing includes single and multi‑factor strategies designed to provide a variety of outcomes, including maximum diversification, dividend income, downside mitigation, minimum volatility, thematic and targeted factor exposure.
Professionals within our institutional and retail distribution channels, direct to investor business and marketing organization sell our products through our centralized distribution model. Our institutional sales team focuses on cultivating relationships with institutional consultants, who account for the majority of the institutional market, as well as asset allocators seeking sub-advisers. Our retail sales team offers intermediary and retirement platform clients, including broker-dealers, retirement platforms and RIA networks, mutual funds and ETFs as well as SMAs through wrap fee programs and access to our investment models through UMAs. Our direct to investor business serves the investment needs of clients including USAA members, the military community, and other individual clients.
We have grown our AUM from $17.9 billion following the management-led buyout with Crestview GP in August 2013 to $154.3 billion at March 31, 2021. We attribute this growth to our success in sourcing acquisitions and evolving them into organic growers, generating strong investment returns, and developing institutional, retail, and direct to investor channels with deep penetration.
THB Asset Management Acquisition – Effective March 1, 2021, the Company completed the acquisition of certain assets of THB Asset Management (“THB”). The acquisition expands and diversifies our investment platform, adding capacity constrained assets classes that we like and know well. The team manages strategies in U.S. micro-cap, small-cap and mid-cap assets classes as well as international small cap and global small cap portfolios; all of which are asset classes in which active management is an important part of a well-diversified portfolio. At March 1, 2021, the THB AUM that was acquired totaled $547 million.
In addition to servicing clients in the U.S., THB has a footprint in Australia and Europe which provides us with expanded distribution opportunities in regions in which we have a limited presence today. This will benefit all of our Franchises as we look to leverage THB’s distribution footprint to sell more of our investment strategies outside the U.S.
Aligning with the Company’s responsible investing initiatives, all of THB’s strategies have environmental, social and governance (“ESG”) considerations fully integrated into their investment processes. THB was an early adopter of responsible investment practices and have been managing responsible investment portfolios for decades.
Nominal consideration was paid for the assets of THB. The THB investment team will share in the revenue generated on their products and benefit from our centralized operational, marketing and distribution platforms. THB has significant room for AUM growth across its product set, which we think will significantly accelerate with our distribution support.
USAA AMCO Acquisition – Effective July 1, 2019, the Company completed the acquisition (the “USAA AMCO Acquisition”) of USAA Asset Management Company (“USAA Adviser”) and Victory Capital Transfer Agency, Inc. (“VCTA”), formally known as the USAA Transfer Agency Company. The transformative acquisition increased AUM by $81.1 billion and significantly impacted our financial results. The acquisition expanded and diversified our investment platform, particularly in the fixed income and solutions asset classes, and increased our size and scale. The acquisition increased AUM and revenue and introduced additional personnel expenses and new and additional operating expenses. In conjunction with the USAA AMCO Acquisition, the Company entered into the 2019 Credit Agreement, dated July 1, 2019, and obtained a seven-year term loan in an aggregate principal amount of $1.1 billion. All indebtedness outstanding under the previous credit agreement was repaid and terminated as of July 1, 2019.
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Total consideration for the USAA AMCO Acquisition was $949.4 million, comprising of $851.3 million of cash paid at closing plus $98.8 million as the estimated fair value of contingent consideration as of the acquisition date 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 date. In 2020, we paid $37.5 million in cash to sellers for the first annual contingent payment.
The estimated fair value of contingent consideration payable to sellers was estimated at $95.0 million at March 31, 2021 as compared to $92.5 million at December 31, 2020 and is included in consideration payable for acquisition of business in the unaudited Condensed Consolidated Balance Sheets. The increase in the liability of $2.5 million in the first quarter of 2021 was recorded in change in value of consideration payable for acquisition of business in the unaudited Condensed Consolidated Statements of Operations.
COVID-19 Pandemic – The global spread of COVID-19 has created significant volatility, uncertainty and economic disruption. While COVID-19 did not have a material adverse effect on our business, operations and financial results, the extent to which the pandemic impacts our business, operations and financial results going forward will depend on numerous evolving factors that we may not be able to accurately predict, including: the duration and scope of the pandemic; governmental, business and individuals’ actions that have been and continue to be taken in response to the pandemic; the impact of the pandemic on economic activity and actions taken in response; and the effect on our ability to sell and provide our services.
COVID-19 continues to impact the manner in which we operate. As of the date of this filing, the majority of our employees are working from home and our employees have significantly reduced business travel. Additionally, many third-party vendors on whom we rely for certain critical functions are also operating in remote environments. Given the continued uncertainty surrounding COVID-19, it is difficult to predict how long such remote working conditions and travel restrictions will last, however; we believe we are operating well under these circumstances, benefitting from the flexible and highly mobile operating environment we have built.
Business Highlights
Assets under management :
•
AUM at March 31, 2021 increased $7.1 billion, or 4.8%, to $154.3 billion from $147.2 billion at December 31, 2020, driven by positive market action of $7.7 billion and acquired assets of $547 million partially offset by net outflows of $1.2 billion. Net flows for the quarter ended March 31, 2021 were comprised of $1.0 billion of long-term outflows and $0.2 billion of short-term outflows.
•
AUM at March 31, 2021 and 2020 was $154.3 billion and $123.8 billion, respectively. We generated $6.8 billion in gross sales including $0.1 billion in short-term gross sales and $1.2 billion in net outflows for the three months ended March 31, 2021 compared to $14.9 billion in gross flows inclusive of $7.7 billion in short-term gross sales and $2.9 billion in net outflows for the same period in 2020. We experienced $7.7 billion in market appreciation for the three months ended March 31, 2021 compared to $25.2 billion in negative market action for the same period in 2020.
Investment performance :
•
45 of our Victory Capital mutual funds and ETFs had overall Morningstar ratings of four or five stars and 62% of our fund and ETF AUM were rated four or five stars overall by Morningstar. 64% of our strategies by AUM had investment returns in excess of their respective benchmarks over a one-year period, 69% over a three-year period, 72% over a five-year period and 75% over a ten-year period. On an equal-weighted basis, 58% of our strategies have outperformed their benchmarks over a one-year period, 53% over a three-year period, 61% over a five-year period and 66% over a ten-year period.
Financial highlights :
•
Total revenue for the three months ended March 31, 2021 was $212.9 million compared to $204.4 million for the same period in 2020.
•
Net income was $65.2 million for the three months ended March 31, 2021 compared to $57.2 million for the same period in 2020.
•
Adjusted EBITDA was $106.8 million for the three months ended March 31, 2021, or 50.2% of revenue, compared to $91.5 million, or 44.8% of revenue, for the same period in 2020. Refer to “Supplemental Non-GAAP Financial Information” for further information about the Adjusted EBITDA calculation and reconciliation of generally accepted accounting principles (“GAAP”) net income to Adjusted EBITDA.
•
Adjusted Net Income with tax benefit was $83.6 million for the three months ended March 31, 2021 compared to $68.5 million for the three months ended March 31, 2020. Refer to “Supplemental Non-GAAP Financial Information” for further information about the Adjusted Net Income calculation and reconciliation of GAAP net income to Adjusted Net Income.
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Key Performance Indicators
The following table is a summary of key performance indicators utilized by management to assess results of operations:
Three Months Ended March 31,
($ in millions, except for basis points and percentages)
2021
2020
AUM at period end
$
154,331
$
123,779
Average AUM
151,090
144,112
Gross flows
6,833
14,925
Net short term flows
(191
)
201
Net long term flows
(983
)
(3,101
)
Net flows
(1,174
)
(2,900
)
Total revenue
212.9
204.4
Revenue on average AUM
57 bps
57 bps
Net income
65.2
57.2
Adjusted EBITDA (1)
106.8
91.5
Adjusted EBITDA Margin (2)
50.2
%
44.8
%
Adjusted Net Income (1)
76.7
61.7
Tax benefit of goodwill and acquired intangibles (3)
6.9
6.7
( 1 )
Management utilizes Adjusted EBITDA and Adjusted Net Income to measure the operating profitability of the business. These measures eliminate the impact of one‑time acquisition, restructuring and integration costs and demonstrate the ongoing operating earnings metrics of the business. These measures are explained in more detail and reconciled to net income calculated in accordance with GAAP in “Supplemental Non‑GAAP Financial Information.”
( 2 )
Adjusted EBITDA margin represents Adjusted EBITDA as a percentage of total revenue.
( 3 )
Represents the tax benefits associated with deductions allowed for intangibles and goodwill generated from prior acquisitions in which we received a step-up in basis for tax purposes. Acquired intangible assets and goodwill may be amortized for tax purposes, generally over a 15-year period. The tax benefit from amortization on these assets is included to show the full economic benefit of deductions for all acquired intangibles with a step-up in tax basis. Due to our acquisitive nature, tax deductions allowed on acquired intangible assets and goodwill provide us with a significant supplemental economic benefit.
Assets Under Management
Our profitability is largely affected by the level and composition of our AUM (including asset class and distribution channel) and the effective fee rates on our products. The amount and composition of our AUM are, and will continue to be, influenced by a number of factors, including; (i) investment performance, including fluctuations in the financial markets and the quality of our investment decisions; (ii) client flows into and out of our various strategies and investment vehicles; (iii) industry trends toward products or strategies that we either do or do not offer; (iv) our ability to attract and retain high quality investment, distribution, marketing and management personnel; (v) our decision to close strategies or limit growth of assets in a strategy when we believe it is in the best interest of our clients or conversely to re‑open strategies in part or entirely; and (vi) general investor sentiment and confidence. Our goal is to establish and maintain a client base that is diversified by Franchise and Solutions, asset class, distribution channel and vehicle. Due to rounding, AUM numbers presented in the tables below may not add up precisely to the totals provided.
The following table presents our AUM by asset class as of the dates indicated:
As of
March 31,
(in millions)
2021
2020
Fixed Income
$
36,776
$
35,402
Solutions
35,356
25,526
U.S. Mid Cap Equity
29,156
18,622
U.S. Small Cap Equity
20,230
11,885
U.S. Large Cap Equity
14,448
10,703
Global / Non-U.S. Equity
14,652
9,372
Other
341
140
Total Long-Term Assets
$
150,958
$
111,650
Money Market & Short-Term Assets
3,373
12,129
Total
$
154,331
$
123,779
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The following tables summarize our asset flows by asset class for the periods indicated:
U.S. Mid
U.S. Small
U.S. Large
Global /
Money
Cap
Cap
Fixed
Cap
Non-U.S.
Total
Market /
(in millions)
Equity
Equity
Income
Equity
Equity
Solutions
Other
Long-term
Short-term
Total
For the Three Months Ended March 31, 2021
Beginning AUM
$
26,230
$
18,368
$
36,599
$
14,230
$
13,982
$
34,041
$
257
$
143,706
$
3,534
$
147,241
Gross client cash inflows
1,741
1,072
2,024
98
593
1,143
55
6,726
108
6,833
Gross client cash outflows
(1,854
)
(1,696
)
(1,701
)
(432
)
(648
)
(1,350
)
(28
)
(7,709
)
(299
)
(8,007
)
Net client cash flows
(112
)
(624
)
323
(334
)
(55
)
(207
)
27
(983
)
(191
)
(1,174
)
Market appreciation / (depreciation)
3,032
2,024
(219
)
604
700
1,521
57
7,720
(2
)
7,718
Net transfers
6
461
73
(52
)
25
1
—
515
32
547
Ending AUM
$
29,156
$
20,230
$
36,776
$
14,448
$
14,652
$
35,356
$
341
$
150,958
$
3,373
$
154,331
For the Three Months Ended March 31, 2020
Beginning AUM
$
26,347
$
17,346
$
37,973
$
14,091
$
12,603
$
31,649
$
236
$
140,245
$
11,587
$
151,832
Gross client cash inflows
1,474
1,233
1,951
238
671
1,695
11
7,273
7,652
14,925
Gross client cash outflows
(2,265
)
(1,310
)
(2,890
)
(807
)
(684
)
(2,394
)
(24
)
(10,374
)
(7,451
)
(17,825
)
Net client cash flows
(791
)
(77
)
(939
)
(569
)
(13
)
(699
)
(12
)
(3,101
)
201
(2,900
)
Market appreciation / (depreciation)
(6,907
)
(5,325
)
(1,361
)
(2,828
)
(3,245
)
(5,436
)
(86
)
(25,187
)
34
(25,153
)
Net transfers
(28
)
(59
)
(272
)
9
27
12
3
(307
)
307
—
Ending AUM
$
18,622
$
11,885
$
35,402
$
10,703
$
9,372
$
25,526
$
140
$
111,650
$
12,129
$
123,779
The following table presents our AUM by distribution channel as of the dates indicated:
As of March 31,
2021
2020
(in millions)
Amount
% of total
Amount
% of total
Investor
$
68,477
44
%
$
64,188
52
%
Institutional
44,469
29
%
30,235
24
%
Retail
41,385
27
%
29,356
24
%
Total AUM (1)
$
154,331
100
%
$
123,779
100
%
(1) The allocation of AUM by distribution channel involves the use of estimates and the exercise of judgment.
The following tables summarize our asset flows by vehicle for the periods indicated:
Separate
Accounts and
Other Pooled
(in millions)
Mutual Funds(1)
ETFs(2)
Vehicles(3)
Total
Three Months Ended March 31, 2021
Beginning AUM
$
112,998
$
3,976
$
30,267
$
147,241
Gross client cash inflows
5,465
240
1,128
6,833
Gross client cash outflows
(6,293
)
(117
)
(1,598
)
(8,007
)
Net client cash flows
(828
)
123
(469
)
(1,174
)
Market appreciation (depreciation)
5,575
343
1,801
7,718
Net transfers
85
—
462
547
Ending AUM
$
117,830
$
4,441
$
32,061
$
154,331
Three Months Ended March 31, 2020
Beginning AUM
$
118,605
$
4,213
$
29,014
$
151,832
Gross client cash inflows
13,745
255
925
14,925
Gross client cash outflows
(15,631
)
(461
)
(1,733
)
(17,825
)
Net client cash flows
(1,886
)
(205
)
(809
)
(2,900
)
Market appreciation (depreciation)
(18,413
)
(830
)
(5,910
)
(25,153
)
Net transfers
—
—
—
—
Ending AUM
$
98,305
$
3,177
$
22,296
$
123,779
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(1) Includes institutional and retail share classe s, money market and Variable Insurance Products or VIP funds.
(2) Excludes assets managed for other proprietary product (i.e. funds of funds) in order to adjust for double counting.
(3) Includes collective trust funds, wrap program accounts, UMAs, UCITS, private funds and non-U.S. domiciled pooled vehicles.
March 31, 2021 AUM compared to December 31, 2020 AUM. At March 31, 2021, our total AUM was $154.3 billion, an increase of $7.1 billion, or 4.8%, from $147.2 billion at December 31, 2020, primarily due to positive market action of $7.7 billion and acquired assets of $547 million partially offset by net outflows of $1.2 billion.
Net inflows into our fixed income strategies of $0.3 billion were offset by net outflows in our U.S. small cap equity and U.S. large cap equity strategies of $0.6 billion and $0.3 billion, respectively, as well as net outflows in our Solutions platform and money markets of $0.2 billion each.
GAAP Results of Operations
The following table presents our GAAP results of operations for the three months ended March 31, 2021 and 2020.
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Three Months Ended March 31,
(in thousands, except per share data)
2021
2020
Revenue
Investment management fees
$
160,284
$
146,881
Fund administration and distribution fees
52,665
57,540
Total revenue
212,949
204,421
Expenses
Personnel compensation and benefits
59,006
47,571
Distribution and other asset-based expenses
42,103
54,860
General and administrative
13,310
11,888
Depreciation and amortization
4,385
4,050
Change in value of consideration payable for acquisition of business
2,500
(5,500
)
Acquisition-related costs
(164
)
(69
)
Restructuring and integration costs
2,053
998
Total operating expenses
123,193
113,798
Income from operations
89,756
90,623
Other income (expense)
Interest income and other income (expense)
2,734
(4,172
)
Interest expense and other financing costs
(6,845
)
(11,408
)
Loss on debt extinguishment
(2,781
)
(1,054
)
Total other income (expense), net
(6,892
)
(16,634
)
Income before income taxes
82,864
73,989
Income tax expense
(17,662
)
(16,823
)
Net income
$
65,202
$
57,166
Earnings per share of common stock
Basic
$
0.96
$
0.84
Diluted
$
0.88
$
0.77
Weighted average number of shares outstanding
Basic
67,761
67,790
Diluted
74,108
74,350
Dividends declared per share of common stock
$
0.09
$
0.05
Investment Management Fees
Three months ended March 31, 2021 compared to March 31, 2020 . Investment management fees increased by $13.4 million, or 9.1%, to $160.3 million for the three months ended March 31, 2021 from $146.9 million for the same period in 2020 due to an increase in average AUM year over year. Average AUM was $151.1 billion for the three months ended March 31, 2021 compared to $144.1 billion for the same period in 2020, largely attributable to positive market action.
Fund Administration and Distribution Fees
Three months ended March 31, 2021 compared to March 31, 2020 . Fund administration and distribution fees decreased by $4.9 million, or 8.5%, to $52.7 million for the three months ended March 31, 2021 from $57.5 million for the same period in 2020 due to the combination of a decrease in transfer agent fees and a shift in the mix of assets to lower 12b-1 paying share classes .
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Personnel Compensation and Benefits
The following table presents the components of GAAP personnel compensation and benefits expense for the three months ended March 31, 2021 and 2020:
Three Months Ended March 31,
(in thousands)
2021
2020
Salaries, payroll related taxes and employee benefits
$
25,201
$
16,562
Incentive compensation
23,168
20,504
Sales-based compensation (1)
5,090
3,919
Equity awards granted to employees and directors (2)
5,547
5,993
Acquisition and transaction-related compensation
—
593
Total personnel compensation and benefits expense
$
59,006
$
47,571
(1)
Represents sales-based commissions paid to our distribution teams. Sales-based compensation varies based on gross client cash flows and revenue earned on sales.
(2)
Equity awards typically vest over several years based on service and the achievement of specific business and financial targets. The value of the equity awards is recognized as compensation expense over the vesting period.
Three months ended March 31, 2021 compared to March 31, 2020 . Personnel compensation and benefits were $59.0 million for the three months ended March 31, 2021, an increase of $11.4 million, or 24.0%, from $47.6 million for the same period in 2020 primarily attributable to the combination of an increase in the change in deferred compensation plan liability as well as an increase in headcount due to the launch of the new direct to investor digital platform. Incentive compensation and equity awards granted to employees and directors were $23.2 million and $5.5 million, respectively, for the three months ended March 31, 2021, compared to $20.5 million and $6.0 million, respectively, for the same period in 2020. Salaries, payroll related taxes and employee benefits were $25.2 million and $16.6 million, respectively, for the three months ended March 31, 2021 and 2020.
Distribution and Other Asset‑Based Expenses
The following table presents the components of distribution and other asset-based expenses for the three months ended March 31, 2021 and 2020:
Three Months Ended March 31,
(in thousands)
2021
2020
Broker-dealer distribution fees
$
6,201
$
6,108
Platform distribution fees
25,832
38,992
Sub-administration
4,091
4,082
Sub-advisory
3,330
3,237
Middle-office
2,649
2,441
Total distribution and other asset-based expenses
$
42,103
$
54,860
Three months ended March 31, 2021 compared to March 31, 2020 . Distribution and other asset-based expenses are based on amount and composition of AUM. For the three months ended March 31, 2021, distribution and other asset-based expenses were $42.1 million, a decrease of $12.8 million, or 23.3%, from $54.9 million for the same period in 2020, primarily due to a change in asset mix of our underlying retail distribution platforms .
General and Administrative
Three months ended March 31, 2021 compared to March 31, 2020 . General and administrative expenses were $13.3 million for the three months ended March 31, 2021 compared to $11.9 million for the same period in 2020. The increase of $1.4 million, or 12.0%, was primarily due to increases in technology and professional fees partially offset by a reduction in transition service agreement costs related to the USAA AMCO Acquisition, which ended in the fourth quarter 2020.
Depreciation and Amortization
Three months ended March 31, 2021 compared to March 31, 2020 . Depreciation and amortization increased by $0.3 million, or 8.3%, to $4.4 million for the three months ended March 31, 2021 from $4.1 million for the same period in 2020, due to the addition of depreciation expense related to the launch of the Company’s new direct to investor digital platform, which went live in November 2020.
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Change in Value of Consideration Payable for Acquisition of Business
Three months ended March 31, 2021 compared to March 31, 2020 . The fair value of the contingent consideration associated with the USAA AMCO acquisition increased by $2.5 million, resulting in a change in the estimated fair value of consideration payable of $2.5 million for the three months ended March 31, 2021. Refer to Note 4, Acquisitions, for further details on the fair value of contingent consideration payable.
Acquisition‑Related Costs
Three months ended March 31, 2021 compared to March 31, 2020 . Acquisition-related costs were relatively flat at ($0.2) million and ($0.1) million for the three months ended March 31, 2021 and 2020, respectively.
Restructuring and Integration Costs
Three months ended March 31, 2021 compared to March 31, 2020 . Restructuring and integration costs for the three months ended March 31, 2021 and 2020 were $2.1 million and $1.0 million, respectively. The increase is primarily due personnel restructuring within the direct to investor business.
Interest Income and Other Income/(Expense)
Three months ended March 31, 2021 compared to March 31, 2020 . Interest income and other income/(expense) was income of $2.7 million for the three months ended March 31, 2021 compared to expense of $4.2 million for the same period in 2020. The income for the three months ended March 31, 2021 was due to a $2.6 million increase in the net unrealized fair value of deferred compensation plan investments compared to a $4.8 million reduction in the net unrealized fair value of deferred compensation plan investments for the same period in 2020.
Interest Expense and Other Financing Costs
Three months ended March 31, 2021 compared to March 31, 2020 . Interest expense and other financing costs decreased $4.6 million to $6.8 million for the three months ended March 31, 2021, compared to $11.4 million for the same period in 2020 due a decrease in interest payments as a result of a lower debt principal balance and interest rate over the comparable period.
Loss on Debt Extinguishment
Three months ended March 31, 2021 compared to March 31, 2020 . Loss on debt extinguishment was $2.8 million and $1.1 million, respectively, for the three months ended March 31, 2021 and 2020. The Company wrote-off a pro-rata portion of the unamortized debt issuance costs and unamortized debt discount due to accelerating the paydown of debt principal under the 2019 Credit Agreement and 2021 term loan repricing. The Company paid down $50.0 million of debt during the first quarter of 2021 compared to $38.0 million for the same period in 2020. Refer to Note 9, Debt, for further details on the 2019 Credit Agreement.
Income Tax Expense
Three months ended March 31, 2021 compared to March 31, 2020 . The effective tax rate for the three months ended March 31, 2021 and 2020 was 21.3% and 22.7%, respectively. The decrease in the effective tax rate was primarily due to higher excess tax benefits on share-based compensation.
Supplemental Non‑GAAP Financial Information
We use non-GAAP performance measures to evaluate the underlying operations of our business. Due to our acquisitive nature, there are a number of acquisition and restructuring related expenses included in GAAP measures that we believe distort the economic value of our organization and we believe that many investors use this information when assessing the financial performance of companies in the investment management industry. We have included these non-GAAP measures to provide investors with the same financial metrics used by management to assess the operating performance of our Company. The non-GAAP measures we report are Adjusted EBITDA and Adjusted Net Income.
The following table sets forth a reconciliation from GAAP financial measures to non-GAAP measures for the periods indicated:
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Three Months Ended March 31,
(in thousands)
2021
2020
Reconciliation of non-GAAP financial measures:
Net income (GAAP)
$
65,202
$
57,166
Income tax expense
(17,662
)
(16,823
)
Income before income taxes
$
82,864
$
73,989
Interest expense (1)
7,310
10,528
Depreciation (2)
1,246
884
Other business taxes (3)
374
(3,296
)
Amortization of acquisition-related intangible assets (4)
3,138
3,166
Stock-based compensation (5)
4,636
5,372
Acquisition, restructuring and exit costs (6)
4,389
(1,542
)
Debt issuance costs (7)
2,793
2,389
Earnings/losses from equity method investments (8)
92
—
Adjusted EBITDA
$
106,842
$
91,490
Three Months Ended March 31,
(in thousands)
2021
2020
Reconciliation of non-GAAP financial measures:
Net income (GAAP)
$
65,202
$
57,166
Adjustments to reflect the operating performance of the Company:
i. Other business taxes (3)
374
(3,296
)
ii. Amortization of acquisition-related intangible assets (4)
3,138
3,166
iii. Stock-based compensation (5)
4,636
5,372
iv. Acquisition, restructuring and exit costs (6)
4,389
(1,542
)
v. Debt issuance costs (7)
2,793
2,389
Tax effect of above adjustments (9)
(3,832
)
(1,522
)
Adjusted Net Income
$
76,700
$
61,733
Tax benefit of goodwill and acquired intangibles (10)
$
6,918
$
6,728
Adjustments made to GAAP Net Income to calculate Adjusted EBITDA and Adjusted Net Income, as applicable, are:
(1) Adding back interest paid on debt and other financing costs, net of interest income.
(2) Adding back depreciation on property and equipment.
(3) Adding back other business taxes.
(4) Adding back amortization expense on acquisition ‑related intangible assets.
(5) Adding back stock ‑based compensation associated with equity awards issued from pools created in connection with the management‑led buyout and various acquisitions and as a result of equity grants related to the IPO.
(6) Adding back direct incremental costs of acquisition s, including restructuring costs.
Three Months Ended March 31,
(in thousands)
2021
2020
Acquisition-related costs
$
(164
)
$
(69
)
Restructuring and integration costs
2,053
998
Change in value of consideration payable for acquisition of business
2,500
(5,500
)
General and administrative
—
2,436
Personnel compensation and benefits
—
593
Total acquisition, restructuring and exit costs
$
4,389
$
(1,542
)
(7)
Adding back debt issuance costs.
( 8 )
We adjust for earnings/losses on equity method investments.
( 9 )
Subtracting an estimate of income tax expense applied to the sum of the adjustments above.
( 10 )
Represents the tax benefits associated with deductions allowed for intangible assets and goodwill generated from prior acquisitions in which we received a step-up in basis for tax purposes. Acquired intangible assets and goodwill may be amortized for tax purposes, generally over a 15-
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year period. The tax benefit from amortization on these assets is included to show the full economic benefit of deductions for all acquired intangible assets with a step-up in tax basis. Due to our acquisitive nature, tax deductions allowed on acquired intangible assets and goodwill provide us with a significant supplemental economic benefit.
Non-GAAP measures should be considered in addition to, and not as a substitute for, financial measures prepared in accordance with GAAP. Our non-GAAP measures may differ from similar measures at other companies, even if similar terms are used to identify these measures.
Liquidity and Capital Resources
Our primary uses of cash relate to repayment of our debt obligations, funding of acquisitions and working capital needs, repurchasing of shares and payment of dividends, which are all expected to be met through cash generated from our operations and available capital resources.
We cannot predict the duration or scope of the COVID-19 pandemic, its impact on our business, and the potential negative financial impact to our results, but the Company has actively positioned itself so that our cash flows from operations and financing sources will be sufficient to meet our needs. During the period of uncertainty related to the COVID-19 pandemic, we continue to monitor our liquidity.
The following table shows our liquidity position as of March 31, 2021 and December 31, 2020.
March 31,
December 31,
(in thousands)
2021
2020
Cash and cash equivalents
$
30,386
$
22,744
Accounts and other receivables
91,924
88,182
Undrawn commitment on credit facility (1)
100,000
100,000
Accounts and other payables
(91,320
)
(89,422
)
(1)
The balance at March 31, 2021 represents the Company’s $99.9 million revolving credit facility and a $0.1 million standby letter of credit used as collateral for THB’s real estate location.
We manage our cash balances in order to fund our day-to-day operations. Our accounts receivable consists primarily of investment management fees that have been earned but not yet received from clients, income and other taxes receivable, and amounts receivable from the funds. We perform a review of our receivables on a monthly basis to assess collectability. We continue to actively monitor the impact of the COVID-19 pandemic on the collectability of certain receivables. We maintained a $100.0 million revolving credit facility at March 31, 2021 and December 31, 2020 (under the 2019 Credit Agreement) which had approximately $100.0 million undrawn as of March 31, 2021 and December 31, 2020.
2019 Credit Agreement and 2020 and 2021 Debt Repricing
In conjunction with the USAA AMCO Acquisition, the Company entered into the 2019 Credit Agreement, dated July 1, 2019, and obtained a seven-year term loan in an aggregate principal amount of $1.1 billion. All indebtedness outstanding under the previous credit agreement was repaid and terminated as of July 1, 2019. During the first quarter, the Company reduced outstanding debt by an additional $50.0 million. Subsequent to March 31, 2021, the Company reduced outstanding debt by $27.0 million, for a total debt reduction of $388.8 million since July 1, 2019. As of March 31, 2021, we were in compliance with our financial performance covenant. Refer to Note 4, Acquisitions, to the unaudited condensed consolidated financial statements for further details on the USAA AMCO Acquisition, as well as Note 9, Debt, for further information on the 2019 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. The Company refinanced the 2019 term loans for a reduced applicable margin on LIBOR of 75 basis points. After the January 2020 repricing, the applicable margin on LIBOR was 2.50%, compared to 3.25% under the 2019 term loans.
On February 18, 2021, the Company entered into the Second Amendment (the “Second Amendment”) to the 2019 Credit Agreement, as amended, with the other loan parties thereto, Barclays Bank PLC, as administrative agent, and the Royal Bank of Canada as fronting bank. Pursuant to the Second Amendment, the Company refinanced the existing term loans (the “Existing Term Loans”) with replacement term loans in an aggregate principal amount of $755.7 (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 1, 2026, except that the Repriced Term Loans provide for a reduced applicable margin on LIBOR of 25 basis points. The applicable margin on LIBOR under the Repriced Term Loans is 2.25%, compared to 2.50% under the First Amendment. Refer to Note 9, Debt, for further information on the repricing.
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2020 Swap Transaction
On March 27, 2020, the Company executed a floating-to-fixed interest rate swap transaction (“Swap”) 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. At March 31, 2021, the $450 million notional value Swap had a fair value of $4.2 million, which was included in other assets on the unaudited Condensed Consolidated Balance Sheets. For the three months ended March 31, 2021, the Company recognized income, net of tax, of $10.8 million in accumulated other comprehensive income (loss). For the three months ended March 31, 2021, the Company reclassified a loss of $0.8 million from accumulated other comprehensive income (loss) to interest expense and other financing costs on the unaudited Condensed Consolidated Statements of Operations. Refer to Note 14, Derivatives, for further information on the Swap.
Capital Requirements
Victory Capital Services is a registered broker-dealer subject to the Uniform Net Capital requirements under the Exchange Act, which requires maintenance of certain minimum net capital levels. In addition, we have certain non-U.S. subsidiaries that have minimum capital requirements. As a result, such subsidiaries of our Company may be restricted in their ability to transfer cash to their parents.
Cash Flows
The following table is derived from our unaudited Condensed Consolidated Statements of Cash Flows:
Three Months Ended March 31,
(in thousands)
2021
2020
Net cash provided by operating activities
$
79,634
$
51,922
Net cash used in investing activities
(1,140
)
(2,234
)
Net cash used in financing activities
(70,834
)
(49,573
)
Operating Activities – Cash provided by operating activities during the three months ended March 31, 2021 was $79.6 million, compared to $51.9 million of cash provided by operating activities for the same period in 2020. The $27.7 million increase in cash provided by operating activities was primarily due to an $8.0 million increase in net income, $8.1 million increase in non-cash items, a $11.6 million net increase in working capital items.
Cash provided by operating activities during the three months ended March 31, 2020 was $51.9 million and consisted of $57.2 million of net income and $15.7 million of non-cash items, partially offset by $20.9 million in working capital items.
Investing Activities – Cash used in investing activities during the three months ended March 31, 2021 was $1.1 million and consisted of net trading activity of $0.7 million and $0.4 million of property and equipment purchases. The nature of our trading activities is further described in Note 2, Significant Accounting Policies, to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2020.
Cash used in investing activities during the three months ended March 31, 2020 was $2.2 million and consisted of net trading activity of $1.5 million and $0.7 million of property and equipment purchases.
Financing Activities – Cash used in financing activities during the three months ended March 31, 2021 was $70.8 million and was mostly attributable to repayment of long-term debt under the 2019 Credit Agreement, repurchases of common stock, payment of taxes related to net share settlements, and payment of dividends of $50.0 million, $7.7 million, $7.7 million and $6.4 million, respectively.
Cash used in financing activities during the three months ended March 31, 2020 was $49.6 million and was mostly attributable to repayment of long-term debt under the 2019 Credit Agreement, repurchases of common stock, and payment of dividends of $38.0 million, $6.0 million and $3.5 million, respectively.
Contractual Obligations
On February 18, 2021, the Company entered into the Second 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 Second Amendment, the Company repriced its Term Loan, lowering the interest rate spread by 25 basis points, from 2.50% over LIBOR, to 2.25% over LIBOR.
For the three months ended March 31, 2021, the Company recorded a $2.5 million increase in the USAA AMCO Acquisition contingent payment liability, which is included in consideration payable for acquisition of business in the unaudited Condensed Consolidated Balance Sheets. 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. During the fourth quarter of 2020, the Company paid $37.5 million in cash to sellers for the first annual earn out period. A maximum of $112.5 million in contingent consideration ($37.5 million per year for the remaining 3 years of the earn out period) was payable to sellers at March 31, 2021.
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There were no other significant changes to our contractual obligations as reported in our Annual Report on Form 10-K for the year ended December 31, 20 20 .
Off‑Balance Sheet Arrangements
In connection with dividends declared in February 2017 and December 2017, holders of restricted stock awards that were unvested at the time such dividends were declared are entitled to be paid the dividends as and when the restricted stock vests. Holders of stock options that were unvested at the time the December 2017 dividend was declared are entitled to receive a cash bonus equivalent of the December 2017 dividend as and when their stock options vest.
The Company announced the initiation of quarterly cash dividends in August 2019. Holders of restricted stock awards that are unvested at the time the quarterly dividends are declared are entitled to be paid these dividends as and when the restricted stock vests.
As of March 31, 2021 and December 31, 2020, 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 $1.2 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.
On September 20, 2020, the Company acquired, through a wholly owned subsidiary, a 15% interest in Alderwood and made a capital contribution of $1.5 million in cash. 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, upon the satisfaction of certain conditions. Until these conditions are satisfied, the Company does not have an obligation to contribute the additional capital and has not met the recognition criteria for a liability. On March 8, 2021, the Company announced that one of the conditions had been met. Alderwood Capital had received authorization from the Financial Conduct Authority of the United Kingdom and Alderwood’s private fund had been formally launched to investors. Refer to Note 15, Equity Method Investment, for further discussion regarding the investment.
Critical Accounting Policies and Estimates
Our consolidated financial statements and the notes are prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of estimates. Actual results will vary from these estimates. A discussion of our critical accounting policies and estimates is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K. A complete description of our significant accounting policies is included in our Annual Report on Form 10-K.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.