Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement Regarding Forward Looking Statements
This Quarterly Report on Form 10-Q contains statements that are, or may be considered to be, forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995, as amended, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements that are not historical facts, including statements about our beliefs or expectations, are "forward-looking statements." These statements may be identified by such forward-looking terminology as "expect," "estimate," "intent," "plan," "intend," "believe," "anticipate," "may," "will," "should," "could," "continue," "project," "opportunity," "predict," "would," "potential," "future," "forecast," "guarantee," "assume," "likely," "target" or similar statements or variations of such terms.
Our forward-looking statements are based on a series of expectations, assumptions and projections about the Company and the markets in which we operate, are not guarantees of future results or performance, and involve substantial risks and uncertainty, including assumptions and projections concerning our assets under management, net asset inflows and outflows, operating cash flows, business plans and ability to borrow, for all future periods. All forward-looking statements contained in this Quarterly Report on Form 10-Q are as of the date of this Quarterly Report on Form 10-Q only.
We can give no assurance that such expectations or forward-looking statements will prove to be correct. Actual results may differ materially. We do not undertake or plan to update or revise any such forward-looking statements to reflect actual results, changes in plans, assumptions, estimates or projections, or other circumstances occurring after the date of this Quarterly Report on Form 10-Q, even if such results, changes or circumstances make it clear that any forward-looking information will not be realized. If there are any future public statements or disclosures by us that modify or impact any of the forward-looking statements contained in or accompanying this Quarterly Report on Form 10-Q, such statements or disclosures will be deemed to modify or supersede such statements in this Quarterly Report on Form 10-Q.
Our business and our forward-looking statements involve substantial known and unknown risks and uncertainties, including those discussed under "Risk Factors" and "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in our 2019 Annual Report on Form 10-K and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, as well as the following risks and uncertainties resulting from: (i) the on-going effects of the COVID-19 pandemic and associated global economic disruption; (ii) any reduction in our assets under management; (iii) withdrawal, renegotiation or termination of investment advisory agreements; (iv) damage to our reputation; (v) failure to comply with investment guidelines or other contractual requirements; (vi) inability to satisfy financial covenants and payments related to our indebtedness; (vii) inability to attract and retain key personnel; (viii) challenges from the competition we face in our business; (ix) adverse regulatory and legal developments; (x) unfavorable changes in tax laws or limitations; (xi) adverse developments related to unaffiliated subadvisers; (xii) negative implications of changes in key distribution relationships; (xiii) interruptions in or failure to provide critical technological service by us or third parties; (xiv) volatility associated with our common stock; (xv) adverse civil litigation and government investigations or proceedings; (xvi) risk of loss on our investments; (xvii) inability to make quarterly common stock dividends; (xviii) lack of sufficient capital on satisfactory terms; (xix) losses or costs not covered by insurance; (xx) impairment of goodwill or intangible assets; (xxi) inability to achieve expected acquisition-related benefits; and other risks and uncertainties. Any occurrence of, or any material adverse change in, one or more risk factors or risks and uncertainties referred to above, in our 2019 Annual Report on Form 10-K, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 and our other periodic reports filed with the Securities and Exchange Commission (the "SEC") could materially and adversely affect our operations, financial results, cash flows, prospects and liquidity.
Certain other factors that may impact our continuing operations, prospects, financial results and liquidity, or that may cause actual results to differ from such forward-looking statements, are discussed or included in the Company’s periodic reports filed with the SEC and are available on our website at www.virtus.com under "Investor Relations." You are urged to carefully consider all such factors.
Overview
Our Business
We provide investment management and related services to individuals and institutions. We use a multi-manager, multi-style approach, offering investment strategies from affiliated managers, each having its own distinct investment style, autonomous investment process and individual brand. By offering a broad array of products, we believe we can appeal to a greater number of investors and have offerings across market cycles and through changes in investor preferences. Our earnings
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are primarily driven by asset-based fees charged for services relating to these various products, including investment management, fund administration, distribution and shareholder services.
We offer investment strategies for individual and institutional investors in different product structures and through multiple distribution channels. Our investment strategies are available in a diverse range of styles and disciplines, managed by a collection of differentiated investment managers. We have offerings in various asset classes (equity, fixed income and alternative), geographies (domestic, international and emerging), market capitalizations (large, mid and small), styles (growth, core and value) and investment approaches (fundamental, quantitative and thematic). Our retail products include open-end funds and exchange traded funds ("ETFs") as well as closed-end funds and retail separate accounts. Our institutional products are offered through separate accounts and pooled or commingled structures to a variety of institutional clients. We also provide subadvisory services to other investment advisers and serve as the collateral manager for structured products.
We distribute our open-end funds and ETFs principally through financial intermediaries. We have broad distribution access in the retail market, with distribution partners that include national and regional broker-dealers, independent broker-dealers and registered investment advisers, banks and insurance companies. In many of these firms, we have a number of products that are on preferred "recommended" lists and on fee-based advisory programs. Our sales efforts are supported by regional sales professionals, a national account relationship group, and separate teams for ETFs and the retirement and insurance channels. We leverage third-party distributors for off-shore products and in certain international jurisdictions. Our retail separate accounts are distributed through financial intermediaries and directly to private clients by teams at an affiliated manager.
Our institutional services are marketed through relationships with consultants as well as directly to clients. We target key market segments, including foundations and endowments, corporate, public and private pension plans, and subadvisory relationships.
Recent Market Developments
During the first half of 2020, the novel coronavirus global pandemic ("COVID-19") significantly impacted the global economy and financial markets, creating uncertainty, market volatility and dislocation. Financial markets experienced significant declines during the first quarter of 2020 and in the second quarter, certain markets, including domestic equity securities, experienced recoveries erasing much of the first quarter decline. In an effort to contain COVID-19 in the U.S., or slow its spread, the federal government and nearly every state enacted varying degrees of social containment measures, restricting business and related activities, closing borders, and restricting travel. Governments around the world have responded to COVID-19 with economic stimulus measures. These measures are intended to support businesses, employees and consumers until economic activities recover. Although financial markets, particularly domestic equity securities, have largely recovered in the second quarter, the economy has been slower to recover. The timing and magnitude of the economic recovery, as well as the sustainability of the financial markets second quarter recovery, is uncertain.
Impact of COVID-19 to our Business
As a result of the challenging and volatile capital, equity and credit markets our assets under management experienced significant market volatility during the first six months of 2020 with market depreciation of $16.6 billion and market appreciation of $15.2 billion during the first and second quarters of 2020, respectively. In addition, the fair market value of our seed capital and other investments experienced similar volatility. To the extent that financial markets continue to be impacted, we may experience further volatility in our assets under management and the fair market value of our seed capital and other investments.
Financial Highlights
•
Net income per diluted share was $1.43 in the second quarter of 2020 , as compared to net income per diluted share of $3.26 in the second quarter of 2019 .
•
Total sales were $9.1 billion in the second quarter of 2020 , an increase of $4.0 billion , or 77.5% , from $5.1 billion in the second quarter of 2019 . Net flows were $2.5 billion in the second quarter of 2020 compared to $0.1 billion in the second quarter of 2019 .
•
Assets under management were $108.5 billion at June 30, 2020 , an increase of $3.5 billion , or 3.3% , from June 30, 2019 .
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Assets Under Management
At June 30, 2020 , total assets under management were $108.5 billion , representing an increase of $3.5 billion , or 3.3% , from June 30, 2019 , and a decrease of $0.4 billion , or 0.4% , from December 31, 2019 . The change in total assets under management from June 30, 2019 included $4.6 billion of positive market performance and $0.5 billion of positive flows. The change in total assets under management from December 31, 2019 was due to $1.3 billion of negative market performance partially offset by $1.3 billion of positive net flows.
Average long-term assets under management, which represent the majority of our fee-earning asset levels, were $100.8 billion for the six months ended June 30, 2020 , an increase of $3.2 billion , or 3.3% , from $97.6 billion for the six months ended June 30, 2019 . The increase in average long-term assets under management compared to the prior year period was primarily due to market performance and positive net flows.
Operating Results
In the second quarter of 2020 , total revenues decreased 5.4% to $ 132.9 million from $140.5 million in the second quarter of 2019 , primarily as a result of lower average assets under management in our open-end funds. Operating income decreased $3.5 million to $ 26.6 million in the second quarter of 2020 compared to $ 30.1 million in the second quarter of 2019 , primarily due to decreased revenue partially offset by lower operating expenses.
Assets Under Management by Product
The following table summarizes our assets under management by product:
As of June 30,
Change
(in millions)
2020
2019
$
%
Open-End Funds (1)
$
40,053
$
41,223
$
(1,170
)
(2.8
)%
Closed-End Funds
5,639
6,653
(1,014
)
(15.2
)%
Exchange Traded Funds
541
1,078
(537
)
(49.8
)%
Retail Separate Accounts
22,054
18,260
3,794
20.8
%
Institutional Accounts
34,545
32,056
2,489
7.8
%
Structured Products
4,264
3,984
280
7.0
%
Total Long-Term
107,096
103,254
3,842
3.7
%
Liquidity (2)
1,365
1,752
(387
)
(22.1
)%
Total
$
108,461
$
105,006
$
3,455
3.3
%
Average Assets Under Management (3)
$
102,031
$
99,316
$
2,715
2.7
%
Average Long-Term Assets Under Management (3)
$
100,788
$
97,569
$
3,219
3.3
%
(1)
Represents assets under management of U.S. retail funds, offshore funds and variable insurance funds.
(2)
Represents assets under management in liquidity strategies, including in certain open-end funds and institutional accounts.
(3)
Averages for the six-month period ended June 30 were calculated as follows:
-
Funds - average daily or weekly balances
-
Retail Separate Accounts - prior-quarter ending balances
-
Institutional Accounts and Structured Products - average of month-end balances
Asset Flows by Product
The following table summarizes asset flows by product:
Three Months Ended June 30,
Six Months Ended June 30,
(in millions)
2020
2019
2020
2019
Open-End Funds (1)
Beginning balance
$
33,498
$
40,633
$
42,870
$
37,710
Inflows
4,388
2,510
8,262
5,510
Outflows
(4,005
)
(3,214
)
(9,476
)
(7,081
)
Net flows
383
(704
)
(1,214
)
(1,571
)
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Three Months Ended June 30,
Six Months Ended June 30,
(in millions)
2020
2019
2020
2019
Market performance
6,244
1,465
(1,486
)
5,304
Other (2)
(72
)
(171
)
(117
)
(220
)
Ending balance
$
40,053
$
41,223
$
40,053
$
41,223
Closed-End Funds
Beginning balance
$
5,343
$
6,553
$
6,748
$
5,956
Inflows
—
9
5
20
Outflows
—
—
—
—
Net flows
—
9
5
20
Market performance
380
182
(805
)
844
Other (2)
(84
)
(91
)
(309
)
(167
)
Ending balance
$
5,639
$
6,653
$
5,639
$
6,653
Exchange Traded Funds
Beginning balance
$
480
$
1,102
$
1,156
$
668
Inflows
74
132
160
526
Outflows
(140
)
(117
)
(373
)
(163
)
Net flows
(66
)
15
(213
)
363
Market performance
137
(5
)
(368
)
103
Other (2)
(10
)
(34
)
(34
)
(56
)
Ending balance
$
541
$
1,078
$
541
$
1,078
Retail Separate Accounts
Beginning balance
$
17,660
$
17,123
$
20,414
$
14,998
Inflows
1,483
731
2,544
1,484
Outflows
(654
)
(447
)
(1,429
)
(919
)
Net flows
829
284
1,115
565
Market performance
3,560
877
520
2,772
Other (2)
5
(24
)
5
(75
)
Ending balance
$
22,054
$
18,260
$
22,054
$
18,260
Institutional Accounts
Beginning balance
$
28,210
$
30,514
$
32,635
$
27,445
Inflows
3,141
1,737
4,640
2,691
Outflows
(1,666
)
(1,259
)
(3,443
)
(2,413
)
Net flows
1,475
478
1,197
278
Market performance
4,877
1,141
727
4,297
Other (2)
(17
)
(77
)
(14
)
36
Ending balance
$
34,545
$
32,056
$
34,545
$
32,056
Structured Products
Beginning balance
$
4,343
$
3,998
$
3,903
$
3,640
Inflows
—
—
491
389
Outflows
(73
)
(21
)
(115
)
(37
)
Net flows
(73
)
(21
)
376
352
Market performance
33
56
72
83
Other (2)
(39
)
(49
)
(87
)
(91
)
Ending balance
$
4,264
$
3,984
$
4,264
$
3,984
Total Long-Term
Beginning balance
$
89,534
$
99,923
$
107,726
$
90,417
Inflows
9,086
5,119
16,102
10,620
Outflows
(6,538
)
(5,058
)
(14,836
)
(10,613
)
Net flows
2,548
61
1,266
7
Market performance
15,231
3,716
(1,340
)
13,403
Other (2)
(217
)
(446
)
(556
)
(573
)
Ending balance
$
107,096
$
103,254
$
107,096
$
103,254
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Three Months Ended June 30,
Six Months Ended June 30,
(in millions)
2020
2019
2020
2019
Liquidity (3)
Beginning balance
$
1,160
$
1,789
$
1,178
$
1,613
Other (2)
205
(37
)
187
139
Ending balance
$
1,365
$
1,752
$
1,365
$
1,752
Total
Beginning balance
$
90,694
$
101,712
$
108,904
$
92,030
Inflows
9,086
5,119
16,102
10,620
Outflows
(6,538
)
(5,058
)
(14,836
)
(10,613
)
Net flows
2,548
61
1,266
7
Market performance
15,231
3,716
(1,340
)
13,403
Other (2)
(12
)
(483
)
(369
)
(434
)
Ending balance
$
108,461
$
105,006
$
108,461
$
105,006
(1)
Represents assets under management of U.S. retail funds, offshore funds and variable insurance funds.
(2)
Represents open-end and closed-end fund distributions net of reinvestments, the net change in assets from liquidity strategies and the effect on net flows from non-sales related activities such as asset acquisitions/(dispositions), seed capital investments/(withdrawals), structured products reset transactions and the use of leverage.
(3)
Represents assets under management in liquidity strategies, including in certain open-end funds and institutional accounts.
Assets Under Management by Asset Class
The following table summarizes our assets under management by asset class:
As of June 30,
Change
% of Total
(in millions)
2020
2019
$
%
2020
2019
Asset Class
Equity
$
73,823
$
64,888
$
8,935
13.8
%
68.1
%
61.8
%
Fixed income
28,870
32,983
(4,113
)
(12.5
)%
26.6
%
31.4
%
Alternatives (1)
4,403
5,383
(980
)
(18.2
)%
4.1
%
5.1
%
Liquidity (2)
1,365
1,752
(387
)
(22.1
)%
1.2
%
1.7
%
Total
$
108,461
$
105,006
$
3,455
3.3
%
100.0
%
100.0
%
(1)
Consists of real estate securities, mid-stream energy securities and master limited partnerships, options strategies and other.
(2)
Represents assets under management in liquidity strategies, including in certain open-end funds and institutional accounts.
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Average Assets Under Management and Average Basis Points
The following table summarizes the average management fees earned in basis points and average assets under management:
Three Months Ended June 30,
Average Fee Earned
(expressed in basis points)
Average Assets Under
Management
(in millions) (2)
2020
2019
2020
2019
Products
Open-End Funds (1)
58.4
55.7
$
37,198
$
40,961
Closed-End Funds
61.8
65.0
5,566
6,551
Exchange Traded Funds
14.1
23.4
554
1,082
Retail Separate Accounts
51.0
48.4
17,660
17,123
Institutional Accounts
31.3
30.8
31,648
30,771
Structured Products
26.8
35.3
4,265
3,968
All Long-Term Products
46.8
46.3
96,891
100,456
Liquidity (3)
11.8
10.6
1,267
1,769
All Products
46.3
45.7
$
98,158
$
102,225
Six Months Ended June 30,
Average Fee Earned
(expressed in basis points)
Average Assets Under
Management
(in millions) (2)
2020
2019
2020
2019
Products
Open-End Funds (1)
58.1
55.2
$
39,129
$
40,247
Closed-End Funds
62.3
65.0
6,045
6,404
Exchange Traded Funds
18.7
20.4
758
977
Retail Separate Accounts
50.8
48.6
19,037
16,061
Institutional Accounts
30.3
30.7
31,591
30,062
Structured Products
30.3
36.1
4,228
3,818
All Long-Term Products
46.8
46.1
100,788
97,569
Liquidity (3)
10.8
10.2
1,243
1,747
All Products
46.4
45.5
$
102,031
$
99,316
(1)
Represents assets under management of U.S. retail funds, offshore funds and variable insurance funds.
(2)
Averages are calculated as follows:
-
Funds - average daily or weekly balances
-
Retail Separate Accounts - prior-quarter ending balances
-
Institutional Accounts and Structured Products - average of month-end balances
(3)
Represents assets under management in liquidity strategies, including in certain open-end funds and institutional accounts.
Average fees earned represent investment management fees before the impact of consolidation of investment products ("CIP") divided by average net assets. Fund fees are calculated based on average daily or weekly net assets. Retail separate account fees are calculated based on the end of the preceding or current quarter’s asset values or on an average of month-end balances. Institutional account fees are calculated based on an average of month-end balances or current quarter’s asset values. Structured product fees are calculated based on a combination of the underlying cash flows and the principal value of the product. Average fees earned will vary based on several factors, including the asset mix and expense reimbursements to funds.
The average fee rate earned on long-term products for the three and six months ended June 30, 2020 increased by 0.5 and 0.7 basis points, respectively, compared to the same periods in the prior year. The primary reason for the increase during the three and six months ended June 30, 2020 was due to changes in the underlying asset mix to higher fee earning strategies in open-end funds and retail separate accounts during the current year.
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Results of Operations
Summary Financial Data
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2020
2019
2020 vs. 2019
%
2020
2019
2020 vs. 2019
%
Investment management fees
$
110,550
$
114,591
$
(4,041
)
(3.5
)%
$
230,838
$
220,509
$
10,329
4.7
%
Other revenue
22,344
25,898
(3,554
)
(13.7
)%
46,622
50,698
(4,076
)
(8.0
)%
Total revenues
132,894
140,489
(7,595
)
(5.4
)%
277,460
271,207
6,253
2.3
%
Total operating expenses
106,272
110,361
(4,089
)
(3.7
)%
226,236
220,080
6,156
2.8
%
Operating income (loss)
26,622
30,128
(3,506
)
(11.6
)%
51,224
51,127
97
0.2
%
Other income (expense), net
(435
)
12,455
(12,890
)
(103.5
)%
(16,036
)
14,417
(30,453
)
(211.2
)%
Interest income (expense), net
(2,400
)
(5,896
)
3,496
(59.3
)%
(104
)
(2,170
)
2,066
(95.2
)%
Income (loss) before income taxes
23,787
36,687
(12,900
)
(35.2
)%
35,084
63,374
(28,290
)
(44.6
)%
Income tax expense (benefit)
7,578
8,788
(1,210
)
(13.8
)%
17,869
13,007
4,862
37.4
%
Net income (loss)
16,209
27,899
(11,690
)
(41.9
)%
17,215
50,367
(33,152
)
(65.8
)%
Noncontrolling interests
(4,930
)
(973
)
(3,957
)
406.7
%
(10,221
)
(1,695
)
(8,526
)
503.0
%
Net Income (Loss) Attributable to Stockholders
11,279
26,926
(15,647
)
(58.1
)%
6,994
48,672
(41,678
)
(85.6
)%
Preferred stockholder dividends
—
(2,084
)
2,084
(100.0
)%
—
(4,168
)
4,168
(100.0
)%
Net Income (Loss) Attributable to Common Stockholders
$
11,279
$
24,842
$
(13,563
)
(54.6
)%
$
6,994
$
44,504
$
(37,510
)
(84.3
)%
Revenues
Revenues by source were as follows:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2020
2019
2020 vs. 2019
%
2020
2019
2020 vs. 2019
%
Investment management fees
Open-end funds
$
54,018
$
56,973
$
(2,955
)
(5.2
)%
$
113,126
$
110,266
$
2,860
2.6
%
Closed-end funds
8,557
10,620
(2,063
)
(19.4
)%
18,736
20,639
(1,903
)
(9.2
)%
Retail separate accounts
22,398
20,664
1,734
8.4
%
48,112
38,669
9,443
24.4
%
Institutional accounts
24,606
23,656
950
4.0
%
47,523
45,833
1,690
3.7
%
Structured products
417
1,585
(1,168
)
(73.7
)%
1,991
3,232
(1,241
)
(38.4
)%
Other products
554
1,093
(539
)
(49.3
)%
1,350
1,870
(520
)
(27.8
)%
Total investment management fees
110,550
114,591
(4,041
)
(3.5
)%
230,838
220,509
10,329
4.7
%
Distribution and service fees
8,889
10,617
(1,728
)
(16.3
)%
18,349
20,680
(2,331
)
(11.3
)%
Administration and shareholder service fees
13,289
15,054
(1,765
)
(11.7
)%
27,942
29,467
(1,525
)
(5.2
)%
Other income and fees
166
227
(61
)
(26.9
)%
331
551
(220
)
(39.9
)%
Total revenues
$
132,894
$
140,489
$
(7,595
)
(5.4
)%
$
277,460
$
271,207
$
6,253
2.3
%
Investment Management Fees
Investment management fees are earned based on a percentage of assets under management and are paid pursuant to the terms of the respective investment management contracts, which generally require monthly or quarterly payments. Investment management fees decreased by $4.0 million , or 3.5% , and increased $10.3 million , or 4.7% , for the three and six months ended June 30, 2020 , respectively, compared to the same periods in the prior year. The decrease in investment management fees during the three-month period was due to a decrease in average assets under management of $4.1 billion , or 4.0% , partially offset by an increase in the total average fee rate of 0.6 basis points. The increase in investment management fees during the six-month period was due to an increase in average assets under management of $2.7 billion and an increase in
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the total average fee rate of 0.9 basis points.
Distribution and Service Fees
Distribution and service fees are sales- and asset-based fees earned from open-end funds for marketing and distribution services. Distribution and service fees decreased by $1.7 million , or 16.3% , and $2.3 million , or 11.3% , for the three and six months ended June 30, 2020 , respectively, compared to the same period in the prior year, primarily due to lower sales and average assets for open-end funds in share classes that have distribution and service fees.
Administration and Shareholder Service Fees
Administration and shareholder service fees represent fees earned for fund administration and shareholder services from our open-end mutual funds and certain of our closed-end funds. Fund administration and shareholder service fees decreased by $1.8 million , or 11.7% , and $1.5 million , or 5.2% , for the three and six months ended June 30, 2020 , respectively, compared to the same periods in the prior year primarily due to the decrease in average assets under management for open-end funds.
Other Income and Fees
Other income and fees primarily represent contingent sales charges earned from investor redemptions of certain shares sold without a front-end sales charge. Other income and fees remained generally consistent for the three and six months ended June 30, 2020 , compared to the same periods in the prior year.
Operating Expenses
Operating expenses by category were as follows:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2020
2019
2020 vs. 2019
%
2020
2019
2020 vs. 2019
%
Operating expenses
Employment expenses
$
60,163
$
58,123
$
2,040
3.5
%
$
126,293
$
118,974
$
7,319
6.2
%
Distribution and other asset-based expenses
17,345
21,322
(3,977
)
(18.7
)%
36,754
41,086
(4,332
)
(10.5
)%
Other operating expenses
17,436
19,174
(1,738
)
(9.1
)%
36,321
37,897
(1,576
)
(4.2
)%
Other operating expenses of CIP
2,179
2,568
(389
)
(15.1
)%
8,928
3,019
5,909
195.7
%
Restructuring and severance
420
320
100
31.3
%
420
1,496
(1,076
)
(71.9
)%
Depreciation expense
1,196
1,271
(75
)
(5.9
)%
2,454
2,484
(30
)
(1.2
)%
Amortization expense
7,533
7,583
(50
)
(0.7
)%
15,066
15,124
(58
)
(0.4
)%
Total operating expenses
$
106,272
$
110,361
$
(4,089
)
(3.7
)%
$
226,236
$
220,080
$
6,156
2.8
%
Employment Expenses
Employment expenses consist of fixed and variable compensation and related employee benefit costs. Employment expenses for the three and six months ended June 30, 2020 were $60.2 million and $126.3 million , respectively, which represented an increase of $2.0 million , or 3.5% , and $7.3 million , or 6.2% , compared to the same periods in the prior year. The increase for the three months ended June 30, 2020 was primarily due to increased sales-based compensation partially offset by lower profit-based compensation. The increase for the six months ended June 30, 2020 was primarily due to increased profit- and sales-based compensation partially offset by lower stock-based compensation.
Distribution and Other Asset-Based Expenses
Distribution and other asset-based expenses consist primarily of payments to third-party client intermediaries for providing services to investors in sponsored investment products. These payments are primarily based on percentages of sales, assets under management or revenues. These expenses also include the amortization of deferred sales commissions related to up-front commissions on shares sold without a front-end sales charge to shareholders. The deferred sales commissions are amortized on a straight-line basis over the periods in which commissions are generally recovered from distribution fee revenues
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and contingent sales charges received from shareholders of the funds upon redemption of their shares. Distribution and other asset-based expenses decreased by $4.0 million , or 18.7% , and $4.3 million , or 10.5% , for the three and six months ended June 30, 2020 , respectively, as compared to the same periods in the prior year, primarily due to a lower percentage of sales and assets under management in share classes that have distribution and other asset-based expenses.
Other Operating Expenses
Other operating expenses primarily consist of investment research and technology costs, professional fees, travel and distribution related costs, rent and occupancy expenses, and other business costs. Other operating expenses for the three and six months ended June 30, 2020 decreased by $1.7 million , or 9.1% , and $1.6 million , or 4.2% , respectively, as compared to the same periods in the prior year, due to decreased travel expenses primarily as a result of the impact of COVID-19 on the current operating environment.
Other Operating Expenses of CIP
Other operating expenses of CIP decreased $0.4 million , or 15.1% to $2.2 million for the three months ended June 30, 2020 and increased $5.9 million , or 195.7% , to $8.9 million , for the six months ended June 30, 2020 , compared to the same periods in the prior year. The decrease during the three-month period was primarily due to costs associated with the issuance of a CLO in the prior-year period. The increase in the six-month period was primarily due to costs associated with the issuance of an additional CLO as well as the refinancing of debt for two CLOs in the current year period.
Restructuring and Severance
During the three and six months ended June 30, 2020 , we incurred $0.4 million in restructuring and severance costs. During the three and six months ended June 30, 2019, we incurred $0.3 million and $1.5 million , respectively in restructuring and severance costs. The costs primarily related to severance costs in all periods.
Depreciation Expense
Depreciation expense consists primarily of the straight-line depreciation of furniture, equipment and leasehold improvements. Depreciation expense remained generally consistent for the three and six months ended June 30, 2020 , compared to the same periods in the prior year.
Amortization Expense
Amortization expense consists of the amortization of definite-lived intangible assets over their estimated useful lives.
Amortization expense remained generally consistent for the three and six months ended June 30, 2020 compared to the same periods in the prior year.
Other Income (Expense)
Other Income (Expense), net by category were as follows:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2020
2019
2020 vs. 2019
%
2020
2019
2020 vs. 2019
%
Other Income (Expense)
Realized and unrealized gain (loss) on investments, net
$
7,114
$
2,039
$
5,075
248.9
%
$
(430
)
$
5,472
$
(5,902
)
(107.9
)%
Realized and unrealized gain (loss) of CIP, net
(6,744
)
9,720
(16,464
)
(169.4
)%
(15,413
)
7,799
(23,212
)
(297.6
)%
Other income (expense), net
(805
)
696
(1,501
)
(215.7
)%
(193
)
1,146
(1,339
)
(116.8
)%
Total Other Income (Expense), net
$
(435
)
$
12,455
$
(12,890
)
(103.5
)%
$
(16,036
)
$
14,417
$
(30,453
)
(211.2
)%
Realized and unrealized gain (loss) on investments, net
Realized and unrealized gain (loss) on investments, net changed during the three and six months ended June 30, 2020 by $5.1 million , or 248.9% , and $(5.9) million , or (107.9)% , respectively, as compared to the same periods in the prior year.
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The realized and unrealized gains and losses during the three and six months ended June 30, 2020 reflected changes in overall market conditions experienced during the periods.
Realized and unrealized gain (loss) of CIP, net
Realized and unrealized gain (loss) of CIP, net changed $(16.5) million , or (169.4)% , and $(23.2) million , or (297.6)% , respectively, during the three and six months ended June 30, 2020 , compared to the same periods in the prior year. The change consisted primarily of an increase in net realized and unrealized losses of $81.7 million and $171.9 million for the three- and six-month periods ended June 30, 2020, respectively, primarily due to changes in market values of leveraged loans, partially offset by an increase of $65.2 million and $148.7 million in the three- and six-month periods, respectively, in unrealized gains on notes payable.
Other income (expense), net
Other income (expense), net decreased $1.5 million , or (215.7)% , and $1.3 million , or (116.8)% , respectively, for the three and six months ended June 30, 2020 compared to the same periods in the prior year due to losses from equity method investments during the current year periods.
Interest Income (Expense)
Interest Income (Expense), net by category were as follows:
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2020
2019
2020 vs. 2019
%
2020
2019
2020 vs. 2019
%
Interest Income (Expense)
Interest expense
$
(3,126
)
$
(5,151
)
$
2,025
(39.3
)%
$
(6,325
)
$
(10,316
)
$
3,991
(38.7
)%
Interest and dividend income
242
964
(722
)
(74.9
)%
994
2,154
(1,160
)
(53.9
)%
Interest and dividend income of investments of CIP
28,634
29,368
(734
)
(2.5
)%
57,863
56,770
1,093
1.9
%
Interest expense of CIP
(28,150
)
(31,077
)
2,927
(9.4
)%
(52,636
)
(50,778
)
(1,858
)
3.7
%
Total Interest Income (Expense), net
$
(2,400
)
$
(5,896
)
$
3,496
(59.3
)%
$
(104
)
$
(2,170
)
$
2,066
(95.2
)%
Interest Expense
Interest expense decreased $2.0 million , or 39.3% , and $4.0 million , or 38.7% , respectively, for the three and six months ended June 30, 2020 compared to the same periods in the prior year. The decreases were due to a decrease in the average levels of debt outstanding, including a gain on the early extinguishment of debt in the current six-month period, and a lower average interest rate compared to the same periods in the prior year.
Interest and Dividend Income
Interest and dividend income is earned on cash equivalents and our marketable securities. Interest and dividend income decreased $0.7 million , or 74.9% , and $1.2 million , or 53.9% , respectively, for the three and six months ended June 30, 2020 , compared to the same periods in the prior year. The decreases were primarily due to lower interest rates earned on cash and lower investment balances as compared to the corresponding periods in the prior year.
Interest and Dividend Income of Investments of CIP
Interest and dividend income of investments of CIP decreased $0.7 million , or 2.5% , and increased $1.1 million , or 1.9% , respectively, for the three and six months ended June 30, 2020 , compared to the same periods in the prior year. The decrease during the three-month period was primarily due to a decrease in interest rates partially offset by increased investments of CIP. The increase during the six-months ended June 30, 2020 compared to the same period in the prior year was due to increased investments of CIP during the current year period.
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Interest Expense of CIP
Interest expense of CIP represents interest expense on the notes payable of CIP. Interest expense of CIP decreased by $2.9 million , or 9.4% , and increased by $1.9 million , or 3.7% , respectively, for the three and six months ended June 30, 2020 , compared to the same periods in the prior year. The decrease during the three months ended June 30, 2020 was primarily due to $4.5 million of amortization of discounts on notes payable in the prior year partially offset by higher average debt balances of CIP during the current year period. The increase during the six-month period was primarily due to higher average debt balances of CIP during the current year period.
Income Tax Expense (Benefit)
The provision for income taxes reflected U.S. federal, state and local taxes at an estimated effective tax rate of 50.9% and 20.5% for the six months ended June 30, 2020 and 2019 , respectively. The increase in the estimated effective tax rate for the six months ended June 30, 2020 was primarily due to unrealized losses on various Company investments for which a valuation allowance was recorded.
On March 27, 2020, the United States enacted the Coronavirus Aid, Relief, and Economic Security Act, referred to herein as the CARES Act, which contains several income tax provisions. Some of these tax provisions are expected to be effective retroactively for years ending before the date of enactment. The Company has evaluated the current legislation and, at this time, does not anticipate the CARES Act to have a material impact on its condensed consolidated financial statements.
Liquidity and Capital Resources
Certain Financial Data
The following table summarizes certain financial data relating to our liquidity and capital resources:
June 30, 2020
December 31, 2019
Change
(in thousands)
2020 vs. 2019
%
Balance Sheet Data
Cash and cash equivalents
$
168,268
$
221,781
$
(53,513
)
(24.1
)%
Investments
61,301
83,206
(21,905
)
(26.3
)%
Debt
234,765
277,839
(43,074
)
(15.5
)%
Redeemable noncontrolling interests
90,687
63,845
26,842
42.0
%
Total equity
666,511
686,257
(19,746
)
(2.9
)%
Six Months Ended June 30,
Change
(in thousands)
2020
2019
2020 vs. 2019
%
Cash Flow Data
Provided by (Used In):
Operating Activities
$
(449,712
)
$
(143,668
)
$
(306,044
)
213.0
%
Investing Activities
9,249
(5,638
)
14,887
(264.0
)%
Financing Activities
370,577
145,934
224,643
153.9
%
Overview
At June 30, 2020 , we had $168.3 million of cash and cash equivalents and $61.3 million of investments, which included $40.0 million of investment securities, compared to $221.8 million of cash and cash equivalents and $83.2 million of investments, which included $61.0 million of investment securities, at December 31, 2019 .
At June 30, 2020 , we had $240.7 million of principal outstanding under our term loan maturing June 1, 2024 and no outstanding borrowings under our $100.0 million revolving credit facility. The Company's liquidity and capital resources were not materially impacted by the economic conditions during the first six months of 2020 as a result of the COVID-19 pandemic.
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Uses of Capital
Our main uses of capital related to operating activities include payments of annual incentive compensation, interest on our indebtedness, income taxes and other operating expenses, which primarily consist of investment research, technology costs, professional fees and distribution and occupancy costs. Annual incentive compensation, which is one of the largest annual operating cash expenditures, is typically paid in the first quarter of the year. In the first quarter of 2020 and 2019 , we paid $84.7 million and $76.2 million, respectively, in incentive compensation earned during the years ended December 31, 2019 and 2018 , respectively.
In addition to operating activities, other uses of cash could include: (i) investments in organic growth, including expanding our distribution efforts; (ii) seeding or launching new products, including seeding funds or sponsoring CLO issuances; (iii) principal payments on debt outstanding through scheduled amortization, excess cash flow payment requirements or additional paydowns; (iv) dividend payments to common stockholders; (v) repurchases of our common stock; (vi) investments in our infrastructure; (vii) investments in inorganic growth opportunities as they arise where the purchase price can take the form of upfront payments and/or contingent consideration; (viii) integration costs, including restructuring and severance, related to potential acquisitions, if any; and (ix) purchases of affiliate noncontrolling interests.
Capital and Reserve Requirements
We operate a broker-dealer subsidiary registered with the SEC that is subject to certain rules regarding minimum net capital. The broker-dealer is required to maintain a ratio of "aggregate indebtedness" to "net capital," as defined, which may not exceed 15 to 1 and must also maintain a minimum amount of net capital. Failure to meet these requirements could result in adverse consequences to us, including additional reporting requirements, a lower required ratio of aggregate indebtedness to net capital or interruption of our business. At June 30, 2020 , the ratio of aggregate indebtedness to net capital of our broker-dealer was below the maximum allowed, and net capital was significantly greater than the required minimum.
Balance Sheet
Cash and cash equivalents consist of cash in banks and money market fund investments. Investments consist primarily of investments in our sponsored funds. CIP represent investment products for which we provide investment management services and where we have either a controlling financial interest or we are considered the primary beneficiary of an investment product that is considered a variable interest entity.
Operating Cash Flow
Net cash used in operating activities of $449.7 million for the six months ended June 30, 2020 increased by $306.0 million from net cash used in operating activities of $143.7 million for the same period in the prior year primarily due to increased net purchases of investments by CIP of $294.0 million in the current year period compared to the prior year period.
Investing Cash Flow
Cash flows from investing activities consist primarily of capital expenditures and other investing activities related to our business operations. Net cash provided by investing activities was $9.2 million for the six months ended June 30, 2020 compared to net cash used in investing activities of $5.6 million in the same period for the prior year. The primary investing activities for the six months ended June 30, 2020 were related increases in cash of CIP due to the consolidation of additional investment products. The primary investing activities for the six months ended June 30, 2019 were capital expenditures and other asset purchases of $6.1 million partially offset by the sale of investments in unconsolidated CLOs of $2.0 million.
Financing Cash Flow
Cash flows from financing activities consist primarily of the issuance of common stock, return of capital through repurchases of common shares, dividends, withholding obligations for the net share settlement of employee share transactions, issuance of and repayment of debt by us, our CIP and contributions to noncontrolling interests related to CIP. Net cash provided by financing activities increased by $224.6 million to $370.6 million for the six months ended June 30, 2020 as compared to net cash provided by financing activities of $145.9 million for the six months ended June 30, 2019 . Net cash provided by financing activities increased during the period primarily due to an increase of $249.9 million in net borrowings of CIP during the six months ended June 30, 2020 compared to the prior year period, partially offset by an increase of $19.2 million on the repayment of debt during the six months ended June 30, 2020 compared to the prior year period.
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C redit Agreement
The Company's credit agreement, as amended (the "Credit Agreement"), is comprised of (i) $365.0 million of seven-year term debt (the "Term Loan") expiring in June 2024 and (ii) a $100.0 million five-year revolving credit facility (the "Credit Facility") expiring in June 2022. At June 30, 2020 , $240.7 million was outstanding under the Term Loan, and there were no outstanding borrowings under the Credit Facility. In accordance with Accounting Standards Codification 835, Interest, the amounts outstanding under the Term Loan are presented in the Condensed Consolidated Balance Sheet net of related debt issuance costs, which were $5.9 million as of June 30, 2020 .
Contractual Obligations
Our contractual obligations are summarized in our 2019 Annual Report on Form 10-K. As of June 30, 2020 , there have been no material changes outside of the ordinary course of business in our contractual obligations since December 31, 2019 .
Critical Accounting Policies and Estimates
Our financial statements and the accompanying 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 our 2019 Annual Report on Form 10-K. A complete description of our significant accounting policies is included in our 2019 Annual Report on Form 10-K. There were no material changes in our critical accounting policies in the three months ended June 30, 2020 .
Recently Issued Accounting Pronouncements
For a discussion of accounting standards, see Note 2 in our condensed consolidated financial statements.
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.