Virtus Investment Partners, Inc. (VRTS) Q1 2018 Earnings Report, Transcript and Summary

Good morning. My name is Amanda, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners Quarterly Conference Call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com. The call is also being recorded and will be available for replay on the Virtus website. [Operator Instructions]. I will now turn the conference over to your host, Jeanne Hess.

Thank you, and good morning, everyone. On behalf of Virtus Investment Partners, I would like to welcome you to the discussion of our operating and financial results for the first quarter of 2018. Before we begin, I direct your attention to the important disclosures on Page two of the slide presentation that accompanies this webcast. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and as such, are subject to known and unknown risks and uncertainties, including, but not limited to, those factors set forth in today's earnings release and discussed in our annual report on Form 10-K and quarterly report on Form 10-Q and other SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements. In addition to results presented on a GAAP basis, Virtus uses certain non-GAAP measures to evaluate its financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results and should be read in conjunction with GAAP results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our earnings press release, which is available on our website. Now I would like to turn the call over to our President and CEO, George Aylward. George?

Thank you, Jeanne. Good morning, everyone. I'll start today by reviewing the key items in the quarter followed by a brief update on the status of the pending transaction with Sustainable Growth Advisers, or SGA. Mike will then provide more detail on our financial results and capital position. Let me begin with assets under management and flows. We ended the quarter with long term AUM of $87.4 billion, sequential decrease of 1.6%, primarily attributable to net outflows and market depreciation, reflecting the impact of the first negative quarter for the equity markets since 2015. Total assets which include liquidity strategies ended the period at $89.1 billion. Total sales increased 32% sequentially to $5.4 billion, reflecting higher sales in open-end funds and a CLO issuance of $0.4 billion. Starting with a particularly strong January, mutual fund sales increased 43% in the quarter due to growth in sales, domestic equity, fixed income and international strategies. Total net flows were negative $0.7 billion in the quarter compared with negative $0.8 billion sequentially as positive net flows in structured products, open-end funds and ETFs were more than offset by net outflows in institutional. The positive flows in structured products resulted from the new CLO managed by Seix. Mutual fund net flows were positive $0.1 billion, an improvement from the negative $0.6 billion sequentially, reflecting the continued growth in the quality oriented equity strategies managed by Kayne Anderson Rudnick as well as improved flows in fixed income. Retail separate accounts in total were modestly negative in the quarter as continued positive net flows intermediary sold managed accounts were offset by net outflows in the private client business, which resulted from the redemption of a single low-fee account. Equity strategies in intermediary sold managed accounts continued to generate positive flows, which more than offset redemptions in high yield strategies, reflective of industry trends. Overall, our retail separate accounts have been growing and positive, and we continue to see great opportunity in this category going forward. Institutional net flows, which tend to be lumpy, were negative $1.2 billion in the quarter due primarily to $0.8 billion in partial redemptions from existing client accounts, predominantly high yield and option strategies, which were impacted by the volatile equity markets. In terms of what we're seeing in April for flows, we're pleased that the mutual fund sales remained strong and net flows continue to be positive. Regarding other products, one thing of note is that we have 3 domestic equity mandates from new clients at Ceredex and Kayne, totaling $0.9 billion funding for April. We have not had or been notified of any meaningful redemption during the month in institutional business. However, institutional flows by their nature are difficult to predict and there could be outflows at any point. Our relative investment performance continued to be strong as of March 31 with 98% of rated fund AUM having 3, 4 and 5 stars and approximately 94% of institutional assets beating their benchmark on a three and five year basis. Moving to the financial results. Operating income as adjusted and the related margin were $32.8 million and 30% compared with $39.1 million and 36% in the prior quarter. It's important to note that the first quarter results were impacted by $6.8 million seasonally higher employment expenses, primarily incremental payroll taxes and increased benefit costs, resulting from the timing of annual incentive payments. Excluding these expenses, operating income, as adjusted, and the related margin would have been $39.6 million and 37%, respectively. First quarter earnings per share, as adjusted, of $2.59 was essentially flat with the prior quarter as the seasonally higher employment expenses were offset by a lower effective tax rate and an increase in other income. Turning to the balance sheet. Cash and cash equivalents decreased 39% sequentially to $80.8 million as cash generated was more than offset by the timing of annual incentive payments and an investment in the newly issued CLO. In terms of CLOs going forward, the recent repeal of U.S. risk retention rules may allow us to continue to grow this business without being required to invest in each issuance. We are evaluating this development for how it may apply to our next potential CLO that is currently in the warehouse phase. In February, we refinanced our term loan, lowering the variable rate of interest and decreasing -- increasing our financial flexibility. We also secured an additional $105 million of term loan debt that will be drawn at the closing of the SGA transaction. In terms of the status of the SGA transaction, we're pleased with the progress we've made towards the closing, which we still expect to occur midyear. The client consent process is well underway and progressing as expected. SGA's assets under management were $11.6 billion in March 31, which is consistent with the AUM levels at December 31. In terms of the transactions financial impacts, we continue to expect EPS as adjusted accretion for approximately 6%, incorporating earnings from SGA, partially offset by the incremental financing costs associated with the $105 million of additional term loan. The accretion estimate includes the impacts of their higher margin, which will provide a modest benefit to the company's total margin reflecting the size of SGA in comparison to the overall business. Now I'll turn it over to Mike to provide more detailed view on the financial results and our capital position. Mike?

Thank you, George. Good morning, everyone. Starting on Slide seven, assets under management. We ended the quarter with long-term assets of $89.1 billion, which reflects a sequential quarter decrease of 1.6% and an increase of 86% from the prior year quarter. Sequential decrease reflects that outflows of $0.7 billion, market depreciation of $0.4 billion and $0.3 billion reduction from other activity, primarily dividend distributions. The change from the prior year reflects the assets from the RidgeWorth acquisition, market appreciation of $6.2 billion and net outflows of $1.5 billion. Our long-term AUM continues to be well diversified by product type with $43.2 billion in open-end funds, $19.4 billion in institutional, $14 billion in retail separate accounts, $6.1 billion in closed-end funds, $3.7 billion of structured products and $1 billion in ETFs. At March 31, our long-term assets remained balanced between equity and fixed income, with the level of equity assets increasing in each of the last four quarters to 53% of total assets, which is reflected in our blended fee rate. Turning to Slide eight, asset flows. Total sales were $5.4 billion, a sequential quarter increase of $1.3 billion or 32%, primarily due to $1.1 billion in higher open end fund sales and $0.4 billion from the launch of the CLO. Total sales increased from the prior year quarter by 64% or $2.1 billion on higher sales in open end funds, structured projects and institutional. Net outflows for the quarter were $0.7 billion as the combined net inflows of $0.6 billion from structured projects, open end funds and ETFs were more than offset by net outflows in institutional and retail separate accounts. With respect to mutual funds, net flows for the quarter were $0.1 billion, representing an annualized organic growth rate of 1.1%. We are pleased with this result given the market volatility in the quarter. In January, we started with strong sales and flows. We saw outflows in February during the market pullback and then a return to positive flows in March, which has continued in April. The fund flows in the first quarter by asset class were as follows: Domestic equity funds had net inflows of $0.4 billion, an increase from net outflows of $0.1 billion sequentially as small-cap strategies at Kayne continued to generate strong levels of sales. International equity funds were breakeven in the quarter compared to net inflows of $0.2 billion in the prior quarter. Positive net flows of $0.1 billion in the International Small-Cap Fund were offset by modest outflows in the Emerging Markets Opportunities Fund. Fixed income funds had net outflows of $0.1 billion compared to net outflows of $0.6 billion in the fourth quarter. The improvement was primarily due to bank loan strategies managed by Seix that generated $0.1 billion of positive flows in the quarter compared to $0.3 billion of outflows in the fourth quarter. Turning to Slide nine. Investment management fees as adjusted of $102 million were flat sequentially as two fewer days in the quarter partially offset higher-average assets under management and a higher net fee rate. The average fee rate on long-term assets for the quarter was 46 basis points compared with 45.4 basis points in the prior quarter due to increases in the blended fee rates for several products. The open end fund fee rate increased to 50.3 basis points from 50.1 basis points in the fourth quarter due to net flows into higher fee domestic equity products, primarily managed by Kayne. The blended fee rate on first quarter mutual fund sales was 56.4 basis points compared to a rate of 49 basis points on the first quarter of redemptions. The separately managed accounts fee rate increased 1.5 basis points sequentially to 47.6 basis points due to a shift in the mix of assets as a result of positive flows in Kayne's equity strategies. Net outflows in the high yield fixed income strategies and the redemption of a large very low fee private client account. For modeling purposes, we believe that current quarter fee rate for open-end funds is reasonable, all else being equal. Slide 10 shows the five quarter trend in employment expenses. Total employment expenses as adjusted of $58.8 million increased sequentially and reflected $6.8 million of seasonally higher employment expenses, resulting from the timing of incentive payments. The $6.8 million included $3.9 million of incremental payroll taxes, $2.3 million of increased benefit costs, primarily the timing of the 401K match, reflecting higher staffing levels and plan modifications, resulting in more expense being recognized earlier in the year and $0.6 million of accelerated compensation expense as a result of annual equity awards made to retirement eligible employees. As a percentage of revenues as adjusted employment expenses were 54%, excluding the $6.8 million of the seasonally higher costs and the employment ratio was 48% consistent with the prior quarter. The trend in other operating expenses as adjusted reflects the timing of product, distribution and operational activities. Other operating expenses as adjusted were $15.7 million, a decrease of $1 million or 6% from the prior quarter, which included $0.9 million of transaction costs associated with the SGA agreement. In addition, as we point out each year, the second quarter will include the annual equity grant to our independent directors, that totaled $0.7 million in the second quarter of 2017. Slide 12 illustrates the trend of financial results. In terms of the non-GAAP results, operating income as adjusted was $32.8 million, a decrease of $6.3 million or 16% sequentially due primarily to the seasonally higher employment expenses. Operating margin as adjusted was 30% compared with 21% in the prior year quarter. Excluding those seasonal expenses, operating margin as adjusted was 37%, an increase from 36% in the fourth quarter and 28% in the prior year quarter. The first quarter effective tax rate, as adjusted, decreased sequentially to 28% from 39% in the prior quarter, primarily reflecting the impact of the Tax Cuts and Jobs Act. Net income as adjusted of $21.8 million or $2.59 per diluted share was essentially flat with the prior quarter as the benefit from the lower effective tax rate as adjusted, was offset by the seasonally higher employment expenses. The quarter also benefited from $1.1 million of other income as adjusted, which increased by $0.6 million from the prior and previous quarters, reflecting earnings on equity method investments. It's important to note that while our non-GAAP earnings do not include $3.4 million of interest and dividends earned on seed and CLO investments, they provide a significant economic benefit to the company. Regarding GAAP results, first quarter financials reflect the recent adoption of the new revenue recognition accounting standard, which became effective on January 1, 2018. The adoption of the standard had only a reclassification impact between two line items on the income statement with no impact to net income. Specifically, the reclass relates to the presentation of certain distribution costs, which were previously included net against revenues in the distribution and services fee row and are now presented as an operating expense on a gross basis in the distribution and other asset-based expenses row. First quarter GAAP net income per share increased to $2.77 from $0.46 in the fourth quarter, which included a noncash tax charge of $1.76 per share, resulting from the Tax Cuts and Jobs Act. First quarter net of tax GAAP earnings included the following items: $4.9 million or $0.58 per share of seasonally higher employment expenses; $2.7 million or $0.32 per share related to unrealized gains; $2.2 million or $0.26 per share of acquisition and integration costs; and in terms of the share count, there was a 13% increase in weighted average diluted shares outstanding due primarily to this quarter's [calculation of the if] converted method. Slide 13 shows the trend of our capital position and related liquidity metrics. At March 31, seed capital investments were $115.8 million and within the targeted range of $100 million to $150 million, which will fluctuate based on our specific product and distribution needs. In the quarter, we recycled certain existing seed investments and launched two new products. CLO investments increased to $133.2 million at March 31, primarily reflecting the company's $20.2 million investment in the CLO managed by Seix. In the quarter, we refinanced our term loan that lowered the variable rate of interest from LIBOR plus 375 basis points to LIBOR plus 250 basis points and increased the company's financial flexibility by removing the financial maintenance covenant. The effective interest rate for the quarter was 5.9%. Net debt at March 31 was $177.9 million that resulted in a one times net debt to bank EBITDA ratio. In February, we secured an additional $105 million of term loan debt to partially fund the majority interest acquisition of SGA that will be drawn at the time of the close. With that, let me turn the call back over to George. George?

Thanks, Mike. That concludes our prepared remarks. Now we'll take your questions. Amanda, can you open up the lines, please?

Thank you [Operator Instructions].Our first question is from the line of Ari Ghosh of Crédit Suisse. Your line is open.

Hey good morning, everyone.

Good morning, Ari.

Just on the institutional business. Can you give us a little more color as to why this conversion cycle seems to be taking a little longer to materialize? Just what were the key products that were seeing demand on the Virtus side and Ridgeworth side 12 months ago and is it like pricing, performance and more of a macro sort of factors that are impacting the flows right now? Like I appreciate that this could be a bit lumpy, but just trying to get a sense of what your outlook is for the balance of 2018 on the institutional side.

Sure. So again, our institutional business pre-Ridgeworth was an area that we have been investing in and trying to grow out and we've been pleased over the last year or two, having starting to have increased activity. In terms of what you saw in this quarter, they were the partial redemptions. So again to be clear, they are reductions in existing accounts, not closed accounts. And as we highlighted they were focused really on the high yield and the optional related strategies, both of which in the quarter generally had idiosyncratic experiences where it would not be illogical for people to downsize their allocations to those. So we did note that in the quarter. In terms of what we are seeing in April, as we did highlight, for us really for the first time that I can remember, we have three mandates funding from two different managers in one month, which we're very pleased to see. So that's a very hopeful sign. And as you sort of look through the institutional business, which takes a long time to build up the activity, what we've really seen over the last year or so is an increase in activity and then we've seen a little bit more increase in semifinals and then actually seeing at least from my perspective, more activity in finals than I can personally recall in a while. And again, you're saying some of that turned into actual business in terms of the three funded mandates that we spoke to, to April. So still early for us in terms of building that up. We're pleased with what we've seen, and as it relates to sort of Ridgeworth, if you may remember, we never built in any kind of revenue synergies or growth projections from that transaction. But we pointed out at that time that we were very optimistic about some of the resources and leveraging those abilities and at least in one or two of the instances of the flows that we are talking about in April, they really are the result of some of those additional resources and capabilities. So we're very happy to see that as we expanded our resources and introduced some of them to our new partners from either side that were actually starting to see some activity for that. So it's little too early for us to be giving more clarity around our pipeline going forward, but again, as I sit here, I'm seeing more activity hearing more about finals than I heard in a very long time.

Got it. That's really helpful. And then just a quick follow up. Could you update us on the new product launches for 2018? I believe you recently launched a new small cap fund, the Kayne Anderson Fund, I believe. So I'm just wondering if there is anything additional in the pipeline for this year?

Sure. And we're always looking to see other capabilities that we want to bring to market. I think the Kayne product is a great example. Kayne has done an incredible job in terms of generating sustainable strong performance. We're seeing that clearly reflected in our flows, not only in open-end funds, institutional and in other areas. And that is a product for which we didn't have a open-end fund for strategy that actually existed in the retail -- the intermediaries of retail accounts. So that was really creating a complement for something we've already had success in raising assets on the separate account side. So we did that alongside that. In terms of other products, we are thoughtfully working in terms of what other ETF capabilities that we're working on and in late last year, you saw that we had launched the UCIT. So from mutual funds, we have a lot of mutual funds and most of our primary strategies are represented in the mutual fund line that became sort of one that we didn't have. We continue to look to see the reasonable opportunities on the ETF side and UCIT side but I don't have any other specific new product launches to discuss right now.

Great. Thank you very much.

Thank you.

Thank you. Our next question is from the line of Alex Blostein of Goldman Sachs. Your line is open.

Hey guys, good morning. A couple of questions for you. So first maybe we can just start with an update on the SGA deal. It will help us to get a sense on kind of where the assets are today. What kind of flows they've seen in the first quarter? And maybe just a refresher on kind of where does the run rate EBITDA stand here as we are quarter or so away from closing this transaction?

Sure, so for SGA obviously their primary focus right now is managing their clients' assets and then working on the change of control and the consents, which is obviously a big area of focus for them. So as we pointed out their assets are really unchanged from the end of 12/31, so our AUM is down 1.6%. Theirs was flat. And really their focus right now on the quarter where they're in the midst of a change of control notification, you should not expect like lots of activity as it relates to flows. Though there was a PR yesterday they put out an announcement related to a win they previously had. So will give more clarity in terms of where they are as we get closer to the midyear point. But we're still incredibly pleased with SGA, how they're performing, and how they are working on their business. And again, as we said, we think it will be midyear when we close. Mike, do you want to?

Yes. In terms of the financial impact, I think we alluded to in the script, the 6% accretion level, which will reflect the $11.6 billion of AUM that we are contemplating on a pro forma basis, is how we calculated that number. And as we've indicated that full $11.6 billion is institutional assets, I think, last quarter we talked about the impact on our blended institutional fee rate of 31 basis points as a good level to use for the top line. So when you look at that and reflect the fact that it has a modest incremental benefit to the margin that we reported, you sort of get the you can get the specific line items that will be impacted on employment and other operating which we're continuing to refine as we move toward closing. I think the other important thing to note, is this is a majority owned situation. So you will see the minority interest well impacted -- will reflect a 100% of the results in our income statement items and there will be minority interest impact of this part of the business that we don't own, so you will see that flow in. And then, the other element is we're going to be going down on a $105 million of the term loan at the closing to finance partial of the transaction using existing balance sheet resources for the remainder, so each of the elements should help you kind of build out your model there.

Yes. But doesn't sound like a lot of change from what you said before on the announcement. I guess to the last point that you mentioned around the new loan and just maybe that's a good way to talk about capital broadly for you guys. So continue to generate a lot of free cash flow, significantly higher than your net income you highlighted couple of million dollars obviously of earnings that's not even showing up on your adjusted results. So I guess, how we’re thinking about the capital return strategy from here? Is the deleveraging still kind of the first priority after you guys closed the deal? Is there an opportunity to both or do little bit of a buyback as well as deleveraging, so kind of maybe walk us through this kind of next several quarter opportunity set?

I think our perspective as we look at capital is we always keep an open mind in terms of any individual points to sort of determine what is the highest and best use of capital and balancing the different opportunities in terms of either investing in new product, returning capital to shareholders to repurchases and obviously now leverage is something we have to be very mindful of. So I think in terms of the way that our term loan is structured, there is a mechanism by which it does pull in cash to sort of pull down a little bit of the leverage, so that will be what it will be. In terms of other capital priorities, obviously our first priority is to close on SGA and execute on all of that. But we'll continue to look at -- is the appropriate use at a point in time more on the delevering side, we want to make sure that we have a reasonable level of leverage not -- and not too much or too little. And then at the same time, we do fully understand that returning capital to shareholders, which, as you know, is something we consistently used as a point of our tools, is something we'll consider given our -- whatever the levels of cash flow are at the time. Mike, you want to...

No. I think you summarized it well. I think, the other thing that we alluded to in the script is we're evaluating the implications of the risk retention changes, and we're certainly pleased around go-forward CLOs that there may not be a requirement to invest alongside each of our CLO issuances. So I think that's a net positive given the strength of our CLO capabilities. But now we'll maintain a prudent approach to our balance sheet and balance all the investment in the business and return on capital as well as focus on the debt paydown.

Yes. This CLO definitely sound like an incremental positive for you guys. Mike, I don't think -- I don't -- sorry, if I missed, but I don't think you had much on the kind of the expense outlook. Maybe, it's good place to walk through that as well? Just I heard the comments on comp but SGA deal side and kind of obviously the expenses that will come in with it or sort of anything integration related. How are you guys thinking about just kind of other operating expenses for the rest of the year?

Yes, I think, the two elements that we alluded to the employment expenses, we certainly give some color on the employment expenses excluding the seasonal items and talked about a 48% level of revenues as adjusted and referenced that each of last two quarters have been at that level. So we think that's an appropriate perspective. And then other operating expenses as adjusted, I think, you're starting to see a normalized level on a couple of fronts. I think the last few quarters, we have been at 16.1%, 15.8%, 15.7%, I think, give or take. So we're seeing that level and that rounds out to 14.5% of revenues as adjusted. So I think it's a good range to model on an absolute basis that -- I think the last time we talked about it was around $16 million and still think those were appropriate levels.

Got it. Thanks a lot.

The other item, I did point out in the script for modeling purposes, we have the annual equity grant to our directors in the second quarters. That's just a seasonal item that I think you're all well aware of.

Yes. We got that. Great. Thanks.

Thanks, Alex.

Our next question is from the line of Michael Carrier of BoA Merrill Lynch.

All right. Thank guys. Maybe first on the mutual fund flows. You guys -- things have been kind of holding up better than in the industry. And you pointed some to the performance and then some on the products. Just wanted to get a sense. I think you mentioned both in the domestic and the international side on the small cap your strategies doing well. Any like from a capacity standpoint, any potential constraints. Maybe an update there and where you're seeing the momentum?

Sure. We've been pleased and even given the environment other than the month of February to have the level of sales, right. Because having a good level of sales is sort of a helpful driver. So we're seeing that every month except for February and there has been diversity of those sales. So as Mike, indicated, domestic equity in particularly a lot of the Kayne strategies have performed well. We've seen some improvements in more of the asset class centric kind of strategies like loans, which seem to go in and out of favor in alternating quarters frequently. So we sort of seen it across several different products and several different managers, so we sort of pleased with that. In terms of those that may have some capacity, so in terms of Kayne, which has a lot of strong, small, mid, mid types of strategies, so there is literally multiple orients of those of value growth core. one or two of them have been very successful. So there are some strategies like the core that have used up a proportion of capacity. I think, as you know, if we do look at our funds for closing, we do it in terms of soft closes, which sort of allows us to maintain the relationships with some of the big platforms to allow for continual replenishment. But there is a number of other strategies offered by the same manager that are still well within the capacity and we're happy we are sort of seeing close in things like international small-cap which is actually one of their newer strategies where unlike some of the others that they've accumulated a lot of assets over the years. That is not one that has capacity issues given the current level of assets.

Okay. That's helpful. And then, maybe, just a follow-up to when I think about Virtus and what you guys had kind of prior to RidgeWorth and then SGA? Like from a product standpoint we get -- and when you add-on RidgeWorth and SGA, we know their strategies. From a distribution standpoint, obviously, you mentioned on the SGA side, it's more institutional. But how should we think about that, maybe, from past investment and then with these new entities, what that means for the kind of the combined Virtus over the next few years? Meaning where you think do you see more opportunity from maybe some of the legacy products and different distribution channels over the coming years?

Sure. So our family of boutique managers is really about all of us having the building blocks of well-diversified portfolios to offer to institutional and to retail investors. And we're sort of hopeful in terms of our objective, which is take those really good managers and try to expand their opportunity sets for new channels. So we -- our legacy was much stronger, obviously, in retail than institutional. So a lot of the investments we've made and some of the resources brought in from RidgeWorth have really been about not only increasing the opportunity set for the previous RidgeWorth affiliated managers, but adding that to some of the Virtus legacy managers. So taking again the same managers we have with skills, and broadening their opportunity set to include institutional, which is sort of the same driver for our slow buildout of the UCIT opportunity, right? So getting to non-U.S. market opportunities, we very thoughtfully launched a few funds, built a three-year track record on several of them, starting to get access. So it's really about having those good differentiated distinctive managers, making them available in as many channels and as many product structures as we can just to leverage the natural leveragability of our portfolio management capability, right? If you have the same team, managing the same strategy in multiple markets, it's a nice growth trajectory. So, we continue to look to sort of maximize the opportunity set for the capabilities that we have. And right now with the SGA transaction being the most recently announced transaction, we really feel we have a very strong stable of very differentiated distinctive types of managers in many of the traditional asset classes. So we feel good about the effort -- we feel good about the investment capabilities and we're excited to really spend our time focusing on driving the increasing assets in multiple channels for each of them.

Okay. Thanks a lot.

Thank you.

Our next question is from the line of Michael Cyprys of Morgan Stanley. Your line is open.

Hi, Good morning. Thanks for taking my question. Just hoping you could update us on new -- potential new sub-advisory relationships. Just how you're thinking about expanding that from here? How those conversations are progressing? What sort of interest do you have? What sort of interest are you seeing out there for managers around the world looking for help with distribution and what make sense today as you look across your platform?

Sure. Great question. So going back to my previous comments. So with our objective of really trying to offer a good set of distinctive differentiated products to retail and institutional investors, we do employee sub-advisory in the instances where we don't have an affiliated manager providing that capability. So we selective legal [ph] partner with sub-advisors for very specific areas and opportunities. So that continues to be something that we do. Right now, I think our focus really is more on leveraging the great managers that we currently have, and to the extent that there is something that we see that is not something that is going to come from an existing manager or through a transaction. We would continue to look at the sub-advisory, but I would say, right now, our primary focus is on maximizing the growth opportunities of our existing managers, and we would be open to maybe a select opportunity in the sub-advisory side, but for us that probably less propriety. What I would say though to part of your question, I continue to see that there are a lot of people, particularly non-U.S. asset managers, who would like opportunities in the U.S. market through sub-advisory and there is only a few -- with a several managers, who do sub-advisory. So I think right now, the supply is greater than the demand. But right now, I would say our focus is really on growing our existing managers, and we'll keep our eyes open for sub-advisory, but it wouldn't be the primary objective.

Thanks for that. Just a quick follow-up on M&A. Just curious your updated thoughts around that with the SGA deal set to close coming up? Does that put you out of the market for some time and thinking about other sort of transactions? How you're feeling here about other sort of smaller bolt-ons like this versus more transformative? What strategies could make sense, are you interested in? And looking out for three to five years how different could Virtus look from the way it looks today?

Sure, I mean, one thing I think we always try to say is that our plan for long-term growth is not dependent upon M&A. So haven't been build our long-term strategy on the premise that we need to continually do M&A and expand the business that way. So our focus will be on organically maximizing the opportunity set of what I think of a great capabilities that we currently have. And not only on investment side, I think, we've certain strength on the distribution side that are great. So that will always really be sort of the core of what we see in the long-term growth strategy looking like. But structurally, we're multi-boutique. And as you've seen with the SGA transaction, three affiliates that we added from the RidgeWorth transaction, the Rampart transaction prior to that, the ETF solutions transaction prior to that, and the liftout that created the Newfleet opportunity, that is something that's in our arsenal of things that we will do. But it will only be when it makes sense and it is just right thing for us to do with capital and if it is the right thing for us to do in terms of focusing our distribution resources. So what I would like to say is as we go forward, in three or five years, our goal would be to maximize more opportunities from our existing managers, but absolutely, if there is something transformational that made sense or something that was a product capability, we'd certainly consider it. But for us, we don't view that as being necessary component of being successfully growing the company.

Got it. A quick follow-up here. Just given your comments that you focus more on the organic growth side and focused on flows. As we look at your flows, it's been in outflows for four years and then, again, this quarter. Just what do you need to do, you think, to meaningfully inflect growth on the organic side of the equation to achieve what you're just articulating? What needs to be done?

Sure, yes. As you go over that period of time, there is a mix of different things. So, yes, there were outflows in some prior years related to portfolio management change at a sub-advisor, which have obviously now totally reversed and gone the other way. So we sort of have been hovering around that breakeven of flows in an environment, which as you are aware, active management has struggled in some of the increasing markets. So we've gone in and out of positive flows over the last few quarters. And again, I think we highlighted in this first quarter, open-end mutual funds are positive, retail separate accounts, the intermediary side are positive, ETFs have been positive. So we've been hovering right around there. So I think like all active managers, we have to deal with reality of where the demand is in terms of active and passive and then as it relates to individual asset classes. But right now, I feel pretty good that each of our product category is absolutely -- has either been in net positive flows or has been right around -- hovering right around that cost. So I feel we're -- on a relative basis pretty well positioned.

Great. Thanks for taking my question.

Thank you. Our next question is from the line of Andrew Disdier of Sandler O'Neill. Your line is open.

Hey, morning everyone. So, first on the institutional outflows during the quarters. I was wondering if you can provide us with one, fee rates associated with the outflows and then two, the breakouts between the options and high yield products. I think with the options overlay we got about 35 basis point fee rate. And then, I know there are number of high-yield products between Seix and Newfleet. So just little clarity there would help?

Yes. I think you have the option strategy, right. But I think the generally the blended fee rate that we reported would be appropriate to assume in terms of the net outflows. The overall intuition is right around 31.

Okay. And then, [focusing on SGA] I know you got the update of consistent $11.6 billion of AUM. And -- but I guess, from a flow perspective, we're seeing net redemptions from their flagship U.S. large-cap equity strategy and that pulled at least from what you can see the fermented net outlfow mode, with all of their products being in inflow mode. So was wondering if you could clarify some of the flow trends? And then, George, not sure if you alluded to it or not, but would you be able to comment on any of the impact from the three unfunded mandates aggregating to $825 million into the flow numbers?

For SGA is a sort of indicated in the three-month period that we're speaking about. Their primary focus is managing their clients assets. And obviously, they're very busy on executing a change of control communication with existing and potential clients. So generally, the expectation would be during a period like that, companies are really going to be focused on that as opposed to new business. We're not going to give any specifics in terms of any small inflow or outflow. We gave the AUM change period over period. Again, we want them continue to focus on what they're doing and get the transaction closed. Again, I continue to feel their opportunity set is very strong in the market and again, having the change of control behind them, obviously, will be helpful as they try to win new business. But I think they are in pretty good place. And Mike, anything in terms of?

No. Your question, it was on the April mandate that we alluded to earlier?

No. In the purchase agreement between Virtus and SGA it looks like there were three mandates, $625 million, $100 million, $100 million that were won but not yet funded by SGA, so I was just wondering if that was going to woven into any of those have hit or have not hit during the first quarter of 2018?

Yes, that goes back to some of the -- at that time the agreement was signed, which dates back to September 30, so the numbers that we're talking about would incorporate those kind of mandates that will be in the $11.6 billion.

Got it. Got it. Okay. And then one last one, if you don't mind. Saw that there were some of the -- some expense caps put in place in March. So a multi-part question here and whether it would at a firm level or also at an industry level. So one, I went through some of the filings, and it seems like the sales charges are an expense that a client could still incur, but it's unclear as to where exactly we'll see the fee waivers or expense reimbursements, whether it would be distribution, admin, T&A – TA [ph]. So just wondering the impact there. And then, two, do you think that these caps can ever really be lifted, whether it'd be industry-wide or at a Virtus and multi-affiliate level?

Yes. So, I would focus on the expense caps. I would not focus on sales charges. Most of our sales are in NAV to the intermediary partners that we distribute through, right? So if you think sort of about the cap, so we continuously evaluate all of our funds and their expense ratios and the competitiveness of them. And as you noted, there are periods -- there are multiple times where we made tweaks or brought the expense caps down to increase the marketability. Sometimes it's on tiny newly issued funds like R6s. We've done a lot in terms of the retirement channel. In terms of the increasing the competitiveness of our R6, doesn't really impact our P&L because there are no assets. It's really been done more for future growth opportunity set to make sure we are as competitive as we could be. We have previously made some changes in some of our fixed funds where we want to make sure, that we are as competitive as we can be. As a smaller shop, we're pleased that we have better performance than a lot of our competitors. But we don't have the same scale so we continuously look at that. And really where you see that is the net management fee rate because all of the caps you won't see in the admin and the TA line. If we cap the total expense ratio of a fund, they don't show up in the net fee. And then your question about -- you never raised the expense ratio. That's not something I've seen in the industry, but if you cap something and it ultimately grows out of its cap, what you'll see is the reduction in the funds under reimbursement, right? So if you cap a fund and you're bringing it down below its run rate of expenses, you're sort of reducing the income you take home, but when that fund then grows and can cover its own expenses, it goes away. So you actually do see a pickup not by increasing the cap, but by growing the fund above the level of assets to sustain the expenses. Is that helpful?

Yes. Absolutely. Thanks for taking the question.

You're welcome.

Thank you. And our next question is from the line of Surinder Thind of Jefferies. Your line is open.

A quick follow-up on the CLO, our regulatory requirements. Obviously, it sounds like it's a positive for future issuance. But would it also potentially have an impact on your current CLOs? Meaning that, could you redeem the capital that you have, and if so, how much of the capital is currently locked up?

Technically, absolutely, yes. And I think that's why Mike or I sort of indicated that we're sort of sensing the implications and its not only on the next one to be issued, which as I indicated was in the warehouse phase. But again, it does change some of the legal requirements. But remember there's two aspects to investing in products like CLOs. One, is the U.S. risk retention guideline, but there is also client expectations, because for us and for clients, it's sometimes important that they see that the adviser is aligning themselves through investments. So it's not as simple as once the risk retention goes away, people can do whatever they want. Clients are very important to us in making sure that we don't make changes that would cause them to believe we don't believe in our products. So there'll be more comm on that. Mike, anything you want to add?

Yes, I think, George, alluded to it well. The other consideration, as you know, the EU risk retention rules do remain in place to the extent. There are transactions that are EU risk retention compliant. We would have to take that into consideration for who the clients and investors are. And then to the extent there are transactions that were executed through a risk retention vehicle, we have some implications around that. But we are evaluating the existing portfolios as well as go-forward issuances and we will be mindful of that as the rules change.

And it's definitely a plus. So we definitely be there positively.

Understood. And then, maybe, perhaps a quick modeling question here. Post the SGA transaction, what was the total debt load? If you can just remind us there, maybe actually more importantly, what the blended rate should look like?

We'll be undertaking an incremental $105 million of financing. So I guess, on the $259 million or $260 million plus $105 million will get us to $364 million, $365 million. We did lower the interest rate in the quarter with a refinancing in February to LIBOR plus $250 million. We've seen LIBOR tick up a bit, but we sided the effective interest rate of, I think, it was 559 [ph] in the first quarter and just keeping an eye on LIBOR. That's as good as rate to use on a go-forward basis.

And Mike, in terms of the mechanisms that are in place that will bring down the debt.

Yes. And we talked a little bit about the excess cash flow sweep around debt payments. The first debt paydown requirement would be in the first quarter 2019 would be based on an assessment of 2018 bank EBITDA levels and the requirement of cash flow that would go to pay down debt. So we'll be focused on that as we kind of step through the rest of 2018 as required by the financing agreement.

Understood. And then, just following up on the capital management questions. Obviously, there's a number of things that you guys can do and do evaluate. But why not just be more aggressive with debt paydown? Does that not open up all sorts of other options in the sense that, obviously, you could get more aggressive with M&A if you needed to? And in – in like a market correction or something like that versus doing share repurchases now, if there was a market correction you guys could relever up if you needed to. It just seems that there would be more options on the table versus necessarily trying to optimize based on the current market environment.

Yes it's a fair comment. And I think we agree that absolutely that is definitely something that could make a lot of sense. Again, that's why we always try to say, we maintain an open mind of flexibility given where we are. We do have competing demands for capital being responsive on building out new product, being responsive on returning capital. So I don't disagree with what you're saying, but we're not going to give any specifics in terms of where we're going right now.

Okay. And then, related to the M&A question. Obviously, you guys have mentioned that organic growth is the primary focus. But given that the challenge is that the industry has had and the fact that you guys do have a relatively unique model with the boutiques, and there's not a lot of other managers out there with that model. Does it not make sense to perhaps switch the order. Obviously, you want to invest as much you can to get organic growth, but if the industry is -- there's a lot of headwinds out there, why not be more aggressive with M&A?

Yes. I mean, that's fair, and I wouldn't want you to interpret what I said is that we definitely wouldn't. I mean, some people were surprised we did SGA. So soon after closing on RidgeWorth, we absolutely participate and look for any opportunities that are out there. We want to give consideration to those and SGA is perfect example where we literally found an incredibly differentiated, high-conviction manager with a global equity capability. That was a perfect fit for us. So we're not saying we wouldn't look at those and in those instances where you're talking about where there is a great opportunity, we are absolutely open to that. What I was trying to communicate is we don't need that to be successful in the long term in our view because we have so many capabilities that we can grow. But again, as I went through the list of whether it is SGA, Ceredex, Seix, Silvant, the Newfleet launch, ETF, Rampart, we've been -- we're certainly open to that. Have done quite a bit of it. And we'll keep that as an opportunity. If the right thing comes along, we certainly will always consider it.

Thank you.

Okay. Thank you.

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

So, I want to thank, everyone, for joining us today and we certainly encourage you to call us if you have any other questions and look forward to speaking with you in the next call. Thanks, everyone.

This concludes today's teleconference. Thank you for participating. You may now disconnect.