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Edited Transcript of VRTS earnings conference call or presentation 28-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Virtus Investment Partners Inc Earnings Call

HARTFORD May 2, 2017 (Thomson StreetEvents) -- Edited Transcript of Virtus Investment Partners Inc earnings conference call or presentation Friday, April 28, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* George R. Aylward

Virtus Investment Partners, Inc. - CEO, President and Executive Director

* Jeanne Hess

Virtus Investment Partners, Inc. - VP and Director of IR

* Michael A. Angerthal

Virtus Investment Partners, Inc. - CFO, EVP and Treasurer

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Conference Call Participants

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* Andrew Paul Disdier

Sandler O'Neill + Partners, L.P., Research Division - Analyst

* Arinash Ghosh

Crédit Suisse AG, Research Division - Research Analyst

* Daniel Jacoby

Goldman Sachs Group Inc., Research Division - Research Analyst

* Sameer Murukutla

BofA Merrill Lynch, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Leanne, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners quarterly conference call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com. This call is also being recorded and will be available for replay on the Virtus website. (Operator Instructions)

I would now turn the conference over to your host, Jeanne Hess.

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Jeanne Hess, Virtus Investment Partners, Inc. - VP and Director of IR [2]

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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 2017.

Before we begin, I direct your attention to the important disclosures on Page 2 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. These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements. These statements may be identified by such words as expect, anticipate, believe, outlook, may and similar terms.

For a discussion of these risks and uncertainties, please see the Risk Factors and management discussion and analysis sections of our periodic reports that are filed with the SEC as well as our other recent filings, which are available in the Investor Relations section of our website, virtus.com. We do not undertake any obligation to update forward-looking 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?

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [3]

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Thank you, Jeanne. Good morning, everyone. I'll start today by reviewing the key items in the quarter, followed by an update on our pending acquisition of RidgeWorth Investments. Mike will then provide a detailed overview of the financial results before we take your questions. So let me begin with assets under managements and flows. We ended the quarter with assets under management of $48 billion, an increase of 6% from December 31, which reflects market appreciation and positive total net flows of $0.5 billion. Sales increased sequentially by $635 million or 24% to $3.3 billion due to higher sales in open-end funds, separately managed accounts and ETFs. Mutual fund sales of $2 billion increased by $390 million or 24% from the prior quarter and reflect a solid annualized sales rate of 35%. Sales increased in the quarter in fixed income products, managed by Newfleet and domestic equity products, managed by Kayne Anderson Rudnick. Mutual fund net flows were modestly negative at $102 million, which was a sequential quarter improvement from $742 million of outflows and represented our best quarter of net flows in 10 quarters.

Relative investment performance continued to be very strong with 20 funds representing 85% of rated fund AUM having 4 and 5 Stars as of March 31. I would also point out that 2 of our funds recently won Lipper awards for 2017. The Virtus Multi-Sector Short-Term Bond Fund managed by Newfleet and the Virtus International Real Estate Securities Fund managed by Duff & Phelps were named the best short-intermediate investment grade debt fund for the 5-year period and the best international real estate fund for the 3-year period, respectively.

In terms of our other products, we're pleased to have continued positive flows in SMAs, ETFs and Institutional. SMAs had another strong quarter with sales of $0.7 billion, up 48% from $0.5 billion sequentially, as Kayne's high-quality, high-conviction small cap equity strategies continue to gather assets. SMA assets ended the quarter at $9.3 billion, representing a 33% increase from March 31 of 2016. Sales of ETFs increased sequentially for the third straight quarter to $266 million from $201 million, reflecting recent product introduction. ETF assets were $863 million at March 31, an increase of more than 100% from March 31 of 2016. Institutional sales were $278 million, a modest increase -- decrease from the $322 million in the prior quarter. In terms of what we're seeing in April, flow trends in all product categories have generally been consistent with what we saw in the first quarter.

Turning now to the financial results. Operating income as adjusted in the related margin were $13.5 million and 21% compared with $18.2 million and 28% from the prior quarter. It's important to note that the first quarter results were impacted by $4.9 million of specific employment expenses that included $3.4 million of seasonal expenses, primarily payroll taxes, an incremental incentive compensation of $1.5 million primarily related to efforts associated with the RidgeWorth transaction. Excluding these specific expenses, operating income as adjusted and the related margin would have been $18.4 million and 28%, respectively.

First quarter earnings per share as adjusted were $1.16, reflecting the impact of $0.41 per share of the specific employment expenses as well as $0.24 from the higher share count following equity offerings in anticipation of the RidgeWorth transaction. When excluding the impact of both of these items, earnings per share as adjusted would have been $1.81.

In terms of capital activities, in the quarter we completed equity offerings of 1 million shares of common stock and 1.2 million shares of 7.25% mandatory convertible preferred stock for total proceeds of $221.4 million. In addition to the equity offerings, we priced a $260 million 7-year term loan that will be drawn at the closing of the acquisition. The remainder of the consideration will come from existing balance sheet resources.

Now let me provide an update on the RidgeWorth acquisition, which we expect to close by the end of the second quarter. We're pleased with the significant progress we have made towards closing the transaction and executing on our integration plan. In terms of closing the transaction, as I mentioned, we completed the financing in the first quarter, which is an important milestone. The process to obtain the required client consents and approval is underway and progressing as expected. Institutional clients have been responding, and we are pleased with the results to date. Mutual fund clients have been asked to approve a reorganization of the RidgeWorth funds into the Virtus funds.

With regard to the integration, teams from each of our business support areas have been spending a considerable amount of time and effort, focused on their respective integration activities and are partnering with their RidgeWorth counterparts to execute on the integration plan. I would like to thank all of those involved for their hard work. In terms of RidgeWorth's business, it performed well in the quarter. Their ending total AUM increased sequentially by $2.2 billion or 5% to $42.3 billion on positive net flows of $0.5 billion that reflect inflows in both mutual funds and institutional. Long-term AUM, which excludes $6.6 billion in liquidity products, increased 4% sequentially to $35.7 billion.

Management fees, excluding CLO-related performance fees, which do not occur in every period, increased 2% over the prior quarter to $35.7 million with an average net fee rate of approximately 34 basis points. Additional information, including AUM and fee rate by products, can be found in the appendix to this presentation. RidgeWorth's relative investment performance continued to be very strong, with 14 funds representing 86% of rated fund AUM having 4 and 5 stars as of March 31. In terms of our expectations of the transaction's financial impact, we've not changed our synergy estimate of $25 million. However, we have increased our earnings accretion estimate to approximately 20% reflecting the final capital raising activities in the first quarter assets levels, all else being equal. As we approach the closing of the transaction, we're pleased that both Virtus and RidgeWorth delivered positive flows and have very strong investment performance in what continues to be a difficult environment for active managers. We're excited about the opportunities going forward for the combined business.

Now I'll turn it over to Mike to provide a more detailed view of the financial results and balance sheet. Mike?

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Michael A. Angerthal, Virtus Investment Partners, Inc. - CFO, EVP and Treasurer [4]

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Thank you, George. Good morning, everyone. Starting on Slide 8, Assets Under Management.

We ended the quarter with assets of $48 billion, which represents an increase of 6% and 5% from the prior quarter and prior year quarter, respectively.

The $2.6 billion sequential increase in AUM is primarily attributable to the market appreciation of $2.4 billion and net inflows of $0.5 billion, partially offset by net dividend distributions of $0.2 billion. The $2.3 billion year-over-year increase in AUM is primarily attributable to $4.5 billion in market appreciation, partially offset by $1.5 billion of net outflows and $0.6 billion of net dividend distributions.

Total AUM at quarter end was diversified by asset class and investment style, with 38% in domestic equity, 33% in fixed income, 20% in international equity and 9% in alternatives and other.

By product, open-end fund assets were 52% of total AUM, separately managed accounts were 19%, closed-end funds were 14%, institutional was 13% and ETFs were 2%.

Turning to Slide 9, Asset Flows. Total sales were $3.3 billion, a sequential quarter increase of $0.6 billion or 24%, primarily due to higher sales in mutual funds, separately managed accounts and ETFs. Total sales also increased from the prior year quarter by 15% or $0.4 billion, as higher sales in separately managed accounts, ETFs and institutional were partially offset by lower sales in mutual funds. Gross sales in open-end mutual funds were $2 billion, an increase of 24% from the fourth quarter due to higher sales in all of the major asset classes. Mutual fund flows by asset class were as follows: Fixed income strategies have positive net flows of $0.1 billion compared to $0.1 billion of net outflows in the prior quarter. Sales increased by 26% sequentially, primarily due to increased flows into the Multi-Sector Short-Term Bond Fund managed by Newfleet.

Domestic equity funds had breakeven net flows compared to $0.2 billion of net outflows in the prior quarter. Sales increased 47% sequentially due to higher sales in all of the small-cap strategies at Kayne Anderson Rudnick, including the Small Cap Sustainable Growth Fund whose sales grew by 53% to $0.2 billion in the quarter.

International equity net flows are modestly negative at $0.1 billion, an improvement from $0.3 billion of net outflows in the prior quarter. Sales increased 12% due to an increase in sales in both the Emerging Market Opportunities Fund managed by Vontobel and the International Small-Cap Fund managed by Kayne Anderson Rudnick.

In separately managed accounts, flows are positive $391 million due to continued strong sales in intermediary sponsored managed accounts and positive net flows in the wealth advisory business at Kayne. ETFs had positive net flows of $243 million during the quarter. The Newfleet Dynamic Credit Strategy, which was launched in the fourth quarter of 2016 and the InfraCap MLP product were the primary drivers of growth in the quarter. Institutional continued to generate positive net flows of $69 million in the quarter, primarily due to inflows into existing accounts at Rampart.

Turning to Slide 10. Investment management fees as adjusted of $59.5 million were relatively flat on a sequential quarter basis. This was due to higher average assets under management and a slightly higher net fee rate, partially offset by 2 fewer days in the quarter. Average assets increased 2% in the quarter due to net inflows and market appreciation. The average fee rate increased modestly on a sequential quarter basis to 51.3 basis points from 51.2 basis points. The average ETF fee rate increased sequentially to 31.7 bps from 24.6 bps last quarter, which was impacted by higher expense reimbursements. These items were partially offset by the lower day count that resulted in $0.9 million of lower investment management fees.

Slide 11 shows the 5-quarter trend in employment expenses. Total employment expenses as adjusted of $39.6 million increased from the prior quarter, primarily due to $4.9 million of specific expenses that includes seasonal expenses of $3.4 million comprising $2.5 million of higher payroll taxes primarily associated with the payment of annual incentive compensation, $0.5 million of increased benefits, primarily the timing of the 401(k) match, which is higher in the first quarter and $0.4 million of accelerated compensation expense as a result of annual equity awards made to certain retirement-eligible employees.

In addition to these seasonal items, there was incremental incentive compensation of $1.5 million, primarily related to efforts associated with the RidgeWorth transaction. While this amount would not have been paid if not for the RidgeWorth transaction, we have not included it within acquisition and integration costs as it was not part of a specific program or for dedicated resources for the integration. Excluding the $4.9 million, employment expenses increased sequentially by $1.2 million or 4%, primarily due to increased variable sales-based compensation reflecting higher mutual fund sales. And as a percentage of revenues as adjusted, employment expenses were 54%, in line 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 of $10.9 million decreased $0.8 million or 7% from the fourth quarter. The key drivers of the decrease included lower sales and marketing expenses of $0.6 million and lower professional fees of $0.2 million.

Slide 13 illustrates the trend of adjusted results. In the first quarter, operating income as adjusted was $13.5 million compared with $18.2 million in the prior quarter, a decrease of $4.7 million or 26%. The change primarily reflects higher operating expenses as adjusted. The related margin for the first quarter was 21%, compared with 28% in the fourth quarter and 24% in the prior year quarter. Excluding the specific employment expenses, operating margin as adjusted would have been 28%. Before reviewing the EPS results, I want to highlight the treatment of the 1,150,000 convertible preferred shares in our non-GAAP results.

We are including the shares as converted in the diluted common share count and are excluding the $2.1 million quarterly preferred stockholder dividend from net income as adjusted. We believe that this is appropriate given that the shares will mandatorily convert to common shares on February 1, 2020, within the range of $110 to $132 per share. Additionally, for modeling the common share count following the close of the transaction, approximately $25 million of RidgeWorth equity held by key investment professionals will be reissued as Virtus stock at the average price per share over the 10-day period prior to the closing date.

Turning to earnings. First quarter net income as adjusted was $8.6 million or $1.16 per diluted share. The quarter included $4.9 million or $0.41 per share of specific employment expenses and $0.24 per share from the higher share count following the equity issuances in January.

With respect to GAAP results, GAAP earnings per diluted common share were $1.62. The quarter includes $0.71 per share related to unrealized gains on the company's seed and CLO investments, $0.17 per share from the higher share count following the common equity issuance, $0.31 per share of preferred dividends. I would point out that for GAAP purposes, the preferred dividends are included in EPS and the preferred shares are excluded from the diluted share count. And $0.15 per share of acquisition and integration costs associated with the RidgeWorth transaction. In order to provide transparency into the costs necessary to complete the acquisition and integrate the business, we are presenting these costs separately in the reconciliation of GAAP to non-GAAP results under the acquisition and integration expenses category.

The effective tax rate of 24% reflects the release of a net valuation allowance of $2 million related to unrealized gains in our marketable securities and $0.3 million of excess tax benefits associated with stock-based compensation. This compares to an effective rate of 4% in the prior quarter that included a $4.3 million valuation allowance release.

Slide 14 shows the trend of our capital position and key financial metrics. In addition to the equity issuances during the quarter, we priced a $260 million 7-year term loan at an interest rate of LIBOR plus 375 basis points that will be drawn when the transaction closes. One element of the term loan to highlight is that it requires the company to pay it down by a percentage of excess cash flow that varies based on the net leverage ratio. Excess cash flow will approximate EBITDA plus expected synergies, less other cash items such as interest, taxes and dividends.

In the quarter, we paid down the outstanding balance of $30 million on our existing credit facility, which will be closed and replaced with a $100 million 5-year senior secured revolver at the close of the acquisition. Cash and investments ended the quarter at $441 million or $55 on a per share basis, up $9 or 20% from the fourth quarter, reflecting the net proceeds from the equity offerings.

Seed capital investments of $175 million were largely unchanged from the fourth quarter as sales of investments were partially offset by market appreciation. As we've mentioned on prior calls, our targeted seed capital range has been $125 million to $175 million, and we do expect to be at the lower end of the range following the closing.

With that, let me turn the call back over to George. George?

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [5]

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Thanks, Mike. In closing, before we turn it over to your questions, our first quarter financial results were impacted by the specific employment expense items. This was a strong quarter, as evidenced by the positive overall net flows, growth in sales, higher asset levels in all product categories and investment performance that remains very strong. We believe we are well positioned in the current environment. In addition, we are pleased with the progress we've made towards closing the RidgeWorth transaction and integrating the businesses and remain excited about the opportunities and plans that we have with the combined company.

With that, we'll now take your questions. Leanne, can you open up the lines please?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Ari Ghosh with Crédit Suisse.

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Arinash Ghosh, Crédit Suisse AG, Research Division - Research Analyst [2]

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Just starting with RidgeWorth. It looks like the retail flows have really turned here. So was hoping for a little more color on what's driving the improvement? And also if the RidgeWorth products are already tied into your distribution pipes. And then just looking at the separate account and institutional AUM over there, once RidgeWorth AUM rolls over, is it fair to assume that you're looking at similar levels of organic growth that you've seen over the last couple of quarters? Or -- if there's any color that you could provide there as well would be really helpful.

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [3]

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Sure. Couple of things. On one point in four, since we haven't closed yet and while we are working on integration, obviously, until we close, we can't formally connect or do certain things. So their products are not connected in our pipes at this point, though our people are fully aware of all of their product capabilities, and vice versa. So -- in terms of flows, again, if you look at their flows and their product suite, particularly on the fixed income side, I think the market environment just as it was for some of our fixed income products. They have other products that were also in demand in the quarter. And again their equity products continued to do well. So it was an environment where their strategies and capabilities were attractive. In terms of SMAs, I think your question was sort of with the growth rate we've had in SMAs, once they roll into us, will it be a similar type of a growth rate, is that the way you're asking it?

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Arinash Ghosh, Crédit Suisse AG, Research Division - Research Analyst [4]

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Yes. So once it rolls over, is it fair to assume that it will be flat to slightly up, or just in line with what you're seeing? Or if there's anything that will move that rate one way or the other?

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [5]

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Well couple of things. One, as we've said before, when we sort of look at the pro forma and we give you accretion estimates, we are not including any types of revenue synergies or synergies from growth by putting their products through our distribution, and vice versa. That being so if you just look at the businesses and we've -- in our -- on the SMA side, which has been driven by Kayne Anderson Rudnick, they've had a nice strong prolonged period of growing that AUM, and that has been nice. RidgeWorth separately has their own SMA business and we might be on a slightly different trajectory prior to being part of our distribution. So in terms of total AUM level, it's probably detailed in the appendix what that detailed level is. So I wouldn't assume that necessarily the growth rate is exactly the same, because there'll be a bigger block of business with more mature assets.

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Arinash Ghosh, Crédit Suisse AG, Research Division - Research Analyst [6]

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Got it. And then just as a follow-up. Could you update us on your thoughts around capital deployment. Based on your pro forma numbers, including the tax savings, it looks like you'll be generating a decent amount of free cash flow. So just in terms of priorities, how do you rank either like paying down debt versus buybacks as we look at the second half of '17 and into '18?

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [7]

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Sure. And obviously as we indicated, our expectation is to close by the end of the second quarter. And obviously, we have done the equity raise and the financing, all anticipation of that. So obviously at the time of the transaction closing, that will absorb a lot of resources. But as you point out, on a pro forma basis, we'll be generating a high level of cash flow. I think as you heard Mike sort of speak to, in the term loan facility, one of the mechanisms in that facility does sort of pull back a certain amount of excess cash flow to pay down the -- that outstanding debt. So that will vary on whatever leverage ratio we're out. But fundamentally, our overall strategy and approach of making sure we've adequate capital to protect the business, that we invest in growth and that we return capital at reasonable levels, that hasn't changed. But clearly, getting through the transaction and then using our current cash flow to replenish to the levels of working capital that we think are appropriate, but again in terms of the loan, I think it is important to know there is a mechanism that will pull in some of our excess cash flow to pay that down. Mike?

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Michael A. Angerthal, Virtus Investment Partners, Inc. - CFO, EVP and Treasurer [8]

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No, I think that answers it.

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Operator [9]

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And our next question comes from Andrew Disdier with Sandler O'Neill.

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Andrew Paul Disdier, Sandler O'Neill + Partners, L.P., Research Division - Analyst [10]

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So on the SMA side and just to the broader channel. Definitely been a steady grower for you over time, both on the AUM front and the fee composition basis. And listening to some other earnings calls, peers have called out the channel as an opportunity within the retail space. So I guess, the backwards looking question is, what have been the traditional drivers to the steady growth? I know you mentioned Kayne Anderson. And then kind of looking at the outlook or the expectations given the capacity on some of the Kayne Anderson small-cap products and then also demand within the client channel.

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [11]

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Sure. So I think, there are sort of 2 general categories of drivers in that space. One is just the strategies and the performance of Kayne Anderson. So I think small caps and their strong relative performance have certainly driven a large amount of the growth that you've seen over the trailing quarters in that space. I think separately from that and probably why maybe you're hearing a little bit more on other calls is, I think, the SMA product category has itself garnered a lot more opportunities. I think as firms and financial advisers have struggled with fiduciary rule thoughts and costs and consistencies, they've -- I think there are people that have been more attracted to utilizing those types of strategies. So I think you're sort of seeing 2 drivers to that growth. In terms of how it looks going forward, I mean there is no reason not to think that neither of those things will change. So performance will be what performance will be. We're very excited with the RidgeWorth transaction that will now have some more capabilities in that channel where, I think, as you know, we have a more robust retail distribution, and RidgeWorth is stronger on the institutional side. And then these other product capabilities that we have, that we think while we previously haven't made them available in SMAs, there may be some opportunities going forward there. So I think it's a great product category. I think it solves very important needs for clients and investors, and we're very focused on increasing our attention and focus in that area. Kayne capacity. You mentioned capacity for Kayne. Kayne -- they've had very strong relative performance across multiple products. And in terms of the small caps and SMids and mid-caps, they have several different approaches in terms of value growth core. So I think as you see -- Mike sort of mentioned as he went through it, we're really seeing close in a lot of the different flavors, for lack of a better word, of those capabilities. So there still is good capacity in many of those products. But again, we've had great flows and you're seeing them on both the retail -- the SMA side, you're seeing a little bit of it in the fund side and a little bit in the institutional side.

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Andrew Paul Disdier, Sandler O'Neill + Partners, L.P., Research Division - Analyst [12]

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Absolutely. And then just appreciate the update on RidgeWorth. I know there is the, I think it's the May 9 shareholder vote for the mutual fund side of the business. But just thinking about the expenses this quarter, do you see these expenses kind of persisting throughout or up until close and kind of at the same levels? And then on the flows, I know you said about, I think, it was $0.5 billion of net inflows on an institutional mutual fund side. Can you provide that in context, maybe we're trailing 12 months or so?

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [13]

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Well, couple of things. First, well, let me do the first piece, and then I'll turn it to Mike. And then we'll -- Mike can give you the flows as well. The acquisition integration costs, and the reason that Mike is sort of indicating that we're going to give you the transparency in the non-GAAP, is there's going to be several different types of costs, right? It's acquisition and integration. And some of the stuff you're seeing, particularly early on, would fit more into the traditional bucket of acquisition-related: fees to professionals, cost to affect the deal, all of those types of costs. So those who really run the gamut, as you already saw, from signing to a little bit after close, kind of. And then the bucket will become much more focused on the integration side and there'll be a lot of activities as it relates to integration and, particularly, you may recall when we announced the deal, we focused in a lot on the cost to achieve synergies. So you sort of have to think about it that way. Mike, do you want to give any more?

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Michael A. Angerthal, Virtus Investment Partners, Inc. - CFO, EVP and Treasurer [14]

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Yes. We will provide the transparency on an ongoing basis and enable you to look into the business and our non-GAAP results to ensure you're seeing what we think reflects the ongoing operating results of managing third-party client assets. So to the extent there are costs that are specific to the integration, which can generally be onetime in nature, we'll provide that transparency to aid in your modeling on a go-forward basis. I think with respect to flows, we began to provide detail into the RidgeWorth results to start really providing that granularity in terms of modeling. As George indicated, once the transaction closes, at that point in time, we will integrate, move them, flow reporting policies into how we've been reporting it on an ongoing basis. But this we believe is a good start to have you all seeing the top line and the revenue line, as we're getting closer to the closing dates.

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Operator [15]

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Our next question comes from Michael Carrier with Bank of America.

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Sameer Murukutla, BofA Merrill Lynch, Research Division - Research Analyst [16]

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This is Sameer Murukutla on for Mike. Just had a quick one on just overall margin goals. Given the improved revenues, the higher markets and your overall flow outlook, but your continued investment needs and the higher 1Q expenses, what are your long-term goals on margin? And what is the -- what -- is there any flexibility on the cost side to protect the margins? And I guess on the flip side, if markets continue to be positive, how much operating leverage is in the model and going forward, especially with RidgeWorth?

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [17]

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Sure. So couple of things. Obviously, you know the industry has been under pressure in terms of levels of fee rates as well as the cost to run the business. So overall the whole asset management sector has had that pressure. And I think everyone would probably sort of agree the old traditional target operating margin of asset managers is lower now than it was 10 years ago. And no one is sort of immune to that. And you sort of see, when we took up specific items, et cetera, on a comparable basis, the margin was about 28%. And as you know, previously we've had margins significantly above that. We do have a very leverageable model. There are a large number of our expenses that are variable, big percentage of our compensation as well as some of our operating expenses, but we do obviously have fixed costs. So there's a little bit of flexibility on the leverageability side. And as you may recall last year, when we were feeling a little more pressure on that margin, we did step up and take actions to reduce some of our fixed costs. So we're very cognizant of the margin. We want to make sure we maintain a margin that is reasonable in line with what people would expect in the industry averages. And again, so on a comparable basis, we sort of had the 28%. And again, as we look forward to the RidgeWorth transaction, as we've said in previous calls, they run a very profitable business. So we're looking forward to combining the 2 businesses, which give us more scale, which allow us to spread more fixed costs and achieve certain pricing benefits for some of our costs of services.

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Sameer Murukutla, BofA Merrill Lynch, Research Division - Research Analyst [18]

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And just 1 quick follow-up. Just regarding RidgeWorth and, I guess, just the 1Q operating expenses this quarter. Going forward, is there going to be any new nuances regarding just the overall seasonality on the operating expenses in terms of compensation?

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [19]

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Yes. It's good. Well, one thing just to make really clear is, I'm sure you all understand, there will be more noise as we do the RidgeWorth acquisition and depending specifically when we close on it, there will be some noise. As Mike said, we will do our best to be very transparent about what is related to the acquisition, what is not related to the acquisition and our best thoughts of what the run rate is. But I'm just sort of acknowledging there's going to be some noise as you head into that. And seasonality of expenses will continue. But once we're combined with RidgeWorth, the magnitude of the seasonality will be different, because it will be a bigger business. So every year, we do have higher payroll taxes in the first quarter. Every year, we do have accelerated contributions related to 401(k)s. This year it actually got big enough to actually really stand out. And unfortunately our employees are getting older. So we have some more accelerated expenses. So there'll always be that nature, just the magnitude will change over time. Mike, do you want to add anything?

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Michael A. Angerthal, Virtus Investment Partners, Inc. - CFO, EVP and Treasurer [20]

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Yes, I think just the characteristics from RidgeWorth are similar. So their payroll tax item will come forward in the first quarter as ours has. So you'll see that in the first quarter. And certainly, the level will change, and we'll continue to try and provide the appropriate levels of transparency to aid in your modeling on that.

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Operator [21]

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And our next question comes from Alex Blostein with Goldman Sachs.

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Daniel Jacoby, Goldman Sachs Group Inc., Research Division - Research Analyst [22]

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This is Daniel Jacoby filling in for Alex. So just to go back to that increase in the expense number due to seasonality, that $4.9 million number. Is that really kind of onetime issue as kind of the way it was called out in [pies]? Or is that something when we think about going forward, kind of, as you just discussed, it's really something that we should keep in our numbers as we think about modeling 1Q expenses going forward?

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Michael A. Angerthal, Virtus Investment Partners, Inc. - CFO, EVP and Treasurer [23]

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Yes, I think it's really calling it out for the first quarter. As you know, we've talked about payroll taxes every first quarter over the last 9 years as we've been doing this. This year we added to that the 2 items that George alluded to: The 401(k) match item with respect to the benefits and the fact that the GAAP accounting requires that you take a charge at the time of issuing the annual equity grant to retirement-eligible people. And that has consistently been in place, but in this quarter, it became more meaningful, so we called that out. But from a modeling perspective, it is something you'd expect to see each first quarter.

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Daniel Jacoby, Goldman Sachs Group Inc., Research Division - Research Analyst [24]

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Got it. That's helpful. And then one other question. On the accretion estimate, it looks like that number came up to 20% from 15% previously, and I think you guys mentioned capital raising and asset values as driving the increase. Is there anything else we should think about when thinking through the accretion? Or is that really all that changes would just be the capital and the asset levels?

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Michael A. Angerthal, Virtus Investment Partners, Inc. - CFO, EVP and Treasurer [25]

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Yes, this is Mike. We did provide that just to reflect those 2 variables that you indicated, 331 asset levels as well as finalizing the capital structure items. I think as we continue to provide information, as I alluded to the asset levels for RidgeWorth, begin building out your modeling with the data and information we're providing. With respect to accretion dilution, there are many different variables that will impact that over time. So we're trying to provide you the detailed information to continue to refine your models going forward.

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Operator [26]

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This concludes our question-and-answer session. I'd like to turn the conference back to Mr. Aylward.

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George R. Aylward, Virtus Investment Partners, Inc. - CEO, President and Executive Director [27]

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I want to thank everyone for joining us today, and we certainly encourage you to call or reach out if you have any other further questions. Thank you all.

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Operator [28]

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