Good morning. My name is Kevin, and I'll 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 at www.virtus.com. This 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, Sean Rourke.

Thank you, Kevin, 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 second quarter of 2020. Our speakers today are George Aylward, President and CEO of Virtus; and Mike Angerthal, Chief Financial Officer. Following their prepared remarks, we'll have a Q&A period. Before we begin, I direct your attention to the important disclosures on Page 2 of the slide presentation that accompanies the 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 news release and discussed in our 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, we use certain non-GAAP measures to evaluate our financial results. Our non-GAAP financial measures are not substitutes for GAAP financial measures and should be read in conjunction with the GAAP results. Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in today's news release and financial supplement, which are available on the website. Now I'd like to turn the call over to George. George?

Thank you, Sean. Good morning, everyone. Thank you for joining us on our second quarter earnings conference call. We are pleased with the second quarter results, which included strong positive net flows, our highest level of sales, continued excellent investment performance, disciplined expense management and further reduction in debt and continued return of capital. We're especially pleased with the strong organic growth, which exceeded 11% on an annualized basis, and the composition of the growth being broad-based with contributions across product categories and investment strategies. The favorable trends that we've experienced in sales and flows reflect the distinctive and differentiated nature of our investment strategies as well as the quality of our retail and institutional distribution. I would also highlight our announcement earlier this month that we've entered into an agreement for a strategic partnership with Allianz Global investors, which would add approximately $24 billion in assets under management and what we would expect to be a highly accretive transaction that would enhance our fund offerings, distribution capabilities and growth opportunities. So turning now to review of the results. Long-term assets under management at June 30 recovered to near peak levels, increasing sequentially by nearly $18 billion or 20% to $107.1 billion as a result of both market appreciation and positive net flows. Total assets, which include liquidity strategies, ended the period at $108.5 billion. Sales momentum continued with a sequential increase of 30% to $9.1 billion, our highest level since becoming public, with significant increases in open-end funds, retail separate accounts and institutional. For the quarter, we had $2.5 billion of positive net flows with strong momentum across products and asset classes. This continued the favorable trend we've seen this year, other than the disruption earlier in the year during the worst of the market dislocation. Open-end net flows…

Thank you, George. Good morning, everyone. Starting with our results on Slide 7, assets under management. At June 30, long-term assets were $107.1 billion, up 20% from $89.5 billion at March 31. The sequential increase reflected $15.2 billion of market appreciation and $2.5 billion of positive net flows. Nearly all asset classes contributed to AUM growth during the quarter, led by domestic equity, which increased 33%. Assets continue to be diversified by product type with open-end funds, institutional and retail separate accounts representing approximately 37%, 32% and 21% of long-term AUM, respectively. In terms of asset classes, equity assets represented 69% of long-term AUM with 78% of that in domestic equity and 22% in international. Fixed-income assets declined as a percentage of total to 27%, primarily due to the sharp rise in equity markets during the period. We continue to generate strong relative investment performance across our strategies. As of June 30, approximately 84% of rated fund assets had 4 or 5 stars, and 98% were in 3, 4 or 5-star funds. We currently have 9 funds with AUM of $1 billion or more that are rated 4 or 5 stars, representing a diverse set of strategies from 5 different managers. In addition to this very strong fund performance, 94% of institutional assets were beating their benchmarks on a 5-year basis as of June 30, and 82% of assets were exceeding the median performance of their peer groups on the same 5-year basis. Turning to Slide 8, asset flows. Positive net flows of $2.5 billion in the second quarter represented a strong 11% annualized organic growth rate. For the trailing 4 quarters, net flows were positive $0.5 billion. In the second quarter, net flow contributions were diverse by product with positive net flows in open-end funds, retail separate accounts and…

Thanks, Mike. Before we take your questions, I would like to comment on the partnership with Allianz Global investors. We are very excited about this relationship, which is unique and mutually beneficial partnership. For us, the partnership would increase our assets by approximately 22%, add complementary and attractive investment offerings, enhance our distribution capabilities and be highly accretive to earnings without requiring any payments at close. Allianz will gain access to our strong, focused retail distribution and administrative capabilities to support growth, and the partnership would allow them to focus more closely on their U.S. distribution efforts in institutional and other markets that are more closely aligned with their priorities. Upon completion, which is subject to certain approvals and that we expect to occur near the end of the year, we would add Allianz' approximately $24 billion of assets, based on June 30 AUM, by assuming responsibilities as the investment adviser, distributor and/or administrator of their $16 billion of open-end funds, $5 billion of closed-end funds and $3 billion of retail separate accounts. Allianz would continue to manage the majority of the assets, approximately $16 billion, as a select sub-adviser. While their value equity team, which manages approximately $8 billion, would join us as a new affiliate, similar to our other boutique managers. In addition to adding significant scale, the partnership would further diversify our investment strategies, adding multi-asset, thematic equity and alternative strategies that are differentiated from our current offerings and provide the potential for greater opportunity for clients through changing market cycles. Investment performance on these assets has been outstanding. Of the open-end fund AUM, 88% is in the 10 largest rated funds, 7 of which are rated 4 or 5 stars by Morningstar. On a pro forma basis, we would have a total of 41 4 and 5-star funds, representing over 82% of our fund AUM. We will also enhance our growth opportunities by expanding our offerings of funds in retail separate accounts through our broad national distribution in wirehouses and independent brokers, making us a more meaningful distribution partner and leveraging Allianz' investment capabilities to evaluate new products for U.S. retail investors. Regarding the financial impact, the agreement is structured with an alignment of economic interest over time that will not require any payment at close. Based on June 30 assets under management, we would expect the relationship would be immediately accretive to earnings per share, as adjusted, and well in excess of 20%. We will be providing additional financial details and updates as we get closer to the closing of the partnership. So with that, we'll now take your questions. Kevin, would you open up the line, please?

[Operator Instructions] Our first question comes from Jeremy Campbell, Barclays.

So George, the Allianz partnership is really kind of interesting and innovative. Wondering if you can give us some high-level background on how the deal came about. And maybe if you view this as a little bit more of a one-off unique situation, or if there's potential further demand from other asset managers looking to partner on retail distribution.

Sure. I mean the way I would sort of characterize without going into specific details is this is a partnership, not a transaction. This is about growth and alignment of interests. This is a going-forward transaction. So this is not a deal where a party is looking to do a transaction and get a check. This is about 2 companies working together to create growth and profitability and partner on that going forward. So I think in that way, it is a very aligned structure. I think a one that fits the relative nature of what each of us are trying to achieve. So we think it is a very good way of approaching it. It is a little unusual, but I think it's sort of reflective of what we're each sort of looking for in terms of growth in the future. I think, also, it expresses -- I can't speak for Allianz, but I would say it expresses their confidence in themselves and their managers and their ability to generate good performance and their confidence that we can help grow those assets. So clearly, the structure of the deal is much more aligned for them to have the opportunity to continue to participate in that. So I think that is something that actually gives us more confidence, right? So I think it's really -- it's a good structure. It's a good alignment of interest. I think it's good for everyone involved, both Allianz, Virtus, our shareholders, their shareholders and, just as importantly, all the fund shareholders that are involved here. Is this a one-off or will there be others like this? This is unusual. So every circumstance is a little different. I would not expect you to think that every deal you'll see going forward will be structured like this because each one has a different need or a different fit in terms of what they're looking to achieve. And in some instances, there are transactions that really -- particularly, if there is a third-party seller that does require an upfront capital structure as opposed to capital-light or back-end capital type of structure. But if you do hear of any other opportunities of other people interested in doing this deal, you have my contact information, and I encourage you to give that information to them. I'm available 24/7.

Great. And then, Mike, maybe this one is for you. Thanks for the little bit peek behind the curtain on the deal accretion expectations here. Can you just give us a little bit of color on the expected incremental margin that kind of funnels into that ballpark you forecast? I mean I'd imagine that excluding the value team, there really isn't much in the way of incremental expenses to the distribution side on the partnership piece of the equation.

Yes. And I think the major inputs into the level that we refer to being well in excess of 20% are obviously the fee rate on the $24 billion of assets under management. So you have an average fee rate, sort of, in the range of 35 to 40 basis points. And that incremental margins, we've talked historically of 50% to 60% of incremental margins, and that varies depending on the nature of the assets under management. And here, in this structure, as George alluded to, we can largely leverage the existing infrastructure that we have in place from both an administrative and distribution standpoint. So we'd, sort of, be in that range of incremental margin. And certainly, as we alluded to in the prepared remarks, we'll update you on -- as we get closer to the close on some of those specifics.

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

Maybe just one more on the partnership, and maybe partnering that with just your capital position. So you guys have been active on paying down debt. You're in a, I'd say, comfortable position on your net debt level. With this partnership, I know you mentioned no upfront payment, but how will that maybe impact your debt level or that -- your net debt position over the next, I don't know if it's 3 to 5 years in terms of payments? And then given that when you think about capital priority, are you still in a pretty good position that you have flexibility to look at other opportunities if they arise?

Sure. So on the first part of the question, and I think I understand it correctly. So again, the way this will be structured as a participation in effectively net revenues earned, it will always -- whatever we pay will be a subset of what we receive. So if you're sort of trying to understand is there going to be any kind of a mismatch of that or like outstanding debt that reduces our available capital, theoretically, no, right? Because there will always be a net cash contribution as long as there's assets and as long as we continue to sell those. So I think, again, in terms of the impact it has on our capital structure, again, we view it as incredibly favorable, right, because it does not really create any locked-in obligation or an obligation mismatch between the receipt of cash in. So in many ways, I think that is a great structure for us to have. And on your second part, yes, we've been very thoughtful around our capital. We were very pleased that as we went through the dislocations in the first quarter that because we have been thoughtful and cautious with our capital and not being too over-levered that we were able to not only navigate through that period and maintain things like our dividend as well as our stock repurchases as well as our consistent pay down of debt, we also were opportunistically able to reduce even a little bit more debt and to have gone through a quarter like that and have working capital sort of be flat quarter-over-quarter. So as Mike indicated, our working capital is sort of unchanged. We view that as a testament to the thoughtful approach we take to the balance sheet. So I think we do have a good balance sheet that got us through this environment, which was what it was intended to do. We do see opportunities going forward to continue to look for ways to grow the business, right? Our primary focus, and even going back to the Allianz, will be how do we create sustainable growth and the creation of long-term value over the years. And ultimately, having that flexibility in our capital, we view as a positive.

Great. Okay. That makes sense. And then just on the flow stream, so understanding you guys have good performance, some products on demand and industry trends, you've had some kind of rebalancing and reallocation that it looks like you guys have benefitted from, but it still seems like a pretty significant pickup though. Just trying to understand anything lumpy there? And then one of the areas that it seems like has been a little bit more active from an industry standpoint is on the closed-end fund side. And just more curious, obviously, the work from home is probably a little bit tougher for marketing, but over the next 12 months, if you see opportunities in that area as well.

Sure. And on the flows, and we're happy with our ability to continue to generate on a relative basis good flows. Obviously, second quarter, 11% organic growth rate. We're very, very pleased with that. But I actually think the more important and more interesting underlying statistic is really that other than that period of dislocation in that mid-March to very beginning of April, we've actually consistently been in positive flows, which we think is very -- is a very good sign. A lot of it really is we have some great managers and -- across the board from SGA to Kayne to Duff. I mean all of them have really done a great job, and I include the others as well. Because you really can't do any of that unless you really have good performance, predictable performance, differentiated strategy, differentiated capabilities. So that's really the foundational element that they're -- upon which you need to build. I do think we have been effective -- very effective on the distribution side. Retail world has gotten a little more challenging, right? So the relationship-based wholesaling of the past is currently on hold. But that's why relationships are really important, right? Because if you're in a work-from-home environment and you can no longer knock on doors, it's really important that your distribution force has the established relationships where they can get those Zoom calls or the other contact. So we think we've been able to effectively navigate through the use of technology and the leveraging of strong, trusting relationships built over years with our sales force, which generally has above-average years of experience. So we think we've been able to put those together to effectively, on a relative basis, I think, have good -- very good sales, hitting 2 record quarters in a row as well as on the net flow side. And what the future holds? Things will continue to evolve. I think everyone is getting used to navigating in this environment. And I think going forward, there'll be a hybrid model of this. But again, I think in some ways, this will end up being a really good learning experience, particularly in the retail channel, where I think both on the intermediary side as well as on the fund side, the wholesaler side, I think everyone has learned a lot about how to be even more effective and how to be able to share information and thoughtfulness in a way that will hopefully ultimately benefit our mutual clients, which are the ones who entrust their money into either the funds, the separate accounts or an institutional account.

Our next question comes from Michael Cyprys of Morgan Stanley.

Congratulations on the AGI transaction. Looks like the price flexes based on revenue, it sounds like, or AUM or maybe just revenue. So I was hoping you could maybe unpack how to think about what portion -- is there a sort of like a floor minimum amount that would be paid. And how we should be thinking about the sort of breakpoints and the degree of flexibility there that, that contingent payment flexes? So if revenues are down 10% in terms of what's being acquired here, does that contingent payment flex pro rata, so kind of a lower 10% payment that's made, I suppose, on a subsequent basis? Are there any catch-ups on prior payments that are made? How should we be thinking about how that works?

Sure. And again, we're going to give more details and more updates on specifics as we go through the year prior to close. But I would really think about this as participation -- a participatory structure, right? So for dollars coming in, a percentage of those dollars will be the amounts that you would consider, from an accounting perspective, to be consideration of some type. So it will always be a total alignment. So if no dollar comes in, no dollar goes out. There is no minimum. So there is no floor. This is a true alignment of interests, participation in effectively the net revenue type of earnings. So again, there won't be that mismatch, and that's what I was inartfully trying to answer before on the prior question as it related to capital, because it's always going to be a portion of whatever comes in. So there won't be the things to think about in terms of watermarks or catch-up payments, if that's what you're asking. No, it is participation in the profits we jointly generate through the growth of the assets through their managing those assets and us distributing those assets. So I really do think it's a good alignment of interest. And we'll give more details in terms of the timing of payments, but it will be just infrequently once a year after the anniversary of the closing. So we'll have more thoughtfulness and details to give you as we get closer to the closing.

Great. And then just on the accretion, I think you had said well in… [Technical Difficulty]

I'm sorry, you broke up there.

Kevin, is the line open for Michael?

Hello. Can you guys hear me?

Mike, we lost you there.

Sorry about that.

So you might have to repeat the entire question.

Okay. Glad you guys can hear me now. So just on the accretion, you guys had said well in excess of 20%, but I imagine that, that does not reflect the contingent payment that would be made. So I just want to try and get an understanding of if one were to think about the magnitude of that contingent payment, how much would that sort of accretion then come down to if you were to sort of deduct for that? Would that be more like in the high single digits or low-teens area? Just trying to get a framing on the magnitude of that contingency on the payment side. And over what time frame would that be made over? I was thinking about 8 years, but I was hearing maybe 5 for some others. So just how should we be thinking about that?

Yes. So in terms -- so the well in excess of 20% accretion, so again, using June 30th assets and then as we sort of think about it in terms of how it will fit into our net income and our earnings per share that we generate and report. And again, as Mike indicated, we don't technically need a lot of resources because we're leveraging a lot of our own infrastructure, but this is really about growth. So some of the flex in that number of how much in excess of 20% it will be, will be related to what we think are the opportunities for us to invest in maximizing growth opportunities. So we're very excited about the economics of that, and I'll let Mike get into some details. But again, there's no contingent payment, right? They will participate in a percentage of earnings that are generated over a period of time. So again, it will always be a positive number. Mike?

Yes. I guess, just thinking through the contingent payments, that would show up as a financing activity. Really, it's a liquidity activity rather than what we've been referring to in terms of the EPS accretion of well in excess of 20%. So that will show up as a financing activity and liquidity measures. So we'll address that in terms of the accretion through the P&L that we've been talking about. And again, when this gets recorded from an accounting purposes, you'll see a present value of any of these payments be recorded as a liability on the balance sheet at the time of close. And again, there are many inputs that go into that, which, again, we'll provide as we get closer to close.

And if you're -- in terms of, like, free cash flow accretion, it will be free cash flow accretive. Again, if your question was, is it going to be in the 20%-plus level? The answer to that is, no. And as we go forward, you'll get more information in terms -- including periods of time to help you figure that.

Right. That's what I was getting at. What's the free cash flow accretion? Is that more like high single digits or more low teens? Just any way to frame the magnitude?

Yes. When we give more information, you'll be able to triangulate in on that, but it will be an attractive number, but it will not be well in excess of 20%.

Our next question comes from Sumeet Mody with Piper Sandler.

Just noticed that the fee rate on separate accounts remained pretty elevated in the quarter after that nice increase in the first. Now maybe for Mike, just wanted to get an idea of what's driving that, and if we should think about that rate remaining elevated for the rest of the year.

Yes. And again, we talked about some of the inputs that have impacted the fee rate, being the equity markets and the flows. And on separate accounts, we've seen strength predominantly in domestic equity there. So I view this quarter as good a fee rate as any from a modeling perspective, all else being equal with the equity market levels where they're at.

Okay. All right. And then just one other. On interest and dividend income, I just wanted to get a feel for kind of how to think about that line for the remainder of the year and kind of in relation to the CLO book. I know last quarter, you talked about the kind of $1 million to $1.5 million range, but kind of with the improvement of CLOs since the end of March, I mean, is it fair to assume with the rebound in CLOs that, that a portion kind of would improve interest and dividend income? Or is there like a portion of the CLO book that's kind of exposed to troubled sectors, maybe combined with the deferred sub fees that could keep that more subdued for the year?

Yes. And I think in the prepared remarks, we suggested that the current level was appropriate for the third quarter. So I would continue to use that from a modeling perspective. And we're very close to the CLO market, and we'll continue to monitor that and update you as appropriate. But in the immediate term, I think this current quarters is appropriate.

The next question is a follow-up question from Michael Cyprys with Morgan Stanley.

Just wanted to dig in a little bit more on the institutional strength that we saw in the quarter. I was hoping you could help frame maybe how much of the sales were coming from existing clients that are already in those sort of strategies versus existing clients that maybe now you're cross-selling other products to versus new clients that are coming in the door that are new to the firm entirely? And just any sort of color on how that has been evolving and maybe sort of -- any sort of approaches and color you can share around sort of the cross-sell products.

Sure. Well, I'll hit it first, and then Mike will give you some additional thoughts on it. So what was nice about it, it was nice and broad, right? So it included multiple affiliates, multiple strategies and included both new mandates as well as meaningful inputs into existing mandates. So that's sort of a nice -- for us, in terms of our evolution of institutional business, which has gone from a limited number of affiliates to multiple affiliates and then the sporadic nature has gotten more and more consistent. So as I sort of think about it over the last, I don't know, 8, 12, 15 quarters, it's sort of been a nice cumulative building of more consistency, more broadness. And I think the second quarter had a nice illustration, whether -- between the managers as well as the types of strategies. I don't know what the next quarter will look like, but it's good to see it in the way we look at our pipeline, it sort of feels like we're getting to a much more mature place. It's still a lumpy business and I know what we do, there'll be quarters where there'll be big ins and big outs. But I'll let Mike give some thoughts and perspective on the specific question.

Yes. And we -- in the prepared remarks, we did indicate that there were meaningful flows into an existing subadvisory mandate. And certainly, that was good to see. And SGA certainly has broad relationships and has contributed through an important relationship with one of our distribution partners that contributed nicely in the quarter. And then as George alluded to, we had new mandates at both Duff and Kayne, one of which was a new mandate into a strategy where the client had a separate, very good experience with them and funded a different strategy. And we also had a new mandate that came about. So we're seeing traction. It's broad-based, and new mandates as well as existing accounts. So as you know, that business can be lumpy, but we're pleased with the traction over the last several quarters. And as we alluded to in the prepared remarks, what we've seen thus far in July gives us optimism as well.

Great. And any additional color you're able to share on the retail SMA intermediary sold strength that we're seeing? It sounds like that's continuing into July here. Just maybe how many platforms would you say that that's sort of coming from and how diversified across strategies? Any color you could share around the channel there would be helpful.

Sure. It's Mike. And we have had 17 consecutive quarters of positive flows on the retail separate accounts, and again, it's broad-based. We've had success through several of our affiliates, Kayne, SGA and Seix on the fixed income side. So predominantly, the growth over time has been in the domestic equity offerings. Our SMID offerings have been very strong. And it is broad-based on a number of the major distribution platforms where, again, it's indicative of the strength of the investment performance that's been across those offerings. So it is at multiple distribution partners and, again, has been consistent over time.

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

Great. Now I want to thank everyone today. I hope everyone is staying safe and healthy, and look forward to talking to you in the future. In the meantime, if you have any questions, please reach out. Thank you very much.

That concludes today's call. Thank you for participating. You may all now disconnect, and have a wonderful day.