Q2 2020 Victory Capital Holdings Inc Earnings Call
[music].
Ladies and gentlemen, thank you for standing by welcome to the victory Capital Management second quarter 2020 results Conference call. At this time, all participants are going to listen only mode.
After the speakers presentation, there will be a question and answer session.
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Good morning, before I turn the call over to David Brown I would like to know that today's discussion contains forward looking statements and as such includes certain risks and uncertainties. Please refer to our pro.
US relieved that are FCC filings for more information on specific risk factors that could cause actual results to differ materially from those projected in the forward looking statements. While recording of this call will be made available by us on our website any forward looking statements that we make on this call are based on assumptions as of today and we under.
Take no obligation to update these forward looking statements to reflect new information for future events that occur or circumstances that exist. After the date on which they were made in addition to U.S. GAAP reporting. We also report certain financial measures that do not conform to generally accepted accounting principles. We believe these non-GAAP.
Measures enhance the understanding of our business and our performance reconciliations between these non-GAAP measures and the most comparable GAAP measures are included in tables that can be found in our earnings press release and in the slide presentation accompanying this call both of which can be accessed on our investor relations website at <unk> IR.
VCM Dotcom, it's now my pleasure to turn the call over to David Brown, Chairman and CEO.
Thanks, Matt.
Good morning, and welcome to victory Capital's second quarter 2020 earnings call.
Im joined today by Michael Pellet, Carbone, our president and Chief financial and administrative officer, as well as Matt Dennis or Chief of staff in director of Investor Relations.
I am just start with a business overview of the quarter.
Then I will turn it over to Mike who will review our financial results in greater detail.
Following our prepared remarks, Mike, Matt and I will be available to take questions.
The business overview begins on slide five I'm pleased to report that victory capital produced record financial results across a number of different areas for the second quarter and first half from 2020.
Despite the market volatility and complexities related to covert 19, we generated record revenue profit margins and net earnings for the first half of the year.
This is a testament not only to our business model, which is designed to deliver robust profitability in all market conditions, but also to our ability to successfully executing on a long term growth strategy.
I am grew to 129.1 billion for the quarter up from 123.8 billion at March 31 at quarter end AUM was up more than 100% relative to the end of second quarter of 2019.
Turning to flows we experienced significant outflows directly tied to the disruption caused by the closing of the Schwab acquisition of USA A's brokerage business at the end of May one part of that was brokerage clients you chose to transfer their accounts to brokerage competitors other than schwab and at the same time liquidated some early.
All of their USA, a mutual fund holdings.
This impact on flows was onetime in nature and can be compared to a traditional asset management acquisition consent process in which movement of accounts causes some leakage of assets.
While the level of movement was slightly higher than we expected we've continued to see improvement since the closing date.
In addition, and as expected disclosed previously we experienced $8 billion in short term net outflows from our money market funds as they transition to Schwabs platform.
These assets were subject to a revenue sharing arrangement and we're therefore not profitable for us.
Moreover, in conjunction with the sale of the brokerage and you NP businesses. USA also moved this trust service business to a firm with in House Trust capabilities, which resulted in approximately $500 million in long term net outflows for us.
We've also experienced delays and gaining shelf space for the USA fixed income products managed by our USA investments franchise.
These delays were tied to the impact of Kobin 19, and the disruption in the credit markets.
We are seeing activity picked back up and believe this was just a temporary slowdown.
Additionally, we saw a temporary pause in search and finals activities in our institutional channel as decision makers delayed certain allocation processes due to covert 19.
We are starting to see active you return to normal levels in or intermediary in institutional channels.
Our sales pipelines remained strong at our growing quickly and a one but not yet funded book is building and has nice momentum. Additionally, we are close to achieving important milestone within our growth efforts in the direct channel the of the launch of the new digital platform, which we expect to occur this calendar year and we'll have a positive impact on flows over the long term.
I will discuss in detail later on in the presentation.
To be clear what we've experienced during the first two quarters of this year from a flow perspective is attributed to a number of the aforementioned factors many of which are onetime in nature and we believe this is merely a speed bump in our ability to generate organic growth over the longer term.
Overall, our outlook on flows for the remainder of the year and especially into 2021 is trending positive as we work our way through some of the onetime items.
Looking at our financial results for the quarter adjusted net income tax benefit was 89 cents per diluted share an EBITDA was 86.3 million.
Adjusted EBITDA margin improved to a record high of 47.5% for the quarter further demonstrating the power inefficiency of our business model.
Our investment franchises generated outstanding investment performance during the second quarter was 68% of total AUM outperforming benchmarks for the three year period ended June 32020 for the five year period, 69% of our total AUM outperformed their respective benchmarks.
We continued our disciplined capital allocation strategy, we ended the quarter with $881 million of debt Thats down 20% from $1.1 billion in July of 2019.
Subsequent to quarter end, we reduced outstanding debt by additional $20 million to bring the bounced down to $860 million currently.
We have also significantly reduce the cost of our debt through repricing and implementing an interest rate hedge.
The 20% cash dividend increase announced today by our board reflect strong current and projected cash flows for our business.
During the quarter most of our free cash flow was used to reduce debt in preparation for potential acquisition opportunities that we're currently evaluating to be clear our capital allocation strategy has always been to reduce debt as our top priority. So we have the flexibility to do acquisitions in the future our stock buyback in dividend programs are secondary.
Actives.
I also want to acknowledge our talented professionals for their hard work and dedication on behalf of our clients during the past several months despite dealing substantial disruption in my personal lives.
We've continued to deliver exceptional service to our clients during these unprecedented times.
We've also learned a great deals and organization about the important to being nimble and adaptable, which will benefit our business in our clients in the future.
Turning to slide six I wanted to discuss the substantial progress that has been made since we closed the acquisition of USA is asset management business just over one year ago.
As a refresher on July one of last year, we reopened a direct channels. So USAA members could once again invest directly.
We knew that Paramount to our success in indirect channel was creating a foundation for replicating the same high level service that USA members are accustomed to receiving.
As quickly as during our first quarter of ownership.
Service scores were above our goal based on member service completed and remain at that level today.
That was in is quite an achievement and will provide the foundation for our success in this channel.
In parallel with our integration efforts to bring the USA business successfully onto our platform, we've been dedicating financial unprofessional resources to enhance our digital platform for members.
In April we launched or new Genesis call system technology, which improved handle times and enhance efficiency.
Additionally, the new system is fully integrated with our CRM technology. So a better supports our marketing initiatives to gain wallet share with our existing members and attract new members to our platform.
Later this year, we'll be rolling out a new state of the our digital platform. This is going to significantly advance our direct channel marketing opportunities, while delivering a richer digital experience for members, who prefer to track transact or be supported online.
The combination of excellent service from our contact Center Representatives and a new modern digital platform supported by innovative and focused marketing campaigns is the formula for success and growth in this channel. We will also benefit from our ability to leverage the USA brand to deliver a strong diversified set of products to members.
On slide seven I'd like to talk more specifically about the growth opportunities you've seen the direct channel and provide some examples of our progress to date.
Since we closed the acquisition and reopen the channel we've opened approximately 79500, new mutual fund in 529 plan accounts.
That equates to a high single digit annual growth rate would only minimal marketing support to date account openings in the first half of 2020 were up close to 30% relative to the second half of last year. Additionally, approximately 28% of new mutual fund registrations are electing an automatic investment plan, which represents recurring much.
Finally investments into our products again, we achieved these results with only limited marketing support and expect our progress will accelerate as we complete or integration and build efforts and execute against our growth plan for this channel.
The USA 529 College savings plan is a good example that represents a growth opportunity for us as a reminder, we are the exclusive provider of the USA 529 point.
By 29.8, AUM is netflow positive year to date and since the close of the acquisition net New 529 plan accounts are also up for those same time periods.
More than 50% of 5.9 plan accounts are set up is automatic investment plans. Additionally, we're seeing a strong trend towards opening accounts online versus by phone and expect to see those numbers improve even further when we launch or new digital experience.
In Q3, we'll be launching our first multichannel media campaign, a number of regions in the us each with a strong military presence.
The campaign is designed to increased brand awareness and drive engagement among the USA membership and the military community in general.
We expect these kinds of efforts to grow both frequency and scale overtime, which will support the growth of the channel.
In addition to our marketing and digital efforts, we are focused on ensuring that we're continuing to expand the investment expertise that we offer to members as well as through financial advisors.
At the end of Q2, we added new share classes to several USA mutual funds to provide additional choice for advisors and their end clients.
We will also be introducing a new no load member share class for 11 of our existing victory funds later on this year.
This means that members will be able to invest directly in funds and asset classes now previously available through the USA mutual funds platform.
Additionally, we intend to launched three new victory sheriffs thematic GTF. This year two of which are being developed specifically for the military community.
Finally, we are partnering with schwab to serve USAA members.
Ptwop has a long time Cline and trusted business partner and shares our commitment to provide exceptional service. We're excited to be working alongside of them to serve members and deliver focused programs for the military community.
Turning to slide eight I'd like to provide some additional detail around a referral agreement with USA, we continue to partner with USA to market our products through the approximately 12 and a half 1 billion USAA members, who do not have an account with us today.
I'm pleased to report that the referral process that we Havent places working.
As I mentioned previously we've gained 79500 USA mutual fund and 529 of plan account registration since last July.
A core part of the referral process is demand generation efforts at USA is doing with a broader membership on our behalf.
This includes paid median and email campaigns run by USA among other tactics.
Once a member access is a victory capital page and USA Dotcom, there was a clearing easy online path opening and mutual fund or 529 plan account with us.
Keep in mind as well that we have an exclusive license to use the USA brand, which create strong connectivity for members.
The member chooses to call USA A's toll free number the automated voice response system asked them a series of questions is term and if it is appropriate to direct them to the victory capital contact Center, which is staffed by experienced member service Representatives, many of whom our previous USA employees.
So they understand the military community and the importance of providing outstanding service to members.
On Slide 10, I'll review, our investment results for the quarter.
As of June Thirtyth, 64% of companywide AUM mutual funds and EPS was ranked four or five stars overall by Morningstar.
13 funds were ranked in the top quintile by Morningstar for the trailing one year period, including three funds Victor each try Vale International small cap class Hi.
It's a NASDAQ 100 index class, our six and USA, a small cap stock institutional which were ranked in the top decile.
Performance of the fixed income funds managed by our USA investments franchise improve significantly quarter over quarter.
The percentage of AUM in those products outperforming its respective benchmarks over the trailing your three year period was 82% as of June Thirtyth.
Nine out of 14 of those funds were ranked four or five stars overall by Morningstar.
As of June Thirtyth.
This excellent investment performance will help us in our placement and distribution efforts.
Looking at performance of our victory shares EPZ five were ranked in the top quartile by Morningstar, including three ranked in the top three percentiles for the trailing one year period to EPS victory shares dividend accelerated F and victory shares multifactor minimum volatility F.
Achieved their three year track records during the second quarter and during the overall rankings of four and five stars respectively from Morningstar as of June Thirtyth.
On slide 11, I'd like to recap the benefits of our next generation business model. We are a growth company in the industry were most are struggling to maintain the status quo, our model, which combines autonomous investment qualities with the benefits of a fully integrated centralized operating and distribution platform is Jenny.
Only unique.
Our ability to effectively navigate the current environment highlights to resiliency and effectiveness of our model.
Our structure avoids the disadvantages facing multi boutiques such as lacks the control from partial ownership complexity operating redundancies or lack of real scale. We share none of these challenges let me be clear, we do not view ourselves as a multi boutique victory capital as a single registered investment advisor.
Our independently branded investment franchises and solutions platform are not separate entities, but part of our company and our platform.
This provides effective controls while also allowing each franchise to remain completely autonomous in their investment process in their quest to generate alpha. Additionally, our revenue sharing model with our franchises mitigates complexity in creates alignment and we have no significant operating redundancies.
Finally, our ability to preserve the unique investment culture of each franchise, while achieving significant synergies through our centralized platform makes your model very conducive to the current M&A environment.
Now I'll turn it over to Mike for his financial review Mike.
Thanks, Dave and good morning, everyone Financial results review begins on slide 13.
Overall, we're very pleased with our strong financial performance in the quarter and first half.
Revenue for the quarter was $181.9 million inline with the 11% lower average AUM compared with the first quarter.
Revenues were up nearly double versus the same quarter last year.
GAAP earnings were 61 cents per diluted share, which was down from the first quarter, reflecting an additional $12.5 million of acquisition related expenses recorded in the second quarter.
You may recall, we make adjustments to reflect the current fair value of future contingency payments on our balance sheet for the USA acquisition each quarter.
For the second quarter. This resulted in a $10.8 million quarter over quarter increase in GAAP operating expense.
Which accounted for most of the variance.
At the markup and fair value for that contingent liability reflected the markets rebound in the second quarter combined with the lower discount rate used in the net present value calculation and one more quarter of actual results.
Adjusted net income tax benefit was 89 cents per diluted share in the quarter.
This was down three cents from the first quarter and up 134% from the same quarter last year, when we reported and I would tax benefit of 38 cents per diluted share.
GAAP operating margin was 36.2% and reflects the higher non cash balance sheet adjustment I just mentioned.
Its adjusted EBITDA margin expanded to 47.5%, which was 270 basis points wider than in the first quarter.
This record high margin level is particularly noteworthy considering the investments we continue to make.
To support future growth and is a testament to our unique business model.
With continued debt reduction our leverage ratio improved to 2.2 times at the end of June.
In addition, we returned approximately $10.6 million to shareholders in the form of cash dividends and share repurchases.
We exhausted our prior share repurchase program during the quarter and the board authorized the new program that commenced in early June.
And as Dave highlighted we also increased the quarterly cash dividend by 20% to six cents per share beginning with our next dividend, which is being paid in September.
Turning to slide 14, total AUM rose, 4% during the quarter.
The $129.1 billion available at the end of June reflects positive market action during the quarter, which was offset by flows directly and indirectly related to the closing of the sale of USAA is brokerage business.
The outflows for primarily short term money market assets that were not profitable.
So the outflows impacted AUM and revenue there was very little earnings impact due to the offsetting reduction in related distribution fees.
Money market assets declined by $8 million in the quarter to 3.6 billion at June Thirtyth.
Money markets now represent less than 3% of our consolidated Hmm.
This is down from 12.1 billion or nearly 10% of AUM at the end of the first quarter.
Long term assets rose more than 12% from the end of March.
This is inclusive of the nearly $500 million of long term trust assets that we were previously managing which are outsourced by USAA to a third party.
On slide 15 to go into long term asset flow in a bit more detail.
Consistent with the first quarter the year, our credit sensitive fixed income products experienced more outflows compared with our other asset classes.
We experienced redemptions in association with USAA brokerage transaction as Dave mentioned earlier, which closed on May 26.
Timing wise close to half of the net long term outflows during the quarter occurred in may coinciding with the transaction.
As we ended the quarter consolidated net long term flows improved in June compared with May.
Several investment franchises and strategies when net flow positive in the quarter and six month period.
For the first half of 2020 in core Dr. Alan.
So for us and the IRS global team all generated positive net long term flows.
Revenues are covered on slide 16.
Quarter over quarter revenues decreased by the same percentage as average AUM, despite a slightly lower average fee rate realization.
Year over year revenues essentially doubled from the same quarter in 2019.
There are several offsetting factors that impacted our average fee rate utilization during the quarter.
Field support uncertain money markets lowered our average fee rate by approximately one basis point.
Partially offsetting this was a beneficial mix shift due to equity market recovery and the money market liquidations associated with the USA brokerage transaction.
In addition, we had less money market assets requiring yield support during the final five weeks for the quarter.
In June.
Our average fee rate realization increased to 57.7 basis points, which is a cleaner view of where we ended the quarter.
Moving to slide 17, total expenses continue to decline in the second quarter.
Personnel expenses went up slightly increasing 3% from the first quarter.
This was solely due to noncash deferred compensation expense, increasing by $7.3 million in the second quarter due to changes in our deferred compensation liability from market action recovery.
This more than offset the impact from lower average AUM in the quarter and a $3.4 million decrease in payroll taxes and employee benefits due to our normal first half calendar seasonality.
Other cash operating expenses were down 17% from the first quarter.
This was driven by 24% decline in distribution and other asset based expenses related to lower platform distribution expenses.
The removal of the money market assets that were previously on USA brokerage platform contributed to this decline.
We also experienced reductions and broker dealer distribution fees and sub administration and Middle office expenses.
These reductions were in line with the change in average AUM during the quarter and see any expense was down 90% quarter over quarter.
Non operating expenses declined 60% and benefited from a 7.3 million dollar improvement in other income.
The higher other income in the quarter resulted primarily from the market recovery and the associated increase in the value of investments in the deferred compensation plan.
Interest expenses and other financing cost declined by 15% from the first quarter due to the lower average debt balance and lower interest rates.
Over the past three quarters interest expense and other financing cost have been slashed by more than 40% from $16.9 million in the third quarter of 2000 $19 million to $9.7 million and the most recent quarter.
This improves our interest coverage ratio to approximately nine times based on the current adjusted EBITDA run rate.
Acquisition related expenses increased $12.5 million from the prior quarter.
As I touched on in my opening remarks at the end of June the carrying value of the contingent acquisition payment liability was marked up by $5.3 million.
This essentially reverse the $5.5 million Mark down at the end of the first quarter, resulting in a negative acquisition related expense for that quarter.
The net impact with a noncash $10.8 million swing between quarters, which drove that increase.
Slide 18 highlights our non-GAAP metrics for the quarter.
Adjusted net income with tax benefits came in at 89 cents per diluted share.
This was off just 3% from the first quarter and up 134% from 38 cents per diluted share some last year same quarter.
Adjusted net income tax benefit totaled $65.1 million in the quarter, which was comprised of adjusted net income of $58.3 million and a cash tax benefit of $6.7 million.
The 5% declined from the first quarter was less than double digit percentage decline in revenue.
This was partially due to the removing the unprofitable money market assets during the quarter.
And I was tax benefit was up 135% from $27.7 million in last year's second quarter.
Adjusted EBITDA was up to 6% from the first quarter at $86.3 million, an increased by 136% from $36.6 million and the second quarter of 2019.
This resulted in adjusted EBITDA margin, expanding by 270 basis points to 47.5% in the second quarter, which set a new record high for any quarter in our history.
With strikes me as I look at this chart is how we have been able to increased margins and sustain healthy earnings despite lower revenue.
Compared to the third quarter of last year, which was our first quarter of ownership. Following the USA acquisition average AUM was down by 12% in the second quarter. This year and revenue was down 15%, However, and I was tax benefit per share only declined 2% on approximately the same number of weighted average shares.
This not only demonstrates another proof point for the efficiency and resiliency of our uniquely integrated model, but also highlights our ability to effectively manage the core elements of our business.
Turning to slide 19, before we leave the non-GAAP discussion.
This chart shows our projected tax amortization schedule over the next 15 years.
You can see the fixed cash tax benefit we anticipate receiving in future years in the dark blue bars.
This schedule assumes we paid 100% of the contingent acquisition payments for the USA acquisition.
Which is what creates the slight ramp.
Through 2024.
Now that we are beyond the first anniversary the acquisition, we're able to confirms that we retain more than 100% other revenue acquired and therefore expect to pay the maximum first year earn out payments of $37.5 million.
That payment will occur in the second half of this year.
For tax purposes, we expect to amortize a total of $1.8 billion over the next 15 years.
Assuming tax rates remain at 25%. This will result in future cash tax savings for us totaling $441 million.
When we discount that cash back to today using a conservative 10% discount rate. This is worth more than $200 million or approximately $3 per share of cash.
All we need to do to guarantee this substantial boost to cash flow is maintained profitability.
Slide 20 is a snapshot of our capital management activity in the quarter.
The returned a total of $10.6 million to shareholders in the form of share repurchases and dividends.
During the quarter, we repurchased 457000 shares at an average cost of $15 to 73 cents.
Our prior $15 million share authorization was exhausted during the second quarter and as previously announced the board authorized a new share repurchase program of the safe same $15 million size that commenced in early June.
At the same time, we paid down an additional $33 million in debt and ended the quarter, but $55 million and cash on the balance sheets.
Our cash balance does not reflect approximately $16.5 million in open market debt purchases made at a discount supplier in the second quarter and had not yet settled by June thirtyth.
By repurchasing our debt at a discount in the market to get an bigger bang for the buck versus paying it down a par.
However, doing this creates a lag between the open market transactions when the trade get settled and when the debt. This formerly retired.
With a total of $240 million in debt reduction since we originated the alone in July of last year, our net debt to trailing 12 month adjusted EBITDA ratio declined to 2.2 times at the end of the quarter.
Our 100 million dollar revolver remains undrawn and we continue to generate substantial cash flow with GAAP net cash flow from operating activities in the first six months of this year totaling more than $120 million, which does not include the more than $13 million of non-GAAP cash tax benefits realized in the period.
Turning to slide 21 quickly before we go to questions I'll leave you with one final comment I'm sure. These charts look familiar to most of you.
They represent our beneficial value creation sites, Nonetheless, and our capital allocation strategy on the right.
Both remain unaffected by the market volatility or disruption associated with the global Cobot pandemic.
Most of our free cash flow is still being allocated to rapidly reducing debt to enhance balance sheet flexibility in preparation for acquisition opportunities.
The chart on the right represents allocations in the second quarter, excluding the $18.1 million increasing cash on hand from the end of March.
As I mentioned most of that increases due to settlement timing of debt repurchases.
We remain confident that our best use of capital.
And for creating shareholder value is leveraging our integrated business model and growing through organic means and acquisitions.
This concludes our prepared remarks, I will now turn it back over to the operator for questions.
As a reminder, if you like to ask a question. Please press Star then the number one on your telephone to what did you want your question Mr pounds or Heskey. Please standby, while we come topic you had a roster.
Again, if you would like to ask your question. Please press Star then the number one and your telephones.
Your first question is from Ken Worthington JP Morgan.
Hi, good morning, Thanks for taking my questions.
First with the Schwab side, which while having closer deal with USAA are you observing any change in behavior or how.
The USA clients are sort of reacting to.
The marketing in your offering.
I apologize you know you give you given engine they take a mile.
But with the information you gave US an account registration to help us put that in context.
You said 79000 accounts. It all 79000 accounts get funded use sort of mentioned MTN registration and then how many closed during that time period, you know us. It's only 5000 closed 79000 looks great 200000 close to 29000 doesn't look as great. So if you can give us that context that would be.
Pull too.
Hi, Ken it's Dave.
So let me take the question in different.
Pieces I think the first part of your question was around are we seeing different behavior from our clients given the Schwab acquisition close the answer is as I said in my prepared remarks during that time.
Have you know switching over to Schwab, we saw a lot of noise, meaning over some.
Brokerage clients that had our funds that either didn't go over to schwab or made changes at those times.
We think that that is more of a onetime phenomenon.
As far as a 79500 that have opened to accounts you have stable funded we used the term registrations, but they've all funded and the way we look at the opportunity said you know, there's 12 and a half newly in USA members that do not have an account with us so the.
Opportunity set for US is is unbelievable as we've said for the last 12 months.
We've we've really not.
Done a large marketing effort just yet we have a very methodical path of how we want to get set up we centered around client service we centered around.
Getting our technology right and then eventually getting to the point, where we go out and start marketing and we're not even at that point, yet and we've already experienced.
79500 accounts.
Looking at the closed accounts.
With the noise around the transaction wouldn't be the way we look added.
What we've seen is really great opportunity and we really are excited about what the future holds.
Okay, great. Thank you.
Then just maybe switching gears a little bit prior to the USA acquisition. One of your focuses was really on small and mid cap investing.
How do you think about boosting smid sales here and returning net flows to the positives.
So chemists Dave again.
We look at our small cap lineup, we have excellent investment performance a lot of those products are distributed through our retirement intermediary channel. Some through the sub advisor channel, we think that we'll be able to grow those products with the performance we have really node.
Different we were in I think a timeframe, where we have some of our products that are closed due to capacity. Some are bringing on good investment performance on as we said we saw some delays in.
Our won but not yet funded.
And our pipelines, which now are building back up and are now starting to fund. So when I look forward on both those asset classes I think we're going to be in really good shape from an organic growth perspective.
Great. Thanks very much.
Your next question is from Alex Bernstein with Goldman Sachs.
Hi, guys.
Building on so many USAA opportunities can you talk a little bit about the size of the USA 529 plan, So where did the stand today in terms of 81.
Doesn't currently consists of only USA.
Kind of legacy product or are you starting to introduce some of the victory.
Products in there as well and kind of how do you anticipate that process to work.
So the USA 529.
Plan I believe.
Is close to $4 billion.
And the product to make up underneath there.
Is made up primarily of.
Our products and if you if you remember we made some changes underneath when we did the acquisition.
At the time, we switched out some sub advisors to other sub advisors and then we also switch to in some of our franchises. So we're really happy with the lineup underneath and we think that that's an area that we can grow we are net flow positive on the USA 529 plan since since Weve purchased the bill.
Business, we also.
Our net account positive on that plan as well and as I said in my prepared remarks, we are the exclusive provider for the USA 529 plan.
Got it that's helpful.
And then just quickly on the modeling you pointed out the June fee rate. It was 57.7 basis points is at a decent jumping off point.
As we're thinking about the third quarter or are there. So and you say engine ounce related to USA transaction or anything else inaudible when you to keep in mind. This as we think about third quarter hearing thanks.
Alex its Mike Good morning, Yeah, there's 57.7 basis points in June as the way, we think about going forward.
That takes out some of the noise in Q2 with respect to some of the liquidations on the money market funds.
Great. Thanks very much.
Your next question is from Kenneth Lee with RBC capital market.
Hi, good morning, and thanks for taking my question I'm wondering if you could just provide a little bit more color around the us solutions business net flows.
Maybe if you just stuck.
I'm going to seeing some net inflows and outflows. Thanks.
Hi, it's Dave can we vis solutions business really saw a good number of outflows.
During the quarter due to a lot of in noise.
That we've seen with the with the Schwab transaction, when we think of that business going forward and we think of what clients are looking for how we think is pretty well positioned to provide.
The the intellectual capabilities that portfolio that portfolios are needing right now so what I mean by that is some of the EPS that we're launching some of the tests that we have some of the separate accounts that were doing for certain institutional clients and then also on the retail and retirement side.
Right and then just one follow up by if I May you mentioned in terms of the distribution expenses. Some removal platform expenses in the quarter wondering if you could quantify the impact or give us good sense of what the run rate could be going forward. Thanks.
Sure. Thanks, Ken it's Mike.
As we talked about and then the slides operating expenses overall were down 9% quarter over quarter and a lot of that was driven by.
The expenses that are tied to average than assets.
And some of that relates to the removal of the money market assets that we paid a distribution expense on.
Well as we saw some additional efficiencies in our broad distribution network.
Got you very helpful. Thank you very much.
Sure.
Your next question is from Randy Byner with B. Riley.
Hey, good morning, I have couple one I guess on the EBITDA margin, obviously is very good this quarter and I think.
I think is above the where we thought it was guided to are targeted.
And the comments on the on the print with the previous analysts there where that your fees a U.M. are gonna stay at a pretty similar levels. So can you are we are we looking at a potentially even higher EBITDA margin as we look forward and the model.
Right, it's Mike good morning.
Yeah, I think our guidance has been 46%.
Post all the synergies and that's really where we are if you look at our year to date margins. That's still the guidance that we would continue to guide towards.
We've talked about you may see some plus or minus a quarter over quarter, just based on efficiencies as well as reinvestment that we're making in the business.
So I think if you look at it we still have guide to the 46% going forward.
Okay, Great and then just on the comments around you know potentially doing another acquisition I guess.
I feel like maybe some of the questions I've touched on it a little bit, but maybe not as directly as I like what what what can you share with us about.
Opportunities that you're seeing in the market.
Hi, Randy it's Dave its <unk> plentiful.
I think we have become an acquirer of choice. So we're having lots of conversations I think we were pretty clear in our prepared remarks about preparing our balance sheet for acquisitions.
And you know historically, we have I'm doing an acquisition every year or so and I think that cadence as we've guided is probably the right way to look at it over a longer period of time.
And you know we have U.S.A. integrated.
We have our debt pay down happening pretty aggressively.
We continue to generate pretty strong cash flow, we have achieved all the synergies from an expense perspective on the U.S.A. [noise] acquisition. So when we look at it right now we think our platforms ready for another acquisition and and we're evaluating.
And many of them now and as we as we do our primary.
Hurdle is does it make our company better and Thats, where we start and as we review the acquisitions you know, we're looking to make our company better and you know that's how I would guide you on that.
What was when making victory better.
The another kind of huge scale play like USA. Those are my words that I think that's what it was or would it be more.
Acquiring you know kind of stickier more value added products.
You know, we really start from the portfolio, we start from the product set and does it fit in the clients portfolio.
You know is it is it a product that clients are going to one you know when you look three years out five years out.
So we start there and I think that would lead you to to deals that could be smaller and that deals could look from a size wise to USA. We've really not you know blocked any any size off.
What I would say is we are absolutely I'm looking at transactions in asset classes that we don't sitting today, which we think Hassane Tailwinds. We think our organization is ready on those and so so I would I would say we trace it back from the portfolio.
And from where we think the clients going to want to go in the future and really don't look at it from you know a size perspective, but I think that lead you really too to doing something smaller into or something larger.
Perfect. Thanks, a lot.
Yes, yes.
Question asked some questions I will jump right Blair.
Hi, good morning.
Okay sounds like Dave you're you're feeling more optimistic on on flows going forward, but.
It looks to me like Theres been roughly another billion dollars of mutual fund outflows in in July give or take.
So just help me reconcile those two thoughts and do you see a path to positive flows in the back half.
So I think that there let me start off by saying that there is definitely noise in our flow numbers, which we view a lot of that noise to be onetime in nature centered around really the transaction of schwab purchasing the USA brokers business.
Coupled with that.
There has been as I said in my prepared remarks, a little bit slowdown on gaining shelf space for some of our products due to covert 19.
Some of the institutional allocators.
Slowed down we're seeing those two things pick back up.
I'm very encouraged by what I've seen on the direct channel I'll remind you that we go back and we've been talking about this for a year, there's 12 and a half million members that don't have an account with us and we have not aggressively marketed that at all yet I'm very encouraged by the investment performance.
Have a number of our products. So you know we were looking forward and I think as we work our way through into lease I think you'll see some of the investments. We've made in some of the products that are doing well from a performance perspective really lead the way in growing.
Just a follow up on that if U.S. say mutual fund clients or are.
In the case, where they would move.
[noise] their assets to like a swap.
Brokerage accounts and liquidate their USA funds as part of that.
What would that would you know that they're going to to Schwab I know that's not necessarily this you've been seeing but would you have any way to know that.
We have transparency into whether they hold our mutual fund or not what they do after they liquidate we don't know.
We have our direct accounts, which we have our direct relationships with and then we have accounts.
And with the rest of our business, where we are a provider on a platform and that's how I'd categorize.
The account that sit within schwab.
Okay, and then lastly, you talked about this the sea ray kind of being consistent with June going forward that it's a good jumping off point, but I didn't want to just go back to.
The fact that the USA fulcrum fees start to take effect. So should we view that is basically a ought to wash.
Hey, Chris Good morning, it's Mike So I think as we've said on the folks come fee, we waived it for the first 12 months. So it's not in the Q2 numbers.
It will begin in Q3.
And as we've said, it's it's on certain but not all of the USA funds.
And it's also in accumulating calculation so to start with if you will the starting of the 13th month, and then roll up to a rolling 36 month calculation.
At this point, we don't have an estimate the performance obviously is fluid and builds ongoing as part of the calculation, but that will be in our Q3 numbers will be the first instance, or the focal fee impact.
Okay. So at this point you don't have a view, whether that's a positive or negative to the secret.
Correct.
Okay. Thank you.
Your next question some Jeremy Campbell with Barclays.
Hey, Thanks, Dave you know I know you mentioned that knows in here be built cash and mentioned the M&A opportunities are plentiful I'm. Just wondering if you can provide some color on whether the year to date code experience with the big Selloff in subsequent rally back has perhaps brought some new or potential sellers the table.
For these mostly asset managers that we're looking to sell in 2019, but maybe just got delayed deals they could sell off.
I would say both I think there's some delayed sellers and I, absolutely think that has brought new new.
Participants and potentially selling asset management businesses. So as I said, there's a lot of opportunity.
Out there to do a lot of different things and I think.
For us it's it's a.
Transaction that fits into our longer term strategy.
In our challenge is not really the volume of opportunity. The challenge is finding the correct one.
Got it and then just maybe as a follow up there obviously in a we also recently had a deal in the market, where we're all leon's effectively partnering with Vertis for retail distribution and victory has a very robust retail sell platform as well. So just wondering if something like that in a more capital light partnership type deal structure would look attractive.
You. In addition to your more typical M&A kind of bio deal structure.
It would.
We thought that transaction was creative.
And we think that for the right partner and the right opportunity, we would be open to that.
I think theres going to be more.
Structured transactions that look like a partnership as opposed to traditional acquisition going forward given the dynamics of distribution.
And that really is centered around.
If you have established distribution today.
I think there's an opportunity to be successful in distributing your product. If you do all the right things. If you don't have established distribution today, Kobin 19, as well as the evolving industry really makes it challenging to kind of start from scratch and distribution. So I think there is.
To be lots of opportunity and we and we would be a participant in that if we found the right opportunity.
Great. Thanks, a lot.
Yes.
Your next question.
Moody with Piper Jaffray Piper Sandler.
Hi, guys. Just just one for me on the on the comp ratio kind of bump up in a quarter just wanted to see how we should think about that accrual for 2020 during the first second quarters.
[noise] estimate it's Mike Good morning, Yes, if you look at that cash compensation ratio, it's held at about 23% for the first and second quarter.
What what we've talked about in the prepared remarks, and we've talked about in Q1 is there is some noise related to our mark to market for our deferred compensation plan with all of the volatility in the marketplace. So that was a 7.3 million dollar expense to compensation in Q2, that's driving that a little bit higher.
Higher when you look at the overall compensation ratio.
The offset to that is sitting in other income.
So that is a mark to market of assets that fit in a plan and an offset to expense. So it really has no piano or cash impact associated with that.
That's how we look at it so from a cash compensation on an ongoing perspective, 23% is the ballpark plus or minus based on what's happening from a growth perspective in the business.
Got it thank you.
Sure.
Your next question from Robert Lee with A.B.W.
[noise] high grade at the morning close like my question I get the first one is.
On the earn outs, you just remind us and listen to the first on that you're the.
The leaders not there too lumpy sort of stupid stuff remind us on part of the earn outs the potential future earn out sort of Apollo.
Sure up it's Mike So the way the Ernesto structure, it's a maximum of $150 million that can be paid out.
And the way we structured it is.
A fourth events or 37, and a half million dollars each year. So you'll look at it and what we've said in our remarks is.
The first starting out will be paid in the second half of this year. The full 37 and a half million dollars is what we expect and then there will be three more beyond that as well.
Okay, Great and then also on the USA, bringing up I know I believe that with a.
Three your agreement that you could use the brand and that kind of revaluate. So I know, it's only a year in the you just.
Update or something.
You know if that is.
I am correct.
Kind of have to keep some type of licensing agreement with USA or so.
To maintain the brand building now you know any it's looked out what that could entail.
Its Dave how are you.
It is a three year agreement, where one year into the three years and I think we're very early on you know in in the in the licensing agreement I think we've done a phenomenal job representing USA in serving their members which has been our.
Collective goal USA and victory is to give great client service to their members and I think we've done that so I think we've done an excellent job I'm doing that and we have two more years under this licensing agreement as you said.
Okay, Let's maybe lost when the last summer when you make.
He $7 million came it does that generate or create.
Additional tax benefits and others that kind of you know when most of them, but they will goodwill and some forms.
Some of create some type of up for goodwill.
Yep rabbits might get guys. So I think we've been qualified this quarter that shows the tax amortization that we expect to achieve over the next 15 years and there is a little bit of a ramp up over the next four years.
And that really is as we make those payments those go into the tax amortization calculation.
Okay, great. Thanks for taking my question.
Sure.
Your next question is.
She Michigan with Bank of America.
Hi that this is actually sitting in on behalf of okay.
The question of how to mine waste regarding the flow you mentioned.
Not that much having them up off the outlook for the rest of the yeah I was just curious.
I will call on almost every I think it's fun to watch some of it adds that we could potentially some business I think all ended at Escobal yeah. Thanks.
Hi, it's Dave.
Some areas, where we're seeing strength, our won but not yet funded.
Book is as strong as it's been a this year a lot of that is in the sub advisor and institutional part of our business. We've also seen a pickup in our retirement side as well.
As I said in my prepared remarks.
The second half for the year will be we'll be launching our digital platform, which will be positive.
From a from a gross flow perspective for their direct platform.
Our investment performance has come back exceptionally strong on or USA fixed income franchise, and we're starting to see that franchise gain really important shelf space.
That we were unable to gain during the second quarter and first quarter a lot because of the cobot 19 impact. We're also launching some new products, we talked about three new each yes tool them all be geared towards the military community.
And then on the other side of that some of the noise or onetime impact of the close of the the acquisition of the USA brokerage business by Schwab, well, absolutely slowdown and is slowing down and when you put all that together or outlook as I've said, it, especially as you move into 2021 is quite Pos.
I would have on that front.
Your next question is from Michael Cyrus with Morgan Stanley.
Hey, good morning, Thanks for taking the questions just wanted to follow up on the they do slide that you haven't here on the cash tax benefits I'm, just curious how you're thinking about potential impact of tax rates go up saying from 21% statutory to.
20%, maybe at the high end up that's kind of been discussed how would that impact the calculations on the.
The cash tax benefits have you thinking about that.
Sure Mike It's Mike Good morning, Yeah. So we would look at it we've assumed a 25% tax rate in that calculation. So rates do go up to something higher than 25% from a corporate.
On a federal and state perspective, how we look at it to something higher the tax amortization that we'll be able to recognize will be higher than that so there will be a higher impact the overall cash savings.
And what's the underlying federal that you're assuming in your 25 is at a 21 plus a four for study if that's what anyone you have 21 plus four.
Got it so if the federal goes from 21 to 28 and that 700 basis points pick up and you'd kind of add onto the 25. So you'd be at 31 is what you'd be using here instead of the 25 is that the right way to think about that.
That's the way we're thinking about it yes.
Got it okay. Thanks, and then just maybe a follow up on the fixed income side the industry saw a lot of.
Inflows in the second quarter in fixed income they can prove man over 100 billion across the industry. Yeah. When we look at your gross sales they were down a bit sequentially on the gross sales I understand all the redemption side, which you've you've talked about some of the pressures with the brokerage, but just on the gross sales any color you can provide their around why that was down.
Meaningfully in the quarter and what your expectations are here until second half.
And Mike It's Dave Good morning.
Really that's around we think about the future for fixed income at least for us it's around gaining shelf space. So as we were in the second quarter, our ability to to really introduce the U.S.A. investments franchise onto new platforms with slowed down.
And as we look forward, we're gaining shelf space will gain shelf space as well as the significant pickup in investment performance.
We think we'll participate kind of into tailwind, but but the second quarter. We did not participate as much as we wanted to as we watched the industry grow we were unable to do that but I think when we look forward gaining shelf space, coupled with really good investment performance and I've really long term track record of success.
Yes, we feel really good about the opportunity there.
Any incremental color you could provide around some of the actions that you're taking and initiatives that you haven't place in order to help further accelerate the gains on the shelf space side.
Really it's been the same playbook, we've used over the last decade.
What has occurred is that.
The inability to really get the meetings and have their shelf space providers put new funds onto the platform I think as their shelf space.
Yeah analysts are more comfortable with the environment. We're in there there put it you're starting to put new products on the shelf. So is really no new tactics that was really working our way through the current situation with koby 19, and really just continuing to do that things we've done in the past.
Great. Thank you.
Your final question, it's a follow up question from Robert Lee APW.
Great. Thanks for taking my follow up quickly going back to the M&A and acquisition just remind us I mean.
How you think about.
If there is even any capacity constraints, how you're thinking about.
Your capacity for transaction in terms of.
No kind of where understanding things like that they will pay down debt rapidly, but kind of how you think about where you kind of want it popped out and say that debt to EBITDA kind of how you're thinking about your capacity size wise for transaction going forward.
Hi, it's Dave So the way we look at it is we feel like we have a number of different tools to do acquisitions.
Clearly we have debt we have cash that we we're accumulating that you would accumulate between announcement close.
There's a structuring element to it where you can have an earn out structure you could utilize revenue share.
And when we put all of those pieces together, we think we have all the tools to two to really have a full flexibility to do the acquisitions.
That with her in scope right now for us.
We have not given a top end on a debt to EBITDA or leverage ratio I think every transaction is different.
But I think where we're at today, we don't really see our balance sheet or financing as a constraint to execute on anything that we're considering today.
Great. Thank for taking my follow up.
I would now like to turn the call back over to David Brown for any final comments.
Thank you for joining us. This morning, we look forward to keep you updated on our progress next week. We are attending the you'd be S. financial services conference and on September 15th will be at the Barclays Global Financial Services Conference, we hope to see their virtually I hope you all have a good day and stay well.
This concludes today's conference call. Thank you for participating you may now disconnect.