Good morning, and welcome to Victory Capital's First Quarter 2018 Earnings Conference Call. My name is Nicole, and I'll be your conference operator today. [Operator Instructions] Please note that this conference is being recorded. I would now like to turn the conference over to Lisa Seballos, Director of Finance for Victory Capital. Please go ahead.

Good morning. Before I turn the call over to David Brown, I'd like to note that today's discussion may contain forward-looking statements, and as such, include certain risks and uncertainties. Please refer to our press release and our SEC filings for more information on the specific risk factors that could cause our actual results to differ materially from the projections described in today's discussion. While a 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 undertake no obligation to update these forward-looking statements to reflect new information or future events that occur or circumstances that exist after the date on which they are made. In addition to U.S. GAAP reporting, we report certain financial measures that do not conform to Generally Accepted Accounting Principles. We believe these non-GAAP measures enhance the understanding of our performance. Reconciliations between these GAAP and non-GAAP measures are included in the table found in our earnings release and the slide presentation accompanying this call, which can be accessed on the Investor Relations portion of our website located at ir.vcm.com. Now I would like to turn the call over the David Brown, Chairman and CEO.

Good morning, and welcome to Victory Capital's First Quarter 2018 Earnings Call. I'm joined today by Terry Sullivan, our Chief Financial Officer; and Mike Policarpo, our Chief Operating Officer. I'm going to spend a few minutes discussing highlights of our Q1 results as well as our long-term strategy, and then I will turn it over to Terry who will review our financial results for the quarter in more detail. Following our prepared remarks, Terry, Mike and I will be available to take questions. We'll start on Slide 6. In a quarter that marked the return to higher levels of volatility for the equity markets, I'm pleased to report that Victory Capital delivered very solid results. Relative investment performance across our Investment Franchises and our Solutions Platform remains strong, with 87% of our AUM outperforming its respective benchmarks over the trailing 1-year, 71% over the trailing 3-year, 83% over the trailing 5-year and 79% over the trailing 10-year. Looking at performance based on the number of strategies, 75% of our strategies outperformed benchmarks over the trailing 1-year, 70% over the trailing 3-year, 76% over the trailing 5-year and 72% over the trailing 10-year. Additionally, as of March 31, 2018, 69% of our AUM in our mutual funds and ETFs earned 4- or 5-star ratings overall from Morningstar, 59% over 3 years, 68% over 5 years and 66% over 10 years. Assets under management declined slightly for the quarter to $60.9 billion due to net outflows of $633 million and market depreciation. Given the lumpiness of our business quarter-to-quarter when it comes to flows and the higher than normal levels of client rebalancing activity we have experienced, the outflows this quarter were not outside of our expectations. These results come on the heels of a net flow positive Q4 2017, which really…

Thanks, Dave. The financial results review for the first quarter of 2018 begins on Page 22. We're pleased to report very solid results for the quarter. AUM ended the period at $60.9 billion, down 1.5% due to negative market action and net flows. Revenue decreased slightly to $105 million. Our ANI with tax benefit EPS was $0.40 and EBITDA margin was 37.9%. Both measures were in line with fourth quarter 2017. The first quarter was effective for Victory Capital from a capital management perspective. We concurrently executed a successful $167 million IPO and $360 million debt refinancing. The IPO marks an important step in the evolution of our capital structure and provides a strong foundation for future growth. The IPO proceeds, along with the use of free cash flow, enabled us to reduce our debt level 35% from year-end 2017 levels to $323 million at the end of the quarter. We also lowered our cost of debt by 250 basis points to LIBOR plus 275 basis points. In April and early May, we used additional cash flow to pay down debt to $305 million and upsized our credit revolver to $100 million. Lastly, our capital management activities were recognized by the rating agencies, as both Moody's and S&P upgraded us to Ba3 and BB, respectively. Slide 23 provides more perspective on our AUM progression. As Dave discussed earlier, our business has diversification elements consistent with those of larger asset managers. Our assets are diversified across 9 distinct investment franchises and a solutions platform, 8 asset classes, 72 investment strategies and 2 broad distribution channels in the institutional and retail markets. Our AUM grew 8% from Q1 '17, eclipsing the $60 billion level in late 2017. Slide 24 highlights our organic growth performance over the last several quarters. A few points…

[Operator Instructions] Our first question comes from the line of Michael Cyprys of Morgan Stanley.

Just on the M&A front, if we could just talk about that for a little moment. As you're thinking about your story, just curious what resonates in the conversations you're having with potential targets in terms of why would someone sell to Victory as opposed to some of the other boutiques that are out there. What is most compelling about your value proposition with potential targets?

So this is Dave. A couple of things. First is we are seeing a lot of activity. We are busier really than ever from an M&A perspective. We're having a lot of conversations and what we're hearing in the market and what we've heard in the market before is our integrated platform, which really allows a firm to kind of come onto our platform and then utilize all the strengths of our platform, our distribution, our marketing, our operational and technology expertise is a real differentiator, and especially in today's environment, our track record, the idea that a firm can come into our platform and actually speak to other employees that have been from other firms and see the experience that they've had is a real differentiator as well.

Great. And just as a follow-up question on M&A. Just curious how you think about prioritizing different types of transactions that you could do, firms that could add other product capabilities such as alternatives or firms that maybe can enhance your distribution or firms that maybe provide cost synergy opportunities. How are you thinking about that? What's most important today to Victory as you're thinking about the current stage of evolution of the company from the M&A front?

So we really start first and we look at the product set and what's most important to us is does the product fit within the clients' portfolio? Is it a product for the future? Is it an innovative product? So we want to buy businesses, partner with organizations that actually produce products that matter for today and really for tomorrow. From there, we want to be, as we said all along, we want to be in asset classes that have the right attributes, that can win going forward from an active management perspective, have all the attributes of a product where you can still hold pricing because it matters within the clients' portfolio where potentially the organization, in addition to the product, could make our business better, maybe from a distribution perspective, maybe from an operational perspective. And when I think about prioritizing, I start off with really the product set and how it fits and then, from there, it really just depends on the specific opportunity.

Got it. And if I could sneak one last one in here. You mentioned the pipeline was pretty strong on M&A. Any sense on timing, how we should be thinking about that?

No sense on timing. We -- let me make this clear. I mean, we have not done an acquisition in over a year. It's not because we haven't had the opportunity. It's not because we've been disadvantaged by the model or pricing or anything else. We're just highly disciplined and selective. So we are waiting for the right one and when that one comes along, we're fully prepared to execute on it. But as I said, we're having lots of conversations. It is -- this is probably the busiest we've ever been on that front.

Our next question comes from the line of Michael Carrier of Bank of America Merrill Lynch.

This is actually [ Jeff ], filling in for Mike. I guess, just first on flows in the quarter, in terms of the client rebalancing, I was wondering if you can maybe size that potentially for us? And are you seeing that continuing in 2Q?

Yes, it's Terry. I'll take that question. I think that, in terms of the rebalancing, what I'd say is that it's, as you know, a function of strong investment performance in a lot of ways and it continues to be a major component of the outflows that we saw this quarter. It follows on the heels of a positive quarter, from the fourth quarter where we felt it was a little bit more neutralized. So I'd say, generally, it's something that we're starting to see lighten up a little bit. And that's really been expressed from a financial standpoint in our strong won but not funded pipe and our general healthy sales pipeline.

And then maybe on that pipeline, would you be able to size that for us and maybe talk about, I guess, from like a fee rate point of view, like how the mix is in the pipe?

Yes. I'd say that we're not really quantifying the pipeline. Dave talked a little bit about the lumpiness of the business, and so I think you got to look at this a little bit more holistically and long term. So that's not something that we quantify. I'd say, from a fee standpoint, we're seeing the pipeline widespread across our franchises and vehicles. And as such, there's no real movements one way or another relative to the fee levels that you just saw from us in the last quarter.

Our next question comes from the line of Ken Worthington of JPMorgan.

So can you talk about the progress in transitioning both the sales force and your clients away from the 2 big Sycamore funds to some of the other SMid products and global products that are performing so well. So basically, how is that transition coming? And then, a follow-up on the pipeline question. Which products or franchises seem to be driving the pipeline success? You talked about it doing well. Are there certain pockets that seem to be gathering more success in that -- really that institutional pipeline than others?

Sure. Thanks, Ken, it's Dave. To answer your first part of your question, let me clear up on Sycamore as well. Although the Sycamore small cap is closed and the Sycamore mid-cap is soft-closed, we are still accepting assets or flows from existing clients and we anticipate that we'll have some activity on that franchise this year. So that is still, if you will, bringing on assets and -- but when we think of really the transition from our current flow leaders, which Sycamore is one of them, we think about the future and the transition around VictoryShares, which is happening today, and you can see in the numbers. Trivalent has had a lot of progress, great investment performance and a lot of momentum. And then, really when we think about the emerging flow leaders, we're thinking about Sophus, which Terry mentioned, the 5-year track record that just has come on. We've invested heavily in the marketing of that franchise. VictoryShares, as good as the momentum has been, we see that increasing, looking forward, as the performance continues to do well and as we gain access to new platforms. RS growth has really come on and we're very excited about that. And then we also think Integrity has a lot of upside in a couple of their products, and really that's just the shorter to midterm. And then in the longer term, we have obviously some of our other franchises, which are building nice track records. And as far as -- and I would say, lastly, Ken, on the pipeline question. I would say that the aforementioned franchise really fill up the pipeline of when we think of who's in the pipeline. We are -- when I think of our pipeline, I think of the words widespread, healthy, and then really supported by excellent investment performance.

Great. And then maybe to follow up on Michael's question earlier. Talk about the deal pipeline, you said that you're maybe more active than you've ever been. In your conversations with potential sellers, what's really bringing them to the table? What's driving them today when they might not have been coming to the table a year or 2 ago?

It's Dave. I think the industry landscape, the lack of access to distribution on both sides, be it Institutional and Retail, typically, we are talking to groups that might have access to one channel and maybe not both channels, the continued need to reinvest in their technology and operating platform. And I think those are the 2 driving factors.

Our next question comes from the line of Kenneth Lee of RBC Capital Markets.

Just want to follow up on the potential deal activity. As you mentioned in your prepared remarks, there's the potential for you guys to look at targets outside of the historical opportunity set. Just wondering what factors could lead you to look at outside the opportunity set?

It's Dave. We evaluate a lot of different factors and metrics when we look at opportunities. Probably one of the most important one is, does it make our company better? I can't give you a specific metric or factor on why we would go outside, but the driving factor would be, does it make our company better? We evaluate each deal individually. We have engaged and looked at things that are outside of the scope and we've chosen not to do anything. That doesn't mean we won't do something in the future that's outside of what we've traditionally done. We're very flexible.

Great, and just one quick follow-up. When you think about potential financial capacity for conducting transactions, what would you -- how would you size that?

When we think about capacity, we really think that we have all the tools we need to execute on the transactions we're looking at and really, to date, we have not been handcuffed from a tool set perspective.

Our next question comes from the line of Jeremy Campbell of Barclays.

So just looking at like the flows in your ETF, obviously it's been a growth driver. And if I'm remembering it correctly, a lot of your ETFs are kind of positioned to outperform periods of enhanced volatility. So I'm just wondering if you guys could talk a little bit about the performance and flows of those products, specifically during the big February spike and also if you're getting increasing interest in these strategies from retail or institutional type investors now that volatility has come back a little bit more this year.

Yes, it's Dave. I would keep in mind that our ETF product set does -- we believe in and from the information that we've seen does well really in all market environments. It doesn't really do any better in a volatile or a highly volatile or less volatile market. We've seen great strength this quarter. It's continuing in April and we really have a lot of momentum there. We're seeing a lot of interest and a lot of activity. And we think that the ETFs are really all-weather products and not specifically positioned to do -- for clients' portfolios, in certain volatile markets, we think it fits in a portfolio long term.

Okay. But there are kind of volatility overlays in a lot of them, right?

Yes. We use volatility in constructing the portfolio, and that's one of the key drivers in how we construct the portfolio.

Okay. But has -- so has the interest in that sleeve picked up at all with volatility kind of coming back at all?

Yes. It's been consistently good, so it hasn't spiked up or spiked down.

Okay. And then, just kind of tagging a -- one extra one here on the M&A side of things, along with everybody else. Just kind of wondering, as you kind of look at the tools in your toolkit now that you have a public currency available to you, is there any sort of preference for kind of the financing structure of a potential deal on a go-forward and maybe also any commentary you might have on kind of like balance between kind of the macro conditions of -- it might make a manager a little bit kind of cheaper to acquire, but at the same time, your public currency may have pulled back during the same time horizon as well?

Yes. It's Terry. I think, Jeremy, the real key for us and what we're laser focused on is shareholder value creation when we approach the M&A market. And as Dave mentioned earlier, it's a comprehensive approach that we take in evaluating and the metrics that we use, so it's both strategic and financial metrics that we look at that need to be compelling for us to move forward. And I think in terms of the strategy for financing, particular M&A situations, it's going to be case-by-case. We've got the tools in the tool kit that we need and we -- when we evaluate strategically and financially, what's compelling, the financing strategy will follow that overall thesis, if you will. So I think when -- and you've got to keep in mind the value proposition that we have relative to what Dave talked about earlier. There's a lot of different things that we can bring to platforms to make them better, which obviously results in, we think, shareholder value creation.

Our next question comes from the line of Andrew Disdier of Sandler O'Neill.

Just starting off on the new franchise front. Just as far as -- would you be able to talk about some of the characteristics of the sellers where you're seeing the most interest? Meaning, are they individual proprietors or owners of the firm? Are they private equity type owners? Or are those asset managers kind of under a larger strategic umbrella with the more strategic firm focused on more core businesses?

It's Dave. I think it's quite, honestly, a mix. We have the categories you've just gone through. I would tell you that we have had conversations, really, with all types of firms, but the commonality, what we're seeing is the desire for distribution access to approach distribution in a scaled way, the desire really to sit on an operating platform that's current and that will continue to be current, and really to be part of an investment-centric and employee ownership culture. And those things, I think, are the commonality. And we're seeing that, if you think about private equity owned, big financial sponsor, or financial companies that own businesses, individuals, sole proprietors, really, we've spoken to all of those and really it's the commonality of the points that I made.

Got it, got it. And then just this morning, saw some updates to kind of mutual fund pricing and gross expense ratios. Wasn't able to get through all the detail, but can you just talk at a higher level, focusing on some of the pricing of -- within the various asset classes and strategies, understanding the competitive dynamics within your focused asset classes on a go forward basis?

Yes. So we have -- we, like all other active managers, have gone back and reevaluated our pricing. In some areas, we've reduced pricing in mutual funds to be competitive. We've negotiated pricing with some of our institutional clients. That being said, we're not seeing a material erosion of our pricing. If you look at our average fee for our business, it's high. We think it's high for 2 reasons: one is we know the products we have are value-adding portfolios and people are willing to pay for that; and two, we think we're in the right asset classes as well where the pricing pressure isn't as high as some of the other asset classes.

Our next question comes from the line of Alex Blostein of Goldman Sachs.

This is Sheriq, filling in for Alex. Can you talk about the competitive landscape of the ETF offering and how well it's actually positioned? Was it the other large-scale players? And any incremental color that you can provide on the distribution side of your ETF products.

So our ETFs, we think, are very differentiated. These are 30 to 45 basis point ETFs. Three of -- as we stated in our prepared remarks, 3 of our ETFs have 3-year track records, all 5-star, ranked by Morningstar. We think the differentiation comes not only in the track record, but out methodology and the way we're constructing the portfolios. We have seen, and we've launched a number of new products as well, a number of ETFs. And we are really gaining traction with the larger distribution platforms with our ETFs and we're really excited about the opportunity when we look forward with our ETF business.

And just one more from us. Any plans for the dividends going forward? And just on the question on financing, any long-term target, the leverage ratio that you have in mind that you feel comfortable about?

Sure. It's Terry. I'd say, in terms of dividend, we don't have a dividend policy declared. And that's really purposeful in the sense that, as we look at capital management, we want our capital management policy to follow our growth strategy. And so we feel that there's better opportunities for us to deploy capital in other areas, for example, M&A or deleveraging, which we did quite a bit of since our IPO. And we think that's just, right now, a better proposition for shareholders and a better step to creating shareholder value. And then on the second part, leverage, you can see that through some proactiveness, from a paydown perspective, we are at basically 2x debt-to-EBITDA. That's a range that we're comfortable with and we'll evaluate capital deployment as we move forward.

Our next question comes from the line of Chris Shutler of William Blair.

I want to come back to the MA discussion once again. So you've talked about a pretty broad $10 billion to $75 billion focused range. How shall we think about, I guess, where in that range you're seeing more than near- to medium-term opportunities and maybe also just talk about the pricing you're seeing in the market?

Yes. Chris, maybe I'll take the pricing point, first. I think, generally, what we're seeing right now is really a broad range of outcomes in the private market and that's really, if you think about it, it's reflective of, I think, the general environment that we're in, growth prospects that targets really have, the momentum they have in their business, and then positioning of their businesses. So I think it's hard to narrow in on a range, and I think, as we approach the market, that's something that we are cognizant of. And I think, again, when you overlay the value proposition that we can bring to the table, whether it's synergies, the ability to have a tax step-up and then, importantly, plugging these platforms into our business, that can generate a lot of potential growth for them. We think there's a very compelling equation, and thus, that's why our pipeline is full and we're pretty active.

And in terms of the range, Terry, just kind of broad-based or any percent is more likely bottom end to that $10 billion to $75 billion or upper end.

Yes. I would say that, as we look at the pipeline, it's, for the most part, spread across that range. I think that if you had to tilt it one way or the other, maybe it's on the lower end of that range from just an AUM standpoint. And I think that's because we're seeing, and it's tied back a little bit to the macro thesis that Dave mentioned earlier, we're seeing folks that are looking for better resource, better infrastructure to plug into to better their business. And obviously, our integrated multi-boutique is pretty attractive from that standpoint and then when you layer in some of the other elements, autonomy, et cetera, we feel that, that's where we're getting a lot of traction.

All right, it makes sense. And then, just one follow-up, the -- on incentive comp line, Terry. Can you talk about where that fell in the quarter as a percentage of pre-bonus EBITDA and where do you anticipate that percentage being for the year?

Yes. It's consistent with where we basically said we would be, which is in the 30% area. And as we look at the performance of the business through the first quarter and as we look out with the momentum in the business, we see no reason to change that.

This concludes our question-and-answer session today. I'd like to turn the conference back over to David Brown for any closing remarks.

Thank you for taking the time today to participate in our earnings call. If you have any additional questions, please don't hesitate to contact us. We will be participating in several upcoming conferences and look forward to seeing some of you there. Thank you for your interest in Victory Capital.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.