Victory Capital Holdings, Inc. (VCTR) Q3 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Victory Capital Third Quarter 2019 Earnings Conference Call. At this time, all participants lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference maybe recorded [Operator Instructions]. I would now like to hand the conference over to your speaker today, Mr. Matt Dennis, Chief of Staff and Director of Investor Relations. Please go ahead, sir.

Thank you, Liz. Good morning. Before I turn the call over to David Brown, I would like to note that today's discussion contains forward-looking statements and as such includes certain risks and uncertainties. Please refer to our press release and our SEC 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 of the 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 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, related GAAP measures are included in tables that can be found in our earnings press release and in the slide presentation accompanying this call. Both can be accessed on the Investor Relations portion of our website at ir.vcm.com. Now, I will turn the call over to David Brown, Chairman and CEO.

Thanks, Matt. Good morning, and welcome to Victory Capital's third Quarter 2019 Earnings Call. I'm joined today by Michael Policarpo, Our President, Chief Financial and Administrative Officer, as well as Matt Dennis, Chief of Staff and Director of Investor Relations. I'm going to spend a few minutes discussing our business and investment results. I'll also share an update on the integration of USAA Asset Management Company. Then, I will turn it over to Mike who will review our financial results for the quarter. Following our prepared remarks, Mike, Matt, and I will be available to take questions. The business overview begins on Slide 5. The financial and operating results reported last night represent the culmination of the crisp execution of our long-term strategy to profitably grow the business. We the business. We more than doubled the adjusted earnings and expanded margins, reinforcing the power of our unique business model. The total AUM grew from $64.1 billion as of June 30, 2019 $145.8 billion as of the end of the quarter. Long-term net inflows were positive for the second consecutive quarter at $726 million and are $3.3 billion year-to-date Revenue and adjusted net income more than doubled sequentially and adjusted EBITDA margin expanded by 480 basis points to a record high of 44.8% as of the end of the quarter. This marks our third consecutive quarter of meaningful margin expansion. Turning to the deleveraging front, we paid down $63 million of debt during the quarter to end the quarter with a debt balance of $1.037 billion. Subsequent to quarter-end, we've paid down an additional $40 million, bringing our debt balance to $997 million. That's down from $1.1 billion on July 1, 2019. Our run rate net debt leverage ratio is now 2.4 times. Additionally, we've declared a second consecutive quarterly cash dividend of $0.05 per share. As previously announced, we closed on the acquisition of USAA Asset Management Company on July 1. Our integration efforts following the close of the acquisition continue to progress well. And I'm pleased to announce that we expect to achieve our estimated cost synergies of $120 million faster than our previous guidance. The direct channel for USAA members was reopened on July 1, 2019 and our call center, which is staffed largely by former USAA employees, is actively serving members' investment needs. As of the end of the third quarter, the metrics we use to evaluate service were in line with those achieved by USAA prior to the acquisition. We believe our ability to drive these results is particularly notable, given USAA's well established reputation for providing exceptional service to its members. We also view this as a foundation for future success in this channel. Our Investment Franchise and Solutions Platform continued to deliver excellent investment results during the third quarter, as illustrated on Slide 7. 68% of AUM in our mutual funds in ETFs was ranked 4 or 5 stars overall by Morningstar as of September 30, 2019. Over the trailing 3-year period ended September 30, 83% of AUM and legacy Victory Capital strategies outperformed its respective benchmarks. I'd also like to point out that we had multiple franchises with mutual funds ranked in top quintile by Morningstar for the trailing one-year period, including Sycamore Capital, RS Investments, INCORE, Munder Capital Management and USAA Investments. Looking at AUM in the USAA fixed income strategies that we acquired, 88% outperformed benchmarks over the trailing 3-year period. Additionally, all 12 USAA fixed income mutual funds were rated 4 or 5 stars overall by Morningstar as of the end of the third quarter Our VictoryShares ETF platform also continued to deliver strong investment results during the quarter. As of September 30, 2019, three VictoryShares ETFs were ranked in the top decile and 6 ETFs were ranked in top quintile by Morningstar for the trailing one-year period. Across the total platform, which includes the legacy Victory funds and the acquired USAA funds, 64% of AUM outperformed benchmarks for the trailing 3-year period ended September 30, 2019. Slide 8 illustrates the percentage of strategies that have outperformed their benchmarks over the 1-year, 3-year, 5-year and 10-year trailing periods ended September 30, 2019. We believe these results demonstrate that we are producing for our current clients and our platform is attractive to new clients seeking the types of investment solutions that we provide. Turning to Slide 10, I'd like to provide an update on our acquisition of USAA Asset Management Company and our integration efforts. As I said earlier, our dedicated call center for the direct member channels opened and we are interacting live with members 6 days a week. Our member service representative have taken more than a 150,000 call since July 1, and we are operating at member satisfaction levels that are in line with those achieved by USAA prior to the acquisition. USAA's reputation for service is world-class. So, it is a high bar we are meeting. We are very pleased with our ability to operate at those service levels and it is our intent to work to improve even further upon USAA's historically high member satisfaction levels for the direct channel over time. The call center is staffed primarily with long-tenured employees who came over to Victory Capital or our operating partner from USAA. So, they are familiar with and understand how to serve members' needs. Our call center staff includes licensed professionals who are available to conduct personalized portfolio reviews, provide college financial planning assistance and offer general investment guidance at no cost to the member. We offer these services because we believe they provide significant value to the members and members are validating the importance of these customized services in our conversations with them. We are very happy with how our call center operation is evolving and it is working the way we envisioned. Business that we purchased from USAA is unique in many respects, and we've only just begun to tap into the tremendous opportunity its direct member channel represents. Members invested in the mutual funds in the 529 College Savings Plan are extremely are extremely loyal with high historical retention rates. Many members invested through the direct channel also have automatic investment plans. This is particularly true among investors in the 529 College Savings Plan. Additionally, most are registered users on usaa.com. Today, through our strong partnership with USAA, we continue to provide a seamless digital and mobile experience on usaa.com. We're also evolving the Victory Capital digital and mobile platforms to upgrade the experience for members when they fully transition to our servicing platform mid next year. Slide 11 provides a snapshot of the USAA mutual funds homepage on usaa.com as well as an example of a recent email campaign designed to increase share of wallet among members currently invested in the USAA 529 College Savings Plan. There are two important points that I would like to cover on this page. First, our branded products are well represented throughout USAA's wide range of digital assets, which is where most member transactions take place. We also have a process in place to ensure that members calling or interacting digitally with USAA who would like to invest directly with us are transferred to Victory Capital member service representatives or are directed to our pages on usaa.com. We expect this process to remain consistent after Schwab's acquisition of the USAA brokerage business is complete. Members who want to invest directly in the USAA mutual funds or the USAA 529 College Savings Plan and receive advice from our member service representatives will continue to be able to do so in a seamless manner. We believe this illustrates the strength of our partnership with USAA as well as USAA's desire to ensure that their members' investment needs continue to be served. Second, we are actively doing outreach either through email or providing outbound calls to members who are currently invested with us to expand those relationships. Moreover, we are starting to market our capabilities to the broader USAA member base. We expect these efforts to continue to ramp up in the coming months and quarters, and we'll plan to share some details as we cycle through some of the programs we have planned. Turning to Slide 12, the Victory Capital Direct member channel represents just a portion of the overall distribution opportunity for this acquisition. We are leveraging our well-established distribution team to bring the USAA strategies to our intermediary, RIA and retirement partners, as well as to institutional consultants and clients. While there is a longer sales cycle in this part of our business, we expect to begin to see more impactful results through the end of this year and get into full swing next year, given the strength of our distribution effort and our history of successfully integrating products from acquisitions onto our platform. Importantly, there have been no disruptions for the investment professionals who came over from USAA who are managing client assets. Additionally, we've been able to enhance been able to enhance a number of the investment tools and technology that they're using to manage their portfolios to our state-of-the-art operating capabilities. On Slide 13, I'd like to spend a few minutes discussing our solutions platform. The platform is comprised primarily of rules and factor-based solutions available through a number of different vehicles such as institutional separate accounts, ETFs and mutual funds. This includes multi-asset, target date, target risk, active fixed income ETFs and completion portfolio of capabilities, some of which were added through the USAA Asset Management Company acquisition. Total AUM for the solutions platform increased to $49.1 billion as of September 30th. Growth in the AUM is tied primarily to the funding of significant mandates year-to-date in our multi-asset global dividend and customized schematic strategies. These findings have come through a number of different channels, including institutional, sub-advisor and traditional retail intermediary. The retail intermediary wins have been through both platforms and financial advisors. The solutions platform is a high margin competitive fee business for us. The strategies on the platform yield competitive fee rates that are lower than the average fee rate for our business as a whole. However, we are achieving higher than overall average firmwide margins on these products due to a number of factors including the lower cost of managing these strategies. This is an important concept, which is exemplified by our ability to grow margins quarter-over-quarter, while our average fee rate slightly declined. As I've said in the past, our integrated multi-boutique model is designed for success in the evolving industry environment and the changing dynamics around fees, costs and flows. Before I turn it over to Mike to review our financial results for the quarter, I'd like to provide a brief update on our acquisition sourcing activity. We are actively engaged in a good number of discussions and I would characterize the acquisition environment for us as very active. We continue to believe that our platform is unique and value-added to many sellers, particularly given our proven track record of successfully integrating investment franchises without disrupting our ability to manage assets and service clients while ultimately growing our client base through our distribution capabilities. Additionally, we able to retain their unique brands and individual investment purchase. As a result, we are seeing more inbound increase than we ever have in the history of the firm. I am confident in our ability to execute, as we have in the past, transactions that enhance our existing business and produce real value for our clients and our shareholders. We have the capital flexibility, bandwidth, experience and vision to be an active participant in the consolidation we believe is only going to accelerate as the industry continues to evolve and mature. Now, I'll turn it over to Mike.

Thanks, Dave, and good morning. The financial results review begins on slide 15. Total AUM increased to $145.8 billion $145.8 billion as a September 30, 2019. Long-term net flows were positive for the quarter at $726 million. This is our second consecutive quarter of positive net flows, and we are long-term net flow positive year-to-date as a September 30 at $3.3 billion. Revenue for the quarter was $215 million, up 135% from $91.4 million in the second quarter. Revenue was positively impacted by higher average AUM following in the USAA Asset Management Company acquisition and one extra day in the quarter. Adjusted net income with tax benefit increased 139% to $0.91 per share relative to the prior quarter. Adjusted EBITDA margin grew to 44.8% from 40%, or 480 basis points from the prior quarter. We believe this meaningful growth in AUM, revenue and earnings along with the achievement of industry-leading margins demonstrates the power of our integrated multi-boutique model. Our model gives us the flexibility to scale up significantly through acquisitions such as the one that we just completed. At the same time, we have been able to deliver record financial results of driving measurable operating efficiencies. Note that we have been able to achieve these efficiencies while continuing to invest in areas to support our future growth. On the capital management front, we ended the quarter with $1.037 billion of debt outstanding. Subsequent to quarter-end, we reduced our outstanding debt $997 million, bringing our total debt pay-down $103 million since July 1st. We returned $9.1 million to shareholders during the third quarter through a combination of $4.0 million in dividends and $5.1 million of share repurchases. Finally, we have declared a second quarterly cash dividend of $0.05 per share payable on December 26, 2018 to shareholders of record on December 10, 2019. Slide 16 provides a snapshot of our AUM growth year-to-date. Our AUM increased to $145.8 billion as of September 30th, up 128% from $64.1 billion at the end of the second quarter This increase in AUM was driven by acquired assets from the USAA Asset Management Company transaction and positive net flows. The acquisition of USAA Asset Management Company has enabled us to achieve significant growth in size and scale, while further diversifying our business, both in terms of channel and asset class mix. As of the end of the quarter, 49% of our assets were invested through the direct member channel, 26% through the institutional channel and 25% through the retail channel. Our asset class mix as of September 30th was 38% US equities, 8% global non-US equities non-US equities, 20% solutions and 34% fixed income and money markets. I would like to drill down on the money market business to provide some additional context. Based on the information that is publicly available today, we do expect to see a decline in the portion of the money market fund assets we manage that currently set on the USAA brokerage platform following the close of Schwab's planned acquisition of that business. However, because those money market assets are currently subject to an arm's length revenue share arrangement, they are profit neutral to us. Therefore, we do not anticipate any negative impact to profitability, should these assets. That said, we believe it's important for members who invest through the USAA brokerage platform to continue to have a higher yielding investment option for the cash portion of their accounts. As a result, we will continue to manage money markets on that platform for the benefit of members who choose to invest their cash with us. On the other hand, and quite different, the money market assets that sit on and are sourced through the direct member channel are not subject to the revenue share arrangement and are profitable to us. We intend to continue to work to grow those assets over time. Turning to slide 17, long-term net flows were positive for the second consecutive quarter at $726 million. Year-to-date, long-term net flows were also positive at $3.3 billion. Gross long-term flows were consistent quarter-over-quarter at $7.5 billion. During the quarter, we saw the funding of several sizable mandates in our institutional business. From an asset class perspective, we saw strong positive net flows in fixed income during the quarter. Six franchises plus our solutions platform are net flow positive year-to-date as of September 30. Our sales pipeline is solid and we remain confident that our diverse, high performing product platform is appropriately weighted toward strategies that represent the growers of the future. Slide 18 provides a snapshot of quarterly revenues. Third quarter 2019 revenues increased 135% to $250 million relative to the second quarter. Average AUM increased $85.8 billion to $145.9 billion quarter-over-quarter following the close of the acquisition of USAA Asset Management Company. Revenue realization declined to 58.5 basis points in the third quarter compared to 61 basis points in the second quarter of 2019. To drill down on this, our average fee rates have been slightly impacted by the funding of a number of sizable wins in lower fee strategies in our institutional business year-to-date. Additionally, we are seeing a shift away from 12P-1 fees in our retail intermediary business, which have almost been full offset and expensed in our distribution and other asset-based expense line item. Also, many of the USAA funds have historically been have historically been subject to fulcrum fees, which were agreed to waive through July 1st, 2020. This has a direct impact on the fee rates. We expect to reinstate those fees in the third quarter of next year after our fee waiver agreement expires. As I've said in the past, our average fee rates will vary based upon asset class mix, client mix and product mix. But fees on all of our strategies meet our margin threshold. The significant increase in margins that we achieved from 40% to 44.8% in a quarter where our average fee rate decreased slightly is evidence of the strength and efficiency of our integrated multi-boutique model Turning to Slide 19, expenses were $180.9 million for the quarter compared with $72.5 million in the second quarter of 2019. The increase in expenses was in line with projected costs related to the USAA Asset Management Company acquisition. This includes the hiring of more than 110 new employees and increases in distribution and asset-based expenses such as platform distribution, sub-administration, sub-advisory and middle-office expenses, as well as certain general administrative expenses. Non-operating expenses also increased due to higher interest cost and loss on debt extinguishment related to the refinancing and subsequent pre-payments made in the third quarter on the new term loan B facility. Importantly, note that approximately two-thirds of our expenses are variable. Additionally, the acquisition-related, restructuring and integration expenses that we experienced during the quarter are one-time and are in line with previous estimates. We were able to achieve a substantial amount of the projected synergies in the first quarter of ownership. We achieved $105 million in annual run rate synergies in the third quarter. This is faster than the guidance we provided last quarter. We expect to achieve an additional $50 million in annual synergies by 3Q 2020 for a total of $120 million. These cost synergies are net of investments in the business, which I will touch on momentarily. Lastly, as of the end of the quarter, we have spent $18 million of the projected $50 million of one-time costs, and we do not anticipate exceeding that projected amount. We expect to spend the remaining $32 million over the next 12 months. We continue to manage controllable expenses in -- to effectively drive strong, industry leading margins. It's important to note that this prudent expense management has not impaired our ability to invest in the platform. We continue to make great strides through investment and enhancing our investment support, technology, marketing and distribution capabilities to support future growth. A few examples of specific areas in which we are currently investing are the build-out of our direct member channel, the evolution of our web and mobile platform to support all of our all of our business channels and the enhancement of our digital efforts around advanced analytics and technologies. We believe the ability to effectively manage expenses while still investing in our platform is a distinct advantage of our integrated operating model. Our non-GAAP earnings EPS and margin metrics are shown on Slide 20. Adjusted net income with tax benefit increased to $0.91 per diluted share in the third quarter of 2019, up from $0.38 per share in the second quarter, an increase of 139%. ANI with tax benefit for the quarter increased 143% to $67.3 million compared with $27.7 million in the second quarter. Adjusted EBITDA was $96.3 million, up from $36.6 million in Q2 2019, an increase of $59.7 million or 163%. Adjusted EBITDA margin expanded 480 basis points from Q2 and 640 basis points from Q1 to 44.8%. With the incremental size and scale associated with the closing of the USAA Asset Management Company transaction and its integration onto our business operating platform, we expect to realize modest incremental margin expansion, in line with target levels of approximately 46%, as we recognize the remaining cost synergies and continue to make investments in the business. Turning to Slide 21, we continue to deliver against our balanced and strategically aligned capital management plan in the third quarter. We increased our cash balance to $79 million at September 30th, 2019, up from $51.5 million at December 31st, 2018. We believe this demonstrates our ability to consistently deliver strong cash generation, as evidenced by Q3 GAAP operating cash flows of $118.4 million. We ended the quarter with $1.03 billion in debt outstanding after paying down $63 million during the quarter. Subsequent to quarter-end, we have paid down additional $40 million in debt and our outstanding debt now stands at $997 million. Our net debt to pro forma EBITDA ratio at the end of the quarter was 2.4 times. This is down from 2.7 times on July 1st, 2019 at the close of the USAA. Asset Management Company transaction. In August, we announced a new common stock repurchase program authorizing the buyback of up to $15 million of Class A shares through 31, 2020, as our prior $15 million repurchase program was completed. We repurchased 300,000 shares in Q3. We believe the share buyback program demonstrates our thoughtful and proactive approach to approach to capital management, and reflects the confidence in our long-term business strategy. Turning to Slide 22, we believe we have all the tools at our disposal to drive shareholder value as we execute on our business strategy through our integrated multi-boutique business model. Our balance sheet flexibility allows us to execute accretive transactions, build the necessary scale in today's market environment and capitalize on the industry trends of consolidation and asset management. Our integrated business model provides distinct advantages that enable us to attract investment professionals and execute on our organic and inorganic growth strategy, which in turn allows us to reward our shareholders. Finally, turning to slide 23 I would like to reaffirm our guidance on the USAA Asset Management Company transaction. Our integration efforts are on track and we remain on target to achieve total annual cost synergy estimates of $120 million net of investments in the business ahead of our previously communicated timeline. We are also on target not to exceed the $50 million in one-time cost associated with the aforementioned synergies. The acquisition is expected to result in significant accretion to earnings per share. We expect EPS accretion of more than 100% in 2020, our first full year of ownership. The impact on EPS accretion is expected to be greater than 40% in 2019, which represents a partial year based on the July 1, 2019 transaction close. We are quite pleased with our Q3 results and the progress we have made following the close of the USAA Asset Management Company transaction. We believe our larger scales and more diversified business supported by our unique integrated multi-boutique business model, strong investment performance and the breadth and depth of our product offerings, positions us well for continued strong business and financial results, This concludes our prepared remarks. I'd like to turn the call back to the operator for the Q&A.

[Operator Instructions]. And our first question is from Chris Shutler from William Blair. Your line is now open.

Hey guys, good morning. Just talk about how much of the synergies actually hit the P&L in the third quarter, I think it was between $75 million and $105 million. It sounds like closer to a $105 million. But if you could get a little more granular there would be great.

Yes, good morning, it's Mike. Yeah, I think, the way we've looked at it is substantially all of the $105 million was out from the beginning of the quarter. So if you look at the margins of 44.8% for the quarter and think about the guidance we gave of 46% kind of fully synergized, you look at that and it's basically baked into the full amount in the third quarter.

Okay, great. And then I guess secondly on the solutions mandates, I know you've had a couple of quarters here of good flows. I know you can't give specific client names, but could you walk us through a couple of examples of how you're going to market with those strategies, why people chose Victory and how we should think about the incremental margins?

Hi, Chris, it's Dave. Good morning. First, let me address where we're winning those mandates. As I said in my prepared remarks, really in a number of different channels, it isn't concentrated into one channel. When you think about the margins on that business, again as we've said in our prepared remarks, they're typically going to be higher than our overall margins for our business. They're selecting our team and our products really because of the performance, because of our capabilities. We enhanced some of those capabilities with the USAA acquisition by bringing on additional people, some additional product set. It has been an area of growth. That being said, we have 6 of our 10 franchises plus the solutions platform is positive -- are positive year-to-date. So although we've highlighted it, although we've seen some recent success, let's not forget about these other asset classes that we're in and some of these other franchises that have really strong investment performance and then are quite competitive as well.

Thank you.

Thank you. Our next question is from Ken Worthington from JPMorgan. Your line is now open.

Great, thank you. I'll try this. I was hoping to get some additional metrics on USAA. If you're opening net new accounts, at what level are you opening them? And are you generating net sales through the USAA distribution channel? I know it's early and there's integration issues. So if not, maybe how does this change as the integration continues? And I guess along these lines, you talked about the 529 plans actually a number of times. Is that where you're seeing kind of the most success, at least initially from the USAA relationship?

Good morning, Ken. It's Dave. Let me start off with the number of accounts and net sales. We have not reported our net new number of accounts, we've not reported actually net sales on the direct channel. What I can tell you is, we really look at this as a building-block approach. Our first objectives were to really lock down the service and what I mean by that is really getting to the getting to the service levels that the members of USAA have -- expect. And a couple of those metrics are average speed to answer. There's a member satisfaction score that they -- that members -- that we score based on surveys. Those are at the levels -- as I said in my prepared remarks, those are at the levels that they were prior to the acquisition. So, we have reproduced what I would say is a world-class service center and call center. That was really important to us. That's the foundation for the channel. We are now pivoting toward really gaining new accounts, gaining new net sales, gaining new members. And as we progress into this quarter, into next year, we think we're going to see the benefits of that because of the foundation we've set. I would also point out that the USAA investment franchise first quarter, which is this quarter, that we've owned that franchise, is net flow positive. So, that's been very positive in a sense that we've grown that franchise to start. We have called out the 529 plan. That is not the only area we're seeing growth. There's a tremendous opportunity to grow that channel. As we've said in the past, there's potentially 12 million members that do not have an investment in our mutual funds or in our 529 plan. We're really just getting started to market to them. And as we've mentioned in the past, it's important for the current members that actually are investing in our products to make sure that we sit down with them, either live or through digital means, to make sure that their portfolios are taken care of. And there's a real opportunity there to grow the wallet share with those existing members. So to really sum it up, we look at that channel as a tremendous growth opportunity. It's going to take some time. It is early, as you've pointed out, but there's a tremendous opportunity there to grow and we really are just starting to begin tapping into that. Okay, great. Thank you very much.

Okay, great. Thank you very much.

Thank you. Our next question is from Mike Carrier from Bank of America. Your line is now open.

Hi guys, this is actually Shaun Calnan on for Mike. Based on the performance numbers on Slide 7, it appears USAA's non-fixed income AUM is underperforming. Can you talk about some of the ways you're trying to improve this?

Good morning, Shaun. You're correct in what you have pointed out. I would say -- I wouldn't use the term underperforming. There is really some room for opportunity there. We have taken a look at those strategies and have actively made some changes to the sub-advisors. We are more actively managing those portfolios. We feel pretty confident over the long term that we'll improve upon those. And as we move through the quarters and years, I think you'll start to see some of the positive performance starting to hit.

Okay, thanks. And then on the waiving of the fulcrum fees, do you guys have a revenue or a fee rate impact that you could give us on that?

Sure, it's Mike. Yeah, the waiver of the fulcrum fees was in place really for the first year post the transaction. So beginning in July of 2020 the fulcrum fees on certain USAA mutual funds will begin to accrue. We've estimated that be between 1 basis point and 2 basis points at the firm level.

Okay, thanks guys.

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

Hey, good morning guys. Question around Schwab's acquisition of USAA brokerage business. I know you guys gave some overlaps on the money market funds. But I guess taking a step back, can you just kind of give us a bigger picture overlap between USAA AUM that you've acquired versus the brokerage business that Schwab's acquired and kind of help us think about any other areas of risks from AUM retention as those assets migrate over?

Good morning, Alex. It's Dave. Let me take a step back on the brokerage channel -- the USAA brokerage channel. First, that has historically and today been an open architecture environment. All of the investments we have on that channel have been self-directed into the funds, so members have actively directed into the mutual funds. I think they've placed some value on the brand, and it's really important to note that today, and when Schwab completes their acquisition of the USAA brokerage channel -- or brokerage business, that we are paying an arm's length revenue share. So, we look at that channel really as not any more risk than any other assets we have for any client that we manage. We compete every day in an open architecture environment. We have great product, great investment performance, great client service. And I'd actually say the brand really allows some of those assets potentially to be even stickier. Some of those assets potentially have tax gains. So, there is some inertia in moving those out. So, we don't look at those as any more risk. And really, there's been a lot of discussion about this. This acquisition is so much more than the brokerage channel. It's a tremendous opportunity for our business. It's transformational and it's opened up a great new channel for us. And then I would say, lastly we think Schwab's success on the brokerage side, some of that will actually accrue to us through some of the members investing in USAA mutual funds or the 529 plan. We don't look at the Schwab acquisition of the brokerage channel as a headwind. We actually look at it as a tailwind.

Got it. Thanks for that. And then the second question just around capital priorities, when we look at the share price today and you kind of look at the free cash flow yield conversion you guys highlighted on one of the slides, it looks like the stock is trading with over 20% free cash flow yield. So maybe talk a little bit about the appetite for buybacks from here versus the pace for deleveraging and obviously you highlighted the M&A pipeline remains quite robust. So maybe a comment on what the probability of some of the deals coming through in the next kind of, call it, 12 months or so. Thanks.

So, it's Dave. We are looking at our capital management policy really to align with our overall strategy. We want to create flexibility and right now, our priorities are to delever. About 90% of our free cash flow has gone and probably will go toward delevering. We do have a small buyback program. We do have a small dividend program. We view these as ancillary parts to our strategy. We look at the buyback as a way to manage shares -- outstanding shares. So, we are going to focus on delevering. Gets to the second part of your question around M&A as I said in my prepared remarks, it is extremely busy for us and constructive. We are getting more inbound calls than we ever have. And I think what is starting to come to us is some of the opportunities where we are solving a number of issues for smaller businesses or businesses of our size where we're able to provide a world-class operating platform, allow the sellers to keep their brands, to keep their investment philosophy, develop their own portfolios and to plug into a really effective distribution network. And I think because of that, we're getting more opportunities and we think that we're going to have the opportunity to continue to do transformational acquisitions. As far as timing, we really don't have any guidance on that. If you go back and look historically, since our MBO since our MBO we've probably averaged about one transaction a year or so. I think that's a good guidance as we've guided before, but there is really no exact way to predict on when the next transaction would occur.

Okay, thanks very much.

Thank you. Our next question is from Randy Binner from B Riley. Your line is now open.

Good morning. I have a little bit of a higher level question. And it goes back to Slide 18 and just the pace of kind of the headline feed AUM decline. Understanding that it was a solid quarter and there's a lot of scale in the business, how should we expect -- based on what you know, now that you have better visibility on the USAA, assets being in-house and how solutions in fixed income production is for progressing, how should we think about that pace of sequential fee decline? I mean is it good for people to play in on a couple of basis points a quarter, just to kind of create a level? So, I'd just be interested to think about that cadence.

Good morning, Randy. It really -- as Mike said, it really depends on asset mix, client mix and a number of other factors. If we could predict where clients were going to allocate assets in a portfolio it'd be much easier. I don't think fees are increasing in the industry, as we all know. But that being said, the issue of some of our fees declining, some of it has been around the waiver of a fulcrum fee, some of it has been around the asset mix and the channel mix. Depending on how those things play out, you could see some erosion down. But that being said, there is also another scenario which could even be just as likely, that the fees stay flat. So, we really don't have any guidance on that going forward but the fee erosion is not around discounting. But what we're focused on as an organization is really around the margins. You can see this quarter the expansion of the margins by 480 basis points in a quarter where we have some slight fee erosion. It really speaks to our model. What we are confident on is the guidance of the 46% margin. And I think when we look at new products, when we look at channels, when we look at clients, we were looking at the margin threshold and not necessarily on the fee rates.

All right, that's helpful. Thank you.

Thank you. [Operator Instructions]. Our next question is from Kenneth Lee from RBC. Your line is now open.

Thanks for taking my question. In the past, you've talked about having certain focused investment categories where you could potentially see faster growth in terms of organic growth. And obviously, with the USAA Asset Management acquisition you've certainly added a number of interesting products target day, target risk, active fixed income. Just at a high level, which categories -- which asset categories do you think will be the ones where you can see potentially the highest growth opportunities looking forward across the portfolio right now?

Good morning. As I said earlier -- it's Dave. As I said earlier, we do have 6 of our 10 franchises plus our solutions platform positive year-to-date. So, it has been in a number of different asset classes. I think what you're seeing today and what we've seen this quarter is some investors are looking at where the markets are at all-time highs and they're allocating new assets into fixed income, into solutions. Some have pulled back on some of our focused asset classes -- what we've historically classified as focused asset classes, U.S. Small Cap, Mid Cap, international emerging markets. Some of the growth is really going to come from where clients feel they want to allocate. What's important to us is that we have really competitive product in the asset classes where we're less likely to be disintermediative by passive, and that's what we think we have across our portfolio of franchises where we have great U.S. Small Cap managers, U.S. Mid Cap managers, international equity, emerging markets equity and then solutions in active fixed income. Part of the USAA transaction, one of the great benefits, was the diversification of the lineup of products that we have. We now have really competitive products and solutions in active fixed income. So when clients decide to allocate there based on where we are in the market cycle, we'll be there to gather assets and continue to be growing.

Very helpful. Thank you very much.

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to David Brown for closing remarks.

Thank you for your time this morning. Tomorrow, we will be in New York attending the Bank of America Merrill Lynch Conference and will be back in New York next month at the Goldman Sachs Financial Services Conference. We look forward to seeing some of you at those events. And as always, if you have any additional questions please don't hesitate to contact Matt. Have a great day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.