Good day, ladies and gentlemen and thank you for standing by and welcome to the Victory Capital Second Quarter 2019 Earnings Call. At this time all participants are in a listen-only mode. [Operator Instructions] Now it's my pleasure to turn the call to Matt Dennis, Director of Investor Relations. You may begin.

Thank you, Carmen. 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 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 the tables that can be found in our 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'll turn the call over to David Brown, Chairman and CEO.

Thank you, Matt. Good morning, and welcome to Victory Capital's second quarter 2019 earnings call. I'm joined today by Mike Policarpo, our President, Chief Financial and Administrative Officer, as well as Matt Dennis, our Director of Investor Relations. I’m going to spend a few minutes discussing our business results, the USAA Asset Management Company acquisition, as well as our decision to initiate a quarterly cash dividend, which we believe is a meaningful development for our shareholders. 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. We will start on Slide 5. I’m pleased to report that our investment and financial results were excellent in the second quarter. AUM for Victory Capital grew to $64.1 billion as of June 30, 2019. AUM as of July 31, 2019 inclusive of the USAA Asset Management Company acquisition was a $147.8 billion. Additionally, net flows were positive at $3.7 billion for the quarter and $2.6 billion through the first six months of the year. Gross flows were robust for the quarter at $7.5 billion. I’m pleased to report that as of today net flows are positive for this quarter for the combined business as well. We also announced the initiation of a quarterly cash dividend. The first dividend of $0.05 per share will be payable on September 25, 2019 to shareholders of record on September 10, 2019. The decision by our Board of Directors to initiate a dividend exemplifies the confidence we have in the strength and durability of our business and underscores our commitment to enhancing shareholder value. It also adds another ancillary component to our capital allocation strategy, while maintaining a primary focus on creating the capital flexibility needed to…

Thanks, Dave, and good morning. The financial results review begins on Slide 16. Victory Capital achieved excellent financial results in the second quarter of 2019. Total AUM increased to $64.1 billion as of June 30, 2019. Net flows were positive for the quarter at $3.7 billion and year-to-date through the end of June at $2.6 billion. We're continuing to see solid momentum in the third quarter. As Dave said earlier, net flows for the combined business are currently positive for the third quarter. Revenue increased 4.5% to $91.4 million, which includes the impact of the adoption of ASU 2014-09 on January 1, 2019. Revenue was impacted by increased AUM, our overall asset mix in one extra day in the quarter. Revenue realization declined slightly to 61 basis points relative to the prior quarter based on the quarters activity, which included the funding of some lower fee mandates in certain channels. As I’ve stated in the past, our fees vary based on channels and products, but all meet our margin thresholds. Adjusted net income with tax benefit increased 9.5% to $27.7 million or $0.38 per share relative to the prior quarter. Adjusted EBITDA margins grew to 40%, up from 38.4% in the prior quarter. We believe this solid growth and earnings and the achievement on industry-leading margins demonstrate the power of our integrated model to deliver strong results, while driving operating efficiencies. Note that we're able to achieve these efficiencies, while continuing to invest in areas to support our future growth. In the capital management front, we ended the quarter with $280 million of debt outstanding. On July 1, 2019 at the close of the USAA Asset Management Company acquisition, we entered into a new $1.1 billion covenant-light 7-year term loan, which is priced at LIBOR plus 325 basis points. The…

Thank you. [Operator Instructions] Our first question is from Robert Lee with KBW. Your line is open.

Great. Thanks. Thanks for taking my questions. Maybe just going to the -- is it possible to give little bit more color maybe on kind of the more recent flows and you mentioned there positive quarter to date, but are you seeing a similar mix and any kind of specifics or color on the pipeline that you have that as we look further out into the quarter or maybe towards the end of the year, kind of get a sense of their sustainability?

Hi. It's Dave. First let me say that we're extremely happy with the evolution of our flow trajectory. I mean being positive in the second quarter, positive year-to-date and then positive through today in the third quarter are something that we're really proud of. Our flow trajectory is really supported by the great investment performance we have, the new channel and channels that we've opened up, the product set. And really what we see from a flow perspective in this quarter pretty well diversified just as it's been well diversified. As Mike said, we had five of our nine franchises plus the solutions platform, all positive. And we really see that as we look over the horizon in the third and quarter in the rest of the year as kind of stay in the same. Nothing really exchange. As Mike said, we are seeing strong gross sales, redemptions has slowed. And we really think all of that it's just differentiated and a real testament to really our model and really the culture that we have.

Okay. And then maybe a capital management question. I know post deal you’ve indicated you already paid down $20 million, but as we look out over the next 18 months or so, do you have maybe specific target or range where you kind of want to see your debt to EBITDA ratio get down to -- so with the dividend, obviously some minor share buyback. Is there any reason to expect that the lion share of your capital generation at least over the next 18 months or so is going to continue be focused on a debt reduction?

Yes. Let me be clear. I mean, our primary use of cash is going to be to delever. It's been our goal to create flexibility in our balance sheet to continue with acquisitions that participate in the consolidation of the industry. So nothing has changed with the announcement of the dividend, nothing has changed with our buyback program. The primary use of cash is going to be to pay down debt. I think good indication is we’ve already pay down $20 million within the first six weeks since we closed and we are continuing to really have that focus on delevering.

Great. Thanks for taking my questions.

Thank you. Our next question comes from Randy Binner with B. Riley FBR. Your line is open.

Hey, good morning, everyone. This is Ryan Aceto on for Randy. Just looking to fee as a percent of AUM, it's been drifting down a little bit and I know the solutions business has become a bigger part of the pie. Looking toward the USAA integration, could you guys dimension out where you expect fee income to kind of level out, or any color you have going forward there with the new assets coming onboard?

Hey, Ryan. It's Mike. Good morning. Yes, so I think maybe just to reiterate, so I think our fees are stable. There's really no significant price pressure that we've experienced. We’ve said it, our asset and client mix is really the driver of kind of the output of our 61 basis points. And that’s really kind of ebbs and flows based on where we are seeing activity, but we're very mindful of our margins. And as we said our margins expanded in the second quarter. As we disclosed previously, the average basis points on the USAA products are right in the same 60 to 61 basis point range. So when you look at where the legacy Victory business is, adding on the USAA business, we believe it will remain relatively stable in that ZIP code.

Great. Thanks for that. And then, I guess one more on USAA. Have you guys started opening up the USAA to Victory products and then any initial color you guys could have on the first, call, month and a half of cross-selling initiatives if you have had that?

Its Dave. First on the opening up the USAA channel to Victory products, the USAA channel today, the direct channel is really focused on the USAA products. Our sales and service center is taking calls and their advising members that are doing portfolio planning session with members and they’re really having discussions around the USAA product. We're very happy with the progress we've made. As we said in our prepared remarks, the USAA direct channel is going to be a wonderful channel for us and we are as happy as we could be with what's happening there and we are looking forward to reporting our results quarterly as we go forward on some of the progress we've made.

Great. Thank you.

Thank you. Our next question comes from Chris Shutler with William Blair. Your line is open.

Hey, guys. Good morning. Can you give us some more detail on the big mandate wins in the solutions in the quarter and how those came together multi-asset global dividend and thematic areas aren't ones I think that we’ve heard you talk a whole lot about in the past? Thanks.

Hi, Chris. It's Dave. We’ve had a number of larger mandates in our pipeline for a while, not just specifically in solutions I think in some of our other franchises. As we’ve talked about and as I talked about today in our prepared remarks, the solutions business is going to be an important part of our business going forward. It is where the industry is going, some of the capabilities we’ve acquired, some we have build over time. We focused a lot of time on VictoryShares over the last year. So VictoryShares is just one component of the solutions platform. Really don't -- we don't disclose specific individual client mandate wins, but I would just remind you within the second quarter we didn't just put on assets in solutions. We had other franchises that were positive and I think it was five of our nine plus solutions. So it's really a mix of those franchises and the solutions.

Okay. Thanks, Dave. And then I also want to ask about USAA and some of the wealth management business to Schwab, which I know touched on. But for USAA members, do you think that creates any potential confusion between kind of what is Victory and what is Schwab. I mean, if somebody calls up the call center they say they’ve a question about investments, how will USAA ensure that they get routed to the right place?

USAA is doing a great job educating their members. I think it's pretty clear to members that Charles Schwab purchased the Wealth Management business and anybody who has an interest in wealth management would be directed to Charles Schwab today to USAA until at least door closes. And then anybody that's interested in USAA mutual funds or a 529 plan will be directed to us. They will question their members to a point where they know where to direct them. USAA is committed into choice -- committed to choices for their members and they have even as much as the welcome letter and announcing the Charles Schwab acquisition they put our logo and Charles Schwab's logo side-by-side and really did a good job explaining it. So we are concerned about a member calling and not knowing where to go or being confused because I think USAA has done a really good job with it and will continue to enhance it. And like I said, we are live, we are up and running, we are getting lots of transfers and calls direct to our sales and service center and its working exactly how we envisioned.

Okay. Thank you.

Thank you. Our next question comes from Kenneth Lee with RBC Capital.

Hi. Good morning and thanks for taking my question. Just a little bit -- a follow-up on the USAA. Have you given -- is there an updated estimate in terms of pro forma adjusted EBITDA guidance post integration?

Hey, Ken. It's Mike. Yes, I think we’ve really kind of gone out and kind of affirmed, kind of the levels that we had provided previously. So we talked about kind of affirming the $120 million cost synergy takeout when you look at the as well as the timing of those and execution of those, we are highly confident in the execution and that was really $75 million at closing, an incremental $25 million by year-end, and then the full $120 million really within 12 to 15 months of close. So putting it into kind of the Q2, Q3 timeframe next year. So our execution on that has gone very well. I think looking at the level of assets as of the end of July at $147.8 billion. We can say that we acquired about $81 billion of assets with USAA transaction, so right in line with what our expectations were. And we've also kind of confirm that at the kind of full-scale, we expect to be in the mid-40s from an EBITDA margin perspective. So I think really from our perspective we’ve really just kind of affirm the numbers that we’ve gone out with them. We are highly confident in those.

Great. That’s helpful. And just one follow-up, if I can. Just following up on the prepared remarks regarding VictoryShares, it sounds like there were some kind of reallocation as well, but maybe you could just step back and just give us some color and how would you characterize the current demand and competitive environment for just smart beta ETFs in general, and what VictoryShares is facing there? Thanks.

It's Dave. I think the environment for smart beta ETFs over the last two years has increased as we’ve seen more competitors come into the space. That being said, we have really, really good investment performance on a number of our ETFs as I’ve said in my prepared remarks. We think some of the outflows we’ve seen in the first two quarters of this year really result of the fourth quarter of 2018 disruption. And I think the outlook as I said is, we think that we will turn to a more positive flow per trajectory in the second half of the year. But no doubt the smart beta ETF environment is more competitive than it's -- then really it's ever been and has increased that competitiveness over the last couple of years.

Great. That’s helpful. Thank you very much.

Thank you. Our next question comes from Ken Worthington with J.P. Morgan.

Hi. Good morning. I’m going to keep going on the USAA acquisition. So, Victory has purchased the right to sell USAA and Victory Mutual Funds in a mutual fund only account. Schwab seems to have similar rights to sell brokerage accounts where they can purchase both USAA and Victory Mutual Funds as you guys highlighted, but like thousands of other mutual funds and ETFs and they have like stock capabilities and bond capabilities as well. So once Schwab gets up and running, how will Victory pitch the value proposition for USAA members to open a mutual fund only account with Victory versus the value proposition for USAA members to open up a Schwab account, which would seem to have the same capabilities, but much more. Does that make sense as a question?

Sure. Hi, Ken. It's Dave. Let me start off and talk about the brokerage channel. Today it's fully open architecture and all of the members have actively selected their investments. Three quarters of the assets, as I said, are self-directed. And we actually believe that the brand needs a lot and to the member and if you look at the history of the channel the brand support -- that supports that the brand matters. I think when you look at a member choosing do I want to open up a brokerage account or do I want to go direct to Victory Capital, one of the things that we believe is that there are different types of members seeking different types of investments. And Schwab has purchased the Wealth Management business. We believe Schwab is going to pursue wealth management clients, we are not necessarily. We are working with members who want live sales and service advice where they can up and get portfolio planning advice, they can call up and get help with their transaction and there isn't a minimum amount of investment to do that. We do have the USAA brand and we do have it on our mutual funds, in our 529. So we really think there's different parts of the membership population and the way we really look at it is, there's a lane of success that we think we can carve out and have carved out. And we think there's a lane of success that Schwab will be able to carve out. And it also just reminds you that if a member does go on to the brokerage platform, they can still buy a USAA mutual fund, they can still buy a USAA ETF, which will -- the benefits will accrue to us. We are paying an arm's length revenue platform, revenue share today to USAA and that will go over to Charles Schwab. And we think that you put all that together and we think that we are going to do very well within the USAA membership, inclusive of Schwab coming in and owning the brokerage channel.

Okay, great. Thank you. And I will just maybe follow-up on that. Have you been opening up new mutual fund accounts since the platform was reopened on a net basis? I know it's really early and you guys have just started your marketing and you’re up and live on the website. But I kind of feel like there's a 6 to 9-month window before Schwab gets it shot to start marketing as well again. So early days are you opening up net new accounts?

Absolutely. As I said in my prepared remarks, we've taken close to 80,000 calls. We’ve touched three quarters of a million members through our welcome letter. We're absolutely opening up net new accounts. And I would also comment that we think that -- that the pursuit of members is really more than the brand from a Schwab perspective. We think it's a connection to the membership. We think it's around the product offering. We think it's representation on the digital assets. We think it's the client segmenting. So like I said, I think that we're going to be very successful in the channel with Schwab. And then don't forget Schwab is a very good partner of our and we are going to work very closely with Schwab to make it a win-win relationship between members, between Schwab and between Victory and ultimately USAA.

Okay, great. Thank you very much.

Thank you. Our next question is from Michael Cyprys with Morgan Stanley.

Hey, good morning. Thanks for taking the question. Just wanted to dig in a little bit on the fee rate. I was hoping you could give a little bit more color around the fee rate at which the $7.5 billion of gross sales came in during the quarter compared to the $3.8 billion or so of redemption. How that stacks up relative to 61 basis point average fee rate that you guys reported? We’ve seen the inflows are coming in at meaningfully lower fee rates. Just hoping you could help flush that out and how you see that trajecting here in the third quarter, which you commented? We are seeing similar flow pattern, but also an inflows for another quarter?

Mike, it's Mike. We -- so we don't give out kind of as you know the kind of rates of wins and losses because there's a lot of activity that we see. We did mention that in the second quarter we saw asset classes that had inflows included solutions, it included fixed income, it included mid-cap equities from a domestic perspective as well as global non-U.S. So there's a pretty good mix as you know our business for we’ve got a very well diversified product set offering. The domestic equity and the non-U.S equity products have higher fees. And then the fixed income and the solutions product tend to have lower fees. And again it also will matter channel by channel and client by clients. As we think about the progress we've made through the beginning of the third quarter, we really continue to see the flows coming into the asset classes that we’ve kind of said will be the growers of the future, that non-U.S equities, small cap, mid-cap as well as solutions and fixed income. Having a stronger, more diversified fixed-income capability and offering is powerful for us, not only just within the member channel, but also being able to get out and have our institutional and intermediary teams get the word out on the USAA franchise. So we are seeing success really across the board, it's not one or two mandates. So, again, you net it altogether and we come out to 61 basis points on USAA businesses in that range as well when we layer that on. And then we are focused on the margins. The way our business model works and the way that our platform works, we believe that all of the products that that we have, whether it's a lower basis point product than our 61 or higher basis point product than the 61, our additive to our overall margins, and that's really how we think about it.

Great. Thanks. And just maybe a follow-up on some of the flows. I think on the small cap side, the gross sales have softened a bit this quarter $700 million relative to the past couple of quarters. Any color you could share on that how much of that softness that explain about any sort of hard or soft cap on the funds? And then just maybe on the fixed income side, the gross sales you had here $500 million on fixed income strong as that we’ve seen in some time. Any color you could share on what particular investment strategies on the fixed income side standout that are resonating which franchises? And then just lastly on the large cap side, I remember about a year-ago we had some redemption headwinds with diversified large cap strategy. I was just hoping you could update us on that. You got about $4 billion AUM on the large cap side. How much of that do you see as a headwind from here?

So it's Dave, Mike. On the small cap side, nothing really to note. We still have some really good small cap products that are open, for example, RS Small Cap Growth. We've seen some momentum. So there's really nothing to note there. I think from a fixed income perspective, just generally speaking, its INCORE. And I think the strength you’ve seen there is really all through INCORE as you look further out in the third quarter beyond you will see the USAA fixed income strategies come on line, how excited we are about those and the excellent investment performance. And then on the U.S Large Cap Side, I think Mike said in his prepared remarks, the redemptions have slowed. Of course, it's a challenging asset class, but there are still winners in that asset class and we have good investment performance across the board and we don't really see any material erosion in that asset class either.

Great. Thank you.

Thank you. [Operator Instructions] And we have a follow-up from Robert Lee with KBW. Your line is open.

Great. Thanks for taking my follow-up. Just a quick one on -- I’m just curious, I know -- again, very early days, and Mike, you did mention about trying to get the -- and Dave, sorry to get the USAA fixed income funds on other platform. Just given that you usually have to go through due diligence process and go through gatekeepers and all that. I mean, what are your own expectations for when you expect to start seeing kind of that, let's call it, cross-sell benefit come through on the -- as you introduce USAA products into your existing channels?

It's Dave. As I said in my prepared remarks, that is a longer sales cycle, but we have done this a few times and we've hit the ground running. We’ve had time between announce and close to have our sales force educated on these products and talk to our partners. So there's probably an accelerated timeline than you would have just typically. That being said, it's probably as we move through the year, you will start to see it impact our numbers more, and then clearly as you move into 2020. But we’ve seen some small wins already in the third quarter, and so we are quite happy about it and the strategies have great investment performance, the funds have scale. And those are two important components to get shelf space with partners that we do business with. So we’re pretty bullish about it. And as we move through the year, I think you will see more and more of an impact in our numbers.

Great. Thanks for taking my follow-up.

Thank you. And we’ve a question from the line of Mike Carrier with Bank of America. Your line is open.

Good morning, guys. Maybe first question just on the flows in the quarter. I know you gave some detail on the products, but if we look over the last couple of quarters, you were running at a modest outflows and obviously like a big quarter in terms of the inflows. So just wanted to get maybe some color, on -- more on the distribution side in terms of like the client channels, like where you're seeing those wins. Was it on the institutional? Was it in new platforms? Just any context given, I would say the magnitude of the shift that we're seeing?

Yes, it's Dave. You know, we’ve been saying for a while that we thought from a distribution and flow perspective that we will turn the corner. And I think we have turned the corner to have positive flows in the second quarter, which now gives us positive flows year-to-date, positive flows as of today for the third quarter, positive flows year-to-date. It is across the board. We have channels that have longer sales cycles like sub-advisor. We are seeing some of our retirement channels and clients, strong flows there, but I can't say that it's one specific channel. I do think it's broader than that. And I think when you look at our business and you look at the investment performance, you look at the product set, and now when you look at the direct channel and you look at some of the other dynamics happening, I think we're very well-positioned to grow our business organically with obviously ebb and flow in quarter-to-quarter. But when you look at it over a longer period of time, as I've said, we've said pretty consistently, we think we will be an organic grower.

Okay. That's helpful. And then just a follow-up, and thanks for all the color on the USAA transaction and then the relationship with Schwab. So from the get-go, you guys called out like $10 billion or so, like in the managed products that were on the brokerage platform. Just curious, like, how do you guys think about maybe the stickiness of those assets and the change to the accretion, if they do like leave over time? And then the second part, just away for the managed account products, so call it the other $74 billion or so, is that mostly on like the direct channel or the direct platform or is there also some of those assets that are on the brokerage side?

It's Dave. I think, yes, two questions there. One was on the managed money and whether it was at risk. And let me start there. Let me actually start and just make sure that there's a good understanding of what these assets are. They’re proprietary USAA Wealth Management offering, that's really made up depending on the offering of either USAA funds in a portion or in total as the underlying investments. It's really important to note that the members, the clients have actively selected to be in products either made up of USAA funds or not made up of USAA funds. So they've actively selected that. The assets in these products, some of them are taxable, some of them are not taxable, and some of them have embedded gains. And as I think we've made clear, we’ve a 2-year assurance that the assets will stay from close and that's in the contract. We pay an arm's length revenue share fee today to USAA for those assets, we will pay that to Schwab when the transaction closes. And we really feel that those assets are pretty secure because of the brand which is important and that the members have actively chosen to be in those funds, and they're not 100%, the $10 billion. But the total program is not 100% USAA funds. And then on top of that, as I said, we plan to partner with Schwab on this and other things. I think that it can be a real win-win for us, Schwab and then for the members. As far as the other assets, think of those as obviously brokerage direct and then there's some third-party assets that make up the remaining total assets.

Okay. Thanks a lot.

And the majority of those are direct.

Got it.

Thank you. And we have time for one more question, and Alex Blostein from Goldman Sachs. Your line is open.

Good morning. This is actually Ryan Bailey on behalf of Alex. I wanted to come back to capital just really quickly. I was wondering if you could help us think about the methodology that you came up with to set the dividend payout rate and then how we should think about growth in the dividend over time?

It's Dave. I think we reviewed with our Board a number of different components of our capital structure. And we've done that for a few quarters and came up with the $0.05 per share. We don't disclose the methodology or we won't disclose the methodology. I think as you look forward, we will continue to evaluate it every quarter and we will look at our overall capital position. We look at our cash balance, we look at our primary use of cash and deleveraging. And we will put that all together and really set the strategy every quarter.

Got it. Thank you.

Thank you. And this concludes our Q&A session for today. I would like to turn the call back to David Brown for his final remarks.

Thank you. Thanks for taking the time to participate in our call. We really appreciate your interest in Victory Capital, and we're looking forward to keeping you updated on our progress. Next month we will be meeting with investors at the Barclays Financial Services Conference in New York and hope to see some of you there. As always, if you’ve any additional questions, please don't hesitate to contact Matt, and have a great day.

And with that, ladies and gentlemen, we thank you for participating in today’s program. You may all disconnect. Have a wonderful day.