Ladies and gentlemen, thank you for standing by, and welcome to the Victory Capital Holdings, Inc., Fourth Quarter 2019 Conference Call. [Operator Instructions]. I would now like to hand the conference over to Matt Dennis. Please go ahead, sir.

Good morning. Before I turn the call over to David Brown, I'd like to note that today's discussion contains 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 specific risk factors that could cause actual results to differ materially from those projected in the forward-looking statements. 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 were made. In addition to U.S. GAAP reporting, we also report certain financial measures that do not conform to generally accepted accounting principles. We believe these non-GAAP measures enhance the understanding of our business and our performance. Reconciliations between these non-GAAP measures and the most comparable GAAP measures are included in the tables that can be found in our earnings press release and in the slide presentation accompanying this call, both of which can be accessed on the Investor Relations portion of our website at ir.vcm.com. Now, it's my pleasure to turn the call over to David Brown, Chairman and CEO. David?

Thanks, Matt. Good morning, and welcome to Victory Capital's Fourth Quarter 2019 Earnings call. I'm joined today by Michael Policarpo, our President, Chief Financial and Administrative Officer as well as Matt Dennis, our Chief of Staff and Director of Investor Relations. I'm going to spend a few minutes discussing our record fourth quarter results, which I believe demonstrate the earnings power of our integrated business model. I'll also share an update on the integration of the USAA Investments acquisition. Then I will turn it over to Mike, who will review our financial results for the quarter and full year in greater detail. Following our prepared remarks, Mike, Matt and I will be available to take questions. The business overview begins on Slide 5. 2019 was a transformational year for Victory Capital in many levels. We significantly increased our size, scale, asset class, product and client diversification, while generating outstanding financial results for our shareholders and investing significantly for the future. Total AUM grew to $151.8 billion at the end of 2019. AUM increased by 188% year-over-year, reflecting acquired assets and long-term net inflows of $1.8 billion. Positive flows during the full year period were driven by net inflows into our recently acquired USAA Investments franchise as well as our Solutions Platform. Both benefited from industry trends favoring fixed income and competitively priced Solutions products. As a reminder, the margins we earn on most of our Solutions strategies are higher than our firm-wide average despite typically lower-than-average fee rates. This is due to the efficiencies gained by managing rules-based quantitative strategies on our integrated platform. After two straight quarters of positive net flows, we did experience net long-term outflows of $1.5 billion during the fourth quarter, reflecting a significant amount of client reallocations tied to strong investment performance by our franchises,…

Thanks, Dave, and good morning. The financial results review begins on Slide 13. Revenue for the quarter was $219 million, up 128% from the fourth quarter of 2018. Our average fee rate remained steady quarter-over-quarter at 58.7 basis points. Adjusted net income with tax benefit increased to $0.99 per diluted share, up 9% relative to the prior quarter, and 161% relative to the prior year. Adjusted EBITDA margins grew to 46.8%, that's an increase of 200 basis points relative to the prior quarter and 890 basis points relative to the prior year. We are pleased with our ability to quickly achieve most of the acquisition-related cost synergies and earn record high margins in the fourth quarter. We will continue to make investments in the business for the future so we are maintaining our forward guidance on our adjusted EBITDA margin of approximately 46%. This number will fluctuate slightly up or down as the timing of these investments will not be steady, but we are confident in our overall guidance moving forward. The ability to maintain these margin levels and make the necessary investments in the business further illustrate the advantages of our model and our superior execution. Moreover, our model gives us the flexibility to scale up significantly and quickly through acquisitions. At the same time, we have been able to deliver record financial results while driving measurable operating efficiencies. We are able to take advantage of our strong financial performance to reprice our Term Loan B and reduced interest expense by 75 basis points, which will increase free cash flow used for deleveraging and future strategic initiatives. We also returned $9.6 million to shareholders during the fourth quarter through share repurchases and dividends, bringing total capital return to shareholders during 2019 to $23 million. Slide 14 provides a snapshot…

[Operator Instructions]. Our first question will come from the line of Randy Binner with B. Riley.

I just wanted to ask maybe about the cadence of integrating acquisitions, I think. With people I talked to the kind of the rapid integration of USAA and the paydown of debt has people thinking ahead when there might be another acquisition. So can you remind us of what that cadence timing is?

Randy, the cadence I was referring to is really our historical pace of acquisitions, which over the last 6 years, we've averaged probably 1 or so every year or 2. We can't predict when we're going to do the next acquisition. But based on what we're seeing in the market, we're really excited. We think there's great opportunities. In my prepared remarks, I mentioned that I thought we were becoming an acquirer of choice for many in the industry. We're seeing that. So my reference to the cadence is really about what we've done historically and really the opportunity we set seeing -- going forward. The strengthening of our balance sheet, I think, allows us to really be flexible on what we can do. And as you know, our desire is to delever quickly, of course, to derisk, but also to set us up for the next transaction, given what's happening in the industry.

All right. Yes, I appreciate that. I guess, my follow-up would be that the USAA deal is quite a bit larger than the historical deal. So is it -- is your integration machine running smoothly enough that even though it's larger that the processes could move along fast enough that you might be ready like this year because if you look at that EBITDA and other metrics, it seems like you would be back to kind of a pre-USAA balance sheet situation by the end of this year?

Yes.

Your next question will come from the line of Alex Blostein with Goldman Sachs.

Couple of questions. So first, I was hoping you could frame the distribution opportunity versus -- with the USAA. So maybe how big the addressable market is there for Victory's products, sort of what percentage of the customer wallet you guys have today where they could go? And also, what type of products on the Victory side you think are most likely to gain share of assets on that platform?

Alex, it's Dave. First, on the addressable size of the USAA market, I believe, there's about 13 -- 13.5 million members. We have close to 1 million members as clients today. So I think the remaining members who don't have products with us today could be potential clients. The -- when I think about the opportunity and some of the information we shared today in the prepared remarks around some of the progress we're making, we feel really good as those are really small, but tangible results and also feel that they're really good test cases. So we're starting to accelerate that as we think about this year and the years to come. As far as products, I will say that one product that we feel is very applicable to that group is our USAA 529 plan product, where we're conversing with members around college savings, around savings for their children's education. And we have seen good results with that. So that's one example. We think that, that there's obviously other products, but that's a really good example of something that we feel we can make really good progress with.

Great. And second question just around the profitability. So the EBITDA margin is obviously quite strong, over 46% in the quarter. Just curious why 46% EBITDA margin is still the right target over the near term, given the fact that, obviously, markets have been supportive, assets are up. Understanding you guys are doing incremental investments. So maybe help us frame how much in incremental cost you expect to run through the model as you make these enhancements? And what are the kind of probabilities? And what's kind of the moving needle on potentially getting to about 46% EBITDA margin this year?

Alex, it's Mike. Yes, I think we have stated the guidance of 46%. We had a very strong quarter in Q4, as you mentioned, with respect to the markets. But we also mentioned that we're making investments in the business and some of those investments will be over time as we think about it. And we talked about the areas of the direct channel, standing up the direct platform as well as thinking about continuing to invest in the investment support for our franchises, client service, distribution and technology. But I would say, as we think about going forward, the 46%, it will be tight to that range, inclusive of those investments longer term, absent and the ability to see expanded margins will really depend on our next phase from an acquisition perspective and inorganic growth, what we can accomplish. But we're confident in the 46%, and there will be a tight range around that.

Your next question comes from the line of Ken Worthington with JPMorgan.

Maybe first on solutions. Can you talk about the pipeline there? You've had a couple of quarters now of 2020 outflows. So how does the pipeline look for solutions over, say, the next couple of quarters?

Ken, it's Dave. We're very happy with our solutions business. It has grown from where we really started it back in April 2015. We think it's going to be a bigger part of our business going forward. We have a lot of clients that have -- that we're working with around outcomes. And we think that the pipeline is strong. Sometimes, the sales cycle depends on the client and depends on the work that we're doing. So sometimes, it's a quarter, it could be multiple quarters, but we feel really good about the pipeline. We feel really good about that part of our business. And that is definitely a portion of where the industry is going, and we think we're pretty well positioned there with the team that we have and the products that we have.

Great. You mentioned the referral agreement. I was hoping you could give us a little more information in terms of how the direct account business is growing, if there's any information you can share, either growth rates or number of accounts? And I know this is starting from a standstill, but again any sense would be great. And then what does the sales cycle look like in the direct account business? So once you get a referral, how long is it taking to turn referral into account opening? I assume it's fairly short, but maybe that's wrong.

So the referral agreement, as we referenced in our prepared remarks, is in place. It's working. There's some incentivization for USAA to pass us referrals through the earn out. They've been great partners, and it's really working the way we envisioned. We shared some statistics. Again, those are just pieces of what we are doing. We're not in a position today or would not like today to share some of the more detailed numbers, but what I can share with you is that it's working the way we envisioned. I can also share that with you that we think we're really just beginning and starting to scratch the surface on those opportunities. We have started off really focusing on service, service to the members in a way that USAA members would expect. We've been able to reproduce that service, if not, expand that service and do a better job. And now we're pivoting towards working with the members and thinking about how we can grow wallet share, how we'd be a better partner for them. We have taken 300,000 calls, as I said in my prepared remarks, since July 1. That is 300,000 calls that we've been able to interact, converse, guide members with -- and it's a touch point. So we think there's a lot of opportunity in this channel. And we think our product set will work for a large group of these members that we get to interact with and we get to touch.

Your next question comes from the line of Mike Carrier with Bank of America.

First, just on the flows. So you got positive for the year and then some outflows in the fourth quarter, Dave, I think you mentioned you'd some cyclical client rebalancing. Maybe just some color based on like either historical perspective, knowing like the clients and the affiliates. Just how long does that tend to last? And then given some of the strategic focus you have with USAA solutions, do you think there's enough, maybe, momentum in those other areas to offset some of that cyclical rebalancing?

Sure. We have seen -- we saw in the fourth quarter, a heightened level of client reallocations. As I said in my prepared remarks, sometimes, those reallocations, they occur as a net outflow, but we actually have a larger economic relationship with the client. Those, if there are good outflows, that is a good outflow. That is a client that's rebalancing to their investment guidelines or in their investment policy. So we are perfectly fine with those. Those are cyclical in nature, but there's definitely been a heightened level of those, and I would attribute that to where we are in the market cycle. As far as do we have enough to offset that, I would absolutely say yes. We have a diversified product set. We have a really good investment performance and with some of the products we have that are just getting pushed into our traditional channels, the fixed income -- USAA fixed income, the solutions product and then the opportunity set in the direct side, we're encouraged by our opportunity to be in net inflows in 2020 and forward.

Okay. And then just a follow-up. So given the USAA deal and then some of the strategic focus on some of the organic growth opportunities, I guess, maybe from like a time standpoint, like how active are you guys looking for new affiliates, any particular areas? And maybe a little bit of like who's responsible for driving USAA forward versus looking for some of the new potential out there?

So let me start to say that doing acquisitions is really a part of our culture. It's part of our management team. So I would say that our management team is responsible for pushing the opportunity in USAA forward and being successful there as well as finding new opportunities from an inorganic growth perspective. As we've said before, we start off looking at inorganic growth opportunities, to say, does this opportunity make our company better. It isn't just about financial engineering, it isn't about size and scale. It starts off, does this make our company better. We also look at the product set. What I've always said and what we've always kind of communicated is that we are looking for products that work for clients in the portfolios, where they're willing to pay a fair fee for and where we think we can win, where there's less opportunity to be disintermediated by a passive product. And we use those as principles to look for opportunities. We are active, as I've said, searching for those opportunities. It is an interesting time in the industry. We have -- as I said earlier, that we have become, I believe, for many an acquirer of choice. We're mindful of what we want to do. We also are creative, and we're very well experienced. So I think the ability to make USAA successful as well as the ability to pursue inorganic growth opportunities, we're perfectly capable of doing both. And I think we're actually pursuing those in a really good way at this point.

Your next question comes from the line of Kenneth Lee with RBC Capital markets.

Just one on the net flows. Were there any kind of key redemptions within the fixed income or any other key net flows that you'd like to highlight in the quarter? And then looking forward, could you just comment on your expectations for net flows within fixed income? And whether the product offerings there are well positioned to allow you to take advantage of client demand that's being seen across the industry?

Sure, Ken. It's Mike. No significant flows to highlight in Q4 for fixed income or any of the product offerings. I think we saw activity and flows across all channels and products and franchises, but nothing significant. They've highlighted some reallocations with respect to the positive momentum in the equity markets, but nothing to point out. As far as going forward, I think we've talked a lot about now having 1/3 of our assets in high-performing fixed income products with the USAA acquisition plus our INCORE franchise. We feel like we are very well positioned in the fixed income across all strategies to continue to look at capitalizing on both the distribution within the direct channel as well as our institutional and retail and retirement distribution. Fixed income offers us a great opportunity, especially as we think about where markets are today. It just offers us another bucket to continue to capture organic growth.

Great. And just one follow-up, if I may. In terms of the investments you're going to make and that includes the digital platform, the marketing direct member channel and a couple of other efforts that you mentioned. It feels as if most of the investments are going to be within this year. Just wanted to check on terms of time frames, whether it's maybe just this year? Or could it potentially spill over into next year?

It's Dave. It's definitely in this year, but these are investments to stay competitive that will continually make as we think about moving forward. The investment in technology, the investment in data, the investment in the ability to service clients better, faster and with better transparency, those are going to be things that we're going to need to continue to do. But that being said, our model and our ability to make those investments and ability to make those investments once across our entire platform and not have redundancies is really an advantage that we see with our model as we move forward and as there is a requirement for reinvestment and evolution and change in the industry. We just think we're very well positioned to continue to make these investments at a very efficient way.

[Operator Instructions]. Your next question will come from the line of Alex Blostein with Goldman Sachs.

Just wanted to get your thoughts on the mix of capital priorities as you progress through 2020. So obviously, nice to see the loan refi. You lowered the cost by significant 75 basis points. Does that decelerate at all the need to delever and maybe use some of the excess cash towards the buyback, given the fact that the stock is still trading at quite a low multiple, both on earnings and EBITDA? So just some thoughts around the pace of deleveraging from here and the buyback?

Alex, it's Dave. I'd start off saying, I agree with you on your analysis of the stock. But that being said, our goal is to create the balance sheet, where we have the most flexibility to execute our strategic growth plan. And today, that is around delevering. We have a small, as you know, buyback program and a small dividend program. I don't see those programs changing in the near future. We think the best use of our capital is to delever to create a balance sheet that gives us the most flexibility to go out and do future acquisitions.

Your next question will come from the line of Michael Cyprys with Morgan Stanley.

Just on the -- as you think about your operating platform today, largely outsourced model, just thinking around capacity to do a deal from an operating platform perspective, so I guess with the more outsourced model that you have, I guess, how much more an assets could you bolt-on, say, in similar asset classes to what you have today without meaningfully changing the expense and margin profile of the company?

Mike, it's Mike. Yes, I think we've talked a lot about the model that we have and the integrated operating platform. That does allow us with the outsourced model that we have to scale up pretty quickly. So with that said, there really isn't an asset level that we say we cannot handle. We talk a lot about the types of assets that we do and the complexity of the business. As you said, if we are looking at asset classes that we already trade, settle, have compliance programs around, those are very easy for us to kind of execute upon and to integrate, where we start to see the complexity is that there's different asset classes and/or different geographies. And those are things that we would take slowly to walk through, but have the platform and the experience to be able to leverage. So I think the answer really comes down to, we can continue based on the business model we have where we're making the investments once and it's a singular platform to continue to scale.

Should I take away from that, if the acquisition is similar asset classes and we should expect a similar EBITDA, 46% sort of margin, assuming it's similar to what you have today in terms of asset classes?

It's Dave. I think each acquisition is different. It depends on a lot of different variables. I think what you should take away is that we have been able to grow our business pretty significantly over the last few years through acquisitions and really execute the same business model. As we look forward, I don't see that opportunity set changing. I think our platform is built to grow, also the outsourcing relationships we have. We have great partners. We also had built a really strong internal platform as well to manage the business. So going forward, be it in the same asset classes, be it in new asset classes or new geographies, we feel that we're well positioned to grow through acquisition. And we don't really see any limits today within the universe that we're looking at.

Okay, great. And then just a follow-up question, maybe just on the sales side of things. Pace of gross sales looked like it was down a little bit in the quarter. Just curious to any color you could share around the decline there? And as you look forward from here, I guess, where from a sales perspective, do you think you're most underpenetrated from, say, a channel or asset class perspective?

I wouldn't take anything from the quarter on gross sales, quarter-over-quarter on the reduction. Either it was cyclical or -- I don't think there's anything to take from there. I think we're pretty well penetrated in the markets that we want to be in around our institutional, retail and retirement side. We're working on the direct channel, obviously. But I don't think there's a market that I'd point out to say that we're really focusing on to get more penetration in.

And we have no further questions at this time. I'll turn the conference back over to management for any closing remarks.

Thank you for participating in today's call. We look forward to providing you with ongoing updates as we continue to execute on our strategy, and I hope all of you have a wonderful day. Thank you.

Ladies and gentlemen, this concludes today's call. Thank you all for joining, and you may now disconnect.