Victory Capital Holdings Inc

NASDAQ:VCTR

Earnings Call Transcript 2021-Q1

[Operator]

Welcome to the Victory Capital First Quarter 2021 Earnings Conference Call. [Operator Instructions]

I will now turn the call over to Matt Dennis, Chief of Staff and Director of Investor Relations. Please go ahead, Mr. Dennis.

[Matthew Dennis, executive]

Thank you, and good morning. Before I turn the call over to David Brown, I would like to remind you that during today's conference call, we may make a number of forward-looking statements. Please note that Victory Capital's actual results may differ materially from these statements. Please refer to our SEC filings for a list of some of the risk factors that may cause actual results to differ materially from those expressed on today's call. Victory Capital assumes no duty and does not undertake any obligation to update any forward-looking statements.

Our press release that was issued after the market closed yesterday disclosed both GAAP and non-GAAP financial results. We believe the non-GAAP measures enhance the understanding of our business and our performance. Reconciliations between these non-GAAP measures and the most comparable GAAP measures are included in tables that can be found in our earnings press release and in the slide presentation accompanying this call, both of which are available on the Investor Relations portion of our website at ir.vcm.com.

It's now my pleasure to turn the call over to David Brown, Chairman and CEO. David?

[David Brown, executive]

Thank you, Matt. Good morning, and welcome to Victory Capital's First Quarter 2021 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'll start by providing an overview of the strong operating and investment performance we achieved to start the new year. Then I will expand on our improving organic growth outlook with some detailed information. After that, I will turn it over to Michael, who will review our first quarter financial results in greater depth. Following our prepared remarks, Michael, Matt and I will be available to take your questions.

The business overview begins on Slide 5. Victory Capital began 2021 much the same way we ended 2020. Net asset flows continued their improving trajectory that began in the middle of last year. Investment excellence persisted with the vast majority of our assets under management continuing to outperform respective benchmarks and achieve very competitive rankings relative to their applicable peer groups, while the efficiency of our platform also resulted in robust profit margins and record earnings for our shareholders.

We ended the quarter with total AUM of $154.3 billion as well as long-term AUM of $151 billion, both of which were records. Net flows improved again for the quarter as well as during the quarter, culminating in positive net flows in the month of March. We maintained the momentum we had in March thus far in the second quarter as of today's call. Revenues improved quarter-over-quarter by 6% on the higher AUM and improving average fee rate, which was the highest realized average fee rate in more than a year. Adjusted earnings per share included tax benefit, rose in line with revenues and also grew by 6%.

Moreover, adjusted EBITDA margin came in above 50% for the third quarter in a row. Consistent with our stated capital allocation strategy, we deployed most of our excess cash flow to further reducing debt and paid down an additional $50 million during the first quarter, reducing our net debt to annualized adjusted EBITDA leverage ratio to 1.6x. Our ancillary uses of excess cash flow included raising the quarterly dividend and continuing to repurchase shares in the open market. With the $0.12 per share cash dividend declared yesterday, we've increased our cash dividend by 140% since this time last year.

Turning to Page 6. Investment performance continued to be excellent, which is a testament to our unique operating platform and culture. The majority of AUM has outperformed benchmarks for all standard measurement periods and the majority of our strategies have also outpaced their respective benchmarks on an equal weighted basis. We provide our investment franchises with a centralized and fully integrated operating platform, featuring best-in-class tools, which enables our investment professionals to focus their time on managing assets and servicing clients.

With the closing of our most recent acquisition, THB Asset Management, on March 1, we added their 5-star rated THB Micro Cap Fund to our lineup. Our total number of mutual funds and ETFs with 4 or 5-star ratings by Morningstar grew to 45 at the end of the quarter. Together, these 45 products represent 62% of our AUM in mutual fund and ETF wrappers.

Moving to Slide 8, I'd like to provide some color on why we are optimistic about our long-term outlook for organic growth. I will start with our recent acquisition of THB and our investment in Alderwood. Between the various strategies offered by THB, we have approximately $15 billion of open capacity. These are micro, small and mid-cap strategies in the U.S. and international markets. These are capacity constrained asset classes where active management is relevant and with THB's exceptional long-term investment track records and the added feature of the long history of ESG integration we anticipate steadily filling that available capacity over time.

In September of 2020, we made our strategic investment in Alderwood, which provided us with an entry into alternatives. Alderwood received formal FCA authorization in the first quarter and has plans to begin fundraising for their initial fund in the second half of this year. We'll be assisting Alderwood in the fundraising and will be including their net flows. As a reminder, Alderwood will be charging fees similar to other private closed end funds. Alderwood is targeting to size their initial fund to be between $1 million and $2 billion with a total life of 10 years.

Next, we are well positioned to provide investors with highly rated products built for the current and quickly evolving interest rate environment. One example is our 5-star rated Refinitiv Lipper Award winning floating rate fund that has been accumulating assets with strong positive net flows and currently is approximately $1.3 billion in AUM. This product is selling very well across a number of large intermediary platforms in RIAs. We expect this positive momentum to continue given many investors' views on the future direction of interest rates.

Our high-yield fund is also rated 5 stars and is a recent Refinitiv Lipper Award winner. Our Market Neutral Income Fund, which is managed by our solutions team, has consistently been one of our top-performing products from an organic growth standpoint over the past several quarters. This product is unique and generates an attractive income yield for investors without using bonds. As investors reevaluate their traditional 60/40 portfolios, they are attracted to differentiated income projects such as this, which is currently the third best-selling Market Neutral Income Fund in the country according to Morningstar.

It offers an attractive yield, low volatility and risk characteristics similar to traditional fixed income products with low correlation to both the equity and bond markets. On top of that, it has a lower fee than many traditional fixed income products and provides a majority of its income in the form of qualified dividend income. With the rotation from growth to value as well as into mid- and smaller capitalization stocks, we have a host of highly rated products and strategies that could benefit from a continuation of this rotation and that are managed by a number of our franchises. Those franchises are Sycamore, Integrity and THB to name a few.

Additionally, active global and international strategies are also in demand with investors. We have a sizable amount of open capacity in these asset classes, supported by high-performing investment franchises with RS and Trivalent to highlight 2 of them. Our VictoryShares ETF platform is net flow positive for the second quarter in a row. With the continued industry-wide momentum in ETFs and now with the emergence of thematic ETFs, we believe we are well positioned to be a beneficiary of this trend.

Our CDC and CSB ETFs are 5-star rated and provide unique investment characteristics and both are resonating well with clients. We have also had success with our Nasdaq Next 50 product, QQQN, which was launched in September of last year. Lastly, our new VTRN product is a good example of our thematic capability with its focus on veterans. This product is just being rolled out with a new digital marketing campaign and is very applicable to our direct investor client base.

Lastly, as we look out beyond the next several months, we have a number of emerging opportunities to drive organic growth in fixed income products, managed by our USAA Investments franchise. These include our newly launched SMAs and 2 active fixed income ETFs that have excellent investment performance and are highly rated. Our SMAs are now live at Fidelity and Schwab, and we are in advanced discussions for these offerings with top-tier wrap sponsors. We are also winning excellent shelf space for our USAA fixed income mutual funds, which is building the pipeline for the future. I will review this point in more detail later in the presentation.

Turning to Slide 9, we present a different view with specific in demand asset classes coupled with franchise that managed products within those asset classes. As you can see, we have multiple franchises with multiple products in most of these asset classes. If market leadership continues to rotate from momentum and in the companies with strong fundamentals in sectors poised for earnings growth, as well as into capacity constrained asset classes that make up a relatively larger portion of our current AUM and opportunity, it bodes well for not only continued strong investment performance, but also enhances our potential to further accelerate our improving net flow trajectory.

Turning to Slide 10. Our institutional book of won but not yet funded mandates continues to grow. While a few mandates did fund since the start of this year, we anticipate the funding of new mandates will accelerate as we progress through the year. These wins have been achieved by many of our franchises, and they have been awarded to us by a well-diversified set of clients across our institutional footprint. To give you an example of the solid positioning of our institutional strategies, we had 15 different strategies that ranked in the top quartile by eVestment over both the 3 and 5-year periods ending March 31. Given the aforementioned, we are optimistic that we will continue to secure additional new mandates as the year progresses.

Starting on Slide 11, I will review our direct investor business and then our USAA Investments franchise. We've increased the products available to our direct investors to 56 mutual funds, which were made up of both USAA and Victory mutual funds. We also have launched a digital portfolio planner that offers investors a self-guided tool that can assist them in their financial planning. We also now offer a customized fixed income estimate to this client base. Our referral agreement with USAA continues to produce new account registrations, many of which have automatic investment plans associated with them, which are beginning to bring in meaningful asset flows. As a reminder, the direct channel was closed prior to our acquisition, so we are very pleased with the traction we are beginning to see.

Our 529 College Savings Plan remains net flow positive since the close of the USAA acquisition, and AUM has reached approximately $5 billion. Many of our 529 plan participants utilize the automatic investment plan option as well, which brings in a steady flow of assets. Lastly, the fixed income products managed by our USAA Investments franchise continue to post excellent investment performance, and we've been accelerating the reach of these products with our distribution partners, which is covered on Slide 12.

Our retail retirement and national accounts distribution teams have made great progress in winning new shelf space for the fixed income products managed by our USAA Investments franchise. You have heard us refer to this as installing the distribution pipes that will help drive future organic growth in these products. 100% of these fixed income products outperformed their respective benchmarks for the 1-year period and 94% of them outperformed for the 3, 5 and 10-year periods, creating meaningful tailwinds for this initiative.

Our progress was somewhat impeded last year by COVID as approving new product placements took a back seat with many of our intermediary partners who turned their focus to navigating the pandemic. That situation has evolved and a more normalized environment is beginning to emerge. We have significantly expanded the depth and breadth of our distribution reach for these products with new and expanded relationships at a very well diversified set of leading defined contribution and national retail platforms. Many of them are also adding these products to their respective recommended lists.

We have executed brand-new agreements with Ameriprise, Ascensus, ADP, Broadridge, Lincoln Retirement, American Funds, TIAA, Principal and Empower, which just acquired MassMutual's retirement plan business, where we also had a new agreement. The same goes for Principal Retirement, which just acquired Wells Fargo Retirement, where we also had secured a new agreement. On the retail side of Prudential, we now have multiple products on their PRUChoice platform. We also recently added Morningstar, which came with the benefit of being including the Morningstar's fiduciary product offered through Voya.

At Voya Retirement, we achieved inclusion on their closed menu product. We have likewise secured space on Transamerica's closed menu product, which is similar to a focus list. RBC Wealth Management added the VictoryShares USAA active fixed income ETFs and Fidelity Direct added 15 USAA funds to their Fidelity personal investors channel, no transaction fee platform.

Edward Jones added multiple USAA mutual funds, including the USAA intermediate term and short-term bond funds through their approved and research list as well as their guided solution fund and flex advisory platform. This is the first time these products have been available to Edward Jones brokerage and adviser accounts. We see great opportunity for the USAA Investments franchise as we are bringing together excellent investment performance with expanded distribution.

Lastly, I would like to mention that we continue to be extremely active in our pursuit of acquisitions. We are in various stages of our evaluation process with a number of potential opportunities with some getting into the very final stages. The environment for us is better than at any time I can remember. We are very well positioned to participate in the consolidation of the industry, given our track record and success acquiring companies. We have purposely used the majority of our free cash flow to reduce our leverage, so we would have the flexibility to execute, which is where I believe we are today.

With that, I will turn it over to Michael for a more in-depth discussion of our financial results. Michael?

[Michael Policarpo, executive]

Thanks, Dave, and good morning, everyone. The financial results review begins on Slide 14. Revenue increased 6% from the fourth quarter, reaching $213 million in the first quarter of the year. Our operating margin expanded on a GAAP basis from 39% in the fourth quarter to 42% in the first quarter. The quarter-over-quarter margin improvement was the result of better operating leverage as operating expenses such as general and administrative, depreciation and amortization increased at a slower pace than our revenue growth. We also recorded lower noncash acquisition-related expenses in the first quarter, which contributed to the wider GAAP margins.

Adjusted EBITDA margin was 50.2% in the first quarter. This was modestly impacted by seasonally higher payroll-related costs associated with higher employee benefit and payroll taxes, which tend to be front-end loaded in each calendar year. Adjusted EBITDA set a new quarterly record of $106.8 million in the first quarter compared with $103.8 million in the fourth quarter. GAAP net income reached $65.2 million or $0.88 per diluted share, up from $54.9 million or $0.75 per diluted share in the fourth quarter. Our adjusted net income, a tax benefit of $1.13 per diluted share, set another record high.

We're active on the capital management front in the quarter. In February, we repriced our debt for the second time since the beginning of last year. With this latest repricing, we successfully lowered the interest rate spread by another 25 basis points, bringing the total spread reduction over LIBOR to 100 basis points when combined with the 75 basis point reduction in January of 2020. We returned a total of $14 million to shareholders in the form of cash dividends and share repurchases. During the quarter, we repurchased approximately 287,000 shares, and our Board approved a 33% increase in the dividend to $0.12 per share, payable on June 25 to shareholders of record on June 10.

Turning to Slide 15. Total AUM rose 5% during the quarter to $154.3 billion as of March 31. The 5% increase in AUM since the beginning of the year was due to positive market action in the acquired assets from the THB acquisition, which totaled $547 million. This was partially offset by net outflows. Long-term asset flows are covered on Slide 16. We achieved an 18% increase in long-term gross sales during the quarter and net long-term outflows improved to $983 million, which was a 33% improvement from the $1.5 billion net long-term outflows in the fourth quarter and well below prior periods. This was our third consecutive quarter of improving net flows. Echoing Dave's comments, we have many reasons to be optimistic about our organic growth prospects moving forward.

Turning to Slide 17. Quarter-over-quarter revenues increased by 6% on higher average AUM and slightly higher average fee rate realization in the first quarter. Money market yield support and fulcrum fees on certain USAA mutual funds together negatively impacted fee realization in the first quarter by approximately 1.2 basis points, which was an improvement from their impact in the fourth quarter. Given the strong investment performance of the fixed income products managed by our USAA Investments franchise, we would expect to continue to see the fulcrum fee impact on our revenue realization improve. As we discussed previously, beyond eventually reaching a neutral impact on fees, which we are not at today, there is the potential for the fulcrum fees to exceed parity and to positively impact our consolidated realized revenues by as much as 1 to 2 basis points.

Moving to Slide 18. We have changed the manner in which we illustrate our expenses to enhance transparency. We've received questions related to the quarterly volatility in our reported GAAP expenses, which is often attributed to the accounting for the noncash mark-to-market impact of the investments in our deferred compensation plan, which has no overall impact to earnings. So we are breaking that component out of our compensation expense, which you can see in the shaded gray row. And to show the exact offset, which is accounted for below the operating line in other income, we have also shaded that line in gray.

With the updated presentation, this offset should be more clearly seen. We also added a yellow line across the bars to illustrate the relatively consistent cash compensation ratio over the last few quarters that hovers around 23%. Total expenses increased slightly in the first quarter. This reflects higher variable expenses associated with the higher AUM revenue and earnings reported as well as the seasonality of certain payroll tax and employee benefits expenses. These were largely offset by the lower acquisition-related expenses in the first quarter.

The quarterly adjustment of the fair value of contingent acquisition earnout payments on our balance sheet was $7 million lower in the first quarter compared with the fourth quarter. The non-GAAP metrics for the first quarter are presented on Slide 19. Adjusted net income with tax benefit per diluted share of $1.13 was up 6% from the fourth quarter and up 23% from $0.92 per diluted share reported in last year's first quarter. Adjusted net income of $83.6 million generated in the first quarter set another quarterly record. This includes a $6.9 million tax benefit which was up from the prior quarter due to a full quarter's impact of the first contingent payment to USAA, which was made in Q4 of 2020.

These payments increased total goodwill and acquired intangible assets which we then amortize over a 15-year period for tax purposes. In the event there's a corporate tax increase, our gross tax benefits from this amortization would also increase. Adjusted EBITDA margin was narrower versus the fourth quarter, which was expected. For modeling purposes, we are maintaining our annual adjusted EBITDA margin guidance of approximately 49%. And keep in mind, this includes investments we continue to make in the business to drive future growth.

Moving to our capital management activities on Slide 20. We paid down an additional $50 million in debt during the quarter and another $27 million subsequent to quarter end. Since the origination of the term loan in July of 2019, we have repaid approximately $389 million or 35% of the original outstanding principle. As a result of our proactive measures to reduce outstanding debt and interest costs, our cost of debt declined by 12% to $6.8 million in the first quarter of 2021 versus the prior quarter. This represents a 60% decline in our debt servicing cost since we originated the loan less than 2 years ago. In absolute dollars, this translates to more than $10 million in interest savings per quarter on a run rate basis. Additionally, our $100 million committed revolver remains undrawn.

That concludes our prepared remarks, and I will now turn it back over to the operator for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Kenneth Lee with RBC Capital Markets.

[Kenneth Lee, analyst]

The expense breakdown on Slide 18 is very helpful. Wonder if you could just talk a little bit more about the components within comp expense. Specifically, it looks like there's some seasonal increases and perhaps some items related to fund sales on the variable comp expense. Which items would you consider to be relatively nonrecurring?

[Michael Policarpo, executive]

Thanks, Ken. It's Mike. Yes. Within the comp expense, as we said in the prepared remarks, there is seasonality with respect to resets on payroll taxes and employee benefits. The increase in the benefits and payroll taxes were about $2.9 million quarter-over-quarter, which really we look at as seasonality and will even itself out over the course of the year as has in past years. So that's one item that we think is nonrecurring from what's sitting within the compensation expense. You pointed out, we did also highlight the mark-to-market on a deferred compensation plan. That element was $2.7 million.

It's a noncash element that's offset in nonoperating income. So the impact to GAAP net income is 0, but that is included in the compensation line. But again, we've carved that out, so you can now see that much more clearly as well as the history. And then lastly, yes, you did highlight that commissions will be -- have increased quarter-over-quarter, really as a result of the higher long-term flows as well as the funding of some of the institutional won but not yet funded that has now come in quarter-over-quarter. So we look at that as a great increase in compensation expense as we're growing the business. So those will be the highlights I'd give you.

[Kenneth Lee, analyst]

Great. That's very helpful. And just one follow-up, if I may. And this is just on the THB. Just wondering if you could just share with us. As there is a potential ramp-up in AUM within THB, as you leverage Victory's distribution platform, just wondering how you think about the potential ramp-up of AUM within THB?

[David Brown, executive]

It's Dave. I'll take that question. We closed the THB transaction on March 1. So we're integrating the platform into our distribution relationships and our distribution platform. It will take time. I mentioned in my prepared remarks that we had about $15 billion of capacity in the products that they manage. I would imagine that capacity gets filled over a number of years. And as we get out to the relationships that we have, as we build new relationships, but it's going to take some time, but 2021 should be a year where we begin to close business on that platform. And as we go past 2021, I would imagine that would accelerate.

[Operator]

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

[Michael Carrier, analyst]

First, I just wanted to maybe dig into the shift from outflows to inflows in recent months versus last year. And maybe -- and I know this is difficult, but can you quantify maybe how much is related to maybe less pressure from some of the USAA Schwab transaction versus increased transaction in some of the areas you mentioned like expanding your distribution relationships? Basically just trying to figure out like how much upside potential do you see from some of those initiatives ahead versus what's already in the run rate?

[David Brown, executive]

It's Dave. Let me break that down. First, I think there is a lessening impact from the USAA Schwab transaction. So I think that, that's one contributor. I would say that, that has an impact. I wouldn't say it is a material impact. The other aspects of what's happening is, number one, I think you're seeing some of the investments we've made in distribution we're starting to get some returns on. We've made quite a few investments over the last year, and I think you're seeing a pickup. You're also starting to see some of the distribution, as we outlined in our prepared remarks, around the USAA Investments getting to now platforms that they didn't have access to in the past, and you're starting to see some results there.

And then you can see from the one page in our slide, with all of those products with the excellent investment performance really in asset classes where you're seeing investors allocate dollars, we have great product and really marrying that up with great distribution. That's probably the area of biggest impact. And when we look forward, I think that there is a lot of upside in those areas, meaning areas where investors are looking at products that fit their portfolio for this evolving market environment. And we happen to have a lot of really well-performing products that are priced competitively with good distribution.

And I think we're just starting to see the beginning of it. And that's why we're so optimistic about what our organic growth outlook is. We steadily -- if you go back to last year, we steadily improved quarter-over-quarter-over-quarter. And as we said in our prepared remarks, March was a net flow positive month, and that momentum has really continued into the second quarter, and we're pretty optimistic about the organic growth. No different than what we've been saying all along is when you look in larger or longer periods, we think we can grow organically. And some of the issues we've had in the past have been very transactional or onetime in nature, and we're moving further away from that. And that's been a little bit of a drag, but I think it's really the future that we're looking at and how we're positioned and why we're so optimistic.

[Michael Carrier, analyst]

All right. Great. And then, Mike, maybe just on the fulcrum fees. I know you mentioned them, but can you provide just a negative impact, let's say, in the quarter? And then the delta that would get you to breakeven. And I think the max benefit, I think, you mentioned would be like 1 to 2 basis points. I just want to make sure I have sort of the degrees of benefit from here that we could see performance continues to do well.

[Michael Policarpo, executive]

Sure. That's a good question. So as we did say, the maximum benefit is between 1 to 2 basis points on the overall business. Where we are today and what we included in the fourth quarter, the impact of the fulcrum fees was negative 0.4 basis points on the business.

[David Brown, executive]

In the first quarter.

[Michael Policarpo, executive]

I'm sorry, in the first quarter is negative 0.4, which was an increase of 0.2 basis points from the fourth quarter of last year. So we have seen some improvement quarter-over-quarter. But again, to reiterate, it was negative 0.4 in the first quarter. And the upside really for those funds, as we look at the performance improvement that we've seen and continue to see across the board, is 1 to 2 basis points on the firm level.

[Operator]

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

[Alexander Blostein, analyst]

Dave, I want to dig into the M&A pipeline a little bit more. It sounds like you guys are getting closer maybe to some of these deals being announced. Any way to help us kind of think through the investment management kind of styles or types that are a little bit towards the front of that pipeline?

[David Brown, executive]

Let me take that in 2 pieces. The first is just our strategy. We have historically done 2 types of deals. We've done deals where we'll call them transformational at the time of the transaction, USAA, RS and longer at the times, were transformational in size and scale. And that's one big bucket for us. And we are actively pursuing those types of transactions. And then the other types of deals we've done, I would call them as impactful, which are smaller in size, but very strategic. I'd call that a THB or the CEMP deal we did years ago. And that's another big bucket for us that we're working on and, again, actively discussing it. And they're different in size. Both are strategic. Both add a lot of value to our business in a lot of different ways.

When we think of our pipeline today, as I said in the prepared remarks, we're moving some of the opportunities into the very, very final stages. Our balance sheet -- we spent a lot of our excess cash flow paying down our debt to really have a balance sheet that gives us the flexibility to really execute on opportunities. And I think that's exactly where we are today is we have that flexibility to do a transformational transaction and at the same time do an impactful transaction as I've categorized them. The environment is better than I have seen at any point really in my career. There are lots of conversations happening. We're involved in many of them. And it isn't issue of opportunity for us. It's an issue of selecting the right opportunity.

Then so I would tell you that we bucket them in transformational and impactful, and we're evaluating both of those types of transactions. As far as product set, you should expect, as we've said before, we start with the client's portfolio, where we want to be in products that matter, where investors are allocating dollars. And that can be in traditional long-only products. It also would be in alternatives. I mentioned in my prepared remarks about Alderwood. It was our first entrance into alternatives. That is an area that we have historically acquired into. I think looking forward, it's an area that we're very interested in and an area that we're working on. And I would anticipate longer term, that's an area that we're going to be involved in. And it's going to keep the same principles that we have today on our platform. But that's an area where we know we can add a lot of value to those firms looking to partner up.

[Alexander Blostein, analyst]

Got it. Very helpful. Mike, a follow-up for you. And I think I heard it right, but the EBITDA margin guide for the year, adjusted EBITDA margin, I think you said is 49% unchanged. I think you guys did a little over 50% in the first quarter despite, obviously, seasonally higher expense item you mentioned, and it feels like the revenue momentum in the business is obviously quite strong between the markets flows in the period. So maybe give us some thoughts around sort of sensitivity around the 49% for the year. Are there things where you're kind of investing in incrementally more and that's sort of the offset that we need to be thinking about? Or is it just kind of a level of conservatism given uncertainty one like College Savings come back and things like that?

[Michael Policarpo, executive]

Yes. Thanks, Alex. As you said, I think we did post our third consecutive quarter over 50% from an adjusted EBITDA margin perspective. And in the prepared remarks, we did say that we -- the guidance really remains unchanged at 49%. But as you also mentioned, I think we are making investments in the business around distribution, as Dave highlighted in his comments, digital marketing, around our digital platform, products, data and analytics. So we are making investments. So our quarter-to-quarter margins could fluctuate based on the timing and the opportunity that we see in making some of those investments.

Clearly, we've demonstrated a strong operating model, and it does flex with the variable expenses that we have in the business with growth and/or decline from a market and revenue perspective. So there will be quarters where we'll be above that. But again, we've kind of kept the 49% long-term view just as we think about whether that's investments we need to make or in some level of post COVID and travel and some of those things. So I think we're comfortable with the 49%, but we do think there's opportunity quarter-to-quarter as we think about the investments we're making.

[Operator]

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

[Kenneth Worthington, analyst]

In terms of the M&A environment, I think part of the solution Victory provided for smaller asset managers was access to better distribution as wirehouses and brokers reduced the number of managers on their platform over the last number of years. Is Victory still seeing access to distribution for smaller asset managers under increasing pressure? Or have we reached sort of a steady state with regard to their access?

[David Brown, executive]

Ken, it's Dave. I'd say our value proposition for smaller managers really is multifaceted. First, as you mentioned, it's access to distribution that they just wouldn't have access to at a smaller size or a smaller scale or channels that they would not be staffed up to penetrate. We also have a pretty well-developed operating platform that we think is best-in-class that they get access to. And then I think the stability and the experience of just a larger money manager that's -- that can add a lot of ancillary things to what they do.

Specifically on distribution, as you can see with what we've done with USAA Investments, and we went into quite amount of detail in our prepared remarks. I think that there's plenty of opportunity for managers that are smaller in size, that have investment excellence in the right asset classes, that are priced right to get distribution, specifically on the retail side, on the retirement side and certain institutional situations in the U.S., outside of the U.S. So we're still seeing that.

As far as the industry goes, I believe that a lot of the platforms are reducing the number of firms they are working with. I would say that on most of the platforms, that's not us. We've had great relationships and great distribution. A lot of the asset classes, though, that we're in are capacity constrained. And one of the challenges for platforms is how do you access new managers in this capacity constrained asset classes and we solve an issue for them. So a long way of answering is we still think that, that value proposition on the distribution side holds true for small managers. And THB is a really good example as we continue to build out their distribution now.

[Kenneth Worthington, analyst]

Awesome. And then you said maybe just a moment ago that the environment is better than you had seen from an M&A perspective. So the question is, why is it better? It seems like from the seller's perspective, market levels are at all-time highs, so it makes sense to me that they might be looking to monetize their investment in their franchises. But that doesn't mean it's necessarily better for you in terms of that meeting of the minds and finding a price. So could you just flesh out your comments why you think the environment has improved? Or what are the characteristics that have driven your comments?

[David Brown, executive]

Sure. I think pricing is one element of it. Although the market has increased and -- but I still think that the investment managers are not priced to the value that they bring. So I think that the investment managers are still inexpensive on a historical basis. So I'd start there. But price is one aspect of it. The reason I feel that is pretty -- an environment where there is a lot of opportunities. The issues that managers face today, they've not changed with the increase in the market. Access to distribution, access to technology, the need for scale, all of those things have been furthered along. Meaning that if you had that issue in the past, you have more of that issue today.

And so when you have that, coupled with a realization that the market is up, and you have more people discussing the future and looking for partners. And because of that, there are a lot of firms that are thinking about doing something that in the past would have never thought about it. We've seen some of the larger higher profile transactions occur that I think some of the firms, if you went back a few years, you would say that those firms would never have transacted. And I think there's a lot more to come. And so the issues with the industry really the haves and the have nots have really been highlighted. And because of that, I think it's the best environment, like I said, I've seen in my career.

[Operator]

Your next question comes from the line of Cullen Johnson with B. Riley Securities.

[Cullen Johnson, analyst]

This is Cullen Johnson. I'm on for Randy this morning with B. Riley. You touched on flows a bit already, but I just want to look specifically at the fixed income segment this quarter. Was there anything that stood out in fixed income, you think drove those positive net flows in the quarter?

[David Brown, executive]

It's Dave. Nothing specifically. I think many of the allocators are thinking about increasing interest rates or potentially increasing interest rates and how they switch around their portfolios. We've also built out the USAA Investments distribution, which I think has given us some increase in flows. And then as we highlighted on the one slide, we have a number of really, really good performing and kind of a product for the times on the fixed income side, our floating rate product, our high-yield product. Those have really done well with investors, given what's happening with the interest rate environment.

[Cullen Johnson, analyst]

Got it. That's helpful. And then we noticed there's a buyback as well as an increase in the dividend this quarter. So just kind of wondering how do you evaluate the relative benefits of buybacks relative to dividends when you're looking to return some capital to shareholders?

[Michael Policarpo, executive]

It's Mike. Yes. I think we've been pretty consistent on our capital management strategy, and it really remains unchanged. We want the flexibility to execute our business strategy. And as we talked about, our primary use of our free cash flow has been to delever. We paid down $77 million year-to-date, 35% of the original term loan from July of 2019 and significantly lowered our leverage ratio. We've done that as well as looking at being opportunistic and repricing our debt. So we've seen a significant reduction in our interest carry, both in the reduction of the principal debt as well as the reduction in the rates. So we're down over 300 -- almost 300 basis points from an interest cost perspective since we took up the loan in July of 2019. So as we've done that, we've introduced really what we call an ancillary shareholder return program through buybacks and dividends and really would be able to take the savings from an interest perspective and drive that back to the shareholders.

We think that's important. And that's something that we've continued to do as we've grown the business, while still balancing the allocation between debt paydown and shareholder return. As far as the metrics we look at going forward, I think it really depends on facts and circumstances. Dave mentioned, our primary goal is to really recoil our balance sheet to look at and be able to execute on M&A. And the balance sheet today is ready for that, even inclusive of the shareholder return components and the deleveraging component. So we balance a lot as we look at it. And really -- it really is based on the kind of current facts and circumstances and the environment that we're in. And we think we've been very successful in being able to manage our way through all of those things and to deliver shareholder return and financial returns.

[David Brown, executive]

And I would add -- it's Dave. I would add just a few things to that. One is we bought double the amount of shares in 2020 than we did in '19, and I believe we bought more shares back in the first quarter of 2021 than we did in the fourth quarter of '20. I think that, that should give you an indication of what we think the value is in our stock at this point. That being said, we have increased our dividend pretty aggressively over the last year and over the last quarter. It's a facts and circumstances analysis. Meaning we look at our entire portfolio of things we can do with our free cash, discuss it with our Board. And then we set our policies.

But I would say that we have been the beneficiary and our shareholders are going to be the beneficiary of really good capital management around the cost of our debt, reducing the debt. And I think as we look forward, we think we can actually hit on all 3 pieces: continue to buy back shares, continue to pay a dividend, and also most importantly continue to pay down debt to recoil the balance sheet to do really accretive transactions.

[Operator]

Your next question comes from the line of Jeremy Campbell with Barclays.

[Jeremy Campbell, analyst]

Maybe just another one on M&A optionality. Dave, I know you talked a little bit about the value prop here on the call to -- of distribution to smaller managers. But maybe just as you survey the landscape of what sounds like an active deal market, are there inorganic opportunities to onboard a manager that's strong in a distribution channel that you're still kind of building out like SMA or retirement or retail direct where there might even be greater 2-way synergistic fit to more typical deal flow where it's mostly just a really nice product fit?

[David Brown, executive]

Correct. I think on the acquisitions we've done in the past, a lot of the businesses we have bought have brought things to us as well. So it isn't always one sided. Use the example of SMA. That's an area that we're building out pretty nicely with our USAA business. We're entering into that market. If there were a manager that was already established there, that would be value to us. And remember, our acquisition strategy starts off with, is it strategic? Does it make our company better? We don't really do just financial deals. We're not interested in just a financial deal where we can increase earnings, and there's no strategic value to it.

So when we look at the transactions, there are situations where, for example, maybe on an international distribution in a certain country where we can gain distribution. THB is a great example. They have a presence in Australia. They have a relationship in Australia. We did not. And when we bought their business, we started a new relationship in Australia. Same thing when we did the RS Investments transaction. It gave us access to Japan. So when we look at transactions, we do evaluate that, and there are opportunities where, as you said, it actually makes our business better from a distribution perspective.

[Jeremy Campbell, analyst]

Got it. Great. And then I know you're probably going to say this as an end proposition. But on the organic growth side, where you have a lot of momentum, what are you most excited about? Is it the capacity and performance you guys nicely laid out on Slide 8? Is it expand distribution to the SMAs, further building out retail direct? What are you most excited about here?

[David Brown, executive]

I really think it's all of the above. But if I had to highlight a few areas where I think we have great opportunity, I would say, investors are rethinking their portfolios today. There's a shift in the market happening. And there's also potentially a pretty significant change in interest rates coming, and then put on top of that a potential tax change. And I think it has investors rethinking their portfolios. As they rethink their portfolios, there's a couple of key areas where I think we have great investment performance, long track records and distribution setup.

So when you think about some of the interest rate changes, I think about our floating rate fund, as we highlighted, actually, our Market Neutral Income Fund, our high-yield, that's very interesting to investors. And I think that's exciting for us. Our ETF business, 2 quarters in a row of organic growth, great product. We have the size and the scale. And I think some of the tax changes could move some investor into ETFs. And I think we're well positioned there to be a specialist ETF provider.

And then when I think about some of the portfolios moving from maybe the growth and momentum type stocks and portfolios into a different type of portfolio, we have a lot of products that are pretty well established, great track records, 5-star rated, 4-star rated funds that have pre-existing distribution. That gets me excited. And then lastly, we haven't talked too much about ESG, but THB has a long history of integrating ESG principles into their investment portfolios. And I think that, that's another area of growth. I think we have about 70% of our assets today integrating ESG principles into the portfolios. And I think that's going to be another area that you're going to see a lot of growth in the industry as well as with us.

[Operator]

Your next question comes from the line of Robert Lee with KBW.

[Robert Lee, analyst]

Great. Maybe the first one, Mike, if you could just refresh us on, I believe, I think maybe it's a year that USAA might -- I think it's a year the licensing agreement is up for renewal? I'm assuming you want to start these conversations well in advance. Is there any color you could give us on kind of your expectations around some incremental costs around that? Or should we assume that at this point that whatever revenue share you have with USAA, that's kind of where you'd continue going forward?

[David Brown, executive]

Sure. It's Dave. USAA has been a great partner to us. You can see some of the numbers in the new account registration since we've announced the transaction. And I would say that we're a pretty ingrained partner in a lot of different things with them. And there's really no change to the licensing or the brand agreement we have with them. And as we get closer to the expiration of it, we'll sit down with them and talk about what the best route forward is.

[Robert Lee, analyst]

And sorry, David, I don't know why I said. Apologies. But second question is, just kind of curious, arguably, one of the challenges your stock maybe has from a valuation perspective is kind of limited liquidity. And I guess, your PE owners is still on the vast majority of stock. And one of them is also an investor in arguably competing business shortly. So I'm just kind of curious if there's -- with one of your Board members now owning or soon to own a competing business, should we be thinking that's going to be possible in a loosening of or issuing some stock and get a little bit more liquidity? Or if not, how do you kind of manage that kind of conflict at the Board level?

[David Brown, executive]

So our private equity partners have been tremendous partners to us. They are Board members first. And our Board has been excellent and supportive in our success over the years in our growth. And I think we have a pretty great track record of where we started to where we are today, and they've been extremely supportive of how we've gotten there. As far as their desire to put shares into the market, as you've referenced or anything else, that's their decision and their decision solely.

They have -- they're fiduciaries to our company. They sit on the Board, and they're well experienced. So I'm not in a position to speak for them. As far as the Board member working or being a partner in a firm that has made another investment and another investment management firm, any potential conflicts, if there ever was, would be dealt with at the Board. We don't see any. And I'll go back and say that our success that we've had over the years has been because we have great partners and a great Board and a great group of employees.

[Operator]

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

[Michael Cyprys, analyst]

I just want to dig in a little bit more on the direct channel as you look at the direct channel and the customer set there. I guess what strategies and capabilities do you see a demand from these customers that you do not already have on your platform today or don't have capacity on your platform, strategies perhaps that you see as white space that maybe you would think about filling either organically or inorganically?

[David Brown, executive]

Mike, it's Dave. A couple of pieces to that. One is we've added a number of products to the direct to investor business. We have now had 56 mutual funds, which has increased pretty significantly from when we started. We added a portfolio planner. We've added the fixed income SMAs, and we have more things to come to add. And that will satisfy a lot of our investors' needs there. And I would imagine, over time, you should expect over time that our product set there is going to expand and potentially expand into some different areas that we're not into today as part of the investments that we're making.

But today, as we said, I think that there's a wholesome product set. There are definitely opportunities in different areas. And we'll -- we are evaluating them. We're investing in them today. And this has always been for us a block by block building opportunity. We have set a really great foundation with service. We've set a great foundation with products. We've set a great foundation with performance. And now what we're doing is really going to the next level where we're going to expand our product set there and continue to kind of drive the growth that we think we can accomplish in that part of our business.

[Michael Cyprys, analyst]

Great. And just a quick follow-up, if I could, just on Alderwood. I was hoping you could elaborate a bit more on the strategic relationship with Alderwood, your aspirations there. And maybe you could just remind us of your ownership level there. What's leading you to include their AUM and flows in your numbers?

[David Brown, executive]

So Alderwood is going to be a private fund. That they'll raise their first fund here in the second half of this year and into next year. We'll help them in distribution. So from a perspective of -- in the U.S., we'll help them sell that product, that fund. We own a 15% stake in the business. And we'll account for it, as I said in our prepared remarks, the way that most managers account for ownership stakes, that way of including their flows in our flow profile.

[Operator]

Our final question will come from the line of Owen Lau with Oppenheimer.

[Kwun Sum Lau, analyst]

So I think, Dave, you touched on this a little bit, but could you please add a little bit more color about the impact of potential cash tax change on Victory overall?

[David Brown, executive]

Sure. First, there's a number of proposals out there today. We don't think that the proposals as they sit today will actually get through and become law. I think you'll see a negotiated or a slim down version of what's out there. But that being said, I think on one of the areas of impact could be an increase in capital gains for high earners. And from there, I think there could be some movement out of mutual funds potentially into ETFs or into SMAs. But remember, there's still a very large part of the mutual fund industry that's in retirement assets. So you could see an impact of some outflows in mutual funds. But for us, specifically, our ETF platform, our SMA build business that we're building, and then how deep we are in the retirement, I don't anticipate really an impact to our business, potentially maybe in a positive way for some of the other areas, but I don't see a major impact there.

And then I would also say a lot of the tax changes when you think about capital gains probably doesn't affect fixed income products. A lot of the fixed income products, maybe people will move into municipal bond funds or funds that have an advantageous tax treatment. We have a number of products there that are high performers and are really good distribution established. So I think we potentially could see some additive flows there. But when you really take a step back for our business specifically, I think there could be potentially some moving of assets into one structure into another. But I don't see it having a material impact on our flow outlook or our AUM outlook.

[Kwun Sum Lau, analyst]

Okay. Got it. And then quickly going back to USAA, would you be able to provide more information about the non 529 Plan, including maybe like retention rate, AUM flow and fee rate? Any more color would be very helpful.

[David Brown, executive]

We've provided the new account registrations I think there was a lot of noise around really 2 transactions, us acquiring the mutual fund and 529 business and then Schwab acquiring the brokerage business. I don't think there's a lot of value to be had in drilling down into some of the detailed numbers. That's just not how we report it. What I can tell you is we are making great progress. And I think you can see that in the overall flow numbers and how optimistic we are. But we're making great progress in that part of our business. We've expanded the product set. We have aspirations to continue to expand it. Our service is excellent. And I think it's an area when we look out longer term, is going to be potentially a differentiator for us, having a sizable direct to investor business that we'll be growing. And I think that, that will be a differentiator for our business when you look at a traditional money manager.

[Operator]

At this time, I will turn the conference over to Dave Brown for closing remarks.

[David Brown, executive]

Thank you. Thank you for attending our call, and I hope all of you have a great day, and we'll talk to you next quarter.

[Operator]

Thank you for participating. You may disconnect at this time.