Invesco Ltd (IVZ) — Q4 2017 Earnings Call Transcript

This presentation and comments made in the associated conference call today may include forward-looking statements. Forward-looking statements include information concerning future results of our operations, expenses, earnings, liquidity, cash flow and capital expenditures, industry or market condition, AUM, geopolitical events and their potential impact on the company, acquisitions and divestitures, debt and our ability to obtain additional financing or make payments, regulatory developments, demand for and pricing of our products or other aspects of our business or general economic conditions. In addition, words such as believes, expects, anticipates, intends, plans, estimates, projects, forecasts, and future conditional verbs such as will, may, could, should and would, as well as any other statement that necessarily depends on future events, are intended to identify forward-looking statements. Forward-looking statements are not guarantees and they involve risks, uncertainties and assumptions. There can be no assurance that actual results will not differ materially from our expectations. We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks described in our most recent Form 10-K and subsequent forms 10-Q filed with the SEC. You may obtain these reports from the SEC’s website. We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statement later turns out to be inaccurate.

Thank you very much and thank you for joining us, everybody. If you are inclined, you can follow the presentation that's available on the website. So I will spend a few minutes reviewing the full year results and the fourth quarter results of 2017, give an update on where we are with the two acquisitions that we are involved in and Loren will go into the financial results, and then we will open up to Q&A. Let me start by highlighting our firm's operating results for the full year, and I am on page 4 if you are following along. Investment performance continued to be very strong throughout the year, and looking back, a very strong investment performance, really our movement to focus on outcome-oriented solutions contributed to long term net inflows of $11.5 billion during the year. The organic growth rate was 1.7%. I want to highlight that 2017 represents the ninth consecutive year of positive long-term net inflows from Invesco, and I will come back to that in a minute. The combination of all these efforts, performance, the capabilities, and delivery for clients resulted in achieving record earnings per share for Invesco of $2.70 per share, that's up 21% year-over-year. The adjusted operating margin was 39.4% for the year, up from 38.7%. We returned $472 million in dividends throughout 2017. So if you turn to page 5, I want to come back to the consistency and the diversity of our long-term flows, which really is in the context of nine years of net inflows. This chart on page 5 shows the relationship between organic growth rate and the variability of that growth. The vertical axis is the average organic growth rate over the prior five years through 2017 among public company peers. The horizontal axis is the standard deviation of those flows reflecting the sustainability or variability of the organic growth rate. If you look at Invesco against our peers, it’s evident that the diversification is benefitting Invesco. Invesco has the lowest standard deviation of flows of the group, reflecting a high level of flow consistency. Additionally, we are just outside the top third of the average organic growth rates of that peer group, something that we absolutely intend to close. Having strong and diversified sets of offerings and assets under management really puts us in a position to better serve our clients. But as a business, it absolutely makes us stronger, by not being overly reliant on any one geography, any distribution channel, or asset class. So again, diversification is good for portfolios, it’s great for business, and this is not a concept anymore; this is proven in these results. We believe that this diversification of the business leads to better flow consistency and represents a strong opportunity for us to reach that targeted organic growth rate of 3% to 5% in the near future. Lastly, I want to point out, despite our continuous inflows and the low volatility of those flows, Invesco continues to sell at a discount versus peers. We do not believe that our current valuation fairly reflects our ability to grow organically, as measured by history, and we think on the future potential of Invesco. Now let me turn to page 6 and take a minute to talk about the achievements over the past year, all of which were intended to strengthen our ability to help our clients meet their needs and further advance our competitive position. Investment performance was very strong during the year, as I mentioned. 64% of our assets beat peers on a three-year basis and 75% on a five-year basis. This was one of the principal drivers, good performance over the past nine years, generating the flows that we talked about and in particular, in this year, the record earnings per share of $2.70. Throughout 2017, we continued to build our competitive range of active, passive, and alternative capabilities, which is really important for the future success of any money manager. We completed the acquisition of Source and announced the acquisition of Guggenheim Investments' ETF business, both of which I will talk about in just a minute. In 2017, we continued to expand our Solutions business, which brings together the full capabilities of the firm to provide outcomes for clients. This is a really developing and very important element that we are seeing emerge, where clients are looking from money managers. One of the highlighted closures within the year, as everybody knows, was Rhode Island, about 29 accounts. Importantly, we are also seeing success with Solutions and traction within the Wealth Management platform, along with our different opportunities in various parts of the world, institutionally as well. Regarding our digital advice platform, Jemstep, we announced partnerships with a number of large enterprises in 2017, and we are well down the implementation path with several of them. The sales and onboarding pipeline continues to be very strong. In particular, we saw strong demand from banks, which view digital advice as a really important means for them to enhance their relationships with clients, as they build comprehensive Wealth Management services. Jemstep differentiates itself by offering advisor-powered technology, enhancing the human touch, not replacing it, but enhancing it. The partnerships with our partners are very important, and it works quite well. We also continue to drive savings through our business optimization program, delivering more than $43 million in annual run rate savings as of the end of 2017. We will use the savings to offset investments in key initiatives that help us better meet client needs, strengthen our competitive position, and help us grow the business as we look to the future. A handful of the initiatives I might highlight, for example, we have improved factor-based investing, which will also complement and improve self-indexing, enhancing our ETF business while continuing to advance our institutional business globally and expand in China, all of which we talked about in 2017, and we will provide further updates in 2018. Now let me take a minute to update you on our acquisitions in 2017. Again, both of which we are focusing on expanding and improving our global ETF platform. Both of them will enhance our competitive position in the growing ETF business. The EMEA platform has been significantly helped with the closure of Source and Guggenheim, also here in the United States. Our EMEA ETF business totaled $27.9 billion at the end of 2017, up from $26 billion at the time of acquisition. This is a strong result of our efforts to successfully manage the integration post-acquisition, and typically we did not see any of the integration issues that often happen with acquisitions. The EMEA acquisition expands the diversity of our ETFs across equity, fixed income, commodities, smart beta, and active ETFs, making it really complementary to our platform. We launched 10 new ETFs in the fourth quarter, the point being that we're looking to take advantage of the platform in a very rapid fashion. The Guggenheim investment ETF business continued to expand assets under management and had strong performance within that platform. We still intend to close in the second quarter of this year, and again the Guggenheim platform will add equity, fixed income, and alternative ETFs, enhancing the range of capabilities we have and allowing us to create client-directed proprietary indexes through self-indexing capabilities. Spending a minute on the fourth-quarter results on slide 10; you'll see that again, strong investment performance helped drive assets under management to $937 billion, up from $917 billion in the prior quarter. We had solid retail and institutional demand led by long-term net inflows of $4.4 billion, and the organic growth rate was 2.3% during the quarter. Adjusted operating income was $399 million compared to $397 million in the prior quarter. The adjusted operating margin increased slightly to 40.7%, and we returned $119 million to shareholders through dividends during the quarter; the quarterly dividend remains constant at $0.29 per share. Talking about performance, let's turn to flows on page 13; we saw solid demand for active and passive capabilities during the quarter. Gross sales and net inflows of active capabilities in the fourth quarter built on solid demand from the prior quarter. Strong flows were evident in taxable fixed income, international equity firms, and domestic equity. Turning to passive, we saw strong flows into domestic equity, fixed income, international equity ETFs, and as noted in the presentation, our ETF acquisition in EMEA is contributing to net flows and building strong demand for ETFs in that region. We saw very strong retail and institutional demand during the quarter, as you will see on slide 14. This was the sixth consecutive quarter of net positive flows for EMEA, led by strong institutional and cross-border flows. As you can imagine, with markets continuing to rise, demand for risk mitigation strategies remains strong, particularly among institutional investors, and the pipeline of one, but not funded institutional mandates also remains very strong. We saw strong flows in global targeted return funds, led by institutional investors, and we also saw solid flows in the Pan-European High Income, as well as commodities and emerging market ETFs. So again, the flow picture continues to be robust and is ever-increasing as we look to the future. Let me now turn it over to Loren, so he can give you more specifics, and then we will open up to Q&A.

Thanks a lot, Marty. So quarter-over-quarter, we saw total AUM increase by $20.1 billion or 2.2%. That was driven by market gains of $14.9 billion, long term net inflows of $4.4 billion, which included $5.9 billion of reinvested dividends and capital gains in the quarter. We saw a positive foreign exchange translation of $2.5 billion and inflows into non-management fee earning AUM of $1.6 billion. These factors were somewhat offset by outflows from institutional money market products of $3.3 billion. Our average AUM for the fourth quarter was $930.3 billion, which was up 4.4% versus the third quarter, and our annualized long-term organic growth rate in Q4 was 2.3% compared to 3% in the third quarter. Before turning to net revenue yield as I do typically, I want to provide one quick update on the change in this quarter and how long term inflows are being calculated. Beginning with the fourth quarter, our flows and AUM of our unit investment trusts, or UITs as they are known, as well as changes in product leverage are no longer going to be classified as long term, and instead are being presented alongside the Invesco PowerShares QQQ product, categorized as flows of non-management fee earning AUM. Since none of these products earn management fees, similar to the QQQ, we thought it was more accurately reflecting the nature of long-term flows in AUM to exclude these products from those flows going forward. All prior periods have been restated to allow for a consistent presentation and comparability. Let me get to the net revenue yield; our net revenue yield came in at 43.2 basis points, and our net revenue yield, excluding performance fees was 41.3 basis points, which was a decrease of 0.6 basis points versus Q3. The impact of a full quarter of results for the acquired European ETF business reduced our yield by 0.5 basis points, and we also saw a non-recurring reduction in service and distribution revenues in the quarter. That decreased the yield by 0.2 basis points. These were then somewhat offset by a positive impact of foreign exchange and mix, which added 0.1 basis points. Ultimately, the mix improvement that was anticipated when we provided the net revenue yield guidance last quarter did not fully materialize to the extent that we had expected, as we saw higher outflows from some of our U.S. retail equity products, as well as a modest slowdown in flows versus our expectations from our cross-border fund range in the fourth quarter. Let’s move to slide 17; that provides our U.S. GAAP operating results for the quarter. As is customary, my comments today will focus exclusively on the variances related to our non-GAAP adjusted measures found on page 18. So moving to that page; net revenues increased by $28.3 million or 2.9% quarter-over-quarter. Just over $10 billion included a positive foreign exchange impact of $2.6 million. Within the net revenue number, you’ll see that adjusted investment management fees increased by $37.3 million or 3.4% to $1.12 billion. This primarily reflects higher average AUM for the quarter. Then we had adjusted service and distribution revenue, which decreased by $0.1 million compared to the third quarter. Adjusted performance fees came in at $43.3 million in Q4 and were primarily earned from real estate and bank loan products. Going into 2018, we want to provide some guidance here. We do expect that performance fees will be up versus our prior guidance by roughly $10 million to $15 million per quarter. Our adjusted other revenues in the fourth quarter came in at $18.4 million, which was an increase of $1.7 million from the prior quarter, primarily due to increased real estate transaction fees. Looking forward to 2018, again providing guidance; we would expect other revenues to remain at a similar level to the fourth quarter, around $16 million to $18 million per quarter through the remainder of 2018. Next, dropping to the third-party distribution service and advisory expense line item that we net against gross revenues, that increased by $10.6 million or 2.8%, which is consistent with the increased revenues derived from our related retail AUM. Before turning to expenses, let me summarize all the revenue guidance I just provided regarding yield. Looking into 2018, we expect to see our net revenue yields, excluding performance fees, decline modestly by approximately 0.5 basis points year-over-year to about 41 basis points. This decline is driven by our full-year results from the acquired European ETF business, as well as the inclusion of the Guggenheim ETF assets, that we would expect beginning in the second quarter of 2018, which will reduce yield by roughly 1.5 basis points. These impacts will be somewhat, but not fully offset by the improving foreign exchange rate that we are seeing, as well as the sales mix trends in the business. Let me then move on to expenses; moving on to the slide, you will see that our adjusted operating expenses at $605.7 million increased by $26.5 million or 4.6%, relative to Q3, foreign exchange, with an impact on our adjusted operating expenses of roughly $0.9 million during the quarter. Our adjusted employee compensation came in at $376.3 million, which is a decrease of $70.6 million or 2%. This is driven by lower variable compensation and the $5.5 million non-cash charge related to the company’s U.K. defined benefit plan, which we recognized in Q3. Looking ahead into 2018, again providing guidance; we expect compensation expense of roughly $410 million to $415 million per quarter. The increase in the first quarter reflects the seasonality of payroll taxes, as well as the one-month impact from the base salary increases, in addition to the higher foreign exchange impact. The seasonal taxes should then drop off in Q2 but will be offset by the costs for the Guggenheim ETF business, as well as variable compensation being reflected. This guidance is based on flat markets, consistent foreign exchange, and revenue guidance provided earlier around fee rates. Our adjusted marketing increased in Q4 by $9.7 million, which is 32.2% higher at $39.8 million. This was related to marketing campaigns connected to the acquired ETF business, as well as cross-border funds and normal seasonal increases in advertising, client events, and other marketing costs. Looking forward to 2018, we expect marketing expenses to come in at roughly $32 million per quarter. Dropping down to the adjusted property, office, and technology line item, that came in at $100.8 million, an increase of $7.1 million or 7.6% over the third quarter. This reflects increased outsourced and administration costs associated with MiFID II reporting, as required, and other regulatory compliance costs, as well as higher software costs. Looking forward to 2018, we expect property, office, and technology expenses to hold roughly in line with fourth-quarter levels, around $102 million to $104 million per quarter. Next, our adjusted G&A expenses increased somewhat higher than we had guided, coming in at $88.8 million, which was an increase of $17.3 million or 24.2% more than Q3. The fourth quarter reflected an increase of $9.3 million, primarily related to regulatory preparation for regulatory changes. There were business growth initiatives, which included product costs, legal, consulting, and professional services costs within that line item. These increased costs also led to an overall increase of $1.7 million in irrecoverable taxes compared to the third quarter. In terms of guidance, we expect to see our G&A run rate decrease going into 2018, but this decrease will be partially offset by costs incurred related to the MiFID II hard dollar payments that we have discussed in the past. Overall, quarterly rates should be around $80 million to $83 million per quarter for 2018. Based on the guidance provided today and assuming flat markets and foreign exchange, we believe our margin is sustainable at current levels into 2018, and our incremental margin target for the year remains at the 40% to 50% level, consistent with prior guidance. Looking into 2019 and beyond, we believe that our incremental margin could return to the 50% to 65% level, consistent with historical guidance. Drawing back to the current results, going down the page, you will notice our adjusted non-operating income increased $2.2 million compared to Q3, driven by mark-to-market gains on seed money investments. Then moving to taxes, the firm's effective tax rate in the quarter came in at 26.8%. As expected, our 2018 effective tax rate will be impacted by the Tax Cut and Jobs Act enacted last month. Given our domicile in Bermuda, we have always paid tax under a territorial system in the jurisdictions where our income is earned, but we will benefit from the lower U.S. tax rate on our U.S. generated earnings. Our current analysis guides us to an overall effective tax rate for Invesco between 20% to 21% for 2018. This estimated rate could be impacted as we continue to review the rules, alongside any additional regulatory guidance provided on the legislation. Another point is just on the GAAP results; you will note that we had a one-time benefit of $130.7 million in the quarter reflecting the revaluation of our deferred taxes at the new lower corporate tax rate. This amount was adjusted out for purposes of our non-GAAP results. Our intention, as these questions come up, about the cash related to the benefit on the tax rate, is to use this cash to reduce our anticipated outstanding balance on the credit facility, which will fund the majority of the Guggenheim acquisition beginning in Q2. After the acquisition is completed and our leverage ratio is reduced to the pre-acquisition levels you see today, any residual excess cash will surely follow our stated capital priorities. As a reminder, these priorities are to reinvest cash back into the business as needed through seed money and co-investments, then to dividends, and finally, share repurchases. This brings us back to the current quarter, delivering EPS at $0.73 and an adjusted operating margin of 39.7% for the quarter. Before I turn things back to Marty, I wanted to offer an update on net flows, as we have always done. In January, we continue to see significant strength in our EMEA business, as well as Asia-Pacific, both on the retail and institutional side. This has been somewhat offset by some weakness in U.S. flows, largely within the retail space. Overall, through January 29, we have seen $1 billion of long-term net flows. We are not done with the month, and certainly, there is institutional activity that happens during the month. This number hopefully could improve from the number I just provided. Now I will turn it back over to Marty.

Thank you, Loren. Operator, can you open it up for questions, please?

Hi, good morning, and thank you for taking my questions. I guess, maybe first, in terms of ETFs in Europe, has MiFID II impacted the conversation on ETFs and factor-based investing yet? How is the conversation changing now that rules are in place? Can you also discuss the marketing effort behind Source in the U.K.? Lastly, what lessons have you learned from Source that you could apply to Guggenheim? Thanks.

Thanks, Ken. Everything at the time of the announcement that we talked about, the landscape in Europe, advancing, MiFID being very supportive of ETFs as a more important part of the investing landscape, it’s all in place. We think this will result in a very important business for us. Nothing has changed. We are just moving strongly ahead. The integration has gone very well. It's a very talented group of people, and it's complementary to what we have. We expect solid results moving forward. From a marketing point of view, it expands what we have been doing as an organization, using a combination of active-passive and alternatives. From a distribution focus, we are pulling every lever that you can imagine to drive gross sales to achieve net flows. We're focusing on distribution excellence across retail, institutional, and enhancing brand positioning to strengthen outcomes for clients leading to net flows. Source is a very important part of our global ETF business, and nothing has changed from what we thought at the time of the announcement.

I know our institutional salespeople are extremely excited about the prospect of using ETFs within the Solutions context. It’s something that has not been available to them before. As we have added more resources around Solutions to provide institutions with those solutions, the ETF business is factoring into those conversations significantly. It’s a little early days to predict where it's going, but it's definitely enhancing our discussions.

Thank you. Marty, you have highlighted investments made in Europe, Asia, and U.S. institutional sales. I believe that Asia institutional sales have weakened somewhat, but we are not yet seeing improved net or gross sales in the institutional side as we expected. So is the good news coming? When do you expect good news? What level of gross sales should we expect when the good news arrives?

Good is coming, and it’s real. If you look out a couple of years, we expect that good news to be material. Our aspiration is to have much different outcomes than what we are seeing now. Everything is in place for that to happen. We have the factor capability, alternative capability, and Solutions capability, backed by a solid team. Our execution is ongoing.

If it's any indication, our one, not funded pipeline is up 34% through 2017. The fee rates are well above the firm's overall fee rate, up 35% higher than the overall fee rate. The outflows we've experienced on the institutional business have decreased 33% versus last year. And the fee rate on what is likely to terminate is about 45% lower than the overall firm's fee rate, so significantly less impact. We see strong distribution across all regions, both U.S., Asia, and Europe. The institutional business is adding a significant number of resources that continue to make a positive impact.

Thank you very much.

You guys changed your influence to incorporate reinvested dividends and capital gains. I am wondering if you could separate out gross sales and reinvestments. You have the footnote from the total flow profile, but it's not stratified on a product or active-passive basis.

The first part of your question got cut off. I heard your inquiry about providing detail on capital gains and reinvestments at a more detailed level. We can look into that. Some details are hard to obtain because we don’t sell to third parties. We felt it was more consistent with some of the largest industry peers with this level of disclosure, and we will work on being able to provide more detail going forward.

Sure. I don't know if I missed this or not, but what do you expect for full year MiFID expenses in 2018?

Regarding the payment of hard dollars for research, we said it would be in the tens of millions. This quantification is not specific due to the dynamic nature of these discussions, but we anticipate costs may decline as the industry corrects and adjusts.

The full impact is included in the guidance you provided in G&A for this.

Great. Lastly, related to Guggenheim, how has it performed since the last call, regarding flows at the AUM level? Is it tracking in line with expectations?

It has certainly grown. It's at around $37 billion in size, and in terms of flows since the announcement, it has generated about $700 million of long-term flows, maintaining its historical performance. Once it becomes part of Invesco, we expect to accelerate its growth significantly, which is our plan.

Great. Thanks a lot.

Good morning, Marty, Loren.

Hey Craig.

Starting on Jemstep; I know you announced a few wins here and they are on the path to implementation. Can you provide timing for when these related business wins will start to show up in flows and revenues?

You have to look to 2019 for significant effect. We are developing a strategic competitive strength. We believe it will enhance our business, but it takes time to implement.

Can you elaborate on the average bank in that pipeline? What does it look like in terms of size and client base?

I would be careful, due to the confidentiality of contracts, but it's broad from regional to larger banks. We think this is a key development for us, and the partnerships with banks are aligning well.

There has been chatter about troubles with the new all-in expense reporting with MiFID II. What are your thoughts on that and how do you think you came out on those metrics?

I'm not aware of any issues, sorry.

Sure. Just as a follow-up on the institutional pipeline data you provided, is it just Europe and Asia or all regions?

It's total pipeline for all of Invesco, but it is about a third in each region.

Great. The $1 billion of long-term net flows in January, is a lot of reinvested dividends and capital gains included in that?

None. That’s not reflected in that number.

Perfect. Thank you.

Excuse me, just coming back to expense guidance; can you parse out how much will be contributed by Guggenheim versus the core investment into the business? And relatedly, how do you think the drivers for the incremental margin are looking towards 2019?

Guggenheim is coming in with an incremental margin of about 85%, assumed to start in Q2. Total expenses associated with Guggenheim are just over $10 million over that period. The investment in other areas, like Jemstep and institutional capabilities, will advance our growth. This will bring our incremental margins down by roughly 10 percentage points for the year. Revenue trajectory, due to improving sales mix, will drive margin expansion into 2019 and beyond.

How critical is institutional cash business to you? How do you see the industry evolving?

It is important, representing a growth opportunity. There is a continuing need, but the consolidation of players has been striking. It’s an important business for us.

Just a quick follow-up on your effective tax rate guide. Does the 20% to 21% for 2018 include share-based comp accounting change impact from last year?

Yes, it does. There is typically a first-quarter impact that you see there, and that will happen again this quarter.

What sort of order of magnitude do you have embedded into that 20% to 21% for 2018?

I can’t imagine it is more than a percentage point.

Got it. The guidance seems better on revenue, but the expense guide is worse. Just confirming that the tens of millions related to MiFID are within G&A, and the tech line had an uplift from MiFID separately; the total costs will exceed that baseline?

Yes, the tens of millions are captured within G&A, and the property, office, and tech adjustments relate to further regulatory compliance costs due to MiFID II. That cost is included in the guidance of approximately $102 million to $104 million.

Thanks for the clarification.

Could you help update us on larger intermediaries and their platforms? Could you discuss the impact of your ETF platform sustaining shelf space with distributors?

We are navigating the consolidation of managers on platforms well. Our strong convictions and diversified offerings allow us to maintain and grow our positions. With the significant number of mergers and shifts in platform coverage, we anticipate that managers remaining will benefit. We remain focused on keeping high-quality capabilities, client service, and leveraging our ETF platform.

On Guggenheim transaction; with tax rates decreasing, does this reduce the value of the tax yield?

Yes, the tax yield is significantly reduced. But as for the total operating income, value is prioritized, so we don’t see substantial impact overall.

Final question; does the U.S. adopting a territorial tax system lessen the benefit of being domiciled in Bermuda?

The effect of domicile isn’t impacted; both are territorial. This asks us to analyze regulations closely, but we have no need to change.

On expense guidance; if I look at that, it seems to imply low double-digit growth. Can you break that down into components?

Expenses aren't accelerating in 2018; we operate within a stable and fixed range. We expect incremental margins well above 30% by year-end. Investments will lead to healthy margin expansion.

Thoughts on opportunities in Asia and particularly China? How do you see that market continuing to open up?

We are well-positioned in China, with long-standing relationships offering numerous institutional mandates. We expect significant growth in the next few years and plan to pursue these opportunities aggressively.

On MiFID II costs; was the estimate based only on European clients and how would it change if adopted globally?

Yes, it is based on the European business, and discussions are ongoing regarding its potential adoption globally. It may result in numbers higher than what we currently anticipate, but not significantly material.

We will continue to adapt as necessary and pursue good management of resources according to our needs.

Great, appreciate it.

Thank you all for your participation today. We look forward to sharing more updates soon.