Invesco Ltd (IVZ) — Q4 2018 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 conditions, 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, and 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 the 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 statements later turns out to be inaccurate.

Thank you very much, and thank you everybody for joining us. Again, if you're so inclined, the presentation that we'll be addressing is on the website. Please feel free to follow if you'd like to. So we'll cover the business results for the fourth quarter today. Greg is going to go through the investment highlights, but will also talk about the environment and what the combined investment firm will look like. Loren will go into greater detail on our financials, and then finally, I'll give an update on where we are with the Oppenheimer combination. So turning to highlights on page five, there's no question that the fourth quarter was very challenging for the industry and for us. Eight out of ten asset classes were in negative territory in 2018. It's the worst on record in decades, and 74% of all listed companies were in their market territories. So again, it's much more difficult than we've generally understood in the marketplace. Looking at our fourth quarter results, we were not immune to the impact of these market dynamics. The good news was gross sales were up— that's a nice health indicator— but we absolutely had net flows during the quarter, driven by these market dynamics and a big risk-off move by many investors around the world. It was further impacted by a number of our key investment capabilities having relative underperformance with those with a value bias during that period. We purchased $300 million of stock during the quarter from the $1.2 billion stock buyback program we announced last October. As we've previously talked about, over the past few years, we've been actively repositioning the company for what we think are the opportunities in the market. Oppenheimer is an essential part of this work and will greatly accelerate our activities. We are on track to hit our $475 million of synergies, and we're making meaningful progress towards achieving the close in the second quarter of this year with Oppenheimer. We will revisit the financial returns with the combination since the fourth quarter being so difficult, and you'll see they are compelling still.

Yes. Thank you very much, Marty. On slide six, you're going to see a summary of the results for the fourth quarter. 54% and 63% of actively managed assets were in the top half of peers over the three and five-year periods, while the one-year numbers dropped a bit to 41%. We saw significant performance improvement in December and into 2019. Greg is going to talk about that a little bit later in the presentation. While gross sales were up nearly 27% versus the prior quarter, the market dynamics that Martin talked about, and some near-term performance challenges continued to set redemptions at a higher than normal level. Total long-term net outflows were $20.1 billion for the quarter, significantly contributed by just a small number of larger institutional client redemptions. Adjusted net operating income was $300 million for the quarter, down from $358 million in the prior quarter. The lower revenue environment also impacted our adjusted operating margin, which decreased to 32.6% from 37% in the prior quarter. We returned $422 million of capital to shareholders during the quarter through $122 million of dividends and $300 million of buybacks. Now let's look at the long-term flows found on page seven. For actively managed strategies, outflows remained elevated in Q4. This was particularly true for our U.S. and UK retail equity products, which faced some investment performance headwinds. Active flows were also impacted by a handful of institutional outflows; for example, in October, we experienced a $5.5 billion low fee mandate redemption associated with a single client. Our passive flows were also somewhat mixed in the quarter; we saw good sales into our European S&P 500 bullet shares, low volatility, and ultra-short duration ETFs. However, this was more than offset by outflows due to $1.2 billion of naturally maturing bullet shares at year-end and $1.7 billion in negative flows from our senior loan ETF. The strength of our pipeline was reflected in our institutional results, as gross sales were up more than 80% versus Q3. The single account $5.5 billion low fee outflow that I mentioned previously drove us into negative net flow territory. The strength of our gross sales was well diversified and led by real estate, stable value, fixed income, and quantitative equity products. Additionally, we benefited from strong flows into our Great Wall JV money market products, which added nearly $3 billion in inflows in the quarter. Turning to slide eight, our assets under management decreased by $927 billion or 9.5 percentage points, reflecting the impact of negative market returns and long-term outflows. Our net revenue yield excluding performance fees was down 0.3 basis points to 38.6 basis points. This decline was driven primarily by the negative impact of FX and market on our AUM mix, which was partially offset by an increase in the day count and higher real estate transaction fees and other revenues. Let's move to slide nine, where we provide our U.S. GAAP operating results by quarter. My comments today will focus on the variances related to our non-GAAP adjusted measures, which can be found on slide 10. Before turning to those results, I want to highlight one item on our U.S. GAAP financials for the quarter: a new expense line item named transaction integration and restructuring expenses. This line item includes transaction-related costs for acquisitions as well as integration and restructuring-related costs. You might remember, in fact, that we used the same line/annual approach for the Van Kampen acquisition, given the size of that deal and the size of the Oppenheimer deal. The presentation to prior period business combinations and optimization amounts has also been reclassified to be consistent with the current period presentation. This reclassification has no impact on total operating revenues, total operating expenses, or net income on a GAAP or on a non-GAAP adjusted basis.

Thank you very much, Loren. There are a couple of key topics that I'd like to cover today just to set the stage. First, I want to cover investment performance for Invesco as a standalone firm and provide some color on our long-term investment performance. Within that context, we'll look at some early signs of improvement. Secondly, I want to highlight the significant benefits that we believe we'll achieve through our combination with OppenheimerFunds. Finally, I'll highlight how the expansion of our capabilities with the addition of OppenheimerFunds will enable us to provide better outcomes to clients, and that's something we're very excited about. If you can turn to slide 13, we'll just take a quick look at performance overall. Our long-term performance remained strong with 63% of our overall actively managed assets in the top half of our peer group. In total, our five-year performance has remained strong despite challenging market conditions that Marty referenced, which you're all aware of over the past 18 months. Favorably, and what's not on the slide, we had 40% of our total actively managed assets in the top quartile of our peers on a five-year basis, which speaks to our long-term capabilities and reflects our quality investment teams. Turning to slide 14, the market for much of 2017 and 2018 was fueled by growth and momentum, which did not benefit active management. Our investment team stayed the course, reflecting our strong belief that discipline is critical to producing repeatable alpha through market cycles. As you look at recent investment results, while it's still early days, we are seeing significant performance improvement in a number of areas. For instance, on the upper left portion of this slide, we show our total U.S. mutual fund assets. On a one-year trailing basis, performance in the top half of peer groups improved from 11% to 42% from the end of November last year to the middle of January this year. We've also seen significant improvements in the performance of our largest mutual funds in the U.S. Importantly, we're seeing material improvement in the one-year peer relative rankings for several strategies that have experienced the greatest flow challenges. Specifically, diversified income improved from the 88th percentile to the 18th percentile on a one-year basis; international growth moved from the 66th percentile to the 46th percentile; developing markets from the 74th percentile to the 46th percentile; and UK income advanced from the 88th percentile to the 37th percentile. This improvement was achieved due to investment teams staying true to their philosophy and approach. While six weeks is not necessarily a trend, we recognize the short-term nature of that, and we're encouraged by this early improvement in performance, which we believe would set us up for better flow experience in the coming months. Let me now turn to the combination with OppenheimerFunds from an investment perspective. Upon closing the transaction, Invesco will be better situated than ever to serve clients with a more complete and comprehensive array of world-class investment teams and capabilities that can produce strong relative performance over a market cycle. Specifically, we believe we'll be better positioned to provide the following benefits to clients post-closing: a stronger, deeper investment organization; complementary investment capabilities that will drive enhanced and more stable long-term investment results; and greater sources of alpha to better align with client needs across the globe and in different channels. The combination significantly enhances our scale within the U.S. mutual fund market, which will afford us greater platform access and relevance to clients. We think this is critical in the retail channel as intermediaries are looking to partner with fewer firms. This increased size and scale will also provide greater access to capital markets, which we believe is important and obtaining access to deal flow, research, and firm exposure.

Thanks, Greg. If you turn to page 20, I'll pick up there and just spend a minute talking about an update on Oppenheimer. To level set, let me put in context what I talked about earlier. We have been aggressively repositioning the business over the last number of years, focusing on strengthening our leadership positions in core markets while investing in areas of rapid growth and client need, including ETFs, China, digital platforms, and factors. This combination with Oppenheimer and the relationship with MassMutual will accelerate this work. We are expanding our leadership in the U.S. wealth management channel with Oppenheimer, which is very important as it is the largest pool of assets in the world and most competitive. It will strengthen our ability to execute in several high growth areas we've discussed in the past. In light of the market dynamics, you can see the unique opportunity for us to create greater operating leverage and scale by combining the two organizations. We will do this using the framework from the past that has served us well. There were significant accomplishments made during the quarter. I want to thank both organizations for their hard work. I confirm the synergy target of $475 million, and we feel very confident about it. We also feel we will emerge as a stronger business post-close. The Oppenheimer investment teams are excited to be part of the combined firm. A very important milestone during the quarter was the approval of the transaction by the OppenheimerFunds Board of Trustees. This is foundational and a real catalyst to achieve our synergy targets. The mutual fund proxies have been filed with the SEC and will be in the market; you know that becomes another gating factor to close. We are actively engaged with MassMutual on future partnership opportunities. So again, we're making very good progress during the quarter. Let's turn back to the financials. We wanted to recap the financials in light of the very difficult fourth quarter. I think what you'll see is they remained compelling. EPS accretion remains strong; if you look on a pro forma basis, it will add $0.10 in 2019. For 2020, we expect accretion to be $0.52 per share. Looking at assets under management as of December 31, 2018, the internal rate of return was 16%, down three percentage points from the time of announcement, but again it is an extremely strong return given the market we've been through. The combination and expected synergies of $475 million will add more than $800 million in EBITDA with an operating margin in excess of 40%. The combined annual EBITDA will be $2.5 billion. The financial returns are compelling for shareholders with the firm dramatically stronger than prior to the transaction. Let's spend a little more time on the synergies. On page 23, we've laid out various categories for the emerging opportunities. We have robust plans in place heading towards closing and execution. Many of which are underway, including consolidating key platforms, addressing overlap in distribution, consolidating product support functions, and moving to a common technology and infrastructure plan. These activities will not only help reduce costs but will drive further decision-making, helping us refine our strategy and strengthen the organization.

So Ken, in terms of expenses, a lot of the marketing-related expenses were planned well in advance of the fourth quarter. These are product launches and events that were scheduled and committed to, so there isn't much flexibility around managing marketing expenses. As we got into the challenging parts of Q4, we pulled back wherever we could, but it was not enough to significantly impact marketing expenses. I would say there was about $10 million in unusually high marketing expenses that should be taken into consideration. No expenses were pulled forward from Q1 into Q4. The Q4 numbers were punctuated by higher expenses, particularly around G&A, which included about $6 million of probably one-time costs that should be accounted for when thinking about a true run rate. We feel like we're on track for optimization and achieving total cost savings. There may still be a bit of realization in Q1.

Hi. Good morning, and thank you for taking my questions. First on expenses, there is clearly seasonality in 4Q for your non-comp expenses, but maybe why weren't you better able to pivot given market conditions when the market started weak earlier in the quarter? And then Loren, were there any pull forwards in expenses from 1Q 2019 or 2019 in general into 4Q, such as prepaying of marketing or other expenses? Lastly, how much cost-cutting from your efficiency program was realized in 4Q, both actual and the run rate of savings as we go into 1Q?

So, Ken, let's say in terms of expenses, a lot of the expenses related to marketing were planned well in advance of being in the fourth quarter. So these are product launches, events that have been scheduled and committed to, so there isn’t much flexibility around marketing expense management. As we got into the more challenging parts of Q4, what we could pull back, we did, but it really wasn’t enough to move the dial on the marketing expenses. I would say that there’s about $10 million of unusually high run-rate marketing expense to consider. In terms of any pull forward, no, there was nothing pulled forward from Q1 into Q4. The Q4 numbers were punctuated by some higher expenses, particularly around G&A as mentioned, which was about $6 million of probably one-time costs that should be considered in terms of what a true run rate would look like for us. In terms of the cost cutting, we feel like we're absolutely on track in terms of the optimization. So in terms of achieving the total goal of run-rate expense savings, I think we are at that level, maybe a little bit still going to happen in Q1.

Thank you for your question. There are a couple of key topics that I'd like to cover. First, I want to cover investment performance for Invesco as a standalone firm and provide some color on long-term investment performance. Within that context, we'll look at some early signs of improvement. Secondly, I want to highlight the significant benefits that we believe we will achieve through our combination with OppenheimerFunds. Finally, I will highlight how the expansion of our capabilities with the addition of OppenheimerFunds will enable us to provide better outcomes to clients, and that's something we're very excited about.

Thank you for your question, Ken. Look, we have a high degree of confidence in our investment teams and their performance. Yes, we’ll continue to strengthen as the market evolves. We've just made great progress in investing and repositioning our firm ahead of where we think client demand is and where opportunities are. The combination with Oppenheimer will accelerate these efforts to drive further growth in trading scale and client relevance for us as an organization.

Thank you.

Again, I wanted to thank everyone for participating and I look forward to speaking with you all soon. Have a great rest of the day.