Earnings Call Transcript - VCTR Q1 2022

Operator, Operator

Good morning and welcome to the Victory Capital First Quarter 2022 Earnings Conference Call. All callers are in listen-only mode. Following the company's prepared remarks, there will be a question-and-answer session. I will now turn the call over to Mr. Matthew Dennis, Chief of Staff and Director of Investor Relations. Please go ahead, Mr. Dennis.

Matthew Dennis, Chief of Staff and Director of Investor Relations

Thank you. 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 close yesterday disclosed both GAAP and non-GAAP financial results. We believe that 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 is now my pleasure to turn the call over to David Brown, Chairman and CEO.

David Brown, Chairman and CEO

Thanks, Matt. Good morning, and welcome to Victory Capital's first quarter 2022 earnings conference 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 today by providing an overview of the first quarter. Then I will cover our investment performance, which strengthened even further in the quarter, and touch on our new equity buyback program. After that, I’ll turn the call over to Mike to review the financial results in greater detail. Following our prepared remarks, Mike, Matt, and I will be available to take your questions. The quarterly overview begins on Slide 5. We started 2022 on a high note as we posted our seventh consecutive quarter of revenue growth. We also had robust growth sales and net flows, which can be attributed to prior strategic investments we have made and our focused execution. The $11 billion of growth sales achieved in the first quarter was the cumulation of positive contributions across each of our distribution channels and a well-diversified mix of investment strategies and products. Over the past few years, we have purposely diversified our business into new asset classes, investment vehicles, and distribution channels. For example, recall our CEMP acquisition in 2015; one component of this relatively small acquisition was the Victory Market Neutral Income Fund, which had AUM of approximately $60 million when we closed the acquisition. Today, the fund has grown to more than $3.8 billion and is currently the top-selling fund in its Morningstar category while also being ranked five stars overall by Morningstar. The recent addition of WestEnd Advisors model strategies and the launch of our alternative investments platform last year are recent examples of diversifying our investment vehicles and asset class offerings. Investments in technology and data are also continuing to produce positive results. As a data-driven firm, we are making smarter decisions and becoming a more efficient organization through these investments. On the institutional business front, activities are returning to more normalized conditions. We had a number of institutional fundings during the first quarter, and we're able to successfully replenish our pipeline with additional wins that are expected to fund as the year progresses. Our current book of one, but not yet funded institutional business is not only robust, but also very well-diversified across investment franchises and by institutional client types. We are also making progress with THP, which we acquired early last year. Just like we have in the past, we're following a proven playbook of building the distribution pipes and obtaining premium shelf space to generate sales activity. We've already secured buy ratings with six institutional consultants, and the THP small-cap core strategy was recently added to the UMA and SMA platform at a top-tier wirehouse in March. With approximately $15 billion of capacity and strong investment performance, building these pipes creates a solid foundation for stimulating future sales activity. Our retail and intermediary teams also had a very productive quarter with a number of large wins and strategic product placements. We are also seeing encouraging activity in this channel with our newest franchise, WestEnd Advisors. Positive momentum in our direct investor business continued during the first quarter as well. This resulted in the best quarter of net flows for that channel since the acquisition. Our 529 Education Savings Plan experienced positive net flows in the quarter as well, bolstered by integrated marketing campaigns targeting direct investors. Looking forward on net flows, we are seeing the same momentum we had in the first quarter carrying over to the second quarter. We are encouraged with the start of the second quarter from a net flow perspective. Lastly, we reported the highest level of GAAP operating income in our history, exceeding $100 million in the quarter. Despite the lower markets and accelerating inflationary environment, our operating model flexed as designed to maintain very attractive margins. Our adjusted EBITDA margin was 49.7%, which was in excess of our long-term guidance of 49%. This is a very good example of the power of our operating model and how it performs well in many market conditions. On Slide 7, you can see our strong investment performance improved even further in the first quarter of the year. At the end of the quarter, we had 44 mutual funds and ETFs with a four or five-star rating from Morningstar. This translates to 65% of our mutual fund and ETF AUM with four or five-star ratings by Morningstar. The percentage of firm-wide AUM that outperformed benchmarks rose during the first quarter for each respective measurement period. We were particularly gratified to achieve outperformance over the three- and five-year time periods with 78% and 83% of our total AUM outperforming benchmarks, respectively. Over the same time periods, our investment performance was well-diversified across asset classes, strategies, and vehicles. A few examples are 100% of WestEnd Advisors assets outperformed their benchmarks, as did 96% of the AUM for products managed by USAA Investments at the end of this quarter. Turning to Slide 8. In yesterday's press release, we announced that the Board approved a $100 million share repurchase program. This is the largest program in our history and gives us the flexibility to be opportunistic in executing this program. Although the buyback program is the largest in our history, our capital allocation strategy has not changed. I want to be clear on this point: We are committed to reducing debt to increase balance sheet flexibility so we can have the ability to make strategic investments by acquisitions to drive profitable and sustainable growth. As our business has grown, so has our cash flow. We now have the benefit of being able to execute on our capital allocation strategy while also being able to return larger amounts of capital to shareholders via dividends and buybacks. Before I turn it over to Mike, I will mention that the M&A environment remains very constructive, and we are continuing to conduct diligence on multiple prospective deals. We have ample capital capacity and the financial wherewithal to continue executing both large transformational deals as well as smaller impactful ones. In the past eight years, we've closed eight transactions and expect that cadence to continue going forward. Our focus remains on acquisitions that have a strategic element, and we'll make our company better, stronger, and more competitive. With that, I will turn it over to Mike for more details in the quarter's financials.

Michael Policarpo, President, Chief Financial and Administrative Officer

Thanks, Dave, and good morning, everyone. The financial results review begins on Slide 10. Total AUM decreased by $5.6 billion, or 3%, in the quarter to $178.1 billion at the end of March. This decrease was driven by market action and was partially offset by the $3 billion of positive inflows during the quarter. AUM at quarter-end was 15% higher than at the same time last year. Revenues rose to $230 million in the quarter. Revenue was positively impacted by the business as we acquired, and our asset mix shifted slightly due to the WestEnd Advisors acquisition, which I will cover in more detail momentarily. During the quarter, GAAP operating income was favorably impacted by lower acquisition-related costs. We had a $6.7 million swing related to the change in contingent consideration on our balance sheet. This is the liability associated with contingent that is valued quarterly with quarter-over-quarter changes flowing through the income statement. In the fourth quarter, this resulted in a non-cash expense of $3.2 million, which reversed to a non-cash $3.5 million positive contribution to operating income in the first quarter. Most of the difference quarter-over-quarter was related to the change in interest rates resulting in a higher discount rate being applied to the NPV calculation. Partially offsetting these lower expenses, depreciation and amortization expense increased by $5.2 million in the first quarter, reflecting the NEC and WestEnd acquisitions that closed in the fourth quarter of last year. Adjusted EBITDA was $114.4 million in the first quarter. Given the incremental expenses associated with the two acquisitions closing in Q4, we're pleased to see our operating model calibrate as it is designed to do, resulting in an adjusted EBITDA margin of 49.7%. We believe this is yet another proof point for our operating model and the benefits of our variable cost structure. As a reminder, approximately two-thirds of our expenses are variable and one-third of our expenses are fixed. GAAP net income was $71.3 million, or $0.97 per diluted share. And ANI with tax benefit was $1.23 per diluted share. We returned $27 million of capital to shareholders in the quarter in share repurchases and cash dividends. The cash dividend was maintained at $0.25 per share for the current quarter. On Slide 11, we see total AUM was $178.1 billion at the end of the first quarter and well-diversified from a distribution channel and client-based perspective. This is only down 3% from the end of the fourth quarter. Long-term AUM totaled $175 billion at quarter-end. This was 16% higher than the $151 billion of long-term AUM at the end of last year's first quarter. Turning to Slide 12, we have $3 billion of positive net long-term flows in the quarter. This was the third out of the last four quarters that we had positive net long-term flows. The strong first quarter net inflows resulted in trailing 12-month net long-term flows turning positive as well. Our sales activity has been very well-diversified across franchises and distribution channels, as Dave described. Past investments made to enhance our distribution capabilities, which includes advancing our use of technology and data, seasonal marketing initiatives, and the addition of an experienced team of RIA and multi-family office sales specialists are all yielding results we expected. Our ETF sales have also been strong. The first quarter was our sixth consecutive quarter of positive net flows in our Victory ETFs, with March marking the 17th consecutive month of positive net flows. Our ETF AUM has grown 18% year-over-year through the end of the first quarter and is up 65% over the past two years. Slide 13 illustrates our steadily growing revenue. The increase in quarter-over-quarter average AUM and the decrease in the fee rate realization are primarily due to the WestEnd Advisors acquisition and in line with our expectations. WestEnd Advisors average 30 basis points, which is below our firm’s historical investment management fee rate. Moreover, WestEnd Advisors model business does not include any of the fund administration, distribution, or transfer agent fees that have charged on our mutual fund vehicles. As the quarter progressed, these benefited from a consistent reduction in money market yield support as interest rates rose. This resulted in a drag on our consolidated average fee rate in the first quarter, improving to one half of a basis point, compared with a drag of a quarter of a basis point in the fourth quarter. Given the forecast for future interest rate hikes, we anticipate that money market yield support will eventually not be needed and we will realize an increase in our average fee rate as a result. We also experienced improvements in the fulcrum fees associated with certain USAA Mutual Funds in the quarter. This reduced our average fee rate by two-tenths of a basis point in the first quarter, compared with a four-tenths of a basis point reduction in the fourth quarter. On Slide 14, we breakout our expenses. Total expenses of $139.5 million in the first quarter declined from the fourth quarter due to lower operating expenses. This was partially offset by higher depreciation and amortization and higher interest expense associated with the incremental term loan used to finance the WestEnd Advisors acquisition. Compensation expense rose as a result of several factors. First, the normal seasonality we experienced in the first calendar quarter of every year associated with resetting payroll taxes and benefits on January 1, which had approximately 100 basis points impact on the cash compensation ratio. Additionally, Q1 was the first full quarter of compensation associated with the acquisitions closed in the fourth quarter, and we experienced prior sales commissions related to the strong growth and net flows in the quarter. As you may recall from our call last quarter, some of the performance-based acquisition earnout payments are being recorded as compensation. As a result, we are providing that potential compensation that’s still related and breaking it out here for transparency. GAAP operating expenses declined $10.8 million quarter-over-quarter. This was primarily a result of lower acquisition, restructuring, and integration expenses, where we recorded a $3.4 million benefit to operating income versus a $13.3 million expense in the prior quarter. We also incurred slightly higher non-compensation expenses associated with the integration of expenses related to both the NEC and WestEnd Advisors acquisitions. Despite all the noise in our GAAP results this quarter, these increases in cash expenses were essentially absorbed by our variable cost structure, automatically reducing expenses in other areas. For example, we reported lower distribution and other asset-based expenses, as well as lower general and administrative expenses in the quarter. That leads us to Slide 15, where we cover our non-GAAP metrics. Needless to say, we are satisfied with the way our operating model adjusted expenses in the quarter to maintain healthy margins. We continue to invest back into the business to support future growth while simultaneously generating attractive margins. Consistent with prior investments, the investments we are making today in technology, data, distribution, and product development are intended to underpin future success. You can see in a chart on the slide that our cash tax benefit increased $2 million to $9.3 million in the quarter as a result of the WestEnd Advisors and NEC acquisitions. In the appendix of the slide deck, we have included a graphic that lays out the predictable cash tax savings we are scheduled to realize over the next 15 years. Assuming a 25% tax rate, these total approximately $525 million of future cash savings. Turning to Slide 16. On the capital management front, we repaid $70 million of debt during the quarter. Our net leverage ratio at quarter-end was 2.2x, and we repaid an additional $20 million thus far in the second quarter, for a total of $90 million year to date. Our blended interest rate on debt during the quarter was approximately 2.9%. As we reduce debt, we’re electing to pay down the incremental term loan portion first. We believe that the interest rate hedge we have in place on $450 million of the original term loan is beneficial to us in a rising rate environment. Currently, we're paying 3.2% on that hedged portion of our debt. In addition to the debt reduction, we returned $27 million of capital to shareholders via share repurchases and cash dividends in the quarter.

Operator, Operator

Thank you. Our first question is from Craig Siegenthaler with Bank of America. Your line is open.

Craig Siegenthaler, Analyst

Hey, good morning, David, Michael. Hope you're both doing well?

Michael Policarpo, President, Chief Financial and Administrative Officer

Good morning, Craig.

Craig Siegenthaler, Analyst

So my first question is on WestEnd. Can you update us on these strategic cross-sell opportunities that Victory can harvest through this recent acquisition and also how is it playing out to date?

David Brown, Chairman and CEO

Let me start off on how it's playing to date. We've seen, as we said in the script, a lot of good momentum with that product in our different relationships. Really, since we acquired the business, we have not seen a drop-off in organic growth. We are really just getting started there. So, the opportunity to cross-sell Victory products with existing WestEnd relationships, and then the opportunity to sell WestEnd products with existing Victory relationships is starting to take shape. As we move through the end of the year, I would imagine that those opportunities would start to materialize even more than they are today. But we're very encouraged by the activity we've seen, the growth we've seen, and as we said when we announced the transaction, we think that this product and this team are excellent and it's going to be a big growth driver for us going forward.

Craig Siegenthaler, Analyst

Thanks, David. And just for my follow-up, can you walk us through any fees fundraising pipeline? And any color on timing magnitude as we think about forecasting net flows?

David Brown, Chairman and CEO

As far as NEC, we are executing on our growth plan. We had always imagined that NEC would grow with our help and further existing LP relationships, and we're executing on that plan. As far as magnitude, I'm not in a position to say what the sizing of that growth will be, but our original plans had been growing more aggressively than they've grown in the past. As far as management fees, I'll let Mike take that.

Michael Policarpo, President, Chief Financial and Administrative Officer

Yes. The management fee rate for NEC is consistent with what you see with alternatives, which is above the levels obviously that we have seen as a firm in the 53 basis point range. As Dave said, the size will drive incremental expansion of our overall fee rates. Currently, the AUM in the segment is relatively small compared to the overall business, but we do expect that to grow as Dave said, as we go out. And we'll expect to see the overall fee rate increase as we accumulate the growth across the alternative segment.

Craig Siegenthaler, Analyst

Thanks, Michael. And just want to congratulate you guys on a strong quarter despite the backdrop for flows. I think it was your second strongest slow quarter ever.

Michael Policarpo, President, Chief Financial and Administrative Officer

Correct. Thank you, Craig.

Operator, Operator

Our next question is from Kenneth Lee with RBC Capital Markets. Your line is open.

Kenneth Lee, Analyst

Hi. Thanks for taking my question. I mean the prepared remarks you mentioned the institutional pipeline being greater than historical level. Just wondering if you could provide a little bit more color, which strategies are you seeing making contribution or gaining traction there?

David Brown, Chairman and CEO

Good morning. Our institutional activity in the first quarter, we had funded a number of things that were in our one, but not yet funded pipeline. We've been able to rebuild that. So, what we're sitting with today is really replenish one, but not yet funded institutional pipeline very similar to what we've had in the first quarter. As far as the product set that's in that one, but not yet funded pipeline, it's pretty broad. It spans from some of our global and international products to U.S. products and even to some of our solutions products. So, we're pretty excited about the activity. There is a lot of money in motion as the market has turned over as people have rethought their portfolios, it has put money in motion, and money in motion usually seeks out different types of strategies and we've seen a big benefit from that, and you can tell from our flow quarter.

Kenneth Lee, Analyst

Great. Very helpful. And just one follow-up, if I may, you mentioned that the THP franchise is getting some buy ratings from some institutional consultants. What are the next steps that you would expect as you continue to ramp up this franchise? And when can we start seeing some kind of distribution to organic growth?

David Brown, Chairman and CEO

We’re about a year into the close of the acquisition, and with THP, our strategy as with other acquisitions is to really build the distribution pipes. So, we're in the process now of building those distribution pipes. We have buy ratings at six institutional consultants. We mentioned one of the products securing really good shelf space on one of the major platform distributors, and we're going to see more of that as we move forward. The next step from there will actually be to start to work with those platforms and those consultants to get allocations. So, I think as we move through 2022 and into 2023, you'll see growth in THP. That really has been our plan, and that has been – if you go back and look at our acquisitions, that has been the model. I think a great way to think of it is, I mentioned in the script, the CEMP acquisition and the growth of the Market Neutral Income product. We did the CEMP acquisition in 2015. Here we are in the first quarter of 2022, and that product today has over actually $4 billion, and that started out with $60 million. So, it takes time to build the distribution pipes. But over time, it grows once you have either the distribution, and I think THP is going to take the same path as some of our other franchises we've acquired.

Kenneth Lee, Analyst

Right, very helpful. Thanks again.

Operator, Operator

The next question is from Alex Blostein with Goldman Sachs. Your line is open.

Alex Blostein, Analyst

Thanks. Good morning, guys. Dave, I was wondering if you could expand on your comments around the M&A landscape a little bit broadly. It sounds like the activity continues to be fairly healthy on both larger deals and smaller deals. Obviously in the prior cycle, we've seen periods of volatility tend to kind of stall these things out a little bit. Does it feel different this time around, and if so, why? And then maybe you could comment on multiples as well? Have we seen multiples come down as well in your conversations reflected of the environment?

David Brown, Chairman and CEO

Good morning, Alex. So, this is a very unique time for our industry. If you go back and look at periods of volatility, things did slow down. I would say that things are different this time, at least in the period we're at right now. We have not seen a slowdown at all. I think there are really two reactions to what's happening in the environment today from sellers. One is, you do see some sellers pull back and say, 'I will wait' – that's a smaller amount that we're seeing; but you're seeing a lot of other sellers actually accelerate into it. So, it's really one extreme or the other, and there's more people accelerating into a transaction than pulling away from a transaction. Different than the past, I don't expect the acquisition activity at least to slow down. There could be challenges with financing and other things that could slow it down depending on the market conditions. But as far as the activity in the conversations, we've actually seen a little bit of an uptick, which is a little bit different from times in the past. As far as multiples, I think the multiples today, we've not seen them come down yet. I anticipate that the multiples will come down as the market that we're currently in starts to season, but we haven't seen them come down yet; I anticipate they will.

Alex Blostein, Analyst

Great. Very helpful. My second question was around the fixed-income business. We've obviously seen a lot of dislocation in the fixed market, particularly with core, core-plus type of products over the course of the last few months. How is your fixed-income franchise positioned in this environment? Could there be an opportunity to pick up extra share, specifically in the legacy USAA channel?

David Brown, Chairman and CEO

Yes. Our USAA investment franchise, which is one of our two fixed-income franchises, has done excellent from an investment performance perspective. These types of markets are actually markets in which they do very well, and you can see that from the investment performance. So, we're super excited about the investment performance. I think there is a lot of money in motion in the fixed-income world today. I anticipate that with our performance over a period of time and some of our peers' and competitors' performance, which has not been as good as ours, I would anticipate we would be able to pick up market share from a flow perspective. From a retention perspective, I think we've done very well relative to the industry, and I think some of that has to do with our existing client base and then a lot of it has to do with the excellent investment performance. I'm really encouraged. We've always thought when there's a market disruption in fixed income that we would have a great opportunity with money in motion to capture some of that money in motion and also pick up market share.

Alex Blostein, Analyst

Awesome. Great. Just maybe a one quick cleanup question modeling related, given your comments around both the fee waivers and the fulcrum fees getting better, as you roll forward into this quarter and the second quarter, how should we be thinking about the effective fee rate given all the kind of puts and takes in the business? Thanks.

Michael Policarpo, President, Chief Financial and Administrative Officer

Yes, thanks, Alex. I think we said in the script that the impact of the money market waivers in the first quarter was 25 basis points. With recent rate hikes, we expect that to phase out in the second quarter. So, we will expect to see the pickup where we’ll be making, kind of the full fee on the money market business. We also highlighted the fulcrum fees, which were on the USAA mutual fund products or select USA mutual fund products. The drag on that in the quarter was 0.2 basis points. What we said there with the span in which it covers my product perspective is that has the opportunity to expand our overall basis points by one to two. We continue to see strong performance using statistics on USAA fixed income products, the continuously strong investment performance that continues to improve. There is some opportunity to see expansion on that as we move forward, but the 53 basis point range really is the level if you think about the infusion in the acquisition from a base perspective. Start with 53, and we've got some upside with those elements. Of course, going forward, asset mix, client mix, and product mix will continue to move that around a little bit, but we do see some opportunity going forward.

David Brown, Chairman and CEO

One additional point, Alex, is if you think about last quarter or some of our historical fee rates, the drop in the fee rate from the fourth quarter to the first quarter is primarily almost entirely because of the WestEnd revenue and the amount that they earn on the revenue. That is just purely a function of math.

Operator, Operator

The next question is from Ken Worthington with JPMorgan. Your line is open.

Ken Worthington, Analyst

Hi, good morning. Maybe start with a modeling question. In terms of the acquisition-related compensation, what drives that up and down? Is it AUM, is it sales, is it profitability? Maybe next, is there seasonality to it? Is Q4 or Q1 going to be unusually big in the rest of the quarters small? Or is it pretty even throughout? And then is there, like almost an accrued figure that we should be thinking about that's going to be paid out over time given the Q1 level of whatever it is, AUM sales, profitability that ultimately drives it?

Michael Policarpo, President, Chief Financial and Administrative Officer

Sure. The acquisition-related compensation that was recorded in Q1 really had two components. There's an element associated with some sellers' finance retention incentives that will be paid out at the end of this year, and that's a smaller component of it. The other element is the NEC earnout. The composition from an investment accounting perspective, we're taking the estimated earnout, which is about $35 million to be paid over five years, and it is being taken through the P&L on that line item. We're taking it ratably over the five years, so I think it's about $1.5 million in the first quarter. That will be paid out as we've said as the targets are hit from a revenue growth perspective and will be paid out again in future periods. So, it's a non-cash expense at this point in time, but I think for modeling purposes, the $1.5 million a quarter is what you should expect for NEC. There are some short-term elements of retention incentives put in place through WestEnd that will be accrued over the course of 2022.

Alex Blostein, Analyst

Okay, brilliant. Thank you. And then wanted to just dig into solutions in mid-cap a little bit. Gross inflows picked up a bunch. I assume this is the fundings on the institutional pipeline that you guys talked about in your prepared remarks, which brands in mid-cap are driving the success there? I think you've got a couple of different brands that we could choose from, but which are the ones that are driving the success here, and then within solutions, any more color you can give us and which part of the solutions franchise is driving the pop in the gross sales we saw during the quarter? And then just in mid-cap, the market impact was strong in the quarter. It looks like Sycamore seems to be doing great. You've got some exposure to oil and gas. What is ultimately driving the strong results in mid-cap? Is it, again, it seems like it might be an overexposure to oil and gas, but it could be off there?

Michael Policarpo, President, Chief Financial and Administrative Officer

So, a number of questions in there. Let me try to unpack them one by one. First, when you think about what's driving some of the flows in our mid-cap asset class, I'd say it's led by Sycamore. That's probably a good way to think about it. They actually, as you've stated, have excellent short and long-term investment performance. I can't pinpoint one part of the portfolio, which is driving the performance. They have a well-diversified portfolio—it's in a number of different sectors. So, I don't think that it is more exposure to oil or less exposure to oil. I think it's really just around their investment process. So, there’s not one piece of their portfolio that I would say is driving that. As far as solutions on what's driving some of the flows in there, first, WestEnd Advisors, our new acquisition and franchise resides within our solutions bucket. Our ETF business, Victory Shares, which was mentioned, has been net flow positive for probably over the last year and a half, and that's driving it. Those are probably the two big buckets if you think about what you're able to see that are driving that growth. As far as investment performance, if you go back and look at the improved investment performance quarter-over-quarter I've just generally across our firm, we think of Sycamore, think of our ETF business, WestEnd Advisors, USAA, our RS Global Product, and our RS Value Product. Those all are really doing well, have done well in the first quarter, and continue to do well. These challenging, volatile markets, we believe are going to allow the really good active managers to shine. We're excited to have our franchisees maneuver through these markets and put up really strong competitive performance, and that's what we saw in the first quarter and continue to see so far in the second quarter.

Alex Blostein, Analyst

Okay. Awesome. Thank you for answering all the questions. I appreciate it.

Operator, Operator

The next question is from Robert Lee with KBW. Your line is open.

Robert Lee, Analyst

Great. Good morning. Thank you for taking my questions. Hope everyone is doing well? Could you maybe put a little bit more color on the flows from kind of an economic contribution perspective? So, if you think the flow is on an organic basis and it's hovering around 7% annualized, but we really think of that as kind of an organic revenue or EBITDA contribution, just given that obviously WestEnd is no more moderate fee rate. How should we think the revenue or EBITDA contribution is similar to the flow? Is it half? I mean, trying to get some better sense of that contribution.

Michael Policarpo, President, Chief Financial and Administrative Officer

Good morning. Let me start off by saying, as we have said over a number of years, we are margin-focused. We've always looked at our business. We think we have a unique operating model and operating platform. We are margin-focused. We've guided at 49%. We've exceeded that over a number of quarters and actually exceeded it this quarter in a really volatile and challenging quarter. So, when I think of fee rates and I think of our organic growth, it's close to what our average fee rate is. So, there is a scenario where we're selling or growing and selling some very low-fee product and losing very high-fee product, if that's part of your question. In general, it's around what our average fee rate is. Specifically, WestEnd Advisors' average fee is about 30 basis points. That is, as I said earlier, probably if not all a material amount of the drop in our average fee rate, but keep in mind WestEnd Advisors' margin exceeds our margin. So, it's actually margin additive. Although it's fee rate less than our fee rate from an overall perspective, I'll go back to what I started off with: We are 100% focused on margins from a product perspective, not necessarily fee rates, just because our operating model or operating platform, we think, is unique and allows us to do that.

Robert Lee, Analyst

Okay, great. And maybe a follow-up just on capital management and buybacks. So, your majority PE owners have obviously started to monetize a part of that position; you have the buyback. How do you think of and who knows what their intention is to monetize over the near term, but how do you think of the trade-off between if they were to come to market, given where the stock is trading, plus your desire to deleverage the company and to kind of reload? So, would it be something that if there was stock available at a cheap price, you would slow the pace in debt reduction for a couple of quarters to take advantage of that? What are your current thoughts on how you maneuver through that?

David Brown, Chairman and CEO

As far as our corporate strategy in our capital allocation, nothing’s really changed. Although we had the board approve our largest buyback in our history at $100 million, nothing has changed from our mindset or capital allocation policy. Our number one priority is to pay down debt to provide a flexible balance sheet, a balance sheet that's ready to go and do accretive, profitable acquisitions that make our company better. That is our number one priority. We've grown over the years, and so has our cash flow. Our cash flow has grown and has allowed us to be flexible in our buyback and our dividend policy. This $100 million approval of this buyback program gives us the ability to be opportunistic and flexible with market conditions that allow us to go in and buy our stock at a very advantageous price. We think that the $100 million is the right number to provide that balance. But the balance is always going to lean for us to really pay down debt. Not only does it reduce our interest expense, but it lowers our leverage amount and allows us to have the fuel to go out and do additional acquisitions. If you look at our history of doing acquisitions, I think they've been really shareholder accretive, create a lot of value, and we think there's a lot of opportunities in the market, and that's how we're going to use our capital and be able to do the buyback program at the levels we are, being able to pay the dividend at the levels we are is really a reward to our shareholders for our growth and our cash flow growth.

Robert Lee, Analyst

Great, thank you. Maybe just one quick follow-up on capital management. This was the first quarter in a while; you actually didn't increase the dividend, which was expected, but as the dividend strategy means some companies have a long-term strategy; they just want to be able to increase it every year and build that long-term record of annual raises. Is that, maybe that’s a capital management strategy? I mean, even if it's a modest increase and your payout ratio is modest, is that something you think about? Do you want to be one of those companies that can, ten to fifteen years from now, say you’ve increased this every year for a decade?

Michael Policarpo, President, Chief Financial and Administrative Officer

Historically, we have increased our dividend every quarter. We went last quarter to a larger increase for that quarter-over-quarter, and now we're doing an annual review. We think with the growth of our business and our future outlook that we'll be able to continue that. But everything is going to be based on facts and circumstances. With a business that's growing, with cash flow that's growing, and our ability to convert earnings into free cash flow, I would anticipate that we will continue down the same path we've been on, but that's going to be fact and circumstances-based.

Operator, Operator

The next question is from Brennan Hawken with UBS. Your line is open.

Brennan Hawken, Analyst

Good morning. Thank you for taking my questions. Curious on really strong contributor here to the flow, the flows this quarter. Was there anything that was chunky—such as the launch of a fund or strategy—that contributed? Just trying to get a sense of that.

Michael Policarpo, President, Chief Financial and Administrative Officer

Good morning. Nothing that's chunky. Our Market Neutral Income product is within our ops category, and I think as we said in our script, that was a fast grower, given its strategy. So that is a driver of most of the growth within that bucket.

Brennan Hawken, Analyst

Yeah, I could see how that—a product like that would be appealing in this market. So that makes sense. Okay. So, then, second one, WestEnd, is there —I know that this is a product that's on a bunch of platforms. When we think about the typical pattern of flows that WestEnd sees when they're added to a platform. Is that a fairly linear trajectory, or is there some parabola to that line as more advisors sign up? And when you think about that, based on the cadence of platforms that they've been adding recently, is there any way to think about what that might suggest for flow trajectory from that business from here?

Michael Policarpo, President, Chief Financial and Administrative Officer

Sure. Just maybe to go back a little bit on WestEnd, they did, prior to the acquisition, $4.4 billion of net flows in 2021. They did about over $8 billion for the five years that they were independent up to 2021. They have historically grown at a very, very fast rate. They do business today with a little over 3,000 advisors. We do business with over 100,000 advisors across the industry. There is a lot of opportunity to sell WestEnd products on the existing platforms that they’re on and that we have relationships on, just to expand their reach within those platforms. Getting on new platforms is partially what we're focused on, and when they get on a platform, what typically happens is, you're going to work with an advisor, an advisor is going to start to use the product, and over time when they see the value of the product, they see the value of the collateral that's being provided to them. Historically, what they have seen is that that advisor will use more of their portfolio and allocate it more to WestEnd Advisors. So, over time, when we think about WestEnd going forward, we think of that platform, that franchise, those products growing at an accelerated pace because we're building out distribution on the new platforms and the new advisors. And keep in mind that a new advisor doesn't necessarily have to be on a new platform; they'll use more of the WestEnd product as they try it out and see the value of it as they use the collateral.

Brennan Hawken, Analyst

Great. Thank you for that color.

Operator, Operator

The next question is from Michael Cyprys with Morgan Stanley. Your line is open.

Michael Cyprys, Analyst

Hi, good morning. Thanks for taking the question. It's been a number of years that you guys have had the direct channel. So, just curious what lessons learned you have from the direct channel from that experience? And what do you know today that maybe you wish you had known three or four years ago? And to what extent does it entice you to go direct in a broader way beyond the USAA network? Right? You have a platform, you have technology. I guess what would hold you back from doing direct in a much broader way?

Michael Policarpo, President, Chief Financial and Administrative Officer

Good morning, Mike. First, let me point out that we had our best quarter from a flow perspective in the direct channel this past quarter. We've actually seen consistent progress every single quarter, I think for the last year and a half or so. So, we're really quite pleased with what's happening there. From a lessons learned perspective, we have gotten a lot better on servicing, on technology, on training, and there have been a lot of lessons learned, and I think that we have done a good job, and we are now doing a great job. There is nothing holding us back from expanding our direct business in any way at all. Today, our business is available to USAA members and non-USAA members. In fact, there is a portion of the new accounts that are people that are not USAA members. We look at it as a platform. As we think about the industry going forward, we think about our capabilities. We think it's unique for a firm like ours to have this direct business, and we plan to capitalize on it going forward through product expansion—where we’re expanding our marketing campaigns. We have done it slowly; we've managed it. We've learned along the way, and I think we have built a phenomenal platform for the future. We're looking not just at quarters; we're looking at years. We see a lot of the trends, and we think we have a really valuable asset here in having a direct-to-consumer platform.

Michael Cyprys, Analyst

Great. And then just on digital marketing, you had mentioned that earlier. I was just hoping you can expand a little bit about what exactly that means for Victory? Maybe you could talk about how much success you're having with digital marketing initiatives? How do you think about measuring the return on digital marketing, and maybe you can elaborate on how much you're spending there?

David Brown, Chairman and CEO

On the digital marketing, I think most firms during the period of COVID were forced forward to really increase the amount of digital marketing to gain the capabilities, and we were part of that. I think the thing that's unique about us is we have a large part of our business where we are direct marketing—digital marketing to a consumer through our direct business. We do it through email campaigns and other media. We have made a lot of progress there. We have some internal proprietary measuring statistics that we use that are unique to our business. As far as the costs, we don't break out the costs. We have built a shared services platform, which is part of our operating model. The best part about that is all of the learnings we have in our direct business with digital marketing and really direct marketing are being applied to our other parts of our business, which I think is really value-added. Again, it's not the entire future of the industry, but it is going to be a bigger piece year in and year out. We think we have the benefit of having this direct channel and direct business to refine what we're doing, and then we can apply it to a larger base in other parts of the business.

Michael Cyprys, Analyst

Great. Thanks for taking my questions.

Operator, Operator

Our final question is from Owen Lau with Oppenheimer. Your line is open.

Owen Lau, Analyst

Good morning, and thank you for taking my questions. Dave, going back to your earlier comment about the uptick, maybe in M&A activities or conversations this time, compared to the auto market historically speaking, if you take a little bit deeper, why this time it's different? Is it because people feel like this time the correction will last longer, or anything else? And also, what metrics would you look at and finally put a trigger to start making acquisitions? Thank you.

David Brown, Chairman and CEO

I think what has changed is really our industry. The challenges that cause consolidation or a manager to sell themselves have not changed. In fact, you could argue that a market like we have today actually accelerates those challenges. I think in the past, when you’ve had this kind of market disruption, the challenges weren't as present or highlighted; but today, if you fast forward from years ago, those challenges that investment managers are facing have not gotten any easier—they've actually gotten harder. A hard market is actually accelerating even more. Whether this is a long correction or short correction, I don't necessarily think that plays into the acceleration of a firm that wants to sell themselves, at least not materially. As far as our evaluation, we always start off with a simple question: does this acquisition make our company better? Does it make us more competitive? Does it give us certain characteristics that we don't have today? Does it move us forward in certain areas to make us more competitive generally? We always look at pricing where we want to be competitive, and we also look at the market and multiples. So, we don't have one core metric that says we should do this transaction or not. We have a core concept of whether this makes our company better, and that is always the check to do a transaction.

Owen Lau, Analyst

Got, and then to follow-up along that line. So, what do you see about active versus passive investing in the current environment? I mean, you obviously had strong inflows in the first quarter. Is it the beginning of the shift toward active investing if the current volatile market continues, or is it still too early to say? Thanks.

David Brown, Chairman and CEO

I'm glad we're an active manager. That's how I’d answer that. I think that in markets like this, with the volatility, good active managers look good, and I'm glad we're an active manager.

Operator, Operator

That concludes the question-and-answer session. I'll turn it over to David Brown for any closing remarks.

David Brown, Chairman and CEO

Thank you for participating in today's call. We appreciate your interest in Victory Capital and look forward to keeping you updated on our progress. Later this month, we'll be attending the B. Riley Annual Investor Conference in Los Angeles, and we hope to see you all there. Have a great rest of your day. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.