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Waddell & Reed Financial Inc  (NYSE:WDR)
Q4 2018 Earnings Conference Call
Feb. 05, 2019, 10:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good morning, and welcome to the Waddell & Reed Financial Fourth Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mike Daley, Vice President, Corporate Controller and Investor Relations. Please go ahead.

Michael John Daley -- Vice President, Corporate Controller and Investor Relations

Thank you. On behalf of our management team, I would like to welcome you to our quarterly earnings conference call. Joining me on our call today are Phil Sanders, our CEO; Ben Clouse, our CFO; Brent Bloss, our COO; Shawn Mihal, President of our Retail Broker-Dealer, Waddell & Reed, Inc; and Amy Scupham, President of Ivy Distributors Inc.

Before we begin, I would like to remind you that some of our comments and responses may include forward-looking statements. While we believe these statements to be reasonable based on information that is currently available to us, actual results could materially differ from those expressed or implied due to a number of factors that we reference in our public filings with the SEC. We assume no duty to update any forward-looking statements. Materials relevant to today's call, including a copy of the press release and supplemental schedules, have been posted on the Investor Relations section of our website at ir.waddell.com.

I would now like to turn the call over to Phil.

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

Good morning. Thanks for joining us. Today, we reported net income of $46 million or $0.60 per share for the fourth quarter, compared to $46 million or $0.58 per share during the prior quarter. As you saw in our release this morning, the quarter included a $16.1 million gain from the revaluation of our pension liability. We also incurred severance related charges of $3.2 million. These items netted to a $0.13 benefit to earnings for the quarter. For the full year of 2018, net income improved meaningfully but mostly due to benefits from corporate tax reform. Operating income improved for the year by $2.3 million or 1%.

Despite the market volatility experienced in the fourth quarter and the challenging end to the year, we made solid progress in 2018 on delivering against the corporate initiatives we have highlighted in past calls. Through the hard work and dedication of many individuals, we continue to lay the groundwork to improve the structural outlook of all phases of our business, with the goal of best serving clients, advisors and stockholders. There is no doubt that the industry landscape remains challenging and there is plenty more to be done, but we have made significant strides in improving our Company's long-term competitive positioning.

Specific examples of foundational improvements across 2018 include the following. Within Ivy Investments, our asset management business, we continue to add investment analyst resources, strengthen our portfolio management teams and implement technology, that facilitates enhanced sharing and collaboration across our investment teams. We also reduced expenses on 10 key funds and completed the merger of Arranger funds as we continue to refine our product set and focused on strategies where we feel we are best positioned to compete. Finally, we realigned Ivy sales leadership to provide optimal coverage as we work to maximize our sales and servicing efforts across all distribution channels.

With respect to the transformation of our broker-dealer, evolution continues at a rapid pace, as we recently announced several initiatives, including launching plans for advisor technology platform, that will integrate all of our enterprise technology applications, and provide a desktop workstation, where advisors can manage all aspects of their business, allowing advisors to serve their clients efficiently and seamlessly. Also, in response to growing advisor and investor needs, we continued to expand our advisory product lineup and providers, adding a third-party strategist program with multiple ETF portfolios. Initiatives also continue regarding the reduction of our broker-dealers real estate footprint in favor of a more industry standard independent model. Amidst all of these initiatives, advisor attrition has slowed, while overall advisor productivity has increased meaningfully.

From an organizational standpoint, we have reduced costs in a targeted and effective manner. We are instituting enhanced efficiency and accountability through an enterprise project management organization, with deliberate focus on maximizing resource effectiveness. We are also advancing our culture by further investing in our people through talent management, training and development, while ensuring our resources are aligned in the most productive and effective manner. As we build a framework for long-term success.

Clearly, we have experienced challenging flow dynamics as we undergo this transition. But we expect underlying progress to continue in 2019. There will undoubtedly be challenges ahead, but for any step backwards, our goal is to take two steps forward.

I'll now expand a little more on what we saw in the fourth quarter before I turn it over to Ben for more financial detail and analysis. Volatility was the dominant theme as 2018 came to a close. US equity markets set record highs during the year, only to see those gains erased by late December. The sell-off experienced toward year end sent the equity markets into correction territory with virtually every asset class ending the year with negative returns. Several forces have contributed to the volatility, including ongoing trade disputes, Central Bank policies, geopolitical tensions, slowing global growth rates and reduced corporate earnings visibility. Equity markets have experienced a meaningful rebound in the early part of 2019, but they could remain volatile in the near and intermediate term until some of these issues are resolved, or at least come into clearer focus. This environment proved challenging for active asset managers as outflows pressured overall assets under management for our company and many of our peers.

While volatility can at times, provide a favorable backdrop for active managers and we firmly believe that research and insight can identify differentiated ideas for investors, the flow toward passive strategies remained steady in 2018. Organic growth across the industry remains muted. As uncertainties continue into 2019, however, we believe investors are likely to seek out financial guidance realizing the merits that can come from a long-term financial plan built around distinct investment products. To this end, we are confident that active management will play an important role in our client's long-term financial solutions. Our diversified business model should continue to resonate even as we face an evolving industry landscape.

Now some comments with respect to investment performance. Fourth quarter performance was somewhat mixed during this period of pronounced market volatility. However, for the year, relative investment performance showed significant improvement with the majority of our assets now having either a four or five star overall Morningstar rating. As you know, we have made a concerted effort over the past couple of years to prioritize the resourcing of our investment management organization, including research, portfolio management and risk management.

Our strengthened investment organization and commitment to internal research provides a stable foundation for us as we move forward and should become an even more distinguishing attribute as sell-side research continues to be pressured. Fundamental, independent and collaborative research is what we've been doing for decades. It's in our DNA. I firmly believe our commitment here does and will increasingly resonate in the marketplace.

Okay. Now turning to flows for a moment. The market volatility in the quarter certainly resulted in elevated outflows, particularly in the unaffiliated channel. Within the unaffiliated channel, net outflows of $2.1 billion were impacted by one large client who moved $500 million in assets from retail into an institutional product as part of their broader strategy. Without that transfer, net outflows in that channel would have been $1.6 billion. During this period of volatility, investors gravitated toward more defensive strategies, such as short-term fixed income at the expense of international and higher beta domestic strategies.

This was particularly impactful to us given our equity heavy asset mix. Our international core equity and emerging market equity products experienced outflows during the quarter after flowing positive for much of the year. We also experienced some elevated outflows in our Science & Technology Fund in our High Income Fund to higher beta strategies that encountered some headwinds in this risk-off environment. On a positive note, we did see positive flows for the quarter in several of our mid cap and small cap strategies where performance is quite strong across multiple time periods.

Within our affiliated broker-dealer, we saw some improvement as Ivy net outflows of just under $1 billion slowed 12% compared to last quarter and were at their lowest level in six quarters. Within the institutional channel, net outflows were $700 million. This incorporates approximately $1 billion of institutional outflows that we signaled last quarter and are primarily related to personnel changes at the portfolio manager level that occurred earlier in the year. As mentioned earlier, this also includes the benefit of a $500 million client transfer from the retail unaffiliated channel to the institutional channel. Challenges in the institutional business persist and we have been notified of another $500 million of redemptions that we are likely to experience in the first half of 2019. Based on what we know now, our expectation is that by mid-year, we will have moved past most of the instability in our institutional channel. As a reminder, the institutional channel currently comprises less than 6% of our total AUM.

In light of the broader market focuses -- forces, we are focused every single day on actions that will create meaningful improvement in flows. Despite a challenging year, we have seen some progress from our efforts as in total net outflows have slowed 9% year-over-year on a reported basis and would have been notably less excluding the outsized impact of institutional flows due to personnel changes. We remain committed to our strategy of diversifying our assets under management and flow profile across the various distribution channels.

During 2019, we intend to introduce seven portfolios in a model delivery format, providing advisors and investors a new way to access existing strategies. We are also making incremental progress to enhance the positioning of our platform and distribution efforts. In particular, we are making strides in terms of modernizing our analytics and data capabilities that will support more targeted sales and marketing efforts. These initiatives combined with improving investment performance and competitive fees, are resulting in more constructive dialog with distribution partners and we are optimistic that we will be able to capitalize on some of these opportunities in the year ahead.

Let's now discuss the progress we've made toward evolving our broker-dealer business. As a refresher, remember that our immediate goal is to have a market competitive platform that is designed to evolve as the industry changes. The market changes, and the needs of investors change. We want to be nimble, responsive and proactively support advisors. We are receiving positive feedback from the advisor community concerning the changes that we recently announced and are actively implementing. We visited the majority of our advisor markets in December and the overwhelming sense is that advisors understand and are enthusiastic about the direction we're taking the business. We are focused on the areas of highest priority to advisors, including an improved support structure with the robust practice in business development focus, a market competitive technology platform and targeted support to the highest producers. They are embracing our new model of making long-term investments based on the value proposition for the business and positioning the firm for future growth.

Attrition of advisors has decelerated during the year. The attrition we saw through 2018 was largely due to the strategic departure of lower producing advisors. It is our intention to be in a position to attract experienced high producing advisors to the firm to understand and value a robust product line, superb technology and outstanding support. We ended the year with 1,060 financial advisors and an additional 343 advisor associates for a total of 1,403. We continue to focus our efforts and resources on the growth of high producing advisors as evidenced by average productivity of $378,000 for the trailing 12 months ended December 31, 2018, a 48% increase compared with the prior year. During the quarter, we also announced an increase to the compensation payout rates to our affiliated financial advisors, effective January 1st of this year. And a plan to exit broker-dealer field office real estate by the end of 2020.

On the technology front, we recently signed an agreement to deploy the Thomson ONE advisor desktop solution as the first of many steps toward streamlining advisors' experience and technology access. Adding Thomson ONE is an important step for advisors, as it will create the hub that brings all of our data and tools together in a single desktop workspace. In the end, this will result in a streamlining of processes for advisors and long-term cost reduction.

Let me now turn it over to Ben and then we'll open it up for questions. Ben?

Benjamin R. Clouse -- Senior Vice President and Chief Financial Officer

Thank you, Phil, and good morning everyone. As Phil noted, we reported fourth quarter net income of $46.5 million or $0.60 per share compared to $46.3 million or $0.58 per share during the prior quarter. The fourth quarter included a net $0.13 positive impact including a gain due to the annual revaluation of our pension liability driven by the interest rate environment, which was offset partly by some severance costs of $3.2 million as we realigned some of our support functions in the quarter. Operating income decreased $15.1 million on lower revenues, partially offset by a decrease in our operating costs compared to the prior quarter. The lower revenues were driven by lower assets under management as market volatility during the quarter had an outsized impact on our average asset base.

Continued reductions in our share count also increased earnings per share for the quarter. For the full year 2018, we reported net income of $183.6 million or $2.28 per share compared to $141.3 million or $1.69 per share during the prior year. This represents an increase in net income of approximately 35% compared to the prior year, primarily due to the benefits from corporate tax reform. Assets under management ended the quarter at $65.8 billion, a 17% decrease compared to the prior quarter, while average assets under management of $71.6 billion, decreased 12%. Despite the market volatility experienced in the fourth quarter, average assets for the full year of 2018 of $78.3 billion, only decreased 3% compared to 2017.

Within the broker-dealer, assets under administration ended the quarter at $51.3 billion, down 12% compared to the third quarter, again due to the market volatility experienced in the fourth quarter. As it relates to our Ivy products within the broker-dealer's assets under administration, the pace of net outflows from legacy products to newer advisory products continues to slow, and in aggregate remains well within our expectations.

As Phil mentioned, we recently announced an increase to the compensation payout rates for financial advisors and we are exiting broker-dealer field real estate by the end of 2020. We continue to expect that the reinvestment in our business through what we believe is the best-in-class compensation grid will be fully offset by savings from a reduction in our field office footprint and the corresponding support overhead by 2021.

Turning to the income statement, revenues of $272 million decreased 8% compared to the third quarter due to lower assets under management and administration as well as the full quarter impact of the fee reductions we announced earlier in the year, which were effective July 31st. Operating cost declined $7.8 million sequentially primarily due to distribution cost, which moved in line with distribution revenue. Compensation decreased $400,000 due to lower incentive compensation and a reduction in stock-based compensation despite severance charges of $3.2 million. In addition, occupancy costs were notably lower by 14% as we began to realize the benefits from field office closures.

We remain focused on long-term controllable expenses, which includes compensation, G&A technology, occupancy and marketing. These line items totaled $106 million during the quarter and $440 million year-to-date. We've made considerable progress on this front, having reduced controllable expenses nearly 8% since 2015 while continuing to invest in areas focused on strategic growth, including adding resources to our investment management team, pricing and product changes to support our distribution efforts and improving the underlying support structure and systems in our broker-dealer. As we've previously mentioned, we will continue to advance our investments in 2019 in improved technology, which are expected to have some incremental implementation costs.

Given those investments as well as normal inflationary increases, we expect controllable operating expenses for the full year of 2019 to be flat with the $440 million in 2018. Additionally, we expect depreciation costs to decrease meaningfully to a range of $15 million to $20 million for the full year as we continue to shift our technologies toward software-as-a-service. The effective income tax rate was 23% for both the quarter and the year. We continue to expect that the tax run rate to be in the range of 23% to 25% excluding the impact of any non-recurring or discrete items or issuance of additional guidance on tax legislation.

Finally, we ended the quarter with cash and investments of $849 million. During 2018, we paid off $95 million of debt, repurchased $136 million of stock and paid $81 million in dividends, while continuing to generate positive cash flow. We continue to be opportunistic with our capital management, including taking advantage of lower prices during the quarter as we progress toward our goal of $250 million in share buybacks by the end of 2019. Our balance sheet remains a strength as we continue to execute our growth plans while continuing to provide attractive capital returns to stockholders.

That concludes my comments. Operator, we would now like to open the call for questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session. (Operation Instructions) Our first question comes from Craig Siegenthaler with Credit Suisse. Please go ahead.

Craig Siegenthaler -- Credit Suisse -- Analyst

Thanks. Good morning, Phil.

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

Good morning.

Craig Siegenthaler -- Credit Suisse -- Analyst

First just starting on excess capital. Waddell has about $750 million of net cash and investments, less debt. I'm just -- I wanted the update here in terms of what's the level of working capital and regulatory capital within this balance?

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

I might let Ben address the working capital requirements. Ben?

Benjamin R. Clouse -- Senior Vice President and Chief Financial Officer

Sure. Good morning, Craig.

Craig Siegenthaler -- Credit Suisse -- Analyst

Hi. Good morning, Ben.

Benjamin R. Clouse -- Senior Vice President and Chief Financial Officer

As you know, we operate actually two broker-dealers, the retail and then our distributor as a broker-dealer, both have some regulatory capital requirements although they're not particularly significant in regard to working capital. We're very much focused on thinking about flexibility and the long term. And I'll let Phil add to this, but clearly we're thinking about what we will do next and we focus on this every quarter with our Board as we work toward concluding our repurchase program and thinking about what the future might hold after the end of '19.

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

Yeah, really the only thing to add there, Craig, is that obviously the balance sheet, as you point out is, is really a source of strength and provides us a lot of flexibility as we've undergone our business model transition, and especially in kind of uncertain times in the marketplace. So, as Ben indicated, we've been pretty active and persistent in terms of share repurchases. This will be something that we fully expect to complete our commitment and we'll readdress with the Board moving forward as we move throughout 2019. We talked in the past about the opportunity to do some incremental acquisitions, our enhanced capabilities. If we -- if the right thing comes along, we certainly have that flexibility. So, we took a lot of the tough decisions early two years ago when we started this process with the reduction of the dividend and improved the capital flexibility. And I think we're in a good spot going forward. The early part of this transition, a lot of it has been focused on self-help and a lot of things we're doing internally. As we transition into 2019, I think there's an opportunity to be more forward looking and be more growth minded and that's kind of where we're focused right now.

Craig Siegenthaler -- Credit Suisse -- Analyst

Got it. And that number is important because I think a lot of us in our valuation exercise look at your PE multiple would then add something for excess capital. So it's important for us to understand what sort of the two access there? But just as my follow-up, it's nice to see actually the broker-dealer AUM flows actually improving against such a tough backdrop. And it looks like proprietary share of Waddell & Reed funds in the broker-dealer is more or less stabilizing here. So I just wonder if you had any kind of thoughts in terms of what's driving that stabilization at this point?

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

I might let maybe Shawn address some of what's going on in the broker-dealer and the -- and how he sees that playing out.

Shawn M. Mihal -- President, Retail Broker-Dealer

Yeah, good morning, Craig. Yeah, absolutely, we are seeing some stabilization with respect to the affiliated funds inside the broker-dealer channel. We know that we've launched a significant amount of change inside the broker-dealer including the introduction of some advisory programs that include exposure to unaffiliated funds. And over the course of that time, we saw some of the ranges in which we expected and forecasted some movement from affiliated funds to those new programs to make some of those transitions of affiliated holdings into unaffiliated holdings with the launch of those programs.

There was some demand initially when we launched that primarily in mid of 2017, that ran its course through a portion of 2018 and we saw some stabilization there is that demand started to subside. We expect with new sales as we continue to open up new products to see that stabilization across all of our product platform. So our expectations are relatively on a go forward basis that we see that continued stabilization on the affiliated assets under management.

Craig Siegenthaler -- Credit Suisse -- Analyst

Great. Thank you, guys.

Operator

The next question comes from Glenn Schorr with Evercore ISI. Please go ahead.

Glenn Schorr -- Evercore ISI -- Analyst

Hi, thanks very much. So bright spot in a tough backdrop was I think sales were up 7% quarter-on-quarter and kind of flat year-on-year in such a brutal market backdrop. I'm curious if you could give a little more color on, on what seems to have momentum? And if you can attribute it, any of that to the recent fee cuts or is it too early to see an impact there?

Amy Jo Scupham -- President, Ivy Distributors Inc.

Hi, Glenn, this is Amy. I do think that we can attribute it a little bit to some of the fee cuts, Although fees obviously don't drive sales in and of themselves. Over the course of the year, we saw market improvement from a performance standpoint across a lot of our products. And as a distribution force, we really have worked to focus in on where we feel we are best positioned to compete and really had each of our distribution channels focused on their client base, which is starting to show some pay off here in the short term.

We saw some -- we saw market increase in sales in our midcap franchises and in our small cap franchises. We continue to -- as we look into 2019, we have a broader product set that selling, if you look back a year ago, we had pretty high concentration of sales in our international core and emerging market equity product that those two products continue to garner gross sales and it's extending into some of our domestic equity in our high income franchises as well.

Glenn Schorr -- Evercore ISI -- Analyst

Okay. Appreciate that. And just a follow-up, on the -- you mentioned once or twice that there is a realignment of sales leadership across the channels. Can you just expand a little bit more? I'm just curious on what you guys did there and how that's going to drive growth?

Amy Jo Scupham -- President, Ivy Distributors Inc.

Yeah, sure. I think historically as an organization, we haven't put a lot of investment into what we're today calling our professional buyer distribution channel, which is inclusive of institutional RIA, defined contribution or retirement business and our insurance business. And really separating out those businesses and focusing in on the unique needs of the client basis. So throughout 2018 under the leadership of Grant Cleghorn we -- we've built out all of those teams and we continue to push forward with the strong messaging in the evolutions that we've had as a firm, which won't -- it be a little bit of a longer-term payoff as it's a longer term sales cycle there, but we're looking forward to that.

And then in September, we brought in Joe Moran and he is running our broker-dealer channel or what we refer to as our national channel, which is inclusive of national accounts and broker-dealer wholesale and our Waddell & Reed specific channel. And having all of those really working together in a more focused effort is improving and really focusing in on where we're spending our resources and where we spend our dollars is starting to pay off as well. And we -- and we think it will continue to throughout 2019.

Glenn Schorr -- Evercore ISI -- Analyst

All right. Thanks very much.

Operator

The next question comes from Bill Katz with Citigroup. Please go ahead.

Bill Katz -- Citigroup -- Analyst

Okay, thank you very much for the updated guidance and taking the questions this morning. Just on that $440 million, how much flexibility do you have around that number, like I want to get a sort of maybe ring-fence so an upside-downside scenario of market start to cooperate or become more problematic from here?

Benjamin R. Clouse -- Senior Vice President and Chief Financial Officer

Good morning, Bill, it's Ben. I want to point out maybe just a couple of things on the $440 million. That is inclusive of the incremental implementation investment we're making in technology, which will start next year. In regard to flexibility, we are constantly assessing our expense base, and looking at all of the ways we do business and we'll continue to be prudent in our ongoing assessment of those costs. If we face some sustained headwinds in the market, we do have the ability to pull back in certain areas and manage our way through that. With that said, you won't see us overreacting to the short-term. We're very much focused on the long term, and we don't ever want to compromise or cut back on the things that we believe will position us to be competitive in the longer term.

Bill Katz -- Citigroup -- Analyst

Okay, that's helpful. And just a follow-up question, just on the SA (ph) pipeline and maybe transition assistance dynamics. Can you give us a sense now that it seems like some of the core run off and repositioning of the footprint is behind you? How does the pipeline look? And then how is sort of pricing of that, is it more or less competitive given some of the changes you've been making?

Shawn M. Mihal -- President, Retail Broker-Dealer

Hi, Bill, Shawn Mihal. I'll take that question. We are starting to see some turnaround with respect to the pipeline, and having some active recruits that we are working with today. We are also doing through our changes in November, a substantive overhaul with regard to our recruiting resources and really bringing a national recruiting model in place, which we are working to stand up currently, as we're seeking to fill open positions in our recruiting department. So we do have expectations of continued growth in our recruiting channels for 2019. Along with that, as was mentioned in the -- the call this morning, the attrition that has been slowing inside the broker-dealer channel as we've made several changes in 2018. We do expect to see a little bit of a drop here at the beginning of 2019 as we typically work through our low producing advisor terminations at the close of the year. So we do have a little bit of a drop just based on the lower producing advisors that didn't meet minimum production requirements.

But however, we are focused through 2019 to continue our efforts and expansion of our recruiting, focus more on high producing advisors. So our target advisor has really changed from what we used to recruit in the past being very inexperienced advisors, new advisors to the industry, where our targeted focus going forward will be focused on those high producing advisors typically targeting over $200,000 in annual production as we move forward. And the pipeline is starting to grow as we've announced some of these more substantive changes and we're continuing to explore more inside our recruiting channels particularly as we add these additional recruiting resources in.

Bill Katz -- Citigroup -- Analyst

Okay, thank you for taking the questions.

Operator

The next question comes from Kenneth Lee with RBC Capital Markets. Please go ahead.

Kenneth Lee -- RBC Capital Markets -- Analyst

Hi, thanks for taking my question. Just a follow-up on the incremental tech costs. Elevated expenses, it looks like for 2019 and presumably there is going to be a similar level of spend in 2020. Is that correct? Thanks.

Benjamin R. Clouse -- Senior Vice President and Chief Financial Officer

Good morning, Kenneth. I would put that those incremental costs as part of our expense base somewhere in the range of $5 million to $10 million, but with that said, we're at the very early end of the implementation of that. I think you are correct, that will span from '19 into '20 although I expect it to be a bit heavier in 2019 versus 2020, although I don't know that I have a particular breakdown. One other point, just to reiterate some statements I made in the last quarter. In the longer term, we really expect the run rate there to moderate as we're also working to sunset some older systems, at the same time we stand up some of this new more software-as-a-service model. So I think in the long term we'll see a bit more moderation there once we get through the next 1.5 year to 2 year implementation period.

Kenneth Lee -- RBC Capital Markets -- Analyst

Okay, great. And just a follow-up on the sales realignments. Stepping back, I think a while back there were efforts initiated to institutionalize so to speak the investment process, the risk management and obviously the sales. Just wondering if we were to look at a higher level, is it sort of like correct to say that the restructuring process, so to speak, is pretty much nearly complete at this point and then we should start to see more the benefits? Or just wanted to see where we are in terms of that -- the whole set of efforts there. Thanks.

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

Okay. This is Phil. I'll take this and then maybe Amy can add if she wants to. When we refer to the institutionalization process, we're really talking about clearly articulated philosophies, processes, full risk analytics, attribution, dynamics. All of those types of things that we need in today's world in portfolio management. I think looking back years ago, there was some delineation between the institutional side of our business and retail. As we see the industry evolving today, those lines are really going away and are very blurred. Almost every distribution channel has a gatekeeper in which case they're requiring pretty high levels of analytics and due diligence and consistency of how you deliver the product.

So we've essentially completed that at least vastly completed that through the investment management division. As you know, we've talked in the past about kind of fortifying our portfolio teams. We've transitioned over the last couple of years from a lot of single PM strategies to team managed products. We've back-filled with strengthening our investment research, capabilities. We have a Chief Risk Officer in place now for the last 2.5 years or so. He's -- he and his team is fully embedded within our investment division. We are now -- all of that is now being integrated and dealing with the distribution folks and the marketing folks on a day-to-day basis.

So I think we've spent -- we worked really hard and a lot of people have contributed to kind of laying the groundwork for how we move forward and positioning the Company to be successful and what's expected moving forward. So I think we're in a pretty good spot. There are always ways we can get better and we're continuing to look at resources and whether it's through technology or individuals and we'll continue to assess that and make investments where needed. But I think we have a pretty clear understanding of what's required to be successful in this business. My background was in the institutional side their, Director of Research came from the institutional side, Amy's background is from the consulting side. So I think we've got that DNA kind of pushing through the whole organization. I don't know, Amy, if there's anything to add there.

Amy Jo Scupham -- President, Ivy Distributors Inc.

No, I don't think there's much, like I said, the build out of our professional buyer distribution or a more institutional like channel is complete and we look forward to over the course of the next 18 months to 24 months, really starting to see that come to fruition alongside all of the evolutions that have happened in investment management, which just help us to better service our clients across all distribution channels.

Kenneth Lee -- RBC Capital Markets -- Analyst

Okay, great. Very helpful. Thank you very much.

Operator

The next question comes from Robert Lee with KBW. Please go ahead.

Robert Lee -- KBW -- Analyst

Great. Good morning. Thanks for taking my questions. I guess my first question would be a little bit on the distribution, particularly the unaffiliated channel, I mean, would that the levels down to about $25 billion at quarter end? And I'm sure they're backup somewhat now. But can you maybe update us on, you know that seems to be a kind of a level that -- are you -- is it a struggle to be relevant with the large distributors? I mean, have you had to adopt or change your approach to unaffiliated distributors in terms of making sure you have enough mind share in different places to be relevant to them?

Amy Jo Scupham -- President, Ivy Distributors Inc.

I'll take that question. So, is it a struggle to be relevant? I'm going to go with no. We know and we recognize that we can't be everything to everyone. And this is a trend that is going across the industry. So if you look at our unaffiliated assets under management and flow that's inclusive today of RIA, retirements, broker-dealer and our insurance variable annuity fund. So that's everything all kind of lumped into one. The steps that we've taken over the course of 2018 and as we roll into 2019 is to really say where do we -- where do we want to and need to be relevant and what does that look like.

So we're, like I said earlier, where are we putting our resources from a partnership standpoint, where are we best positioned to compete from a product standpoint. And ensuring that, all of our sales force from national accounts to our wholesalers, to our RIA investment consultants, to our retirement investment consultants, everyone is carrying the same message, talking about the same product, setting the appropriate expectations for how our products that is going to compete and really just making sure that we address the needs of each of our partners in a unique manner. So it's really just about becoming more focused and not trying to be all things to all people.

Robert Lee -- KBW -- Analyst

Thank you. And maybe as a follow-up one, I'll go back to maybe the expense question. And just want make sure I understand it, means, with the -- your -- the expense guidance for next year, understanding there is a step up in tech spending as you -- among other things, and you've built out research and investment capabilities. But, how much of that should we think about as we look for is kind of -- really kind of a new run rate expense and there's really just kind of not that much -- there's always some flexibility, I guess, that's kind of really kind of your base expense space. So if you look into 2020 or maybe ventured even think beyond that, that there's just not a lot of room. The room for expenses to fall off from that or how should we be kind of thinking of the progression over the next year or two?

Benjamin R. Clouse -- Senior Vice President and Chief Financial Officer

Good morning, Rob, it's Ben. In regard to technology in particular, I think as I stated earlier, we'll have some implementation costs which obviously won't continue in the longer term in the base or the run rate. We clearly have some run rate costs from older systems that will sunset as we stand up some of our new software and systems that are more cloud-based or hosted solutions. In the long-term thinking about late 2020 and beyond, again I expect those to moderate to a level that's relatively consistent with our current technology run rate, once we get through a period of swap out, so to speak when we're standing up some new things and some sun setting some old things. In the longer term, though, I don't expect that to have a significant increase over our run rate today.

Robert Lee -- KBW -- Analyst

Okay. Thank you for the additional color.

Operator

The next question comes from Michael Cyprys with Morgan Stanley. Please go ahead.

Michael Cyprys -- Morgan Stanley -- Analyst

Hi, good morning. Thanks for taking the question. Just wanted to circle back on the seven portfolios that you guys are going to be introducing in model delivery. If you could just expand on that in terms of the timing, expectations there, goals around that, which particular strategies, if you could comment? And then what's the economics going to be on those new portfolios coming in versus in the commingled funds?

Amy Jo Scupham -- President, Ivy Distributors Inc.

Hi, Michael, it's Amy. Yes, I can expand on that a little bit. So the timing should be sometime here in the first quarter as far as the original implementation and roll-out of it. As we work through 2019, the goal would really be to continue to have extended conversations with some of our other distribution partners around opening up model delivery capabilities on their platforms. So that's probably the first six to nine months would be about extending and expanding that capability. As far as the portfolios that we're opening them in -- we're opening them in our mid-cap franchise, of mid-cap growth and mid-cap income opportunities, we have concentrated versions of both our large cap growth and large cap value.

That will be being offered, small cap growth and then our science and tech portfolio as well as an energy model delivery portfolio. As far as the economics go it's model delivery is a low fee option that's provided to high producing advisors on various platforms from an economic standpoint. From ours -- from our position, it has I think fairly high margins even though the lower fee as it's not paid out in the traditional wholesale expense model.

Michael Cyprys -- Morgan Stanley -- Analyst

Great, thanks. And just a follow-up question for Phil. You mentioned some potential appetite for potential incremental acquisitions or enhanced capabilities, if something comes along. Just hoping you could flesh that out a little bit there, and just in terms of how you're thinking about that, approaching that, where there might be white spaces?

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

Well, I think it's really consistent with what we said in the past. I mean, some extensions are capabilities that are complementary to our core competencies, I think the ability to integrate and cultural fit is significant. I think there's also some interest in uncorrelated asset classes, maybe that are a little bit different than from what we're doing. As you know, we're probably 80% or so equity, if 20% fixed income, half of that is in the high yield or credit side. So, I think we have opportunities in -- from the external side. And also I think internal development, we have a strong balance sheet as we've highlighted and we have some seed capital that we can develop maybe product extensions for existing capabilities, whether it's more concentrated versions of what we're offering, maybe broader -- think more broadly in terms of international enhanced capabilities, our multi-asset as well. So it's kind of a wide range of things that I don't think would be too surprising to others or things that we'd be interested in.

Michael Cyprys -- Morgan Stanley -- Analyst

Great. Thank you.

Operator

The next question comes from Michael Carrier with Bank of America Merrill Lynch. Please go ahead.

Michael Carrier -- Bank of America Merrill Lynch -- Analyst

All right. Thanks and good morning. Ben, maybe just one more on the expenses. When I look at just some of the pressure that we saw on the AUM toward year-end, just wanted to get a sense on, it seems like maybe some of the comp should be a bit more variable as we're going into '19. So if there is maybe some offsets there that are impacting this year, just kind -- I guess any insight there? Because it just seems like there's not as much variability as we expect. And then maybe if you can just give maybe an update on where AUM is just given the rebound in the market because maybe that's some of the offset?

Benjamin R. Clouse -- Senior Vice President and Chief Financial Officer

Hi, Mike -- good morning, Michael. I might start at the end of your question and then I might let Phil add on your comp question. In regard to assets, as you know, we do monthly disclosures, so we'll have our monthly levels disclosed, I believe on Monday. And you've heard Phil and Amy talk a little bit about the sales in the months and what the pipeline looks like. Clearly, the markets were more positive in January and we did see some recovery to our asset levels again and we'll have disclosure on the -- the details on Monday.

In regard to compensation, some of what we have been doing internally is a bit what you described, we're -- clearly we are focused on aligning pay and performance as best we can. And of course we have variable compensation programs for the management team as well as for the portfolio management group. And I'll let Phil finish my answer here, but we even continue to make some modifications to that as well. But as a total of our expense base, those are not large drivers of variability to the total when we think about the incentive portion separated from the base. Not to be repetitive, of course, but all that goes along with my earlier answer that we're obviously constantly looking at the ways we spend money and are very focused on that. So I don't know if you want to add to that in regard to portfolio management.

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

Yeah, I think the only thing to add there is that obviously some portion of the investment staffs compensation over the long term, especially in the portfolio management side, would be based on the growth potential of products and assets under management and that type of thing. But really the bulk of it is driven by performance and that's really what we focus on and I think it's important. What the portfolio managers and our investment research staff and our risk analytics group and these people are working hard every day to generate superior returns and investments for our clients. There also -- we also know that they are the lifeblood of the Company in terms of the asset management side.

So if we have strong performing portfolio management, we're going to compensate them fairly and recognize that. So while there was some incremental flexibility with respect to a compensation, we're not going to short change and make things in the short-term that are going to hinder us in terms of long-term performance and growth.

Michael Carrier -- Bank of America Merrill Lynch -- Analyst

Okay, that's helpful. And then, Ben I think you hit on this a little bit earlier. But just in terms of the balance sheet, if you can provide any color on how you guys think about kind of free cash, the operating cash, regulatory capital and then seed or kind of CapEx, what do you think you have in products that could produce future growth?

Benjamin R. Clouse -- Senior Vice President and Chief Financial Officer

Sure. I mentioned it a little bit of course, we have some regulatory capital requirements, which are not particularly significant to our balance sheet overall, maybe a couple incremental points would be just in the broader picture we do continue to have significant net positive cash flows from operations and we've been able to use those cash flows to execute. Our capital strategy which I talked about in my prepared comments earlier in regard to dividends and buybacks, of course, as well as the pay down of our debt that matured about one year ago, we continue to focus on that each quarter with our Board as we think about the longer-term in regard to how we manage capital. And as Phil mentioned, we're taking a look at the M&A landscape and thinking about opportunities there as well. We are continually looking at our debt level which as you know is minimum and the remaining $95 million comes to maturity in 2021. We have a make-whole provision on that and so it isn't particularly economically beneficial for us to repay it early.

In regard to seed, we have something in the neighborhood of $250 million of seed currently in our products. We look at that on an ongoing basis as Phil alluded to earlier that's clearly a source of strength for us and we have a lot of flexibility there as we are able to develop and roll out products and help them build a track record before they go to market and we use our balance sheet to do that. I don't know that we have any planned significant changes to that. I might let Phil add to that if he has any further thoughts in the longer term.

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

No, I think that pretty much covers that it gives us a lot of flexibility. We're kind of using that as an opportunity to develop new products. It's also of strong interest to our internal portfolio management group and as well as our sales and distribution group. So we'll see how that plays out.

Michael Carrier -- Bank of America Merrill Lynch -- Analyst

Okay, thanks a lot.

Operator

The next question is from Mac Sykes with G.Research. Please go ahead.

Mac Sykes -- G.Research -- Analyst

Good morning, everyone.

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

Good morning.

Mac Sykes -- G.Research -- Analyst

I actually just hit three quick questions from Shawn, I'll just ask him right in a row. I guess, in terms of the broker-dealer business, are there any components in terms of offerings, risk management, digital alternatives? I know you've addressed some of them today that you -- might give you a much bigger edge in terms of being more competitive. And then is there also a level of AUM advisor count where as you scale, you might need a further step-up in fixed investment that we don't have today. And then my last question is just in qualitatively, how does sort of your regional versus your national exposure impact growth and expectations going forward?

Shawn M. Mihal -- President, Retail Broker-Dealer

Good morning. Yeah, let me go back to the first line. I was trying to write them down, so if I can keep me honest here on the questions in case I can't quite remember the details that you're looking for, Mac. But on the digital side, as we announced this morning and through a press release yesterday, we've entered into an agreement with Thomson ONE which is their welfare solution advisor desktop, which we're really excited to enter into that arrangement to collectively pull together the connections of the systems that we use on a day-to-day basis to support our advisors. As you're likely aware, that program supports well over 100,000 advisors in the marketplace today. It's a highly competitive platform, which allows you to aggregate or consolidate down your technology offerings to advisors.

So really utilizing the systems that we use on a day-to-day basis to better connect those and create an overall better experience for our advisors, allowing us to scale better in the support of our advisors by consolidating things down on to one platform in which they access to do business and support clients. So we feel that, that gives us a strong competitive advantage and moving us forward with regard to the other technology packages that we've rolled out. We've gone through significant initiatives throughout the course of the last three or so years in enhancements in technology and this is just another step in that direction to collectively pool all those things together.

We have other technology goals for the 2019 timeframe in which we'll be doing some data consolidation and aggregation to allow us for better overall access to data as well as reporting capabilities. So that is of another project of ours that is under way for 2019 and we'll be looking forward to making some additional announcements about that. Again, producing a more scalable, and more agile environment for the broker-dealer and allowing us to grow the broker-dealer in a meaningful way without significantly increasing costs associated with supporting that business. As well as working on the consolidation of our workflow processes to support our advisors.

So as we continue to converge our advisors and the product offerings and technology, having single processes in which they engage into better overall support their account opening and maintenance processes. So again, we feel that we're moving this in the right direction from an overall technology standpoint, from an digital environment. We feel as we've continue to aggregate and consolidate data into a single environment for the connection places in which we best integrate in our core technology packages, will allow us to further enhance that advisor experience, and allow us to further deliver new innovative solutions to advisors as we continue to grow out the broker-dealer business.

On the AUM and advisor count perspective, we are continuing to focus on the growth of our overall assets under administration inside the broker-dealer, focusing the broker-dealer and positioning it for growth over the next several years. It's an important component for us in the business to invest back into the broker-dealer and we are making those investments on the digital side, which we believe will help us as we continue to grow that advisor count and AUA. I do want to make it clear that our intent is not to grow in the way that we did in the past with recruiting in hundreds of advisors per year that weren't experienced. We are more focused on recruiting higher quality, higher producing advisors, as we move forward. So our expectation is not to see the same type of recruiting numbers that we saw in the past, but rather seeing highly productive advisors as we focus our recruiting efforts on those types of advisors in the industry, so those experienced advisors.

So that'll be a direction for us as we continue into 2019. 2018 saw us work through along the stabilization inside the broker-dealer with regard to a lot of the initiatives that we made announcements on in the fourth quarter, and as we've made some additional announcements here early in January and the February of this year. That will provide us a -- my belief is with the platform and support structure to better grow that overall AUA and advisor count as well as just in general inside the broker-dealer as we focus on continuing to put those investments into the broker-dealer. The last question you had I believe was related to the overall regional verse national model. I'm not sure I quite picked up on all that -- all that what you said. Do you mind just repeating that one?

Mac Sykes -- G.Research -- Analyst

Yeah, just trying to get at where you think you are in terms of the different markets on a national exposure and how that impacts growth? So trying to compete in perhaps faster growing markets versus some of your traditional stronger footprints.

Shawn M. Mihal -- President, Retail Broker-Dealer

So we have aligned from an overall regional structure of really developing on our regionals from two regions to three regions led by three Regional Vice Presidents. And then also our markets and making adjustments across the -- those three regions to six markets per region. We've also focused on establishing a national based recruiting effort in which we are aligning with those particular regions. We've seen strong growth with respect to the broker-dealer business through our more central region. We are focused on the east and west quite a bit for growth opportunity in those particular regions.

And as we've made changes in November of last year to really centralize our core support efforts for our advisors with respect to practice development, advanced sales, as well as a higher level service structure, and as a diamond service grew, we believe that's putting the structure in place to better support that overall existing advisors, plus the growth of new advisors into the organization. We'll continue to focus those efforts across a national channel of advisors and looking for opportunities, particularly as we continue to expand in that overall support model to our advisors. So we are certainly focused on those areas in which we see as presenting opportunity where in the past, we've had overall exposure and concentration with respect to the central markets but really focusing across all three for future growth.

Mac Sykes -- G.Research -- Analyst

Okay. Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Phil Sanders for any closing remarks.

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

Okay, thank you. Listen, I appreciate everybody joining in, and tuning in today. And we will catch up with you here in a few months. Have a great day. Thank you.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 64 minutes

Call participants:

Michael John Daley -- Vice President, Corporate Controller and Investor Relations

Philip J. Sanders -- Chief Executive Officer and Chief Investment Officer

Benjamin R. Clouse -- Senior Vice President and Chief Financial Officer

Craig Siegenthaler -- Credit Suisse -- Analyst

Shawn M. Mihal -- President, Retail Broker-Dealer

Glenn Schorr -- Evercore ISI -- Analyst

Amy Jo Scupham -- President, Ivy Distributors Inc.

Bill Katz -- Citigroup -- Analyst

Kenneth Lee -- RBC Capital Markets -- Analyst

Robert Lee -- KBW -- Analyst

Michael Cyprys -- Morgan Stanley -- Analyst

Michael Carrier -- Bank of America Merrill Lynch -- Analyst

Mac Sykes -- G.Research -- Analyst

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