Legg Mason, Inc. (NYSE:LM) Q4 2019 Results Conference Call May 13, 2019 5:00 PM ET
Alan Magleby - Head of Investor Relations
Joe Sullivan - Chairman and Chief Executive Officer
Pete Nachtwey - Chief Financial Officer
Rick Genoni - Head of ETF Product Management
Conference Call Participants
Chris Harris - Wells Fargo
Robert Lee - KBW
Kenneth Lee - RBC Capital Markets
Bill Katz - Citi
Mac Sykes - G Research
Craig Siegenthaler - Credit Suisse
Brian Bedell - Deutsche Bank
Glenn Schorr - Evercore
Patrick Davitt - Autonomous Research
Michael Cyprys - Morgan Stanley
Welcome to the Legg Mason Fourth Quarter and Fiscal Year End 2019 Earnings Call. My name is Richard and I will be your operator for today’s conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation [Operator Instructions]. Please note that this conference is being recorded.
It is now my pleasure to introduce your host, Alan Magleby, Head of Investor Relations. Thank you, Mr. Magleby. You may begin.
Thank you, Richard. On behalf of Legg Mason, I would like to welcome you to our conference call to discuss operating results for the fiscal 2019 fourth quarter and the fiscal year ended March 31, 2019.
This presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements. For a discussion of these risks and uncertainties, please see Risk Factors and Management’s Discussion and Analysis of Financial Condition and Results of Operations in the company’s annual report on Form 10-K for the fiscal year ended March 31, 2018 and in the company’s subsequent filings with the Securities and Exchange Commission.
During today’s call, we may also discuss non-GAAP financial information. Reconciliations of the non-GAAP financial information to the comparable GAAP financial information can be found in the press release and in the presentation we issued this afternoon, which is available in the investor relations section of our website. The company undertakes no obligation to update the information contained in this presentation to reflect subsequently occurring events or circumstances. Today's call will include remarks from Mr. Joe Sullivan, Legg Mason’s Chairman and CEO, and Mr. Pete Nachtwey, Legg Mason’s CFO who will discuss our financial results. In addition, following a review of the company's quarter, we will then open the call to Q&A.
Now, I would like to turn this call over to Mr. Joe Sullivan. Joe?
Thanks, Alan. And good evening. As always, we appreciate your continued interest in Legg Mason and with me again tonight is our CFO Pete Nachtwey, as we review our performance for the fourth fiscal quarter, ended March 31st.
Starting at a high level, I'm pleased to say that we're continuing to make significant progress, meeting evolving client demand, by expanding client choice through the diversification of our business, across investment strategies, vehicles and distribution access. This has been our strategy for some time now, and I like our progress.
This quarter's performance highlights those efforts, as well as the important headway we are making, and continuing to build a better Legg Mason through a multi faceted approach, which I will discuss in further detail. We netted breakeven long-term flows this quarter, reflecting positive inflows across our alternatives and fixed income businesses offset by net equity outflows. Further this morning, we reported $1.2 billion of positive long-term net flows in April, which is our third straight month of inflows.
Legg Mason’s global retail distribution platform was a solid performer in the quarter, generating positive net sales, the result of both higher sales and lower redemptions. Our AUM ended the quarter at $758 billion, up from $727 billion at December 31. We also refined our plans during the quarter for our global business platform as part of a broader strategic restructuring program that will position the company to drive improving overall margins and profitability. And we continue to thoughtfully allocate our capital in a number of ways, most notably with our board approving a double digit increase in our quarterly dividend as we prepare to de-lever by repaying $250 million of our public debt in July.
We are building a better Legg Mason for our many constituencies, by executing against four key drivers of value creation: Specifically, further leveraging centralized retail distribution to grow; developing the potential of our investments and M&A agenda; to provide investors with greater choice; more effectively managing costs, to improve profitability; and prudently managing the company's balance sheet, while thoughtfully returning capital to shareholders. So let's start now, with where I know you have particular interest, improving profitability by more effectively managing costs.
In our third quarter earnings call, we announced a plan to create a global business platform inclusive of shared services at corporate and certain of our affiliates. We originally projected that plan could deliver $90 million to $110 million of annual run rate savings by the end of calendar year 2022, or just over three years. Since that announcement, our plans have evolved to focus primarily on our corporate operating platform as part of a broader corporate restructuring. Simply stated, our focus is on making our existing corporate global business platform more efficient and effective.
And while we no longer plan to combine affiliate operations into the global business platform, our affiliates will have the opportunity to benefit from leveraging Legg Mason's resources, capabilities and streamlined operating platform, to the extent it makes sense for them to do so. We have also expanded the areas included in our cost savings from our Global Business platform to include broader Legg Mason corporate and distribution functions, as well as efficiency initiatives at certain smaller affiliates that operate outside of revenue sharing arrangements.
While there is much work to be done, we now have increased visibility into and have gained even greater confidence in our ability to deliver $100 million or more of annual savings now within two years. And we have moved from planning to implementation and are showing immediate progress. Specifically, we expect to have achieved 35% of targeted savings on a run rate basis by the end of this quarter, and 75% or more of targeted run rate savings by this fiscal year end. Pete will walk you through more detail of our progress on this restructuring momentarily.
But while operating with a high degree of efficiency is essential. Our value creation strategy will not be limited to simply managing costs, as we must continue to position ourselves to drive sustainable growth. Balancing both demands will require that as we reduce our spend, we must simultaneously prioritize our resources to those areas that enable us to better deliver differentiated investment strategies, vehicles and especially access for our clients with greater investments in the client experience, sales enablement, and data and analytics.
Data and analytics are driving insights across our business and increasing efficiencies, enhancing effectiveness and ultimately enabling us to provide our clients with a much more unique client experience. While we are creating greater efficiency by reducing costs, we are also prioritizing existing resources to better deliver for our clients.
Now, the second aspect of strengthening Legg Mason is the continued improvement of our relative position in the retail channel by leveraging our centralized retail distribution platform. This platform is an important asset of Legg Mason, continuing to provide a tremendous growth opportunity for us. We see meaningful progress in our diversification strategy. In addition to growing market share and some of our core businesses, more diversified flows are becoming an increasing source of business resilience. For example our global business distribution platform saw a significant rebound in business from last quarter with gross sales in Q4 up an impressive 22% on a sequential basis.
Both higher gross sales and a meaningful slowing in redemption rates were key contributors to the solid positive net sales for the quarter. But we also continue to benefit from vehicle choice with mutual funds, separately managed accounts, collective investment trust and exchange treated funds, all generating positive net sales for the quarter through our distribution platform. This diversification of choice in vehicles continues to be a differentiator for us and a driver of growth and persistency in various channels.
Our third key area of focus is developing the potential of our investment and M&A agenda. Clarion Partners, acquired in 2016, is a wonderful example of building a better Legg Mason. Clarion continues to grow organically posting positive net flows in 11 of the past 12 quarters. And just last month, we worked and supported Clarion in acquiring a majority stake in Gramercy Europe, a real estate manager specializing in PAN European logistics and industrial assets.
Gramercy is a strong strategy addition for Clarion, adding to the company's already robust $16 billion 700-property portfolio of logistics assets. As a result of this bolt-on acquisition, Clarion expected more exciting opportunities to expand both products and clients by leveraging this new European platform. Further we are partnering with Clarion to reach more clients across the globe by launching a bespoke front structure in Asia and Switzerland with the private banking client, and developing and offering for U.S. retail to be launched later this year. We also worked recently with RARE and ClearBridge to formalize an agreement between them to pursue operational efficiencies and enhanced growth opportunities for both of their businesses.
On another front, you may recall that we made a minority investment in 2018 in Quantifeed, a leading provider of digital wealth management solutions in Asia, which works closely with leading financial institutions in the APAC region. More recently, we’re pleased to see additional interest in Quantifeed solutions in Australia, Japan, and China. And finally, we are collaborating with Quantifeed on the possibility of QS, providing excess allocation services and our other affiliates acting as potential fulfillment managers on the platform.
And finally, also in April, we were very pleased that the SEC issued notice of its intention to permit to use of– investment's ActiveShares semi-transparent ETF methodology. We believe that ActiveShares has the potential overtime to transform our investors access the active investment strategies of asset managers. Following SEC and exchange approvals, investors will be able to invest in actively managed ETFs that do not disclose individual holdings on a daily basis, yet trade and operate in a manner that is similar to traditional ETFs.
The Precidian team has seen a strong increase and interest from perspective ActiveShares licensees, since the SEC announcement on April 8th, building on an already impressive list of signed licensees. To put that licensing interest into perspective, signed licensees represent AUMs with about a quarter of the addressable active equity mutual fund market captured by their strategies. Subject to SEC and exchange listing approval, we expect ClearBridge to offer its first active ETF using ActiveShares sometime later this year. And so I'd like to congratulate Dan McCabe and the entire Precidian team for their dedication and persistence in pursuing ActiveShares.
A final key driver of building a better Legg Mason is the effective management of Legg Mason’s balance sheet, while thoughtfully returning capital to shareholders. As previously disclosed, we've committed to de-lever our balance sheet. And to that end, we are preparing to pay-off $250 million in notes maturing in July. We were very pleased to see S&P Global ratings raise our ratings outlook from positive-to-positive -- from stable, while affirming our BBB senior debt rating. And consistent with our commitment to return capital to shareholders, our board approved an 18% increase in our annual dividend to $1.60 per share, our 10th straight year of increasing our dividend.
From effective cost management, to thoughtful resource prioritization, to leveraging our global distribution platform, to effective capital allocation; Legg Mason is streamlining its operations, while positioning for growth; to better meet the needs of our clients and deliver value for our shareholders.
And with that, I'd like to turn it over to Pete.
Thanks, Joe. Let's turn to our highlights on slide two. Legg Mason reported net income of $50 million or $0.56 per share. These results included strategic restructuring and affiliate charges with the latter, including Royce management equity plan non-cash charge, which we signaled last quarter. These charges combined to reduce earnings by $0.14 per share.
As Joe reiterated, we expect our strategic restructuring to realize $100 million or more in savings. We estimate our cost to achieve these savings to be in the $130 million to $150 million range. I will provide details behind the timing and geography of both savings and costs in a moment.
Moving on to AUM. Our quarter end assets under management were $758 billion. Long-term net flows were breakeven in the quarter, where alternative inflows were $900 million and fixed income inflows were 100 million. These were offset by equity outflows of $1 billion dollars. Additionally, it's important to note that flow trends across all three asset classes improved from the December quarter. And as Joe noted with the release of our April numbers today, we have some positive flows in each of last three months.
Gross sales were strong across our global distribution platform with positive net sales of $2.5 billion compared to $6.5 billion of net redemptions in the December quarter. As for investment performance, 78% and 74% of AUM beat benchmarks for the three and five year periods respectively, and 63% and 72% of AUM beat Lipper Category Averages for the same periods.
From a capital management standpoint, as Joe noted, the board approved an 18% increase in our dividend. Again, the 10th straight year of double digit increases. And finally, S&P upgraded our credit outlook to positive as they continue to see us making progress on both our de-levering plan and overall business performance, while on the M&A Clarion acquired a majority stake and European real estate business.
Now, let's take a look at our affiliates on Slide 3. As previously noted, our long term net flows were breakeven for the quarter. More importantly, six of our nine affiliates generated positive net long term flows for the quarter, and Seven of Nine saw improved flows from the last quarter. Unfunded wins from committed uncalled capital were down slightly from the prior quarter, primarily reflecting fixed income fundings. You may recall we had over $2 billion in fixed income outflows in January, but these were more than offset by inflows in February and March and fixed income, primarily at Western.
Turning to Slide 4, you can see the mix of our unfunded wins and committed uncalled capital remains diverse with approximately 40% coming from each of fixed income and alternatives and roughly 20% from equities. Furthermore, the $4.5 billion of unfunded wins in fixed income are spread across multiple flagship strategies with a similar diversification story holding true for the $2.3 billion in equities. Finally, on the alternatives front, we're very pleased that our unfunded wins and committed uncalled capital remain strong at a combined $5.1 billion.
Slide 5 highlights our global distribution platform, showing our gross sales increase 22% for the quarter on a sequential of basis. At the same time, redemption rates meaningfully declined, and as a result, we saw positive net sales of $2.5 dollars for the quarter, representing a favorable quarter-over-quarter swing of $9 billion led by the U.S. In fact, our U.S. mutual fund net sales were the best since December of 2014, and we saw market share gains across both taxable fixed income and international equities.
Moving to Slide 6, as I stated earlier, fiscal fourth quarter net income totaled $0.56 per share with a combination of strategic restructuring and affiliate charges, reducing earnings per share by $0.14. Operating revenues decreased by $12 million or 2%, driven by two fewer days in the quarter, partially offset by non-pass through or NPT performance fees, which came in higher than the prior quarter in our forecast. We estimate that next quarter NPT and pass through performance fees will be approximately $5 million each.
Operating expenses decreased as last quarter included certain non-cash impairment charges. Excluding those charges, expenses were up 7% on a sequential basis, primarily due to the increase in mark-to-market on deferred comp and feed, which is offset in non-operating income expense. Our adjusted operating margin was 17.1% for the fourth quarter versus 21.1% in the prior quarter. This primarily reflects a step up in strategic restructuring and affiliate charges, as well as seasonal compensation factors. Finally, our GAAP tax rate came in at 27%, in line with expectations, while our cash tax rate was only 7% for the quarter. We believe that cash tax rate will be in the single digits until approximately fiscal 2024.
On Slide 7, you can see that AUM increased due to market appreciation as long term flows are breakeven for the quarter and liquidity outflows totaled $8 billion. The operating revenue yields came in at 37 basis points in line with last quarter as a modest increase and alternative advisory yields was offset by a slight drop in equity yields.
Operating expenses on Slide 8 decreased by $327 million, largely reflecting the prior quarters' impairment charges. Excluding those charges, expenses were up $38 million due to higher comp and benefits from mark-to-market and seasonal impacts. Increases in the strategic restructuring and other expense categories were offset by lower distribution and servicing expenses, reflecting two fewer days in the quarter.
Turning to Slide 9, our comp ratio for the quarter was 55% in line with our forecasted range, driven by seasonal factors and stepped up commissions on higher LMGD sales. Total comp and benefits increased by $39 million with $27 million of that stemming from higher mark-to-market on deferred compensate. In addition, we saw increased comp and benefits related to strategic restructuring cost, affiliate charges and the Royce management equity plan. Next quarter, we expect our comp ratio to increase to 56%, reflecting a typical pick up in seasonal expenses related to our annual compensation cycle, and in line with the comp ratio on last year’s first fiscal quarter.
On Slide 10, our operating margins adjusted decreased, primarily due to higher seasonal comp factors and higher professional fees. This resulted in a 1.9% margin reduction. In addition, strategic restructuring and affiliate charges further reduced our margin by 3.1%. And recall that last quarter’s restructuring charges reduced the margin in the December quarter by 1%. We’d expect next quarter’s margin, excluding the strategic restructuring cost but including expected sales, to improve the increased revenues from higher average AUM, more than offsetting the impact of higher seasonal comp. But please keep in mind our higher revenue expectation is based on our ending April AUM levels, which we released this morning. And assuming markets remain flat to up for the remainder of the quarter and we’ll have to see how that plays out given the frothiness in the markets over the last week or so.
Another way to look at our margin is look at the parent-only view on Slide 11. We provide this externally on an annual basis, as it shows a more direct view of the revenues available for us to manage for the benefit of shareholders under our multi-affiliate model. In this presentation, we eliminate the revenues the pass through to our affiliates to either fund their operations or go into their management team's bonus pools.
Adversely, the revenues we retain at the parent level are what we manage for the benefit of shareholders. And remember that most costs at the parent level did not vary directly with revenues, providing us with significant operating leverage. Relative to the prior year, the parent margin declined, primarily due to a drop in revenues as a result of lower non-pass through performance fees and lower average operating revenue yields for both equity and alternative assets, as well as a modest 2% increase in parent expenses.
Slide 12 is a roll forward from fiscal Q3's net loss of $2.55 per share to this quarter’s earnings per share of $0.56. Last quarter’s results included the non-cash impairment charges, net discrete expenses and other tax items and restructuring costs. This quarter’s results reflect $0.05 in lower operating earnings due to the seasonal comp factors and increased other operating expenses. Non-operating earnings were $0.02 higher, reflecting mark-to-market on seed investments not offsetting compensation. And lastly, fiscal Q4 items included the strategic restructuring and affiliate charges, which totaled $0.14.
Slide 13 calls out the savings and associated costs related to the strategic restructuring. We've provided the details to align with our P&L, so you can reflect the savings more accurately in your models. As you can see, our segment target has been refined to $100 million or more. And we’ve maintained our cost to achieve at a range of $130 million to $150 million.
Importantly, we’ve moved from planning to implementation. As demonstrated in part by the modest saves we have this quarter, which accelerate in fiscal Q1, which as John noted, 35% in expected run rate savings being achieved by June 30th. As you've also noted, we expect run rate saves of over 75% by fiscal year end. In terms of cost to achieve these savings, we had $9 million this quarter and we're expecting an additional $30 million next quarter. The remaining of fiscal year 2000 -- remainder fiscal year 2020, we're anticipating total costs of $45 million to $55 million with additional costs of approximately $45 million to $55 million in fiscal '21.
I also want to highlight that although our communications and technology expenses are expected to decline as part of this program, approximately $10 million. This is effectively a net number from reducing our business as usual expenses, while continuing to invest in leading edge technology capabilities. Specifically, the actions driving our savings in this area are primarily from streamlining our workforce, increased use of outsourcing, transitioning to more efficient and lower cost cloud-based platforms and rationalizing our application and licensing structures.
This reduction in our day-to-day costs in-turn will allow us to continue to invest in strategic technology initiatives that focused on growth and efficiencies, like data and analytics and sales force tools. And remember, in addition to these parent level investments, our affiliates continue to invest in advanced technologies to support their investment platforms and client experience.
I’ll wrap up on Slide 14, which provides some color on our plans for new non-GAAP measures. After reviewing peer disclosures, along with discussions with excellent advisors and our board, we have decided to start disclosing new non-GAAP earnings and non-GAAP EPS results. The items listed on the slide include regularly recurring items like adding back amortization, adjusting for gains and losses on our investments, not offsetting comps, along with tax impacts from non-GAAP adjustments and other items. You can also see a list of episodic items. And I would highlight one that worked for next quarter and for the next several years which is the charges for our strategic restructuring. Disclosure of these non-GAAP measures will begin next quarter with the start of our fiscal year. And we would expect going forward that consensus estimates in First Call, Bloomberg and so on, will reflect these non-GAAP measures.
With that, let me turn it back over to Joe for his closing comments.
Thanks, Pete. I'd simply like to close with the following. We have made headway on four key drivers of building a better Legg Mason. First, fully leveraging centralized retail distribution to continue to grow in a market that values breadth of capabilities, and ease of access. Secondly, developing the potential of our investment and M&A agenda by supporting bolt-on acquisitions such as Gramercy Europe, investing in innovative firms such as Precidian and Quantifeed and bringing our newer affiliates to market in the retail channel as quickly as possible.
Third, more effectively managing costs to our commitment to 100 million or more in saves over two years, targeting as we’ve said 75% or more in run-rate savings by this fiscal year end. And finally, by prudently managing the company's balance sheet, delivering by $250 million next quarter, while thoughtfully returning capital to shareholders, having just announced an 18% increase in our annual dividend to $1.60 per share. We have seen progress in each of these critical components to execute on our broader strategy, as well as on our mission of investing to improve lives.
And now as we move into Q&A, I'd like to welcome Rick Genoni, Legg Mason’s Global Head of ETFs, who's joining Pete and me this evening, to help with your more specific or detailed technical questions around ActiveShares or Precidian.
And without Richard, I think we'd like to take questions.
Thank you. We will now begin the question-and-answer session. In order to allow everyone the opportunity to ask questions, we ask that you please limit yourself to one question and one follow up [Operator Instructions]. Our first question on line comes from Chris Harris from Wells Fargo.
Yes, thanks, guys. Questions on the strategic restructuring? I'm wondering if you could talk a little bit about the original affiliate plan and exactly what didn't work exactly as planned with it. And just hoping you could elaborate on whether it was a lack of affiliate buy-in or if the answer is a bit more complicated than that? And then, could a cross-sharing initiate with the affiliate see an opportunity down the line for Legg Mason, or should we be completely not thinking about that this time.
So as I mentioned in my comments, Chris, the plans that we announced to create a global business platform inclusive of shared services at corporate and the certain operations that a number of our affiliates did evolve. And that was based on feedback that we got, some before but also after we announced last quarter. And that those plans really have evolved to being largely focused on achieving the classes from our corporate operating platform. And again, that was just really a function of -- and as we talked about on the last earnings call. We announced the design of a global business platform, but we had to really go deeper at that point within not only Legg Mason but also our affiliates to see where that different, where that made sense to do.
We've evolved it in a way that allows our affiliates to still participate, where it makes sense for them to do so in sharing cost and leveraging the platform that we already have. We have a global business platform in existence today. We're just making it significantly more efficient and effective, and leveragable on the part of our affiliates. We're always open to ongoing ideas. And I think the affiliates are as well to things that make sense for them to do to leverage and work to reduce costs. And we have a number of different initiatives continuing underway right now to that end.
Thank you. Our next question on line comes from Mr. Robert Lee with KBW. Please go ahead.
I guess maybe and just wanted to ask a little bit about Capital Management. How you think of this. I mean, you're obviously raised dividend, a pretty hefty amount. Can you just -- where do you put share repurchase or restarting that within the mix going forward, obviously, you have to pay for the restructuring. But how do you think of that within the mix? And maybe as part of that, you have the option now to buy-in the remainder of Precidian. I mean, how does that play into at least over the near term and your thoughts around the capital management?
Thanks, rob me up to speed -- I'll take the first half and Jeremy want to add some things. But what we're looking. As Joe mentioned, the big priority is paying off the debt in July. Good news there is once we pay that off, we don't have another debt payment until 2024. But the one we've got coming up is size of about $250 million. We’ve got the restructuring cost to fund and then we also have the dividend. And there’s a few things that add up that like what you’re mentioning in terms of proceeding in option and any one individually is all that material but there’s a number of those types of things. So what we've consistently said is this is going to more or less conveniently fall under when we typically look at capital planning with our board, which is typically in the, actually starting with a finance committee. And then that leads us into a conversation with the full board in the first calendar quarter of the year in 2020.
So I think we didn’t really look for any material news until then and it’s really difficult to predict, because we want to see what the market looks like, what our stock price looks like and what other opportunities are. But we’ve also said we’re not building cash on the balance sheet.
And I think that’s just what I would reinforce to, Rob, that we don’t intend to sit on large amounts of cash. As Pete said, we don’t have another principal payment. We do have interest payments along the way reduce after we pay off the 250, but we have interest payments on the way but we don’t have another principal payment for five years. And we always look at what we need for CapEx and we look at what we need for seed and things like that. And then we'll just evaluate it as we go until we get done with paying the expenses related to this margin improvement.
Thank you. Our next question online comes from Kenneth Lee from RBC Capital Markets. Please go ahead.
Just a follow-up on prepared remarks regarding the M&A agenda. Is the expectation that following up on the Clarion acquisition of Gramercy Europe that there could be potentially some additional opportunity for M&A down the line with for example bolt-on capability? Just want to get a little bit more color around that. Thanks.
I think that will be the predominance. Looking for opportunities that augment or enhance our existing affiliates, I think it’ll be the bulk of our M&A agenda or add unique capabilities similar to the investors we’ve made in Precidian or the investments we’ve made in -- the investment we’ve made in Quantifeed where we’re investing in digital solutions. We do see a number of those opportunities. And we think those are interesting and new ways to think about accessing the retail channel. But as far as the investment side of the equation goes, we’re always open and we’re talking frequently with our affiliates about opportunities for bolt-ins or to add or improve the capabilities that they have. So I would say that’s going to the predominance of our M&A agenda for now.
Thank you. Our next question online from Bill Katz from Citi. Please go ahead.
I do want to start with the Precidian news, so thanks for providing that. So I want to talk about that. I’m just wondering if you could talk a little bit about the product efficacy, how pricing are different from the active space and how you see it competing, if at all, relative to the passive business?
So Bill, you were a little bit fuzzy there. You said how is pricing relative to active strategies and passives?
I'm sorry, yes, I apologize I'm traveling, so bad connection. So yes, exactly right.
Okay, I’ll let Rick speak to that.
So the pricing on any ActiveShares product will be based on some factors, certainly looking at where other actively managed products are. The licensing fee rate of ActiveShares certainly will be baked into any costs tied to any product that our manager offers. Those licensing fees are expected to be in line with indexed licensing fees in the market.
And Precidian, just to be clear Rick, Precidian doesn't dictate the pricing. Those pricing decisions are made by the managers, correct?
But just as a follow-up just in terms of the pipeline that did go down, you had good sales on the retail side. Just wondering if you could talk about maybe some color on why you're seeing that attraction on the retail side and on the social side? And what is it, is it product or performance, is it just initiatives, just wondering if you could give a little more detail why that has slipped the last couple of quarters?
I don't think there's anything I can point to specifically, Bill. I think that on the pipeline and the unfunded wins. What we saw and I don't think this is unexpected. So we saw little bit of a drop-off after the fourth calendar quarter, so a little bit of a drop-off and the change in the value of awards or mandates that we had won. And I think there was some reallocations within that. You saw lot of volatility and turbulence in that quarter, and I think that changed particularly on the institutional side, or changed some of those applications. But we haven't seen anything. We continue to have a very strong pipeline of opportunities. And I would say about a third to 40% of those or so are in late stage, and so that's encouraging. So we feel -- we continue to feel good. It's going to be up and down. We're going to have times when that pipeline, both unfunded wins and committed and uncalled capital, those things are going to pop up at various times. We don't control the timing of when decisions are made. And they're going to -- we had a very good replenishment of that, of the amount of unfunded wins that was -- that actually funded in the fourth calendar quarter -- fiscal quarter, we had a very healthy replenishment there. But we did have some other offsets. So it's -- but nothing that you can really tie to, not performance or anything else specific that I can point to.
Thank you. Our next question on line comes from Mac Sykes from G Research. Please go ahead.
Could you talk a little bit about the potential tax benefits of using the Precidian ETF versus traditional mutual funds? And would you expect those benefits to be a big driver of demand going forward in terms of mutual fund conversions to those ETF products?
One of the critical things is that accuracy is that ActiveShares is an ETF, and the factors that drive these products, going forward are often driven by the strategy and the client type for passively managed products, the underlying index methodology and fees, are often viewed as the top two drivers by strategists. By practically managed products, fees and track record are areas of focus. And nearly, nine out of 10 people that would say that text management is one of the key factors that they’re looking at. And this make sense as in 2018, over three quarters of all equity mutual funds paid capital gains and 83% of those had capital gains above 2%.
The use of an AP rep in ActiveShares allows the inclined feature that drive tax management in ETFs to stay fully intact. And give the capital gains that are built into mutual funds, certainly post the GSV run up, we would think there's probably less money that we'll move from mutual funds over to ActiveShares near term, but rather see the education that clients have around the benefits of ETFs driving new cash flow into the structure, going forward.
And just a follow up, I understand that there's a couple more applications out there as well. What was it about Precidian's application that got an approval ahead of the other ones? And are the other ones an open platform similar to Precidian in terms of offering license to other firms?
It's hard to comment on where the SEC is with the proxy structures, which is what really all the all the other products are. We're certainly happy with where we where we are in this process, and hope that our order will be granted shortly.
Thank you. Our next question comes from Craig Siegenthaler from Credit Suisse.
Just coming back to the strategic restructuring for a minute, now that the initiative has evolved, so it's 100% coming from the center. How can we get comfortable that this will not have an impact on flows in the future just because $100 million seems like a really big number?
It is a big number. And I think that's an important, a really important question, Craig, I said, we believe that -- everyone in the industry but certainly we need to become more effective and efficient. And we can't let our need to find ways to be more efficient, become an excuse for not growing. As we are reducing our spend, we're challenging everybody in the organization to continue to prioritize our existing resources and point them towards ways that enable us to differentiate with clients, whether that'd be through investment strategies or vehicles or access.
It's a large organization, and sometimes you have to do something dramatic like this to get people to think a little bit differently. We continue to invest, notwithstanding cutting costs and creating a distinctive client experience for our clients, to advance sales enablement and to embrace data and analytics, as I've talked about. These are foundational to most aspects of our business. So we will be able to continue to see new products. We do believe will be able to invest in small bolt-on acquisitions, or at the right time top up our ownership in Precidian, for example. We will work with clients to continue to invest -- develop new investment strategies.
We'll be able to invest in vehicle choice to meet their needs. We will continue, we will be able to continue to do it, to service our clients and we believe, continue to grow. But we have to learn to do it in a different way. And that's what we challenged our troops to do. And as difficult as it is, I candidly have found it very inspiring to see how our team has challenged itself to think differently, and look at things differently from a cost perspective and find different ways to do things.
So I'm confident that we can continue to do it. Frankly, we've touched most of the costs that we've gone after have been away from the distribution side. That's not to say we couldn't become more efficient in distribution, and that's what we're challenging them to do as well.
Thank you. Our next question on learning comes from Brian Bedell from Deutsche Bank. Please go ahead.
Back to the restructuring on the cost save the $100 million. Should we be thinking of that as a total net number in terms of if there's opportunities to reinvest some of those saves and other growth initiatives, and then how might that impact the operating margins longer term versus that $100 million total company?
So Brian, just very simply, because we've talked about this quite a bit, I want to make it very clear that we’ve committed to $100 million or more in savings achieved over the next two years, and we do expect that to flow to the bottom line. Now, I say that and want you to hear that. But as always with any of our profitability and our operating margin, if we see something that makes some sense for us to invest in, we’ll consider that. And we’re not saying we won’t invest anymore, we’re continuing to invest even as we're cutting costs, we're continuing to invest. If anything is material in that sense that would impact that $100 million that you expect to see, we’ll let you know.
And then with respect to the affiliates that have a chance to participate down the road just give us an example of maybe one or two main type of systems that as you implement this in the plan, they may come in and begin to use it? And then can that be even more accretive to the cost saves that you've outlined?
Brian, this is Pete. There's actually a couple of things that are in flight right now as we speak, and it's not just all systems and processes, we’re looking at space and a couple of key geographies we operate in, particularly New York and London where today we have five or six offices in each one of those cities, which creates a huge amount of efficiency as you can imagine and people want to come together and face-off against landlords as one tenant.
We’ve also been working on the common financial platform, we've talked about quite a bit and are starting the implementation of that. We’ve done some things around centralization of procurement. We’re also looking at HR systems enhancements across just about everyone of the affiliates and the parent that also can have significant savings. So we’re going to look at each one of these episodically in strong partnership with the affiliates to find out what makes sense and where does it make time -- where does it make the most sense to invest not just dollars but the sweat equity that takes to drive some of these changes.
I think Brian you may be surprised that how much activity there is that is going on within the firm in terms of continued collaboration and looking for opportunities, create efficiency and savings. And I think the big difference is rather than where we had visioned a quarter ago and creating a new platform where everybody was all-in on everything, we basically said, no we’re going to take this back, we’re going make our existing global operating platform more efficient, more effective and then make it available on a menu basis when that makes sense for both the affiliate and for us, so that we can both realize benefits from them joining that. And it’s not compelled. It’s at their option and where it makes sense for them to do so, more on a menu basis. And I think people would be surprised. Pete just mentioned three. But in almost every area of Legg Mason, I would say -- just thinking, but I think -- is that fair Pete, almost every area, there is some uptake from various affiliates. The reality is different affiliates have different needs and different -- and a different appetite to share functions. And so we’re just open to that and it’s available.
And we’re looking at things that are in the real state and their identities are really important to them and to their clients. So how do we do things that follow the hippocratic oath as well and first do no harm but there's lot of opportunities and a lot of activity as Joe said.
Just down the road, it is possible that we could see some update to this number, system or affiliates doing certain things. Even as you -- we certainly don't want to commit to that now but down the road, because we could see this number get revised upward from…
Well, it's not going to be revised downward, let's put it that way. If there are opportunities, we’ll take them up on it. And I think as we said, away from the broad affiliate question, we see $100 million or more that we can get over the next two years. And then beyond that, we'll see what happens and we will keep your apprised on a quarterly basis if we think there's some things happening that would lift that but we're not there today.
Our next question in line comes from Glenn Schorr from Evercore. Please go ahead.
Just two quick, both should easy. One on the equity front, bucking the trend of what's going on. You noted the $600 million or so in inflows on large cap and another $900 million in unfunded win. So the question there is ask for a little more color on anything on more specific strategy type of client and fees around that, because you're taking the money where everybody's losing. And the other one, I might as well just ask it together, is just big picture. In any other point in our lives, if you have a market that was up like strong double digits, and it was retirement proceeds, so you'd expect the industry and any big participants to have a lot of inflows. I know it's not just you but it's -- and I know, we were coming off an awful fourth quarter but maybe that's the answer. But could you talk about what you think got delayed in terms of client activity? Is it something that you catch up on, or is it just a lost opportunity, because a huge market usually followed with pretty good flow performance?
I think, Glenn, on the second question. I mean, I think investor confidence was quite rattled, coming out of the fourth calendar quarter, the December quarter. I think clients were very, very rattled by what transpired. We have seen, particularly, for example, internationally and in Europe, in particular, a move back into the passive side, a little bit there. And so I think that between a bit of a lack of conviction on the part of investors. Now I know, the market came roaring back but I'm not sure you saw it in the flows. But I think the -- I think there's just a lack of conviction coming out of that.
We saw, on the other hand in our business, a pretty significant rebound in sales. We saw our sales, which were soft in the fourth calendar quarter up and rebound by about 22%. That's the largest quarter-over-quarter increase in sales that we've ever seen in the retail channel. So we felt pretty good about our performance. But I think overall there's still a confidence factor on the part of the average investor.
I think as it relates to for us what we saw on the equity side, we saw good interests really across the board at ClearBridge with their large cap equity, their small cap business as well in equity international. And that was really a winner for us. The equity international space -- international equity space is one which was actually an outflow during the quarter but we were in inflow there, so we felt pretty good about that. We did struggle a bit with all-cap at ClearBridge largecap at Brandywine was out for us in the quarter and then Royce and QS were out a bit as well. But I think overall we feel we feel pretty good about our relative performance, and I think that's it.
Thank you. Our next question in line comes from Patrick Davitt from Autonomous Research.
So as we think about level-setting with your new adjusted earnings reporting, all of the new adjustments. I'm getting to something in the 73% to 75% range, but I just want to make sure that's where you guys are in terms of the run rate if we were to put 4Q in that new framework?
Actually, when you normalize out all the [indiscernible] which we're not allowed to do and put in filings unfortunately but in terms of the things that can be adjusting for that [indiscernible] the way to go. And Alan, on the [indiscernible] that's out there that's public, can help you work through it but that sounds like really difficult.
And then on the modeling, it looks like the net distribution margin improved pretty significantly largely driven on the expense side. Could you walk through the moving parts there? Is that a run rate or something more idiosyncratic to the quarter?
I mean, are you looking at distribution or looking at our total distribution [indiscernible] expenses or…
Yes, the expense going down at $99 million from $109 million, but it doesn't look like the revenue side came down accordingly, which usually happens when that happen?
Yes, I think it's just really more of a mix. We also had a couple of [indiscernible] in the quarter, and it's someone that probably impacted the [indiscernible]…
Thank you. Our next question online comes from Michael Cyprys from Morgan Stanley.
Just wanted to follow up on capital management, because a nice dividend increase in the quarter, looks like around mid-50s dividend payout ratio that's crept up in recent years. So I guess just curious how you're thinking about what the right dividend payout ratio should be for Legg Mason, and how that thinking evolved. And once you get through the one time payments, the debt payments restructuring just how you're thinking about intended uses of capital. I guess should we expect any buybacks, time frame around that? And how do you think about the intended uses of your capital between buybacks, dividends, et cetera? How much is needed to reinvest back in the business here?
Well, first on the dividend. We look at it on a number of different metrics, but the payout ratio and the yields pay a lot of attention as to what others in the peer group are doing. And quite frankly, talking to a number of our investors in terms of what they prioritize. So we think our payout ratio on GAAP earnings can definitely be higher than the peer group, because of the amortization we have of intangibles and so forth. We also think it'd be higher because of the benefits of the tax yield. And again keep in mind the yield number has gone up quite a bit just because of the drop in the whole peer group stock price.
So as we're looking at it, we're looking ahead and saying, okay, where do we want to be in terms of where we hope the stock should get to, because we only increase the dividend once a year. And we want to make sure that as we get through the year, hopefully, get some benefit from the market for the things that we're doing on the cost front that that yields we still want that to be one that's more or less leglating [ph]. And the rest of things Michael, it's pretty much we said before is a lot of factors we go through. We go through this in depth with the finance committee first of our board, which has some of the deepest financial experts that are on our board and look at all the different opportunities or risks. And so when we look at from a shareholder funneling standpoint, we want to be viewed as a firm that’s doing the right thing in terms of recurring capital to shareholders.
And just a quick follow up on the ActiveShares' proceeding, just hoping you could talk a little bit about the degree of tax deficiency in the structure compared to ETF that are in the marketplace today. I guess in what situation could holders be allocated capital gains, how frequently do you expect that to occur? You mentioned 75% of mutual funds have allocated capital gains last year. I guess what would you think the comparable number would be on the ActiveShares?
So again, ActiveShares is an ETF. And so the trading that we will see in this product should happen in-kind revenue in-clash, and that trading will happen through AP rep. So yes, roughly three quarters of mutual funds -- equity mutual funds last year had a capital gain and a large portion of those had a gain over 2%. And so we would expect the ActiveShare ETFs to be able to help me understand that down. But I can’t put a number on how much we can manage down through that. The ActiveShares structure will manage those gains capital through our pro rata slice of the fund rather than choosing individual stocks that is looking to manage capital gains out of. So that’s the structure that we will use, but certainly this structure will help to manage those capital gains. And it's a structure that you of course don’t have today with mutual funds.
And if it's successful in your view, where would you think it could be in a couple of years' time in terms of managing down the capital gains if it's not $75 million. Is it a surge, is it less…
I just can put a number on that.
And thank you. We only have time for one more question. The question is from Mr. Robert Lee from KBW.
Great, thanks for taking my follow up. Actually, a question maybe going back to the new earnings metrics, so I guess two quick ones. First, since extra Alan wants more work, will we begin any recast historic earnings so we can see what comps look like? And when we’re doing the tax adjustment, you mentioned 7% cash tax rate could be single-digits for next five years. So you're going to capture the full impact of the NOL through the new adjusted net income, or it’s just going to be the tax deductible goodwill?
So in terms of when you’ll start seeing this on the June quarter and then we'll providing for all the periods that are presented from a P&L standpoint. It's one of the reasons why we wanted to wait until a new fiscal year to make that claim. So, you'll be able to see it back in terms of both comparable quarters and comparable years. Unfortunately, we can’t -- we’d love to get a normalized cash tax rate that is something that very, very specifically through a lot of, both rules and interpretations et cetera the SEC does not allows us to do. So we’ll still be adjusting things based on the GAAP rate. But we'll be providing as much information as we can to help you guys figure out the appropriate value for the field as we’re going to be using it. So we'll still be providing plenty of color around that just not adjusting for it specifically in the non-GAAP measure.
So you won't be -- the tax deductible benefit will not be flowing through. Also, a quick follow up on global distribution. I just -- clearly, it was up a lot. But it does look like the non-U.S. portion gross sales have been certainly down from peak and running more flat for last several quarters. Could you maybe -- anything specific that maybe influencing where it's running now versus where it had been at least past couple of years.
I would say I wouldn't read too much into it other than thank goodness for the diversification of our business, whether it'd be by the affiliates, with the affiliates, by geography, by vehicle. We saw a significant uptick in our business in Europe in the last year to two, a lot of that driven by success with Macro Ops out of Western, there was some little bit of a performance softness there that slowed things down a little bit. But we saw Japan be more resilient. We're seeing our LatAm business be more resilient. We're seeing our Australian business be more resilient. The U.S. came back strongly. But I wouldn't read anything too much into that.
I think as I mentioned earlier, what we've seen following kind of a really choppy fourth calendar quarter was some flows moving a little bit more from active to passive in Europe, but if you think about it, our first quarter, as I mentioned a couple of times, we saw 22% quarter-over-quarter increase in sales, which was the largest on record, the largest reversal of trend in net flows on record. So we had a really, really strong quarter, but not every single piston in the engine was firing. And so -- but that's OK because that's why our business has been able to be resilient because we're diversified as well as we are. So I think that's a good story and I understand looking for some holes in it, but we're always going to have some geographies, there's some strategies or some vehicles that are out of favor. That's why we like having a lot of chips on a lot of different numbers and colors.
Great, thanks for taking my follow-ups.
You bet. So I think Richard, we're done with Q&A, and I'd just like to close here. Actually, I'd like to close, as I always like to do at the end of each fiscal year, by thanking and applauding my colleagues at both the affiliates and Legg Mason for their ongoing collaboration, for their focus on clients and shareholders and on our communities. And all of which has helped us, I think, to collectively win many of the recognition and awards that you would see on slide 15, so I want to offer my congratulations to all of the affiliates and within Legg Mason's on a job well done. I would like to thank all of you for joining us this evening and I do look forward to updating you further on our progress next quarter. Thank you.
Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect your lines at this time.