Invesco Ltd. — Q3 2017 Form 10-Q
Business context and reporting period. Invesco is a global investment manager. This unaudited quarterly report covers the three and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless stated otherwise. Amounts are in U.S. dollars.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Operating revenue | $1,337.7 million | $1,201.6 million | $3,784.7 million | $3,539.7 million |
| Operating income | $355.3 million | $306.3 million | $932.8 million | $882.2 million |
| GAAP operating margin | 26.6% | 25.5% | 24.6% | 24.9% |
| Net income attributable to Invesco | $267.5 million | $241.2 million | $719.1 million | $627.7 million |
| Diluted EPS | $0.65 | $0.58 | $1.76 | $1.51 |
| Adjusted operating margin (non-GAAP) | 40.7% | 39.7% | 39.3% | 38.6% |
| Adjusted diluted EPS (non-GAAP) | $0.71 | $0.60 | $1.97 | $1.64 |
Q3 revenue rose 11.3% and operating income 16.0% year over year; nine-month revenue rose 6.9% and operating income 5.7%. Management’s non-GAAP measures adjust for items including consolidated investment products, acquisitions, deferred compensation market movements and optimization charges; they are not substitutes for GAAP measures.
- Revenue and AUM: Q3 investment management fees increased 10.0% to $1,062.3 million. Performance fees rose to $42.3 million from $3.4 million, primarily due to Invesco’s Mortgage Recovery Fund. Ending AUM was $917.5 billion, up from $820.2 billion a year earlier; average Q3 AUM was $890.8 billion. Q3 long-term net flows were $6.3 billion, compared with $12.2 billion a year earlier. Nine-month long-term net flows were $7.5 billion, versus $15.4 billion.
- Cash flow: Nine-month consolidated operating cash flow was $1,012.0 million; management reported $1,010.5 million excluding consolidated investment products (CIP). Consolidated investing cash outflow was $490.0 million and financing cash outflow was $220.8 million. Ending cash and cash equivalents were $1,716.3 million, up from $1,328.0 million at year-end 2016.
- Debt and liquidity: Invesco’s long-term debt was $2,075.3 million, down from $2,102.4 million at year-end. The company amended its unsecured credit facility, increasing capacity to $1.5 billion and extending maturity to August 2022; it had no outstanding facility borrowings at quarter-end. Leverage and interest-coverage ratios were 1.22:1 and 18.06:1, respectively, and the company reported compliance with covenants and regulatory minimum capital requirements. The balance sheet also includes $4,323.6 million of CIP debt, which Invesco says is non-recourse and not a corporate obligation.
Material changes and management commentary
- Market appreciation and foreign exchange added to AUM; the Source ETF business acquisition added $26.0 billion of AUM. Invesco completed the acquisition on August 18, 2017, for a reported cash purchase of $299.2 million during the nine-month period.
- Management cited positive global equity and bond markets in Q3. It also noted varied flows by region: nine-month long-term inflows in Continental Europe and Asia were partly offset by outflows in the U.K. and Canada. Stronger passive AUM, including Source, may dilute overall revenue yield.
- Foreign exchange reduced nine-month operating revenue by $67.3 million year over year. Management identified Brexit-related uncertainty and potentially persistently weaker sterling as risks to reported AUM and U.S.-dollar results.
- Operating expenses increased 9.7% in Q3 and 7.3% for the nine months. Drivers included higher variable compensation, acquisition-related costs, technology and outsourced administration, and business transformation spending. The nine-month period also included a $5.5 million U.K. pension settlement charge and $19.7 million of costs associated with senior executive retirements.
- Business optimization charges were $49.0 million for the nine months. The initiative was estimated to cost up to $155 million in total, with about $40 million remaining through 2018. Management reported approximately $38 million of annualized run-rate savings at Q3-end and expected up to $65 million at completion in 2018.
- Management expected to absorb external research costs for MiFID II-affected European funds and accounts beginning in January 2018, which it did not expect to be material. No specific earnings or revenue guidance was provided in the supplied filing text.
Outlook, risks, contingencies and unusual items
- Invesco agreed to acquire Guggenheim Investments’ ETF business, comprising 79 ETFs with $37.3 billion of AUM at September 30, 2017. Closing was expected in Q2 2018 for approximately $1.2 billion, with about 85% expected to be funded through the credit facility; the company planned to repay borrowings during 2018 partly by curtailing open-market repurchases.
- The effective tax rate was 31.0% in Q3 and 28.3% for the nine months, compared with 26.0% and 27.4%, respectively, in 2016. Illinois tax regulation changes contributed to the increase; the filing also reports a $12.2 million retroactive state tax adjustment in non-GAAP reconciliation items and an $11.0 million liability for an uncertain Illinois tax position.
- A Canadian subsidiary is appealing a Tax Court ruling in favor of the Canada Revenue Agency over approximately $7.8 million of goods-and-services-tax assessments and interest. Management believed its position was more likely than not to prevail; no provision was recorded, and a letter of credit secures the amount.
- Risks include market declines and client withdrawals that reduce AUM-based fees, investment underperformance, foreign exchange exposure, interest-rate and credit risks, regulatory requirements, and litigation or regulatory scrutiny. Invesco also disclosed an auditor-independence issue involving PwC and certain lenders that own Invesco fund shares; SEC staff extended no-action relief indefinitely under the described circumstances. Circumstances outside that relief could require another auditor and create costs or reporting impacts.
- Other items to note: gross unrecognized tax benefits were $21.2 million at quarter-end, up from $10.5 million at year-end; undrawn capital commitments were $291.2 million. Q3 dividend of $0.29 per share was announced after quarter-end. The company made no open-market share repurchases during the period.
Important facts for investors to verify
- Whether the elevated performance-fee contribution and positive market returns are sustainable, and how AUM flows and asset mix affect fee yield.
- The final purchase price, financing, integration costs and realized benefits of Source, and the closing, funding and repayment plan for the Guggenheim ETF acquisition.
- Progress against the business optimization savings target and remaining cost estimate.
- Developments in the Illinois tax position, Canadian tax appeal, and PwC independence matter and any effect on financial reporting or financing access.
- Corporate liquidity and leverage excluding CIP balances, including available credit-facility capacity and compliance with covenants and regulatory capital requirements.