美國信安金融集團 (PFG) 2012 Q1 法說會逐字稿

Good morning and welcome to the Principal Financial Group's first quarter 2012 financial results conference call. There will be a question and answer period after the speakers have completed their prepared remarks. (Operator Instructions). I would now like to turn the conference call over to John Egan, Vice President of Investor Relations.

Thank you and good morning. Welcome to the Principal Financial Group's first quarter earnings conference call. As always, our earnings release, financial supplement, and additional investment portfolio detail are available on our website at www.principal.com/investor. Slides related to today's call are also available on our website. Following a reading of the Safe Harbor provision, CEO Larry Zimpleman and CFO Terry Lillis will deliver some prepared remarks. Then we will open up the call for questions. Others available for the Q&A are Dan Houston, Retirement and Investor Services and US Insurance Solutions; Jim McCaughan, Principal Global Investors; Luis Valdez, Principal International; and Julia Lawler, our Chief Investment Officer.

Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The Company does not revise or update them to reflect new information, subsequent events, or changes in strategy. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the Company's most recent annual report on Form 10-K filed by the Company with the Securities and Exchange Commission. I would also like to remind everyone that our 2012 Investor Day will be held Friday morning, September 21, in New York, details to follow closer to the event. Now, I'd like to turn the call over to Larry.

Thanks, John, and welcome to everyone on the call. As usual, I will comment on three areas. First, I will briefly discuss first quarter 2012 results. Second, I will provide an update on the continued successful execution of our strategy, and I'll close with some comments about our capital deployment strategy. Then Terry will cover the financial results in more detail.

As John mentioned, we've provided slides related to today's call. Slide 4 outlines the key themes for the quarter. First quarter was a solid start to the year, as we saw strong growth across all businesses, along with a strategic acquisition in Claritas and effective capital deployment. Total Company operating earnings were $213 million, and we ended the quarter with record assets under management of $364 billion. First quarter 2012 total Company net cash flows of $8 billion are higher than full year 2011 net cash flows. As we move through 2012, this record level of assets under management and momentum in net cash flows, along with stronger variable investment income, higher performance fees, and less seasonality in claims will combine to give us stronger earnings in the second half of the year.

We delivered strong sales and net cash flows in the first quarter, demonstrating our competitive advantages, namely, the strength of our distribution relationships, demand for our products and service, and investment expertise. Key growth metrics from the quarter include full service accumulation sales worth $3.2 billion, up 62% compared to first quarter 2011. Net cash flows of $2 billion are more than double from the year ago quarter. Principal funds had record sales of $3.7 billion and record net cash flows of $1.5 billion. Principal Global Investors had record unaffiliated assets under management of $91 billion and unaffiliated net cash flows worth $3.3 billion, a strong improvement over first quarter 2011. Reported assets under management for Principal International were $59 billion, up 22% over the year-ago quarter, and record net cash flows of $2.3 billion are up 77% over the same time last year. In US Insurance Solutions, individual life sales of $49 million increased 2% over strong sales in first quarter 2011. Specialty benefits premium and fees grew 5% to $354 million over the year-ago quarter.

Behind our momentum in sales and retention is a renewed excitement across the organization. During the first quarter, I attended sales conferences in the US, Asia, and Latin America. The enthusiasm among our teams has never been higher, and the momentum is the strongest I have seen. We have a well-diversified set of businesses, we are in the right geographic markets, and we have exactly the right strategy for future growth.

As we emerge from the economic crisis, we are in the strongest financial position in our history, and we continue to gain market share. We have opportunistically invested in the markets we want to be in, resulting in accelerated growth of our fee-based businesses, which creates increasing amounts of free cash flow and increased financial flexibility. We will continue to strike the right balance between growth and profitability. Because of the new deferred acquisition cost accounting rules, there is now a clearer and direct trade-off between growth and profitability. So while increased sales hurt earnings in the short term, we believe it is the right path which leads to higher earnings over time.

Now let me provide some additional comments on the ongoing implementation of our strategy. In full service accumulation, we continue to focus on winning retirement business across small, medium, and large segments. Principal Total Retirement Suite continues to set the Principal apart, and as part of a broader strategy, to provide advisors and the clients they serve with leading-edge retirement programs that cannot be easily replicated by competitors. Our strategy also includes features like auto enrollment, worksite education, and plan designs that encourage greater savings in support of improving individual retirement readiness. Our independent distribution model continues to drive significant growth in retirement sales. Last quarter, we announced a new relationship with Edward Jones which focuses on the needs of small and medium-sized businesses. We have already had good traction and have generated a retirement pipeline of more than $1 billion to date from this alliance partnership.

Our third-party administration or TPA channel is also a contributor to growth in the small to medium-sized business market, with record sales in the first quarter which are up 23% over first quarter 2011. Principal funds continues to drive record sales with demand for investment solutions that increase income generating potential, limit volatility, and hedge against inflation. We have had tremendous success to date with multiple strategies, including preferred securities, high yield, global diversified income, mid-cap blend, and target risk allocation. We are also well-positioned for future growth with investment strategies launched during the past two years that are focused on managing volatility and protecting purchasing power, such as our global multi-strategy and diversified real asset funds. Our global investment management capabilities and asset allocation flexibility create strategies that when coupled with our distribution reach are clearly resonating with advisors and clients.

Strong investment performance is a leading indicator of growth for our retirement and asset management businesses. Investment performance continues to be strong, which is a differentiator for the Principal. Recent accomplishments include two 2012 Lipper Fund Awards for consistent multi-year performance for the Principal mid-cap blend fund. Additionally, Finisterre Capital, one of our recently acquired boutiques, won the 2011 EuroHedge magazine emerging market fund of the year. These awards and overall strong performance drive demand and mandates for our multiple boutiques.

Moving now to Principal International, which continues to deliver very strong results. In the first quarter, we announced the acquisition of a majority stake in Claritas, a leading Brazilian retail mutual fund and asset management company. Entering the Brazilian mutual fund market has been a strategic priority for the Principal. Claritas has a strong management team, solid investment track record, and diversified distribution through financial advisers, which are all important competencies as we continue to grow our mutual fund and asset management business in Latin America. The acquisition closed in early April, and we anticipate future synergies over time that will enable Claritas to expand beyond the retail mutual fund market into the institutional investor market.

As another positive development, the Malaysian government has approved a new, voluntary, employer-based defined contribution pension system. CIMB-Principal was approved to provide solutions in this new market, demonstrating the success of our long-time foothold in Asia and the strength of our joint venture with CIMB. The Principal's evolution to a global investment management leader with strong competitive positions in the key emerging markets for private retirement solutions has firmly taken hold. We will maintain our focus on helping growing businesses, individuals, and institutional investors around the world save for the long term, invest for growth, and protect their financial well-being.

I'll close with some comments on our capital management strategy. Building on the $1.1 billion of capital deployed in 2011, we continue to actively deploy excess capital in the first quarter, demonstrating the strength of our business model to continuously create free cash flow. In addition to the acquisition of Claritas, we announced the authorization of a $100 million share repurchase and paid our first quarterly dividend to shareholders. These actions reflect our continued confidence in the strength and financial flexibility of our fee-based business model, and we remain on track to deploy $800 million to $900 million of capital in 2012. Excess capital at the end of the first quarter was $1.6 billion, a level that has been fairly consistent over the past year. Certainly, as we came through the financial crisis, it was important to maintain a higher level of excess capital. Although excess capital levels will remain higher than pre-crisis levels across the industry, we expect to see our excess capital levels come down over the next couple of years.

Before I close, let me make a brief comment about one of the biggest highlights from the quarter. In February, during his visit to Iowa, I had the privilege to meet face-to-face with Chinese Vice President Xi Jinping, the expected next president of China. In his comments, Vice President Xi mentioned Principal as an example of a highly-regarded company operating successfully in China. This is a strong endorsement of our efforts to expand our business in China into the enterprise annuity industry in the near future.

Finally, I encourage you to check out our 2011 Year in Review, which can be found on our investor relations website. The book highlights 10 trends that affirm the power of our strategy we put in place more than a decade ago and why I am so confident that our best times are yet to come. Terry?

Thanks, Larry. As Larry mentioned, first-quarter earnings were solid, and our growth metrics continue to show momentum. This morning, I will focus my comments on operating earnings for the quarter, net income, including continued solid performance in the investment portfolio, and the strength of our capital position and strong balance sheet. As a reminder, we adopted new DAC accounting guidance on January 1, 2012, with retrospective application. All financial information presented, including the slides for this call, reflects these changes. The impacts were in line with what we previously communicated.

First quarter 2012 operating earnings of $213 million were down 3% from a year ago quarter. The decline is primarily due to lower variable investment income and higher distribution expenses in the first quarter. We reported earnings per share of $0.70 for the quarter. There were a few items impacting first quarter 2012 EPS. Bank and trust services was negatively impacted by $0.01, primarily due to a legal settlement in the trust company. Principal International was dampened by $0.01 on a net basis from regulatory changes to assigned lives in the Mexican Afore business, which was partially offset by delayed expenses in Latin America. Individual life benefited by $0.01 from a change in prescribed accounting practice, and the corporate segment was reduced by $0.01 from higher tax and legal expenses. Adjusting for these items, we consider the first quarter 2012 earnings per share run rate to be $0.72.

Now let me discuss business unit results. Full service accumulation operating earnings at $70 million were down 4% on lower net revenue from a year ago quarter. Pre-tax return on net revenue remained steady at 30%, as we expected and previously communicated. Let me make a couple of comments related to full service accumulation margins. Slide 5 summarizes the leading factors impacting profitability since 2004.

Factor one, which had the largest impact, is a shift in business mix, which I will describe in more detail in a moment. The second factor is the current market environment, which has slowed the growth of recurring deposits. The third factor listed, growth, retention, and efficiency, is one we have and will continue to influence through scale and focused execution. Assuming these trends continue, we would expect 2012 full service accumulation net revenue to grow between 4% and 6%, based upon an average S&P index level of 1,400 in 2012. Additionally, we would expect to maintain pre-tax return on net revenue of 30% to 32%.

Slide 6 shows how the mix of business is shifting away from general and separate account investments into mutual funds and employer securities, reducing return on assets, but improving free cash flow generation. As this business mix continues to shift and more assets are written on our mutual fund platform and are using more non-domestic equities for investments, fewer dividends are eligible for the dividend received deduction benefit. Return on revenue measures for full service accumulation are better indicators of the financial performance of the business. The bottom of slide 6 illustrates our stable track record of driving revenues to the bottom line, even as customer preferences migrate to different asset types. Return on revenue margins will continue to be a key focus for us.

First quarter 2012 full service accumulation sales of $3.2 billion were very strong, up 62% over 2011. Looking at full year 2012, we would expect to see full service accumulation sales growth of approximately 20% over 2011. Robust transfer deposits and strong client retention helped drive net cash flows of $2 billion, more than doubling first quarter 2011 results. The underlying fundamentals within full service accumulation continue to improve. The sales pipeline continues to build across all market sizes and distribution channels, and the close ratio continues to improve.

We are actively executing on our strategy to win more business and gain market share. Operating earnings per principal funds, at $12 million in the quarter, were flat compared to year ago quarter, due to higher compensation and sales-related expenses as we invest in growing the business. Record sales of $3.7 billion reflect strength across multiple strategies, including preferred securities, high yield, income, mid-cap blend, and target risk allocations. Net cash flows of $1.5 billion were driven by particular strength in our global diversified income fund, which leverages our ability to combine multiple strategies and managers, as well as the Principal Preferred Securities Fund managed by one of our Principal Global Investors boutiques, Spectrum Asset Management.

Investment performance continues to be strong across asset classes and is a differentiator for the Principal. The strong performance includes particular strength in asset allocation, where at quarter end, 93% of our target date and target risk funds were ranked by Morningstar in the top half on a one-year basis, 94% on a three-year basis, and 73% on a five-year basis. Individual annuities operating earnings in first quarter 2012 were $33 million, down $3 million from a year ago quarter, due to lower net investment income and a higher tax rate. As the low interest rate environment persists, individual annuities will be subject to spread compression. Bank and trust services earnings decreased to $6 million, primarily due to a legal settlement in the trust company. First quarter 2012 earnings from Principal Global Investors were $16 million, down 2% from a year ago quarter on a 6% increase in average assets under management.

With a focus on growing our global investment management leadership footprint, we added distribution and investment staff across our boutiques. On a trailing 12-month basis, pre-tax margin of 21.1% was down slightly from fourth quarter at 21.4%. On a full-year basis, we would expect pre-tax margin expansion in 2012 driven by higher profits from performance fees in the second half of the year. Unaffiliated net cash flows for the quarter were $3.3 billion, driven by positive flows into a variety of asset classes including currency, real estate, stable value, and equities. We see rising client interest in awarding new mandates for capabilities from our multiple boutiques. In first quarter 2012, new mandates awarded totaled $3.8 billion. Pipelines continue to build, and the representative offices in the Netherlands and Dubai are now staffed and operational, giving us continued optimism for the remainder of 2012.

Moving to Principal International, operating earnings at $42 million include a one-time loss from the regulatory change impacting Mexican Afore assigned lives, which was partially offset by delayed expenses in our Latin American operations. Assets under management were $59 billion at quarter end, up 22% from a year ago, primarily driven by strong net customer cash flow and a strategic acquisition. Current quarter record net cash flow of $2.3 billion were driven by a 24% increase in BrazilPrev deposits over last year and positive flows in Asia. While the underlying growth of the companies on a local basis remains strong, so far in second quarter, we are facing headwinds from foreign currency exchange rates and slowing inflation. As a reminder, our financial supplement now includes foreign exchange rate information used for financial reporting to help you better analyze the impact of exchange rates on Principal International.

In April, we closed on the Claritas acquisition, and approximately $2.5 million of after-tax transaction costs will impact second quarter Principal International results. The acquisition is expected to be EPS neutral in 2012 and accretive thereafter. Individual life first quarter operating earnings were $32 million. During the quarter, we changed our method of accounting for reinsurance contracts, and this change was included in our recast results released on April 10. Under the new method, we will recognize reinsurance recoveries as they are received, which creates better alignment between accounting and economic results.

Additionally, according to prescribed accounting practices, we changed the amortization basis for certain individual life policies. This change impacted several income statement line items that netted to a $3 million benefit for first quarter earnings. These accounting changes will result in a more intuitive earnings pattern for individual life. We believe the run rate for individual life operating earnings is approximately $30 million per quarter, with variability in any one quarter.

Turning to specialty benefits, first quarter operating earnings were $19 million, down $4 million from a year ago quarter, primarily due to stronger than normal investment performance in 2011. The decline in sequential earnings was due to normal seasonality in dental claims. We continue to experience stable loss ratios. While the first quarter sales were down from record results in 2011, retention results were strong, and premium and fees grew 5% from a year ago quarter. Continued recovery in employment and salary trends were the main drivers of that result. The corporate segment reported an operating loss of $39 million, driven by higher tax and legal expenses. Going forward, due to higher ongoing regulatory expense, we expect quarterly operating losses for the corporate segment of $30 million to $35 million in 2012.

For the quarter, total Company net income was $202 million, an increase of 11% over a year ago quarter. A key contributor to the improvement in net income was a continued reduction in after-tax credit-related losses to $26 million. Our investment-related losses continue to be in line or better than our loss projections and better than market expectations, reflecting sustainable recovery in commercial real estate. This improvement has given us additional financial flexibility.

Moving to our balance sheet, our net unrealized capital gains position of $1.9 billion increased $300 million from fourth quarter 2011, predominantly due to tighter credit spreads. As a reminder, due to our strong asset liability management, changes in net unrealized gain or loss due to interest rate movement do not result in an economic impact and do not force us to sell assets. In late February, we announced a $100 million share buyback authorization and completed half of it during the quarter. As of today, we have completed 80% of that authorization. Looking now at capital adequacy, we estimate our first quarter risk-based capital ratio to be 440%. Relative to a 350% RBC ratio, we have approximately $1.6 billion of total excess capital, with approximately $600 million of the excess capital at the holding company.

Slide 7 illustrates our recent pattern of return on equity. Current operating earnings are in line with pre-crisis levels, yet average equity is 34% higher. We are holding considerably higher amounts of excess capital as compared to pre-crisis levels. As Larry mentioned, higher capital levels are here to stay for us and for the industry. But as our business model becomes more fee-based, we plan to reduce our excess capital of $1.6 billion to our targeted capital reserve, currently at $1.15 billion, over the next couple of years. For 2012, we feel that an RBC ratio of 425 - 435% is appropriate, given our mix of fee-based and risk-based products. Our long-term expected annual return on equity accretion continues to be 50 to 80 basis points.

As outlined on slide 8, so far in 2012, we have allocated $220 million of capital for strategic acquisition, opportunistic share repurchase, and the quarterly common stock dividend. As Larry mentioned, we expect to deploy $800 million to $900 million in capital in 2012. We believe our decision to move to a quarterly common stock dividend and our overall capital deployment actions demonstrate our commitment to creating long-term value for shareholders.

Before I close, I want to take a moment to comment on a couple of things that Larry is too humble to mention. First, if you haven't seen it yet, check out the April issue of Institutional Investor magazine. The magazine did an in-depth and very positive cover profile of Principal's 132-year transformation from a small life insurance company to a global investment management leader. The cover article highlights the leadership team, past and present, at the Principal. Additionally, Larry was recently honored as this year's PLANSPONSOR Magazine lifetime achievement award recipient for his extraordinary contributions to the retirement industry. As a Company, we are all proud of Larry's commitment to the Company and to the industry and congratulate him on this distinguished award.

In closing, we're very pleased with the continued growth and momentum of our businesses as we look into 2012 and beyond. This concludes our prepared remarks. Operator, please open the call to questions.

(Operator Instructions). The first question comes from the line of Joanne Smith with Scotia Capital.

Yes, good morning. I was wondering if you could talk a little bit about the strong sales results in your FSA operations. They far exceeded my expectations, and I was just wondering if you could talk about the trends there.

Joanne, good morning. This is Larry. I will let Dan comment. But what I would say at a very high level is that we are really in a very nice sweet spot in terms of our retirement sales. And I say that based on, of course, having great distribution presence and continuing strong pipeline. We also have, because of PGI, we have very solid investment performance to present to clients, and, of course, the unique bundling that we do around total retirement services, as well as a lot of our work site activities, really does put us in a strong competitive position. I'll let Dan give you some of the specifics.

Thanks, Larry. So, Joanne, a couple of stats you might find interesting. The growth really was across emerging, dynamic and institutional, which is the way would like to see it. We did have seven nice-sized institutional plans come in. Those were plans over $100 million but nothing over $1 billion, so again, this speaks right at that lower end of large and high-end of medium-size marketplace. We had good traction again, continuance in the third-party administration area. About 40% of the sales for the quarter were TRS or Total Retirement Suite, so some combination of the DB/DC or non-qualified or ESOP. And alliance sales were up roughly 120% from first quarter of 2011. And as Larry mentioned in his earlier comments, we did add Edward Jones, which is a really great partner for PFG, and we're looking forward to working with the good people at Edward Jones.

Just as a follow-up, just on the ROA, you mentioned in the beginning of the call that the change in DAC induces a trade-off between good sales numbers and near-term earnings. Can you give us an estimate as to how much the increase in -- or decrease in capitalized acquisition expenses impacted the ROA?

Joanne, this is Larry. I would say it impacts it about $15 million to $20 million in terms of quarterly earnings. So you can sort of work it out from that.

Thank you very much, Larry.

You bet.

The next question comes from the line of John Nadel with Sterne Agee.

Close enough, yet again. Good morning, everybody. Larry, even if I apply a relatively strong ramp to your earnings for the remainder of the year, it appears pretty difficult to get your guidance. But interestingly, your guidance had originally assumed, I think, an average S&P of about 1,275. And that average is already year-to-date 100 points higher. I guess the question is, where is the weakness versus your original expectations, when I would have expected your business model and leverage to equity markets to, frankly, be a nice tailwind?

Sure, John. This is Larry. Let me make a few comments. What I would say here as a very general comment before I walk through little bit of detail with you, what I would say is that guidance is based on a full year. And I would say it would be very important to remember that things that happen over the course of a full year don't happen in 25% increments over each quarter. So, for example, variable investment income, as an example. Last year, that was a little bit front loaded. This year, we expect it to be a little bit back loaded. You have seasonality in specialty benefits, as we have commented before. As a general comment, you might see specialty benefits first quarter earnings be 20% of the full-year earnings, not 25%.

So what I would say is, if you sort of take Terry's normalized, the $0.72, you ramp it up the 2% to 3% that you would expect, sort of based on our assumptions of equity market growth, that gets you very near the $2.95 to $3.00 level. You then adjust for things like variable investment income, specialty benefits. You adjust for this change in share count, and you are, if you will, well inside our previously communicated guidance. Having said all of that, we obviously don't update that guidance. And it really does not take into account, John, at all the very strong asset accumulation and net cash flow growth that we saw in the first quarter, which obviously hasn't yet fed through to financials, because it is just received in the current quarter. And if the markets stay steady and that continues to repeat itself in subsequent quarters, that is going to be a very significant tailwind on earnings as we go into the subsequent quarters of 2012. So like always, there is a number of assumptions in there, but the key thing I would continue to remind everybody is things don't happen in one-fourth increments every year. There's front loads, there's back loads, all of that is taken into account when we gave our guidance back in December.

That's a very helpful. Thank you. I have one separate one, and that is, are you and the Board giving any consideration to changing your approach to setting your buyback authorization? I ask this, Larry, because obviously with your current approach, you are out of the market for the first two months of the year. And that clearly has at least at the margin a negative impact on your ability to generate EPS and ROE improvement at a somewhat faster pace.

Right. So, that is an interesting question, John. And I suspect that every management team you talk to might have a little bit different view on share repurchase in the era post the financial crisis. I think we have tried to communicate over several different times, including at our earnings guidance for 2012, that we see share repurchase now as a more opportunistic lever for us. And we frankly see higher levels of common stock dividend as a more regular lever for us to return capital to shareholders.

So we see ourselves moving to higher payout ratios over time, and we see ourselves moving to somewhat lower levels of share repurchase over time, because we do want to invest in the businesses. And to the extent we would do share repurchase, we would look at that based on sort of our view of the intrinsic value of the shares versus where they are trading at. So, in the past I think share repurchase for many companies has been more of a quote automatic lever. And in our case, we are really trying to not see as much capital return in share repurchase and we're trying to be more thoughtful to make sure that we are doing share repurchase at the right times and that we are not doing it at the wrong times. So I hope that helps a little bit.

That does. I guess my only follow-up to that, Larry, would be -- I'm not necessarily asking you to put up an authorization that would be a giant number that covers the potential buybacks over a couple of years, but I'm not sure I understand why not just an authorization that would cover at least your expectations for that 12-month period, let's say.

Right, and again a lot of that, John, is because I think we are trying to -- recognizing the changing nature of our business model with more fee-based earnings. I would argue that it is much more appropriate for us as a management team and a Board to think about returning capital to shareholders in the form of common stock dividends, more than share repurchases. What you already know from things we have communicated is that somewhere between 65% and 70% of our operating earnings for the year are going to be able to flow through as capital deployed back to shareholders, based on whatever amount of M&A we might do. I don't have to sit and really give you a large share repurchase. Investors already know that the vast majority of our earnings are able to be returned to shareholders.

So, we have shown in the past we are good stewards of our capital. Again, the thing I would want to communicate is that it is going to be done more as common stock dividends and higher payout ratios. That is appropriate, because we have moved to a more fee-based business model, and that is very different than our competitors, where perhaps they're able to return 40% to 50% of their earnings back to shareholders. In our case, that number is closer to 65% to 70%.

The next question comes from the line of Mark Finkelstein with Evercore Partners

Good morning. I guess I wanted go back to Joanne's question, Larry. I think you gave a number of $15 million to $20 million. I actually had the same question regarding kind of what FSA would have looked like were it not for the high sales number. I want to make sure that I understand your answer correctly. So if I look at FSA of kind of pre-tax earnings of $80 million, are you suggesting that the number would have been $15 million to $20 million higher were it kind of -- had not been for the change in the accounting or the extraordinary sales? Can you just give us a feel for exactly what you meant by that comment?

I'm sorry if I confused you, Mark. This is Larry. What I was trying to communicate in answer to Joanne's question was really a more generic question, not answering a question related to the level of sales in first quarter, but was answering the generic question about what impact we would expect to see to FSA from the change in DAC accounting guidance. So that was the question that I was answering. Does that help?

It does, but I think it also kind of brings up a follow up, which is, obviously, you had strong sales in the quarter, good flows in FSA. But I think most of us, including myself, were a little bit surprised that in a market that rallied as much as it had, the ROAs were maybe not as high as maybe we would have expected. So to the extent that there is -- some of that can be attributed to the change in the accounting and higher costs that occurred this quarter relative to what we would expect to be a normalized cost, based on that flow level, it would be helpful to understand kind of how to quantify that number so that we can think about that and how we think about ROAs.

Right. You're exactly right. While there was some positive benefit to FSA in this quarter, it wasn't as great because of the DAC accounting as it would have been under the prior set of rules. So maybe I'll see if Terry wants to comment a little bit about that.

Mark, this is Terry. As you look at the change in the accounting rules, there is less capitalization that is going on, and there is also less amortizations. Because of the $3.2 billion of sales, you're also seeing more of the expense incurred in the current period than you had in the previous accounting. Now, what was gave as guidance for the year was an impact of around $35 million to $45 million of operating earnings, impact due to the change in the accounting rules. We said a little bit over half of that was due to full service accumulation. So, that is basically in line. So if you look at the upper end of that range, a $40 million to $45 million impact, you'd expect about $20 million or $24 million or $25 million due to FSA alone. Now you take a quarter of that, but as Larry says, it doesn't always occur throughout the year. So you are probably getting a number that is more in the $5 million, $6 million after-tax impact on this quarter, because of, once again, lower capitalization and a lower amortization.

The next question comes from the line of Chris Giovanni with Goldman Sachs

Good morning. Thanks so much. First, I guess, following up on John Nadel's question. If the focus really is on generating greater free cash flow and capital, why not have a larger outstanding buyback program to be in the market more opportunistically? I guess, today's kind of the perfect example, where you have $20 million left and the stock is off 6%, and think we now need to wait until mid-May to get another authorization.

Right. Chris, this is Larry. Again, what I would say it is that -- and certainly, we are well aware of some other companies that will announce the potential, the potential, for large multi-year share repurchases. And what would say is, first of all, I don't think that that is necessarily an approach that as a Board, that they have necessarily gotten comfortable with. We have tried to take an alternative, which is to recognize that there is a substantial free cash flow generation capability here. And we have now again tried to refine that further by recognizing that there are times that your shares are outside of what you would consider to be the intrinsic value. If we saw an extended period where that were case, not one day, but if we saw an extended period where that were the case, we would certainly be in a position to build execute a share buyback.

But our focus in terms of capital deployment -- our focus really is more on moving to a higher payout ratio over time and continuing to invest in the business as we need to. So, again, the fact that we have done four acquisitions in the last year, exactly in the spot we want, and there's always some level of sort of pipeline around M&A that you would want to be in position to execute on, I think makes them -- and I completely agree with this, would make me cautious about wanting to promise too much too far into the future. So that is the reason that we have gone the way we have. And I think that is definitely the route that we will continue to operate with.

Okay. And I understand. I guess just with as volatile as things still are today, sometimes the opportunities are there at a present time, and if you just can't be in the market, when things maybe are a bit more irrational, just sometimes can be confusing for investors. But I will leave it there. And then the next thing, just in terms of the trends in terms of number of plans within DC, you had some pretty good momentum there on a sequential basis. I want to see kind of what your thoughts are around that, moving forward.

Sure. Dan, do you want to comment?

Yes, we feel good about that. Thanks for noticing that, Chris. So, up a couple of hundred plans, and this is to the credit of the team, primarily around that emerging and dynamic area taking the necessary steps to do a better job retaining business. There is also fewer plans being terminated. So we are holding onto those plans, and then there has actually been some movement towards startup plans again.

So, we all keep our fingers crossed that we have kind of bottomed out here in terms of the economic fallout and the negative impact it had on qualified retirement plan. Pipeline is up double-digit for both emerging and dynamic. It is a little bit flat for institutional, but that tends to be a little bit lumpy to begin with. So again, the pipelines are very good, and our close ratios are very solid. So to your point, we feel good about our ability to grow these plans going forward.

Okay. And then just one last quick one on foreign exchange. I guess with international growing as quickly as it is, Terry, you made the comment around some FX headwinds here in 2Q. Can you just talk about how you are thinking about potentially hedging of foreign currency?

Chris, this is Terry. We have looked at the possibility of that. But you will see volatility in any hedging that you do, as well as the volatility in the exchange rate. And there's an additional cost associated with that, that at this point in time, we don't know if we're getting that much more value out of it. But we will continue to look at it.

As in the past, what we have seen is PI as a smaller percentage of our earnings, but now it's in that 17%, 18% range and moving up to a larger range. We will take that into consideration in the future. But at this point in time, we are not providing that hedging of that currency. But we are providing in the financial supplement more detail as to what the average we are using on a quarterly basis, as well as the spot yield at the end of the period of time. So it gives you more insights as to what the impact will be, based upon the different currencies and the different locations that we are doing business.

Okay, thanks. Very helpful.

Thanks, Chris.

The next question comes from the line of Randy Binner with FBR.

Thanks. A question on capital deployment. You disclosed that you allocated $220 million in the quarter and $56 million of dividend, $50 million to buyback. Can we assume the rest is for Claritas?

Randy, this is Larry. Yes, I think the Claritas was roughly $65 million.

Randy, this is Terry. That $220 million includes the full authorization of $100 million. If you actually look at what deployed was $50 million of it.

Okay. So Claritas is around $65 million. And can you disclose what level of assets under management you acquired in the deal? It said it was a majority stake, but just looking for a little bit more clarification on what was acquired for that $65 million.

Sure. I will let Luis comment.

The size of that operation is about $2 billion total AUMs. And we acquired 60% of that to the ownership of that company.

It does. Just one last one on that is, what is the -- is it a fixed income, more equity? Or is it just asset type?

It is much more equity and balanced funds, rather than fixed income.

Balanced funds.

Okay.

One of the reasons that we had specifically identified Claritas was because they actually had a slightly -- they had a different portfolio than most mutual fund managers in Brazil. As you probably know, most mutual fund managers are, as you said, invested in not only fixed income, but primarily sovereign debt. So again, Claritas is relatively unique because they've demonstrated competency across several different asset classes within the Brazilian sort of security space, so it was very attractive from that perspective.

All right. Very good. Thanks.

Thanks, Randy.

The next question comes from Steven Schwartz with Raymond James

Good morning, everybody. I want to revisit one more time the FSA -- the effect of sales on FSA, without discussing ASU 2010 26. Just forget about that. Are we looking at a situation similar maybe to some asset managers, where a high level of sales leads to very high expenses before earnings can really come in off of the assets? Is that the situation that we're looking at here?

Okay, Steven. This is Larry. I'm going to stay away from it this time, and I'll let Dan clean it up for you.

I think that is exactly right, as we have changed the accounting methodology. Our full service accumulation, even for our group annuity contracts, which, as you know, has separate accounts as well, will look more like our mutual fund sales, our Principal Advantage product. And that is actually, from our perspective, a good thing. So we are certainly seeing higher expense as a result of acquiring those.

But as long as I'm on that same topic, I was kind of looking closely at where else are we making the investments over and above last year? So what would cause these expenses, where are we making investments? One is around mobile applications. One is around expense fee disclosure, which was a significant investment here in the first quarter. Increasing the size of our sales and service teams.

We're continuing to build out the size of that ESOP practice and defined-benefit capabilities. We're making additional investments in our product development areas, as Larry and Terry both commented about the growth in those diversified real asset and real income mutual fund solutions. Alliance management, we've continued to build out that team. As we add additional alliance partners, we have got to build out relationship managers to go along with that. Income solutions. This is not just about the accumulation business, so we've got to continue to make those investments around how we are going to help those nearing retirement and in retirement draw down those funds. And again, there is a lot of time and resources being spent there.

We still think that the workplace is a great place to educate plan participants on the need to save for retirement, and where some of our competitors have pulled back, we have actually bulked up on our deployment of our workplace efforts. And then lastly, and you keep hearing us talk about the TPA initiative, that also requires a lot of resources. So the expense line is up only modestly. And at the same time, you can see we have got a whole lot of work to do. And it is partially to offset some of the erosion that you have all witnessed in the past on changes that are taking place relative to mix of business, as well as this economic headwind that we continue to fight. The other line worth noting there was the reoccurring deposits are really showing now a nice solid comeback. They're not back to that pre-crisis level, but again, we think that is going to be a nice contributing factor to operating earnings going forward. I hope that helps.

That's good. That's really what I wanted to get a with that question. Just a follow up. Since you mentioned it, fee disclosure. Any new thoughts on that and how that might affect the Company and the business?

Yes, so the 408b, which is the component relative to notification to the plan sponsors, we started back in November of '11. That is effectively completed at this point in time. The 404a is the part that goes to the plan participant. That will happen after July 1, within those first 60 days. And where the majority of our education specialists and relationship managers are spending their time right now isn't on the absolute dollar of the fees. Those decisions have been made. That is water under the bridge.

Now the discussion is pointed toward how does Principal help the plan sponsors go about educating plan participants on behalf of the plan sponsors on what those fees are. So there's a little bit of work. Some employers are making decisions to start paying some of those fees separately. Some of them are revising the investment lineup that they're making available. So that is where a lot of our time is spent. And I would tell you that certainly by the fall time, we will have had a fee disclosure really in our rear view mirror at that point.

Okay. But on existing -- plans that current customers that you currently have, the plan sponsors. Their change in behavior has neither been negative or positive for the Company. Is that correct?

That is correct. There is a few on the edges where, as long as they are reviewing expenses, they might put it out for a check bid. But I would say for all intents and purposes, this discussion has now migrated to how do we go about rolling it out to the participant, more so than the employer going back and forth with PFG.

Okay. And then one for Terry, if I may. Terry, the historical kind of guidance had been for every 2% move in the S&P -- in the S&P 500, it was probably 1% move for EPS for Principal. Is there a relationship that we can look at maybe for that net revenue number?

Steven, just to clarify, we talked about a 10% shock in the equity market, up or down.

Right.

And then followed by a 2% increase on a quarter-by-quarter basis from there would have a 4% to 6% impact on operating earnings. And that was a pre-DAC change guidance. And we think it is very comparable, but we will give you more clarity on that as we see it play out. In terms of the net revenue growth, The net revenue growth I think probably will lag the growth in the assets under management a bit, because of the types of assets don't all have the same net revenue. But we monitor the net revenue growth on each of our different businesses. And that is why we look at a margin of return on that net revenue by each of the businesses.

Now, if you look at -- and what we have said in full service accumulation, for example, we think that the net revenue growth will trend pretty stable. And the stability is in that 30 to 32 basis points -- excuse me, 30% to 32% range for that. But we also look at the total company. And it is really a relationship between the net revenue and the expenses that we really monitor very closely by each of the different product types.

Okay. Thank you very much, guys.

Thanks, Steven.

The next question comes from Eric Berg with RBC Capital Markets.

Thanks very much. Good afternoon. Or rather, good morning to everyone. I realize that there is a lot going on here. That is apparent. Between return on assets, return on net revenues, return on revenues, the DAC accounting, you'd have to be a partner at Deloitte to understand what is going on here. All I know is that for a business, any business's earnings to grow sustainably at a healthy rate, there has got to be revenue growth. There has to be in any business revenue growth. At least this is my view. And so my question is this. Even if you add back the -- absent the variable income that you didn't have, it looks like there wasn't much revenue growth or net revenue growth, again, even if you add back the variable income to the one-time business, this despite the fact that you had respectable asset growth. And so while I do have a second question for Jim on PGI, what I would like to know is what is holding back -- putting aside all this other stuff about margins and accounting changes, what is holding back the revenue growth, even if you adjust to the absence of that variable income, given the strong asset growth that you had? And when can we expect the revenue growth, and why?

Well, Eric, this is Larry. And again, I will take a shot at this and look at Dan and Terry to clean it up. But what I would say is, if you just focus on sort of first quarter over first quarter, the net revenue would look relatively flat, despite the AUM growth. The average account value would be up about 6%. The net revenue would be about flat. The reason that you don't see more net revenue growth -- and again, I want to emphasize, this is just a very short look, quarter over quarter. The reason that you don't see the revenue growth equal to the asset growth for that particular comparison is for two things.

One is the variable income that we've talked about before. In first quarter '11, we had a fairly substantial amount of variable investment income in the form of real estate sales that was distributed out to the business units as additional investment income that was there in 2011, not there in 2012. The second factor that impacts the revenue is that, again, if you will, investor sentiment, investor choice is moving away from guaranteed accounts and is moving towards fee-based accounts. From an investor perspective, that is a good thing. That is a good thing, that it's moving towards fee-based accounts.

So ROA can be down. ROA can be down, but free cash flow is actually up. And again, the primary reason, if you just took quarter over quarter, which I would encourage everyone not to do, because that's too short a period to determine trends, but that is more tied to the issues around the variable investment income. So you will see net revenue growth. We have said before we sort of expect at this point net revenue growth will be in that 4% to 6% range.

And so now the question about seeing growth in FSA earnings will come down to that point that I talked about in my comments and that Dan commented on in the earlier question. It is a point of, do we still feel we need to selectively invest in the business because we have an opportunity to grab substantial market share, and we are investing for the long-term health of the business? So how many of those investments do we have to make in 2012? Or would we rather put all of that into earnings growth? And the answer is, it will be some of both. So, we will see net revenue growth. We'll see some earnings growth. But net revenue is going to trail assets under management because of these investor shift differences.

Thank you. Go ahead, Terry.

No, that's fine.

Thanks very much for giving me the time to answer, because I see we are at the top of the hour now, a question to Jim. Jim, I certainly understand -- congratulations to you on what looks like one of the best quarters in some time in terms of net flows. I know you are making these acquisitions, growing your business very successfully. But here too, we didn't see earnings growth. And I understand that you are investing in your business. How long will these investments sort of last? Will some of these costs go away? And are you -- relatedly, are you dependent on these performance fees to show earnings growth? Thank you.

Okay. Thank you, Eric. There are quite a few pieces to the answer to that question. As we have said, there are a number of accounting issues in the first quarter that make the earnings look worse than I think the underlying performance of the business. We have talked about the tax charge being anomalously high. There was a catch-up one of a few hundred thousand dollars in incentive comp pool in the first quarter, whereas the previous year, there had been a release, the PFG overhead and security benefits. If you take those things out, though, the numbers for Principal Global Investors underlying, are that first quarter 2012 versus 2011 saw a 6% increase in assets under management with a 10% increase in revenue.

So, revenues in the institutional business actually slightly richer, very slightly richer relative to assets and with expenses up 7%. And that increase in expenses, in a way, it is higher than you think it would be if you were looking at the operational leverage in the business. That is where the investment is. And Terry mentioned Amsterdam and Dubai. There is also other areas. Those are not the only places we are investing. We've put more people in China, for example, this year compared with last. These are looking to the growth over the next three to five years. And really, I think what I'm saying here is, by putting on significant assets under management at a time of change in the investment management business, when a lot of other players are seeing big outflows, we can build a lot of long-term shareholder value.

Now as to your question of when will this really show through to earnings, 1.5 years ago at Investor Day, I really talked about improving the pre-tax margin on Principal Global Investors towards 30%, which I regard as a really sort of good industry benchmark over a five-year period. It may look with the growth we have seen and with margins continuing to be a little bit laggard as if we are bit behind schedule on that. We're probably ahead of the schedule that we set 1.5 years ago in terms of flows and AUM. But I think all in all, I feel that that that 30% pre-tax margin remains the target, and I would really like to try and achieve that on five years from the initial time that we set it, which was 1.5 years ago. I hope that puts it in context for you, Eric.

It does. It helps a lot. Thanks to everyone. Thank you.

We have reached the end of our Q&A. Mr. Zimpleman, your closing comments, please.

Thanks to everybody for joining us for the call today. And as always, we appreciate your continuing interest. As I said in my opening comments, the momentum behind our business remains very, very strong. And I do believe that our fee-based business model, along with the improving credit losses, will allow us to continue to return significant amounts of capital to shareholders while still investing for our future. So thanks again for listening. I look forward to seeing many of you on the road in the coming quarter.

Thank you for participating in today's conference call. This call will be available for replay beginning at approximately 8 PM Eastern time until the end of the day, May 4, 2012. The access code for the replay is 66987871. The number to dial for the replay is 855-859-2056 for US and Canadian callers or 404-537-3406 for international callers.