Q2 2022 Victory Capital Holdings Inc Earnings Call
Because we can offer our clients that are suitable for managing through the current volatile environment. Our ETF flows have been positive for seven consecutive quarters and for the past 20 straight months.
One. Good example of a unique Etfs is our victory shares U S equity income enhanced volatility weighted Etfs ticker symbol, CDC, which automatically increases its allocation of that cash during periods of high volatility a feature that is attractive to many of our investors.
Our market neutral income fund ticker symbol CB <unk>.
Also continues to generate positive net asset flows.
It continues to be added to a number of new industry, leading distribution platforms, which provides clients with broader ways to access it.
Net long term flows were a positive $2 $4 billion in the first half of the year.
Second quarter net long term flows were slightly negative at approximately negative $600 million.
Although as a firm we were negative for the quarter, we had significant pockets of strength in various channels products and strategies.
Strength has continued into the third quarter and as of today, We're still positive net long term flows year to date and have a strong net won but not yet funded book along with a robust pipeline of potential new business. We attribute this trend to the excellent investment performance, we have as a firm coupled with a diverse set of products being distributed through multiple channels.
<unk> that we've invested in over the last few years. In addition to continuing to make investments that support organic growth initiatives. We're also continuing to execute on our inorganic growth strategy. The.
The M&A environment remains constructive and we are continuing to conduct diligence on multiple perspective deals with ample financial capacity to execute on a wide range of deals that vary in size structure and product set.
Our focus here remains the same as it has for the last decade.
Every potential acquisition, we look at must have a strategic aspect that will make us a better company.
We start with a view on where investors are potentially we'll be allocating assets and where we can earn a fair fee for the work that we do.
To be clear I do not believe the current environment will impede us on executing a transaction should the right one presented itself given what we know today.
The direct Investor business continues to make good progress our $5 nine education savings plan experienced positive net flows again in the second quarter and the year to date period.
During the current market conditions, we saw an uptick in the number of investor engagement through our communication channels. These.
These types of conversations give us the opportunity to learn about each investor's objectives and risk tolerance as well as offer a portfolio review.
We're also able to educate investors about the potential benefits of dollar cost, averaging and encouraging establishment of automatic investment plans.
Turning to slide seven you can see our strong investment performance continued throughout the second quarter of the year.
During periods of significant market volatility mispricing can occur providing attractive opportunities for active managers to generate alpha.
Over the years, our franchises have excelled during these times and this period is proving to be no different.
At the end of June .
15, mutual funds and Etfs with a four or five star overall ratings from Morningstar.
This is up from 44 funds at the end of March and represents 68% of our mutual fund and ETF AUM up from 65% at the end of the first quarter.
Turning to slide eight as I mentioned earlier, we are not making any changes in our plans to invest in our business organically and inorganically or in our capital allocation strategy.
We continued to generate strong cash flow and pay down debt in the second quarter.
Since the beginning of this year, we allocated the majority of our excess cash flow to reducing debt repaying $150 million of debt through the end of June post June we reduced our debt another $26 million.
As disclosed in yesterday's press release, we returned more capital to shareholders this quarter than during any other quarter in our history via share repurchases and dividends.
We returned a total of $34 million through share repurchases and dividends, which is 26% higher than the $27 million returned in the first quarter of this year.
This increased our year to date return of capital to shareholders to $61 million, which approximates the amount of capital returned to shareholders in all of 2021.
One point I would like to highlight is we will be opportunistic between the paydown of debt and share repurchases given the dynamic market environment, we're in and the flexibility we have through our different programs.
This flexibility should bode well for our shareholders.
With that I will turn it over to Mike for more details on the quarter's financials.
Mike.
Thanks, Dave and good morning, everyone.
The financial results review begins on slide 10.
Total AUM decreased by $23 2 billion or.
We're 13% in the quarter to $154 9 billion at the end of June .
This decrease brought the year to date decline in AUM to $28 7 million.
Our 16% lower than at the beginning of the year.
This was primarily driven by approximately $30 billion.
Of negative market action.
And was partially offset by $2 3 billion.
A positive inflows during the first half of 2022.
AUM at quarter end was 4% lower and at the same time last year.
Revenue of $216 million in the second quarter was 6% lower than in the first quarter due to the lower AUM.
Down 3% from the same quarter last year.
During the second quarter GAAP operating income was favorably impacted by lower acquisition related costs.
$26 $6 million noncash benefit to our GAAP results related to a reduction in the fair value of the contingent earn out liability on our balance sheet.
As you may recall any quarter over quarter change in this liability runs through our income statement.
This resulted in GAAP operating income of $119 million and an operating margin of greater than 75%.
Adjusted EBITDA was $106 2 million in the second quarter were once again pleased with the performance of our operating model, resulting in adjusted EBITDA margin of 49, 2%.
We believe this clearly highlights the benefit of our variable cost structure.
As a reminder.
Proximately two thirds of our expenses are variable.
GAAP net income was $79 $2 million for $1 nine.
Per diluted share.
In Eni was tax benefit was $1 11 per.
Per diluted share.
We paid down $45 million of debt and returned $34 million of capital to shareholders in the quarter, which Dave just highlighted.
We repurchased 640000 shares in the quarter, which was up from 293000 shares in the first quarter.
The cash dividend was maintained at 25 per share for the current quarter.
On Slide 11, you can see total AUM was $154 9 billion.
At the end of June and remains well diversified from a distribution channel and client perspective.
This diversification has served us well in the current volatile market environment.
Long term AUM totaled $152 billion at quarter end.
This was down from 181 billion at the beginning of the year and was 4% lower than the 159 billion of long term AUM at the end of last year's second quarter.
Okay.
Turning to slide 12.
Gross long term flows totaled $9 2 billion in the quarter and we had $600 million of net long term outflows.
This resulted in record first half gross flows of $22 billion and positive year to date net long term inflows of $2 $4 billion.
Given the state of the industry, we are very happy to be net flow positive for the first six months of the year and we are off to a solid start for the third quarter.
Several of our investment franchises are generating positive net flows and our victory shares ETF platform continues to grow nicely as well.
Slide 13 illustrates our revenue, which declined 6% from the first quarter consistent with the quarter over quarter, 6% decline in average AUM.
Our fee rates came in at $52 three basis points.
It was down slightly from the first quarter.
On slide 14, we detailed our expenses, which declined $28 million.
$111 million in the second quarter due.
Due primarily to lower operating expenses.
In addition to lower GAAP compensation expenses, which declined 11%.
And the calibration of our distribution and other asset based expenses.
The greatest quarter over quarter variance was the noncash benefit that I discussed earlier.
Related to potential contingent earn out payments for prior acquisitions.
The single item resulted in $23 million of the sequential reduction in operating expenses versus the first quarter.
On a cash basis compensation was reduced in the second quarter by 9% to $53 6 million.
Or 24, 8% of revenue.
Down from $58 7 million or 25, 5% of revenue in the first quarter.
About $2 million of this decline can be traced to seasonally higher payroll taxes and benefits in the first quarter of the calendar year and the majority of the remaining decline relates to the adjustment of our variable incentive compensation pool, which is linked to revenue and earnings.
Moving to our non-GAAP results on slide 15.
The net income was $71 $4 million in the quarter and a tax benefit was unchanged at $9 3 million.
Resulting in an <unk> tax benefit of $80 7 million or.
Or $1 11 per diluted share.
Our adjusted EBITDA margin was 49, 2% in Q2.
For the first half of the year adjusted EBITDA margin was 49, 5%, which exceeds our long term guidance of 49%, which we are maintaining.
We continue to make strategic investments in technology distribution data marketing and people.
Given the strength and resilience of our operating model, we have the wherewithal to maintain these investments and have no intention to alter our plans to invest for growth.
Finally, turning to slide 16 on.
On the capital management front, we repaid an additional $45 million of debt during the quarter.
Our net leverage ratio at quarter end increased to two three times at.
At the end of June our debt to equity ratio improved to one to one.
Our blended interest rate on debt during the quarter increased to three 2%, which was up from two 9% in the prior quarter.
This was partially offset by the lower level of debt and resulted in our cost of debt increasing by $700000 in the quarter.
$9 9 million.
We're very comfortable with our current debt, particularly considering the floating to fixed swaps that locks in the rate of three 2% on $450 million of the debt.
The balance of our term loans at LIBOR, plus 225 basis points.
Also our $100 million revolver remains undrawn.
After the quarter, we repaid and our repurchased and retired another $26 million of debt.
That concludes our prepared remarks, I will now turn it back over to the operator for questions.
Thank you at this time I'd like to ask a question press star one on your telephone keypad.
If you would like to thank triangles, Jeff from the queue Press Star one again.
Your first question is from the line of Craig <unk> with Bank of America.
Hey, Good morning, David Michael Hope, you're both doing well.
Hey, Greg.
So my first one is on M&A after the west and integration.
Can you update us on your appetite for M&A and also your focus on more highly accretive consolidation type transactions versus more revenue and gross synergistic strategic acquisitions and then also have you seen valuations dip for potential deals in 2022.
So really nothing has changed in our strategy around M&A as I said in our prepared remarks, we've been doing M&A.
Over the last decade, and I think everything has started with does this make our company better does the transaction make our company better and Thats the approach.
We have done all types of transactions small large consolidation growth focused.
Playing field for US if you will is going to be the same we're not leaning towards one or the other we really are looking at does it make our company better if you looked at our west and clearly that was a growth transaction. If you looked at our go.
To go back and look at the USAA transaction that was growth along with expense synergies.
So we're not really leaning towards anything.
Any specific type of transaction.
The environment is extremely constructive and what I mean by that is there are a lot of opportunities with the market dislocation.
As far as valuations.
Think valuations are all over the place.
You do have opportunities where things are at a significant discount.
And probably rightfully so and then there are other opportunities where prices held.
A lot of the pricing can be dealt with through restructuring a lot of the pricing can be dealt with in our platform.
The way we integrate in the way we purchase I think is unique and I think a lot of the pricing could be dealt with that way. So I would say that.
To sum it up our strategy Hasnt changed and were pretty excited about the environment and we've been doing this for a long time and a lot of different market conditions and so we feel really good about the opportunity.
Thank you David and then my second question really is on capacity you do deals.
What is your current excess capital or cash today, and then how much incremental debt capacity do you have to go above that and when you combine these with free cash flow generation. How do you think about total deal capacity over the next year.
So we won't go into detail.
On on what we think our total deal capacity.
Is I don't think we're going to be constrained there are a lot of different ways to approach a deal clearly we've used that in the past.
We have the debt capacity today.
So we have that as a tool we've used deferred payouts in the past and we still will have that we've used revenue sharing future revenue sharing as a tool.
And then we've used structuring as a tool and.
An earn out structure. So I think the way we're looking at it is we don't feel like we're constrained.
And then.
I would also add that the free cash flow we have.
We announced and closed and then ongoing I think should give us all of the fuel. If you will to do really any deal that has approached us. So we don't feel constrained at all.
Great. Thank you David.
Your next question is from the line of Ken Worthington with JP Morgan.
Thanks for taking the questions.
First some markets bouncing back here sort of July and August .
Where do you think client interest and demand might rebound most quickly and where are you focusing our plan to focus your.
Global marketing efforts.
If the market conditions continue to recover.
Hi, Ken it's Dave.
I think people are rethinking their portfolios.
Go back and look during the last decade.
Had.
An environment with low rates, we had an environment, where there was a lot of stimulus if you will put into the.
The economy through.
Buyback of central banks buying back bonds.
And so I think what people are starting to sort through is is that going to be the investing environment going forward and I think many of our clients are thinking about we're into a different investing environment and so a lot of the discussions we're having.
Really around what kind of investments are going to succeed or what types of investments will succeed going forward and a lot of those around active management.
In the past if you were invested in data you did very well.
A lot of the discussions today.
Today, our around active management and being in certain asset classes.
So we're focusing on that I mean, clearly we're an active manager and we think that going forward that active management is going to play an even bigger role in portfolios.
As far as where were focusing our marketing efforts.
We've invested over the last few years very heavily in distribution. We've added people we've entered into different channels, we've invested pretty heavily in data and technology and really around digital marketing and I think you can see in our results through some of the year over year numbers that's coming.
<unk>.
It's paying dividends for us we're going to continue doing that.
And I would also say from a product development perspective, we've launched a good number of products on the ETF side.
TFS I think will continue to be an important part of.
A well diversified portfolio, especially on the retail side.
Also believe private markets.
Through our new energy.
Acquisitions are going to be just as important going forward as they are today.
And so we're going to continue to invest in market there as well.
Okay, great. Thank you.
And then just maybe an easier one on comp.
In the prepared remarks, you spoke about the payroll and some adjustments this quarter due to profitability.
The adjustments this quarter.
<unk> out of our the reversal of accruals that were made Q1and therefore are we not quite at the right run rate or is the <unk> numbers for the right run rate that we should think about.
As we bounce off going forward.
Good morning, Mike.
In the prepared remarks, what was highlighted really is in the first quarter and the first part of each calendar year, we see a reset on payroll taxes and benefits.
And so there was a natural decline from Q1 to Q2 of about $2 million related to as those reset from a timing perspective.
As you think about the comp expense going forward from a cash compensation perspective for 24, 8% this quarter.
Ebbs and flow based on that timing of payroll, but 24% to 25% really is what we look at long term and.
So what you see in Q2 is about the right level.
Lot of our incentive compensation pools flex with the revenue and the earnings of the business.
From a compensation perspective to our investment franchises as well as the overall business and so you saw that flex as well in Q2 as the earnings and the revenue came down.
Okay.
I'm taking for me. It was there was no reversal of accruals.
And this is okay perfect. Thanks that was it.
Yes.
Okay.
Your next question is from the line of late.
RBC capital.
Good morning, and thanks for taking my question.
Wanted to.
Digging a little bit more into the strong net flows within the alternative assets under management.
Wondering how much of a contribution there you saw with Sandy I think theres a market neutral income fund there. Thanks.
Hi, Ken.
The market neutral it was a big part of that.
That is a product that we're just really beginning to get.
Wide distribution on we talked about in our prepared remarks about how the distribution channel channels and the platforms are growing so that was a big part of it.
We have other products in our pipeline that we're thinking about adding as well.
Market neutral, specifically fits really well into the investing environment today and there is an important part of our portfolio as you look going forward with the kind of the new investing environment, we're going to get into.
Got you very helpful. There.
One follow up if I may I know that you have a couple of ongoing efforts in terms of expanding distribution for <unk>.
Several of the new strategies and franchises wondering if you just give us a quick update on that I think at.
Pat you talked about expanding distribution of fixed income products, obviously western as well just wanted to ask more of an update there. Thanks.
So maybe I'll start with west end.
Western has been.
A grower for us since we acquired the business. So that has grown nicely even against the backdrop, where that specific part of the industry is actually contracted for the first half of the year. So they have buck that trend.
We are working with their distribution team.
To really bring their products to more advisers, and then bring their products to more platforms and so we're investing there.
We've also invested.
In different channels, the registered investment advisor channels in area, where the last few years, we've added people and added <unk>.
Spend on data and I think that's worked out very nicely and in that channel, we sold a number of different products.
And then just generally speaking.
We have invested pretty heavily into data and arming our sales force to be better educated walking into potential clients and existing clients as office offices.
So those are areas. There's just a few examples on the private side with new energy, we continue to work with them on.
Increasing the size of their business as we go through the year.
We're right on plan on that.
So from a distribution side you can see the increase kind of this year versus last.
You can see that those investments have come together and really have produced and I think that we're just in the beginning of some momentum from a distribution side and we have begun I think to separate ourselves from some others around some of the investments we've made.
Our own team with some of the products we brought in some of the acquisitions we've done.
Great very helpful. Thanks again.
Your next question is from the line of Michael Brown with K B W.
Okay.
Hi, good morning.
Hey, Mike.
Okay.
Hi, great. Thanks for taking my questions.
Yes, I just wanted to start by parsing out your comments on the on the capital allocation here in the balance between deleveraging and share buybacks now.
So when you think about paying back the debt here what is the leverage ratio you have in mind, when you're thinking about what are your.
Plan to bring out and then.
Just given that the pipeline of deals.
And it does sound pretty good here.
Does it make sense for you to actually run with a bit higher debt than you normally would just to finance future deals given the rising rate environment here and maybe the more attractive rates, which you have on your current borrowings versus.
What.
Current rates have risen to.
It's David.
Think.
What we're doing is we're really looking at the facts and circumstances a lot closer I think if you went back a few years. It was we're in a low interest rate environment, and our playbook lows to automatically pay down debt with our free cash flow.
And buy shares back I think in today's environment.
Looking at it on a much closer than I'd say more.
Daily weekly basis.
I think the share buyback program that we have becomes interesting, especially with.
Our stock at levels that it's at today as you can see this quarter, we bought back more shares than we ever have.
And as far as are our debt we.
We do have a portion as Mike said that is locked in that would be a natural level, where we would think about.
Keeping that.
The part that floats, we do think about that level and we think about you know should.
Should we not pay that down and maybe think about accumulating cash for a potential transaction.
So we evaluate that.
We don't have set boundaries around that we're mindful of it but I would also say that each transaction is going to look very different some will require a significant amount of cash upfront. Some will require less I'd also remind you that we also have the revolver thats undrawn, which is $100 million. So we are looking.
At it.
A lot closer.
Our overall strategy has not changed though our overall strategy is to make sure. We are in a position to do accretive transactions no matter, what the environment is and I can say that where we are today, we're in that position.
Okay, great appreciate the color there.
And then I was just curious about the direct channel here, obviously, that's unique channel net debt that you have can.
Can you just expand on how that has performed during the sharp market sell off in the first half of the year.
Any early reads on how Thats performed.
Quarter to date, and just curious to hear about some of the trends that you've seen from that specific channel.
So just to take us a little bit of a step back and we are building.
Broader wider digital marketplace, they're planning on expanding the product set and the products we have to offer our clients.
Our customer service scores are excellent and continue to be excellent as we took more engagements more calls more interactions. So that has not dip at all.
It gave us a great opportunity to have discussions and interact with clients and talk about some of the benefits of thinking long term, while investing so thats been a big positive or 529 education savings plan continues to grow.
This year this quarter.
So positive.
We're working pretty hard behind the scenes on building new products that we will rollout as we go into this year and into next year.
Been a really solid consistent steady part of our business.
Loyal client base.
Very.
Client base that has not been quick to move assets based on short term thinking so we've been very pleased during this market disruption.
And we think we have the core of something.
Pretty interesting going forward as we continue to think about expanding the product set there and offering more products and becoming more important in those clients financial lives.
Okay, great. Thank you for taking my questions.
Your next question is from the line of Michael <unk> with Morgan Stanley .
Great. Thanks, Good morning, I was hoping you could update us on your retail separately managed account initiatives retail us amazed how much maybe you can remind us how much you have in AUM today, what sort of flow trends youre seeing and how are you thinking about expanding your offerings in the retail SMA space just in terms of number of underlying strategies and such.
Okay.
Good morning, Mike, It's Mike how are you.
Yes, I think from a retail SMA perspective, we have.
Offered a number of our products and continue to expand the product offering.
THB, which came on last year, we now have several offerings.
In the retail space that we've expanded through.
Through a number of intermediaries and wires. It's early days, there, but we see opportunity based on the performance that they have in the product set that they have.
<unk> West end is big in that space and that was really one of the reasons why we wanted to acquire western was the presence that they had and the retail SMA model business space.
And Dave highlighted that we've continued to see very strong success with west and through the first half of the year.
<unk> on the existing platforms that they had as they were acquired by US at the end of last year and then also platform expansion based on the relationships that victory has and has brought to that relationship as well.
From an AUM perspective, west that makes up the predominant amount of our rap retail wrap but we do have a handful of other offerings that had been in place.
Our convertible strategy, our large cap growth strategy and then as I mentioned some of the TSV strategies as well it is a opportunity set for us and we think we've got the product set and the distribution that to continue to capitalize on that as that continues to grow within our business.
I'd add one just to follow up on Mike.
We're probably approaching close to $20 billion of Av.
But you would categorize as SMA or model driven business.
Great and just.
Maybe coming back to some of the commentary on M&A you guys mentioned that your diligence thing.
Number of prospective deals I was hoping you might be able to just give us a little bit of a feel for the types of properties asset classes that are embedded within that perspective deal pipeline. Thank.
Thank you.
I think that they are.
A wide range of opportunities.
From an asset class and size perspective, it really does.
<unk>.
Go to the smaller and larger side.
Again as I said earlier, we start off with does it does it make our business better.
We've done small transactions that had been very impactful. If you go back a number of years, we acquired a very small ETF platform, which is which has turned out.
Wonderful for us with the growth in the size and then we've done large transactions as you know.
And our diligence.
Our.
What we're looking at today really ranges in that size as well. So it is not one specific area or one specific size that we're working on.
Okay, great. Thank you.
As a reminder, if you'd like to ask a question press star one on your telephone keypad.
Your next question is from the line of Brennan Hawken with UBS.
Good morning, Thanks for taking my questions.
You guys flagged inorganic opportunities and spoke about pricing it sounded like it's sort of all over the map.
We've definitely heard some others, saying that M&A is swelling and bid ask spreads are wide. So.
Beyond pricing.
Being in a wide range, maybe could you speak to whether or not that.
Bid ask spread is narrowing and whether or not the sellers.
Expectations have appropriately reset or was a sustained wide spread in between buyer and seller expectations embedded within the comment around pricing just would love to try to flesh that out a bit.
I think the spread the spread has definitely come in.
I think some of the way to deal with.
The difference between buyer and seller expectation is with structuring and timing of payments and.
And partnering on the on the future of growth and I think that ultimately is at the core of the challenge of the spread so what we've seen in the discussions we've had is really around.
Partnering in the future and the deals that we like to do we'd.
We'd like to share and risk going forward and I think sellers have been a lot more open to that concept.
That all being said.
We're still in an environment in my opinion that is going to see a number of transactions. There are definitely executable opportunities and I think people are realistic.
And I think as.
As the industry continues to mature.
At the core of it.
A lot of businesses need to partner.
And they need to partner with platforms that have certain capabilities. They don't happen no matter, what the market is doing and no matter what the pricing is that those capabilities that are needed are not going anywhere.
And so so we think we're in an environment where.
There'll be transactions.
With our experience and our platform I think that there will be tremendous opportunities for us going forward.
There is a pretty long runway of those opportunities.
Okay. Thanks for Flushing that out.
My follow up would be.
Your from your perspective.
Attractive.
Environment.
You just flagged but.
<unk> that would be higher borrowing costs. So how do you strike a balance there and does that is that really embedded within the more creative structure comment or does it does it require something further than that in order to compensate for those higher borrowing cost.
When you pegged to LIBOR and LIBOR has hit multi decade highs here.
Thanks.
I think that there is a few aspects to that one is I think we have a unique platform.
There we have in the past been able to utilize our platform to if you will buy down.
Some of the multiples through integration I think the other unique thing about our businesses.
The transactions. We've done is we have partnered and structured through earn outs.
And through revenue sharing which I think puts us at an advantage.
And then I think the other side is we have a pretty sizable free cash flow.
Profile.
I think we can utilize.
And that all being said I do think borrowing costs have increased.
We'll see where the costs are going forward. There is an assumption and what you said that rates will continue to rise and stay high Im not sure that we are 100% agree with that.
So I think theres a number of inputs.
But you go back to <unk>.
Our history and you go back to the way we've done transactions that we've been extremely creative and we have a number of different levers and I don't think increase borrowing costs will prevent us from executing on our strategy.
Okay. Thanks for that color.
Thank you I will now hand todays call back over.
Two representative for any closing remarks.
Thank you for joining us. This morning next week, we will be meeting with investors at the Bofa Securities Best Smid cap ideas conference and we hope to see you there as a second half of the year unfolds. We look forward to keeping you updated on our progress. Thank you for today.
This concludes today's call. Thank you for joining you may now disconnect your lines.
Okay.
[music].