Q3 2022 Victory Capital Holdings Inc Earnings Call
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Good morning, and welcome to the victory capital third quarter 2022 earnings Conference call.
All callers are in listen only mode. Following the company's prepared remarks, there will be a question and answer session.
I will now turn the call over to Mr. Matthew Dennis Chief of staff and director of Investor Relations.
Please go ahead Mr. Dennis.
Before I turn the call over to David Brown, I would like to remind you that during today's conference call. We may make a number of forward looking.
Please note that victory capital actual results may differ materially from these statements. Please refer to our SEC filings for a list of some of the factors that may cause actual results to differ materially from those expressed on today's call.
And free capital assumes no duty and does not undertake any obligation to update any forward looking statements.
Our press release that was issued after the market closed yesterday disclose both GAAP and non-GAAP financial results. We believe the non-GAAP measures enhance the understanding of our business and our performance reconciliations between these non-GAAP measures and the most comparable GAAP measures are included in tables that can be found in our press release.
And in the slide presentation accompanying this call both of which are available on the Investor relations portion of our website at IR Dot <unk> dot.
Dot com.
Now my pleasure to turn the call over to David Brown, Chairman and CEO David.
Thanks.
Good morning, and welcome to victory Capital's third quarter 2022 earnings Conference call.
Im joined today by Michael Pellekar, Bouck, our President Chief financial and administrative officer, as well as Matt Dennis Chief of staff and director of Investor Relations.
I'll start today by providing an overview of the quarter and year to date period.
Don will cover our investment performance, which continues to be very strong.
After that I will highlight our increasing capital returned to shareholders and then turn the call over to Mike to review the financial results in greater detail.
Following our prepared remarks, Mike, Matt and I will be available to take your questions.
The quarterly business overview begins on slide five.
The equity and debt markets. Both continued their decline in the third quarter.
Through the first nine months of this year investors utilizing the traditional 60 40 portfolio allocation are enduring the largest drawdown since $19 37 to put in perspective, how challenging the markets have been.
Despite the current market environment, our business performed exceptionally well and that was very evident in the financial results we reported yesterday.
AUM and revenues were expectedly lower given the markets adjusted EBITDA margin expanded to 50% in the third quarter, which was the ninth consecutive quarter above our 49% long term guidance.
This resulted in year to date, adjusted EBITDA margin widening to 49, 6%.
The margins in our business are industry, leading and a testament to our business model, but most important in this equation is the excellent people we are operating our business.
Simply I believe we have the best group of employees in the industry here in victory and that to me is very evident in the performance of our company during these markets.
Sales activity remained brisk with $6 6 billion of gross long term sales in the quarter, which is 16% higher than during the same quarter last year and up 29% from the same quarter of 2020.
This is primarily the result of past investments, we've made to build out and enhance our distribution capabilities combined with a well diversified product set which we have consistently expanded over the years.
To that end in October we further extended our product set with the launch of the victory shares West end use sector ETF ticker <unk>.
It delivers an investment approach that Nir is west end advisers existing U S sector strategy.
Single ETF vehicle, increasing availability of this strategy to a broader group of investors.
Year to date gross sales reached a record $26 8 billion for the first nine months of 2022, which also highlights experiencing hard work of the individuals on our distribution and marketing teams.
Net long term flows improved from the second quarter of the year, resulting a positive year to date net long term flows of $1 9 billion.
West end advisers has had positive long term flows every month since we closed the transaction at the end of 2021. Additionally.
Additionally, our victory shares ETF business recorded eight straight quarter of positive long term flows.
Moreover, our institutional distribution channels has had positive net flows year to date as well.
This is just a sample of some of the green shoots around flows we are seeing within our business. During these volatile times.
The Swift upward movement in interest rates and the resulting significant outflows on most fixed income asset classes that have occurred year to date present, a great opportunity once interest rates stabilized to increase market share by capturing a lot of the assets that are left on the way back.
Our USAA fixed income franchise is well positioned to increase market share given the relative outperformance.
Through the end of September , 83% and 96% of the USAA fixed income AUM has outperformed their respective benchmarks over the three and five year periods.
And over an entire 10 year business cycle, 100% of AUM has outperformed benchmarks.
As a well research team that is an excellent long term track record and already manages a sizable amount of assets.
We also generated higher quarter over quarter, adjusted net income with tax benefit per diluted share.
In addition to supporting our industry, leading margins, our flexible cost structure affords us the ability to sustained investments in our strategic growth initiatives.
We are very pleased to have the financial wherewithal to continue to reinvest in our business during all markets.
Our business model is very durable in any market environment and has proven to be very resilient under the current market conditions.
The build out of our digital marketplace continues to make nice progress.
We're looking forward to introducing more investor options and features to broaden and enhance the products and services available on our direct investor business.
We expect to roll these enhancements out during the course of next year.
Turning to slide seven you can see the strong investment performance, we deliver on behalf of our clients has continued in the quarter.
At the end of September we had 52 mutual funds and Etfs with four or five star overall ratings from Morningstar.
This is up from 50 funds at the end of June 44 funds at the end of March and 43 funds at the beginning of the year and reflects our ability to generate excellent risk adjusted returns for clients in a volatile market environment.
These 52 funds account for more than two thirds of our AUM in mutual funds and Etfs.
Looking at total or 81% and 79% of our total AUM outperformed benchmarks for the critical three and five year measurement periods as of September 30, We believe this excellent performance will help augment future net flow activity.
Cash flow generation remained strong in the quarter, we increased share repurchases in the quarter and acquired one 8 million shares.
This is a record amount for a quarter and aligns with our capital allocation strategy of being flexible and opportunistic.
On our last call, we discussed striking a balance between debt reduction and share repurchases and the flexibility we have to pivot quickly should we see an opportunity to be clear, we are still committed to reducing debt aggressively to support our acquisition strategy.
This should be apparent in the amount of debt we've reduced so far this year and most recently this quarter.
That said, we flex towards more share repurchases in the third quarter for a few reasons first we believe that our current share price does not reflect the full value of our company and that it is a good use of our capital to purchase our shares at what we perceive as a discount to its full value.
Second we believe our debt is relatively cheap given our hedge and the existing structure of the non hedged debt.
We will continue to be opportunistic and adjust their strategy to current market conditions as we move forward.
From an acquisition perspective, we are not dissuaded by the current market environment and continue to be very active in evaluating opportunities.
There are a lot of conversations happening and I am encouraged by what we've seen.
With the current market volatility there is a lot of merit and being patient and measured but also having the resources and the wherewithal to execute when the opportunities right I.
I feel we are balanced these two important principles and look forward to continuing our success in acquiring high quality companies like we did in 2021 with the closing of three acquisitions.
With that I will turn it over to Mike for more details on the quarter's financials Mike.
Thanks, Dave and good morning, everyone.
Our financial results review begins on slide 10.
Total AUM decreased by $7 7 billion or 5% in the quarter.
147, 3 billion at the end of September .
This was primarily driven by more than $7 billion of <unk>.
Negative market action in the quarter.
AUM at quarter end was down just under 8% compared with the end of the same quarter last year.
Revenue of $207 million in the third quarter was up 4% from the second quarter due to the lower AUM.
GAAP operating income was favorably impacted by a noncash benefit associated with a reduction in the fair value of the contingent earn out liabilities on our balance sheet.
This benefit to our GAAP results totaled $10 $5 million in the third quarter.
Which was down from the $26 $6 million favorable impact in the second quarter.
Combined with the lower revenue in the quarter. This accounted for a majority of the decline in GAAP operating income.
Adjusted EBITDA was $103 6 million in the third quarter of.
2% decline from the second quarter, resulting in adjusted EBIT margin, expanding 80 basis points to 50%.
This increased year to date adjusted EBIT margin to 49, 6%, which is slightly ahead of our long term guidance.
GAAP net income was $72 8 million or $1 <unk> per diluted share.
And Eni with tax benefit increased to $85 $6 million for $1 19 per diluted share.
Up from $87 million for $1 11 per diluted share in the second quarter.
Net income benefited from a lower tax rate in the quarter associated with a onetime tax benefit associated with stock option exercised by employees in the period.
The estimated impact of this on diluted earnings per share in the quarter was approximately 10.
We reduced debt by $30 million and returned a total of $67 million of capital to shareholders in the quarter.
This includes the shares withheld for tax purposes associated with stock options exercised by employees at the company purchased.
Those without shares that were purchased by the company totaled 992000 in the third quarter.
Historically, the impact of shares withheld for taxes and purchased by the company with less meaningful.
Therefore to enhance transparency we're going.
And to begin showing these repurchases on a separate line of our cash flow statements.
The effect on return of capital and impacted diluted shares is consistent the only difference being the source of shares.
Combined with the open market share purchases of 819000 during Q3 total shares repurchased for $1 8 million in the quarter.
Year to date, the combined number of shares is $3 2 million.
The cash dividend was maintained at 25 per share for the current quarter and.
<unk> represented an additional $17 4 million of capital return to shareholders.
On Slide 11, you can see total AUM was $147 3 billion at the end of the quarter and remains well diversified from a distribution channel and client perspective.
This diversification has served us well in the current volatile market environment.
Turning to slide 12, gross long term flows totaled $6 6 billion in the quarter and we had $553 million of net long term outflows.
This resulted in gross flows of $26 8 billion for the nine months period and positive year to date net long term inflows of $1 9 billion.
Five of our investment franchises and our solutions products generated positive net long term flows in the quarter.
Our victory shares ETF platform continues to grow organically as well and represents an area in which we are continuing to invest and expand our offerings.
Slide 13 illustrates our revenue, which declined 4% from the second quarter consistent with the quarter over quarter, 4% decline in average AUM.
Our fee rate was 51 eight basis points in the quarter down one half of the basis points from the prior quarter.
Reflecting a shift in asset and vehicle mix, which was slightly offset by an increase in fulcrum fees on certain products.
On slide 14, we detail, our expenses, which increased $10 $9 million due solely to the noncash $16 $1 million decline in quarter over quarter benefit associated with marking to market of the earn out liability recorded on our balance sheet.
On a cash basis compensation declined in the third quarter by four 5% to $51 2 million or 24, 7% of revenue.
Down from $53 6 million or 24, 8% of revenue in the second quarter.
Additionally, other non personnel operating expenses declined $3 5 million for five 3% quarter over quarter, driven primarily by lower AUM based expenses.
These declines are associated with a purposeful design of our calibrating business models.
Moving on to our non-GAAP results on slide 15.
Adjusted net income rose, 7% to $76 2 million up from $71 4 million in the second quarter and a tax benefit was unchanged at $9 3 million.
This resulted in an <unk> with tax benefit increasing by 6% to $85 $6 million for $1 19 per diluted share.
$87 million.
Or $1 11 per diluted share in the previous quarter.
Our adjusted EBIT margin widened by 80 basis points to 50% in the quarter.
And we are maintaining our long term guidance of 49%.
Additionally, we are making no changes to our hiring pace or to investments, we are making in various areas to support our growth initiatives.
Moreover.
We have been consistently investing in technology distribution.
Later marketing digital marketplace.
Our people during the year.
Lastly, turning to slide 16.
On the capital management front, we repaid or purchased in the open market and an additional $30 million of debt during the quarter.
With our debt trading at a slight discount to par and as more advantageous for us to acquire our debt in the open market and retire it to capture those economics.
At quarter end $11 million of our repurchase debt obligations had not settled and therefore are not reflected on our September 30 balance sheet.
Our net leverage ratio at quarter end was unchanged at two three times.
During the quarter, we transitioned both the original term loan and our incremental term loan from LIBOR to silver plus a credit spread as.
As well as the interest rate swap on a portion of our total outstanding debt.
This resulted in effectively reducing our spread by a couple of basis points on the floating portion of our debt.
And lowered the effective rate on our floating to fixed interest rate swap by $6 five basis points.
As a result to 450 million dollar hedged portion of our debt has been reduced to $3 one 5%.
As a reminder, the swap is in place.
Through the 2026 maturity of our original term loan.
In addition, our $100 million revolver remains undrawn.
GAAP operating cash flow grew 14% from the second quarter, reaching $103 million in the third quarter.
Year to date, we have realized a $28 million reduction in our corporate cash taxes, representing a small portion of the approximately $500 million.
Cash tax savings, we anticipate over the next 15 years.
These savings are related to the deductibility for corporate tax purposes.
<unk> cost basis of acquired indefinite life intangibles.
And goodwill associated with prior acquisitions.
We have included a chart in the appendix of the slide deck accompanying this call to illustrate the anticipated cash tax savings out through 2036.
That concludes our prepared remarks, I will now turn it back over to the operator for questions.
Thank you if you would like to ask a question. Please press star followed by the number one on your telephone keypad to withdraw your question. Please press star one again.
First question comes from Alex <unk> from Goldman Sachs. Please go ahead. Your line is open.
Hey, good morning, everybody. Thank you for taking the question.
I was hoping we could start with just discussion of how west and it's performing in this environment.
You guys mentioned earlier, obviously, the typical 60 40 portfolio struggling significantly this year. So how has the performance been Howard the flow has been and just more structurally do you think the current sort of decline in the typical portfolios accelerates their market position on the platforms there.
Good morning, Alex It's Dave.
Good to speak with you.
First on Western I've said in the script that they have been every single month through September they had been net flow positive really in an asset class that has seen outflows. So they have outperformed relatively pretty strongly from a flow perspective.
We're really encouraged by that if you go back and look at their history. They.
They have grown pretty significantly pre our acquisition and they've continued that in this environment from an investment performance perspective, they've performed exactly as they should have and as the clients expect.
They are very close and most of their strategies to benchmark and benchmark like returns which is really.
Quite remarkable when you think about how they're approaching the market looking forward when the market normalizes.
We would expect coming out of this cycle that the part of the market that they're in or.
It will actually become more in demand so.
We anticipate that the growth will accelerate.
We're doing today with them as we are working with their existing sales force, which which has been excellent before we acquire them to really integrate what theyre doing into what we're doing and trying to expand out.
The offering we also mentioned that we launched in Etfs.
On the first ETF for West and advisors and that will expand our offering to additional advisers and clients. So we're really encouraged by the acquisition and it's turned out to be.
Almost exactly as we anticipated.
Got it thanks for that and then just a follow up around the capital deployment and it's great to see you guys have been active both on the debt repurchase side and stock buyback, but I guess as you look forward, maybe help us understand the mix of.
Debt repurchases and buybacks given the environment, obviously continues to be pretty volatile.
Over three year end and maybe into early part of next year.
So the start our overall strategy around our capital deployment has not changed we've always talked about.
Making sure we have a balance sheet that is flexible where we can do acquisitions and if we start there that is our primary goal.
From that we've looked at what's happening in the market. It's always based on the current facts and circumstances and we've always talked about being flexible and opportunistic this past quarter, we leaned into share repurchases.
And we still pay down a sizable amount of debt, but we mean to into share repurchases based on our opinion of where our stock is and what the value of our company is.
And we will continue to really look at the current environment.
I wouldn't go out and say that we are going to change and buy less shares this quarter I wouldn't go out and say that we're going to buy more shares this quarter than we bought it's really going to be the current environment, but we are always starting with we want to have a balance sheet, where we can do acquisitions, we've been very successful growing the company through acquisitions and <unk>.
Adding products and expanding our distribution.
And really when you think about what we did this last quarter. It was really a product of where the market was and where we thought our stock price was.
Got it thanks Ed.
Yes.
Our next question comes from Craig Siegenthaler from Bank of America. Please go ahead. Your line is open.
Good morning, Dave Michael Hope, you're both doing well.
Alright.
Are you.
I am good.
Fixed income continues to be a headwind for victory and the industry I think we all know the backdrop is tough.
But I was looking for your perspective on 2023 do you expect to see large industry rally reallocations back into fixed income next year when bond prices start falling yields.
Yields are higher and there is also attractive demographic factors.
And also within that how do you view your broad fixed income suite.
In terms of being positioned for this team.
So we do think in 'twenty, three and when bond prices start falling we do think theres going to be a big shift back into fixed income from an industry perspective.
We really like as we said in the script, we really like the way we're positioned our USAA investments fixed income group has excellent investment performance over the short and long term.
A team that has scale. It's a team that manages a sizable amount of assets and when you go and look at the way some of our competitors have performed during this cycle.
I think we've really stood out from an investment performance standpoint. So we're really excited about when those assets come back into fixed income that we're going to have a great opportunity to capture some of those.
I tell our team all the time that without assets in motion its hard to gather new assets.
And theres going to be a lot of assets in motion and I think we're going to have a great opportunity to.
Call some of those assets and clients hours.
Thanks, Dave and my second one is on M&A.
<unk> targets are cheaper today, both on our valuation and total price basis.
The cost to finance these deals has risen.
May up offset some or all of the valuation benefit so combining both lower valuations, but higher financing costs and sitting in your seat do you see the M&A backdrop is better or worse.
For victory.
Right now versus last year, and does that mean on the margin youre kind of more or less likely to do a transaction today.
Last year was one of our busiest years in 'twenty, one we did three acquisitions.
Really strategic acquisitions.
So it's tough to compare.
One environment to another environment, but when I think about the current environment as you said.
Financing costs are up.
Certain properties.
Probably a little less expensive than maybe they would have been but we really started off with does the acquisition make our company better and we go from there around product said when we go from there around access to new clients were.
We're not dissuaded by the environment.
Are you having lots of conversations.
We have averaged about one per year, if you go back and look.
2013, I think that that average is probably going to when you look at it in a longer period that average is going to stay around one a year.
And I think that if we find something that fits what we're looking to do we have the resources to do it.
I think coming out of this cycle from a big picture perspective, theres going to be a lot of opportunity.
Where I think a lot of the folks that are on the fence on selling will actually get on defense of selling once once the market normalizes.
Thank you Dave.
Our next question comes from Kenneth Lee from RBC Capital. Please go ahead. Your line is open.
Hi, Good morning, Thanks for taking my question just to piggyback that previous question in terms of the M&A discussions you've been having.
Is it your sense that companies are more willing to talk in this kind of environment and get something done potentially or.
Potentially is there more patients just given the.
The underlying market volatility there. Thank you.
I think it depends on the situation we've seen.
Groups that want to accelerated conversations and we've had discussions that have slowed down it really does depend on the situation.
People are transacting it has slowed down a little bit from when you look at the announcements.
But there are plenty of discussions happening in I would probably submit that there is more discussions now then there's really ever been on whether those turn into eventual transactions I guess, we'll see.
But again I'll go back to what I've said before which is we've been pretty consistent we've averaged about one transaction a year and I think when we look forward.
We have the resources today, we have a balance sheet today, and we have I think the experience to do a transaction if we find the right one.
Got you very helpful. There.
And one follow up if I may you mentioned briefly about potential expansion in the victory shares ETF business wondering if you just further expand upon those comments.
Sorts of strategies do you expect to introduce over the near term. Thanks.
Yes.
We're really if you looked at our ETF franchise victory shares it's been a consistent.
Consistent grower I think it's been eight quarters in a row that it has grown.
The products are integrated into our distribution system.
So we're really encouraged by.
ETF structure, we launched the west end advisers.
We are looking at other products to put through there and other investment strategies.
I would probably wait to launch those before we disclose those but thats an area that we're looking to grow and I think we're coming out of.
Coming out of the cycle that we're in and going into the next cycle I think etfs will even be more in demand than they are today.
Got you very helpful. There. Thanks again.
Our next question comes from Ken Worthington from Jpmorgan. Please go ahead. Your line is open.
Hi, good morning, Thanks for taking my questions.
I guess sort of simple ones mid cap franchise generated positive net flows this quarter sort of bucking the trend we're seeing in the broader industry.
Which brands are sort of having the success there and then we saw a big slowdown in alternatives I assume that this is as simple as sort of energy falling from favor during the quarter, but I don't know flush out anything else there.
Hey, Ken its Mike on the mid cap <unk>.
<unk> seen it really has been.
The Sycamore franchise.
And primarily in our institutional channel.
That team has a long standing excellent investment track record and a good solid following from an investment perspective, and institutional client perspective. So we did see some wins in fundings in the midcap strategy that they have.
On the alternative side really that that has been a market neutral income product that we've had which really has.
<unk> has had tremendous success throughout 2022 based on what that product delivers from a market perspective, we did see a bit of a slowdown.
Based on the environment of what that product delivers and how it performs in Q3. So that has been if you will.
The slowdown from an alternatives perspective.
Okay, great. Thank you very much.
As a reminder to ask a question. Please press star followed by the number one our next question comes from Brennan Hawken from UBS. Please go ahead. Your line is open.
Good morning, Thanks for taking my questions.
The fee rate compressed a bit more than we were looking for and it actually diverged from some of the some of your asset management peers, who saw more benign trends given the summer rally in risk assets.
No you ascribe that to mix in your prepared remarks, but maybe you could you could you give a little more color given that there was a divergence versus some of the other public asset managers.
Sure Hey, Brian It's Mike, Yes, I think what we said in the script it really is asset and vehicle mix.
So when you look at where we won business.
It's been institutional business, which tends to have slightly lower fees than retail mutual fund business.
Also one business and our ETF.
Lineup as well, which again just tends to have slightly lower fees from an overall perspective.
So I think as we looked at.
Quarter over quarter decline in fees that really wasn't something that was outside of the range of our expectations.
Further we did highlight that we did.
An increase in bocom fees in some of our products.
It was the first quarter, where we had positive impact of the <unk> fees on some of the USAA mutual funds.
Since we've acquired them.
A testament to the strong investment performance that we've seen in those products since we've taken over the management of those.
That said I think.
Please by case on the margins that we have which is really our focus.
So the fee rate very important but again, we look at it from a margin perspective.
Having a 50% margin quarter for us with the slight decay.
In the revenue realization as kind of a testament to the overall business.
It's Dave I would add one point, maybe with an exclamation point most of those asset management peers margins eroded pretty pretty heavily.
<unk>.
Whereas our margins expanded this quarter.
And I think it just shows you where we're focused which is we do look at the fee rate, but first and foremost we're thinking about every product we have has to meet our margin requirements.
Oh sure Yeah your expense flexibility certainly there's clear in the results and I wasn't trying to suggest that.
That in my question, but thanks for that color that's helpful.
The buybacks were really great you guys spent some time covering that and your dedication to capital return, but when we think about it from a signaling perspective.
Should we should.
Should we read into that that.
If the M&A opportunities, maybe not as robust given some of the volatility some of the movements in financing costs and whatnot and while you guys have an ability to be creative in structuring and everything there might not be as.
The pitches might not be quite so fat so to speak and so when when thats. The environment you guys are going to return capital more from a buyback perspective than seeking the inorganic am I reading too much into it or is that fair.
No.
I would actually say it this way that our our buyback our lean into our buybacks probably came at the expense of paying down some additional debt and when we looked at.
Debt pay down versus buying back our stock we thought given the current trading levels and given what we think the value of the company is that it made a lot of sense to buyback.
Our stock.
I would not read into that buying back stock came at the expense or indicates that we don't think that the M&A environment is fertile because we do.
As I said in my prepared remarks, we're just patient.
And I think why while we are waiting we are looking at how do we deploy our capital paying down debt.
Adding back stock and we're making those decisions really on a very real time basis based on the current facts and circumstances.
That's all fair thanks for that color.
We have no further questions. This will conclude today's conference call. Thank you for your participation you may now disconnect.
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