Q3 2023 Victory Capital Holdings Inc Earnings Call
Good morning.
And welcome to the victory Capital's third quarter 2023 earnings conference call. All colors are in a 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.
Thank you 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 statements. Please note that victory capital's actual results may differ materially from these statements. Please refer to our SEC filings for a.
List of some of the risk factors that may cause actual results to differ materially from those expressed on today's call victory 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 <unk>.
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 earnings 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 Com. It's now my pleasure to turn the call over to David Brown, Chairman and CEO David.
Thanks, Matt Good morning, and welcome to victory Capital's third quarter 2023 earnings Conference call.
Im joined today by Michael Pellekar probe, our president Chief financial and administrative officer, as well as Matt Dennis our chief of staff and director of Investor Relations.
I'll start today by providing an overview of the third quarter after that I will turn the call over to Mike to review the financial results in detail.
Following our prepared remarks, Mike, Matt and I will be available to take your questions.
The quarterly business review begins on slide five.
We reported strong financial results for the third quarter.
Revenue, including adjusted EBITDA earnings and margin net income and earnings per diluted share all rose sequentially from the second quarter, and we achieved the highest levels for each of those metrics, thus far in calendar year 2023.
Our margins remain robust with adjusted EBITDA margin coming in at 51, 1% this quarter, which underscores the strength of our operating platform in all market environments.
This was the 13th quarter in a row that we achieved margins above our long term guidance of 49% and it was the ninth quarter over that period that we reported margins of 50% or higher.
Adjusted net income with tax benefit rose to $1.18 per diluted share in the quarter, a 6% increase over the $1 11 per diluted share that we reported last quarter.
Long term net flows improved from the second quarter with outflows declining to $1 7 billion in the third quarter I.
I would also note that our gross redemptions were the lowest that they had been in the past eight quarters.
Although we are in an environment, where many investors have chosen to either invest in cash and cash equivalents were to pause allocations. We are seeing some significant green shoots with several of our investment franchises.
One franchise I would like to call out as West end advisors, which continues to see positive net flows and significant distribution expansion from platform an advisor perspective.
We made the decision to buildup cash during the quarter to enhance our financial flexibility and ensure we have the means to execute on our capital allocation strategy.
Typically the inorganic aspect of it.
As announced in our latest AUM press release in September we consolidated the former fixed income franchise in quarter under the victory income investors brand, which is also a fixed income franchise.
In conjunction with this consolidation we sold a number of unique accounts totaling approximately $1 $3 billion that were not scalable on our platform.
We did retain a majority of the investment strategies and all of the investment professionals associated with the management of the strategies that transferred under the victory income investors franchise.
Lastly, as we stated in our earnings release, there will not be any material financial impact from these actions.
Consistent with our ongoing growth initiatives, we continue to strategically invest in our platform in several areas.
These include product development enhancing capabilities for our direct Investor Channel technology automation artificial intelligence digital marketing as well as our use of data to make our platform, even more competitive and efficient.
Turning to slide seven you can see that our investment performance remains very strong.
At quarter end 40 of our mutual funds and Etfs had four or five star overall ratings from Morningstar. These.
These products account for more than two thirds of our mutual funds and Etfs. Additionally.
Additionally, more than 80% of our total AUM outperformed benchmarks for the five year measurement period ended September 30th.
One standout in the quarter was our west end advisors investment franchise.
Through quarter end, 98% of West end AUM was outperforming respective benchmarks over the five year period.
This bodes well for accelerating the already positive net flow momentum at western that I mentioned earlier.
With the trillions of dollars that is currently invested in cash and cash equivalents were exceptionally well positioned in anticipation of investors eventually re risking portfolios. When there is more visibility around the direction of interest rates as well as economic and geopolitical conditions, given the investment performance in our fixed income products and.
Our distribution positioning.
Moreover, our suite of equity offerings continues to perform very well and our distribution positioning within our different channels is as strong as ever.
Turning to slide eight we continue to generate robust excess free cash flow in the third quarter.
Subsequent to quarter end, we also monetize our floating to fixed swap that generated $43 million in cash and produced a gain that is now locked in.
Converting to swap into cash only adds to our financial flexibility and we see real benefit the flexibility at this point in the cycle.
We are continuing to have numerous discussions around inorganic opportunities as I've said, many times exact timing is difficult to predict but I do believe that the opportunities that are presenting themselves in this environment are quite attractive becoming more plentiful and executable.
With that in mind, we remain patient disciplined and selective as we evaluate opportunities with the end goal of enhancing long term shareholder value.
With that I will turn the call over to Mike to go through the quarters financial results in greater detail.
Thanks, David and good morning, everyone. The.
The financial results review begins on slide 10.
Assets under management at quarter end were $153 5 billion.
Average assets under management Rose two 4% in the third quarter compared with the second quarter.
Our fee rate was steady at 51 six basis points.
Revenue of $209 7 million in the third quarter was up two 7% compared to the second quarter.
The higher revenue benefited from the higher average AUM as well as one extra day in the quarter.
GAAP operating income was $80 million and our adjusted EBITDA Rose to $107 2 million as adjusted EBIT margin expanded 20 basis points to 51, 1% in the third quarter.
Quarterly net income was $52 million or <unk> 77 per.
Per diluted share on a GAAP basis.
And adjusted net income with tax benefit rose quarter over quarter to $79 8 million.
For $1 18 per diluted share up 6% from the second quarter.
Dave already covered accumulating cash to enhance our flexibility and strengthen the balance sheet during the quarter.
This accumulation resulted in cash increasing to $108 million at quarter end.
Further to this point in October.
Monetize our floating to fixed interest rate swaps locking in the gain on that arrangement, which generated $43 million in cash.
From an accounting standpoint, the gain will be realized on a straight line basis and a decrease in interest expense through the end of the swaps churn in July of 2026.
Our net debt to adjusted EBITDA ratio improved to two one time.
At the end of September reflecting the growth in adjusted EBITDA and our lower net debt.
We returned $21 million to shareholders in the quarter in the form of cash dividends.
And then another $7 million with share repurchases.
Our board of directors declared another quarterly cash dividend of <unk> 32 per share.
This next dividends will be payable on December 20 to shareholders of record on December 11th.
On Slide 11, you can see the steady increase in the total AUM in the first half reversed in the third quarter.
This was driven primarily by negative market action, which reduced <unk> by $4 9 billion in the period.
Our <unk> remains well diversified from a distribution channel and from a client perspective within each channel.
We're also becoming more diversified from a vehicle perspective, with Etfs and separately managed accounts, including model delivery now representing more than a third of our total AUM.
Turning to slide 12.
Ill turn gross flows were $5 3 billion in the quarter and net long term flows were negative one 7 billion.
Gross redemptions improved to their lowest level in two years.
We're not immune to the current industry landscape with muted gross sales, reflecting investors being content to hold cash in this environment.
It's a delay allocations for longer term and higher risk asset classes.
Several franchises had positive net flows in the third quarter, including New energy capital RF Global Trivalent and West end.
<unk> investment in business performance has been very strong and we are beginning to realize the vision of growth for the platform. We had when we made the acquisition.
Another franchise worth noting is <unk> global.
Which has been net flow positive for 10 consecutive quarters.
The overall five star rated RF Global fund ticker R. S. G G X.
The top decile according to Morningstar for the trailing one five and 10 year periods.
As of September 30.
Outperformed benchmarks as well over those same periods.
Slide 13 illustrates revenue by quarter.
See the close correlation between revenues and average assets under management, which resulted in the highest level of quarterly revenue achieved in the past year.
Our fee rate decreased slightly in the third quarter as.
As you may recall, the fee rate realization of quarter in the second quarter was the highest in a year.
In general our investment management fees have remained steady and asset class client and vehicle mix are the primary drivers of quarterly fee rate variations.
On slide 14, we breakout our expenses for the quarter.
GAAP operating expenses rose in the quarter, primarily due to a significant increase in quarter over quarter noncash charge related to the net present value of contingent consideration for prior acquisitions.
This rose to $10 $3 million.
Up from $1 $5 million in the second quarter.
Additionally, some of the increase is related to our variable cost structure and was due to the higher average AUM and revenue reflected in higher asset based expenses such as broker dealer in platform fees Fund administration and Middle office expenses.
Cash compensation as a percentage of revenue held constant at 23, 7% for the third quarter.
Finally, G&A expenses rose slightly due to the timing of our ongoing investments to support growth.
Moving on to our non-GAAP results on slide 15.
Adjusted net income rose to $73 million in the quarter, which was the highest level in the past four quarters.
The cash tax benefit in the quarter was unchanged at $9 $5 million, resulting in an Irish tax benefit growing to $79 $8 million or $1 18 per diluted share.
Our adjusted EBIT margin expanded 20 basis points to 51, 1% in the third quarter.
We achieved steady growth in adjusted earnings per share over the past year, which including our cash tax benefit rose 12% from the level achieved in the final quarter of 2022.
Looking forward, we are maintaining our long term margin guidance of 49%, which is inclusive of the continued investments in numerous areas to support our future growth.
Finally, turning to slide 16, we did not pay down any debt in the first three quarters of this year. However, our net leverage ratio improved to two one times at the end of September reflecting the higher cash balance on our balance sheet and higher earnings.
The average interest rate paid on our debt increased 18 basis points to five 6% in the quarter.
This was the smallest quarter over quarter interest rate increase in the past year and a half.
Our $100 million revolver remains undrawn and GAAP operating cash flow was $91 6 million in the third quarter.
That concludes our prepared remarks, I will now turn it back over to the operator for questions.
Thank you if you have a question. Please press star one on your telephone keypad, if you wish to remove yourself from the queue simply press Star One again one moment. Please for your first question.
Your first question comes from the line of Craig Siegenthaler of Bank of America. Your line is open.
Good morning, Dave Mike Hope everyone's doing well.
My first one is on M&A so.
With $140 million of cash on hand today after the floating to fixed swap monetization can you update us on the M&A pipeline.
Are you holding more meetings with prospects today.
Today than six months ago, and any commentary on valuation multiples would be helpful. Thanks.
Good morning, Craig.
First let me start off on the pipeline.
The pipeline for the last year or so has been pretty full.
And we've been having lots of meetings I wouldn't say that the meetings have increased what I would say is and I've said this in our prepared remarks.
I feel like the ability to execute has gotten a lot better and really us monetizing our hedge and us building cash as a reflection of where we think we are in the cycle and how close we are to potentially doing a transaction that being said.
Nothing is imminent.
And we also look at our capital strategy very Opportunistically and so we had historically or at least this year, but a lot of shares back in.
And continue to pay a dividend I wouldn't say that we wouldn't be buying shares back going forward, but we want to make sure that we have a balance sheet, that's flexible to execute in a really timely matter.
Thanks, Dave.
Just as my follow up on the SMA and other flows of a $440 million a quarter.
Within the $440 million I was wondering if you have the mix.
Provide some color between trust wraps you may you set any other vehicles that I may be missing.
That's been a nice growth engine for you guys and then within that sort of sub buckets.
Which one do you expect to be the biggest flow contributor in 2024.
It's all primarily west and the west than advisors franchise.
And really that is when we bought we purchased that business.
Our thesis really was is that we thought the model.
Business within the large platforms in the industry that was going to increase and that they were well positioned and that has happened.
And so primarily where we think.
Going forward as we think it is all going to be on the model side.
Dave Thank you.
Your next question comes from the line of <unk> Shah of BMO capital markets. Your line is open.
Thank you and good morning, so lots of discussion on the potential too.
Returned to positive net flows in fixed income.
<unk> industry.
So.
Environment, how do you think about promoting your fixed income strategies, both across the direct and retail channels.
So over the last few years.
We have really spent their time to build out our distribution channels.
Victory income investors franchise, and where we have spent the time.
From a marketing from gaining access to different platforms.
And really shoring up the platform and as we said in our prepared remarks, we did consolidate the in core franchise into at least from a brand perspective into the victory income investors franchise, and we think having one brand.
The scalability of that brand and really consolidating all of our efforts under that brand will really help us when when some of these investors come off the sidelines and get out of cash or or decide to allocate back to traditional fixed income.
I would also add one of the best ways to prepare for this to have really really good investment performance and if you were to look at the.
Victory income investors franchise and look at our performance, it's excellent across the board and I think Thats really the best preparation for it.
Okay, and just to circle back on M&A can you give us a sense of the potential size of transactions you are looking at and.
Would you be willing to maybe close multiple transactions.
Relatively short period of time or would you prefer to stick to your historical one transaction per year track record.
Okay.
We really have if you go back and look historically, we have done large transactions I'd say medium size and small and we've always said that because we built such a great platform. We have the benefit of looking at multiple.
Sized transactions and Thats, how we look at it.
Where the transactions have really impacted us.
I've been on the larger side and also on the smaller side.
Historically, if you go back years ago at the beginning of our Etfs business was a was a very small acquisition, which has grown nicely over the last eight years.
From a how many.
We have had where we've done three.
I think at the end of 2021 into 'twenty 2022, we closed three in a quarter or.
Or at least.
In the back half of the year.
And then we've had situations where we have done one and then it's been a few years in between.
Im not in a position to say how.
How quickly what the size would be.
And how many in a year, we're really looking at it on on an opportunistic basis.
Great. Thank you very much.
Your next question comes from the line of Adam Beatty of UBS. Your line is open.
Alright, Thank you and good morning, just to follow up on M&A not to harp on it too much but David used the word executable a couple of times and.
Potential interpretation of that is maybe tighter sort of bid ask spreads. So it was kind of getting more realistic on valuation, but but those are my words, so I'm just curious.
Probably no one out there execute M&A.
M&A in the asset manager space as well as victory. So just curious what you meant by more executable at this at this stage in the cycle. Thanks.
I think you summed it up nicely.
Do think that.
The bid ask spread has tightened and I think buyers and sellers are much more realistic of what valuation is and potentially being open to structuring and so my.
By word of execute execute a bowl is really in reference to that.
Excellent. Thank you I appreciate it.
And then just turning to small and mid cap equities.
You guys had significant scale there.
Good view on the market just wondering.
How you see the climate right now for small and mid cap investing in the outlook given some of the recent fed moves or non moves. Thanks.
Generally speaking there is a lot of investor dollars sitting in cash and cash equivalents I think theres over seven trillion dollars in money markets.
So a lot of investors had decided at least at this point in the cycle to go to cash to get the higher return I do believe going forward that a lot of those dollars will leave the money market asset class and be either put into fixed income.
We're into higher risk type assets, including U S small cap, including U S mid cap.
I also think that there is.
If you go and look at the small and mid cap indices.
They have not performed up to where the overall market has.
So I think that they look like very good potential investments with good returns.
We happen to have multiple franchises in U S small cap and mid cap and really feel like we're well positioned there and I think when when the reallocation occurs some of those assets will fall into those asset classes, and we will be able to gather some of those assets. So we're pretty excited about.
About that opportunity.
Excellent. Thank you very much.
Okay.
Your next question comes from the line of Kenneth Lee of RBC capital markets. Your line is open.
Taking my question.
Just to round out the discussion on M&A.
What's your view.
Do you view the cost of financing as a potential challenge.
The environment for potential M&A there. Thanks.
I would start off by saying that when we think of financing, we really think of all of the tools that we have.
Where you have our cash generation.
We have the ability to structure of course, we can go to the debt markets.
And we have I think over the past really done a nice job on being creative on how we how we structure the transactions.
Financing costs are up obviously over the last year and a half but for us and.
And the way, we execute the transactions and the way we look at the transaction. It is in a hurdle for us.
The cost of financing.
As we said we did accumulate cash this quarter, which is the benefit of having <unk>.
Platform that generates a lot of free excess cash flow and then we also monetized our hedge.
And then as we look forward, we will balance out if we do a transaction how to go about that but I don't feel at least for us the financing costs are going to be a hurdle to executing a transaction.
Right very helpful. There.
And just one follow up.
I may.
It sounds like a new attitude capital had some positive long term net flows in the quarter wondering if you could just give us an update.
<unk> outlook in terms of organic potential organic growth in that franchise going forward. Thanks.
Hey, Ken.
We did mention they had positive flows.
In the third quarter, that's a positive close in the second quarter.
Our thesis around the acquisition of New energy capital continues to hold we're bullish about.
The product set that they have in kind of the private markets with respect to kind of the renewable energy space.
Fund raising in the private side in 2023, I think from an industry perspective has been challenging.
We're pleased with the progress that we've made to date and we're excited about the opportunity as we look out we think what they do is unique and they have a great opportunity to continue to see growth as we move forward and that really was the thesis for us as we did the acquisition. So we're excited about the opportunities that sit in front of us.
And as the industry kind of continues to.
To loosen with respect to private asset raising we'll participate well there.
Great very helpful. Thanks again.
Your next question comes from the line of Mike Brown of <unk>. Your line is open.
Great. Thank you for taking my questions. So.
Wanted to ask about western here the growth continues to be really strong. There can you just give us an update how many platforms that franchise John today.
Today, and just maybe expand on some of the recent growth trends there and the potential going forward do you still see some more room to ramp on the current platforms and is there potential to get added on more platforms for western.
Yes.
The platforms that we're.
We're currently on when we purchase them, we have been able to go deeper on to those platforms.
So today, we're doing business with us significantly.
A higher number of advisors.
They were doing when they were independent.
We've expanded the number of platforms that they're on so not only deepening the relationships with the platforms, but actually expanding the number of platforms.
And then we've also expanded out the product set we launched an ETF the ticker symbol <unk>, which now allows the sales people to offer not just the models, but also in Etfs.
Managed by West end and so there is a tremendous amount of growth from an opportunity standpoint for that franchise. If you think about the current environment that we're in and we've owned that business.
At the end of this year will be coming up on two years and to have that platform that franchise be net flow positive.
Every time period and since inception.
Since we purchased them is really remarkable and just tells you what the opportunity is for that platform and again that was the thesis of the transaction.
Who is taking a tremendous franchise that has a great culture and great investment performance and really good distribution and just making it better.
And scaling it and.
I think that we're well positioned again when when some of these assets move out of cash to really go out and grow and we also have a desire to expand out the product set there as well, which will only add to the upside opportunity.
Great. Thanks, and then Michael maybe just a quick modeling one for me following the monetization of the hedge.
What is the right jumping off point for that interest expense now with the with the impact of the gain that will come through.
Yes, I think the simple way to look at it is we are really locked in at that kind of Q3 rates. So I think we mentioned about five 6% as the kind of combined interest rate going forward based on current rates.
Okay, Great. That's it for me thank you.
Again, if you would like to ask a question Press Star then the number one on your telephone keypad. Your next question comes from the line of Ken Worthington of Jpmorgan. Your line is open.
Hello, Good morning, Mike Hotel in for Ken. Thanks for Thanks for taking my question it's Mike.
My first one I'll disconnect quite an asset cap question as well.
And then you talked about.
M&A and investments I guess just in the event things don't come into fruition near term I guess, how long are you comfortable holding an elevated level of cash.
Yes.
I would say that we are going to look at that.
Our cash levels very opportunistically, it'll be based on the facts and circumstances.
We have.
Pivoted quickly to different strategies, we at one period in our history paid down debt very aggressively and then pivoted to buyback.
By buying back our shares and I would imagine going forward, depending on what's happening at the time will be very opportunistic we have the flexibility to do that we still have over $50 million.
Still offer from our authorization from the board on our buyback program that we can utilize.
And then.
But we're going to take it really as we always have with the current facts and circumstances.
Okay perfect. Thank you and then just switching gears just on G&A.
I think you called out.
And a slightly elevated in the quarter or particular organic investment that pretty I guess, just curious what that organic opportunity.
Both the quarter and then I think you looked at a number of organic investment areas as you do.
Every quarter, but I'm not sure I heard AI before so just curious what your ultimate AI as well. Thank you.
Yes, Thanks, Mike.
There really is no significant one significant investment that we made in the quarter I think we've always said the timing of the investments that we're making really will ebb and flow to the increase in G&A that you saw was really just a timing aspect, where we are investing in the business is really around kind of our data and analytics product developed.
<unk> digital marketing.
We are continuing to invest in our direct investor channel. Those are the areas that we continue to invest in and any elevation or changes you see quarter over quarter is really just timing with respect to that.
And with respect to AI I think we've talked a little bit about some of the investments that we've made in data and analytics for our retail and intermediary distribution team. Yes, we've invested in some proprietary databases that are really making them more effective in the fields.
And utilizing the data that we're capturing from the market from certain dealers. So that's the reference that we're using from an A&P.
My perspective is really to support our distribution efforts as well as supporting the investment franchises, just with providing them more information and more data.
It's David I'd like to add one thing is.
Our platform is so unique.
I think you can see from the margins and how.
How we've performed in a really tough industry environment.
And having guidance at 49%, but but one of the things that that we think is pretty unique is our investments in the dollars that we invest.
I think are as efficient as anybody in the industry given our the way we are structured in our platform and how we're scaled at the size. We're at in these investments, we're making are very applicable to multiple distribution channels to multiple parts of our business.
Our platform is a complex.
And our margins this quarter of 51 one.
And I went through the statistics of 13 straight quarters above.
$49 nine of them.
50% or more.
I just think that we have a really unique platform with a great group of employees executing it with a great culture.
So when we think about investing.
We love to invest there's lots of places to invest we're just getting a lot of bang for a Buck if you will.
Perfect. Thanks, guys.
There are no further questions at this time I will now turn the call over to David Brown for closing remarks.
Thank you and thanks for your interest in victory capital next month, we'll be attending the Goldman Sachs Financial Services Conference in New York City, which is on December six and I look forward to seeing some of you there have a great day and thank you.
This concludes today's conference call you may now disconnect.
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