Victory Capital Holdings, Inc. (NASDAQ:VCTR) Q4 2022 Earnings Call Transcript

Victory Capital Holdings, Inc. (NASDAQ:VCTR) Q4 2022 Earnings Call Transcript February 10, 2023

Operator: Good morning, and welcome to the Victory Capital Fourth Quarter and Full Year 2022 Earnings Conference Call. All callers are in a listen-only mode. Following the company’s prepared remarks, there will be a question-and-answer session. I would now like to turn the call over to Mr. Matthew Dennis, Chief of Staff and Director of Investor Relations. Please go ahead, Mr. Dennis.

Matthew Dennis: 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 could 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 disclosed 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 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.vcm.com. It’s now my pleasure to turn the call over to David Brown, Chairman and CEO. David?

David Brown: Thanks, Matt. Good morning, and welcome to Victory Capital’s third quarter 2022 earnings conference call. I’m joined today by Michael Policarpo, 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 quarter and the full year period. Then I will cover our investment performance, which continues to be very strong. Then I will 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 5. 2022 was a history year for the asset management industry.

The disruptions in both the equity and fixed income markets drove assets levels significantly lower across most asset classes with industry wide declines in year-over-year revenue and operating margins. While we are not immune to the market backdrop, I am very pleased with the results we reported last night. At the end of each year, I like to step back and take a long range view of our company and review our progress against our long-term strategy and goals. At the start of the year, we laid out several key strategic objectives and we have achieved tangible and measurable progress in each area. As part of that, we continue to make strategic investments in hiring, technology, data, and marketing and distribution during the year and we are seeing that these investments are beginning to pay us back.

A good example of this gross long-term flows in 2022 were $33.3 billion which is 20% higher than the gross long-term flows of $27.9 billion generated in 2021 and 44% higher than gross long-term flows in 2020. The $6.5 billion in gross long-term flows achieved in the fourth quarter of 2022 is a record high for any fourth quarter period in our history. These results reinforce our strategy of investing in areas where we can make a meaningful impact on our business. Our long-term net flows were negative $2.5 billion during the year which equates to only 1.4% of the beginning of the year assets under management and pales in comparison to the more than $26 billion of negative market action we experienced since the beginning of the year. Specific to the fourth quarter, net long-term outflows were elevated.

We experienced clients selling assets at an accelerated pace for a number of reasons including tax loss, harvesting, capital gain, distribution avoidance, and pivoting to risk off positions to name a few. To-date in 2023 our net long-term flows have improved materially across our business from the fourth quarter. Operating income rose 7% from $374 million in 2021 to $399 million in 2022. Full year adjusted EBITDA margin was 49.6% in 2022 which exceeded our long-term guidance of 49% and is a good representation of our margin defensibility during a very volatile year. Adjusted net income or tax benefit was $1.05 per dilute share in the quarter and $4.58 per diluted share for all of 2022. We continue to return capital to our shareholders in 2022.

We were opportunistic in our share repurchases which accelerated in the second half of the year. In total we returned more than $200 million of capital to shareholders, which was more than three times the $62 million in capital returned in 2021. At the same time, we continued to reduce debt to increase our balance sheet flexibility. Based on our positive outlook of excess cash flow generation, the Board declared an increase of 28% in our quarterly cash dividend this quarter. Additionally, we have continued to make investments in our business in areas that can have the greatest impacts. These included expanding the use of data in all aspects of our business, enhancing our technology capabilities, investing in distribution, marketing, continuing to hire new talent, as well as expanding the products and service offerings available for our direct investors.

While many in the industry are cutting their capital allocated to invest in their platform and people, we are not. We are continuing to invest and hire at the same steady pace we have maintained over the last few years, and we’ll do the same thing in 2023 while also maintaining our long-term adjusted EBITDA margin guidance of 49%. Turning to Slide 7, you can see the strong investment performance we deliver on behalf of our clients has continued throughout the year and its final quarter. We had 44 mutual funds and ETFs with four or five star overall ratings from Morningstar. These products with four or five stars account for 62% of our AUM in mutual funds and ETFs. Additionally, approximately 80% of our total AUM outperformed benchmarks for the three, five, and 10-year measurement periods as of yearend.

Photo by Anne Nygård on Unsplash

During the year, our WestEnd Advisors franchise secured new platform placements with seven firms. In addition, we experienced more than a 25% increase of new advisors opening their first account with WestEnd during New Year. This sets the foundation for solid organic growth as these new advisors expand the number of underlying clients utilizing WestEnd’s models. 2023 is also off to a strong start with three of WestEnd’s products being added to LPL’s Model Wealth Portfolios platform, which is the flagship platform for many LPL advisors. We are also very well positioned from an investment performance and distribution standpoint to benefit from rotation back into fixed income. The increased shelf space we have secured for our USAA investments franchise outperforming fixed income products over the last few years, has us very well positioned to capture more market share as investors reallocate back to fixed income.

Keep in mind, from a product offering perspective, we have mutual funds, separate accounts, and the ETFs available for this franchise. Turning to Slide 8. Cash flow generation remained strong during the fourth quarter and full year. Share repurchases totaled 4.6 million shares during the year, which was significantly higher than in prior years. We pivoted to allocating more of our excess free cash flow to share repurchases given equity market conditions, and specifically due to the price of VCTR. Additionally, we did continue to reduce debt and we maintained our growing ancillary cash dividend. The chart on the right of this slide illustrates respective full year 2022 capital allocations. Our strategy included deploying capital support, earnings growth, capital appreciation, and balance sheet flexibility, while at the same time rewarding shareholders with capital returns.

We intend to maintain flexibility and strategically allocate excess capital to maximize long-term shareholder value creation. As we continue to conduct diligence on acquisition opportunities, we remain patient and selective. This approach has served us well over time. We are continuing to evaluate a number of opportunities and believe our patience and hard work will yield a positive outcome for our business and for our shareholders. Lastly, subsequent to year end, we announce a new addition to our corporate board. We welcomed Vice Admiral Mary Jackson as a new independent director of the company. Vice Admiral Jackson retired after serving the United States Navy for more than three decades. We look forward to her leadership and contributions to the Board.

With that, I will turn it over to Mike for more details on the quarter’s financials. Mike?

Michael Policarpo: Thanks Dave and good morning everyone. The financial results review begins on Slide 10. Total AUM increased $5.7 billion or 4% in the quarter to $153 billion at the end of December. This was driven by more than $10 billion of positive market actions as the markets rebounded during the quarter. Revenue of $201 million in the fourth quarter was up 3% in the third quarter, which was consistent with the 3% decline in average AUM in the year’s final quarter despite the higher point-to-point AUM. Full year 2022 revenue was $855 million. On a GAAP basis our operating income was $79.6 million in the fourth quarter and $399 million for the full year period. This compares with $89.8 million in the same quarter last year, and $374 million for all of 2021.

The increase in year-over-year operating income is attributable to non-cash items, namely the change in value of contingent consideration for recent acquisitions. Adjusted EBITDA was $100 million in the fourth quarter and $424 million for the year. Our margins have held up better than most all companies in our sector. Adjusted EBITDA margin was 49.7% in the quarter and 49.6% in the full year. Adjusted net income with tax benefit was $74.5 million or $1.05 per diluted share in the fourth quarter and $331.2 million or $4.58 per diluted share for the full year. Looking at capital allocation, we returned a record amount of capital to shareholders during the year. In the fourth quarter, we returned $59 million to shareholders with $42 million of that through share repurchases and $17 million in dividends.

Lastly, we increased our quarterly cash dividend by 28% to $0.32 per share, and that will be payable on March 27th to shareholders of record on March 10th. On Slide 11, you can see total AUM of $153 billion at the end of the year 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, long-term gross flows were $6.5 billion in the fourth quarter, which was the highest we’ve ever reported for a fourth quarter period. Full year gross long-term flows of $33.3 billion, also marked a new record. WestEnd Advisors, Sycamore, Sophus, and RS Global, each had positive net flows for 2022 and the fourth quarter represented the ninth consecutive quarter of positive net flows for our Victory Shares ETF business.

We also earned a number of product recommendations and model allocations during 2022 that will support future sales activity. For example, Fidelity Strategic Advisors and Edward Jones made model allocations to trivalent and RS growth respectively and Schwab added the Victory shares USAA core intermediate term bond ETF to one of its models. In addition, our market neutral income fund was added to the recommended lists at Morgan Stanley, Merrill Lynch, Saterra , Fifth Third Bank and LPL. And this was added to models at both Fidelity and LPL. Slide 13 illustrates our revenue by quarter. One note to make on this slide is our fee rate held up nicely and was 51.7 basis points in the quarter. On Slide 14, we break out our expenses which increased $10.5 million due primarily to an increase in non-cash expense related to the change in value of contingent consideration from recent acquisitions recorded in acquisition, restructuring and integration expenses.

On a cash basis, compensation as a percentage of revenue held steady as designed at 24.5% and our variable operating expenses calibrated with our AUM and revenue. Moving on to our non-GAAP results on Slide 15, adjusted net income was $65 million in the fourth quarter. The tax benefit in the quarter increased to $9.5 million, reflecting the incremental tax benefit associated with the payment of the third USAA earnout payment of $37.5 million made in Q4. ANI with tax benefit was $74.5 million or $1.05 per diluted share. Our adjusted EBITDA margin came in very strong at 49.7% in the quarter. We’re making no changes in maintaining our long-term guidance of 49% for 2023, which is inclusive of our continued investments in numerous areas to support our growth initiatives that Dave highlighted in his opening remarks.

Lastly, turning to Slide 16, our net leverage ratio at year end was 2.4 times. We reduced debt by $150 million during the year through repayments and purchases in the open market. As a reminder, we are reducing the floating portion of our debt and not the $450 million of debt that we have hedged at 3.15% interest rate. In addition, our $100 million revolver remains undrawn. GAAP operating cash flow from operations was $67.1 million in the fourth quarter. That concludes our prepared remarks. I will now turn it back over to the operator for questions.

See also Most Valuable Real Estate Companies and Most Valuable Hotel Companies.

Q&A Session

Operator: Our first question comes from Craig Siegenthaler with Bank of America.

Craig Siegenthaler: Good morning, Dave. Michael, hope you’re both well.

David Brown: Hi, Craig.

Craig Siegenthaler:

10b5:

David Brown: Good morning. So I would think of it this way. We’re opportunistic in our share buyback and really it depends on the market conditions. We talked about in our script the last six months we leaned into buying shares because of the market. When we look at the market going forward we’re going to take it week by week. That’s part of an overall capital allocation strategy, which really the primary purpose of our capital allocation strategy is to really have a flexible balance sheet so we can go ahead and pursue acquisitions and the buyback and the dividend is ancillary to that. So we’ll take it really week by week from the way the market behaves and the way our stock behaves. I’d reiterate what I said in our script that we think that the levels we’re at today, there’s really good value in our stock. But we’ll see how the market does over this quarter and next quarter.

Craig Siegenthaler: And Dave, my followup is also on capital return. You know, with the dividend hike, I think your yield is now around 4%. You know, is the purpose there really to attract more of a long-term income focused shareholder based? Because I’m just thinking about where your stock valuation is today given your desire for M&A, and I know it’s not a ton of capital, but why not focus more on buyback M&A versus the dividend hike going forward?

David Brown: Yes, it’s a good question. I think we’re taking a balanced approach. The dividend increase was not done to attract a certain type of shareholder. I think it was done for the purpose of rewarding shareholders that we have grown. We’re secure enough in our financial position. We have a really positive outlook to the future and we think that the balance we have between debt pay down, buyback and dividend is the right balance. For 2022, if you go ahead and look at how we allocated capital, the majority of our capital allocation did go down to debt pay down. We also have a lot of different tools on M&A. We have an undrawn revolver. We have our structuring. We generate a lot of cash and we have a portion of our debt that as you know, that is hedged out at about 3% plus. So I think all-in-all, we look at the dividend as a component. The increase is a reward. It’s not really being done to attract any certain type of investor.

Craig Siegenthaler: Great. Guys, thank you for taking my questions.

Operator: Our next question comes from Kenneth Lee with RBC Capital Markets.

Kenneth Lee: Hi, good morning, and thanks for taking my question. Wondering if you could just further expand upon your prepared remarks about being well positioned to potentially capture fixed income net flows. If the industry trends inflect, wonder if you just talk about product offerings any gaps and also your current distribution reach as well? Thanks.