Silvercrest Asset Management Group Inc. Q3 FY2020 Earnings Call

Good morning, and welcome to the Silvercrest Asset Management Group Inc. Q3 2020 Earnings Conference Call. Please note, this event is being recorded. Before we begin, let me remind you that during today's call, certain statements made regarding our future performance are forward-looking statements. They are based on current expectations and projections, which are subject to a number of risks and uncertainties, and many factors could cause actual results to differ materially from the statements that are made. Those factors are disclosed in the filings with the SEC under the caption Risk Factors. For all such forward-looking statements, we claim the protections provided by the Litigation Reform Act of 1995. All forward-looking statements made on this call are made as of the date hereof and Silvercrest assumes no obligation to update them. I would like now to turn the conference over to Rick Hough, Chairman and CEO of Silvercrest. Please go ahead.

Thanks, this is Richard Hough joining you. Appreciate you joining us for our third quarter 2020 call. Silvercrest's discretionary assets under management, which drove our top line revenue, grew approximately 4% during the quarter to $17.9 billion as of September 30, 2020. The growth in discretionary assets under management was supported by markets increasing our asset values by $700 million, along with $200 million in new client accounts. These increases were offset by outflows of $200 million, primarily for tax payments as a result of delayed tax deadlines due to the coronavirus crisis. The firm's total assets under management during the quarter increased approximately 3% to end the quarter with $24.4 billion in total assets under management. Due to this year's market recovery, continued organic growth and our accretive acquisition in the second half of 2019, the firm's revenue, our adjusted net income, adjusted EBITDA and adjusted EBITDA margins for the 9 months ended September 30, 2020, have each grown year-over-year. For the 9 months ended September 30, 2020, adjusted diluted earnings per share increased approximately 13% year-over-year. Silvercrest's Outsourced Chief Investment Officer, OCIO, initiative, which we began marketing heavily a year ago, contributed meaningfully to new business development in the third quarter and is poised to cross important AUM thresholds to be considered for new OCIO mandates. We continue to be proud of our progress in that business. Silvercrest institutional asset management pipeline is rebuilding along with new initiatives, and we expect the institutional business to improve and contribute new AUM to the firm. Regardless of the environment, Silvercrest will continue to opportunistically seek to effectively deploy capital to enhance and complement our organic growth. Silvercrest has successfully made investments to organically grow the business and will continue to make those investments with its cash flow and reserves. We've hired new high net worth portfolio management professionals in New York and will continue to add new talent, both to maintain a high level of client service and to grow the business. On November 4, 2020, the Company's Board of Directors declared a quarterly dividend of $0.16 per share of Class A common stock. The dividend will be paid on or about December 18, 2020, to shareholders of record as of close of business on December 11. With that, I'll turn it over to Scott to review our financials, and then we'll open the line for questions. Thanks.

Thanks, Rick. As disclosed in our earnings release for the third quarter, discretionary AUM as of September 30, 2020, was $17.9 billion and total AUM as of September 30 was $24.4 billion. Revenue for the quarter was $27.2 million, and reported consolidated net income for the quarter was $3.5 million. Revenue for the third quarter was approximately $27.2 million, representing approximately a 2% decrease over a revenue of approximately $27.8 million for the same period last year. This decrease was driven by the continued impact of COVID-19 on the financial markets that occurred during the first quarter of 2020, which had the effect of reducing AUM in addition to net client outflows, and this was partially offset by market appreciation during the third quarter of this year. Most of our revenue is billed in advance based on closing market values from the last day of the previous calendar quarter. Third quarter 2020 revenue was primarily based on June 30, 2020, market values. Expenses for the third quarter were $22.2 million, representing approximately a 3% increase from expenses of $21.5 million for the same period last year. This increase was primarily attributable to an increase in general and administrative expenses of $0.6 million. Compensation and benefits expense was flat in the third quarter compared to the same period last year. The increase of approximately $0.6 million in general and administrative expenses in the third quarter of this year was primarily attributable to increases in the fair value of contingent consideration related to the Cortina acquisition and portfolio and systems expense, partially offset by decreases in professional fees due to lower Cortina acquisition-related fees, travel and entertainment and reduced office expenses due to COVID-19. Furthermore, there was a decrease in storage and moving expenses as a result of the completion of the renovation of our space in New York City. Reported consolidated net income was $3.5 million for the quarter. This compared to $4.8 million in the same period last year. Reported net income attributable to Silvercrest or to Class A shareholders for the third quarter of this year was approximately $2.1 million or $0.22 per basic and diluted Class A share. Adjusted EBITDA, which we define as EBITDA without giving effect to equity-based compensation expense and noncore and nonrecurring items, was approximately $8.1 million or 29.9% of revenue for the quarter compared to $8.9 million or 32.1% of revenue for the same period last year. Adjusted net income, which we define as net income without giving effect to noncore and nonrecurring items and income tax expense assuming a corporate rate of 26%, was approximately $5.1 million for the quarter or $0.35 per adjusted basic earnings per share and adjusted diluted earnings per share. Adjusted earnings per share is equal to adjusted net income divided by the actual Class A and Class B shares outstanding as of the end of the reporting period for basic adjusted EPS and, to the extent dilutive, we add unvested restricted stock units and nonqualified stock options to shares outstanding to compute diluted adjusted EPS. Looking year-to-date, revenue for the 9 months ended September 30 of this year was approximately $79.6 million representing approximately a 7% increase over revenue of approximately $74.3 million for the same period last year. This increase was driven primarily by net client inflows in discretionary AUM, including $1.7 billion in assets under management acquired on July 1, 2019, in connection with the Cortina acquisition, partially offset by net client outflows and market depreciation in the first quarter of this year. Expenses for the 9 months ended September 30 were $60.6 million. This represented approximately a 2% increase from expenses of $59.6 million last year. Compensation and benefits expense increased to approximately $1.7 million during the 9 months ended September 30 of this year compared to the same period last year. General and administrative expenses decreased approximately $0.7 million during the 9 months ended September 30 of this year when compared to the same period last year. Looking at comp and benefits, it increased for the 9 months ended September 30 this year, primarily because of an increase in salaries and benefits expense as a result of merit-based increases and newly hired staff, including the addition of Cortina staff, and an increase in the accrual for bonuses, partially offset by a decrease in equity-based compensation expense due to a decrease in the number of unvested restricted stock units and unvested nonqualified stock options outstanding. The decrease in general and administrative expenses for the 9 months ended September 30 of this year was primarily because of year-to-date decreases in the fair value of contingent consideration related to the Cortina deal, travel and entertainment and reduced office expenses, all related to COVID-19. Professional fees were lower due to lower Cortina acquisition-related fees, and we also had reduced printing costs and storage and moving expenses. There were increases in depreciation and amortization expense related mainly to the amortization of intangible assets related to the Cortina acquisition and to the renovation of our office space in New York City. Occupancy and related expenses increased in addition to portfolio and systems expense, annual rate increases in the fair value of contingent consideration related to the Jamison and Cappiccille acquisitions. Reported consolidated net income was approximately $14 million for the 9 months ended September 30. This compared to $11.2 million in the same period last year. Reported net income attributable to Silvercrest or to Class A shareholders for the 9 months ended September 30 was approximately $8.1 million or $0.85 per basic and diluted Class A share. Adjusted EBITDA was approximately $23 million or 28.9% of revenue for the 9 months ended September of this year. This compared to $21.3 million or 28.6% of revenue for the same period last year. Adjusted net income was approximately $14.1 million for the 9 months ended September this year or $0.98 per adjusted basic earnings per share and $0.97 per adjusted diluted EPS. Total assets were approximately $201.2 million as of September 30. This compared to $214.2 million as of December 31 last year. Cash and cash equivalents were approximately $48.2 million in September compared to $52.8 million at December 31 of last year. Total borrowings as of September 30 of this year were $13.5 million and total Class A stockholders' equity was approximately $69.5 million at September 30 of this year. That concludes my remarks, I will turn the call over to Rick for Q&A.

Thanks very much, Scott. We can open the lines now for questions.

Our first question comes from Sumeet Mody with Piper Sandler.

Just wanted to start with the OCIO business. A couple of questions here, but I just wanted to get some color first around the size of the platform today and how big is that. I think you mentioned $500 million last quarter. And this quarter you mentioned it's starting to kind of reach that inflection point today. So can you talk about those levels that sort of qualify for those new mandates?

Yes. As you remember, approximately half of our organic growth in the last quarter came from this. We entered the fourth quarter of last year with virtually no growth, and you're right, our last report indicated $0.5 billion; now it's closer to $0.75 billion, and we have a pipeline of new opportunities. There are over $275 million in actionable opportunities where we have been invited, actively presented, or are in our final presentation stages. One important milestone we're aiming for is reaching $1 billion in assets under management, as this significantly boosts our credibility in the business. It enhances our ability to support our team and ensures the firm continues to allocate resources towards this as a significant endeavor, in addition to the variety and types of institutions we're collaborating with. Furthermore, we have developed relationships and are actively working with OCIO search firms, similar to those working with other institutions for equity or other mandates on their behalf. We are optimistic about the business and are pleased with the progress made during the third quarter of this year.

Okay, that's helpful. And just a follow-up on that, just can you remind us of the mechanics around how the OCIO growth impacts AUM? Is that coming into discretionary AUM as new client assets? And kind of how should we best track the progress?

Yes, sure. Mostly it is. We're taking an OCIO approach where we are acting as a fiduciary, as a discretionary manager. It's a bit differentiated from consultants in some of the other firms that are in OCIO. There will be assets for sure that go into nondiscretionary. That happens with our wealth business as well. I believe we have a mandate in OCIO that is nondiscretionary, but it is being fed at levels that are kind of in between nondiscretionary, pure discretionary. Hopefully, that converts over time. But most of it should be discretionary. It's kind of hard to say what the mix will ultimately be. Our nondiscretionary assets in general, OCIO aside, are flat fee-type businesses of we don't have discretion over the assets and to the extent as OCIO, the fee will be a little bit higher than what we would see on the wealth side for nondiscretionary. So mostly discretionary, but it's hard to say what can happen.

Okay. Is that fee around the institutional rate like 40 to 50 basis points in that range?

Yes. That's right. It's more of an institutional rate business. That's correct.

Okay. And then just to follow up on kind of the first question there on the 6-month actionable pipeline, just pivoting a little bit to the institutional side. I know we're a few months further past the heart of the pandemic, has there been any change in the kind of demand between value and growth? I know performance has remained pretty strong across the board, but has there been any noticeable interest in one direction or the other?

I wouldn't say that. Our excellent growth strategy, which has just put up terrific numbers, as you noted, as have our value strategies, but importantly, our U.S. small cap growth and opportunity capabilities are above the mean of their peer group and had great performance last year. They are in a capacity constrained area in the small cap area of growth. But as you know, small cap has also been a bit out of favor as compared with large cap. And a lot of the attention that we've seen, of course, from institutions is in large cap growth, which is where we're not placed right now. That said, we'll be looking to eventually grow that capability. And the pipeline for our small cap and opportunity growth has grown and is picking up. As you know, a lot of the pipelines froze. Our total opportunity for institutional business across value and growth is close to $1 billion now whereas I didn't report on it, I believe, 2 quarters ago and mentioned last quarter that it was starting to open up. And we're still seeing a beginning to open up both with the economy but also as we get into fall and before getting used to the situation of working. Sumeet, I just want to add, I don't know if you're on the line, I should have mentioned this, this is important that aside from the fact that we've got great performance across our capabilities, which is wonderful we've kept that up, we also have come to an agreement with Edmond de Rothschild in Europe for sub-advising a new fund there, which they will be distributing. That is awaiting final regulatory approval, but that should also lead to very meaningful institutional flows in time in Europe.

Our next question comes from Sandy Mehta with Evaluate Research.

Congratulations, Rick and Scott, on a solid quarter. I have two questions. There has been considerable M&A activity in the industry, including the recent Legg Mason and Eaton Vance deals. Additionally, activist shareholder Trian has acquired stakes in Invesco and Janus. This seems to have altered the valuation dynamics regarding potential acquisitions. What are your thoughts on these transactions, and how do you perceive their impact?

Yes. I don't think they really have much of the valuation impact when you look at our business. When you look at those giant complexes of vast financial supermarkets and capabilities, it's just a completely different world from the primarily wealth management one with small asset management. As you well know, pure asset managers, especially boutiques, have been quite out of favor as a result of struggling to maintain AUM and grow AUM and the length of the competition from passive strategies, and there has been tremendous fee compression. Those big organizations and how they work in their mutual fund complexes and all sorts of other means of making money just aren't apples to apples. So frankly, I don't pay a lot of attention to it. I don't think Scott does either. And of course, those big firms continuing to merge and create giant supermarkets is one reason why there is a burgeoning growth in small boutiques across the country and entrepreneurs. And that's how this firm was founded as a result of those kinds of mergers. So no, I don't think it affects things.

Okay. And a second question was, a few weeks ago, Silvercrest had SEC filing related to a hedge fund offering of $11 million. Was that a routine sort of regulatory filing? Or does that represent some new initiatives on the hedge fund side for Silvercrest?

Without specifics, I'm not sure what that might reference. We have vehicles for our investors that we start from time to time. We had some fund of funds for putting together alternative investments on behalf of our clients, whether that's for a specific strategy in alternatives or to make it possible for clients to diversify across a number of different types of alternative investments. Without specifics, I'm not sure what that might be. It could be any number of filings that we made that are related to what we have or reorganizing something that we've done. But there are no new meaningful initiatives that we would announce at this time.

Our next question comes from Christopher Marinac with Janney.

I wanted to ask about the seasonality of the EBITDA margin. Is that at all something that would evolve this next couple of quarters?

Will evolve, is that what you said?

Yes, the seasonality of the EBITDA margin.

Yes. So there's not a lot of seasonality to it. There's a bit. I'll let Scott address it after I answer your question. If you look over the history of the firm, we're kind of running at our high levels of EBITDA margins right now. I've said in prior calls that as we make investments in the business to grow, which we should all be in favor of, we could be pushing that margin down even to the mid-20s. I've never actually done that. We've grown fast enough to make the investments we want to grow the business without meaningfully hitting our EBITDA, but it's certainly a possibility. In the fourth quarter, we often see a bump in our EBITDA margin because we sometimes have performance fees from alternative investments that basically just pump everything up with no associated costs. But aside from that, I don't think there is a serious pattern to it. Scott?

Yes. There are a few factors that impact expenses in the fourth quarter due to seasonal variations related to year-end, such as increased costs from clients and higher audit fees associated with interim procedures. This results in higher expenses in the fourth quarter compared to the second and third quarters. Additionally, we will finalize our annual compensation in the fourth quarter. In certain years, we have fallen short of compensation goals, while in others, we have exceeded them. Therefore, there could be some fluctuations in our EBITDA margin.

Which is why I say the fourth quarter is not predictable. We may have this additional expense, but we also have the performance fees and we sometimes come in under comp that we would accrue the rest of the year. So there's no real serious pattern. In fact, last year, it bumped up in the fourth quarter, if I recall.

Got it. That's very helpful. And then just a follow-up. When you mentioned about the large cap capability expanding over time, would you prefer to do that organically through your own initiatives? Or would you do something external? Or could it be a combination of both?

When you say doing something externally, do you mean like purchasing or acquiring a large cap growth manager?

Yes.

Yes, we're more inclined to grow organically. Our strategy, which we may not have discussed in previous calls, involves acquiring a group of equity analysts and professionals who align well with our culture and whose strategies we trust completely. They meet all our criteria. A significant aspect of their expertise is in smaller cap issues, which is often a limited capability. This makes expanding in that area appealing. Additionally, we see this as an opportunity to bring in a large cap specialist who has extensive experience in building such capabilities and expanding them, complementing the analyst team and infrastructure we already have. This approach is similar to what we have done at Silvercrest with our value capabilities, where we have six generalist analysts covering around 110 stocks, which can be segmented by market cap. Pursuing organic growth by hiring into a credible infrastructure is a solid strategy for us, and that's what we intend to focus on.

Our next question comes from Chris Sakai with Singular Research.

Could you help me understand why, despite AUM being higher than a year ago this quarter, revenue and earnings were lower than a year ago? That would be appreciated.

Yes. Scott, do you want to take that in terms of revenue and AUM?

Yes. Despite the fact that markets have improved since the first quarter of this year, there is still a lingering effect. Throughout the year, we are gradually returning to asset levels and revenue levels from a year ago. If the markets had been more stable during the pandemic, the disparity would have been more apparent, but that's the situation we've encountered regarding revenue.

I want to emphasize that if we exclude market effects, the organic growth of the business has been quite strong compared to previous years. This year, in terms of new client acquisition, we are already ahead of total year assets from 2017 and 2018. Excluding acquisitions, we are on track to match 2019, and we have experienced lower outflows from our accounts over the past four quarters, including Q4 2019. The issue you're observing is mainly due to the market, and it's important to note that we bill quarterly in advance. Therefore, the market downturn in the first quarter significantly impacted our second quarter revenue. Overall, it is primarily that effect driving our numbers.

The other thing is keeping in mind, for the third quarter, which was primarily based on June 30 asset values of this year, we had a bit of a different mix in our AUM compared to June 30 a year ago. So that, coupled with the other items, contributed to the delta.

Our next question comes from Sumeet Mody with Piper Sandler.

Just following up on kind of the M&A side of things, just wanted to get your point of view on the conversations you guys have had from the acquire side, have you gotten any interest also, secondarily, on buyers looking at Silvercrest as well?

Yes, we are always exploring different business opportunities. Despite the impact of the market downturn on our revenues, the business has remained steady, and we believe we would be even further ahead if not for other challenges. From a mergers and acquisitions perspective, the current market conditions could present opportunities for firms like Silvercrest that have significant resources and a strong operational culture to capitalize on, especially compared to companies that rely heavily on debt to enter the wealth management sector. While many consider strategy important for success in boutique firms, I hold a contrarian view and have not seen reasonable valuations for numerous businesses that are stagnant or have minimal growth, as they often lack scale or proper succession planning. There are boutiques that desire a unique culture and are investment-oriented like Silvercrest, expecting more from a transaction than just financial compensation. We engage in regular discussions as a recognized player in this sector but will not pursue a deal unless it significantly benefits our shareholders and advances the organization as a whole. We won't take on a deal just for the sake of it. The Cortina acquisition was a prime example; it fulfilled multiple strategic objectives for us and involved exceptional people, proving to be immediately beneficial. This is our goal: achieving positive outcomes in a reasonable timeframe. We are continually in talks with various firms about potential opportunities at Silvercrest. This company holds a prestigious reputation, and we consistently evaluate our options alongside the Board, which has been our approach throughout our 20 years as a private entity and now as a public company.

Great. And then just a last one from me kind of cleanup here, but around $151 million of new client assets and discretionary, can you give us maybe a breakout of what those assets were comprised of?

Yes. So close to half of that was OCIO. We also have from existing accounts net cash flows in and out. So the $151 million new client accounts is when the account is opened. But during the subsequent quarters, there can be cash flows in from a new account, and that's counted in our net cash in and out of accounts. So very often, that number is understated from the reality of what is flowing in with new business. But it's the best way for us to capture it and to keep our numbers clean and be able to compare apples to apples over time. But if you just take that number, approximately half of it is OCIO. The other half is family wealth. New business in the institutional space was quite low during the past 2 quarters, we've reported that it's not surprising given what we've said about actions from consultants and what's happening in the pipeline. It should be noted as well that, of course, the V-shaped rebound in the market means there's less shakeout and changing of managers. We saw that in the financial crisis 12 years ago. It takes a while for that opportunity to come to light. Had the markets created greater dispersion among some managers, that would also create more opportunities. But certainly, the pandemic is unusual. So again, on the net organic flows into the business, primarily family wealth and OCIO.

This concludes our question-and-answer session. I would like to turn the conference back over to Richard Hough for any closing remarks.

Thanks. Appreciate you joining us for the third quarter of 2020. We look forward to reporting to you at the end of the year. Given the pandemic environment, we're pleased in particular that we have been able to organically grow the business and sustain that despite the working environment that we have. And the new opportunities that we see in the institutional business as well as the new thresholds in the OCIO business we think looks good for the business going forward. And we'll talk to you in another quarter. Thanks so much.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.