Silvercrest Asset Management Group Inc. Q2 FY2024 Earnings Call

Good morning and welcome to the Silvercrest Asset Management Group Inc. Q2 2024 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 our filings with the SEC under the caption Risk Factors. For all such forward-looking statements, we claim the protection 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 now like to turn the conference over to Rick Hough, Chairman and CEO of Silvercrest. Please go ahead.

Thank you so much, and thank you for joining us for the Second Quarter Earnings Call of 2024. Generally supportive markets and economic conditions continued their progress since the fourth quarter of 2023, but market leadership remained unusually narrow during the second quarter. Large Cap growth primarily drove higher markets, a persistent trend in the market's recovery since 2022. Other segments, including large-cap value and small cap, actually declined during the second quarter, which negatively affected Silvercrest's assets. It's important to note that Silvercrest's U.S. value strategies and U.S. small-cap growth strategies continue to perform well on a relative basis. Broader market participation benefits Silvercrest long term due to the firm's diversified wealth management business and the firm's exposure to the small-cap institutional business. The markets have more recently broadened during the quarter, and if sustained, should improve Silvercrest's future assets under management and our growth. Silvercrest's discretionary AUM decreased $1.1 billion during the quarter to $21.6 billion, primarily due to the loss of institutional mandates. New client accounts and relationships during the quarter were modest but positive. Total AUM at the end of the second quarter was $33.4 billion, an increase of 4.7% year-over-year from the second quarter of 2023. Quarterly revenue year-over-year increased $1.3 million or 4.2%. Silvercrest has been investing in the future growth of the business, including on higher compensation. As a result, while top-line revenue has increased, most metrics of the business are down due to higher expenses. On our last call, I mentioned that Silvercrest has never had more business opportunities underway. We have made and will continue to make investments to drive future growth in the business, including value-added hires. During the second quarter, we announced the hiring of a high-quality, well-known global equity investment team to complement our international strategies. We are excited about the potential for significant institutional mandates in future quarters, raising Silvercrest's visibility globally with institutions and families alike. We also have invested in a new business development professional and market leader in the Southeast, focused on serving ultra-high net worth families and family offices. We expect to make more hires to complement our outstanding professional team and to drive future growth. Silvercrest continues to accrue a higher interim percentage of revenue for compensation. We will adjust variable compensation levels to match these important investments in the business, and will keep you informed of our plans. Silvercrest's pipeline of new institutional business opportunities decreased during the second quarter to $1 billion. The pipeline remains up from the fourth quarter of last year. And importantly, the firm's pipeline does not yet include potential mandates for our new global equity team, which has a high capacity for significant inflows. We continue to expect near-term positive flows to result from opportunities for both our institutional equity and OCIO capabilities in that pipeline. As a high-end wealth and asset management firm, Silvercrest serves families and institutions from across the globe. Despite headline news of international tensions, we see substantial new opportunities globally for a firm with our high-quality capabilities coupled with superior client service. On July 30th of this year, the company's Board of Directors approved an increase of approximately 5% of the company's quarterly dividend, rising from $0.19 per share to $0.20 per share. That dividend will be paid on or about September 20th to shareholders of record. With that, I'll turn things over to Scott Gerard, and then we'll have questions and commentary. Thank you.

Thanks, Rick. Again, as disclosed in our earnings release for the second quarter, discretionary AUM as of June 30th of this year was $21.6 billion and total AUM as of the same period was $33.4 million. Revenue for the quarter was $31 million, and reported consolidated net income for the quarter was $4.4 million. Looking further into the quarter, revenue increased year-over-year by $1.3 million or 4.2%, primarily driven by increased discretionary AUM resulting from market appreciation, partially offset by net client outflows. Expenses for the quarter increased year-over-year by $2.5 million or 10.6%, primarily driven by increased compensation and benefits expense and, to a lesser extent, increased general and administrative expenses. Compensation and benefits expense for the quarter increased year-over-year by $1.7 million or 10.4%, primarily due to an increase in the accrual for bonuses. Based on the increased recurring cash compensation ratio over the past two years, due in part to the investment in the next generation of portfolio managers and other associates, we increased the amount of the interim variable compensation accrual to potentially narrow the adjustment in the fourth quarter. Also, compensation and benefits expense for the quarter increased year-over-year as a result of increases in salaries due to merit-based increases. General and administrative expenses increased by $0.7 million or approximately 11.3%, primarily due to increases in professional fees and recruiting expenses. Reported net income attributable to Silvercrest or the Class A shareholders for the second quarter was approximately $2.7 million or $0.28 per basic and diluted Class A share. Adjusted EBITDA, which we define as EBITDA without giving effect to equity-based compensation expense and non-core and non-recurring items, was approximately $7.2 million or 23.3% of revenue for the quarter. Adjusted net income, which we define as net income without giving effect to non-core and non-recurring items and income tax expense assuming a corporate rate of 26%, was approximately $4.4 million for the quarter or $0.31 and $0.30 per adjusted basic and diluted earnings per share, respectively. 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 had unvested restricted stock units and non-qualified stock options to the total shares outstanding to compute diluted adjusted EPS. Looking at the first half, revenue increased year-over-year by $2.1 million or 3.6%, again, primarily driven by increased discretionary AUM resulting from market appreciation, partially offset by net client outflows. Expenses for the first half increased year-over-year by $4.2 million or 9.1%, primarily driven by increased compensation expense and to a lesser extent increased G&A. Compensation and benefits for the first half increased year-over-year by $2.9 million or 8.7% primarily due to an increase again in the accrual for bonuses. Compensation and benefits also increased for the first half year-over-year due to salary increases. G&A increased by $1.3 million or approximately 9.9%, primarily due to increases in travel and entertainment expenses, occupancy expense, professional fees and recruiting expenses. Reported net income attributable to Silvercrest for the first half was approximately $5.7 million or $0.60 per basic and diluted Class A share. Adjusted EBITDA was approximately $14.7 million or 24% of revenue for the first half. Adjusted net income was approximately $9.1 million for the first half or $0.65 and $0.63 per adjusted basic and diluted EPS, respectively. Looking at the balance sheet, total assets were approximately $177.6 million as of June 30th of this year compared to $199.6 million as of the end of last year. Cash and cash equivalents at June 30th of this year were approximately $49.9 million compared to $70.3 million at the end of last year. As of June 30th, we had no borrowings, but we did renew the term portion of our credit facility for three years. Lastly, total Class A stockholders' equity was approximately $85.3 million at June 30th of this year. That concludes my remarks, and we'll turn it over for Q&A.

Thank you, Scott. We're available now for questions.

Yes, good morning. Rick and Scott, relative performance has been strong. So what exactly are you hearing from consultants and institutional clients? And what is causing the minor outflows?

Thank you. So yes, relative performance has been strong, thankfully. In particular, where we've seen some attrition in the value book, if you look at the trends over the past two years or so, some of it is due to fully funded plans, so that's a shift in allocation, not really something you can do about. We did a great job, and that just happens. There were some long-term clients, so that occurred. The particular outflow that we saw in the second quarter this year was a very large institution that consolidated; their managers have been removed most of them. They had done this two years ago, and we made the cut then, but they brought a lot of their money management internally to them. So that was an unusual change for an institution of this type. We worked with them a very long time. And as you point out, our performance for them was quite good. So look, that kind of thing is just going to happen in the business. We have had, in certain places, very short-term performance, relative underperformance, but that's reversed. We've stayed in close touch with our institutions. And I can safely say we have not lost institutional business due to performance. We have also seen inflows, and we did last quarter; it just did not offset the outflow from that institutional investor from wealth investors and others. That has been a net positive for the firm. There is a tremendous amount of tension, as you might expect, more so on growth, just given the momentum and growth in the market. The value pipeline is very anemic and low right now. It's just not in favor. That will change. These things come in cycles. There just has to be something of a regime change in the markets. People do need to be allocated towards value. And you might even argue the more growth runs, the more they ought to. But of course, that hasn't been the case for a very sustained period of time, as we all know. Small cap remains to be a very favorable asset class. Small cap value portfolio is very strong. Some of the capacity that we have can be filled with higher revenue-paying clients. Small cap growth has been very strong. We have an excellent pipeline there, so that bodes well. And then to finish up, I think, a comprehensive answer for you, the new global equity team that I mentioned in my remarks that we've hired is in the middle of some of the strongest flows that are happening right now from consultants and institutions when you look outside the United States. That is a very strong heavy demand for that capability.

In terms of this new global strategy and opportunity, can you quantify? I mean, looking out a few years without obviously making predictions, but is this a multibillion-dollar opportunity? Any guidance you can give on that or your expectations or hopes?

Yes. I'm careful with that, as you know, and pretty conservative. It's definitely a multibillion-dollar opportunity in the next few years, a very large opportunity. I would not want to get more specific than that. And if all goes well, given the potential for that capability, I think we'll be well on our way within the next few quarters, to be honest. But I have purposely not put that capability into our pipeline because it's new, and we're just developing and building that pipeline by meeting with potential allocators and consultants that would be making allocations to this mandate. One thing that is very encouraging to us as a firm, but also for that capability is that the relationships that have come along with this team include large consultants with whom we have not done much business, and that's exciting to develop new relationships that cannot only allocate to this new capability, but would certainly find our existing value and growth capabilities as well as our international capability and emerging markets capability worthy of allocations. We're out of the incubation period for the international and emerging markets capabilities we already had. This team complements that, and those strategies have excellent long-term track records. In fact, one of them was just awarded one of the top performance awards from PSN for the last three rolling periods. So that all looks pretty positive.

Okay. And where are you in terms of OCIO assets now?

OCIO is approximately $1.5 billion, though that figure has decreased slightly. The pipeline is quite strong, nearing $600 million. The positive aspect of the OCIO pipeline is its increased diversity, which was previously dominated by a few large potential mandates. Now, it consists of a broader range of institutions, making it more reliable. In the past, when the pipeline was focused on larger opportunities, it was more unpredictable—you either secured a large mandate or it fell through, leading to significant fluctuations. Currently, the greater diversification suggests it will be more stable going forward.

Okay. And one final question. You talked about higher compensation expenses and some of the key new hires. Is that something for modeling purposes? Are we looking at sort of higher compensation than normally you would guide us to this year and next year?

Yes, definitely. Let's focus on this year for now, and I will briefly touch on next year. Over the past two or three years, I've been clear about our plans to invest in the business, including technology and new talent, such as portfolio management teams and business development. I have also brought on a new global equity team, which is essential for the company's growth. This means our expenses will exceed the long-standing target of 55% of revenue, which we've hovered around during stronger growth periods. That remains my long-term goal. However, as we make these investments and while we await flows that will support them, our expenses have been running at 57% to 58%. I want to clarify this to avoid substantial adjustments in the fourth quarter, especially since we are accruing for year-end compensation without control over market dynamics and other factors. In prior years, adjustments have varied, with some being quite favorable, while in most years, they have been minimal. I will keep everyone updated on the numbers as warranted for better future visibility. Looking ahead to next year, it will largely depend on how we progress with our current investments and the anticipated flows. Remember, I've been able to hire and grow at a pace faster than our compensation expenses before, especially just before and during the COVID period, despite the associated costs. That growth masked the higher expenses for our investors. Currently, though, we are in a different situation where we need to grow in line with these compensation costs, particularly given the current market dynamics. I hope that's clear, and I'm available for further discussion on this topic as needed.

Our next question today comes from Christopher Marinac with Janney Montgomery Scott.

Good, Rich. How are you? Thanks for taking the question this morning for everybody. Just to go on to the last question, just to go one step further. So is it unusual to accrue extra salary and bonuses this time of year? Or is it normal, or are you just doing a higher amount?

I would say it's normal. In the last earnings call, and certainly in the ones before that, I mentioned that I would be doing this at some point and addressing earnings in this way. I've talked about it for a couple of years. In our last earnings call, I specifically mentioned accruing more at this level. It's not unusual. We set the standard, and we want to make the adjustment as we hire now instead of making a big adjustment later in the year. I'd rather you all see what is happening than stick to our standard 55% and then reach the fourth quarter and say we made these investments we've been talking about and it’s actually 58% or whatever. So, I don't think it's unusual. Scott will provide a little more detail from his perspective. I would also point out that if I'm going to be off the mark with some other hires, I'll let everyone know. Go ahead, Scott.

Yes, Chris. It's always been our policy to monitor the variable compensation adjustment based on our estimates. Given our current hiring mode, which is a bit more dynamic, we needed to take a closer look at that ratio. In this environment, it's wise to make those adjustments quarterly.

That all makes sense. Just want to go back through the pipeline changing from March to June. It feels like you had maybe an unusually strong first quarter, and so you gave that back. But in the big picture, you still have a pipeline. It's still going to contribute positively. So I guess I just want to put the weight or maybe not as much weight on this pipeline change. Just wanted to kind of talk through that.

Okay. Are you referring to the decrease? I just want to clarify that we've sometimes adjusted downward, not solely based on winning or losing mandates, but because we are very thorough in managing and measuring it. Occasionally, projects we are actively pursuing might fall outside the 6-month window we anticipate for action, and we remove them from the pipeline. This pipeline is intended to showcase robust opportunities for the next 6 months. Thus, it may decrease for that reason alone. The primary factor for the decrease was that we received a few mandates, but there was also one significant mandate involved, which makes the variability in not securing it more pronounced. This situation is evident in the OCIO book, where that particular opportunity was not successful and was subsequently removed from the pipeline. That's why I mentioned that the current pipeline is more diversified. It's not going to be strictly on or off, meaning hot or cold. It’s more reliable now. If we win some and lose some, it won't drastically alter the pipeline. It is higher than in the fourth quarter, and we've seen it lower than this before, making it a fairly stable and robust pipeline. One unusual observation is the lack of significant contributions from the value pipeline, which is typically a major part of the overall pipeline. Currently, we are focused on OCIO, growth, as well as international and emerging markets. To clarify, I haven’t included potential from the global equity strategy linked to our newly hired team, as their past performance transitioned to Silvercrest has been outstanding, and discussions with investors have been excellent. Recently, our marketing team returned from nearly two weeks in Australia, which hosts substantial capital pools potentially interested in this capability. I prefer not to add this to the pipeline until we have a better sense of its development. Overall, I can say the pipeline is strong, it has improved nicely since the fourth quarter of last year, and its diversification regarding the mandate sizes is beneficial.

Understood, that's great. Last question for me just goes back to sort of the changes in the equity market the last sort of 4, 5 weeks that we've seen post June 30. Has any of that sort of resonated? And I know it's probably early to comment, but just kind of curious on how you have interpreted that here in recent weeks.

Yes, it has resonated. It's quite frustrating to witness what appear to be strong markets accompanied by such limited leadership following a challenging equity year in 2022. We can develop a robust business and have excellent intellectual assets, but the capital gains or losses in any quarter significantly impact our revenue. It's particularly maddening when, as experienced last year, it all hinges on just a few stocks. The market expanded in the fourth quarter, which was positive, but then it tightened again. The recent broader market movement is encouraging, especially in the third quarter, as well as the resurgence of small caps, which is crucial for our institutional business. We have outstanding small-cap capabilities in both international growth and value, delivering excellent relative performance, albeit capacity constrained, as I previously noted. This is vital for our current assets under management and revenue potential from future mandates. The recent regime change is a positive development for our business. However, it's uncertain whether this will be sustained since we've been anticipating small caps to catch up for some time now. There are many factors at play in our economy, including interest rates. The recent regime change is definitely a welcome shift. Additionally, it's tiring to see so much attention on the Fed rather than the fundamentals of businesses and their earnings, particularly for small-cap firms. Ultimately, the focus should be on a growing economy and earnings rather than solely on the Fed, which is critical for a healthy economy and market. We've been in a rather unusual phase since the financial crisis, where certain market values seem distorted and inverted, whether it pertains to capital allocation or which asset classes are favored. That's all I have to say on that topic. I hope that clarifies your question.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Rick Hough for any closing remarks.

Great. Thanks so much. Thanks for joining us. Look forward to updating you at the end of the third quarter. As I mentioned, we've got a very nice pipeline that's well diversified, and we're really excited about the new intellectual capital that we've attracted to this firm. It's top tier, it's compatible and complementary to the capabilities we already have here at the firm, opens up new opportunities for us in terms of visibility with significant asset allocators and families. And I'm generally excited about these investments, whether that's business development in the Southeast or this new equity team or some of the others that potentially come as we grow. So stay tuned. Look forward to updating you next quarter. Thanks so much.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines. And have a wonderful weekend.