Earnings Call Transcript - SAMG Q2 2020

Operator, Operator

Good morning, and welcome to the Silvercrest Asset Management Group Inc. Q2 2020 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. Before we begin, let me remind you that during today's call Silvercrest will make forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact, including statements regarding future events and developments and Silvercrest's future performance as well as management's current expectations, beliefs, plans, estimates or projections relating to the future are forward-looking statements. These forward-looking statements are only predictions based on current expectations and projections about future events. These forward-looking statements are subject to a number of risks and uncertainties and there are important factors that could cause actual results level of activity performance or achievements to differ materially from the statements made. Among these factors are fluctuations in quarterly and annual results in terms of net losses adverse effects of management focusing on implementation of a growth strategy, failure to develop and maintain the Silvercrest brand and other factors disclosed in the company's filings with the SEC, including those factors listed under the caption entitled Risk Factors in the company's annual report on Form 10-K for the year ended December 31, 2019 and quarterly report on Form 10-Q for the three months ended March 31, 2020 and on quarterly report on Form 10-Q for the three and six months ended June 30, 2020 filed with the SEC. In some cases these statements can be identified by forward-looking words such as believe, expect, anticipate, plan, estimate, likely, may, will, could, continue, project, predict, goal the negative or plural of these words and other similar expressions. These forward-looking statements are predictions based on Silvercrest's current expectations and its projections about future events. All forward-looking statements made on this call are made as of the date hereof and Silvercrest assumes no obligation to update these forward-looking statements. I would now like to turn the conference over to Rick Hough, Chairman and CEO of Silvercrest. Please go ahead.

Rick Hough, Chairman and CEO

Thanks and thanks very much for joining us for our second quarter 2020 results. It's good to speak with you all today and it's the first time in five months I've been in the same room with my CFO, which is nice. Silvercrest is pleased to report good results for the second quarter of 2020 ending June 30, despite the challenging backdrop we've all seen with the corona shutdown and we've grown both due to organic growth in each segment of our businesses as well as supportive equity markets. We opened new discretionary accounts of $159 million during the quarter and we saw total net organic inflows of $200 million in discretionary assets under management, which delivered our best organic growth since the second quarter of 2019. Our discretionary assets under management, which drive top line revenue grew 16% from the first quarter and our total assets under management during the quarter increased 16% to $23.8 billion. Importantly, as of June 30, 2020, our assets under management now stand at nearly the same level as Q3 2019. Finally, as a result of the recovery and our accretive combination with Cortina in July 2019, our total assets have increased 10% year-over-year. Accordingly, our revenue adjusted net income, adjusted EBITDA, adjusted EBITDA margins and adjusted diluted earnings per share each show increases or were flat for the quarter and first half versus a year ago. Silvercrest has maintained a proven ability over time even during difficult environments and despite industry trends to continue attracting net positive asset flows from new high net worth families, institutional asset management and for our Outsourced Chief Investment Officer businesses. Last year we announced that 2020 and 2021 would prove important for the OCIO business. While the current environment has slowed searches, we've reported last quarter that OCIO had contributed half of the firm's organic growth and that business continues to develop. With new wins in the second quarter of 2020, the OCIO business now advises on $500 million in assets under management. We are proud of our progress to-date and we expect to grow this business into a few billion in assets under management at the time. Silvercrest's institutional asset management pipeline also is rebuilding after the initial shock and economic shutdown due to the coronavirus. The new business pipeline is recovering and we expect the institutional business to improve as society makes further progress toward reopening. Regardless of the environment, Silvercrest will continue to opportunistically seek to effectively deploy capital to enhance and complement our organic growth, especially during an uncertain environment that is likely to experience continued market volatility. Silvercrest has successfully made investments to organically grow the business, and we'll 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 we'll continue to add new talent both to maintain a high level of client service and to grow the business. On July 28, 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 September 18, 2020 to shareholders of record as of the close of business on September 11, 2020. Before I take questions, I'll turn it over to Scott Gerard, our CFO.

Scott Gerard, CFO

Thanks Rick and second it's great to be in the same room with you as well. As disclosed in our earnings release for the second quarter, discretionary AUM as of June 30, 2020 was $17.3 billion and total AUM as of June 30, 2020 was $23.8 billion. Revenue for the quarter was $24 million and reported consolidated net income for the quarter was $28 million. Delving in the second quarter further, again, revenue was $24 million and that represented approximately a 0.5% increase over revenue of approximately $23.9 million for the same period last year. This increase was driven primarily by increased net client flows and discretionary assets under management, including $1.7 billion in assets under management acquired on July 1, 2019 in connection with the Cortina acquisition partially offset by market depreciation in the first quarter of this year. Revenue for the quarter ended June 30, 2020 related to the Cortina acquisition was approximately $2.6 million. Total AUM increased from March 31, 2020 to 30 June of the same year primarily because of rebounds in the market after significant market declines in the first quarter of this year resulting from the COVID-19 pandemic. Most of our revenue was built in advance, based on closing market values from the last date of the previous calendar quarter. Second quarter 2020 revenue was primarily based on March 31, 2020 values. Expenses for the second quarter were $22.7 million, representing approximately a 16% increase from expenses of $19.5 million for the same period last year. This increase was primarily attributable to an increase in general and administrative expenses of $3.8 million partially offset by a decrease in compensation benefits expense of $0.6 million. Comp and benefits expense decreased primarily as a result of a decrease in the accrual for bonuses as a result of lower revenue and equity-based compensation expense due to a decrease in the number of unvested restricted stock units partially offset by merit increases and newly hired staff including the addition of Cortina staff. The increase in general and administrative expenses in the second quarter of this year was primarily attributable to a $3.8 million increase in the fair value of contingent consideration related to the Cortina acquisition increased portfolio and systems expense and higher depreciation and amortization expense related mainly to the amortization of intangibles related to the Cortina acquisition and to the renovation of our office space in New York City. There were decreases in travel and entertainment storage and moving expenses. Reported consolidated net income was $0.8 million for the quarter as compared to $3.4 million in the same period last year. Reported net income attributable to Silvercrest or to Class A shareholders for the second quarter of 2020 was approximately $0.5 million or $0.05 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 non-recurring items was approximately $6.7 million or 27.7% of revenue for the quarter compared to $6.6 million or 27.5% of revenue for the same period in the prior year. 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 up 26% was approximately $4 million for the quarter or $0.28 per adjusted basic earnings per share and $0.27 per 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 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 of the year revenue was approximately $52.4 million which represented approximately a 13% increase over revenue of approximately $46.5 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 1st 2019 in connection with the Cortina acquisition partially offset by market depreciation in the first quarter of this year. Expenses for the first half were $38.4 million and were basically flat to expenses of $38 million for the same period last year. Comp and benefits increased approximately $1.7 million in the first half compared to last year and G&A expenses decreased approximately $1.3 million in the first half of this year compared to 2019. Compensation and benefits increased for the first half 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 and an increase in the accrual for bonuses. This was partially offset by a decrease in equity-based compensation expense due again to a decrease in the number of unvested restricted stock units and unvested non-qualified stock options which are outstanding. The decrease in G&A for the first half was primarily because of decreases in the fair value of contingent consideration related to the Cortina acquisition also travel and entertainment expenses and storage and moving expenses were lower. Increases in expenses were related to depreciation and amortization as a result of the Cortina acquisition and related to the renovation of our office space in New York City occupancy and related expenses portfolio and systems expense and an increase in the fair value of contingent consideration related to the Jamison and Cappiccille acquisitions. Reported consolidated net income was $10.5 million for the first half as compared to $6.4 million in the same period of last year. Reported net income attributable to Silvercrest or to Class A shareholders for the first half of 2020 was approximately $6 million or $0.64 per basic and diluted Class A share. Adjusted EBITDA was approximately $14.9 million or 28.4% of revenue for the first half. This compared to $12.3 million or 26.5% of revenue for the same period last year. Adjusted net income was approximately $9.1 million for the first half or $0.63 per adjusted basic EPS and $0.62 per adjusted diluted EPS. Looking quickly at the balance sheet, total assets were approximately $193.5 million as of June 30th 2020 compared to $214.2 million as of December 31 2019. Cash and cash equivalents were approximately $37.7 million at June 30th compared to $52.8 million at December 31st last year. Total borrowings as of June 30 were $14.4 million and total Class A stockholders' equity was approximately $68.9 million as of June 30. That concludes my remarks. I'll now turn it over to Rick for Q&A.

Rick Hough, Chairman and CEO

Great. Thanks very much Scott and we're now available for questions. Thank you.

Operator, Operator

Today's first question comes from Sumeet Mody with Piper Sandler. Please go ahead.

Sumeet Mody, Analyst

Thanks. Good morning, Rick and Scott. Just wanted to start with the OCIO business. It seems like there's been pretty nice growth since 3Q 2019. I believe it was roughly $150 million then now reaching about $500 million. Just a couple of questions here but how much did the OCIO initiative contribute to that $159 million in new client assets? And then can you talk a little bit about the impact of the lack of travel on the search environment and how that affects your expectation around the timing of kind of when you'll be able to reach a more scaled level of assets? I think you mentioned a few billion of AUM over time.

Rick Hough, Chairman and CEO

Sure. I'm not certain what the $159 million you mentioned refers to, but we began with no assets, and the OCIO business started gaining traction in the fourth quarter of 2019. We had a significant win in the second quarter of 2020 that contributed meaningfully. The reason I'm unsure is that some contributions from that mandate may have extended into what we're seeing in the third quarter. Currently, the OCIO assets amount to $550 million, and a crucial target for us is to reach $1 billion because we aim to develop this into a multi-million dollar business. Having that level of assets will enhance our opportunities for more introductions and greater recognition in the industry due to the substantial assets we hold. The search environment is quite challenging. I didn’t mention our pipeline of opportunities in my last quarterly call; it essentially stalled. However, we ended the year with an exceptionally strong pipeline, and we didn’t lose any ground—things simply did not progress. Travel complications have certainly made it difficult to connect with consultants and nurture relationships in this sector. Nevertheless, we have been increasing our client interactions and requests for consulting firm conference calls, keeping in touch with research personnel, and we are observing a rise in activity. In fact, the six-month actionable pipeline I stopped discussing a while ago is now around $780 million in the pure equity asset management aspect of the business. This figure represents a very conservative estimate of our pipeline, specifically where we are in invite-only requests or in the semifinals or finals stages for new accounts. Our overall pipeline has a high win rate. I expect that on the OCIO side, activity has slightly slowed since our win in the second quarter, largely due to when nonprofit and other Boards convene. I anticipate that activity will increase again in the fall, a pattern we have seen before. I am involved in boards that oversee endowments and foundations, and they also won’t meet on those matters until the fall. I believe this is the case for other institutions as well. Overall, we feel optimistic about the opportunities in our pipeline, but I don’t expect to see an increase until well into the third quarter.

Sumeet Mody, Analyst

Okay. Great. And just to follow up a little bit on that. I mean can you talk a little bit about the demand where it is across the product set with the institutional pipeline?

Rick Hough, Chairman and CEO

The demand is mostly focused in our value equity capabilities. There's some interest of course in the new growth opportunity, but our ability to bring that to market as fast as we would have liked after the acquisition has certainly been affected by this environment. The performance in our growth capabilities has been better than benchmarks. So we're well positioned for potential searches. It's just a matter of continuing to bring that to market. I'm quite confident, we'll build that pipeline. It's just a terrific team with a great capability, but their ability to market definitely was more affected by coronavirus than our already established value clients. In fact the inflows this quarter institutionally had very strong client additions. I think that's important to note. We didn't have a lot of new wins as you would surmise based on my comments with regards to the ability to travel and what's happened with the pipeline. And the fact I didn't even talk about the pipeline a quarter ago. But we had very strong inflows from institutional investors when the markets were beaten down which was really nice to see that they had that kind of confidence with us and it bodes well for our relationship in the future.

Sumeet Mody, Analyst

That's really helpful. And then one on the seasonal impacts for tax outflows in the quarter. Has that gotten mostly pushed back to the third quarter? I know you mentioned this a little bit last quarter. I just wanted to see if there was any effect there on tax.

Rick Hough, Chairman and CEO

Yes, that's a great question and insightful of you to ask because you're correct. Typically, there’s a considerable amount of headwind at the end of the first quarter or into the second quarter as people raise cash to cover significant tax payments. It's uncertain what the tax impact will be, but I think it’s prudent to note that there will be outflows in the third quarter, since most tax payments have likely been deferred until September. We've already seen some cash being raised. This cash is currently recorded as assets under management and hasn't been disbursed yet for taxes, as clients will also be making quarterly tax payments. It can be challenging for us to grasp fully since tax situations vary widely among individuals. However, I wouldn't be surprised to see the delay effect you mentioned.

Sumeet Mody, Analyst

Okay. Great. And then just one more for me. You saw a nice bump in kind of discretionary fee rate in the quarter. Can you talk about the drivers there? How should we think about that for the remainder of the year?

Rick Hough, Chairman and CEO

Yes. You might find my answer amusing or frustrating. I don't believe you should factor in or consider it too much. Our fee rate has fluctuated between around 57 and 63 for 18 years and has remained at 59 for quite a while. This is mainly influenced by market conditions. During major sell-offs, equity values drop significantly, making our overall fee basis more reliant on fixed income, and the opposite occurs in a bullish market. It's not solely about the business we win; larger mandates typically lead to lower fees, which is expected. Bigger institutional business arises from these large mandates with less need for support, further reducing our fee basis, which is a good problem to have. I would like as much AUM as possible, even at a slightly reduced fee rate. OCIO would show a similar trend. There is a slight potential for a downward trend. Interestingly, our continued growth in the high net worth sector balances this out. Yes, we were a bit higher this quarter. It's challenging to align your model with what we're currently experiencing in reality. Another factor affecting the fee basis is new flows in the quarter and newly added AUM, as they generate stub period revenue. If you are calculating your fee basis based on period AUM without including these additional stub period revenues from new AUM, that could explain some of what you observed in the last quarter regarding the fee basis increase. I assure you, it's simply one of those nuances of the business. Given the market performance and new assets under management, I anticipate that, in the long term, we'll stay around the 60 basis points to high 50s range, with high 50s being more realistic recently. I don't expect that to change unless we have very substantial institutional inflows or OCIO business that outpaces new business from the high net worth side. That’s also a high-class problem. So it's quite difficult to provide guidance, but I'm optimistic about where we stand. I've mentioned fee pressure previously, which is crucial to consider, as many competitors and asset management firms are experiencing fee decompression. We're facing all the challenges those firms encounter on the institutional side. However, when we entered the institutional business in the latter half of the 2000s, many fee compression trends were already established, so we were competitive with our pricing. We haven’t seen additional fee pressures on the business we've acquired, which is significant. There’s no downward spiral from what we currently have. The same applies to the OCIO business; we've only recently entered that space, so we're entering it at prevailing market prices. On the high net worth side, a key distinguishing feature of our model is that we often manage assets for our clients while also providing wealth management advice. This means that if our clients utilize our internal services, we don't charge a second fee. For a single fee, we're offering both wealth management and asset management. Since 18 years ago, and even five years ago, Silvercrest has provided substantial value to clients compared to competitors who need to outsource client assets and impose a second external management fee. In that scenario, the fees tend to get reduced for the asset allocator or wealth manager. While we do have pure open architecture clients and fee arrangements where we outsource everything and compete with open architecture firms, our ability to charge one inclusive fee has provided a significant competitive advantage, which appears low to many competitors, coupled with our high-performing equity and fixed income capabilities, as highlighted in your note.

Sumeet Mody, Analyst

Okay. Great. Thanks. It's really, really helpful color. And with that, I leave it there. Thanks.

Rick Hough, Chairman and CEO

Yeah. Thanks a lot. I appreciate it.

Operator, Operator

And our next question today comes from Sandy Mehta with Evaluate Research. Please go ahead.

Sandy Mehta, Analyst

Thank you. Good morning. Congratulations on a solid set of results, and strong investment performance across the board. You mentioned that, you've hired several new portfolio managers or portfolio management talent, in New York. Is this for new products? Is this for client service, or are you adding to existing fund management teams?

Rick Hough, Chairman and CEO

This is exclusively focused on managing wealth for high net worth families. Due to the specific service needs of this business, we aim to keep a manageable client load per portfolio manager. At Silvercrest, our portfolio managers offer more than what might be considered a relationship manager or wealth manager at other firms; they are true investment professionals. This might cause some confusion regarding the terminology, but their role is purely to serve new high net worth families. For our established partners managing wealth assets, there's a threshold beyond which adding more families can lead to compromises in service quality. Our firm must continue to pursue organic growth, which includes hiring new talent. We brought on one new portfolio manager this year—possibly two—and have added a total of two others in the last one to two years. This illustrates our recent and ongoing hiring efforts, and I anticipate that we will continue this trend in New York and beyond. In a challenging M&A environment, we have been focusing on finding compatible cultures, people, and business models at reasonable prices for our investors and shareholders. As you know, we've been concentrating on organic growth in the wealth sector, which necessitates staffing. We have made investments in both the institutional and OCIO businesses, and I have recently shifted my focus to investing in the wealth management sector.

Sandy Mehta, Analyst

Okay. And just one final question, given the market environment, market volatility and the economic volatility due to COVID, are you seeing more opportunities on the acquisition side? I know you talk to people all the time, but is that creating possibly more opportunities for you?

Rick Hough, Chairman and CEO

No. I don't think it is. So it's kind of funny. If the market had sustained its trough after the speed decline, I think two things would have happened. One, you would have had a lot of stress on players in the industry that have really levered off and used cheap debt to foster what I consider pretty expensive acquisitions and it would have perhaps changed how they looked at acquisitions or their ability to do so, if it were sustained. Secondly, there could have potentially been a resetting of prices for what in many cases, in my experience, are declining annuity businesses without succession planning and a host of other business issues. That didn't happen. The snapback was very fast and a lot of recovery and didn't provide an opportunity in either of those fronts. The other thing that happens, of course, when the markets fall down a lot, especially with closely held proprietorships, which are endemic in this business, is that people can take their firms off the market and just wait for a recovery. So we didn't see that cycle at all. It's just continued as if it were 2019 in many respects. The cheapness of financials in general in the market, it's been a sector that's really struggled for quite some time. And the attractive cash flow characteristics of these businesses, has turned the attention of investors to it. And so the demand has not gone away. And in addition, I would say that to move the needle at this firm in places I want to be, with business models that work with us, that allow us to consistently then organically grow after an acquisition. It's a pretty tall order anyway. We're very selective, which is why we've always concentrated on organic growth. We are always in conversations. There are still firms out there that we’re talking with that we would do a deal with when the timing's right, but the volume of what I'm seeing has not been any more attractive than what I see recently.

Sandy Mehta, Analyst

Great. Thank you.

Rick Hough, Chairman and CEO

You’re welcome.

Operator, Operator

Our next question comes from Chris Sakai with Singular Research. Please go ahead.

Chris Sakai, Analyst

Hi. Good morning. I just had my question regarding if you could share some light on the high net worth client acquisition environment. Just want to know what were some factors there that led to the growth?

Rick Hough, Chairman and CEO

Yes. I'm glad you asked the question, because my experience going through the great financial crisis was that, high net worth investors during that period of time really stuck with the people or management, wealth managers that they were already invested with. It's a relationship business and in that environment it was better the devil you know than taking a chance on someone new. Of course, at the time the firm was six, seven years old when we were going through that crisis and in quite a different position from an AUM perspective as well and stature in the business. But the snapback then, not unlike the snapback now, then allows people to get comfortable, again, with what their wealth management was doing. This time is different and I can't quite tell you why. I expected, along with the institutional pipeline, for the wealth management opportunities to freeze up in this environment. It's a relationship people business. We love meeting our clients and seeing them face-to-face, let alone new prospects. And I have been quite surprised at the amount of interest from high net worth investors this time around. I think a couple of things have changed. Number one would, of course, be technology. All of us have gotten used to video calls and the lack of travels and meetings. And our clients and high net worth investors are no different and they've been willing to do that and engage us. Secondly, I think we've seen people in this particular environment, which is a non-financial crisis, but a societal crisis, people reassessing fundamental things in their lives, relationships and what have you. And there are a couple of incidents with regards to new business, where, I know, that has been a driving factor. A third one, this time around, at least, with a couple of prospects I'm aware of, is that some of the roll-up RIAs and larger very aggressively growing businesses that are aggregating businesses, are either taking their eye off the ball or are pushing product, or giving a sense of insecurity to their client base, because we are seeing opportunities from other RIAs. Very often the business we have won have been from the wirehouses and bullish bracket banks. We are now seeing opportunities not just there, but from some of our competitors. And I think that is an element in what's happening right now. So we don't track a pipeline for the high net worth business. It's a little bit too serendipitous and uneven to predict. It can take years to land a family. It can take two weeks. It just doesn't have the same process that the institutions do, but I will say that the second quarter was pretty good. And that opportunity has not abated, so I look forward to further organic flows there.

Operator, Operator

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

Rick Hough, Chairman and CEO

Well, thank you very much. Appreciate the opportunity to have some pretty good questions this quarter. We're proud of what we achieved and we're able, in this environment, to continue progress with organic growth. And, of course, we're very grateful for the markets revaluing assets, which is something we can do nothing about, but certainly helps the business and allows us to continue making investments, rather than being quite so conservative about concern for the future, which is good news. And in the wake of market volatility and the potential for market volatility, we're going to continue making those investments and focusing on organic growth, while we're keeping an eye out for the right kind of acquisition, not unlike what we did with Cortina last year, which was just terrific. So, thank you very much for your interest and for the questions and I look forward to speaking to you next quarter. Thanks.

Operator, Operator

And thank you, sir. 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 day.