Good morning and welcome to the Victory Capital Third Quarter 2023 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'll now turn the call over to Mr. Matthew Dennis, Chief of Staff and Director of Investor Relations. Please go ahead.

Thank you. Before I turn the call over to David Brown, I would like to remind you that during today's conference call, we may make a number of forward-looking statements. Please note that Victory Capital's actual results may differ materially from these statements. Please refer to our SEC filings for a list of some of the risk factors that may cause actual results to differ materially from those expressed on today's call. Victory Capital assumes no duty and does not undertake any obligation to update any forward-looking statements. Our press release that was issued after the market closed yesterday 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?

Thanks, Matt. Good morning and welcome to Victory Capital's Third Quarter 2023 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, Director of Investor Relations. I'll start today by providing an overview of the third quarter. After that, I will turn the call over to Mike to review the financial results in detail. Following our prepared remarks, Mike, Matt, and I will be available to take your questions. The quarterly business overview begins on slide five. We reported strong financial results for the third quarter. Revenue, including adjusted EBITDA earnings and margin, net income, and earnings per diluted share all rose sequentially from the second quarter and we achieved the highest levels for each of those metrics thus far in calendar year 2023. Our margins remain robust with adjusted EBITDA margin coming in at 51.1% this quarter, which underscores the strength of our operating platform in all market environments. This was the 13th quarter in a row that we achieved margins above our long-term guidance of 49%, and it was the ninth quarter over that period that we reported margins of 50% or higher. Adjusted net income with tax benefit rose to $1.18 per diluted share in the quarter, a 6% increase over the $1.11 per diluted share that we reported last quarter. Long-term net flows improved from the second quarter, with outflows declining to $1.7 billion in the third quarter. I would also note that our gross redemptions are the lowest that they have been in the past eight quarters. Although we are in an environment where many investors have chosen to either invest in cash and cash equivalents or to pause allocations, we are seeing some significant green shoots with several of…

Thanks, Dave, and good morning, everyone. The financial results review begins on slide 10. Assets under management at quarter end were $153.5 billion. Average assets under management rose 2.4% in the third quarter compared with the second quarter. Our fee rate was steady at 51.6 basis points. Revenue of $209.7 million in the third quarter was up 2.7% compared to the second quarter. The higher revenue benefited from the higher average AUM as well as one extra day in the quarter. GAAP operating income was $80 million, and our adjusted EBITDA rose to $107.2 million, as adjusted EBITDA margin expanded 20 basis points to 51.1% in the third quarter. Quarterly net income was $52 million or $0.77 per diluted share on a GAAP basis. And adjusted net income and tax benefit rose quarter-over-quarter to $79.8 million or $1.18 per diluted share, up 6% from the second quarter. Dave already covered accumulating cash to enhance our flexibility and strengthen the balance sheet during the quarter. This accumulation resulted in cash increasing to $108 million at quarter end. Further to this point, in October, we monetized our floating to fixed interest rate swap locking in the gains from that arrangement, which generated $43 million in cash. From an accounting standpoint, the gain will be realized on a straight-line basis as a decrease in interest expense through the end of the swaps term in July of 2026. Our net debt to adjusted EBITDA ratio improved to 2.1 times at the end of September, reflecting the growth in adjusted EBITDA and our lower net debt. We returned $21 million to shareholders in the quarter in the form of cash dividends and another $7 million with share repurchases. Our Board of Directors declared another quarterly cash dividend of $0.32 per share. This next dividend will…

Thank you. [Operator Instructions] Your first question comes from the line of Craig Siegenthaler of Bank of America. Your line is open.

Good morning, Dave, Mike. I hope everyone is doing well. My first one is on M&A. So with $140 million of cash on hand today after the floating to fixed swap monetization, can you update us on the M&A pipeline? And are you holding more meetings with Prospects today than six months ago? And any commentary on valuation multiples would be helpful, though? Thank you.

Good morning, Craig. First, let me start off on the pipeline. The pipeline for the last year or so has been pretty full. And we've been having lots of meetings. I wouldn't say that the meetings have increased. What I would say is, and I said this in our prepared remarks, that I feel like the ability to execute has gotten a lot better and really us monetizing our hedge and us building cash is a reflection of where we think we are in the cycle and how close we are to potentially doing a transaction. That being said, nothing is imminent, and we also look at our capital strategy very opportunistically. And so we had historically, at least this year, bought a lot of shares back and continue to pay a dividend. I wouldn't say that we wouldn't be buying shares back going forward, but we want to make sure that we have a balance sheet that's flexible to execute in a really timely manner.

Thanks, Dave. Just as my follow-up on the SMA and other flows of $440 million in the quarter. Within the $440 million, I was wondering if you have the mix or could provide some color between trust, wraps, UMA, UCITS, any other vehicles that I may be missing because that's been a nice growth engine for you guys. And then within those sort of sub-buckets, which one do you expect to be the biggest flow contributor in 2024?

It's all primarily WestEnd, the WestEnd Advisors franchise. And really, that is when we bought -- we purchased that business, our thesis really was -- is that we thought the model business within the large platforms in the industry, that was going to increase and that they were well positioned, and that's happened. And so primarily, where we think going forward is we think it's all going to be on the model side.

Dave, thank you.

Your next question comes from the line of Etienne Ricard of BMO Capital Markets. Your line is open.

Thank you and good morning. So lots of discussion on the potential to return to positive net flows in fixed income across the industry. So in this environment, how do you think about promoting your fixed income strategies, both across the direct and retail channels?

So over the last few years, we have really spent the time to build out our distribution channels for the Victory Income Investors franchise. And where we've spent the time from a marketing, from gaining access to different platforms and really shoring up the platform. And as we said in our prepared remarks, we did consolidate the INCORE franchise into at least from a brand perspective into the Victory Income Investors franchise. And we think having one brand, the scalability of that brand and really consolidating all of our efforts under that brand will really help us when some of these investors come off the sidelines and get out of cash or decide to allocate back to traditional fixed income. I'd also add, one of the best ways to prepare for it is to have really, really good investment performance. And if you were to look at the Victory Income Investors franchise and look at our performance, it's excellent across the board. And I think that's really the best preparation for it.

Okay. And just to circle back on M&A, can you give us a sense of the potential size of transactions you're looking at? And would you be willing to maybe close multiple transactions in a relatively short period of time? Or would you prefer to stick to your historical one transaction per year track record?

We really have -- if you go back and look historically, we have done large transactions, I'd say, medium size and small. And we've always said that because we've built such a great platform, we have the benefit of looking at multiple sized transactions, and that's how we look at it, where the transactions have really impacted us have been on the larger side and also on the smaller side. Historically, if you go back years ago, the beginning of our ETF business was a very small acquisition, which has grown nicely over the last eight years. From how many, we have had where we've done three, I think at the end of 2021 into 2022, we closed 3.25 or at least in the back half of the year. And then we've had situations where we have done one and then it's been a few years in between. I'm not in a position to say how quickly, what the size would be and how many in a year, we're really looking at it on an opportunistic basis.

Great. Thank you very much.

Your next question comes from the line of Adam Beatty of UBS. Your line is open.

Thank you and good morning. Just a follow-up on M&A, not to harp on it too much, but Dave used the word executable a couple of times. And potential interpretation of that is maybe tighter sort of bid-ask spread, sellers kind of getting more realistic on valuation. But those are my words. So I'm just curious, probably no one out there executes M&A in the asset management space as well as Victory. So just curious what you meant by more executable at this stage in the cycle? Thanks.

I think you summed it up nicely. I do think that the bid and the ask spread has tightened. And I think buyers and sellers are much more realistic of what valuation is and potentially being open to structuring. And so my word of executable is really in reference to that.

Excellent. Thank you. I appreciate it. And then just turning to small and mid-cap equities. You guys have significant scale there, a good view on the market. Just wondering how you see the climate right now for small and mid-cap investing and the outlook given some of the recent Fed moves or non-moves? Thanks.

So generally speaking, there is a lot of investor dollars sitting in cash and cash equivalents. I think there's over $7 trillion in money markets. And so a lot of investors have decided at least at this point in the cycle to go to cash, to get the higher return. I do believe going forward that a lot of those dollars will leave the money market asset class and b) either put into fixed income or into higher-risk type assets, including US small cap, including US Midcap. I also think that if you go and look at the small and mid-cap indices, they have not performed up to where the overall market has. So I think that they look like very good potential investments with good returns. We happen to have multiple franchises in US small cap and mid-cap and really feel like we're well positioned there. And I think when the reallocation occurs, some of those assets will fall into those asset classes, and we'll be able to gather some of those assets. So we're pretty excited about that opportunity.

Excellent. Thank you very much.

Your next question comes from the line of Kenneth Lee of RBC Capital Markets. Your line is open.

Thank you for taking my question. Just to round out the discussion on M&A. What's your view -- do you view the cost of financing as a potential challenge in the environment for potential M&A there? Thanks.

I'd start off by saying that when we think of financing, we really think of all the tools that we have, where you have our cash generation, we have the ability to structure. Of course, we can go to the debt markets. And we have, I think, over the past really done a nice job on being creative on how we structure the transactions. The financing costs are up, obviously, over the last 1.5 years. But for us and the way we execute the transactions and the way we look at the transaction, it isn't a hurdle for us, the cost of financing. As we said, we did accumulate cash this quarter, which is the benefit of having a platform that generates a lot of free excess cash flow. And then we also monetized our hedge. And then as we look forward, we'll balance out if we do a transaction, how to go about that. But I don't feel, at least for us, the financing costs are going to be a hurdle to executing the transaction.

Great. Very helpful there. And just one follow-up, if I may. It sounds like New Energy Capital had some positive long-term net flows in the quarter. Wondering if you could just give us an update or your latest outlook in terms of organic -- potential organic growth in that franchise going forward? Thanks.

Hey, Ken, yes, we did mention we had positive flows in the third quarter. We also had positive flows in the second quarter. I think our thesis around the acquisition of New Energy Capital continues to hold. We're bullish about the product set that they have in kind of the private markets with respect to kind of the renewable energy space. Fundraising in the private side in 2023, I think from the industry perspective, has been challenging. However, we're pleased with the progress that we've made to date, and we're excited about the opportunity as we look out. We think what they do is unique and they have a great opportunity to continue to see growth as we move forward. And that really was a thesis for us as we did the acquisition. So we're excited about the opportunities that sit in front of us. And as the industry kind of continues to loosen with respect to private asset raising, we'll participate well there.

Great. Very helpful there. Thanks again.

Your next question comes from the line of Mike Brown of KBW. Your line is open.

Great. Thank you for taking my question. So I wanted to ask about WestEnd here. The growth continues to be really strong there. Can you just give us an update how many platforms that franchises on today? And just maybe expand on some of the recent growth trends there and the potential going forward. Do you still see some more room to ramp on the current platforms? And is there potential to get added on more platforms for WestEnd?

The platforms that they're -- we're currently on when we purchased them, we have been able to go deeper on to those platforms. So we're -- today, we're doing business with a significantly higher number of advisers than they were doing when they were independent. We've expanded the number of platforms that they're on. So not only deepening the relationships with the platforms, but actually expanding the number of platforms. And then we've also expanded out the product set. We launched an ETF, the ticker symbol MODL, which now allows the sales people to offer not just the models, but also an ETF managed by WestEnd. And so there is a tremendous amount of growth from an opportunity standpoint for that franchise. If you think about the current environment that we're in, and we've owned that business at the end of this year, it will be coming up on two years. And to have that platform or that franchise being net flow positive in every time period, and since inception, since we've purchased them is really remarkable and just tells you what the opportunity is for that platform. And again, that was the thesis of the transaction was taking a tremendous franchise that has a great culture and great investment performance and really good distribution and just making it better and scaling it. And I think that we're well positioned, again, when some of these assets move out of cash to really go out and grow. And we also have a desire to expand out the product set there as well, which will only add to the upside opportunity.

Great. Thanks. And then Michael, maybe just a quick modeling one for me. Following the monetization of the hedge, what is the right jumping off point for that interest expense now with the impact of the gain that will come through?

Yes. I think the simple way to look at it is we really locked in at the kind of Q3 rate. So I think we mentioned about 5.6% is the kind of combined interest rate going forward, based on current rates.

Okay. Great. That's it for me. Thank you.

[Operator Instructions] Our next question comes from the line of Ken Worthington of JPMorgan. Your line is open.

Hello. Good morning. This is Michael Cho in for Ken. Thanks for taking my question. My first one, I'm just going to go and ask the cash question as well. Just -- you talked about M&A and investments. I guess just in the event things don't come into fruition near term. I guess how long are you comfortable holding in an elevated level of cash?

I would say that we are going to look at our cash levels very opportunistically. It will be based on the facts and circumstances. We have pivoted quickly to different strategies. We -- at one period in our history, we paid down debt very aggressively and then pivoted to buyback -- buying back our shares. And I would imagine going forward, depending on what's happening at the time, we'll be very opportunistic. We have the flexibility to do that. We still have over $50 million still off from our authorization from the Board on our buyback program that we can utilize. And then -- but we're going to take it really as we always have with the current fact or circumstances.

Okay. Perfect. Thank you. And then just switching gears, just on G&A, I think you called out just kind of slightly elevated in the quarter for particular organic investment opportunity. I'm just curious what was that organic opportunity that drove the quarter? And then I think you listed a number of organic investment areas as you do every quarter, but I'm not sure I heard AI before. So just curious what you're also doing with AI as well? Thank you.

Yes. Thanks, Mike. Yes. There really is no significant -- one significant investment that we made in the quarter. I think we've always said that timing of the investments that we're making really will ebb and flow. So the increase in G&A that you saw was really just a timing aspect. Where we are investing in the business is really around kind of our data and analytics, product development, digital marketing. We're continuing to invest in our direct investor channel. Those are the areas that we continue to invest in and any elevation or changes you see quarter-over-quarter is really just timing with respect to that. And with respect to AI, I think we've talked a little bit about some of the investments that we've made in data and analytics for our retail and intermediary distribution team. We've invested in some proprietary databases that are really making them more effective in the field and utilizing the data that we're capturing from the market from certain dealers. So that's the reference that we're using from an AI perspective, it's really to support our distribution efforts as well as supporting the investment franchises just with providing them more information and more data.

Yes. And it's Dave. I'd like to add one thing is our platform is so unique, which I think you can see from the margins and how we've performed in a really tough industry environment and having guidance at 49%. But one of the things that we think is pretty unique is our investments and the dollars that we invest, I think are as efficient as anybody in the industry given the way we're structured in our platform and how we're scaled at the size we're at. And these investments we're making are very applicable to multiple distribution channels to multiple parts of our business. Our platform isn't complex. And our margins this quarter are 51.1%, and I went through the statistics of 13 straight quarters above 49, nine of them 50% or more. I just think that we have a really unique platform with a great group of employees executing it with a great culture. So when we think about investing, we love to invest. There's lots of places to invest. We're just getting a lot of bang for our buck, if you will.

Perfect. Thanks guys.

There are no further questions at this time. I will now turn the call over to David Brown for closing remarks.

Thank you and thanks for your interest in Victory Capital. Next month, we'll be attending the Goldman Sachs Financial Services Conference in New York City, which is on December 6th, and I look forward to seeing some of you there. Have a great day, and thank you.

This concludes today's conference call. You may now disconnect.