RF Capital Group Inc. (RCG) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the RF Capital Group Second Quarter 2022 Earnings Conference Call. I would now like to turn the meeting over to Mr. Rocco Colella, Managing Director, Investor Relations. Please go ahead. Mr. Colella.

Thank you, operator. Good morning, everyone, and thanks for joining us today. Welcome to our second quarter 2022 earnings call. If you have questions following this call, please reach out to Investor Relations. My contact information can be found at the end of our earnings release issued last evening. Before we get started, I would like to remind you that this call is being webcast and available for subsequent replay. Today's remarks may contain forward-looking information, and actual results could differ materially. Forward-looking information is subject to many risks and uncertainties. Certain factors or assumptions applied in the forward-looking information can be found in our latest AIF and MD&A. As always, these documents are available on our website and at sedar.com. This morning, our President and CEO, Kish Kapoor, who is in our Montreal office today; and our CFO, Tim Wilson, who is with me here in Toronto, are on the call. Kish will provide opening remarks and key takeaways from the most recent quarter. Tim will then cover financial results. Kish will end with closing remarks, following which we will open the call to questions from analysts. I will now turn the call over to Kish Kapoor.

Thanks, Rocco, and good morning, everyone. Market conditions during the second quarter were the most challenging since 1970. The S&P/TSX Composite Index and the S&P 500 fell 13.8% and 16.4%, respectively, during the quarter. This contributed to a $3 billion decline in our AUA in the second quarter, wiping out most of the gains we enjoyed in 2021. As a result, our fee-based, transactional, and capital markets revenue were all down sequentially. But on the positive side, as a result of average AUA being higher on a year-over-year basis, fee-based revenue were up 6% from the second quarter of last year. Offsetting these declines was a significant increase in insurance revenues from $0.5 million last year to $9.2 million this year. One large insurance contract, the largest in our history and one closed by a recent team that joined us in Montreal, accounted for most -- in fact, accounted for much of the growth. And more generally, many advisers are now including insurance in their core financial planning services. A further positive was the 83% increase in interest revenue in Q2 to $8.1 million. Interest revenue was higher because of rising benchmark rates. The net effect of these factors resulted in our total revenues rising to $91 million in the quarter, a new high for us. Furthermore, adjusted EBITDA also climbed to a historic high of $16.6 million on a consolidated basis and $18.3 million in Wealth Management. While we are pleased with these results, especially since they highlight the benefit of increasing revenue diversification, we remain cautious about our outlook for the coming quarters, like many in the financial services industry. Market sentiment remains weak, and this is likely going to have a protracted impact on our AUA, revenues and EBITDA for the coming quarters. That said, we remain excited about our business and are executing our 3-pillar growth strategy successfully. From a strategic standpoint, 3 new advisers joined our firm during the second quarter, and we lost 1 to a competitor. We're making great strides in making many of our promises and expect more advisers to join us in the coming quarters. I would like to take this opportunity to welcome the following advisers, [ Blight Homes and Joanna Calder, Matteo Verrilli and Carolyn Saint Marie and Michael Talon ]. In addition, we're encouraged by the $3 billion in growth in our recruiting pipeline, which has now reached $21 billion. A highlight in our strategic progress was launching Envestnet this quarter. So far, the feedback from our advisers has been very positive. As you might expect, though, with the project this size and scope, there remains more work to be done in terms of training and helping them to use the sophisticated portfolio management platform. Outsourcing our carrying broker operations to Fidelity's uniFide platform is proceeding as planned with the conversion scheduled for December 31. This conversion will complement our launch of Envestnet nicely. Our advisers told us that at end of year conversion makes the most sense for them and their clients. It simplifies tax reporting and allows more time for customizing the platform. Last month, we hosted our first in-person adviser conference at Richardson Wealth. Over 200 people representing 85% of AUA attended the conference in Winnipeg in-person and 700 more participated virtually. Due to our firm's deep roots and a proud history, a conference team was appropriately titled back to the future. And Winnipeg was an obvious choice since it was there where our growth story began nearly 2 decades ago. We received excellent feedback from our advisers about our progress, which reassures us that we are on the right track and inspires confidence in our future. This feedback is consistent with what we heard from our valued IA teams, our clients during our coast-to-coast road show that started in Sydney B.C. and ended this past week in Charlottetown PEI. Even though the markets are challenging, people are encouraged by the progress we're making and cared enough to share their ideas and their concerns on how we can do more to better serve them and help manage the significant pace of change at our firm. Personally, I find their constructive criticism and thoughtful input the key to our success as it helps allocate resources and priorities to the areas of greatest impact. Turning to our shares, we remain disappointed by the performance, which has only been made worse by the drop in the equity markets. We've been active under our NCIB during the quarter, repurchasing 16,000 shares for cancellation and a further 6,000 shares to date in July. The NCIB gives us the ability to return capital to shareholders by repurchasing shares when the market price does not fully reflect their value. All-in-all, the events of the past few months have been challenging for all. In this environment, we see our advisers investing more time helping their clients navigate the current market environment. And we're squarely focused on supporting them in doing so. With that, I'll turn the call over to Tim.

Thanks, Kish, and good morning, everybody. As mentioned earlier, our investments in strengthening our organization and diversifying our revenue sources paid off this quarter. Adjusted EBITDA increased by 24% to $16.6 million. The increase was fueled by a 15% rise in revenue to $91 million and positive operating leverage. Wealth Management's adjusted EBITDA grew by 18% to $18.3 million. In that business, the operating margin rose to just over 20%. Let me expand on the 3 key drivers of revenue growth highlighted by Kish. Interest revenue grew by 83% to $8.1 million. We earned more on our cash balances and margin loans as benchmark rates rise. With interest rates expected to rise even further in the second half of the year, we anticipate interest revenue to increase from Q2 and contribute to further EBITDA growth. Insurance revenue was $9.2 million, up from $500,000 in Q2 of last year. While insurance revenue will likely be lower in future quarters because of the one material contract that we closed in Q2, we expect to continue building our insurance business more broadly, thanks to our growing pipeline of opportunities. Additionally, fee revenue was up by $3.4 million or 6%. Higher average AUA contributed to this increase. As a result of volatile market conditions, our AUA ended June at $33.9 billion, approximately the same as last year. But because of the pattern of increase last year and decreased this year, the average, which is what drives the revenue was up by 5%. Sequentially, AUA was down $3.2 billion or 8.7% with about half of the decrease occurring in June. We do not expect markets to stage a recovery this year. We believe the pressure on fee revenue will continue into Q3 and Q4. That pressure will be partly offset by the addition of new advisory teams. Corporate finance revenue was down 59% because of weak new issue activity across the industry. We participated in 65 transactions this quarter compared to 149 in Q2 of last year. Companies have paused capital raising activities due to the challenging market conditions. We do not expect the activity to pick up significantly in the second half of 2022. Now let's talk briefly about expenses. In comparison with a 15% increase in revenue, adjusted operating expenses were up by 11%. The increase was led largely by higher compensation costs. We experienced a 14% increase in this area due to annual inflation adjustments, challenging labor market conditions and general hiring to support business growth. We also saw an increase in share-based compensation expenses in connection with the deferred compensation program that was implemented in Q1 2021 after Richardson Wealth became fully owned by a public company. These deferred compensation grants best and are amortized into income over 3 years, so the program costs are still ramping up. Until the program reaches steady state in 2024, cost increases will continue to be more significant. In support of business growth, SG&A increased by $1 million or 8% across a variety of categories. Part of the increase was driven by a return to work and a return to business travel. As we look into the future, we will continue investing responsibly in our business to support our growth goals. As mentioned earlier, the conversion to Fidelity's uniFide technology platform will take place on December 31. Outsourcing our carrying broker operations will result in an annual estimated EBITDA benefit of just under $10 million, including $6 million of run rate cost savings. As well, our cost base will become more variable, and we will be able to achieve greater scale faster as a result of this initiative. We will begin to realize these benefits in January 2023. Now let's look at the key balance sheet items. We continue to have strong capital levels. At the end of June, we had $104 million in total net working capital and $10 million to $15 million of excess. As stated previously, we expect to drive down on that excess this year to finance our growth plans. Combined with positive operating cash flow and our credit facility, we have ample capital to support all of our growth initiatives. This includes supporting existing advisers, recruiting more, repurchasing shares under our NCIB and acquiring businesses if the opportunity presents itself. So overall, it was a really solid quarter. And because of our performance year-to-date, we still expect full year adjusted EBITDA for 2022 to be higher than in fiscal 2021 despite the challenging market conditions. This expectation is, of course, subject to broad market conditions. Our ability to deliver on our promises and support our advisers remain strong as we enter the second half of 2022, and we continue to believe that the foundations we are laying will translate into long-term shareholder value. Now I'll turn it back to Kish for closing remarks.

Thanks, Tim. There are 2 common threads in all transformative strategies like ours. First, a commitment must be made to deliver. And second is that one must have the discipline and courage to stay the course amid market disruptions. And rest assured, we intend to do both these well. With the strong commitment of our Board, our people, our management team, to our long-term goals and our success to date, I'm confident we're building the brand that all our shareholders can be proud of and one that we believe will, in time, create sustained value for all. Thank you for joining us today, and we look forward to updating you on our progress in the coming quarters. I'll now turn the call back over to Rocco.

Thanks, Kish. That concludes our formal remarks this morning. Operator, we are now ready to open the call to questions from analysts.

[Operator Instructions] The first question is from Jim Byrne from Acumen Capital.

Congrats on the solid quarter. Kish, maybe you could just talk about what you're seeing on the competitive environment, just hearing a couple of anecdotes through some friends and clients just about increased competition, even the banks getting more involved in recruiting. I just wanted to see what you're seeing out there and how confident you are in your pipeline conversion?

Well, thanks for the question, Jim. Thanks for attending the call, especially on a Friday just before a long weekend. We see that the competitive landscape was actually pretty solid. We see a lot of activity amongst independents being very successful in engaging in conversations with people working at bank-owned firms, telling the story about the strength of independence. And I see, in fact, and hear stories of pretty much all the independents enjoying success like us in attracting people to the firm. And in terms of the banks, I think banks have never really stopped recruiting and they're always a force to be reckoned with. But I think the market is so big. I think what have we got Rocco today, some $5 trillion size of the pricing in Canada that is expected to double by the end of 2030. That in the context of this growing market and even though it's disruptive now, I think there's a lot of money in motion. A lot of people are listening to the stories of the independents. And there's a very healthy, both competition and movement amongst various organizations. So maybe there's a little bit of a slowdown because of the market, people are a little concerned about moving when having to have a conversation with the clients because the portfolios are down. But when you look at our pipeline, having grown by $3 billion, we're seeing a lot of activity, a lot of people having the conversations, planning whether it will be this quarter, next quarter or the third quarter. Everybody is starting to explore all of their options. So I would say it's a very healthy environment. I don't know, Tim, do you want to add anything to that?

No, that's exactly right. I'd say more broadly, we remain committed to our recruiting goals. Our desire to bring in approximately $2 billion of new recruits per year. And we believe that the efforts that we're making on that front are really paying dividends as we see our pipeline continuing to grow.

And Jim, our -- Natalie, this is who heads up our corporate development team, tells me, in the last while we met more billion-dollar teams that have had conversations with us than we had in a long time. So these are all good signs. And some of these calls that we're getting now are all inbound, which is also very meaningful and interesting.

Okay. Maybe just kind of a 2-part question. I thought, remind me if -- maybe I was mistaken. The Fidelity conversion, is that a move to December 31 from kind of October, if that's not the case and that I'm mistaken? But and then also maybe just an update on spending, capital spending for your office space in Toronto?

Right. So on the Fidelity, we always said it was going to be in Q4. We had 2 windows on when we would move to Fidelity. It was either early in Q4 or late in Q4. And we decided that for a variety of reasons, including the advice that we got from our IAs, that a smoother transition for clients, it simplifies tax reporting, it's a much cleaner cutoff from one system to the next system and that there was just an overwhelming consensus that we should migrate at December 31 for that reason. And also, we've had a fairly significant amount of change within our organization, including people embracing and adopting Envestnet and all of the training. And taking all of that into account, we felt that it was absolutely prudent to not take the first window, to take the second window. And the second window of December 31 we think, especially in discussions we also have with Fidelity makes the most amount of sense. And so that's why we picked that. And with respect to the second question, and perhaps I can turn that over to Tim to answer.

Yes. So the move to the Toronto office continues to move along quite well and within our plans, even with all the disruptions that have happened with supply chains and the construction labor market in Ontario. So we're pleased with how that's moving along and we're scheduled to start moving in at the beginning of October. With that, obviously, we are spending money. The original capital budget was a little over $20 million, and we probably outlaid about 1/3 of that so far. And then as I mentioned in my remarks, we expect to use our excess capital, our excess working capital this year, and a good portion of that will actually be on the Toronto office in the move.

[Operator Instructions] The next question is from Jeff Fenwick from Cormark Securities.

So Kish, just wanted to start off with the insurance sales you had going on in that one sizable one you called out in the quarter. And I just want to see what -- that's a much more sizable, I guess, commission off of that than I might have expected. Can you just run us through like what type of insurance product was that? It was just like a very large -- is someone using P&C against the business they own within your group or is it aa life insurance contract? Or any color you can offer up there? Just a bit larger than I would have thought you might see.

So Jeff, let me just step forward and answer that question first, and then Tim can add to it. You recall that last year around April of 2021, we had launched our own MGA after terminating the relationship with [ BPI ]. And our team did an extraordinary job in building a good platform to be able to support our advisers, including hiring a number of consultants to assist and to support and also negotiated really good contracts with 8 life insurance carriers, a direct contract so that our opportunity to provide better service to advisers, better compensation to our advisers, all of that was done by the end of September of last year. And we started seeing not only a greater adoption of insurance strategies within organizations through a lot more financial plans being done. Identification, I think, we have probably more cases this year than last year. In fact, our total insurance revenues at the end of June are about $12 million, all of 2021 was $6 million. So we're already doubling that trend. And what we were also very fortunate to have experienced this year is recruiting and attracting a lot of talent from firms where financial planning was at the heart of everything, and people who had deep insurance capability and some of the people that have joined us in the recent past that came to us from the Investors Group, have a very significant understanding. And one of them that joined us here in our Montreal office is a very sophisticated adviser, did some very sophisticated planning for ultra-high net worth family and as a part of their overall estate planning for multiple generations. He used very sophistic to called mine mapping. He was able to persuade them and get them to understand the benefits of insurance for their family for multiple generations, and they bought essentially a life insurance policy for a variety of members of the family. And I think they've only done half of it now, and they will probably do another half later next year maybe. But he is engaged in a lot of activities like this as are now some of our other advisers, and that's what we're seeing some of the success. Does that help you frame what our insurance plan is?

It does, yes. And I guess the trick is always trying to benchmark against a reasonable expectation on progression from here. As you mentioned, you're up year-over-year nicely, and it looks like you probably had 1 contract though that really [ moved the needle ] by several million dollars. So you don't want to bake in an assumption like those come along and they are nice to have, and you've got people capable of doing it, but that's not your standard sort of result, I guess, we'd expect.

No, no. And you're right, asset management fee-based business is easier to predict and forecast. Insurance is not, but it's a great business to be in. Right now, our revenues are somewhere between 1.5% of growth are in insurance. Our strategy and goal is to get that to 7% to 8.5%. It may take us 3 years to do that. But we obviously are recruiting people that understand it, are knowledgeable enough to actually explain it to clients. So all of that is in the right direction, but I agree that in modeling it is harder to do.

Fair enough. And then maybe we can switch over to the recruiting pipeline and maybe connect it in with the move over to Fidelity and Envestnet, everything sort of fully baked in here through the end of the year. What are the prospects saying to you around how much that influences their decision to move? Do they want to wait until that's settled? I mean, obviously encouraging to see several teams come over during the quarter in a period of volatility. I thought that was impressive to pull that off. So what's the feedback there? Are they waiting for the most timely period in terms of you being operationally prepared for them to step in and we can expect things maybe to accelerate after that happens? Or how should we think about that?

That's a good question, too. So we expect -- there are a few teams that will, in fact, join us early in Q3, well in advance of our move to Fidelity. And I'm going to say a few teams, you know 2 to 3 teams to join us early. But the bulk of the teams that have expressed a strong interest in joining our firm, really were going to join us as soon as Fidelity was implemented. And so those teams we will likely announce the joining us in January and February 2023 and not in November or December of this year. So it's a mix of both. There are people who are -- feel that their business will be -- that they can take advantage by joining us now relative to where they are. And they think that Fidelity is just going to be a benefit and they'll be able to cope with the disruption. They'll move quickly. But other sizable practices are going to be a little bit more cautious, especially with the market as well. And while they're completely committed and ready to come, they've told us, look, we just think it's more prudent for us to come in January and February 2023, and we are accommodating. Because we think about our business in the long term, I'm not going to push anyone to come in at a time which is not perfect for them. And if we end up having to wait several quarters before they come, that's okay. We just have to get the Fidelity decision done right, make sure there are 164 teams well transitioned over, they don't have any significant disruption. And likewise, when new people come on board, we want to make sure that their experience also is extraordinary. So if I look back here on the end of Q2 of 2023 or Q1 of 2022 and said, thank God, we waited for Fidelity and we've digested. I'm going to be good with that.

That's helpful color, and it makes a lot of sense. Maybe we could just touch on the run rate of the G&A in the business. You called out some inflation there, and then there's a bit of pressure everywhere, I know on wages currently. And you are speaking to higher G&A through the back half of the year versus last year. How should we think about that in terms of sequentially from here? I know you've had some initiatives underway and probably some added spend as you're ramping up your -- on your various things that you've got on the go there. Is the G&A likely decline progressively than over the remainder of the year? And then I know you stepped down a bit with the Fidelity at the start of next year.

I'm going to get Tim to answer that question, but I just want to give you one overarching statement is that, while we see everything else that's going on in the industry with respect to the market, there really is still a war on talent going on in the country. People are very aggressive in hunting for talent, paying for talent, and we have not been immune from suffering the consequences of that. At the beginning of the quarter, we lost more people than we expected. And it was hard for us to find replacements. In fact, when we made 7 offers, we only got 2 successful candidates for replacement. But towards the end of the quarter, the trend started reversing where we put out 10 offers and we got all 10. And so, we're starting to attract talent back again. So there's been ebbs and flows in the war in talent and some of which are reflected in the numbers, and Tim can speak to that. So over to you, Tim, for that.

Thanks, Kish. It's a great question, Jeff, given the trends that we see in the business year-over-year. But when you look at it sequentially, I don't actually expect much growth in SG&A over the remaining quarters of the year. We continue, obviously, to invest heavily in the business and growth initiatives. But I think I would call that if I look forward, the number should be flat to very modestly up.

There are no further questions registered at this time. I will turn the call back to Mr. Colella.

Thank you, everyone, for joining us today. As always, please feel free to reach out to Investor Relations, if you have any further questions. Have a great long weekend. Stay safe. Thank you.

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.