LPL Financial Holdings Inc. Q1 FY2021 Earnings Call

Good afternoon, and thank you for joining the First Quarter 2021 Earnings Conference Call for LPL Financial Holdings Inc. Joining the call today are our President and Chief Executive Officer, Dan Arnold; and Chief Financial Officer, Matt Audette. Dan and Matt will offer introductory remarks, and then the call will be open for questions. The company would appreciate if analysts would limit themselves to one question and one follow-up each. The company has posted its earnings press release and supplementary information on the Investor Relations section of the company's website, investor.lpl.com. Today's call will include forward-looking statements, including statements about LPL Financial's future financial and operating results, outlook, business strategies and plans as well as other opportunities and potential risks that management foresees. Such forward-looking statements reflect management's current estimates or beliefs and are subject to known and unknown risks and uncertainties, as that may cause actual results or the timing of events to differ materially from those expressed or implied in such forward-looking statements. The company refers listeners to the disclosures set forth under the caption Forward-Looking Statements in the earnings press release as well as the risk factors and the other disclosures contained in the company's recent filings with the Securities and Exchange Commission for more information about such risks and uncertainties. During the call, the company will also discuss certain non-GAAP financial measures. For a reconciliation of such non-GAAP financial measures to the comparable GAAP figures, please refer to the company's earnings release, which can be found at the investor.lpl.com. With that, I will now turn the call over to Mr. Arnold.

Thank you, Kirby, and thanks to everyone for joining our call today. Over the past quarter, our advisors continue to be a source of extraordinary support and guidance for their clients. At the same time, we remain focused on our mission of taking care of our advisors so they can take care of their clients. This combination positions us to deliver another quarter of solid results while also continuing to make progress on our strategic plan. I'd like to review both of these areas, starting with our first quarter business results. In the quarter, total assets reached a new high of over $950 billion, up more than 40% from a year ago. This increase was primarily driven by continued organic growth and equity market appreciation. With respect to organic growth, first quarter net new assets were $29 billion, which included $12 billion from BMO Harris Financial Advisors. This result translated to double-digit annualized growth of 13%, driven by continued strength across new store sales, same-store sales, and retention. First quarter recruited assets were $24 billion, which includes $15 billion from BMO. This result brought our total recruited assets over the past year to a new high of $56 billion. Our continued progress on recruiting is primarily driven by the appeal of our model, our ongoing innovation for the future, and the expanded flexibility of our platform. At the same time, we further enhanced the advisor experience through continued delivery of new capabilities and technology as well as the ongoing modernization of our service and operations functions. As a result, asset retention remained solid at 98% in the first quarter, and Net Promoter Scores increased year-over-year. Our first quarter business results led to solid financial outcomes with $1.77 of EPS prior to intangibles and acquisition costs. Let's now turn to the progress we have made executing our strategic plan. As a reminder, we have evolved our long-term vision. We aspire to expand beyond our old vision of extending our leadership in the independent space and redefine the independent model over time, and by doing so, become the leader across the entire advisor-centered marketplace. Our approach is to build a platform that is simple and straightforward for advisors to use with the flexibility to construct the perfect practice for themselves and their clients. This approach breaks down the walls between traditional market segments and instead focuses on creating total empowerment for LPL advisors to thrive. That is the heart of our mission. Doing this well gives us a sustainable path to higher levels of organic growth, increased market leadership, and long-term shareholder value creation. To execute on our strategy, we have organized our work into four strategic plays, which I'd like to review with you in turn. Our first strategic play involves meeting advisors where they are in the evolution of their practice. By winning in our traditional markets while also leveraging new affiliation models to expand our addressable markets. Strategically, we believe this combination positions us to not only deliver sustainable and repeatable organic growth but to also increase our growth rate over time. In our traditional markets, overall industry advisor movement remained at lower levels in the first quarter, but we continue to gain share and grow our pipeline. Looking more specifically at the regional bank segment of our financial institution channel, we onboarded BMO Harris Financial Advisors in late March. We continue to prepare for M&T to join in the next few months, and we advanced conversations with additional prospects. With respect to the expansion of our addressable markets, we continue to see momentum building in our new affiliation models. Earlier this month, we onboarded two new practices to Strategic Wealth Services, bringing us to a total of seven on the platform. Earlier this week, we added another advisor to our employee-based model. Looking ahead, we feel good about our pipeline for both of these models. Another key component of this strategic play is using M&A as a complement to organic growth. Regarding our acquisition of Waddell & Reed's wealth management business, we now have commitments from Waddell & Reed advisors who serve approximately 95% of client assets. We are engaging closely with these advisors to help them prepare to transition to LPL and begin leveraging our platform to serve their clients and grow their businesses. Our second strategic play focuses on providing capabilities that help our existing advisors differentiate in the marketplace and drive efficiency in their practices. One of the key components of this play is enriching the end-client experience. Advisory platforms are increasingly at the center of the end-client experience as the secular trend toward advisory continues in our business and across the industry. Given this, we remain focused on providing our advisors with an industry-leading advisory platform, including a number of recent enhancements. Within the quarter, we introduced simplified pricing and lowered account minimums on our centrally managed platforms. We also expanded our no-transaction-fee ETF product offering, which now serves about 40% of ETF assets in advisory accounts. At the same time, we are introducing new platform capabilities in the spirit of creating a differentiated UMA offering that combines multiple centrally managed portfolios within a single account. These enhancements increase the appeal, accessibility, and flexibility of our advisory offering, which in turn supports our advisors' efforts to serve their clients and win in the marketplace. Let's next move to our third strategic play, which involves creating an industry-leading service experience to delight advisors and their clients, and that, in turn, helps drive advisor retention. A key component of this strategic play is transforming our service model into an omnichannel client care model that provides our advisors with differentiated service. In Q1, we completed the rollout of live chat as a complement to our voice channel. Advisors now have a choice of either voice or chat to efficiently connect with a service professional who is trained and certified to answer their specific question. Our next step is completing the rollout of our digital self-service experience, which, together with voice and chat, will position advisors to access industry-leading service at a time and in a manner that works best for them. We also continue to automate and streamline key elements of our service operations. In Q1, our area of focus included enhancing the administrative support around tax season, digitizing forms, and automating account transfers. Enhancements in these areas are helping strengthen the advisor experience and the scalability of our platform as our business grows. By remaining focused on the transformation of our service model into a client care model and continuous improvement through the automation and streamlining of our service operations, we believe we are making positive contributions to the service experience, advisor retention, and Net Promoter Scores. Our fourth strategic play is focused on helping advisors run the most successful businesses in the independent marketplace. One of the key components of this play is our portfolio of business solutions, which help advisors operate their businesses so they can focus on serving their clients and growing their practices. As we discussed last quarter, we see several pathways for continued business solutions growth, including partnering with more of our advisors, introducing new solutions to the portfolio, and experimenting with serving advisors outside LPL. In the first quarter, our subscription base continued to scale to about 1,700 monthly subscriptions, generating annualized revenue of approximately $19 million. This growth was primarily driven by our ongoing expansion and evolution of the value proposition of our existing portfolio. Looking at our product roadmap, we continue to enhance our existing portfolio of solutions, while expanding into new offerings. In Q1, we launched M&A solutions, which is generating solid demand, including over 50 advisors who are leveraging this offering today. In Q2, we plan to introduce our seventh business solution, Client Engage. This evolved from our existing marketing offering and is focused on providing advisors with a digital approach to effectively and efficiently stay connected with their clients. As we look outside LPL, we plan to begin marketing M&A solutions later this year. By experimenting with this scalable technology-driven solution, we can efficiently learn from serving outside advisors while continuing to focus our resources and investments on delivering business solutions to LPL advisors. Before closing, I also want to highlight that we released our 2021 sustainability report last week. We believe operating a sustainable business is good for all of our stakeholders. We hope this report provides helpful insight into our practices and performance. In summary, in the first quarter, we continued to invest in the value proposition for advisors and their clients, while driving growth and increasing our market leadership. As we look ahead, we remain focused on executing our strategy to help our advisors further differentiate and win in the marketplace, and as a result, drive long-term shareholder value. With that, I'll turn the call over to Matt.

All right. Thank you, Dan, and I'm glad to speak with everyone on today's call. As we move into 2021, we remain focused on serving our advisors, growing our business, and delivering shareholder value. This focus led to the highest quarter of organic growth in our history. Additionally, we are in the midst of onboarding three of our largest partners in BMO, M&T, and Waddell & Reed. We expect these three partners to collectively add approximately $100 billion of AUM to our platform, bringing our total AUM to over $1 trillion. Now let's turn to our first quarter business results. Total advisory and brokerage assets increased to a new high of $958 billion, up 6% from Q4, driven by continued organic growth and higher equity markets. Looking at organic growth, total net new assets were $29 billion, which translates to a 12.8% annualized growth rate. Before large bank onboarding, organic growth was 7.6%. Moving on to recruiting and retention, we continue to produce strong results in the first quarter. Recruited assets in Q1 were the strongest in our history at $24 billion, which included $15 billion from large bank onboarding. These results brought our 12-month recruiting total to a new high of $56 billion. Looking at retention, it remained strong at 98.1%. I would also note that we updated our retention metric to reflect asset retention rather than our previous method of production retention. We believe this change will be more helpful in evaluating our business results, and we have provided historical data in our Key Metrics presentation, so you can see both the old and new metrics. Moving on to our business mix, we continue to see positive trends in Q1. Advisory net new assets were $23 billion or a 20% annualized growth rate. With this growth, our advisory assets are now 52% of total assets as we continue to deliver differentiated advisory capabilities and benefit from the secular trend toward advisory. Now let's turn to our Q1 financial results. Strong organic growth combined with expense discipline led to EPS prior to intangibles and acquisition costs of $1.77. Looking at our top line growth, gross profit reached a new high of $579 million, up $46 million or 9% sequentially. Looking at the components, commission and advisory fees net of payout were $184 million, up $31 million from Q4, primarily driven by organic growth and seasonally lower production expenses. Moving on to asset-based revenues, sponsor revenues were $168 million in Q1, up $14 million sequentially as average assets increased due to organic growth and higher equity markets. Turning to client cash revenues, they were $97 million, down $8 million from Q4, driven by lower client cash yields. Looking at client cash balances, they remained elevated at $48 million, roughly flat with last quarter. Regarding client cash yields, our Q1 ICA yield was 99 basis points, which is down nine basis points from Q4. The decrease during the quarter was primarily driven by fixed-rate and LIBOR-based contracts that matured and lower short-term interest rates. Looking ahead to Q2, we will have the full quarter impact of $0.5 billion of fixed-rate contracts maturing in Q1 as well as another $1 billion of fixed-rate contracts maturing in Q2. Given these factors and where interest rates, client rates and cash balances are today, we expect our Q2 ICA yield to be in the mid-90 basis points range. I would also note that we have no additional fixed-rate contracts maturing in the second half of this year. Moving on to Q1 transaction and fee revenues—they were $141 million, up $11 million sequentially, driven by trading volume that increased throughout the quarter. Looking ahead to Q2, trading activity in April has declined from the elevated levels we saw in Q1. If this trend continues through the quarter, we expect transaction revenue to decline by about $10 million. Turning to Business Solutions, they continue to scale with 1,700 subscriptions at the end of Q1. This is up 300 from last quarter and more than double from a year ago. These offerings now generate roughly $19 million of annual revenue, up from $17 million last quarter. More importantly, they help free up additional time for advisors to spend on more valuable activities, including serving their clients and growing their practices. Now let's turn to expenses, starting with core G&A. It was $236 million in Q1. Looking ahead, we anticipate full year 2021 core G&A to be in the range of $975 million to $1 billion. As a reminder, this includes costs to support BMO and M&T but is prior to expenses associated with Waddell & Reed. Moving on to Q1 promotional expenses, they were $54 million, up $6 million sequentially, primarily driven by increased transition assistance from higher recruiting and large bank onboarding expenses. Turning to Q2, we anticipate promotional expenses to increase by approximately $5 million prior to Waddell & Reed, primarily driven by increased transition assistance and large bank onboarding expenses. Regarding share-based compensation expense, it was $11 million in Q1, up from $8 million in Q4. Looking ahead to Q2, we expect share-based compensation expense to be at a similar level to Q1. Turning to depreciation and amortization, it was $35 million in Q1, which is up $7 million sequentially as several improvements to our advisory platform and end-client experience were rolled out sooner than anticipated. Looking ahead, we expect depreciation in Q2 to be in line with Q1 levels. Now let's move to Waddell & Reed. The transaction is progressing better than we originally estimated across multiple fronts. As mentioned, Waddell & Reed advisors serving approximately 95% of client assets have committed to join our platform. Factoring in this higher level of retention and current asset levels, we expect the run rate EBITDA benefit from Waddell & Reed to be at least $80 million, up from our original $50 million estimate. As a result of the higher retention, we now expect $110 million of acquisition costs, up from our original estimate of $85 million. These updates bring our estimated purchase multiple to five times EBITDA, an improvement from our original estimate of 6.5 times EBITDA. Now I want to provide an update on our expected close timing. Over the past several months, we have had strong collaboration with Waddell & Reed and Macquarie, and we have received the required regulatory approvals. As a result, we anticipate closing the acquisition of Waddell & Reed's wealth management business as early as tomorrow. We continue to expect to onboard the advisors a few months after closing. Looking ahead, we are focused on providing transparency on the progress we are making on the transaction. With this in mind, we will share Waddell & Reed financial results in two primary categories. First, to provide more clarity around our results, we have added an acquisition cost line item to our management P&L. Looking at Q2, we expect roughly one-third of our total acquisition costs to be incurred during the quarter. Second, we will keep you updated each quarter on how we expect EBITDA to build as we progress toward hitting the full run rate benefit by the middle of 2022. In Q2, we expect annualized negative run rate EBITDA of approximately $10 million as we add resources to prepare to support Waddell & Reed. Moving on to capital management, starting with our debt refinancing. Given the continued strength of our business, combined with the low-interest rate environment, we were able to refinance our highest-cost debt from 5.75% to 4%, reducing our annual interest expense by $13 million. We also increased the size of our revolver from $750 million to $1 billion. As for capital deployment, our framework remains focused on allocating capital aligned with the returns we generate, investing in organic growth first and foremost, pursuing M&A where appropriate, and returning excess capital to shareholders. In the near term, we continue to expect the majority of our capital deployment to be focused on organic growth and M&A as we onboard BMO, M&T, and Waddell & Reed. Once we have completed these transitions, we plan to reassess our capital deployment opportunities. If at that time we have excess capital to deploy beyond organic growth and M&A, we would anticipate restarting share repurchases. That said, we will have to see what our options look like at that time. In closing, we delivered another quarter of strong business and financial results. As we look forward, we remain excited about the opportunities we see to continue investing to serve our advisors, grow our business, and create long-term shareholder value. With that, operator, please open the call for questions.

Okay. Thank you very much, and good evening, everybody. So maybe, Dan, to start off with you. It seems like I'm seeing from the headlines in your comments that there's been an acceleration in both Strategic Wealth Services and building on the independent play side. What's changing at the margin here? Is it just time, or maybe a sense of peel back a layer on what’s been the incremental change in the marketplace that's resonating better?

Yes, Bill, thanks for the question. And as a reminder, we just launched these last year, SWS in April and then the employee model in the second half of last year. As you know, it takes a bit of positioning in the marketplace, seasoning, iterating on your value proposition as you learn and get feedback, bringing on clients, and then having a good experience and being able to use them as a reference to future prospects and considerations. We've also continued to invest and enhance the talent on our business development team. So a combination of those things are driving a bigger pipeline, better positioning out in the marketplace from a competitive standpoint, building on existing clients who are having a good experience, and then finally using that quality talent to execute. So that's a similar concept for both. SWS or Strategic Wealth Services is a bit ahead of the independent employee model only because it started several months earlier, but you can see them on a similar trajectory. I hope that helps.

Yes. Thanks. And then maybe one just for Matt. I guess one of the themes that's been coming out is sort of this excess liquidity in the system overall. I think you mentioned in the last quarter as well. Can you sort of maybe update us on your thinking on how to track through fixed to float or float to fix, I should say, and the ability to sort of drive the third-party sweep opportunity?

Yes. Sure, Bill. I think that maybe just starting with our strategy and goals here, which are really unchanged, specifically on the fixed-rate deposit side, which is really to get to a place where 50% to 75% of the portfolio is fixed. So I think from a long-term perspective, that's where we're headed. But to the point of your question and similar to last quarter, when you look at the amount of liquidity in the system right now, there's very little demand for deposits. That said, I think you're starting to see some early indicators of that changing and maybe really early indicators, but things like the yield curve starting to steepen, right? The 10-year moving up, where, for those banks that are on the demand side of these deposits, there's some economics in the spread for them to invest it. Consumer spending picking up, right? There's trillions of dollars in savings and checking accounts that's built up over the pandemic. As that spending picks up, that returning back into the market is one of the things that could lead to that demand. So if those trends continue, I think those are some of the things that could change and improve that demand. But I’d emphasize we’re not seeing that pick up today. But I’d end with, I think, our long-term strategy of moving into that 50% to 75% fixed zone. When there is demand, we feel good about being able to execute it then.

Next question comes from the line of Steven Chubak of Wolfe Research. Steven, your line is now open.

Hey, Dan, Matt, good afternoon. I wanted to start off with a question on M&A and the appetite for more transformational deals. In August '17, you announced the NPH transaction. You retained about 70% of the assets as part of the deal. Since then, you've made a lot of enhancements, whether it's investments in digital or just to the platform more broadly and fast forward to Waddell, and now you've retained 95%. Given the stronger retention and favorable experience with Waddell, I'm curious whether that increases your appetite to do more transformational deals as a much higher retention significantly impacts some of the future deal math?

Yes. So Steven, it's Dan. We continue to see M&A from a strategy standpoint as a complement to our organic growth, and as you know, we look across the lens of growth opportunities or acceleration of capabilities. That hasn't changed in our overall strategy. We believe that if we're good at executing on these transactions, then that becomes an interesting differentiator and an opportunity for us in terms of how we might structure a deal, value a deal, etc. We are staying disciplined in ensuring with every acquisition that we learn from those and apply those insights and learnings so we can execute better the next time. If you look at the drivers of the difference in these two transactions, I think most of it were activities that we control or drive, where we maybe didn't execute as well back in 2017, '18, and we did much better today. Activities such as being able to automate and streamline the transition of assets and advisors moving from one place to the next. You take the friction out and help them continue to focus on their clients, creating a more appealing scenario. Our ability to deliver a strategy in a simple and articulate manner to help advisors understand what that experience would be like, what their structure, what their economics will look like post-transaction, and doing it at pace and clarity, you begin to create the right dialogues very quickly that lead to good outcomes. These are examples that we continue to learn, evolve, and get better at executing. So as we go forward, to your point, do we think there's continued consolidation, both in what I might call the smaller transactions and larger transactions? Yes. Would we continue to have an opening and exploring and potentially participating in some of that consolidation? I think based on our strategy, the absolute answer would be yes. To the extent that we get better at executing on these, we will use that insight perspective and advantage to think about how we consider approaching them.

Thanks for that color, Dan. For my follow-up, I wanted to ask about the centrally managed platform. The assets grew organically at a very impressive 47% rate. It looks like the bulk of the increase in the quarter was tied to the BMO onboarding. I hope you could speak to what drove such strong demand for the centrally managed product from those advisors. Should we expect a higher ROA on those assets given the more attractive economics of centrally managed?

Yes. Steven, you made a great observation regarding solid growth in centrally managed platforms. You're continuing to see strong baseline growth and utilization of that platform increase, right? That didn’t change in the first quarter across our entire platform. As we invest and add capabilities, investment content, and lower prices, we expect those centrally managed solutions to only become more appealing. When you complement that with BMO's utilization of centrally managed solutions, that creates a really interesting opportunity for us to expand and grow our centrally managed platform, even unique capabilities we may put inside that are helpful and supportive of large institutions. The robust centrally managed solution aligns excellently with a platform responding to market needs, and this generates higher ROA with more advisory and utilization of those centrally managed platforms. Today, BMO's business is about one-third advisory, two-thirds brokerage. As we move forward, our platform is positioned well to help them evolve their business to best serve their clients.

Hey, good afternoon, everybody. I was hoping to focus on the retention stats you provided. It looks like you guys are running at about 98% overall retention on the assets. It’s quite a bit above where we've been historically. I believe Dan mentioned the pandemic might be a factor. It feels like it's sticking around. What are your updated thoughts on whether we're entering a new paradigm with retention of the assets being as high as it's been recently?

Yes, absolutely. If you look back historically, three years ago, you saw a retention rate in the 96% range. Over the last 12 months, we've seen retention in the 97.5% level. We've observed good stability in that 97% to 98% range for the better part of the last three quarters, indicating good staying power beyond the pandemic as you return to what I might call normal movement of advisors in the marketplace. We’re encouraged by that. We continue to invest in the model to improve that service experience, expand capabilities, and deliver those to our advisors such that it helps them operate an efficient and effective practice, serve their clients, and grow their businesses. Expect retention rates to be sticky. For us, we aim to manage that within the 97% to 98% range, which we feel is a solid and sustainable outcome if we're fulfilling our commitment to client service.

On expenses, starting with core G&A, it was $236 million in Q1. Looking ahead, we anticipate full year 2021 core G&A to be between $975 million and $1 billion. This includes costs to support BMO and M&T but is prior to expenses associated with Waddell & Reed. Our share-based compensation expense was $11 million in Q1, up from $8 million in Q4. Looking ahead to Q2, we expect similar levels to Q1.

You guys are growing so incredibly fast right now. Can you talk about how you feel about the platform from a capacity perspective? Do you have the services in place to support the incremental growth you're seeing?

That's a great question. It goes back to our mission; we need to support our advisors so they can take care of their clients, which requires platform stability and providing them the necessary capabilities to create efficient workflows and differentiate with their clients. We've been diligent in planning for growth and ensuring we have the technology and engineering capabilities to scale our platform. Our operating metrics track our daily activities, ensuring our platform operates effectively during periods of growth. It’s crucial for us to listen to feedback, and if there’s an area for improvement, we address it quickly. We aim to invest in technology and automation that enables us to scale. By deploying robotics, AI, and machine learning, we can continue to enhance our offerings and support our growth.

Circling back to Business Solutions, I’m curious if you’ve tracked any data points around the overlap among advisors in relation to the different solutions. If adoption of one such as an admin solution or CFO solution could work as a gateway to additional services, have you seen that metric develop?

That’s a great strategic insight. We are seeing a trend that once an advisor engages with a service, if they're successful, they’re more likely to use additional offerings. We’re iterating on our product portfolio and expanding offerings. As we assess our service quality, we can provide advisors with high-quality services at a lower cost than local alternatives, creating a compelling advantage that can drive further engagement across the suite of services.

Thanks for taking my question. Following up on Waddell and the profile of what it will look like, can you give guidance on whether financial advisors will ramp over time or if assets will come on board in mass? How should we think about revenues and expenses when modeling this?

We did some updated disclosures in our key metric materials regarding Waddell's mix when we announced the deal, which was a little over 50% brokerage, and about 45% advisory. Onboarding will happen in mass a few months after closing, leading to gross profit synergies, followed by integration work to generate expense synergies, which we expect will take about a year from close. You can refer to the details in our slides for a clearer view of the expected path from here to hitting the run rate EBITDA.

Relative to your gross profit point, since this is an acquisition, the ramp is different from a standard recruiting scenario. The assets and advisors will transition over in mass, making it different from typical gradual transitions. If we close tomorrow, the assets and advisors would come over in a weekend, allowing for quick ramp-up.

There are no further questions at this time. I will turn it back to Mr. Arnold.

Thank you for taking the time to join us this afternoon, and we look forward to speaking with you again next quarter. Stay safe.

Thank you so much for our presenters and everyone who participated. This concludes today’s conference call. You may now disconnect. Have a great day.