LPL Financial Holdings Inc. Q2 FY2022 Earnings Call

Good afternoon and thank you for joining the Second Quarter 2022 Earnings Conference Call for LPL Financial Holdings Inc. Joining on the call today are 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 has posted its earnings and press release and supplementary information on the Investor Relations section of the company's website. Today's call includes forward-looking statements, including statements about LPL's financial future 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 that may cause actual results or the timing of events to differ materially from those expressed or implied in such forward-looking statements. For more information about such risks and uncertainties, 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 other disclosures contained in the company's recent filings with the Securities and Exchange Commission. 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.

Thank you for joining our call. Over the past quarter, we remain focused on our mission of taking care of our advisers so they can take care of their performance. Amid persistent market volatility and geopolitical uncertainty, our advisers reinforce the value they provide to clients by helping them navigate times of uncertainty. In that spirit, I want to recognize our advisers for their continued care and dedication to their clients, especially when they need it most. Our second quarter business results led to a solid financial outlook. At the same time, we continue to make progress on our strategic plan. I'll review both, starting with our second quarter business results. Total assets decreased to $1.1 trillion as continued solid organic growth was offset by lower equity markets. The business continued to perform well despite market volatility. Second quarter net new assets were $37 billion, which included $25 billion from CUNA and represented 13% annualized growth. These quarterly results contributed to a 10% organic growth rate for the past 12 months. Recruited assets were $44 billion in Q2, including $32 billion from CUNA. This brought our total recruited assets for the past 12 months to $84 billion, up $4 billion from the same period a year ago. Our advisers continue to focus on serving clients and differentiating their solutions in the marketplace. While market volatility led some clients to moderate activity in the quarter, periods of heightened uncertainty often reinforce the value of professional advice and serve as a catalyst for advisers to grow their products. With respect to retention, we enhanced the adviser experience through delivering new capabilities and technology, as well as the ongoing modernization of our service and operations. As a result, asset retention was approximately 98% in the second quarter and for the past 12 months. Our second quarter business results led to solid financial outcomes of $2.24 of EPS prior to intangibles and acquisition, an increase of 21% from a year ago. Now to turn to our strategic plan. Our long-term vision is to become the leader across the entire advisor-centered market, meaning being the best at empowering advisers and institutions to deliver great advice to their clients and to be great operators of their businesses. To bring this vision to life, we are providing the capabilities and solutions that help our advisers deliver personalized advice and planning experiences to their clients. Doing this well gives us a sustainable path to industry leadership across adviser experience, organic growth, and market share. We have organized our work into four strategic plays which I will review. Our first strategic play involves meeting advisers and institutions where they are in the evolution of the business by winning in our traditional markets and leveraging new affiliation models to expand our addressable markets. Our recruiting in traditional markets continued to be a source of growth in Q2 with approximately $9 billion in assets. We've continued to increase our win rates and expand the depth and breadth of our pipeline, notwithstanding a broader slowdown in adviser movement over the past couple of quarters. Historically, during elevated market volatility, advisers focus on supporting existing clients and may pause strategic decisions like switching firms. However, after advisers have acclimated to the conditions, they often consider new options for their practice, creating an opportunity for us from a recruiting standpoint. In this environment, we recruited over $2 billion in assets in Q2 and believe we are well positioned to drive continued growth across all models. The second quarter saw a new high for recruited assets in our employee model, as the value proposition has proven to be compelling. As a complement to our organic growth, we announced the acquisition of the Private Client Group business at Boenning and Scattergood, which we will onboard to our employee model early next year. We onboarded CUNA in May and are on track to onboard People's United later this year. We continue to learn from each experience to drive innovation that improves the transition to LPL and make our offerings even more appealing. As we look ahead, we expect to continue winning in this market as demand for our model grows. Our second strategic play is focused on providing capabilities that help our advisers differentiate in the marketplace and drive efficiency in their practices. As part of that focus, we continue to enhance ClientWorks, our core operating platform with digitized workflows. In Q2, we introduced enhancements to our Move Money solution, making it easier and more automated for advisers to support deposits and withdrawals within client accounts. Our transformation efforts are focused on four clearing functions, including money movement, account opening, and account transfer, which drive the majority of our operational process. By expanding automation of these critical processes, we increase the scalability and efficiency of our platform while enhancing the client experience. Our third strategic play focuses on developing a services portfolio that helps advisers and institutions deliver comprehensive advice to clients. In Q2, our subscription base ended at nearly 3,900, with sequential growth moderating slightly. As we work with advisers on existing services, we continue to identify new needs, stimulating further innovation that expands our existing services' value propositions. I believe our second quarter business results reflect our continued investment in the value proposition for advisers and their clients while driving growth and increasing our market leadership. Looking ahead, we remain focused on helping our advisers differentiate and win in the marketplace to drive long-term shareholder value. With that, I'll turn the call over to Matt.

Thank you, Dan, and I'm glad to speak with everyone on today's call. In the second quarter, we remained focused on serving our advisers, growing our business, and delivering shareholder value. Against the volatile market background, we delivered another quarter of solid net new assets and earnings growth. We progressed the work to enhance our suite program utilizing free credits to create the client cash account. We substantially completed the integration of Waddell & Reed, signed an agreement to acquire Boenning and Scattergood, onboarded CUNA, and are preparing to onboard People's United. As we look ahead, we remain excited by the opportunities to help our advisers differentiate and win in the marketplace. Now, let's turn to our second quarter business results. Total advisory and brokerage assets were $1.1 trillion, down 8% from Q1, as continued organic growth was offset by lower equity markets. Total net new assets were $37 billion or a 13% annualized growth rate. Looking more closely at recruiting, Q2 recruited assets were the strongest in our history at $44 billion, which included $32 million from CUNA. These results brought our 12-month total to $84 billion. Now, let's turn to our Q2 financials. The combination of organic growth, rising interest rates, higher client cash balances, and expense discipline led to EPS prior to intangibles and acquisition costs of $2.24, which was up 21% from a year ago. Gross profit reached a new high of $711 million, up $42 million or 6% sequentially. Commission and advisory fees net of payout were $205 million, down $22 million from Q1, primarily driven by seasonal production bonuses and lower advisory fees following the Q1 equity market decline. In Q2, our payout rate was 87%, up about 90 basis points from Q1 due to seasonality. Looking ahead to Q3, we anticipate our payout rate will increase to roughly 88%, driven by typical seasonal builds. Sponsor revenue was $208 million in Q2, down $4 million sequentially as average assets decreased during the quarter. Client cash revenue was $156 million, up $71 million from Q1. Overall client cash balances were up, ending at $70 billion. We saw improvements in bank deposit demand, leading to increases in balances. We'll be focusing on how to enhance and expand our services portfolio better to support our advisers and drive growth. In closing, we delivered another quarter of strong business and financial results. We remain excited about opportunities to continue investing to serve our advisers and grow our business.

So Matt, maybe we’ll just start off with some of the cash sweep dynamics. In one of the slides, you referenced that the deposit betas on subsequent hikes beyond 100 basis points are running a little bit lower than what you experienced in the last cycle. Could you offer your thoughts on why that is? Is it just the pace of rate hikes has been too fast and we’re going to likely play a little bit of a catch-up? Or do you think there’s a reason to believe that, that’s more sustainable? And maybe just as a follow-up to that, would love a comment on appetite for additional fixed duration as we saw you guys have done in the quarter?

Sure, Alex. I think the operative point on that slide is the betas in the prior cycle. Given how much cash is in the system, I’m not surprised the betas have been better. I emphasize that the pricing of the product is likely similar to last time, which indicates it's not really a rate-sensitive product. Regarding your second question about fixed, our objective remains to get into a range of 50% to 75% of the portfolio on the fixed rate side. The key driver for our ability to achieve that really depends on demand coming back. Even though we added some fixed rates this quarter, due to growth, we still ended up at about 25% fixed rates. Given the current environment, we believe demand is building for fixed rates as the Fed raises rates and reduces the money supply. Therefore, that will likely lead to more overall sweep demand and some fixed rate management.

I'll take that one, Alex. Look, if you examine the quarter closely, we saw solid new store activities. In our traditional markets, the newly recruited models showed robust activity, even with some diminishing relative to prior quarters. We believe this is largely due to the current macro backdrop. As advisers adjust to this environment, they will begin to consider new options for their practice. Thus, these conditions generally create opportunities for us. The retention levels remain stable at around 98%, which gives us confidence looking forward.

I wanted to unpack a recent announcement that you made in hiring Bill Sappington. Can you speak to the decision around the new hire? It certainly sends a strong signal that you're focused on growing some of your banking and lending solutions. What’s the long-term revenue opportunity here, especially since your advisers haven’t historically utilized that lending product?

From a strategic standpoint, we are attempting to solve for two opportunities. We hear from our advisers an appetite to broaden their value to clients and provide more of what we might call a holistic approach to the overall advice spectrum. Thus, it makes sense to think about bringing lending capabilities into the overall client experience. By enabling this process, we create economics around it that are strategically appealing. We are actively seeking experienced leadership to operationalize this concept and execute on it, creating value for our advisers and their clients.

I want to dig into the pool of advisers in motion today. What are you seeing in terms of M&A properties? Is there any affiliation model that people are gravitating towards in this current environment?

In terms of the opportunity, there's been less movement than historical norms in the overall marketplace. Questions around performance and growth often persist and with our strong pipeline of solutions, we proactively attract new advisers. We're committed to making our offerings appealing through continuous enhancements to our model and addressing the unique needs of our advisers. I believe we are seeing a growing interest in our models particularly among those who value the independence from traditional structures.

Can you give us a little insight into the stickiness of the subscriptions and the renewal terms on your services? How do you see the longer-term opportunity with these products?

Our subscriptions generally have a one-year contract to start. This gives advisers enough time to evaluate the service's value without a long-term commitment. We have high retention rates for our services, and our aim is to continue creating awareness while expanding our solution offerings to better serve advisers and foster deeper relationships. Understanding advisers' needs allows us to innovate and provide value, contributing to their businesses' overall success.