LPL Financial Holdings Inc. (NASDAQ:LPLA) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Good afternoon, and thank you for joining the Fourth Quarter 2022 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 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's financial future financial and operating results, outlook, business strategy and plans as well as other opportunities and potential risks that management foresees.

Such forward-looking statements reflect management's current 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, which can be found at investor.lpl.com.

With that, I'll turn the call over to Mr. Arnold.

Dan Arnold: Thank you, John, and thanks, everyone, for joining our call today. Over the past quarter and throughout 2022, our advisers remain the source of support and guidance for their clients against the backdrop of increased market volatility. In doing so, they reinforce the value of their advice and the important role they play for their clients. We thank them for their continued commitment and dedication as we focus on our mission, taking care of our advisers so they can take care of their client. With respect to our performance, our fourth quarter business results drove a solid financial outlook, while at the same time, we continue to make progress on the execution of our strategic plan. I'll review both of these areas, starting with our fourth quarter business results.

In the quarter, total assets increased to $1.1 trillion as continued solid organic growth was complemented by higher equity markets. With respect to organic growth, fourth quarter net new assets were $21 billion, representing 8% annualized growth. This contributed to net new assets for the year of $96 billion, also representing an 8% organic growth. Recruited assets were $15 billion Q4, bringing our total for the full year to $82 billion. These results were driven by the ongoing enhancements to our model and our expanded addressable markets. Looking at same-store sales, our advisers remain focused on serving the clients and delivering a differentiated experience. As a result, our advisers are both winning new clients and expanding wallet share with existing clients, a combination which drove solid same-store sales in the fourth quarter.

With respect to retention, we continue to enhance the adviser experience through the delivery of new capabilities and technology as well as the ongoing modernization of our service and operations. As a result, asset retention for the fourth quarter and full year was approximately 98%. Our fourth quarter business results led to solid financial outcomes of $4.21 of EPS prior to intangibles and acquisition costs, which brought our full year total to $11.52, an increase of 64% from a year ago. Now let's turn to the progress we made on our strategic plan. As a reminder, our long-term vision has become the leader across the adviser center market, which for us means being the best at empowering advisers and enterprises to deliver great advice to their clients and to be great operators of the business.

Now to bring this vision to life, we are providing the capabilities and solutions to help our advisers deliver personalized advice and planning experience to their clients. And at the same time, through human-driven technology-enabled solutions and expertise, we're supporting advisers in their efforts the extraordinary business. Doing this well gives us a sustainable path to industry leadership across the adviser experience, organic growth and market share. Now to execute on our strategy, we have organized our work into four strategic plays, which I'll review in turn. Our first strategic play involves meeting advisers and institutions where they are in the evolution of the business, by winning in our traditional markets, also leveraging new affiliation models, which expand our addressable market.

In our traditional markets, ongoing enhancements to our platform and the efficacy of our business development team led to continued improvement to our win rates and an expansion of the depth and breadth of our despite adviser movement in the industry remaining at lower levels. As a result, Q4 was our strongest quarter of recruiting in 2022 in our traditional markets with approximately $11 billion in assets. looking ahead, we expect to carry this recruiting momentum into Q1. With respect to our new affiliation models, strategic wealth, employee and our enhanced RIA offering, we recruited over $1 billion in assets in Q4. In each of these models, we continue to see growing demand and expanding pipeline, which position them for increased contributions for our organic growth.

With respect to large enterprises, they remained a meaningful source of recruiting in 2022, including the additions of CUNA and People's United. Looking ahead, we expect to onboard Commerce Bank around the middle of this year and continue to see our pipeline build as demand for our model grows. And at the same time, we continue to have success recruiting in our traditional enterprise channel, including the addition of bank for South in Q4. Within this strategic play, we are also seeing positive early momentum with our most recent innovation of liquidity and succession capability where we are providing a differentiated offer to meet succession needs of the advisers. Over the next decade, it is estimated that up to 1/3 of advisers will be retired and will likely address succession needs of their practices.

To solve for this need, our first innovation was providing M&A support service to help facilitate the transition of practices from adviser to advisory. Our key learnings from that experience, there are many instances due to factors like large practice size or lack of an identified successor that will require a different solution. And without of this need, we created our differentiated liquidity and succession offering, which LPL will step in to purchase an adviser's business and serve as a bridge to the next entrepreneurial successor, all while preserving the principles of independent. The offering has been well received and we are encouraged our early momentum, having already executed on a handful of transactions with providers on our product.

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This year, we will also plan to take the capability to the external marketplace and look forward to sharing our progress. Our second strategic play is to provide capability to help our advisers differentiate the marketplace and drive efficiency in the back. In 2023, we will focus our development of new capabilities and solutions within this play across four key areas. First, we will continue to enhance our wealth management platform to help advisers provide their clients to differentiated advice, products and pricing. Second, we will continue to advance ClientWorks, our core operating platform, with additional digitized workflows to help advisers operate more efficiently and increase their scalability to serve more fun. Third, we will expand our banking and lending services to help advisers address a broader spectrum of the clients' financial needs and thus deepen their role as an essential partner.

And the final area is to enrich the end client experience with additional digital solutions that increase personalization and self-service and enable advisers to create customized experiences for their business. We believe these evolving capabilities will help drive increased adviser growth, productivity and retention. Now let's move to our third strategic play, which is focused on creating an industry-leading service experience that delights advisers and their clients and, in turn, helps drive adviser recruiting and retention. As a reminder, over the past couple of years, we've been on a journey to transform our service model into an omnichannel client care model, including voice, chat and digital support. And as part of this journey, we have evolved the technology and instrumentation of our traditional voice channel while also making meaningful enhancements to our always- on digital support capabilities.

As a result, approximately 75% of engagements with our digital channel fully resolve the service request and don't necessitate a phone call to complete the task. As we continue to expand and refine our digital support channel, we believe that an increasing share of advisers will leverage digital-first support for more flexible and efficient service experience. As we continue to evolve our service interface, we're also transforming the operational processing that takes place behind that interface. For example, last year, we began automating much of the processing for our core clearing, including money movement, account opening and account transfer, which collectively drive the majority of our operational process. And with these learnings from our transformation and service and operations, we are reengineering other areas of the business, including our compliance and risk management.

Out of that end, we've applied robotics and AI capabilities through a number of our compliance review workloads, which has improved both the efficiency of the reviews as well as the efficacy of the overall risk management. Efforts on this front include automating the reviews of client communications, marketing materials and transactions. Now by automating more workflows, we continue to increase the scalability of our platform while also enhancing plan is good. Our fourth strategic play is focused on developing a services portfolio that helps advisers and institutions from driving businesses and deliver comprehensive advice to their client. As we discussed last quarter, we are encouraged by the seasoning of this business and the evolving appeal of our value proposition.

As a result of solid demand, in Q4, the number of advisers utilizing our services group continued to increase. We ended the year at over 3,000 active users, up more than 30% year-over-year and generating run rate revenue of $36 million. Now when we started our services group, we focused on addressing some of the most complex challenges facing our advisers. We were often more acute for advisers with larger practices. With the insights and learnings from this initial client segment, we're now expanding our service portfolio to address the needs of a broader adviser base. As we continue to evolve the offering in 2023, we are focused on several key opportunities for our services group: first, addressing additional channels, specifically building solutions solve for needs of enterprises; second, leveraging our structured approach to innovation in order to continue to develop new services and evolve our existing portfolio; and third, contributing to the growth of our new affiliation models, Strategic Wealth and Linsco, as well as expanding our ability to serve high net worth.

So, in summary, in the fourth quarter and throughout the year, we continued to invest in value proposition for advisers 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 advisers further differentiate and win in the marketplace. And as a result, we have long-term shareholder value. With that, I'll turn the call over to Matt.

Matthew Audette: All right. Thank you, Dan, and I'm glad to speak with everyone on today's call. Before I review our fourth quarter results, I'd like to highlight our progress during 2022. Against an evolving market backdrop, we maintained our focus on supporting our advisers and their clients while executing on our strategic priorities. We continue to grow assets organically in both our traditional and new markets, successfully onboarded new enterprise clients, developed and piloted our new liquidity and succession capability and announced two strategic acquisitions. We accomplished this all while continuing to invest in our industry-leading value proposition and delivering record earnings per share. Now let's turn to our fourth quarter business results.

Total advisory and brokerage assets were $1.1 trillion, up 7% from Q3 as continued organic growth was complemented by higher equity markets. Total net new assets were $21 billion or an 8% annualized growth rate. Our Q4 recruited assets were $15 billion. I would note, this included $11 billion from our traditional independent model, which was the highest quarter of the year. Looking ahead to Q1, our overall pipelines continue to remain strong. In particular, I would highlight that within our traditional models, the momentum we saw in Q4 has continued into Q1, and we are on pace to deliver one of our strongest first quarters in what is typically our slowest quarter of the year. As for our Q4 financial results, the combination of organic growth, rising interest rates and expense discipline led to EPS prior to intangibles and acquisition costs of $4.21, the highest in our history.

Looking at our top line growth, gross profit reached a new high of $972 million, up $135 million or 16% sequentially. As for the components, commission advisory fees net of payout were $172 million, down $10 million from Q3, primarily driven by the seasonal increase in production mode. In Q4, our payout rate was 88.4%, up about 50 basis points from Q3 due to the seasonal build in the production model. Looking ahead to Q1, we anticipate our payout rate will decline to approximately 87% as the production bonus reset at the beginning of each year. With respect to client cash revenue, it was $439 million, up $136 million from Q3 as the impact of higher short- term interest rates more than offset a sequential decline in balances. Looking at overall client cash balances, they ended the quarter at $64 billion, down $3 billion driven by record net buying of $25 billion.

Within our ICA As for Q1, we expect our ICA yield to increase to approximately 315 basis points, which include yesterday's 25 basis point hike at an assumed deposit beta of 25%. As for service and fee revenue, it was $120 million in Q4, down $2 million from Q3. This decline was primarily driven by lower conference revenue, following our largest adviser conference of the year in Q3. Looking ahead to Q1, we expect typical seasonal increases in IRA to be offset by lower comp charge, so we anticipate service and fee revenue to be roughly flat to Q4. Regarding Q4 transaction revenue, it was $47 million, up $4 million sequentially as trading volume increased. Based on what we have seen in Q1 to date, we would expect transaction revenue to be roughly flat with Q4.

Turning to expenses. Our core G&A was $327 million in Q4, bringing our full year core G&A to $1.192 billion. This was in the middle of our outlook range and, for the full year, represents approximately 13% growth. As for our outlook for 2023, our long-term cost strategy remains unchanged. We plan to continue to prioritize investments that drive organic growth and create incremental operating leverage in our core business. As we shared at our Investor and Analyst Day, the current environment is creating opportunities to accelerate our investment plans. As such, we expect to grow our investments at a similar pace this year. More specifically, we plan to grow our 2023 core G&A in the range of 12% to 15%. To share a little more color on where our investments are focused, this expense growth spans the following three broad categories, with each driving approximately 4% to 5% growth in core G&A.

First, to support our core business growth, including investments in technology and capabilities. second, to support growth in our expanded addressable market and to scale our new services. and third, to accelerate the timing of investments that advance our strategy. To give you a sense of the near-term timing of this spend, as we look ahead to Q1, we would expect core G&A to be in the range of $320 million to $325 million. As always, we will remain flexible and can adjust to shifts in the operating. Turning to promotional expense. In Q4, it was $84 million, down $15 million sequentially, primarily driven by lower conference spend. In Q1, we expect promotional expense will increase by approximately $25 million as we have two of our largest conferences of the year during the quarter.

Looking at share-based compensation expense, it was $12 million in Q4, up $1 million from Q3. As we look ahead, we anticipate this expense will increase by approximately $5 million sequentially in Q1 as it tends to be our highest quarter of the year given the timing of our annual stock awards. As for interest expense, it was $37 million in Q4 and up $4 million sequentially as higher LIBOR rates increased the cost of our floating rate debt. Regarding capital management. Our balance sheet remained strong in Q4 with corporate cash of $459 million, up $35 million from Q3. Our leverage ratio was 1.4 time, down from 1.7 time in Q3. This decline was driven by a combination of our continued growth in a higher interest rate environment, both of which have meaningfully improved our earnings power.

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. As we look ahead to 2023, the strength of our balance sheet leaves us with ample capacity to allocate capital across our entire framework. Specific to organic growth, we see opportunities in recruiting and continued investment in our technology platform. On M&A, we see opportunities in the succession offering where we are emerging from the pilot phase and closed four deals in 2022 for around $50 million. With regards to capital return, we plan to increase our share repurchases to roughly $250 million in Q1.

And lastly, we plan to increase our quarterly dividend by 20% beginning in Q1. To summarize, our balance sheet is strong, and we are well positioned to drive value through our capital allocation framework. 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 advisers, grow our business and create long-term shareholder value. With that, operator, please open the call for questions.

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