Envestnet, Inc. (NYSE:ENV) Q1 2023 Earnings Call Transcript May 6, 2023

Operator: Greetings, and welcome to the Envestnet First Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Pete D’Arrigo, CFO. Thank you, Mr. D’Arrigo, you may begin.

Pete D’Arrigo: Good afternoon, everyone. Thank you for joining us on today’s first quarter 2023 earnings call. I’d like to begin by noting that our earnings press release, supplemental presentation and associated Form 10-Q will be available under the Investor Relations section of our website at envestnet.com. This call is being webcast live and a replay will be available for one-month under the Investor Relations section of our website as well. During the call, we will be discussing certain forward-looking information. This information is based on our current expectations and is not a guarantee of future performance. I encourage you to review the cautionary statements on Slide 2 of the supplemental presentation for the potential risks, uncertainties and other factors that could cause actual results to differ from those expressed by the forward-looking statements.

Further information can be found in our regular SEC filings. During this call, we will be referring to certain non-GAAP financial measures. Please refer to the non-GAAP disclosure statement on Slide 3 of the supplemental presentation for an explanation of the non-GAAP financial measures and to the appendix in our supplemental presentation for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures. Joining me on today’s call is Bill Crager, Envestnet’s Chief Executive Officer. Bill and I will provide a company update as well as an overview of the company’s first quarter 2023 results. After our prepared remarks, we will open the call to questions. [Operator Instructions] And with that, I will turn the call over to Bill.

Bill Crager: Thank you, Pete, and thank you, everyone, for joining us this evening. In 2021, Envestnet took a very deliberate stance and announced our strategy to invest in the economic opportunity inherent in our unparalleled client footprint, breadth of services and industry leadership that’s been driven by years of innovation. We understood better than anyone that our clients would need a partner to provide institutional scale that was connected to a powerful ecosystem that enables more holistic advice, connected to more services and more solutions. We are the category leader. We are deepening that position. We are extending market share. We are investing into the growth strategy for the industry and for Envestnet. Despite the macro environment, which includes ongoing banking upheaval and banks do represent an important segment of our client base, the first quarter of 2023 saw very solid results with revenue essentially in line and EBITDA ahead of guidance.

We’ve created leverage that will continue to drive Envestnet’s top and bottom line. We are just back from our annual client conference, our Elevate Summit in Denver, Colorado. A record number of advisers, home office decision-makers and our best partners engaged with our team there. Our clients are telling us that we are delivering a better experience with integrations that are driving business for them. They are saying our infrastructure is the best in the industry. We’re delivering the most powerful operating system, enhancing the broadest set of marketplace solutions, empowering digital engagement tools to more easily connect advisers and clients all made more intelligent with our data. I heard this over and over again in Denver. By utilizing the Envestnet technology, advisers can spend more time offering holistic, connected advice driving deeper client engagement and growth.

Our clients are playing back for us the benefits of our strategy, and it is translating to significant activity in our platform and increased consolidation of their business with us. For more than the past 20 years, Envestnet has been creating long-term value for stakeholders by allocating capital to enable market position and growth, driving industry innovation, creating scale and building sustainable competitive advantage. That’s why we increased our investments two years ago, and it is paying off, both in the deepening market position we have, but is importantly in the operating leverage we’re creating to drive sustained profitability growth. While at the same time, we’re managing costs as we historically have during both good markets and difficult market periods.

Our investment cycle is mostly complete, but we still have some work to do. And while we’re executing on our plan, we’re also making sustained progress towards our margin expansion goals, building on EBITDA growth again this quarter. Market dynamics are important to understand, and I want to frame the environment we operate in, despite the headwinds of the macro period that we’re experiencing. This is a growth market. In the U.S., financial advisers managed an estimated $27 trillion of assets, and the market continues to expand. What’s encouraging is that investor’s willingness to pay for advice has increased significantly over the last decade and it’s highest among consumers in their 30s. This opportunity is a tailwind for Envestnet’s growth.

First, the independent advice channel, where we have our strongest positioning, is growing faster than the overall market. Secondly, in these channels, fee-based assets currently just over half of the industry’s total continues to gain ground. And when you zoom in on those fee-based assets, managed accounts and UMA specifically are growing the fastest. In all industry segments, which also includes technology-enabled offerings and more and more industry utilization of data and insights, the market is moving in Envestnet’s direction. We’re capitalizing by gaining share. In the first quarter, net flows from AUM/A were $20 billion, representing an annualized organic asset growth rate of 11%. These flows are very healthy, especially in the context of the broader industry.

For example, long-term mutual fund and ETF flows across the industry were essentially flat in the first quarter. Looking at annualized organic asset growth for public companies that have reported thus far this quarter, the average growth was between 2% and 6% compared to our 11%. That is considerable outperformance, which we’ve been delivering quarter-after-quarter. This is reflected in more activity, utilizing more services by more advisers. In the first quarter, the number of accounts on our platform grew 4% year-over-year to 18.5 million, and AUM/A accounts per adviser grew 6% year-over-year. Our personalized investment solutions like direct indexing and overlay services continues to grow new advisers and new accounts. We’ve been investing to modernize the platform to deliver for our clients and better integrate their workflows, increasing our operating leverage through automation and processes and monetizing higher-margin solutions.

On the revenue side, yes, we’ll be challenged by choppy markets, but we are gaining share, and that will drive faster organic growth rate in more normalized conditions. We’re going deeper with more clients, cross-selling more solutions in our renewals and winning new logos and new conversions, as well our pipelines and bookings are up significantly since last year. Let me share a few highlights of the impact that we’re seeing this year. Our high net worth solutions; these are comprised of our investment specialists who construct custom portfolios for advisers and their clients. These solutions leverage all the investment products on our platform. To highlight their growth, last year we had $4.5 billion in gross flows from a universe of approximately 12,000 advisers who had access to our high net worth program.

In the first quarter of this year we drove $1.3 billion of flows and project $6 billion in flows in 2023 with a footprint of now approximately 30,000 advisers. We’re increasing firm and adviser access and increasing the penetration of existing high net worth advisers by upselling tax overlay and direct indexing. We expect flows to continue to grow and these solutions carry an average fee rate of 20 basis points to 30 basis points. In the RIA channel, where we have over 2,000 firms using our software we are leveraging our integrated platform to expand the adoption of investment management solutions. We currently have $6 billion of assets, and we forecast $10 billion by the end of this year. As we sell our managed account product, we’ll be able to cross-sell additional investment solutions increasing our revenue opportunity by 10 basis points to 15 basis points.

We’re also beginning to drive adoption of other solutions such as alternatives, insurance and credit. The retirement space is another important growth segment for Envestnet. Fundamentally, we’re making it easier for our core segment of advisers beyond just retirement specialists to provide 401(k) solutions to their end business-owning clients. We’re capturing the regulatory tailwind created by the SECURE Act 2.0 and delivering a simpler, integrated technology and data platform. We’re winning new mandates; we’re winning new logos including agreements with a global wirehouse, and recently announced a partnership with Empower, one of the largest retirement plan service providers in the United States. The adviser footprint including newly signed firms is at 30,000 providing a lift in subscription revenue and expands the opportunity for Envestnet’s fiduciary solutions with fees that range from 3 basis points to 9 basis points.

Lastly, in our wealth data platform, we’ve launched an integrated holistic data environment delivered through digital experiences that make our analytics even more actionable. Our client and prospect pipeline had doubled since September because we are able to cross-sell very unique capabilities like our Insights Engine. The feedback from our clients last week at our Elevate Summit was outstanding as firms want to get insights into their advisers’ hands as soon as possible. Here’s why: today we are publishing 24 million of these insights today across 96 different use cases. Networked to our broad range of solutions, Insights can drive on average a 31% organic deeper wallet share revenue gain in an adviser’s practice, while they deliver better client outcomes and more use of Envestnet solutions.

Today, we serve 106,000 financial advisers on our platform. Today, we know we can grow the average adviser by 31%. And today, more of our clients are asking us to connect them to the Insights Engine because we can help them grow and in turn, Envestnet grows [ph]. In all of these important segments, the tangible proof of our investments, integrating our data in our technology is giving us the right to win and go deeper with more clients. On the expense side, we’ve been modernizing our platform to drive greater operating leverage while managing controllable costs in the near-term. Our investment cycle peaked in 2022. For 2023, our forecast for adjusted operating expenses is down approximately 4% year-over-year despite the inflationary environment.

We are continuing to gain efficiency from modernization. We processed another record number of trades last quarter, 58 million with lower headcount and fewer errors as we continue to automate service requests and reduce the number of support tickets that we serve. We continue to reduce our real estate footprint and optimize our office space. Occupancy costs are down 35% since 2021. We are doing more for more clients than ever before, but we are doing it with more and more streamlined operating infrastructure and fewer personnel. Our data business has begun to leverage an outsourced environment. Our wealth business is beginning to leverage our modernization efforts. The benefits of each of these are just beginning to be experienced in our service model and in our financial results.

Bottom line is this: we’re driving multiple new higher-margin revenue streams, leveraging investments for operating efficiency while carefully managing expenses. All of this will propel us towards our 25% adjusted EBITDA margin target by 2025. We will keep innovating and adding to our ecosystem to drive more and more engagement on the platform, creating greater value for our clients and creating greater distance from our competitors. Let me take a moment to share some very tangible examples. We invested in our next-generation proposal engine, which is a critical piece of technology and at the center of driving more utilization of the platform. And this is rolled out, and by the end of the year it will be live in 5,000 firms covering 77,000 financial advisers.

This is so important because this proposal engine not only has best-in-class user experience, it also allows for personalization of portfolios at scale by fully integrating the entirety of the Envestnet ecosystem, that’s data plus planning, network to all of our solutions, investments, insurance, credit, the entirety of what we offer being available to all of our advisers that speeds adoption, reduces administrative friction and is just one of the ways we are enabling service and operating scale for our company. Our partnership with FNZ is creating tremendous interest in the marketplace and was the highlight in standing-room-only discussion at the summit. Together, we are solving real challenges for the industry and the work we’re doing with FNZ is on schedule.

We are hitting all the milestones on our road map to build out an end-to-end Envestnet plus FNZ technology option. And we expect to be in the market by the end of this year and see gaining traction starting in 2024. To put a little perspective or color around it, in the RIA world, all economics related to custody average around 15 basis points and in the broker-dealer market, around 9 basis points. With FNZ, we’ll begin to participate in those economics for the first time, and the opportunity that we have is significant, exemplified by the $1 trillion plus of annual gross flows that runs through our platform every year. We are making considerable progress. Our clients are leaning in with us, and we’re going deeper. I am super energized by the progress we’ve made and the validation the market is reflecting to us.

It’s important to understand the impact Envestnet is making for our clients as we deliver our results. I’ll turn the call now over to Pete, who will provide details on this quarter’s performance and our outlook for the rest of the year.

Pete D’Arrigo: Thank you, Bill. Our first quarter results continue to reflect the impact of our strategy and the anticipated progression from 2022 into 2023. During the first quarter, the economic environment brought further uncertainty with regard to continued market volatility, inflation, liquidity of regional banks and so on. Our first quarter further demonstrates the attractiveness of our business model and the impact of the actions we’ve taken amidst this current economic environment. As we think about the first quarter and the rest of 2023, I want to remind you of the context of our financial performance. In 2021, we announced a long-range plan to better organize and streamline the company, working more deeply with our clients and in more ways, ultimately paving the way for longer-term sustainable revenue growth and higher levels of profitability.

We began these investments in 2021 and had them fully included in our operating expense base in 2022. Now 2023 becomes a year focused on execution and delivery with the anticipated result of margin expansion. We saw the beginning of this in Q4 2022 and continuing sequentially into the first quarter of 2023. For the first quarter, although the challenging environment continued to have an impact on our clients, adjusted revenue was approximately $299 million, and adjusted EBITDA was $55.4 million and adjusted EPS was $0.46 in Q1. Our guidance for Q2 and the rest of 2023 is laid out in the earnings release and in the supplemental presentation. Overall, the economic environment in Q1 produced a difficult time for clients and prospective clients, impacting both segments of our business with extended decision-making processes and ultimately prolonged sales cycles in some cases.

This dynamic affected both segments and asset-based subscription and professional services revenue in Q1. While industry-wide flows remain under pressure, the wealth segment continues to experience positive net flows in our asset-based products. Subscription and professional services revenue was relatively more impacted by the economy. Our outlook for the rest of the year takes further on-boarding delays throughout the rest of the year into consideration, to some extent offsetting higher revenue from Q1 capital markets increases. The Data & Analytics segment had a number of potential and existing clients affected by the regional banking crisis. We saw a number of smaller tech clients put a hold on data spending due to liquidity challenges. However, we remain encouraged by the level of interest and the progress we’re making in building the overall pipeline.

For the second quarter, we expect adjusted revenue to be between $312 million and $315 million, adjusted EBITDA to be between $55 million and $57 million, and adjusted EPS to be $0.45 to $0.46. For the full year, we are raising our revenue guidance to be between $1.26 billion and $1.27 billion, adjusted EBITDA to a range of $253 million and $260 million, and EPS of $2.11 and $2.19. Our guidance as always does not assume any changes in the capital markets from prior quarter end and is based on market levels as of March 31st. Also, Q2 carries with it a seasonal increase in professional services revenue and cost of revenue related to the Elevate Summit. Turning to the balance sheet; we ended March with $53 million in cash and debt of $938 million, making our net leverage ratio just below 4 times EBITDA.

Seasonally, the first quarter is always the highest use of cash as we pay the majority of our incentive compensation in Q1 as well as the most significant vesting dates for employee equity compensation, giving rise to high employment taxes due. Additionally, as we’ve managed through the impact to our asset-based revenue from declining capital markets in 2022, Q4 of last year and Q1 of this year also carried with it elevated severance expense, which we expect to decline in the last three quarters of the year. We expect our high point for the leverage ratio to be in the first half of the year, dropping below 3.5 times by the end of the year. Thank you for your support of Envestnet. And before we open it up for Q&A, I’ll turn it back to Bill for his final remarks.

Bill Crager: Thank you, Pete. Envestnet is succeeding in a challenging market by delivering what we’ve committed to. Our business is executing on this strategy, and we have a leading competitive position in a growing marketplace. We’re delivering significantly for all stakeholders. This is through our deep understanding of the marketplace, a drive to serve our clients today and into the future through the dedication and hard work of our team. We’re managing expenses and leveraging our investments in scale to drive organic growth and margin expansion. We are building on the progress that we’ve invested in, driving margin expansion throughout 2023 and reaffirming our goal of 25% adjusted EBITDA margins in 2025. We’re doing what we said we would do.

We are modernizing the platform and integrating it for our clients. We’re increasing our operating leverage, becoming more efficient. We’re also going deeper with clients and growing higher-margin solutions. I want to thank our clients for the trust they put in us. They recognize the value we provide for them today and into the future. I also want to add a very special note of immense gratitude to retiring Director Ross Chapin. He’s been a tremendous steward of the business and an incredible support to Envestnet during the highs of this incredible journey as well as an essential pillar in the company’s hardest days following the death of Jud Bergman. At every turn, Ross has been a driver and a tremendous steward on behalf of the company and our shareholders.

Finally, to the Envestnet team, every day you execute, building, innovating, enhancing the advice to drive the success of our clients and millions and millions of end consumers, and you are driving the success of our business. As one client of ours said to me last week at the conference, what you are doing is extraordinary. I thank you. Now I’ll hand it over to the operator for questions.

Q&A Session

Operator: Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Devin Ryan with JMP Securities. Please proceed with your question.

Operator: Thank you. Our next question comes from Michael Cho with JPMorgan. Please proceed with your question.

Operator: Thank you. Our next question is from Alex Kramm with UBS. Please proceed with your question.

Operator: Thank you. Our next question comes from Surinder Thind with Jefferies. Please proceed with your question.

Operator: Thank you. [Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to CEO, Bill Crager for closing comments.

Bill Crager: Thank you, Camilla. I want to thank everybody for your support of Envestnet, and I look forward to speaking with all of you next quarter. Thank you very much. Have a very good evening, and we’ll talk to you next quarter. Thank you.

Operator: Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.