Envestnet, Inc. (NYSE:ENV) Q3 2023 Earnings Call Transcript

Envestnet, Inc. (NYSE:ENV) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Greetings, and welcome to the Envestnet Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Josh Warren, Incoming Chief Financial Officer. Thank you, Mr. Warren, you may begin.

Josh Warren: Thank you, and good afternoon, everyone. I am Josh Warren, Incoming Chief Financial Officer of Envestnet. Thank you for joining us on today’s third quarter 2023 earnings call. Before we begin, I’d like to point out that our earnings press release supplemental presentation and associated Form 10-Q can be found 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 slides 2 and 3 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 as-adjusted financial Matters. Please refer to the appendix in our supplemental presentation for a reconciliation of these as-adjusted financial measures to the most directly comparable GAAP measures. Joining me on today’s call are Bill Crager, Envestnet ‘s Chief Executive Officer and Tom Sipp, Executive Vice President for Business Lines. On our call this afternoon, we will provide a company update as well as an overview of the company’s third quarter 2023 results. After our prepared remarks, we will open the call to questions. During the Q&A, please limit yourself to one question plus one follow-up. You may get back into the queue if you have additional questions.

With that, I will turn the call over to Bill.

Bill Crager: Thank you Josh. Envestnet leads the wealth industry because we serve better, we scale better, and we have consistently and repeatedly delivered on the future needs of our clients. We have the vision and conviction that our industry’s ability to deliver greater advice required automated connected technology platform with a broader set of solutions that is powered by data intelligence. We are delivering this industry-leading environment making us more embedded and more essential to our clients. Over the past two years, we invested very specifically to extend our market leading position and to take share and also to increase the operating leverage and margins in our business. Our investment cycle was necessary, and it is now complete.

We’ve integrated systems, embedded automation in our processes, and upgraded our technology. As we review our results and accomplishments tonight, there are three things to focus on. First, our competitive position is unparalleled and is being validated by the marketplace we serve. We are significantly extending our competitive position by delivering a fully connected environment, with by far industry leading scale. We are confident in the growth opportunity ahead, which is evidenced by client and market share gains in a challenging macro environment. Second, we are better servicing our clients with greater efficiency, leading them to increase their engagement with us. Over the last 18 months, enabled by our investments, our client service scores have risen dramatically, which shows up in our 95%-plus wealth client renewal rates.

Also, our clients are contracting to do more with us, using more of our integrated services and solutions with our contracted [indiscernible] up 30% year-over-year. And then third, the long term, sustainable operating leverage we have created will meaningfully increase shareholder value. The automation and consolidation of our platforms is delivering greater operating and expense efficiency. Since the start of 2023 we have reduced our operating expenses by over $60 million on a run rate basis. We are structurally a higher margin company than we were before. Our leading competitive position and the ability to take share, along with significantly enhanced operating leverage are the gains we are experiencing, based on the success of our investment cycle.

I now want to introduce you to Tom Sipp. Tom leads the Business Lines for Envestnet. And he’s going to review our third quarter results.

Tom Sipp: Thank you Bill. Our performance in the third quarter reflects Envestnet’s focus and execution within a demanding macro environment. We are enhancing our platform, strengthening client satisfaction and winning market share. With the investment cycle now firmly in the past, we’ve become a more efficient, effective and profitable company, while accelerating additional cost reduction measures. Here are the key highlights for Envestnet for the third quarter. Revenue in the third quarter grew 3% year-over-year to $316.8 million within our guidance range, despite softness in the subscription revenue. Adjusted EBITDA grew 26% year-over-year to $67.2 million, above the high end of the guidance range. The adjusted EBITDA margin was 21%, an improvement of 380 basis points year-over-year.

And adjusted earnings per share was $0.56, also above the range. Now moving on to expenses, Q3 personnel costs as-adjusted for severance and non-cash compensation expenses were down 15% year-over-year. These reductions primarily reflect our planned exit from the investment cycle, as well as expense management actions that had been fully implemented. It’s important to note that even with reduced personnel costs, we are more efficient, delivering new products, technology and solutions to our clients with greater service levels. Increasing automation of service and operations is a key benefit of our investment plan. Overall, the macro environment in Q3 continued to present challenges for clients and prospects as well as our business. In the wealth segment, our Q3 revenues grew to $275 million, up 7% when compared to Q3 2022.

We are pleased with our performance in light of a difficult market environment where industry wide flows remained remain challenged. Envestnet continues to generate positive net flows into both AUM and EUA. But the mix in the quarter was unfavorable for our fee rate. Our asset-based revenues increased to $193.9 million, up 9.5% when compared to Q3 2022. Our wealth business continues to increase market share. Our Q4 results are impacted by markets during Q3 where the blended 60/40 portfolio was down approximately 3%. For Q4 we anticipate asset-based revenue to be between $183.5 million and $186.5 million. Assuming the midpoint this leads to our projected asset-based revenue growth to be approximately one half of 1% for the full year 2023. As a reminder, all Envestnet’s asset based pricing models are in our wealth segment.

Our subscription-based revenues in wealth increased to $76.8 million up 1.1% when compared to Q3 2022. Our Q4 performance in wealth will be negatively impacted by timing delays in connection with new client conversions, and new programs coming online that we now expect to begin recognizing in 2024. We do not believe that the Q4 wealth subscription performance reflect the underlying opportunity for this business. Recent pricing actions and new customer wins gives us confidence in an accelerated subscription revenue growth rate in the next few years. All-in-all, our expectations remain to grow our wealth subscription revenue at approximately 6% in 2023. In our data and analytics business, our revenues declined 15% compared to Q3 2022 to $41.8 million, but grew sequentially by 2.4% compared to Q2 2023.

As discussed in previous quarters, the banking crisis led to client cost cutting initiatives and implementation delays, continuing lower than forecasted, subscription revenues in bank and tech channels. That being said, our revenue has stabilized and business metrics, including pipeline and bookings are strengthening, giving us optimism as we go into 2024. As we look out to Q4 and the full year and consistent with how we provided information previously, for the fourth quarter, we expect revenues to be between $309 million and $314 million, Adjusted EBITA to be between $64.5 million and $68.5 million and adjusted earnings per share to be between $0.51 and $0.54. Therefore, for the full year 2023, we expect revenues to be between $1.237 billion and $1.242 billion, adjusted EBITDA to be between $245 million and $249 million and adjusted earnings per share to be between $1.98 and $2.01.

With that, let me turn it over to Bill to highlight the conviction we have for the opportunity before us.

Bill Crager: Thank you, Tom. Let me share our marketplace perspective with you. For the first time in a generation, there is the option to place assets in money market funds and secure higher yields. In Q3, the industry once again saw negative long term fund flows and public commentary from asset and what wealth managers has noted that account cash balances are rapidly growing. Retail money market fund assets are up 50% in the last year. Financial advisors are asset allocators and fiduciaries. And given the environment, we’re seeing them shift to securing and protecting capital, while they are creating and revisiting financial plans with their clients. We’ve seen a significant influx of reporting only accounts as investors allocate more to cash.

There will always be market cycles in the current cycle of higher interest rates and depressed equity flows are a challenge. However, and this is important, our operating metrics are strong. We’re taking share. Our annualized AUM&A organic growth of 11% in the quarter compares to low to mid-single digits for other companies. On a trailing 12 month basis. Our organic asset growth rates have been 8% for AUM&A that is well ahead of the industry. Also, advisors are using more of what we offer with increasing adoption and activity on our platform. Something I track very closely is our AUM and accounts per advisor. And those are up 9% year-over-year that is impressive given the environment. We are focused on ensuring that as assets begin to rebalance into investment portfolios, we are extremely well positioned for the demand and growth that will come.

This is the advantage we have in the scale and depth of our installed base as we serve 107,000, more than 107,000 financial advisors and $5.4 trillion in assets. Investment is more deeply engaged and connected with our clients and partners than ever before. Our clients are adapting to the environment and using the cycle to look at their cost structure and operating environment. They are focused on making their technology and solution stack simpler, more connected and more efficient by doing more with fewer partners. Our focused engagement model and the work we did to integrate our capabilities has put us at the center of many vendor consolidation discussions. At a recent meeting with a large client of ours. They told me that their analysis discovered that Envestnet could help them consolidate over 68 different applications they use to operate their business today.

This proof of our progress it’s evidencing itself in many ways, including new logo wins and deepening contracts with our installed base of clients. A recent announcement of our partnership with First Command is a bellwether of what we’re accomplishing. As First Command stated Envestnet has all the capabilities, solutions and tools that we need to serve our military families. Envestnet is the leading platform in the space. First Command is signing up for our full platform and our full suite of solutions. Long time significant customer of ours is another example of a client doing more with us. They’ve expanded beyond our managed account platform to include a broad set of our services, including a mandate to carriers and advisors that 100% of annual annuity contracts will be processed through the Envestnet Insurance Exchange.

This is a long term client who is consolidating vendors, leading to the expansion of Envestnet’s reach. Adding more solutions to our contracts is a leading indicator of future results. Our enhanced operating environment has led to deeper engagements, and this is evidenced by addendums to our contracts which are up 30% year-over-year. We’re seeing a convergence point for our partners as well as they position themselves to benefit from our distribution footprint. It is because we have connected the components of investment and engage more advisors that now we have more levers to drive incremental revenue streams through partnerships. Among these are asset managers. We’re expanding our relationship model, adding new distribution and collaboration opportunities as the leading asset managers focus on capabilities that will drive their growth.

Another area is custody partners. We sit at a key convergence point for a truly integrated wealth plus custody platform that the market needs for greater scale and operating flexibility. We’re incredibly bullish on the long term revenue opportunity that this creates for our shareholders. We’re leaned into this partnership with FNZ, and are building out a differentiated option for the marketplace with growing customer interest. Additionally, we’ve seen increased interest from existing custodial relationships that integrate more closely with us. And this is a recognition of our scale, and our distribution strength. A brief update on our data and analytics business. Last quarter, we outlined the critical factors for stabilization of this business.

While there continues to be softness in banking and aggregation sectors, the research business reached a significant milestone as the new datasets have been on boarded. After only one month, we are seeing a meaningful rebound in our business indicators and results. In Q3 new bookings are up $2 million year-over-year. There are also 21 opportunities that are in the research trial queue representing $8.3 million of potential Q4 bookings. This is progress. We’re on an improving path for this business. And we’ll report on the progression we achieve in next quarters meeting. To summarize, we’re operating with deeper client engagement, quality of service and efficiency. Let me be clear, client feedback is strong. Our service scores have risen by 40% over the last 18 months.

In the second half of this year, we’ll have lifted our adjusted EBITDA by 19% versus the first half of this year. We are confident that this will continue. Now I’ll hand it over to Josh Warren, who we are very excited to welcome to Envestnet and be fully installed as our Chief Financial Officer next week. His common set the stage as he steps into his new role. Josh?

Josh Warren: Thank you Bill. I’d also like to thank the entire team at Envestnet for a warm welcome and Pete D’Arrigo, Envestnet’s CFO for the last 15 years in particular for helping me with the smooth transition. I’m excited about the journey ahead because Envestnet holds a distinct position within the ecosystem that others have tried and failed to replicate. This position is important and impactful, powering financial advisors and the millions of clients they serve. I’d also like to emphasize that the long term sustainable operating leverage created will meaningfully increase shareholder value. You’re seeing the benefits of the investment cycle being completed, more automation, scale, and an ability to reduce costs while delivering an industry leading platform and operating environment for clients that are looking to have fewer and deeper partner relationships.

We ended September with $43.2 million of cash and $892.5 million of total debt from our two tranches of convertible notes. Based on the operating results that Tom outlined, we reduced our net leverage ratio, our net debt over trailing adjusted EBITDA to just shy of 3.7 times as of September 30. Based on the rest of the year outlook outlined previously, we expect to reduce our net leverage ratio to approximately three and a half times by the end of this year. We’re in the process of our annual planning cycle, and we’ll give an appropriate outlook for 2024 on our next call, but let me share how we’re thinking about the outlook to provide some added visibility and transparency. Envestnet is now a structurally more efficient company following the conclusion of our investment cycle.

Bill and Tom mentioned the investments made and automation and scale during 2023. These initiatives are expected to yield approximately $27 million in expense savings, with the additional expense savings to be recognized in 2024 and beyond in a combination of compensation and non-compensation related expenses. Further, given our scale and our operating leverage, we expect future revenue growth initiatives, such as those that Bill and Tom outlined will all be margin accretive as they scale. Those who have followed Envestnet are familiar with our as-adjusted metrics. On our income statement, we’re naturally progressing to our 2025 target of 25% adjusted EBITDA margins, the metric we’ve used in our debt covenants and provided guidance on. I would also like to add some additional commentary here as it relates to free cash flow, compensation expense and software development as we look forward.

This year Envestnet will pay approximately $34 million of cash for severance expenses, which we expect will impact our free cash flow during 2023. We expect severance expenses to be significantly lower going forward. Given our lower employee base, we expect our non-cash stock-based compensation will be down by approximately 15%. We anticipate providing visibility on our free cash flow generation going forward for transparency and comparability. Our free cash flow will deduct both our capital expenditures and our internally developed software or IDs capitalized under GAAP, based on the stage of development and deployment. While our 2023 CapEx, as previously stated, will be approximately the same as it was in 2022, our internally developed software costs for 2023 are expected to be approximately $93 million, representing a 4% increase from 2022 IDS.

Now that the investment cycle is complete, we anticipate both our CapEx and our IDS to be lower in 2024. To summarize, because of the investment cycle, in 2022, and for the full year 2023, Envestnet’s free cash flow was and will be negative. This will not be the case in 2024. And we’ll give greater detail on our February call. One final note before I move on. As of October 1, the advisor focused wealth analytics business transferred over to the wealth segment to better align reporting with the way we manage the business focused on the clients that we serve. We anticipate this transfer to be approximately $4 million of revenue in Q4. And it is reflected in the outlook that Tom provided earlier. As stated in February on our next earnings call, we’ll provide an update and outlook at that time.

Thank you. And I’ll now turn it back to bill for closing remarks.

Bill Crager: Thank you, Josh. And once again welcome to invest that I want to spend just a moment to recognize and thank our departing Chief Financial Officer, Pete D’Arrigo. Since joining investment in 2008, Pete has made invaluable contributions to our organization and to our success. He helped to lead our successful IPO and he’s helped guide our company through multiple market cycles. Pete has been an exceptional colleague and leader and his tenure as investment CFO has been vital. Pete, thank you. Now let me wrap up our prepared remarks, and I’ll conclude with this. Our investment cycle is complete and has been successfully implemented. Our competitive position is unparalleled. And our long term growth thesis is being validated by the marketplace that we serve.

We’re better servicing our clients with greater efficiency, leading them to increase their engagement with us. And the long term sustainable operating leverage we have created will meaningfully increase shareholder value. We’re doing what we said we would do and it is working. Despite negative industry flows, we’re gaining share, and if solidified the right to win in the marketplace. We’re using our leading technology solutions and data intelligence as powerful competitive advantages to go deeper and become even more essential to our customers. And importantly, we will build on the progress we’ve already made on delivering increasing economic and operating leverage. I’m incredibly grateful for our clients, partners and employees of Envestnet for making such a difference in the advice that thousands of advisors offer to millions and millions of American households.

I’ll now turn it over to the operator for questions. Thank you very much.

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Michael Cho with JPMorgan. Please proceed with your question. Hi, good.

Michael Cho: Hi, good evening guys. Hi. Thanks for taking my question. I guess my first question, I appreciate all the color around, the expenses and the ’24 kind of initial thoughts. I guess I was just kind of just curious if you know if you could elaborate a bit more in terms of kind of how we should think about margin progression, over the course of ’24 as you think about the 25% targets for 2025. And I think Bill, you mentioned that $60 million kind of run rate savings. And Josh, I think you said $27 million of expense savings in ’23 to-date. Maybe if you want to talk through maybe a run rate, exit run rate in ’23. And how we should kind of think about that for ’24 as well. Thank.

Bill Crager: Great. I’m going to add, Tom — Tom Sipp is going to begin and then Josh will finish?

Tom Sipp: Yeah, Michael, I would think about it a couple of ways. First, we’ve seen some pretty good margin expansion over the past, 12, 18 months. We are well on our way to the 25% target. We think it will not be backend weighted. We will evidence some pretty material progress in ’24. So think about it as more of a linear progression, from ’22, ’23, all the way out to ’25. There exist expense initiatives that we’ve already implemented that will flow through next year. And then the other thing that you should think about is our free cash flow conversion rate will improve as well. So we’re on our way to the 25%. It’ll be a linear progression, and more will drop to the bottom line, going forward. And with that, Josh?

Josh Warren: Yeah, thanks, Tom. And Michael, let me just say, first, as a reminder, just with regard to our 2023 OpEx that Tom mentioned, given our outlook to the full year, a headline to take away is on roughly a flat top line during 2023, which is of course, a composite of wealth and D&A. Our 2023 expenses has been reduced by approximately $27 million. And in connection with that, you asked about the $60 million of run rate savings. That’s based on actions already taken. About half will be — was recognized this year, and the remainder of the $60 million will be recognized next year, in a combination of operating and capital expenses by the end of 2024. But to be clear, our priority going forward is free cash flow generation. And we’re of course, very focused on delivering a robust and sustainable free cash flow generating franchise going forward, as we continue to deliver the highest quality platform in the industry.

Michael Cho: Perfect, thank you. And so for my follow up, I just want to switch gears a little bit just kind of zooming out here. I mean, we’ve kind of talked about the opportunity set for the Custodian for some time now. Just one, kind of curious on an update on timing there. And then two, you talked about kind of a large set of long term revenue opportunity there for investment looking ahead. I mean, how do you think about sizing this kind of opportunity for this Custodian offering over the medium term for investment? Is it really just really offering custody to clients? Or are there other synergistic areas that might create, further value for investment?

Bill Crager: Yeah, awesome, Michael. Yeah, no, making very good progress with our partners at FNZ. They have recently transitioned to their operating platform that is mostly trust focused and we will be in market with them either in Q2, or Q3 of this year. When market analysts as well as clients take a look at the operating environment that we’re going to be able to offer them, it is differentiated, and there’s a great deal of interest. Again, we’re making a lot of engagement progress, integration, progress. And now to get to market by Q2 or Q3 that does not include the broker dealer registration, which they filed with the regulators. And we’re hopeful that they receive that and we’re in operation with the broker dealer side of the offering at some point in 2024.

But we’re encouraged. The other dynamic, Michael, that I would just spotlight is that overall, I think that the custody environment sees that the integration of what we do and what they do as a very meaningful step forward in operating efficiency, helping our clients take out costs, helping them open accounts and manage accounts with less friction. So we’re deeply engaged with legacy custodians on how we offer that. And in each of those environments, both the FNZ and with our current custody partners, we believe there’s financial benefit for investment. So we’re working hard and that’s a focus point of ours. The other area of opportunity I spotlighted, when I talked — when it comes to strategic partners is asset managers. And y we own and have a very critical distribution footprint.

And as we brought the platforms together, and all of our advisors have access to all of what we do, it becomes an incredibly valuable conduit to reach more and more advisors with capabilities that asset managers are focused on and investing more in, which includes personalization, which includes overlay and adding value, alpha to performance through things like tax overlay, risk overlay and individualized portfolios that are defined by the industry as direct indexing. Tom, would you add anything to this.

Tom Sipp: I would just add on the custody, Michael, we’re going to retain revenue on custody economics. Think of that, you know, as two to five basis points, and we will provide an integrated custody, wealth custody ecosystem, real time account opening real time, real time trading, so a better solution. And we’re going to have several options. FNZ will be one option, and then we’ll have at least one, if not more options from the established players in the U.S. market. And initially, we’ll be in market with Bank Trust departments, and RIEs, call it middle of next year, and then, we will then cross sell to our broker dealer clients, end of next year into ’25. But for the first time Envestnet been participating in those custody economics, which include, the money they make on cash.

And then when Bill was talking about the asset managers we’re seeing a big trend in personalization. We have — we work with 800, 900 asset managers, as part of our marketplace today. There is an opportunity. We’ve invested a lot in personalized capabilities. So think of direct indexing, think of high net worth solutions, trust solutions, we’re going to work with a smaller group. It’s going to be, call it a handful of major asset management partners, and the economic relationship with those partners will be very different than what Envestnet’s experienced with the asset management community before. And then they’ll also lean in from a marketing distribution, sales footprint perspective. So you’re seeing a theme here, where we’re participating in more economics, from the custodians and from the asset managers, which over the next couple of years are going to start to be a meaningful impact to our P&L.

Bill Crager: Which really is all made possible, because we brought the platform together into an integrated conduit to reach so many advisors. Michael, thank you for your questions.

Michael Cho: Perfect. Thanks, guys.

Operator: Thank you. Our next question comes from the line of Alex Kramm with UBS. Please proceed with your question.

Bill Crager: Good morning, Alex.

Alex Kramm: Good, good, thank you. Good evening, everyone. First off, maybe on the topic of pricing and this may be a two parter, but maybe it’s the one partner. But I think Tom, you made some comments. And I think it related to the subscription side, that you’ve taken some pricing action and looking for things to turn around. So maybe you can just flush out what exactly you did and what that meant. And then connected to that. Just quickly, I think the revenue guide for the fourth quarter assumes some sort of pricing deterioration on the AUM AUA side, like maybe like 3% 4% or so at the midpoint, so maybe, I don’t know if those two things are related or different. So maybe just flush out those two things. Thanks.