LPL Financial Holdings Inc. (NASDAQ:LPLA) Q3 2023 Earnings Call Transcript

LPL Financial Holdings Inc. (NASDAQ:LPLA) Q3 2023 Earnings Call Transcript October 26, 2023

LPL Financial Holdings Inc. beats earnings expectations. Reported EPS is $3.74, expectations were $3.59.

Operator: Good afternoon, and thank you for joining the Third Quarter 2023 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 and Head of Business Operations, Matt Audette. Dan and Matt will offer introductory remarks, and then the call will be opened for questions. The company would appreciate if analysts would limit themselves to one question and a 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 risk 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 disclosure 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.

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With that, I will now turn the call over to Mr. Arnold.

Dan Arnold: Thank you, Tanya, and thanks to everyone for joining our call today. Over the past quarter, our advisors continued to provide their clients with personalized financial guidance, on the journey to help them achieve their life goals and dreams. To help support that important work, we remained focused on our mission: of taking care of our advisors, so they can take care of their clients. This quarter we continued to see the appeal of our model grow due to the combination of our robust and feature-rich platform, the stability and scale of our industry-leading model, and our capacity and commitment to invest back into the platform. As a result, we continue to make solid progress in helping advisors and enterprises solve challenges, and capitalize on opportunities better than anyone else, and thereby serve as the most appealing player in the industry.

With respect to our performance, we delivered another quarter of solid results, while also continuing to make progress on the execution of our strategic plan. I’ll review both of these areas, starting with our third quarter business results. In the quarter, total assets remained at $1.2 trillion, as continued solid organic growth was offset by lower equity markets. Third quarter organic net new assets were $33 billion, representing 11% annualized growth. This contributed to organic net new assets over the past 12 months of $97 billion, representing approximately a 9% growth rate. In the quarter, Recruited Assets were $31 billion, including $12 billion from Bank of the West and Commerce Bank. Prior to large enterprises, Q3 represents a quarterly record for recruiting.

This outcome was driven by the ongoing enhancements to our model, as well as our expanded addressable markets. Looking at same store sales, our advisors remain focused on taking care of their clients and delivering a differentiated experience. As a result, our advisors are both winning new clients, and expanding wallet share with existing clients, a combination that drove solid same store sales in Q3. With respect to Retention, we continue to enhance the advisor experience through the delivery of new capabilities and technology, as well as the evolution of our service and operations functions. As a result, Asset Retention for the third quarter and over the last 12 months was approximately 99%. Our third quarter business results led to solid financial outcomes of $3.74 of adjusted EPS, an increase of 19% from a year ago.

Let’s now turn to the progress we made on our strategic plan. Now, as a reminder, our long-term vision is to become the leader across the advisor-centered marketplace, which, for us, means being the best at empowering advisors and enterprises to deliver great advice to their clients and to be great operators of their businesses. Doing this well gives us a sustainable path to industry leadership across the advisor experience, organic growth, and market share. Now to execute on our strategy, we organize our work around two primary categories: horizontal expansion, where we look to expand the ways that advisors and enterprises can affiliate with us, and vertical integration, where we focus on providing capabilities that solve for a broader spectrum of advisor needs.

Now with that as context, let’s start with our efforts around horizontal expansion. This work involves meeting advisors and enterprises where they are in the evolution of their businesses by creating flexibility in our affiliation models such that we can compete for all 300,000 advisors in the marketplace. As a result, this component of our strategy helps contribute to solid growth in our traditional markets, while also expanding our addressable markets. Now, over the third quarter, we saw strong recruiting in our traditional independent market, adding approximately $13 billion in assets. And as a result of the appeal of our model and the efficacy of our business development team, we maintained our industry-leading win rates while also expanding the breadth and depth of our pipeline.

With respect to our new affiliation models, strategic wealth, employee, and our enhanced RAA offering, we delivered our strongest quarter-to-date, recruiting roughly $5 billion in assets in Q3. Subsequent to launching these models a few years ago, we have continued to enhance their capabilities and thus further differentiate their value. Add to that the growing awareness of these models in the marketplace and that combination is creating more demand from prospective advisors. As a result, we expect to see a sustained increase in growth within our new affiliation models. Next, the traditional banking credit union space continues to be a consistent contributor to organic growth as we added approximately $1 billion of recruited assets in Q3. During the quarter, we also continue to make progress with large enterprises, onboarding Bank of the West and Commerce Bank.

The early feedback from these transitions has been positive as we continue to apply the learnings from previous onboardings to further enhance the experience. Looking ahead, we are confident that our industry-leading onboarding experience match with the expanding appeal of our model positions us well as a compelling alternative in this part of the market. In Q3, we also announced that Prudential Financial would onboard its retail wealth management business to our enterprise platform in the second half of 2024. This milestone reinforces the appeal of our value proposition for enterprises and reflects our commitment to help solve the unique and complex needs of a broad spectrum of institutions. Looking ahead, we are encouraged by the momentum and strong pipelines across the enterprise market.

Now, within our vertical integration efforts, we are focused on delivering a comprehensive platform of capabilities, services, and technology that help our advisors differentiate and win in the marketplace and run thriving businesses. Now, over the past quarter, we continued to make progress across several key fronts on this part of our strategy, including continuing the journey to build a world-class wealth management platform. This work includes evolving and enhancing our advisory platforms through simplified and lowered pricing, enhanced trading capabilities, value-added services like tax management, and the expanded investment choice and flexibility within our UMA platform. These efforts will help our advisors continue to provide more value for the clients in a differentiated and more personalized way.

Now, as an additional part of our vertical integration strategy, we continue to expand and enhance our services portfolio and are encouraged by the evolving appeal of our value proposition and the seasoning of this business. As a result of solid demand in Q3, the number of advisors utilizing our Services Group continued to increase. We ended the quarter with approximately 3,700 active users, up 26% year-over-year. As a reminder, a recent innovation in this portfolio is our Liquidity & Succession solution, which is resonating with existing LPL advisors, where to date, we have deployed approximately $275 million of capital and closed 20 deals. With the benefit of our learnings and insights, we recently began offering this solution to advisors that are external to LPL and are encouraged to see the early interest building.

Finally, this service is also enriching the appeal of our model and by doing so, providing another differentiated solution to support our advisor recruiting efforts. In summary, in the third 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 on our strategy to help advisors further differentiate and win in the marketplace, and as a result, drive long-term shareholder value. With that, I will turn the call over to Matt.

Matt Audette: Thank you, Dan. And I am glad to speak with everyone on today’s call. In the third quarter, we remain focused on serving our advisors, growing our business, and delivering shareholder value. This focus led to strong organic growth in both our traditional and new markets, and we continue to make progress with our Liquidity & Succession solution. In addition, we onboarded Bank of the West and Commerce Bank and are preparing to onboard the wealth management business of Prudential. We accomplished all of this while continuing to invest in our industry-leading value proposition. So as we look ahead, we continue to be excited by the opportunities we have to help our advisors differentiate and win in the marketplace. Now let’s turn to our third quarter business results.

Total advisory and brokerage assets were $1.2 trillion, unchanged from Q2, as continued organic growth was offset by lower equity markets. Total organic net new assets were $33 billion, or approximately an 11% annualized growth rate. Our Q3 recruited assets were $31 billion, which included $12 billion from Bank of the West and Commerce. Prior to these large enterprises, this was a quarterly record for overall recruiting, as well as for our new affiliation models, which contributed $5 billion in the quarter. As for our Q3 financial results, the combination of organic growth and expense discipline led to adjusted EPS of $3.74; gross profit was $1.10 billion up $20 million, or 2% sequentially. As for the components, commission advisory fees net of payout were $219 million, up $1 million from Q2.

In Q3, our payout rate was 87.3%, up 60 basis points from Q2 due to typical seasonality in the onboarding of Bank of the West and Commerce Bank. Looking ahead to Q4, a reminder that the production bonus increases throughout the year and is typically highest in Q4, so we anticipate our payout rate will be approximately 88%. With respect to client cash revenue, it was $378 million, down $18 million from Q2 as cash balances declined $3 billion to $47 billion. This marked the smallest quarterly decline we’ve seen this year. Within our ICA portfolio, the mix of fixed rate balances increased to roughly 65% within our target range of 50% to 75%. Our ICA yield averaged 318 basis points in the quarter, down four basis points from Q2 driven by a decline in floating rate balances.

As for Q4, based on where client cash balances and interest rates are today, we expect our ICA yield to decline by roughly five basis points due to the mix impact of lower floating rate balances. As for service and fee revenue, it was $136 million in Q3, up $13 million from Q2, primarily driven by revenues from our National Advisor Conference and IRA fees. Looking ahead to Q4, we do not have any large advisor conferences and expect seasonally lower IRA fees. Given this, we anticipate service and fee revenue will decline by roughly $10 million sequentially. Moving on to Q3 transaction revenue. It was $50 million, up $3 million sequentially due to increased trading volume. As we look ahead to Q4, we have seen an increase in trading activity in October.

So based on what we have seen to date, we would expect transaction revenue to increase by a couple million sequentially. Now let’s turn to our strategic relationship with Prudential. In August, we announced that Prudential will onboard its retail wealth management business onto our platform, including their roughly 2,600 advisors serving approximately $50 billion of client assets. The investments we are making in connection with this relationship would not only help us serve Prudential and their advisors, but also improve the experience for our existing advisors and help unlock a broader opportunity to serve enterprises. With respect to the ongoing earnings benefit from Prudential, we continue to estimate a run rate EBITDA benefit for approximately $60 million once they’re onboard.

Looking ahead, we’ll continue to provide updates in the progress we’re making as we prepare to onboard Prudential. With that said, in terms of the cost transition, we continue to estimate total onboarding and integration costs of roughly $125 million with approximately $20 million expected in Q4. Now, let’s turn to expenses starting with core G&A. It was $342 million in Q3, up $5 million from Q2. Looking ahead, given our strong levels of organic growth and the variable costs associated with supporting that growth, we are increasing the lower end of our 2023 core G&A range by $5 million. As a result, we now expect 2023 core G&A to be in a range of $1,350 million to $1,307 million. Moving on to Q3 promotional expense. It was $140 million up $33 million sequentially as we hosted our largest advisor conference of the year during the quarter.

We also incurred roughly $6 million of Prudential related promotional expense in Q3. Looking ahead to Q4, we expect conference spend to decline by approximately $20 million. At the same time, we’ll be ramping preparation for Prudential and expect related onboarding and integration costs to increase by roughly $15 million from Q3. So overall, we expect Q4 promotional expense to be flat to down $5 million sequentially. Turning to depreciation on amortization. It was $65 million in Q3, up $7 million sequentially. Looking ahead to Q4, we expect depreciation and amortization to increase by roughly $5 million sequentially. As for interest expense, it was $48 million in Q3, up $3 million sequentially, driven by the impact of higher short-term interest rates on our floating rate debt and increased usage of our revolver.

Looking ahead to Q4, given current debt balances and interest rates, we expect interest expense to increase by approximately $1 million from Q3. Regarding capital management, our balance sheet remains strong. We ended Q3 with corporate cash of $309 million down $16 million from Q2. Our leverage ratio is 1.3 times up slightly from Q2. 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 were appropriate and returning excess capital to shareholders. In Q3, we allocated capital across our entire framework. We continue to invest to drive and support organic growth, allocated capital to M&A within our liquidity and succession solution, and return capital to our shareholders repurchasing $250 million of shares.

As we look ahead to Q4, we plan to repurchase $200 million of our shares, keeping us on track to execute on our $2 billion authorization over two years. 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 advisors, grow our business, and create long-term shareholder value. With that, operator, please open the call for questions.

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Q&A Session

Operator: Certainly. [Operator Instructions] And our first question will be coming from Steven Chubak of Wolfe Research. Your line is open.

Steven Chubak: Hi, good afternoon, Dan. Good afternoon, Matt.

Dan Arnold: Good afternoon.

Steven Chubak: So, I wanted to start off with a question just on the organic growth outlook. The 11% NNA figure came in at the higher end of the 7% to 13% range you guys have talked about in the past. I would say what really stood out was the strong result relative to the slowdown in NNA that we saw at some of your peers. I was hoping you could unpack what were the biggest contributors to the share gains in the quarter? And with the recruited assets tracking up 40%, how confident are you that this level of organic growth can, in fact, be sustained?

Dan Arnold: Steven, it’s Dan. Let me take that. And certainly, we can build off of that answer. So, look, I think in the short-term, we’ve got a jumping off point that, as you said, is in the solid place of 11% growth for the quarter. And probably just as importantly, we saw a diverse contribution across all of our advisor and enterprise models, which I think speaks to not only the volume of growth, but the breadth and diversity of the sources of growth. And I think if I highlighted a couple of things inside Q3 that maybe are significant to that overall outcome, the first would be we continue to see low levels of attrition in that 1% to 1.5% zone. That’s certainly a solid outcome and reinforces the appeal and the execution quality of the operation day to day.

And I think it’s complemented by the solid performance in new store sales where we recruited $31 billion of assets for the quarter. And if you click down on that $31 billion of assets, I think if you look at that prior to large enterprises, right, Q3 has quarterly high recruiting of $19 billion in assets, which is more than double a year ago. And I think when you take out or back out some of the lumpier nature of some of the large enterprise recruiting you put down underneath that, again, you see the diversity of that growth in new store sales, as well as it happening across all of our different advisor-oriented models. And you feel pretty good about the sustainability of that opportunity set. And so look, the drivers of that, right, the flexibility of the affiliation model gives us and puts us in a position of competing for potentially any advisor that’s looking for a newer, better home.

It’s continued expansion of our capabilities to help us differentiate our model. And then you continue to invest in simplifying the onboarding to make it easier and easier to move and take friction out. We believe we do those things well, and it creates a key contributor to our overall growth and a good, solid, sustainable growth rate as we go forward. So I hope that helps.

Steven Chubak: Yes, it’s a really helpful color, Dan. And for my follow-up for Matt, surprise, surprise, a question on client cash. 3Q cash levels were down 5%, admittedly more resilient than the sweep deposit decline that we saw of roughly 7% to 10% at peers. So that being said, cash outflows did continue in September. How are client cash balances trending so far in October? And are you anticipating any seasonal benefit to 4Q cash levels from tax loss harvesting?

Matt Audette: Yes, Steven. So I think on just – and maybe to answer the last part of your question first, I think if history is a guy, you typically do see some seasonal build-in at the end of the fourth quarter, typically in December for some cash or tax loss harvesting. So I’d be surprised if we did not see that this year. It’s pretty common. I think on the core of your question, when we look at how things are going in October, I’d say that the headline is on the cash sweep side as we continue to see some of the stability that we started to see in the third quarter and specifically a reminder that advisory fees primarily come out in the first month of the quarter, and that’s for October it would be a little over $1.1 billion, which is going to immediately bring down cash, but cash flows outside of that have been relatively flat here almost at the end of the month.

So that would put cash sweep at around $46.2 billion is really those advisory fees coming out. And from a percent of AUM would put it right at 3.8% of AUM, which would be the fourth month in a row that we were at that level. So I think when we look at those trends, and I think as we’ve talked a bit about before, we’re starting to get to a place where you’ve got a natural amount of cash necessary to really manage the account. And of course, it could go down further from here, but I think you’re starting to see those resistance levels that we talked about before in those balances. Now, some of the other drivers there, maybe just to speak to how organic growth is going, because a lot of that drives and brings in cash as well, when we look at what we’ve seen in October, is really continuing some of those positive trends that Dan was just talking about in Q3.

And keeping in mind that the seasonal nature of the first month as well on organic growth with those advisory fees come out as well, when you look at what we’ve seen so far for October, prior to any additional assets coming on board from Bank of the West, Commerce, organic growth is running in the 6% zone. That compares to 4% prior to large enterprises in October of last year. So we’re continuing to see that strength there. And then there is about $1.5 billion of AUM left to come on board from those two institutions, and some of that may come in, in October, so that would bias it up from there. So overall, I think, I’d summarize October as stability starting to show in cash sweep and organic growth continuing to come in at solid levels.

Steven Chubak: That’s a great color, Matt. Thanks for taking my questions.

Operator: And one moment for our next question. And our next question will be coming from Alexander Blostein of Goldman Sachs. Your line is open.

Unidentified Analyst: Hi, all. This is Luke on for Alex. Thanks for taking the question. If we could start with Prudential. We’ve seen LPL expand into new channels a number of times, with the insurance channel being the newest one, with the Pru partnership. Can you just talk through how you expect this opportunity to expand over time? And how you think about the TAM? And then could you also refresh us on the P&L dynamics and the timing you’re thinking through there? Thanks.

Dan Arnold: Let me start with answering that, and then Matt will come in and answer maybe the second part of that. And so look at the headline level, if you take a step back and just look at the large enterprise opportunity set with respect to the bank space as you know we onboarded two new large enterprises this quarter, and we continue to see a opportunity set in that large enterprise space of those that continue to act as their own broker dealers and RIAs and do the business in-house and see an interesting TAM that would consider a different strategic approach. And so I think those wins reinforced that value proposition. Our continued investment in this and our experience in managing and working with these large enterprises did certainly help us as we go forward in that part of the large enterprise space.

And as you said the announcement of the Pru win kind of opens up a different part of large enterprises, in this case perhaps insurance-owned solution sets and/or part of the market space. And look, for there, we think – again we take that similar chassis. We’re building some personalized and interesting customized solutions for Prudential that we think will resonate with other solutions in that part of the space. They’ve got similar needs from a value proposition standpoint when you think about the improvement driving efficiencies within their models, shifting their risk profiles, enhancing economics, and even working to stimulate top-line growth, all things that I think similar large enterprises are looking to do. These are things that we’re working on collectively with banks and ultimately with Prudential.

So we think there is a relevant opportunity. We think Prudential opportunity is a catalyst to open up more discussions in that part of the space. So we think, again, that the broader enterprise, large enterprise market is an interesting continued durable growth opportunity for us, both on the bank side and on the broader insurance, if that helps.