Blucora, Inc.

Good morning and welcome to the third quarter 2022 Blue Cora earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then 2. Please note this event is being recorded. I would now like to turn the conference over to D. Littrell, Director of Investor Relations, Blue Cora. Please go ahead.

Thank you and welcome everyone to Blue Cora's third quarter 2022 earnings conference call. This morning we posted the earnings release and supplemental information on the investor relations section of our website, at BlueCore.com. I am joined today by Chris Walters, Chief Executive Officer, and Mark Melman, Chief Financial Officer. Before we begin, let me remind everyone that today's discussion contains forward-looking statements that speak only as of the current date. As such, they include risks and uncertainties, and actual results and events could differ materially from our current expectations. Please refer to our press release and our SEC filings including our most recent 10-K and Form 10-Q, for more information on these specific risks and uncertainties. We assume no obligation to update our forward-looking statements except as required by law. We will discuss both GAAP and non-GAAP financial measures today. Our earnings release and supplemental financial information are available on the Investor Relations section of our website at bluecora.com and include full reconciliations of each non-GAAP financial measure discussed to the nearest applicable gap measure. With that, let me hand the call over to Chris.

Good morning. Before we share our third quarter results, Mark and I will discuss the announcement we made earlier this morning. Yesterday, we signed an agreement to sell our software business, TaxAct, to an affiliate of Finven for $720 million in cash. We expect to close the transaction by the end of the year. While the decision to sell TaxAct may come as a bit of surprise for some of you, the board has been consistent in its position to remain open to opportunities to create or unlock value for shareholders. We commenced the process to explore such a transaction, and Sinvin's offer validates the extraordinary work our TaxAct team has done to grow the business by enhancing our products and customer care approach, as well as the significant strides made acquiring customers by increasing the sophistication of our marketing efforts and scaling partnerships. A few of the team's numerous accomplishments over the last few years include increasing NPS scores, providing exemplary customer care with free access to tax experts, and having TaxAct's products rated as the best in market by multiple third-party reviewers, including Business Insider. We believe the sale of the Sinvin, a highly respected private equity firm with deep experience in the tax space, is the right next step for TaxAct to continue to scale. Through our discussions, we recognize that we are completely aligned with Sinvin on the importance of meeting customers' needs, including delivering exceptional software combined with best-in-class customer care for the upcoming tax year and in the future. Sinvin has indicated that it intends to operate TaxAct independently during the transition period, expected to be six to nine months post-closing. on a business as usual basis and prepare for the upcoming tax season to ensure our customers are not impacted by the transaction. Following the closing, we will rebrand Blue Cora to Avantax and focus solely on executing our long-term sustainable growth strategy for our tax-focused wealth business, which has delivered impressive results over the last couple of years. This means aligning the company's operations and enabling strategic investment in high return initiatives to best support the needs of our financial professionals and CPA firms and their clients. Additionally, the transaction should allow us to return significant capital to shareholders. Looking ahead, we see many opportunities for our wealth business. As a pure play wealth management company, we will be laser focused on further differentiating ourselves as the partner of choice for tax-focused financial professionals, tax professionals, and CPAs. Now I'll turn it over to Mark to discuss some of the other details regarding both capital return and the long-term growth algorithm for Vantax.

Thank you, Chris. As Chris shared, the sale of the Tax Act business is compelling for a number of reasons. First, we will create a differentiated, pure-play, tax-focused wealth management company by monetizing Tax Act at a meaningful valuation following a successful turnaround by the management team. Second, the proceeds of the transaction, totaling expected after-tax net cash proceeds of roughly $620 million, will be used to pay down existing debt. With the go-forward net debt to EBITDA target of two to three turns, we will be in position to return significant capital to shareholders, which is expected to be in the range of $400 to $450 million post-close. Moving forward, Avantax will have the focus and cost structure to invest for growth and deliver strong adjusted EBITDA margins, which following the transition services period, we would expect to be in the 16 to 18% range, assuming a more streamlined corporate structure. This transaction will position each of our businesses to operate from a position of strength, after both turned in peak performances this year across the most critical KPIs. To focus on Avantax, given it will be the go-forward company, through the first nine months of this year, it has delivered record-breaking results across the following metrics. 1.3 billion in newly recruited assets on a year-to-date basis is roughly $329 million more than our record performance in all of 2021. $380 million in Q3 positive net flows, our highest results since Q1 2018. Roughly $810 million in year-to-date positive net flows the highest since at least 2015 when we acquired HDVEST. A 99% plus average quarterly production retention rate year to date, considered best in class in the industry. And lastly, advisory assets representing 48.8% of overall assets with 10 straight quarters of upward movement. With this strong foundation in place, we project Avantax to grow revenue annually in the 8.5 to 11% range over the medium term, with an assumption of the market growing at 4%, and additional growth drivers of newly recruited assets, net growth on existing assets, and lastly, high-value mix shifts towards advisory and our RIA business rounding out our growth algorithm. As stated earlier, our profitability expectations of 16% to 18% adjusted EBITDA margins for the go-forward company are grounded in a streamlined corporate structure, the current interest rate environment, and our ability to focus our attention on growing a van tax in an efficient and scalable manner. The TSA period is likely to last between six to nine months, after which we would expect the new margin profile to begin to take hold. With that, let me turn it back to Chris to discuss our third quarter results.

Thanks, Mark. Now I'll highlight our third quarter results, beginning with our tax software segment. As we have mentioned before, our plan to drive TaxAct to profitable, sustainable long-term growth has been built on a base of unit growth fueled by new customer acquisition and customer retention, enabling market share gains combined with higher ARPU through delivering more value to customers. Now that we are past the October tax extension window and with the overall positive third peak performance, we have better visibility across the entirety of the tax season. The DIY market has performed in line with expectations for the second half of the year. We have maintained our market share gains, and our forecast for the balance of the year has us coming in slightly higher on revenue and stable at the midpoint of our segment income guidance. With Tax Year 21 now largely behind us, the Tax Act team will shift their efforts to fully prepare for the upcoming tax season. This season, the team will focus on a few key areas. Investing in tools and technologies to further improve the efficiency of our industry-leading customer care and tax expert teams. Enhancing our products, including an improved mobile offering for consumers and enhanced data import capabilities and forms coverage for tax pros. Continuing to scale our partnership efforts and refine our marketing approach to acquire new customers. Overall, we had a strong season despite the headwind of market declines. We met or exceeded most operating metrics. We accelerated top-line growth, gained market share ahead of schedule, increased ARPU by utilizing bundling of various products, and enhanced our value proposition by providing free access to experts. I am confident that TaxAct will carry this momentum into next season and continue to deliver the best full-featured value software and exceptional customer care in the market. Now turning to our wealth management business. As has been the case over the past several quarters, underperformance in the equity markets negatively impacted advisor-driven revenue as assets associated with equities have declined with the market. However, this was partially offset by an increase in cash sweep revenue driven by the portion of assets held in cash and increased interest rates. In addition, we saw lower payouts for financial professionals due to decreased market levels. Beyond these financial metrics, we have continued to reach new heights across a range of our most important key indicators. First, our net positive flows. For the third straight quarter, we have seen net positive asset flows. In Q3, we had $380 million in net new assets, the highest since Q1 2018. Our year-to-date net flows have now topped $810 million. Second, recruiting. We also continue to successfully recruit financial professionals away from larger firms with over 200 million in newly recruited assets this quarter and have a great pipeline for the remainder of the year. Third, firm acquisitions and succession plans. This quarter, we closed four acquisitions in our RIA business, totaling 20 acquisitions since we began the program. Fourth, on financial professionals attrition, We had fewer departures than anticipated, and this combined with recruited financial professionals allowed us to virtually stay flat quarter over quarter. Of the financial professionals who departed during the quarter, about 81% were non-producing financial professionals with less than 50,000 enrolling gross production. Finally, our production retention rate. We maintained our consistently high production retention rate coming in at 98.6% for the quarter. Now I'll turn it over to Mark, and we'll be happy to answer any questions after the prepared remarks.

Thank you, Chris. I'll provide some additional detail on our third quarter results and our outlook for the remainder of the year, starting with third quarter results. Total revenue of $171.7 million, a decrease of 1% versus the third quarter of the prior year. Total revenue was driven primarily by the wealth management business. Gap net loss of $21.8 million or a loss of 46 cents per diluted share which are 21% and 20% better than prior year respectively. Adjusted EBITDA which excludes certain other factors was $7.7 million meaningfully better than the prior year third quarter figure loss of $800,000. Non-gap net loss of $9.8 million or a loss of 20 cents per diluted share both 23% better than prior year. Turning now to the tax software segment. Tax software segment revenue for the third quarter was $6.7 million, a $1.6 million improvement versus prior year, driven by greater extensions volume versus prior year. We expect this trend to continue into the fourth quarter, resulting in a slight improvement at the midpoint for tax act full year revenue. Segment operating loss was $12.5 million, better than the prior year by $1.3 million, driven primarily by the improved revenue performance. Moving on to wealth management. Third quarter reported wealth management segment revenue was $165 million, up 1% sequentially, despite a meaningfully lower asset base on which we build for advisory assets, offset by the impact of the rising interest rate environment. Transaction-based commission revenues were flat quarter over quarter, coming in at $17.9 million. On a year-over-year basis, total third quarter wealth management revenue was down 2%. Wealth management segment operating income came in at $27.6 million for the third quarter, up 74% sequentially, driven by the rising interest rate environment, and up 41% versus the third quarter of the prior year. Segment operating expenses were down $9.4 million sequentially and $12.2 million year-over-year. Changes in operating expenses included declines in cost of revenue, which is highly variable and dependent on changes in advisory and commission revenue, of $8.2 million and $15.1 million, respectively. On a year-over-year basis, our other operating expenses increased at a lower rate than compared to the first and second quarters of the year as the investments made in the second half of 2021 began to normalize. We saw net inflows in advisory assets of $514 million, with total client assets having net inflows of $380 million, the third straight quarter of driving positive net flows for both advisory and total assets. Our year-to-date net flows of $810 million is the highest value since at least 2015. Newly recruited assets continue to be another bright spot for the business. In the third quarter, we added another $214 million of total client assets, bringing the year-to-date total to $1.3 billion. Total client assets decreased 16% year-over-year to $72.6 billion, reflecting broader market declines, partially offset by successful recruiting efforts. Fee-based advisory assets were down 11% year-over-year. to $35.4 billion with advisory assets as a percentage of total client assets, ending the quarter at 48.8%, an increase of 80 basis points versus last quarter, and up 290 basis points versus Q3 of 2021. We ended the quarter with cash and cash equivalents of $91.1 million and net debt of $434.3 million. Our reported net leverage ratio at the end of the quarter was 3.3 times. In the quarter, we paid down $35 million in our term loan balance, as well as paid the final installment of the earn out related to the HKFS acquisition in the amount of $23 million. With that, let's turn to our full year 2022 outlook. For the full year, we expect our tax software segment revenue of between $249 million to $250 million, and segment income of $89 million to $91 million. For our wealth management segment, we now expect full year revenue of between $660 million to $665 million, with segment income of $93 million to $95 million, reflecting an uptick in more profitable sweep income. This translates to a consolidated full year outlook of revenue of between $909 million and $915 million, adjusted EBITDA of $152 million to $156.5 million, Gap net income attributable to Glucora of $36 million to $41 million, or $0.73 to $0.83 per diluted share, and non-gap net income of $86 million to $90.5 million, or $1.75 to $1.84 per diluted share. This outlook includes $30 million to $29.5 million in corporate unallocated expense. Expectations for next year continue to be robust based on current Fed rate expectations. I shared last quarter that based on rate expectations and, of course, market levels, we could see wealth management segment income approach $120 to $150 million in 2023. While market levels are down somewhat from the end of Q2 and commission revenues continue to show weakness, we estimate that an improved outlook for rates at 4% by year end would now have us delivering roughly 135 million of segment income at an S&P level of 3,000, which is another 16% decline from the S&P close as of September 30th, and upwards of $170 million at market levels above 4250. This concludes our prepared remarks. We will now turn the call over to the operator for Q&A. Operator?

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Dan, excuse me, Dan Kernos with the Benchmark Company. Please go ahead.

Great. Thanks. Good morning. Just when I thought I'd seen everything from you guys, Chris. So the sale of tax, can you just give us some thoughts on timing? You know, obviously the market's messy right now. I think you guys had really good momentum. You were clearly taking share. You know, I know that you guys have the debt back coming up. So, obviously, this takes care of all of that. And, Mark, you gave some good color on capital return in your prepared remarks. But just kind of why now? Can you talk a little bit about the bidding process? How competitive was it? Just maybe some initial thoughts around that would be helpful. Thanks.

Sure. We've been monitoring the business and marketing conditions for Selling Tax Act for a number of years. We've shared publicly that we have constantly been reviewing our strategic options. Until now, there were a number of obstacles to achieving an attractive value for the business, including the pandemic and the unusual revenue and expected expense variations associated with 2020 and 2021 seasons with the shifts in timing. So we decided earlier this year that it was the right time to commence a more deliberate process to explore such a transaction. Simvin's offer validates the extraordinary work of the team over the last couple of years that you were highlighting. We do feel good about the progress in the business and that progress in the business allowed us to get a evaluation that we thought was a good number for the business.

Going forward and just

How do we think about, and maybe this is for Mark, how do we think about where leverage should be now that you'll be in the net cash position? I mean, we can kind of do math you wrote out for us, but I just want to get a sense from you how much cash you want to keep on the balance sheet here. Obviously, you know, you talked last quarter, and I'll get Chris into this too, about the environment being, you know, maybe a little bit harder to do M&A in. But, you know, with sort of the streamlined business you have and a net cash position, you have an interesting opportunity that makes you more attractive potentially to others to go out there and, you know, really aggressively add, especially on the RIA side. How do we think about kind of those puts and takes?

Sure. And thanks for the question this morning, Dan. So I'm not going to get into exact cash balances that we expect to hold. to close and working through transitions and what have you. But what I did share is that we're targeting a two to three times net leverage ratio for this business going forward. Based on what we expect to end this year, you would expect that that leverage ratio would be closer to the high end of that range. And that next year with the expected improvement in profitability, as well as cash generation, we would in essence grow our way down to the lower part of that range. And that range finds the right balance between allowing us to return a significant amount of capital to our shareholders, the 400 to 450 million, obviously dependent on leverage markets when this deal closes and leveraging the financing markets and having something that just feels like a right balance considering the macroeconomic picture today. We will continue to pursue our capital allocation strategy. As I've stated publicly, buybacks always serve as that benchmark by which we make capital allocation decisions. We are still extremely excited about the on-platform acquisitions and the profile that that helps our business develop over time. And so it just comes down to balance, Dan, going forward.

Got it. That's helpful. Maybe this last one and I'll step aside for others. The wealth management business continues to do well. You gave us underlying market assumption in your long-term outlook. I think, Mark, you've said historically that rates probably closer to three or three and a quarter are more sustainable in there. I assume you're taking that longer-term trajectory and assuming that you guys can continue to you know, kind of drive productivity and net inflows, get you kind of the balance of the way to your organic number? Is that the right way to look at it?

Yeah, I would say the revenue guidance figures or long-term outlook that we provided is really in a static environment, one in which rates are not moving around. So I would look at that X rates. So it's a 4% baseline market growth assumption with the difference coming from those other elements that I spoke about.

Okay, well, congratulations on selling tax and another good quarter for Welsh.

So I will step aside, guys. Thank you.

Okay, thanks, Ben.

Again, if you have a question, please press star then 1. The next question comes from Josh Siegler with Cancer Fitzgerald. Please go ahead.

Yes, hi. Good morning. Thanks for taking my question, and congratulations on the results as well as the sales. I'm curious about learning a little more on your vision for realizing competitive advantages on Avantax moving forward without TaxAct. Will Avantax still focus on generating tax alpha, and how do you see your client funnel evolving without the potential to cross-sell in TaxAct? Thank you.

Fortunately, our team has been executing on a sustainable growth strategy for multiple years, and the business results have been quite strong. And so the plan going forward is to continue to execute that strategy, which is a tax-focused wealth strategy. We want to be the best provider who works with tax firms, CPAs, those who want to align with those firms to offer wealth management. And so it will be a continued focus on providing best-in-class service, supporting our financial professionals with the right growth and marketing efforts to help them grow their businesses. And then we also have the mixed shifts that are going on in our business, which is the gradual transition to advisory, as well as slightly faster growth fueled by some of the on-platform M&A into the RIA business, which is a margin-enhancing force. And so we believe that we can continue to execute that strategy and with a heightened level of focus, we can see some really strong results going forward. In terms of anything that will be lost with the departure of the tax act business, we have built over the last couple of years a really strong tech and marketing functions or capabilities within the event tax business that had leveraged a lot of know-how and capability and processes that have come from the tax act business. Given that we've built a very strong team, we do not expect any degradation in the performance associated with the separation.

I appreciate that color. That's very helpful. And then, you know, diving a little further into Avantax, Has the ongoing macro slowdown had any impact on your outlook for the wealth management business? Specifically, are there recessionary risks in the business model, perhaps aside from poor equity market performance, such as net flows or mix shift towards advisory, if we do experience this global growth slowdown?

Yeah, we feel really fortunate. Clearly, in an uncertain kind of macro environment, there are some risks. You highlighted the biggest one, which is the equity market risk. As we've talked about historically, the interest rate impacts on cash sweep tend to trump the impacts of the equity market weakness. And what you've seen is even in this kind of current economic environment, virtually all of our operating metrics are very strong. And so we're quite optimistic about the outlook of the business, even in a potential recessionary environment.

Understood. Thank you very much. And congratulations once again. Great. Thanks so much. Just one moment, please. Again, if you have a question, press star then one.

The next question comes from Alex Paris with Barrington Research. Please go ahead.

Hi, guys. Congratulations on the performance in the quarter and the sale of Tax Act. Just a couple of questions, clarifying questions, I guess. Net debt as of 9-30 was $430 million, and you're expecting $620 million in after-tax proceeds from the Sale of Tax Act by year-end. That leaves you about $190 million in net debt by year-end. You want to run the business two to three times. I don't have the 10Q open. What's the debt maturity schedule going forward? It sounds like you're implying that you're not going to pay off all the debt, which leaves more to return to shareholders and to fund organic growth and inorganic growth initiatives.

The expectation, Alex, would be to... basically refinance at the point of close, whether that takes a form of paying down the entire debt completely, and then just basically refinancing back up to two to three times. That enables us to return the number I mentioned earlier between four and 450 back to shareholders, which is our expectation to return a significant majority, if not all of the excess capital back to shareholders. We're fortunate to operate a business that generates meaningful cash flow, especially going into next year, which will allow us on an ongoing basis to continue doing the things that we do to grow this business, whether it be capital investments, on-platform acquisitions, regular ordinary course buybacks, allowing us to basically return all of this capital back.

Great. And then thank you for that. And then you said that there'll be a temporary services agreement that Blue Cora is going to provide services to the new owner of Tax Act. Is that correct?

Yes. So we'll be providing a variety of services to facilitate a really smooth transition. They're excited about the business. They want it to operate incredibly effectively through the tax season and beyond. And so we do have some shared services that operate across the business. And so we'll be providing those services for some period of time.

And then your compensation for providing those services would come in through an other line on the P&L, I assume?

Yeah, we'll work through the actual mechanics of where it'll show up, Alex, but we'll make sure to create some clarity for folks.

Okay, and then last, an associated question. Over the medium term, you know, the pure play broker-dealer and wealth management business is expected to return 8.5% to 11% organic growth. And adjusted EBITDA margins in the 16% to 18%. What assumption are you making for overhead or corporate costs in that forecast?

So it's an all-inclusive number. So first and foremost, our goal is to get from signing to closing. After that, we have this transition services period where we need to ensure that Tax Act has all the tools that it needs in order to continue delighting its customers. It's after that where a lot of the savings or efficiencies will start to take hold. And so it's an all-encompassing number. It's the core wealth management business plus what we call today unallocated corporate. coming together to create that margin profile. As we get closer to close, you know, we share the next quarter's earnings, we'll be able to share a bit more detail.

Okay. Well, that sounds great. Again, congratulations on the quarter and thanks for the additional color.

Got it.

This concludes our question and answer session. I would like to turn the conference back over to Chris Walters for any closing remarks.

Thank you all for joining us today and for your interest in Blue Cora. We'll speak to you next quarter.

The conference has now concluded. Goodbye. Thank you for attending today's presentation. You may now disconnect.