LPL Financial Holdings Inc.

Good afternoon and thank you for joining the fourth quarter and full year 2020 earnings conference call for LPL Financial Holdings Incorporated. Joining the call today are our President and Chief Executive Officer Dan Arnold and Chief Financial Officer Matt Audet. Dan and Matt will offer introductory remarks and then the call will be open for questions. The company will appreciate if analysts will limit themselves to one question and 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 risks 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. The company refers listeners to the disclosures set forth under the captioned 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 for more information about such risks and uncertainties. During the call, the company will also discuss certain non-GAAP financial measures. For a reconciliation of such non-GAAP financial measures to the comparable GAAP figures, please refer to the company's earnings release, which can be found at investor.lpl.com. With that, I will now turn the call over to Mr. Arnold.

Hey, thank you, Carmen, and thanks to everyone for joining our call today. Over the past quarter and throughout 2020, our focus remained on our mission of taking care of our advisors so they can take care of their clients. This is a credit to our employees who responded with agility and ingenuity to new working conditions and new opportunities to support our advisors. Their dedication is inspired by the unfailing commitment of our advisors who continue to provide much-needed financial advice to millions of Americans managing through a challenging environment. As we enter the new year, we remain focused on executing on our strategy while also evolving our long-term vision of how we deliver on our mission. We aspire to push past our old vision of extending our leadership in the independent space and and redefine the independent model over time. And by doing so, become the leader across the entire advisor-centered marketplace. Our approach is to build a platform that is simple and straightforward for advisors to use in constructing the perfect practice for themselves and their clients. More specifically, this vision centers around making it easy for advisors to join our platform with no friction or complexity, And as simple as turning dials, they can determine the exact services they want to leverage, pick the business model that will work best for them, choose the technology and workflows that make them most efficient, and select the product mix that best meets the needs of their clients, all while leveraging expertise and solutions to enhance the performance of their business. Ultimately, that creates total empowerment for LPL advisors to thrive, and that is the heart of our mission. Doing this well gives us a sustainable path to higher levels of organic growth, increased market leadership, and long-term shareholder value creation. Now, with that context in mind, let's now turn to the fourth quarter and discuss our results and progress on our strategic plan. Let's start with our fourth quarter business results. Total assets reached a new high of over $900 billion, up 18% from a year ago. This increase was primarily driven by continued organic growth and equity market appreciation. With respect to organic growth, fourth quarter net new assets prior to acquisitions were a new high of $18 billion, which translated to an 8.8% annualized growth rate. For the full year, net new assets were $56 billion, which translates to a 7.4% annualized growth rate, up from 5.3% a year ago. This increase was driven by continued strength across new store sales, same store sales, and retention. In the fourth quarter, recruited assets remained solid at 10.8 billion, which brought our full year total to 41 billion. This was up 6 billion from a year ago and by more than 50% over the past three years, primarily driven by the appeal of our model, our ongoing innovation for the future, and continued solid execution by our business development team. In the fourth quarter, we also continued to enhance the advisor experience as we delivered solid service outcomes driven by flexibility of our affiliation models, evolving capabilities and technology, and enhanced service experience. As a result, retention remained approximately 98% for the year, up from 96.5% a year ago. And net promoter scores increased by over 15 points year over year and more than 60 points in three years. Our fourth quarter business results also led to solid financial outcomes with EPS prior to intangibles of $1.53, which brought our full year total to $6.46. Let's now turn to the progress we've made executing on our strategic plan. As we look ahead, we continue to see growing demand for advice and believe we are well positioned to serve our advisors and collectively compete for additional market share. Now, in light of this, we remain focused on executing our four strategic plays. As a reminder, our first strategic play involves meeting our advisors where they are in the evolution of their practices by winning in our traditional markets while also leveraging new affiliation models to expand our adjustable markets. Strategically, We believe this combination positions us not only to deliver sustainable and repeatable organic growth, but also to increase our growth rate over time. In our traditional markets, while advisor movement remained at lower levels over the past year, we continued to drive solid recruiting results and gain market share. To share a little more color specifically on our third-party financial institutions channel, we continue to see good momentum in the core segment of this market, And at the same time, we remain encouraged by our opportunity with regional banks. The planning and preparation for our new relationships with BMO and M&T are going well, and we are in ongoing strategic dialogues with other prospects. With respect to the expansion of our addressable markets, we anticipate our new affiliation models will also contribute additional organic growth in 2021. Following five strategic wealth services practices that onboarded last year, we have a solid pipeline with a number of commitments that will join in the first half of this year. In January, we also onboarded our first independent employee model practice, and we are seeing other prospects progress through the pipeline. Another key component of this strategic play is using M&A as a strategic lever to complement organic growth. In Q4, we onboarded a combined $4 billion of assets from our acquisitions of Lucia and E.K. Riley. Then in December, we signed an agreement to acquire Waddell & Reed's wealth management business, which has over 900 experienced and accomplished advisors, serving approximately $70 billion of client assets. Post the signing, our teams have collaborated well with Waddell & Reed and Macquarie, which is contributing to solid progress on the transactions. Thus far in the process, Waddell & Reed advisors serving approximately 80% of client assets have already committed to join our platform following the close of the transaction. We will give you an update on the rest of the retention pipeline next quarter. Our second strategic play is focused on providing capabilities that help our existing advisors differentiate the marketplace and drive efficiency in their practices. In 2021, we plan to continue our work from last year with a focus on developing capabilities and solutions in two key areas. The first is to enrich the end client experience with expanded digital solutions, enhancements to our advisory platforms, and a broader set of lending solutions. The second key area is using technology, including client works and client works connected, to help advisors enhance the performance of their practices, operate more efficiently, within their key workflows and expand scalability to serve more clients. We believe these evolving capabilities will contribute to an increase in advisor growth and retention rates. Let's next move to our third strategic play, which involves creating an industry-leading experience to delight advisors and their clients, and that in turn helps drive advisor retention. One of the key parts of this strategic play is providing advisors with differentiated service at a time and in a manner that works best for them. We are doing this by transforming our service model into a client care model. And we're about halfway through the implementation of this model, and at this point, it has made a solid contribution to our net promoter scores. We see additional opportunity to drive these outcomes higher as we deliver the second half of this initiative. We also see evolving our custodial platform operations as an opportunity. to further enhance service levels, platform scalability, and efficiency. As part of this work, our areas of focus include automating routine work with robotics, removing paper forms and increasing e-delivery through digitization, and process reengineering to drive continuous improvement. We believe these initiatives, combined with our transformation to a client care model, position us to further strengthen the advisor experience and our platform as our business grows. Our fourth strategic play is focused on helping advisors run the most successful businesses in the independent marketplace. One of the key components of this play is our portfolio of business solutions. Now, as a reminder, when we started business solutions over two years ago, we saw the opportunity to help advisors find better alternatives for certain local services that cost in excess of a billion dollars a year. Our hypothesis? was that we could provide higher quality services at a lower cost and free up additional time for advisors to spend on more valuable activities, including serving their clients and growing their practices. In that spirit, we created our business solutions portfolio to solve for these discrete needs with outsourced professional expertise. Since then, we have been able to expand and evolve the value proposition of the portfolio and scale our subscription base. As a result, we finished the fourth quarter with about 1,400 monthly subscriptions, which more than doubled the level a year ago. At the same time, we have expanded the portfolio to include business optimizers and additional professional services. We're also innovating on how we package these solutions such that we can unlock additional value for advisors when using a combination of different offerings. As we look ahead, we see several pathways for continued growth, including partnering with more of our LPL advisors, introducing new solutions, and experimenting with serving advisors outside of LPL. In Q1, we will launch the next innovation in our portfolio, M&A Solutions, which will be our sixth offering. As context, this service grew out of CFO solutions. as we identified an opportunity to help advisors acquire other practices. That inspired us to develop M&A capabilities as a service for advisors. This M&A offering will provide a turnkey solution and dedicated support for advisors from deal sourcing all the way through transaction advice, capital funding, and process execution. With this offering, Advisors can now more easily use M&A as a repeatable and sustainable growth engine for their practices. In summary, in the fourth quarter and throughout the year, we continue 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 our advisors further differentiate and win in the marketplace and drive long-term shareholder value. With that, I'll turn the call over to Matt.

All right. Thank you, Dan, and I'm glad to speak with everyone on today's call. Before I review our fourth quarter results, I'd like to highlight our progress during 2020. Looking at the year, we are proud of what we accomplished within our framework for driving long-term shareholder value. We entered 2020 with momentum and continued to invest through a volatile environment to provide an industry-leading value proposition for our advisors to serve their clients and win in the marketplace. This commitment to enhancing the support we provide our advisors resulted in the highest quarterly and full year levels of organic net new assets in our history. By leveraging the investments in our platform and the financial strength we built over the last several years, we entered 2021 in an even stronger position as we worked on board our two largest financial institutions M&T and BMO, as well as what Owen Reed. So as we look ahead, we are excited to continue growing our business and leveraging our increased scale and capacity to further invest in our platform, which positions us to drive additional growth and long-term shareholder value. Now let's turn to our fourth quarter business results. Total advisory and brokerage assets increased to a new high of $903 billion, up 11% from Q3, driven by continued organic growth and higher equity markets. Looking at organic growth, total net new assets were $17.8 billion, or an 8.8% annualized growth rate. Moving on to recruiting and retention, which are two key drivers of organic growth, we continued to produce strong results in the fourth quarter. Recruited assets were $10.8 billion in Q4, which was our third consecutive quarter above $10 billion, and brought our 12-month total to a new high of $40.9 billion. At the same time, full-year retention was 97.7%, an improvement of over a percentage point from last year. Looking at our business mix, we continue to see positive trends in Q4. Advisory net new assets were $15.9 billion, or a 16% annualized growth rate. Our full-year total was $50 billion, up almost 50% from last year and more than double our total in 2018. Centrally managed portfolios also continued to grow as net new assets reached a new quarterly high of $2.5 billion, or a 17% annualized growth rate. Now let's turn to our Q4 financial results. Strong organic growth combined with expense discipline led to EPS prior to intangibles of $1.53, up 6% sequentially. Looking at our top line growth, gross profit was $534 million, up $28 million or 6% sequentially. Looking at the components, commission advisory fees net of payout were $153 million, up $11 million from Q3, primarily driven by organic growth in higher equity markets. Moving on to asset-based revenues. Sponsor revenues were $153 million in Q4, up $9 million sequentially, as average assets increased driven by organic growth and higher equity markets. Turning to client cash revenues, they were 105 million, down 4 million from Q3, driven by lower client cash yields. Looking at client cash balances, they remained elevated at 49 billion, up 2 billion sequentially. As for client cash yields, our Q4 ICA yield was 108 basis points, down 10 basis points from Q3. The decrease was primarily driven by half a billion of fixed-rate contracts that matured during the quarter and higher cash balances. Looking ahead to Q1, we will have the full quarter impact of the half a billion of fixed-rate contracts that matured in Q4, as well as another half billion of fixed-rate contracts maturing in Q1. Given these factors and where interest rates, client rates, and cash balances were at the end of Q4, we expect our Q1 ICA yield to be around 100 basis points. Roughly half of the decline is driven by growth and balances, while the other half is driven by fixed-rate contract maturities. Moving on to Q4 transaction and fee revenues, they were $130 million, up $10 million sequentially, driven by higher trading volume and fee revenue. Looking ahead to Q1, while we acknowledge the widely discussed increase in activity in the self-directed space, Our trading levels have remained more stable and consistent with what we would expect to see in the advisor-led wealth management space. As a result, our trading activity through January is in line with Q4 levels. That said, I would note there are three fewer trading days and seasonally lower fee revenue in Q1. So we expect these two items to reduce transaction and fee revenue by $5 million. Turning to business solutions. They continue to scale with 1,400 subscriptions at the end of Q4. This is up 200 from last quarter and double our total from a year ago. These offerings now generate roughly $17 million of annual recurring gross profit, up from $15 million last quarter. And more importantly, they help free up additional time for advisors to spend on more valuable activities, including serving their clients and growing their practices. Now let's turn to expenses, starting with core G&A. It was $252 million in Q4, leading to full-year core G&A of $925 million, in the lower half of our original outlook range of $915 to $940 million. Turning to our outlook for 2021, our long-term cost strategy remains unchanged. We continue to prioritize investments that drive organic growth, while delivering operating leverage in our core business. Looking back, over the last three years, our core G&A has grown in the mid-single-digit range annually as we invested to drive growth. And over the same period, these investments have helped our organic growth more than double from 3% to 7%. Given the success we are seeing with these investments, we are planning the same level of core G&A growth we planned last year, which was 5.5% to 8%. So for 2021, this translates to a range of $975 million to $1 billion. I would note this includes costs to support BMO and M&T, but it's prior to expenses associated with Waddell and Reed. Moving on to Q4 promotional expenses. They were $48 million, down $10 million sequentially, primarily driven by lower conference expenses following our national sales conference in Q3. Turning to Q1, we anticipate promotional expense will increase by approximately $10 million, primarily driven by increased transition assistance from recruiting and BMO and M&T onboarding expenses. Looking ahead, we anticipate BMO will join by the end of Q1 and M&T will join during the middle of this year. Now let's talk about what Ellen Reed. We are excited about the transaction and encouraged by the progress we're making with advisors. As mentioned, Waddell & Reed advisors serving approximately 80% of client assets have committed to join our platform following the close of the transaction. This puts us above our 70% modeling assumption thus far in the process. I would also note Waddell & Reed wealth management assets at the end of Q4 were $70 billion, which is up $7 billion from Q3. With respect to the ongoing earnings benefit from Waddell & Reed, we will have updated estimates as we move towards the close and onboarding dates, which we expect to be in the middle of this year. That said, today I would like to provide some color on the acquisition and integration costs, which we continue to estimate will be approximately $85 million. That said, to provide more transparency, we will add an acquisition cost line item to our management P&L beginning next quarter. We think reviewing our results prior to these acquisition costs will be helpful in understanding our financials. So starting in Q1, we will report our results as EPS prior to intangibles and acquisition costs. As we look ahead, our integration work is progressing well, and we anticipate up to $10 million of acquisition costs in Q1. Looking at share-based compensation expense, it was $8 million in Q4, relatively flat to Q3. Looking ahead, Q1 tends to be our highest quarter of the year, given the timing of our annual stock awards, so we anticipate this expense will increase by a few million dollars sequentially. Turning to depreciation and amortization, it was $29 million in Q4, up $1 million sequentially. Looking ahead, we continue to invest in technology and recently rolled out several improvements to our advisory platform and end client experience. As a result, we expect depreciation and amortization to increase by $4 million sequentially. Moving on to capital allocation, our balance sheet remains strong in Q4 with credit agreement net leverage at 2.16 times and cash available for corporate use of $280 million. 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 opportunities where appropriate, and returning excess capital to shareholders. In the near term, we expect the majority of our capital deployment to be focused on organic growth and M&A as we onboard BMO, M&T, and Waddell and Reed. Once we have completed these transitions, we plan to reassess our capital deployment opportunities. And if at that time we have excess capital to deploy beyond organic growth and M&A opportunities, we would anticipate restarting share purchases. That said, we'll have to see what our opportunities look like at that time. In closing, we delivered another quarter and year of strong business and financial results. And 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.