LPL Financial Holdings Inc.

Good afternoon and thank you for joining the first quarter 2021 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 Odette. Dan and Matt will offer introductory remarks and then the call will be open for questions. The company would appreciate if analysts would 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 opening 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 caption forward-looking statements in the earnings press release as well as the risk factors and the other disclosures contained in the company's recent filings with 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 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 theinvestor.lpl.com. With that, I will now turn the call over to Mr. Arnold.

Thank you, Kirby, and thanks to everyone for joining our call today. Over the past quarter, our advisors continue to be a source of extraordinary support and guidance for their clients. And at the same time, we remain focused on our mission of taking care of our advisors so they can take care of their clients. This combination positioned us to deliver another quarter of solid results while also continuing to make progress on our strategic plan. I'd like to review both of these areas, starting with our first quarter business results. In the quarter, total assets reached a new high of over $950 billion, up more than 40% from a year ago. This increase was primarily driven by continued organic growth and equity market appreciation. With respect to organic growth, first quarter net new assets were $29 billion, which included $12 billion from BMO Harris Financial Advisors. This result translated to double-digit annualized growth of 13%, driven by continued strength across new store sales, same store sales, and retention. First quarter recruited assets were $24 billion, which includes $15 billion from BMO. This result brought our total recruited assets over the past year to a new high of $56 billion. Our continued progress on recruiting is primarily driven by the appeal of our model, our ongoing innovation for the future, and the expanded flexibility of our platform. At the same time, we further enhance the advisor experience through continued delivery of new capabilities and technology, as well as the ongoing modernization of our service and operations functions. As a result, asset retention remained solid at 98% in the first quarter, and net promoter scores increased year over year. Our first quarter business results led to solid financial outcomes with $1.77 of EPS prior to intangibles and acquisition cost. Let's now turn to the progress we have made executing our strategic plan. As a reminder, we have evolved our long-term vision. We aspire to expand beyond our old vision of extending our leadership in the independent space and redefine the independent model over time and by doing so become the leader across the entire advisor-centered marketplace. Now our approach is to build a platform that is simple and straightforward for advisors to use with the flexibility to construct the perfect practice for themselves and their clients. This approach breaks down the walls between traditional market segments and instead focuses on creating 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, to execute on our strategy, we have organized our work into four strategic plays, which I'd like to review with you in turn. Our first strategic play involves meeting advisors where they are in the evolution of their practice. by winning in our traditional markets while also leveraging new affiliation models to expand our addressable markets. Strategically, we believe this combination positions us to not only deliver sustainable and repeatable organic growth, but to also increase our growth rate over time. In our traditional markets, while overall industry advisor movement remained at lower levels in the first quarter, we continued to gain, share, and grow our pipelines. Looking more specifically at the regional bank segment of our financial institution channel, we onboarded BMO Harris Financial Advisors in late March. We continue to prepare for M&T to join in the next few months, and we advance conversations with additional prospects. With respect to the expansion of our addressable markets, we continue to see momentum building in our new affiliation models. Earlier this month, we onboarded two new practices to Strategic Wealth Services bringing us to a total of seven on the platform. And earlier this week, we added another advisor to our employee-based model. Looking ahead, we feel good about our pipeline for both of these models. Another key component of this strategic play is using M&A as a complement to organic growth. With respect to our acquisition of Waddell & Reed's wealth management business, we now have commitments from Waddell & Reed advisors who serve approximately 95% of client assets. We are engaging closely with these advisors to help them prepare to transition to LPL and begin leveraging our platform to serve their clients and grow their businesses. Our second strategic play is focused on providing capabilities that help our existing advisors differentiate in the marketplace and drive efficiency in their practices. One of the key components of this play is enriching the end client experience. Advisory platforms are increasingly at the center of the end client experience. as the secular trend towards advisory continues in our business and across the industry. Given this, we remain focused on providing our advisors with an industry-leading advisory platform, including a number of recent enhancements. Within the quarter, we introduced simplified pricing and lowered account minimums on our centrally managed platforms. We also expanded our no transaction fee ETF product offering, which now serves about 40% of ETF assets and advisory accounts. At the same time, we are introducing new platform capabilities in the spirit of creating a differentiated UMA offering that combines multiple centrally managed portfolios within a single account. These enhancements increase the appeal, accessibility, and flexibility of our advisory offering, which in turn supports our advisors' efforts to serve their clients and win in the marketplace. Let's next move to our third strategic play, which involves creating an industry-leading service experience to delight advisors and their clients, and that in turn helps drive advisor retention. A key component of this strategic play is transforming our service model into an omnichannel client care model that provides our advisors with differentiated service. In Q1, we completed the rollout of live chat as a complement to our voice channel. Advisors now have a choice of either voice or chat to efficiently connect with a service professional who is trained and certified to answer their specific question. Our next step is completing the rollout of our digital self-service experience, which, together with voice and chat, will position advisors to access industry-leading service at a time and in a manner that works best for them. We also continue to automate and streamline key elements of our service operations In Q1, our area of focus included enhancing the administrative support around tax season, digitizing forms, and automating account transfers. Enhancements in these areas are helping strengthen the advisor experience and the scalability of our platform as our business grows. Our remaining focused on the transformation of our service model into a client care model and continuous improvement through the automation and streamlining of our service operations We believe we are making positive contributions to the service experience, advisor retention, and net promoter scores. 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, which help advisors operate their businesses so they can focus on serving their clients and growing their practices. As we discussed last quarter, we see several pathways for continued business solutions growth, including partnering with more of our advisors, introducing new solutions to the portfolio, and experimenting with serving advisors outside LPL. In the first quarter, our subscription base continued to scale to about 1,700 monthly subscriptions that generated annualized revenue of approximately $19 million. This growth was primarily driven by our ongoing expansion and evolution of the value proposition of our existing portfolio. Looking at our product roadmap, we continue to enhance our existing portfolio of solutions while expanding into new offerings. In Q1, we launched M&A Solutions, which is generating solid demand, including over 50 advisors who are leveraging this offering today. In Q2, we plan to introduce our seventh business solution, Client Engage. This evolved from our existing marketing offering and is focused on providing advisors with a digital approach to effectively and efficiently stay connected with their clients. As we look outside LPL, we plan to begin marketing M&A solutions later this year. By experimenting with this scalable technology-driven solution, we can efficiently learn from serving outside advisors while continuing to focus our resources and investments on delivering business solutions to LPL advisors. Now, before closing, I also want to highlight that we released our 2021 sustainability report last week. We believe operating a sustainable business is good for all of our stakeholders. We hope this report provides helpful insight into our practices and performance. In summary, in the first 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 our strategy to help our advisors further differentiate and win in the marketplace, and as a result, 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. As we move into 2021, we remain focused on serving our advisors, growing our business, and delivering shareholder value. This focus led to the highest quarter of organic growth in our history. And in addition, we are in the midst of onboarding what will become three of our largest partners in BMO, M&T, and Waddell & Reed. We expect these three partners to collectively add approximately $100 billion of AUM to our platform bringing our total AUM to over $1 trillion. Now, let's turn to our first quarter business results. Total advisory and brokerage assets increased to a new high of $958 billion, up 6% from Q4, driven by continued organic growth and higher equity markets. Looking at organic growth, total net new assets were $29 billion, which translates to a 12.8% annualized growth rate. Prior to large bank onboarding, organic growth was 7.6%. Moving on to recruiting and retention, we continued to produce strong results in the first quarter. Recruited assets in Q1 were the strongest in our history at $24 billion, which included $15 billion from large bank onboarding. These results brought our 12-month recruiting total to a new high of $56 billion. Looking at retention, it remains strong at 98.1%. I would also note that we updated our retention metric to reflect asset retention rather than our previous method of production retention. We believe this change will be more helpful in evaluating our business results, and we have provided historical data in our key metrics presentation so you can see both the old and new metric. Moving on to our business mix. We continue to see positive trends in Q1. Advisory net new assets were $23 billion, or a 20% annualized growth rate. With this growth, our advisory assets are now 52% of total assets, as we continue to deliver differentiated advisory capabilities and benefit from the secular trend towards advisory. Now let's turn to our Q1 financial results. Strong organic growth combined with expense discipline led to EPS prior to intangibles and acquisition costs of $1.77. Looking at our top-line growth, gross profit reached a new high of $579 million, up 46 million or 9% sequentially. Looking at the components, commission and advisory fees net of payout were $184 million, up $31 million from Q4, primarily driven by organic growth, and seasonally lower production expense. Moving on to asset-based revenues, sponsor revenues were $168 million in Q1, up $14 million sequentially as average assets increased, driven by organic growth and higher equity markets. Turning to client cash revenues, they were $97 million, down $8 million from Q4, driven by lower client cash yields. Looking at client cash balances, They remain elevated at $48 billion, roughly flat with last quarter. As for client cash yields, our Q1 ICA yield was 99 basis points, down 9 basis points from Q4. The decrease during the quarter was primarily driven by fixed rate and LIBOR-based contracts that matured and lower short-term interest rates. Looking ahead to Q2... we will have the full quarter impact of the half a billion of fixed-rate contracts that matured in Q1, as well as another billion of fixed-rate contracts maturing in Q2. Given these factors and where interest rates, client rates, and cash balances are today, we would expect our Q2 ICA yield to be in the mid-90 basis point range. I would also note we have no additional fixed-rate contracts maturing in the second half of this year. Moving on to Q1 transaction and fee revenues. They were $141 million, up $11 million sequentially, driven by trading volume that increased throughout the quarter. Looking ahead to Q2, trading activity in April has declined from the elevated levels we saw in Q1. And if this trend continues through the quarter, we would expect transaction revenue to decline by about $10 million. Turning to business solutions. They continue to scale with 1,700 subscriptions at the end of Q1. This is up 300 from last quarter and more than double a year ago. These offerings now generate roughly $19 million of annual revenue, up from $17 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 $236 million in Q1. Looking ahead, we continue to anticipate full year 2021 Core G&A to be in a range of $975 million to $1 billion. As a reminder, this includes costs to support BMO and M&T, but it's prior to expenses associated with Waddell and Reed. Moving on to Q1 promotional expenses. They were $54 million. up $6 million sequentially, primarily driven by increased transition assistance from higher recruiting and large bank onboarding expenses. Turning to Q2, we anticipate promotional expense will increase by approximately $5 million prior to Waddell and Reed, primarily driven by increased transition assistance and large bank onboarding expenses. Looking at share-based compensation expense, it was $11 million in Q1, up from $8 million Looking ahead to Q2, we expect share-based compensation expense to be at a similar level to Q1. Turning to depreciation and amortization. It was $35 million in Q1, up $7 million sequentially, as several improvements to our advisory platform and end client experience were rolled out sooner than anticipated. Looking ahead, we expect depreciation in Q2 to be in line with Q1 levels. Now let's move to what I want to read. the transaction is progressing better than we originally estimated across multiple fronts. As mentioned, what Owen Reed Advisor is serving approximately 95% of client assets have committed to join our platform. Factoring in this higher level of retention and current asset levels, we expect the run rate EBITDA benefit from what Owen Reed to be at least 80 million, up from our original 50 million estimate. As a result of the higher retention, We now expect $110 million of acquisition costs, up from our original estimate of $85 million. These updates bring our estimated purchase multiple to five times EBITDA, an improvement from our original estimate of six and a half times EBITDA. Now, I want to provide an update on our expected close timing. Over the past several months, we have had strong collaboration with Woodown Reed and Macquarie, and we have received the required regulatory approvals. As a result, we are pleased to share that we anticipate closing the acquisition of what Ellen Reed's wealth management business as early as tomorrow. And we continue to expect to onboard the advisors a few months after closing. Looking ahead, we are focused on providing transparency on the progress we are making on the transaction. With this in mind, we will share what Ellen Reed financial results in two primary categories. First, to provide more clarity around our results, we have added an acquisition cost line item to our management P&L. Looking at Q2, we expect roughly one-third of our total acquisition cost to be incurred during the quarter. Second, we will keep you updated each quarter on how we expect EBITDA to build as we progress towards hitting the full run rate benefit by the middle of 2022. In Q2, we expect annualized negative run rate EBITDA of approximately $10 million as we add resources to prepare to support what Owen Reed. Moving on to capital management, starting with our debt refinancing. Given the continued strength of our business, combined with a low interest rate environment, we were able to refinance our highest cost debt from 5.75% to 4%, reducing our annual interest expense by $13 million. We were also able to increase the size of our revolver from $750 million to $1 billion. 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 where appropriate, and returning excess capital to shareholders. In the near term, we continue to expect the majority of our capital deployment to be focused on organic growth and M&A, as we onboard BMO, M&T, and Waddell & 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, we would anticipate restarting share purchases. That said, we will have to see what our options look like at that time. In closing, we delivered another quarter 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.