LPL Financial Holdings Inc.

Good afternoon, and thank you for joining the second quarter 2022 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, Matt Aldette. 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. The company has posted its earnings and press release and supplementary information on the investor relations section of the company's website, InvestorLPL.com. Today's call includes forward-looking statements, including statements about LPL's financial future and operating results. outlook, business strategies and plans, as well as other opportunities and potential risks that management perceives. 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 disclosures 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 earning relief, which can be found at investor.lpl.com. With that, I would now turn the call over to Mr. Arnold.

Thank you, Justin, and thanks to everyone for joining our call today. Over the past quarter, we remained focused on our mission of taking care of our advisors so they can take care of their clients. Amid persistent market volatility and geopolitical uncertainty, our advisors reinforce the value they provide to their clients by helping them navigate through times of uncertainty. In that spirit, I want to recognize our advisors for their continued care and dedication to their clients, especially when they need it most. With respect to our performance, our second quarter business results led to solid financial outcomes. At the same time, we continue to make progress in our strategic plans. I'll review both of these areas, starting with our second quarter business results. In the quarter, total assets decreased to $1.1 trillion as continued solid organic growth was more than offset by lower equity markets. With respect to organic growth, the business continued to perform well despite market volatility. Second quarter net new assets were $37 billion, which included $25 billion from PUNA and represented 13% annualized growth. These quarterly results contributed to a 10% organic growth rate for the past 12 months. Looking at recruited assets, they were $44 billion in Q2, included $32 billion from CUNA. This brought our total recruited assets over the past 12 months to $84 billion, which was up $4 billion from the same period a year ago. These results were driven by the ongoing enhancements to our model and our expanded addressable market. Looking at same-source sales, our advisors continue to focus on serving their clients and differentiating their solutions in the marketplace. And while market volatility led some clients to moderate their activity in the field, periods of heightened uncertainty are often the environments that reinforce the value of professional advice and with time can serve as a catalyst for advisors to grow their practice. With respect to retention, we continue to enhance the advisor experience through continued delivery of new capabilities and technology, as well as the ongoing modernization of our service and operations. As a result, asset retention was approximately 98% in the second quarter and 98% over the past 12 months. Our second quarter business results led to solid financial outcomes of $2.24 of EPS prior to intangibles and acquisitions, an increase of 21% from the year. Let's now turn to the progress we made on our strategic plan. As a reminder, our long-term vision has become the leader across the entire advisor-centered market, which for us means being the best at empowering advisors and institutions to deliver great advice to their clients and to be great operators of their businesses. To bring this vision to life, we're providing the capabilities and solutions that help our advisors deliver personalized advice and planning experiences to their clients. At the same time, through human-driven technology-enabled solutions and expertise, we're supporting advisors in their efforts to be extraordinary business owners. 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 have organized our work into four strategic plays, which I'll review in turn. Our first strategic play involves meeting advisors and institutions where they are in the evolution of their business by winning in our traditional markets while also leveraging new affiliation models to expand our addressable markets. Our recruiting in traditional markets continue to be a source of growth in Q2 with approximately $9 billion in assets. We continue to increase our win rates and expand the depth and breadth of our pipeline, notwithstanding a broader slowdown in advisor movement over the past couple of quarters. Historically, during the initial stages of elevated market volatility, advisors often focus on supporting existing clients and may pause in making strategic decisions like switching firms. However, after advisors have acclimated to the conditions, they will often use times like this to consider new options for their practice, likely creating an opportunity for us from a recruiting standpoint. With respect to our new affiliation models, strategic wealth, employee, and our enhanced RAA offerings, We recruited over $2 billion in assets in Q3 and believe we are well-positioned to drive continued growth across all three months. The second quarter saw a new high for recruited assets in our employee model, as the value proposition for advisors has proven to be compelling. As a complement to our organic growth, we recently announced the acquisition of the private client group business at Binning and Scatterpool, which we will onboard to our employee model early next year. With respect to large financial institutions, we onboarded CUNA in May, and we are on track to onboard People's United later this year. We continue to learn from each experience and use these findings to drive innovation that improves the transition to LPL, and in turn helps make our offering even more appealing. As we look ahead, we expect to continue winning in this market as demand for our model grows. Our second strategic play? is focused on providing capabilities that help our advisors differentiate in the marketplace and drive efficiency in their practices. As a part of that focus, we continue to enhance ClientWorks, our core operating platform, with the expansion of digitized workflows. For example, in the second quarter, we introduced enhancements to our Move Money solution, which makes it easier and more automated for advisors to support deposits and withdrawals within client accounts. Separately, we also enhance the client management workflow for advisors by integrating goal planning data into our meeting manager solution, which facilitates more efficient preparation for and more value-added dialogue within client reviews. These enhancements help advisors operate more effectively and increase their scalability to serve more clients. Let's next move to our third strategic play, which is focused on creating an industry-leading service experience that delights advisors and their clients, and in turn, helps drive advisor recruiting and retention. As a reminder, over the past two years, we have transformed our service model into an omnichannel client care model, which includes voice, chat, and digital support, thus giving advisors flexibility for when and how they access service. Continue to fine-tune this model to drive additional efficiency and an enhanced experience for our advisors. As part of the next phase of our transformation, we continue to expand and enrich our digital processing capabilities in order to provide greater flexibility, speed, and accuracy for our advisors. Our transformation efforts are currently focused on four clearing functions, including money movement, account opening, and account transfers, which collectively drive the majority of our operational process. And while we remain early in these efforts, we are seeing solid progress as we are now processing millions of transactions for our advisors through the applications of robotics and AI. By expanding the automation of these critical processes, we continue to increase the scalability and efficiency of our platform, while also enhancing the client experience. Our fourth strategic play is focused on developing a services portfolio that helps advisors and institutions run thriving businesses and deliver comprehensive advice to their clients. In the second quarter, our subscription base ended the period at nearly 3,900, with sequential growth moderating slightly in the wake of macro volatility. As we work with advisors on existing services, we continue to identify new needs we can solve for on their behalf, which is a catalyst for further innovation that expands the value proposition of our existing services and surfaces opportunities for new services. One example relates to how former Waddell and Reed advisors utilized our admin solutions on an interim basis to help them during the onboarding process. Based on that insight, we created a set of solutions for shorter-term engagements with our services to solve for a specific need in time for advisors. We are testing some of these with CUNA advisors as they transition to our platform. Looking at our pipeline for the second half of the year, we have several services in pilot and other offerings in the incubation phase. And as we move forward, we remain focused on enhancing and expanding our services portfolio to better support our advisors and drive growth. In summary, in the second quarter, 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 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. In the second quarter, we remained focused on serving our advisors, growing our business, and delivering shareholder value. Against a volatile market backdrop, we delivered another quarter of solid net new assets and earnings growth. In addition, we progressed the work to enhance our suite program utilizing free credits to create a combined cash account, substantially completed the integration of what Owen Reed signed an agreement to acquire Benningham Scattergood, onboarded CUNA, and are preparing to onboard People's United. So as we look ahead, we continue to be excited by the opportunities to help our advisors differentiate and win in the marketplace. Now let's turn to our second quarter business report. Total advisory and brokerage assets were $1.1 trillion, down 8% from Q1 as continued organic growth was more than offset by lower equity markets. Total net new assets were $37 billion for a 13% annualized growth rate. Looking more closely at recruiting, Q2 recruited assets were the strongest in our history at $44 billion, which included $32 from QNAP. These results brought our 12-month total to $84 billion. Now let's turn to our Q2 financial results. The combination of organic growth, rising interest rates, higher client cash balances, and expense discipline led to EPS prior to intangibles and acquisition costs of $2.24. This was up 21% from a year ago and is the highest in our history. Looking at our top-line growth, gross profit reached a new high of $711 million, up $42 million, or 6% sequentially. Looking at the components, commission and advisory fees net of payout were $205 million, down $22 million from Q1. The decrease was primarily driven by the seasonal increase in production bonus expense and lower advisory fees following the Q1 equity market. In Q2, our payout rate was 87%, up about 90 basis points from Q1 due to typical seasonality. Looking ahead to Q3, we anticipate our payout rate will increase to roughly 88%, driven by the typical seasonal build in the production bonus, as well as the onboarding QNAP. Moving on to asset-based revenue. Sponsor revenue was $208 million in Q2, down $4 million sequentially, as average assets decreased during the quarter, driven by lower equities. This was partially offset by an $8 million payment from a sponsor related to higher period activity. Turning to client cash revenue, it was $156 million, up $71 million from Q1. This was driven by higher client cash balance, as well as higher average short-term interest rates. Looking at overall client cash balances, they were up in the period, ending the quarter at $70 billion. Within our ICA portfolio, We added capacity in Q2 as we saw further improvements in bank deposit demand, leading to an increase in balances of $8 billion, of which $3 billion are fixed rates and $5 billion are floating rates. Looking more closely at our ICA yield, it was 134 basis points in Q2, up 32 basis points from Q1, primarily driven by the increase in the Fed funds rate during the quarter. As we look ahead to Q3, we expect our ICA yield to continue to increase. Based on where interest rates are today and our historical betas, we expect our Q3 ICA yield to increase to approximately 195 basis. Before moving on, I want to highlight that we updated our reporting of client cash balances. As we prepare for the introduction of the client cash account as our primary sweep overflow vehicle, we have updated our cash reporting to include these balances. In addition, purchase money market fund balances have been relocated to the end notes of our release. The historical data reflecting these changes is available in our historical information file. Now let's turn to service and fee revenue, which in Q2 was $113 million, unchanged from Q1. Within our services group, we ended the quarter with nearly 3,900 subscriptions, which is up about 300 from last quarter. Our services group now generates roughly $32 million of annual revenue, while also contributing to organic growth by helping drive recruiting, same-store sales, and retention. Looking ahead to Q3, we expect service and fee revenue to increase by roughly $10 million sequential, driven by revenues from our National Advisor Conference and IRA. Moving on to Q2 transaction rate, it was $44 million, down $2 million sequential, due to decreased trading markets. As we look ahead to Q3, volumes in July have seasonally declined, which on a run rate basis would result in a decline in transaction revenue of around $10 million from Q2. Now let's turn to expenses starting with Core G&A. It was $286 million in Q2. Looking ahead, we plan to stay disciplined on expenses while continuing to invest to drive growth. Given the increase in interest rates to date, including the rate hikes last week, we are poised to generate significant additional capital. Our framework for allocating this capital remains aligned with the returns we generate, which first and foremost is investments to drive and support organic growth. Now that we are deeper into the rate cycle, we plan to accelerate some of these investments and anticipate up to $20 million of additional 4G&A in 2022. This increases our 2022 core G&A outlook to a range of $1,170,000,000 to $1,195,000,000. Moving on to Q2 promotional expense, it was $84 million down $4 million sequentially, primarily driven by lower conference expense. Looking ahead to Q3, we expect promotional expense will increase to approximately $105 million, primarily driven by conference spend, as we hosted our largest advisor conference of the year last week, which returned to an in-person format for the first time in three years. Now let's move to what Ellen reached. In total, we onboarded over $70 billion, as 99% of client assets joined our platform. We generated EBITDA of roughly $21 million in Q2, or $85 million on an annualized basis. At the end of the quarter, the run rate EBITDA benefit was approximately $100 million, bringing our estimated purchase multiple to 4.5 times. As we have now substantially completed the integration, going forward, we will no longer break out their standalone results. Turning to depreciation and amortization, it was $48 million in Q2, up $3 million sequentially. Looking ahead to Q3, we expect depreciation and amortization to increase by up to $5 million sequentially. As for interest expense, it was $29 million in Q2, up $2 million sequentially, as higher LIBOR rates increased the cost of our floating rate debt. Looking ahead to Q3, we expect interest expense to increase to approximately $33 million, primarily driven by the increase in LIBOR rates. Moving on to capital management, our balance sheet remains strong in Q2, with a leverage ratio at 2.1 times in corporate cash of $241 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 where appropriate, and returning excess capital to shareholders. In Q2, we allocated capital to both organic growth and share purchases, buying back $50 million for shares. As we look ahead to Q3, Given our improved level of cash generation, we plan to increase share of purchases to approximately 75 million. 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.