LPL Financial : Q2 2022 Earnings Transcript

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EDITED TRANSCRIPT

LPLA.OQ - Q2 2022 LPL Financial Holdings Inc Earnings Call

EVENT DATE/TIME: AUGUST 02, 2022 / 9:00PM GMT

OVERVIEW:

LPLA reported 2Q22 EPS prior to intangibles and acquisition costs of $2.24.

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AUGUST 02, 2022 / 9:00PM, LPLA.OQ - Q2 2022 LPL Financial Holdings Inc Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Dan Hogan Arnold LPL Financial Holdings Inc. - President, CEO & Director

Matthew Jon Audette LPL Financial Holdings Inc. - CFO

C O N F E R E N C E C A L L P A R T I C I P A N T S

Alexander Blostein Goldman Sachs Group, Inc., Research Division - Lead Capital Markets Analyst

Brennan Hawken UBS Investment Bank, Research Division - Executive Director and Equity Research Analyst of Financials

Craig William Siegenthaler BofA Securities, Research Division - MD and Head of the North American Asset Managers, Brokers & Exchanges Team Devin Patrick Ryan JMP Securities LLC, Research Division - MD and Equity Research Analyst

Gerald Edward O'Hara Jefferies LLC, Research Division - Equity Analyst

Kyle Kenneth Voigt Keefe, Bruyette, & Woods, Inc., Research Division - MD

Michael J. Cyprys Morgan Stanley, Research Division - Executive Director and Senior Research Analyst

Steven Joseph Chubak Wolfe Research, LLC - Director of Equity Research

P R E S E N T A T I O N

Operator

Good afternoon, and thank you for joining the Second Quarter 2022 Earnings Conference Call for LPL Financial Holdings Inc. Joining on the call today are President and Chief Executive Officer, Dan Arnold; and Chief Financial Officer, Matt Audette. Dan and Matt will offer introductory remarks, and then the call will be open for questions. (Operator Instructions) The company has posted its earnings and press release and supplementary information on the Investor Relations section of the company's website, investor.lpl.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 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 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 earnings release, which can be found at investor.lpl.com.

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

Dan Hogan Arnold - LPL Financial Holdings Inc. - President, CEO & Director

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 advisers so they can take care of their clients. Amid persistent market volatility and geopolitical uncertainty, our advisers reinforced the value they provide to their clients by helping them navigate through times of uncertainty. In that spirit, I want to recognize our advisers for their continued care and dedication to their clients, especially when they need it most.

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AUGUST 02, 2022 / 9:00PM, LPLA.OQ - Q2 2022 LPL Financial Holdings Inc Earnings Call

With respect to our performance, our second quarter business results led to solid financial outcomes. At the same time, we continue to make progress on our strategic plan. 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 CUNA 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, including $32 billion from CUNA. This brought our total recruited assets over the past 12 months to $84 billion, which is 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 markets.

Looking at same-store sales, our advisers 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 quarter, periods of heightened uncertainty are often the environments that reinforce the value of professional advice and with time and can serve as a catalyst for advisers to grow their practices.

With respect to retention, we continue to enhance the adviser 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 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 acquisition costs, an increase of 21% from a year ago.

Let's now turn to the progress we made on our strategic plan. As a reminder, our long-term vision is to become the leader across the entire advisor-centered marketplace, which for us means being the best at empowering advisers and institutions to deliver great advice to their clients and to be great operators of their businesses. To bring this vision to life, we are providing the capabilities and solutions that help our advisers deliver personalized advice and planning experiences to their clients. At the same time, through human-driventechnology-enabled solutions and expertise, we're supporting advisers in their efforts to be extraordinary business owners. Doing this well gives us a sustainable path to industry leadership across the adviser experience, organic growth and market share.

Now to execute on our strategy, we have organized our work into 4 strategic plays, which I'll review in turn.

Our first strategic play involves meeting advisers and institutions where they are in the evolution of their businesses by winning in our traditional markets while also leveraging new affiliation models to expand our addressable markets.

Our recruiting in traditional markets continued to be a source of growth in Q2 with approximately $9 billion in assets. We continued to increase our win rates and expand the depth and breadth of our pipeline, notwithstanding a broader slowdown in adviser movement over the past couple of quarters. Historically, during the initial stages of elevated market volatility, advisers often focus on supporting existing clients and may pause on making strategic decisions like switching firms. However, after advisers 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 RIA offering, we recruited over $2 billion in assets in Q2 and believe we are well positioned to drive continued growth across all 3 models. The second quarter saw a new high for recruited assets in our employee model as the value proposition for advisers has proven to be compelling. As a complement to our organic growth, we recently announced the acquisition of the Private Client Group business of Boenning and Scattergood, 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.

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AUGUST 02, 2022 / 9:00PM, LPLA.OQ - Q2 2022 LPL Financial Holdings Inc Earnings Call

Our second strategic play is focused on providing capabilities that help our advisers 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 advisers to support deposits and withdrawals within client accounts. Separately, we also enhanced 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 advisers 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 advisers and their clients and in turn, helps drive adviser recruiting and retention.

As a reminder, over the past 2 years we have transformed our service model into an omni-channel, Client Care Model, which includes voice, chat and digital support, thus giving advisers flexibility for when and how they access service. We continue to fine-tune this model to drive additional efficiency and an enhanced experience for advisers.

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 advisers. Our transformation efforts are currently focused on core clearing functions, including money movement, account opening and account transfers, which collectively drive the majority of our operational processing. And while we remain early in these efforts, we are seeing solid progress as we are now processing millions of transactions for our advisers 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 advisers 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 advisers 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 & Reed advisers utilized our Admin Solutions on an interim basis to help them during the onboarding process. And based on that insight, we created a set of solutions for shorter-term engagement with our services to solve for a specific need in time for advisers. And we are testing some of these with CUNA advisers 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 advisers and drive growth.

In summary, in the second quarter, we continued to invest in the value proposition for advisers 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 advisers 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.

Matthew Jon Audette - LPL Financial Holdings Inc. - CFO

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 advisers, 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 sweep program utilizing free credits to create the client cash account, substantially completed the integration of Waddell & Reed, signed an agreement to acquire Boenning and 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 advisers differentiate and win in the marketplace.

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AUGUST 02, 2022 / 9:00PM, LPLA.OQ - Q2 2022 LPL Financial Holdings Inc Earnings Call

Now let's turn to our second quarter business results. 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 or 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 CUNA. 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 decline.

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 of CUNA.

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 equity markets. This was partially offset by an $8 million payment from a sponsor related to prior 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 rate and $5 billion are floating rate.

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 points.

Before moving on, I want to highlight that we updated our reporting of client cash balances this quarter. 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, purchased money market fund balances have been relocated to the endnotes 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 sequentially, driven by revenues from our national adviser conference and IRA fees.

Moving on to Q2 transaction revenue, it was $44 million, down $2 million sequentially due to decreased trading volume. 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

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