Broadridge Financial Solutions, Inc. (BR) Earnings Call Transcript & Summary

Good morning, everybody. Thank you for joining us here for Broadridge. I'm James Faucette, one of the senior analyst here at Morgan Stanley. Very pleased to have Edmund Reese, CFO of Broadridge to join us. Before we get started with our questioning here that -- at least that I have prepared, I do have to read the following for important disclosures, please see Morgan Stanley research disclosure website at morganstanley.com/research disclosures. If you have any questions, please reach out to your Morgan Stanley rep.

So with that and without any more to do. Edmund, maybe for those that aren't familiar, could you give a brief overview of Broadridge or business? And what are the problems Broadridge is trying to solve and where do you fit in the value chain?

Great. First, thank you, James, for having us here today, and good morning to everyone in the audience here. In terms of overview, Broadridge is a global fintech leader. It's $17 billion market cap, about $4 billion in recurring revenue. We provide the critical technology solutions for banks, wealth managers, asset managers, other capital markets and financial institutions that power trading, empower investment -- investor communications and corporate governance. Our business is really broken into 2 segments. The first is what we call the governance business or Investor Communication Services, ICS. That's a $2.3 billion business. It's been growing at 8% over the last 4 years, fiscal '18 through fiscal '22. And that growth has really been driven by increased investor participation in financial markets and the increasing focus on corporate governance. We communicate and distribute over 2 billion communications sitting in the center of this network of over 1,100 broker-dealers, 30,000 mutual funds, 9,000 corporate issuers. All of those are required to communicate to over 120,000 institutional accounts, over 170 million retail investors as well. We use that position in the center of that network to expand our relationships with those players, and we've expanded into a range of services now providing data-driven solutions for the funds, other issuer solutions and nonregulatory communications as well. So that's one of our businesses. The other business is our GTO business or Global Technology and Operations. That's a $1.5 billion business and recurring revenue. It's been growing at 14% over the last 4 years, '18 to '22. And there, we are providing financial institutions with fully integrated trade processing. And that business is really broken between 2 components. One is our capital markets franchise. That's a $903 million business that's been growing at 14% over the last 4 years. There, we are really driving trading innovation, helping with other network-enabled solutions. Last year -- well, in fiscal '21, we bought a company called Itiviti. We've now rebranded it Broadridge trading connectivity solutions, and that has helped us move into the pre-trade world into the front-office of trading and helping drive that capital markets business. The other component of GTO is the Wealth Management business and that has been growing at 11% over the last 4 years. That business is about $550 million in recurring revenue. And there, we're really providing front, middle and back office solutions. Our over 30% of U.S. advisers are using our front office wealth management capabilities. And those are our businesses, but when you think about the business strategy to drive that growth, it's all underpinned by a very strong resilient financial model that I would say is focused on driving sustainable recurring revenue growth, continuing to invest for the long term in each of those businesses, driving margin expansion to the tune of 50 basis points a year, and that is what allows us to drive steady and consistent adjusted earnings growth. All alongside a balanced capital allocation model. So those are our businesses. There is something that I would say is unique about Broadridge in that we really stay focused on the long term. Every 3 years or so, we provide 3-year objectives, top and bottom line objectives for our business. We're right now in the cycle in our current 3-year cycle of fiscal '20 through fiscal '23, we've set as objectives 7% to 9% recurring revenue growth, 5% to 7% of that being organic, 50 basis points of margin expansion and 8% to 12% of adjusted earnings growth. And if you look back over the last couple of cycles, the '14 to '17 period, the '17 to '20 period, you see sort of performance in line with those objectives, as well. So -- and before I turn it back to you, in terms of the overview, let me just make a comment about our Q2. So we just did earnings for our Q2 -- our fiscal Q2 earnings and there we posted 8% recurring revenue growth on a constant currency basis. We had 11% adjusted EPS. But beyond those metrics, I highlighted 3 things, the first of which is that we are reaffirming our guidance for fiscal year '23. In fiscal '23, we have guidance of 6% to 9% recurring revenue growth, margin expansion of 50 basis points and 7% to 11% adjusted EPS growth. Despite this, the volatility that we're seeing in the macro environment that we're in, we're confident in reaffirming our guidance. The second thing I'll point out is, I just talked about the 3-year objectives. If we meet the guidance that I just mentioned and coming off the back of a strong fiscal '21 and strong fiscal '22, we would be at or above the high end of the 3-year objectives that I just mentioned when we get to fiscal '23. And the last thing I'd highlight there is our free cash flow conversion and capital model. We've been in an investment phase, and I'm sure we'll give into what we've been investing in. But we are now past our peak period of investment. We see the client platform spend come down, we see our free cash flow conversion, a metric we use free cash flow conversion relative to earnings, starting to increase. And most importantly, I'd say, we expect the free cash flow conversion to get back to our historical levels in fiscal '24, that will allow us to continue to return capital to our shareholders that will allow us to continue to pay down our variable debt as we maintain an investment-grade credit rating, and that will allow us to have some capacity for any strategic M&A that we'll see as well. So that's sort of the overview to answer your question, and I'll turn it back over to you.

Yes. No, I appreciate it. And I think that's a great overview, and it lays out very clearly, not only where your objectives are or where you're trending and how you're performing versus those -- from my perspective, from a -- and from a technology perspective, you highlighted or what I find really interesting is the ambition in the wealth business right now with that new platform, et cetera. And -- and you've announced a deal with UBS. And I guess one question I have around that is, is it safe to assume that we haven't really had any updates on your expectations for the timing of revenue to go live as well as the ACV of the deal? Like -- or what are there any updates to go with that?

Well, I think the short answer to your question, is it safe to assume that I think is yes, on 2 fronts. One that we still expect to go live in mid-calendar 2023 with UBS and 2 that we expect to recognize revenue in '23 -- in mid-calendar '23 associated with that deal. If I were just to add some more color on that short answer. Look, -- and first, I appreciate you raising the question because it's certainly a significant topic that folks have been focused on. The progress continues to be strong here. We've now completed development across all the modules. We've now completed testing on that platform. You, I know are aware, James, that we have 2 modules that are already live in billing that's driving economics for UBS, that's been live for quite some time. We're actually now in our second generation of the workstation, rolled out to over 15,000 advisers, and that is receiving strong positive feedback as well. Coming back to the point I made on revenue, I do, as I said, expect to recognize revenue in mid-calendar '23, that won't be at the steady state levels that I mentioned on the previous call that will be sort of dependent on the timing of when UBS wants to roll out. But I will say that we expect the earnings to still be in line with what our prior expectations were. Because if revenue is going to be lower, then I'll expect lower cost, I'll expect lower investment as well. And I did say, and I'll repeat again that this project itself will be dilutive to the Broadridge margins, but the operating leverage that we have in the business, I think, still allows us to hit the type of -- that hit the type of objectives of 50 basis of margin expansion that I mentioned earlier. So I feel good about that. And I'll also note that the project itself will be cash flow positive for us as we go into fiscal '24 as well. I did mention earlier that we expect $20 million to $30 million in sales associated with the deal each year and that will be at accretive margins, and I think eventually allow us to get back to the returns that we expect. But most importantly, a point that I made earlier, most important to me is the fact that I expect the free cash flow conversion to continue to move up because we've now come to the end of the investment period. And that's -- we saw in Q2, lower client platform, lower investment.

Right. Right.

It was half. More than half of the prior quarter and half of the last year. I expect the second half of fiscal '23 to also be lower relative to last year, and that is the thing that allows us to continue that trend of seeing free cash flow conversion go back up.

And then like -- so I think that's really helpful, especially from a like investment cycle perspective and starting to recognize revenue while the investment requirements are coming down. In terms of like looking at potential future trajectory for that product. UBS is among the top 5 largest self-clearing broker dealers. And can you -- it seems to me that there's -- that means that there's got to be a lot of product functionality that you've had to build in as a result. And how does that compare for other potential customers? And especially since a lot of them at the same time, will have developed their own solutions internally. So just wondering like where we go from here...

You're almost answering part of the question for me because that's exactly right. When you look across the landscape for wealth tech, for wealth technology. Remember, we say it's a $16 billion market opportunity. There are many players with many different approaches. So there's not one technology player who, I would say, has scaled across the entire platform. And to exactly what you just said, what that means is that institutions are either building their own proprietary capability or they're stitching together a combination of third-party point solutions for their overall capability. What we have is a modular approach with an integration layer that allows us to put our capabilities and allow firms to use their own applications or use third-party solutions as well and have that completely integrated. And yes, UBS was the anchor client for us, but this is a $16 billion market opportunity that's growing at mid-single-digit rates. And we've had success bringing on the second client in RBC in the wealth pipeline, I think we mentioned on our last call was up over 25% as well. So when I think about the prospect and client segmentation that you're asking about here, I sort of bucket it into 4 or 5 buckets. The first is the big guys that you're talking about the Tier 1 broker-dealers. And there, like you just said, they do have their own proprietary solutions but those solutions are aging. They need to be modernized. They need to be upgraded, so they have gaps, and we can bring our componentized solutions to fill those gaps and continue to expand with them. Sort of the second big area for us is the regional and the national brokers as well. And there, they're using some of our competitors, particularly on front office solutions. Front office capability as well. So we have the opportunity, again, with our componentized solutions to go in and upgrade the technology there. The largest sort of group that -- from a segmentation standpoint that we look at is the independent broker-dealers and they're primarily using the large custodial banks that are doing the clearing for them. So it's unlikely we're going to go in and sell all of our capabilities front to back. But again, the modular approach and componentized solutions work for us. I'll mention the RIAs, there, obviously, we have the opportunity to go in and sell the front to back -- front, middle and back-office capabilities and the entire solution. And then new entrants come in as well who are -- if you think about some of these digital solutions there, investors are self-directed -- self-direct investing, they're looking to be self-clearing themselves, and so we have an opportunity there. So when you think about those 5 categories, you can see why we're excited about the opportunity, but more excited about our componentized approach opening up the door for us to be able to sell to all of those categories.

Got it. And then just lastly on the wealth businesses that I think -- the business declined roughly 3% year-over-year, but it seemed like that, that was actually largely due to a large client renewal in the prior year. Are there any other upcoming renewals across your various lines that we should be aware of just that could create a similar situation?

Yes. And let me just clarify the question a little bit or clarify what you just said there. It declined in the second quarter, 3% year-over-year, and it was growing over a license renewal from last year. And the accounting for license when you renew is such that it can have quarterly impacts to us. And on the second quarter call, I did mention that I expect to see because of growing over other license renewals and impact in Q3 in our capital markets business and an impact in Q4 in our Wealth Management business as well. All of that was factored into the guidance that I mentioned to you earlier. And importantly, I do expect the GTO business to still grow in line with our organic objectives of 5% to 7%. And the other thing I'd say about license revenue is that over time -- it's less than 2% of our overall recurring revenue. And over time, as we transition clients from license self-hosted to our SaaS platforms, it will continue to decline.

Got it. So want to turn quickly. One of the questions that we get a lot and that I'm sure creates a lot of line of questioning for you as you go through quarterly earnings reports is event-driven revenue. And kind of recognizing that you're focused on the recurring revenue, and that's really your -- like really what you want to try to drive and what you can control. On the other hand, the event-driven revenue can move numbers around as well, obviously. And it looks like that most recent quarter, that was below what we've come to see as the average at least over the previous year. Given what's happening with mutual fund proxy timing, do you think that could result in a potential rebound in that event-driven revenue? And how should we scale that?

Yes. The first thing I'd say to that is it can move quarterly numbers on an annual basis is quite stable for us. I really try to focus folks on looking at the annual amount of recurring -- I mean, of event-driven revenue. And you're right, in Q2, we saw historically low mutual fund proxy business. And that's mutual funds and ETFs going to a proxy for their Board elections. Now that typically happens every 5 to 7 years. It might slow in the weaker environment, but it's not an optional activity. It has to occur. That's sort of one side of it, on the fund side. On the equity side, I've gotten a lot of questions about contest activity, right? And you think about the contest, and I'd probably separate that into 2 components. One is active is sort of agitating for change versus an actual all-out proxy contest, the latter of which I think is less frequent. And so in terms of the rebound question, what I said on Q2, I still stand by, which is -- I'll probably see lower mutual fund proxy activity this year. I do expect that to be partially mitigated by higher contest activity that will likely put us in the range that we've seen over the last few years, $240 million to $260 million. At that level, we'll still be able to hit the 7% to 11% adjusted EPS that we have as guidance for fiscal '23. And then finally, I talked about it being annual. I'd also say that, over time, I expect event-driven revenue to grow in line with position growth which I expect to be in sort of the mid-single-digit levels.

Got it. Got it. And then you mentioned kind of technology spend, et cetera. But I'm wondering from your customers' perspective and given the breadth of your product portfolio and overall customer base, what's the broader outlook for technology spend in financial services, at least for your customers? Clearly, we've seen some cost cutting and more operational restraint at least at some financial institutions. But our perception is that longer term, transformation and modernization initiatives really remain intact. They remain important, et cetera. But -- what are you seeing? And what nuance would you add to -- from the conversations you're having with your...

I agree with the perception that you just mentioned. These financial institutions are spending $200 billion a year on technology and operations and that's growing at mid-single-digit levels. In my role, I have the opportunity to talk to senior executives at our clients, and they are telling me, for sure, we had a group of them into our offices a month or so back, that they continue to expect to invest in next-gen technology. They want to partner with a company that's investing in the technology because that helps lower their costs. Industry solutions help make them more efficient in their operations and help modernize the capabilities that they have. And so I agree with the sentiment. I think our componentized strategy approach sets us up in these environments to go large or to go smaller. And so I think the pipeline is strong and the runway is strong and long for us when we think about technology spend.

So are you seeing though on that pipeline, are you seeing any changes to pipeline either by region or product line or decision cycles changing? Like -- like I think that's probably the most common question I'm sure everybody get.

It should be because it's the key driver -- revenue from sales, and therefore, why the pipeline is relevant as the key driver of our growth. But I do like to differentiate that we have a sales backlog. It's $430 million, 12% of our recurring revenue growth. That's the key driver of in-year growth. The pipeline, closed sales in the year won't so much impact the revenue, but it's important for future revenue. When I think about the pipeline, I think there are some positives there. We are seeing increased attention for our digital solutions. We've been talking a lot over the past couple of quarters about our wealth and focus products. So we're seeing strong sales there. I mentioned earlier the BTCS acquisition that front office pre-trading capability, continued strength there. And I also mentioned the wealth pipeline being up year-over-year. What I would say in terms of demand is that the first quarter and the second quarter, we're satisfied with that. We're happy with that.

Right, right.

You look back over the last 5 to 6 years, 40% to 50% of our sales have been in the fourth quarter. So it's kind of early for me to say whether the sales cycle is elongated or going to be longer. I'm good with the first half, and we'll see how it plays out for the second half.

So I want to go back to in terms of the net client and the platform spend as well as your free cash flow. And you mentioned a couple of times this morning that free cash flow conversion will return to historical levels by fiscal '24 as you lap the development and testing costs, et cetera, that are starting to come down. But could that change potentially if we were to -- if you were to sign a wealth manager of comparable size to UBS? I mean, would that require customization and then tick back up? Or is that something where the modularization should allow for it not to be as significant of an incremental increase.

Yes. I mean simply on that one, I just think that when we talk about the $20 million to $30 million in sales per year for Wealth Management, our expectation and what drives our business thesis here. I expect that to be componentized sales, but mixed in there some large sales as well. What we've been doing during the UBS build-out is building foundational. Clearly, there's some customization for them as a client, but a lot of this has been foundational build as well for new enhanced technologies, and that means it's reusable. So I've mentioned earlier, the integration layer, the API integration layer or the workstation container as well. You don't have to rebuild that as a new client comes on. And so when I think about whether it's the smaller componentized sales or the larger sales. I think you'll see some investment. The investment will be primarily related to converting those clients.

Right.

And I think it will be more in line with our typical sort of conversion time lines, not as long as the spend.

Got it. Got it. Got it. Taking another topic really from the news and the headlines. There's this pending SEC regulation regarding tailored shareholder reports. Can you provide some color on how Broadridge is getting involved in the creation and production of those tailored reports to help offset some of the small headwind associated with the notice and access fees?

Yes. And you said some terms there that if I weren't at Broadridge, I wouldn't recognize...

Okay. Yes, I'll explain...

So let me make sure folks understand what you're saying. There's new regulation from the SEC related to the semiannual and annual reports that funds are required to disclose. Effective July 2024, they now are required to provide summary 2- to 3-page reports versus what happens today, which is you get a link to go to a big broader report with a lot of information in it. When that goes into effect, the notice and access that we send out to say, hey, your report is available, that will no longer be required and the revenue associated with that goes away. That's roughly $30 million in recurring revenue to the point that you just said. Those things said, first, I would say that we are always in favor of better disclosure to investors. So we support that. And I think there are opportunities for us to be able to mitigate the impact from the notice and access going away. One, when you think about today, for those larger reports, the printing is primarily taking place off-site with other third-party solutions then they send it to us to distribute. If we're going to move to a 2- to 3-page report, then we can print those on site for us as well front to back, just like we do bills and statements and other confirms. That's an opportunity to be able to offset it. The other thing, and this is harder, but we're very excited about it, is to really move upstream in the composition of those reports. If you look at the regulation it's saying, what used to be just send out a report of all your different share classes to all the investors, you now have to send specific information for the specific share class to the investors who are holding that, and that's very complex. And so that's right in line with our omnichannel digital strategy to be able to help there with that complexity and help lower the cost for the funds. So I see that as an opportunity for us to be able to offset the impact of the notice and access fees.

Got it. I mean in the last minute, you kind of highlighted a growth algorithm and a component of that is inorganic growth, like what is -- what are the objectives within that? And I guess one of the questions we often hear around acquisitions or is like what's happening with valuations and opportunities for Broadridge to find out?

I mean we are -- you're right. I highlighted the objectives in. It's worth emphasizing that, that the 7% to 9% recurring revenue growth for us has historically been and will likely continue to be weighted on organic growth. 5% to 7% of organic growth. And we've picked up 1 to 2 points of growth from inorganic acquisition. Clearly, with the investment that we've been making in the wealth management platform with the investment that we made with the purchase of Itiviti, now BTCS, we've been in the phase where we've been paying down the debt to stay at the leverage ratios, stay at the leverage ratios that we want. But going forward, with free cash flow sort of returning to the levels that I talked about, I think we'll have more capacity for M&A. And I'd expect the normal smaller tuck-in types of acquisitions that you've seen historically do. If you look the '18 to '20 time period, the acquisitions were on average $55 million, $60 million, like smaller tuck-in acquisitions. That will be a continued part of our overall capital allocation policy. But broadly, we're about investing organically, returning through dividends, capital to shareholders. If we see the right M&A opportunity that fits our strategy that drives the type of financial return that we want, we'll pursue that. Otherwise, we'll return the rest to shareholders and share repurchases.

Great. Well, that's all the time we have. Edmund, thank you very much. Appreciate your time today.

Yes. Thank you. Thank you, James. Thanks for having me.