LPL Financial Holdings Inc. (LPLA) Earnings Call Transcript & Summary

All right. Good morning, everyone. Let's get started. This is Craig Siegenthaler from Crédit Suisse, and it's my pleasure to introduce Matt Audette. Matt is LPLA's Chief Financial Officer and is also responsible for LPLA's core functions, including financial planning and analysis, treasury, corporate development and investor relations. Prior to joining LPLA in 2015, Matt was the Chief Financial Officer at E*TRADE and spent 16 years there. The LPLA stock is coming off 3 consecutive years of strong outperformance versus broker peers. And what's really amazing is the stock still trades around 11x earnings. So it's been all driven by earnings growth. First, Matt, congrats on your stock performance.

Thank you.

For those of you who don't know LPLA, it's a purely independent broker-dealer platform that has really one main objective to help independent financial advisers. And unlike its peers, it doesn't offer proprietary products. And LPLA's also been expanding into completely new channels and has significantly increased its total addressable market. So good morning, Matt. It's great to have you here with us.

All right. Thanks for having me. Anything else? Or shall I get started?

You ready to go.

Yes. All right. I think everyone's multiple has been to adjust it for the past few days.

I'm happy to adjust that. Yes, that's right.

Yes. So welcome, everybody. Happy to be here. So I've got a lot to cover, and we're going to leave some time for Q&A. And so before I get into the material, just a few things for -- the material's up on the screen and for those of you that have books in front of you. First and foremost, our safe harbor. So I'm going to talk about a handful of things that are forward-looking statements that I think are helpful to give you a perspective on how we think things would play out. But those things are inherently uncertain, and actual results could vary materially. So just keep that in mind as I walk through them. In addition to that, on the next page, I'll also use some non-GAAP financial measures to describe our business, right? As the name states, they're non-GAAP. We think they're important and helpful to understand our business. They're metrics that management use and I use to assess our business. But I'd encourage you to look at the reconciliation of those measures to their GAAP equivalent. You can see a lot of that on Page 3 that you have in front of you. So read through that. So with that, and maybe to build a little bit on what Craig highlighted, if you look at Page 5 up on the screen, it just kind of the metrics behind that performance over the last 3 or 4 years, which I think kind of sets up the rest of the presentation well, right? Let's drive across the page, assets growing in a big way, 50%, since the end of 2015. We're now at $0.75 trillion in AUM, right? The amount of that growth that's come organically. The second chart on that page, right? It's meaningful and growing. If you just look at the percent of organic growth, right, in that 1% to 2%, you go back prior to 2015, it's probably lower than that versus 2018, over 2%; 2019, just under 4%, right? Record levels of organic growth, right? You put that together with disciplined expense management as well as investing in areas for growth, we've got op margins that have gone from 33% to now nearly 50%, right? You put it all together, what does that produce? That produces EBITDA on the right-hand side of the page. It's doubled and now over $1 billion for 2019. So we're excited about those results. We want to continue those trends. So we turn to the next page, what's our strategy to do that. And it's really pretty simple. It's 3 primary areas: first and foremost is play one on the left-hand side of the page, is positioning our models across wealth management, right? So not only our traditional markets, I'll cover in a couple of pages or the next page, how we're expanding the markets that we're competing in, but really driving the growth in those markets is the first part of the strategy. Second, in the middle of the page is really creating an industry-leading service experience at scale, right? It's something when you look at our industry as a whole and us in the past, it's not something that was part of the value proposition to be an independent broker-dealer, right? We're investing in and we're changing that. And then on the right-hand side of the plate, I think this is the one that's really interesting, really new to us into the space. It's helping advisers run successful businesses. When you think about the independent space, right, not only are these folks running and doing wealth management, but they have to run a small business, right? And that's not easy to do. It's not a skill you get when you're at a wirehouse, you're at an employee firm. So there's lots of things that you have to do that you're not skilled at or things that you really need help with, but your firms don't naturally provide, right? And I think this is one where we're, historically, in our space, there's lots of folks that will give tips in consulting and ways to go about things, but no one's really built a capability to actually go do it for them, right? And we think this is something that's going to really resonate well. So that is the overall strategy for us to drive growth. Now if we move into some of the things that really drive the financial results of that strategy. And I'm going to move ahead talking about the markets that we're in. So if you think about just the assets that are managed by advisers, adviser-mediated assets on the left-hand side of this page, right? It continues to grow, right? You look at the estimates at the end of 2019, $21 trillion, right? Adviser-mediated, that's growing on average 5% a year. When you look at the share of the independent space. So before you get to us, just the share of the independent space, center of the page, that continues to grow, right? So growing asset base, growing share, then you get to us on the right-hand side of the page. And I think there's 2 really important things here: first is, if you look at the left-hand side of that right chart, right, our traditional markets, right? You're roughly $4 trillion, $5 trillion, and we're the leader in that space, and we continue to grow, right? The advantages of size and scale and our value prop are resonated and we're growing. I'll talk a little bit more about it when I get into the expense section. But one of the areas that we've really been focused on developing more capabilities is on the right-hand side of this page, right? Our premium model, which really positions us well to compete in that kind of adviser-oriented independent or the independents coming from an employee channel into the independent channel. And then on the far right, the employee market, where the employee markets are $11 trillion. But within that market, there are independent-minded employees, right? Folks that want both. They don't want to run their own business, but they want the benefits of being independent. We think that market is around $4 trillion. So if you look at where we're investing in the total addressable market that we have, we're basically tripling it from roughly $5 trillion to $15 trillion, right? When you think about the growth prospects of LPL over the long term, think of an addressable market of $15 trillion. And I'm going to tell you a little bit about how we're -- the capabilities that are going to get us there. So if we turn to the next slide, and I'm going to -- I've got a handful of slides here, 3 or 4 slides, and I'm going to linger a little bit more than I normally do on the capabilities that we've been building for our advisers. Because I think it's one of the key things that's really been driving that record level of organic growth. So if you think about this from an adviser lens, left-hand side of the page, in that's first triangle, where do they spend their time, right? They spend it in 3 areas: managing their clients, managing their clients' investments and then running their practice, right, that practice management where they run a small business. And if we can develop capabilities that help them do each of those things not only is our value proposition going to be better and more important and helpful for them, it's also going to position them, if you look at that kind of upside down pyramid, it's going to position them to spend more time with their clients. So not only have we helped them on their practice and their business, we've freed them up to be able to grow their own practice, right? And one of the primary ways that we do that is investing in technology. And that's on the right-hand side of the page. And you can see, we have really increased our technology investments. Growing on an average about 25% a year for the past several years. I think when you look at our plans for this year, 2020, it's about in line with last year, right? $160 million versus $155 million last year. And what you're starting to see is we're reaching this equilibrium point where the amount that we can invest. It's started to reach an equilibrium point with the pace at which you can properly develop something, make sure you get the feedback from the clients, make sure you roll it out, make sure that you've got an adoption plan. And I think when you go back to '15 and '16, not only do we -- we were not at that equilibrium, we were really focused inward on infrastructure and kind of fixing things that we hadn't invested for a while versus now in 2018 and '19, and especially in 2020, these are investments to improve and develop new capabilities. So let me tell you about a few of them. So if we move ahead to Slide 10. And this is really about advisory capabilities. So when you think about our returns and the services that we provide to our advisers, you end up providing more services on the advisory side. So that's where a lot of our investments have gone. And you look at the top half of the page, the percent of the assets in advisory continues to grow, right? You can see 2015, just under 40%; end of last year, just under 50%, right? We're not far from being primarily an advisory firm. Now when you look at the bottom of the page, our centrally managed platforms. So this is a capability where if you go back to those pyramids, where the adviser is spending a lot of time actually managing and running the assets for their clients, right? If they can outsource that to someone who can do it better and cheaper, the value prop makes total sense, right? And that's what our essentially managed platforms are. And if you see over there -- not staying in permanent inventory. If you look at the trend on that page, the bars on the net new assets going into those platforms -- the assets in those platforms and the line is the percent of advisory assets overall. So you can see the percent of advisory assets in these centrally managed platforms, it's growing, right? Not only we're providing a value proposition, but we're taking work off of the advisers' plate freeing them up to spend more time with their clients. Now let's go to the next page. So if we look at the lens of all the things that adviser does to run their small business, right? And these are our business solutions. So this is us taking it from -- there are so many people out there giving tips and advice and consulting, about how to run your practice. We're going to create solutions and capabilities to do it. And that's what business solutions are. So you see the 4 in the center of the page there, I'll talk about the 3 primary ones, the admin solutions, simply getting admin for your practice. And think about this as an admin, who's actually in an LPL office, trained on LPL systems is probably the most efficient admin you could think you could possibly hire, right? You need a CFO for your business. Who's going to look at my budget? Who's going to look at my financials? Who's going to tell me whether I can afford this office or that office, or to hire -- to get an admin solution, right? They don't have those services. We could provide them a CFO, right? Marketing, right? This is primarily social media, right? The marketing to bring in new clients into my practice. So when you look at those solutions together, you look on the right-hand side of the page, right? 2018, we were really developing them. We started the prototype. We signed folks up. We had 150 at the end of 2018. You look at the end of 2019, we really started to roll them out, went up by 500 subscribers. We're now at 650 in total, right? And if you look above that bar, these are services that advisers pay for. Not only does it help the productivity of the practice, there's a revenue generation for us. On average, there are about $1,500 a month each, right? So if you do the math on that, that's over $10 million in profit for a service, just to pay for the service. And then you think about the efficiency and the growth of a practice that's using all these services, right? Retention is probably higher. The growth rate is probably higher. So there's lots of benefits other than just the revenue that can potentially come from these services. Let's turn to the next slide. ClientWorks Connected. So when you look at what an adviser does from that client management piece of that period and where do they spend their day, right? And primarily, they spend their day doing 6 things, which are the things that are listed on that page. From going left to right, from attracting prospects, right, one. Two, converting those prospects into clients, right? And you can kind of logically make sense as you move left to right across the page. If I get a client, I now have to onboard them, I now have to manage their assets. And when you look at the technology and capabilities deployed in our space, these are largely things where they were either manual, where we got the new phone calls or spreadsheets or I've got a bunch of different capabilities, so I could patch together myself, right? It's not efficient. So we've been focused on what we call ClientWorks Connected is really digitizing all these workflows. And the key of this concept is in the bottom of the page, which there will be -- think of it as 2 to 3 choices. From a capability for each of these workflows, one of them will be free and integrated into the platform. So easy example of area number two, turning prospects into clients. We went out, bought AdvisoryWorld, integrated that, which is primarily a proposal-generation platform as well as a host of other things that is integrated into the LPL framework, ClientWorks Connected, and it's free. You're with LPL, you get that. Now if you also want to go out and get a third-party solution, CRM is a great example, we built a free CRM solution that comes along with being on the LPL platform. Some folks like Salesforce where they want to use Redtail, and they can go do that. We've also integrated that as well. So the experience that they want to use something else, it's still positive. So if you take a step back and just think about the efficiency and the value prop that comes from having something like this where as an adviser, this is where I spend my day, we think it's going to resonate really, really well. So now let's move on to capital. So you think about it, again, that put yourself in that space of being and running a small business, right? If I want to grow, capital is king, right? And I'm a small business and capital is not easy to get, right? And when you think about it from our lens, we positioned our balance sheet with a large amount of capital capacity, one. Two, who's in the best position to understand the financial wherewithal of these clients than us, right? Nobody is in a better position. We calculate and distribute their revenue, right? It's on CFO solutions. We've got a good understanding and a clear understanding of their entire financial picture. So we're in a great position not only to lend to them, but we also benefit in their growth, right? So if you think about it from onboarding, that's transition assistance and the capital that you see largely consistent and common in our space. But once you're on board, what if you want to grow out? What if you want to open up a new office, right? What if you want to go on a marketing program? What if you want to do your own M&A, which happens a lot at the adviser level? We can provide that capital to them, right? And then once you want to retire, sell your business. Not only it facilitates the process to sell your business, but also the capital necessary for the acquiring adviser to buy it, right? So these are products that some have rolled out, some of them we're currently working through. But again, when you think about that overall needs of running a small business, access to capital to grow is key, and we can provide it. Now if we turn ahead, let's move into organic growth so Page 15, right? And I touched on those a little bit already, but if you look on the far left-hand side of the page, right? Organic growth or net new assets is picking up and growing and coming in at record levels. If you look at the last quarter, Q4, $8.8 billion of organic NNA, our best quarter ever, right? You can see the growth rate is starting to push up to a 5% growth rate. Earlier this week, we released our January metrics. January was a record month, $3.4 billion, right? We're almost at the end of February, so we'll release those in March as we typically do. But I think the general trends we have seen so far, probably anchor them on as of Friday as opposed to what -- we'll have to see what happens this week. We're continuing to have good growth. You are getting what you would expect in a vibrant, growing business with NNA coming in. And even on the cash balance side, we've seen stability on the cash balances. When you typically -- in Q1, you would see that cash growth you would typically see in December, kind of go back in the market. We've had stability in February so far. So big growth coming. I think if you turn ahead to Slide 16 and think through the return on those assets and where that growth is coming. If you move left to right across this page, kind of just getting the dynamic of the more services we're providing, the higher our returns, right? So if you start off with brokerage, the returns in the 20 to 25 basis point range, right? You move over into advisory, goes up 10 basis points, roughly 30 to 35. If within advisory, you're using our centrally managed platforms, you're up to 40 to 45. And then we start to think through, so someone who's doing all of that, plus using, let's just say they're using all of the business solutions, you start to get close to 50 basis points from an ROA. And when you look below each of those circles and look at where the growth is coming from, right? Brokerage up 15%, advisory, up 30%, centrally managed up 36%, right? So the higher the return, the more services we're providing and higher the growth, right? So it's flowing through really, really well. Now if we turn to Slide 17. Let's talk about the macro environment and especially given what's going on this week. I think it's worth reminding folks of how our business model reacts to movements in the macro. So if you look on the left-hand side of the page, so when market levels go down, right, and I think the S&P is a good barometer for -- to use for market levels. Every 100-point decline in the market would be about a $25 million reduction in our gross profit or our revenue. Now typically what happens when the markets go down is cash balances go up, right? People are coming out of the market, they're holding it in cash. Broadly, for every $1 billion of an increase in cash balances, our gross profit will go up $20 million, right? So there is a natural hedge in a natural offset, right? So look at the center of the page, top center of the page, if we look at the last time we really had a big sell off kind of like we're seeing right now with Q4 of '18. And during that quarter, the S&P went down 400 points, right? So simple math, that would be a run rate if it stayed there, which it didn't, but if it stayed there, $100 million reduction in our revenue. In that same quarter, cash balances went up $7 billion, right? So you do that math. You can see it on the page, that more than offsets the decline in equity markets, right? So there's really a natural hedge in the model. Now in addition to that, when the markets go back up and that cash goes into the market, which you can see kind of in the center bottom of the page in Q1 of '19, what typically happens is the cash doesn't go back into the market as quickly as it came out. So you can see the S&P pretty much recovered in Q1 and client cash of that $7 billion, only $4 billion went back into the market in Q1, right? So kind of it eventually gets back in there, but over a slower pace. When you kind of take a step back and think through the impacts of a shock in the market or a swing in the market or dislocation, like we're seeing now, there's some substantial natural hedges built into the model. Now if we move ahead a couple of slides. When we think about interest rates themselves, so Slide 19. So one of the things we've been doing over the past couple of years is really moving those sweet balances from floating rate balances typically tied to fed funds into more fixed rates. So think more of the 3, 4 and 5-year point on the curve. That left-hand side shows you the percent of those ICA balances, which is our primary suite product that is fixed, right? So we've gone from basically, if you go back to kind of mid-'18 and prior, we're basically all floating, right, 10%, then we're a little bit less than that if you go back earlier versus where we are at the end of the year of just at 50%, actually just north of 50%. And the thing that I would emphasize is, you can see at the very bottom of the chart, kind of, the average duration is in that 4-year zone. But we're not moving chunks of, like, if you can see in Q4 of '18, in Q4 of '19, where the periods where we moved large balances in, we're not sticking them in a single maturity year, right? We're -- in addition to focusing on the longer end of the curve, we're laddering out the maturities. So you can think of 3, 4, 5-year mix where there's an average of 4, but you're not setting yourself up for some big maturity event 2 years from now in one single quarter, right? It's really about getting a laddered approach and really reducing the impact of interest rates on the model. So keep that in mind. And then finally, on the right-hand side of the page, if we do get a short-term movement in interest rates, meaning fed funds, what happens. And through the dynamic of moving more into fixed, the impact of that is much, much smaller than it used to be. So if you look in that backward in that 10% fixed, it all depends on the movements in the prices on the customer deposits themselves. But the impact of a simple fed cut would be between $30 million and $45 million, right? You look at where we are today, so that Q4 '19 bar, that green bar, it's $5 million to $20 million right? It's come down meaningfully. So you put all of this together between the natural hedges built in the model, the fixed portfolio and the relatively small impact of a rate cut combined with our balance sheet positioning, our relatively low leverage ratio. I think we feel like we're in a good position to manage through macro environments like we've seen this week. So let's talk margin and expenses and investing. So if we move to Slide 20. And just a little bit of a reminder where I started off on the op margin. You look at the last 3 or 4 years. We -- I think we've really balanced well, expense discipline, driving efficiencies, while at the same time, investing to drive organic growth. And if you're doing all that well, you're going to have margin expansion, and that's what you see in the bottom right-hand corner, right? Just to repeat of those numbers going from 33% in 2015 to nearly 50% in 2019. Now what that does for is, if we turn to Slide 21, it puts us in a position to really invest to drive growth. So if we look on this page and just kind of a reminder of that long-term cost strategy that you can read in the upper left-hand corner. But I wanted to give a little additional color on our plans for spending this year. So if you look at the upper right-hand corner, right? So our 2020 core G&A context, our plan this year is somewhere between 5.5% to 8% core G&A growth. And you can see the context of that in the bottom left-hand corner, right? You go back to 2016 and '17, where we kept expenses relatively flat in a challenging macro environment, especially in early '16 versus the last couple of years, we've started to ramp that up. You see the 5% to 6% for growth. And that's what we're doing this year. But if you look back to the upper right-hand corner, just to give you a little color on where that investing is going. Think of that as about half of it is going into our core business, right? So the things that are driving growth, like supporting existing growth. Those investments in the capabilities that I've talked through, right? That's to drive the growth in the core business. So if you think about the expense growth needed to support that core business, it's low single-digit growth. The other half of that is really the investments to expand that addressable market. So think of things like the investments to create and roll out the premium model; investments to prepare us to roll out the employee model, right; investments to actually scale and grow business solutions, right? So those are really tied to creating new markets. You can think of it as investments to take our total addressable market from $5 trillion to $15 trillion. That's where they are. It's about half of that growth, right? So I think it's something that's well worth. Now the final point on this -- final two points on this. One, we always remain flexible, right? Depending on the environment we're in, if the returns look different than we thought, we can always adjust that, is one. Two, the other thing I would highlight is when you look at that range, 5.5% to 8%, right? But there are several things that can cause us to move around in that range. But probably the primary driver is variable comp, right? So you think about things from whether it be variable comp associated with recruited AUM, things ultimately land to organic growth or net new assets. So if you think through a scenario, okay, what's the scenario where you would be at 8% core G&A growth rate, that's a scenario where organic growth has substantially grown from the prior year, right? So I'll just keep that in mind that, that's the big driver of that variability. Now if we turn ahead, we're going to move into Q&A in a minute or 2 here so just a couple of things to close this out. If you think through kind of the sixth area of capital capacity. And kind of building on that point of us being at 2x leverage or a relatively low leverage ratio, we have substantial capital to deploy, right? Whether it be if there are additional investments for organic growth, if M&A opportunities come up, we position ourselves well to take advantage of that. And more specifically, if you turn ahead to Slide 26, and you think about the M&A market, just look at our traditional markets on the left-hand side of the page, right? It is relatively fragmented, right? We're the largest player in our space. There are other large players. But primarily, if you look at that kind of at 86% in our traditional independent, most of those players are relatively small. So there's a big opportunity there. So if I just -- just to close out before Q&A. So if we think about, ultimately, where this can take us? And what excites us as a management team, what excites me, as you start to think through the cycle of what we're building to, right? So if we look at upper right-hand corner and what we're doing right now, we're attracting assets advisers onto the platform and folks that are using and increasing the amount of services that they use for us, right? And what that could lead to in the bottom right-hand corner, when you combine that with being disciplined on expenses to drive operating leverage, returning excess capital to shareholders, you're going to grow your earnings and EPS. And when you grow your earnings and EPS, what we can do? What does that create the ability to do? Upper left-hand corner, invest even more in more capabilities that can lead to more assets, right? So you start to get that flywheel that can continue to grow in a pretty cool way over time. So I feel like we're in the stages of this thing ramping up really, really well. You see that in the organic growth numbers. And our aim and focus is to continue to invest and continue to drive that. So I think we've got 5 to 10 minutes for Q&A, and happy to take your questions.

I can start with one up here, and then we can get a mic in the back. Matt, you had record organic growth in the month of January. We've seen really consistent acceleration in organic growth for like 3 years now. Can it continue in the future?

Yes. Yes, it can. I mean I think almost everything I walked through, but especially those early pages on capabilities, those are the things that are really driving the growth, right? When you think about an adviser and wanting to be at a firm that can help service their needs and help them grow, it's about the capabilities. But I think what we're doing well and we need to continue to do is invest in those capabilities and drive them. So I think the opportunity to grow that is absolutely there. It's fun to have when you look at Q4 being a record quarter. You look at January being a record month. What we've seen so far in February is continued nice growth. So I think we're feeling good. But at the same time, we're focused on working hard and investing to make sure that it continues.

The expansion of the addressable market that you talked about before. I know, on the last call, Dan mentioned some growth like the RIA platform. You're seeing some teams sign on and a pipeline building. Do you mind just updating us on that specific vertical with a new addressable market?

Yes. That's the premium model. And I think that the point I'd say is, look, it's early. But I think what we're hearing and seeing is the capabilities that we're putting together. Really, you think of this where this premium model resonates the most, our larger teams that are moving from an employee model that want to go independent. And like all, everything about being independent but they need help to get there. And I think it's a capability that we hadn't really had in the past. I think what we're seeing through helping them find physical space and setting up their entities to really taking those business solutions and packaging them in that employee model. We're just -- the feedback what we're hearing is resonating really, really well. It's still early for metrics, right? I think the headline is still -- we've had our first couple of teams joined or signed up on the process at least to joining, they're going through now, which are the things that I just described. And we'll keep you posted along the way. But I think the headline is we think the product and platform we're developing, the response has been positive.