Envestnet, Inc. (NYSE:ENV) Q4 2022 Earnings Call Transcript

Envestnet, Inc. (NYSE:ENV) Q4 2022 Earnings Call Transcript February 23, 2023

Operator: Greetings, and welcome to the Envestnet Fourth Quarter and Full Year 2022 Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question-and-answer session will follow the formal presentation . As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Brian Shipman, Head of Investor Relations. Thank you, Mr. Shipman, you may begin.

Brian Shipman: Good afternoon, everyone. Thank you for joining us on today’s fourth quarter and full year 2022 earnings call. Before we begin, I’d like to point out that our earnings press release, supplemental presentation and associated Form 10-K can be found under the Investor Relations section of our Web site at envestnet.com. This call is being webcast live and a replay will be available for one month on our Web site. During the call, we will be discussing certain forward-looking information. This information is based on our current expectations and is not a of future performance. I encourage you to review the cautionary statement on Slides 2 and 3 for the potential risks, uncertainties and other factors that could cause actual results to differ from those expressed by the forward-looking statements.

Further information can be found in our regular SEC filings. During the call, we will be referring to certain non-GAAP financial measures. Please refer to the appendix in our presentation for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures. The presentation is also posted to the Envestnet Investor Relations Web site. Joining me on today’s call are Bill Crager, our Chief Executive Officer; and Pete D’Arrigo, our Chief Financial Officer. Bill and Pete will provide a company update as well as an overview of the company’s fourth quarter and full year 2022 results. After our prepared remarks, we will open the call to your questions. During the Q&A, please limit yourself to one question plus one follow up.

You may get back into the queue if you have additional question. With that, I will turn the call over to Bill.

Bill Crager: Thank you, Brian. And thank you, everyone, for joining this evening. In 2021, Envestnet took a very deliberate stance and announced our strategy to invest in the economic opportunity inherent in our unparalleled client footprint and our breadth of services. We knew that unlocking the revenue potential of a connected ecosystem would pay tremendous long term dividends for our shareholders. We also knew that by doing so, we would experience a setback in the short term results but that would enable us to deliver the real value creation that is the goal of every sound investment in every resilient business. We are here to tell you that through an exceedingly painful year in our industry marked by stunning inflation, double digit losses in both equity and fixed income markets and a dramatic shift away from an era of low capital cost, the soundness of Envestnet’s vision is paying off.

In our industry leading account growth, deeper adviser penetration and the rapid expansion of higher margin services and the realization of our vision around connected data powered advice, we are demonstrating them by delivering enhanced value to our clients we will truly capitalize on our market share. And in doing so, we are turning the corner on both margin and revenue growth and affirming the path to our long term goals. We have been clear and have delivered on our stated intentions: Those are; to maximize the investment plan we outlined in February of 2021, creating acceleration of our organic revenue and modernizing our platform for greater operating leverage; driving greater engagement and usage of the platform by our clients; taking advantage of new processes and technologies to enable greater expense discipline; and reestablishing our margin expansion in 2023 and reaffirming our commitment to 25% adjusted EBITDA margins in 2025.

Over the last year, we were there for our clients as they navigated through a period of deep market uncertainty and volatility. We delivered managing increased volumes, enabling foundational account growth, offering them more choices to solve the challenges of a historically difficult market. Also, we have heard over and over and over again how the evolution of investments offering is answering the strategic road maps that our clients have planned for their futures. We are delivering the leadership our clients want from us. With foresight in 2021 and from a position of strength, we knew we would create greater value by leveraging that market leadership and making our business resilient in all market cycles. We invested intentionally to modernize the platform into the cloud to better integrate with our clients.

We’re delivering in the marketplace with our new client portal, our data platform, a connected proposal generation tool and enhanced integrations. Also, to increase our operating leverage, becoming more efficient as we streamline and automate more of our processes from daily reconciliations and service requests to compliance reporting and client conversions as well to accelerate high margin businesses in our fiduciary solutions, integrating and enhancing technology with data into a broader set of client demanded offerings like direct indexing, tax overlay, RIA managed accounts, digital insurance platform and retirement services. Investing into this moment produces an unparalleled offering coupled with extraordinary industry reach, creating what we believe is an out-sized long term opportunity for shareholders.

We are more essential and more embedded into the workflows of our clients. We have delivered for them. We are aligned with and addressing how they win in the next transformation in wealth management, and that is the next super cycle of holistic, connected advice. We’ve earned the right and are going deeper to be an even more important part of how they grow, how they expand revenue, margin and enterprise value in their businesses. This is what our investments and our work are accomplishing. Our results prove the strength of our business, not despite but a recognition of the environment that we’re operating in. Macro headwinds were numerous in 2022. A 60/40 portfolio was down 17% its worst performance since the year 1937, and the NASDAQ was down more than 30%.

Importantly, the US retail asset management industry saw over $500 billion of net outflows across the combination of long term mutual funds and ETFs and an organic growth rate last year of negative 1.7% compared to a growth rate of 3.5% in 2021, that is more than a 5% swing. In the face of the market we experienced in 2022, our operating results signal the progress our business is making. Envestnet posted $132 billion of total platform net flows, including $57 billion from AUM/A. Our 7% organic growth is a very strong result. Consider that for a cohort of large wealth management firms that have reported fourth quarter results thus far, organic fee based asset growth fell substantially year-over-year to 4% on average. In the AUM/A bucket, Envestnet posted $32 billion of AUM net flows or 9% organic growth, reflecting continued uptake of our fiduciary solutions, which typically carry more attractive fee rates than AUA.

These results are significantly higher than the marketplace data that we track. Our clients are valuing in using our platform more and more, creating cross sell and bundled pricing opportunities for us. Over the last year, the number of platform accounts grew to more than 18 million that we serve, an increase of over 5%. AUM/A accounts per adviser grew 9% last year. Last year, over 130 firms on the Envestnet platform adopted a new AUM program, over 2,000 advisers using Envestnet proprietary managed portfolio for the very first time. Over 100 new solution amendments were signed across client enterprises providing thousands and thousands of advisers with access to the cutting edge features available through Envestnet, ultimately expanding their options to better serve their clients.

We have signed several new contracts across the business from our financial planning business to data and analytics, the core Envestnet wealth platform. We are successfully expanding the footprint of distribution and we are importantly going deeper by expanding our services to existing clients. These results are beginning to drop to the bottom line. We have turned the corner on improving profitability. Our guidance in 2023, which is based on markets as of December 31 calls for margin expansion of around 200 basis points, which would bring the margin to approximately 20% for the year. Factors underlying this margin expansion in 2023 incorporated the anticipated pressure that we’ll see on revenue growth, countered by greater operating efficiency, given our investments as well as taking tangible steps we have to reduce expenses with laser sharp focus on the most important priorities.

In 2022, we streamlined the business to drive greater connectivity, client responsiveness and organizational efficiency. We see the collective benefit of all of our businesses working together and the investments made to strengthen the platform and create seamless personalized connected experiences, we are driving delivery of hyper personalization, which is a critical, critical secular trend for the industry. One example is our wealth data platform, which utilizes our data and connects that data to our next generation proposal tool in our financial planning software and those offerings and technologies then connect to a broadening array of portfolio solutions. The interconnectivity of this environment is what drives accelerated usage and more profitable growth for our clients and for Envestnet.

Add on to this interconnectivity, the unique capability we have here at Envestnet to provide our clients with extraordinary insights to better serve their clients. We are now serving over 20 million personalized actionable insights a day versus 11 million insights a day last year. We have created the foundation for Envestnet’s accelerated revenue growth that we articulated two years ago. The progress we have made puts us in a competitively differentiated place just as the industry is beginning to transition to a more holistic advice model. This would not have been possible without the investments we have made. The resulting opportunities to drive our organic growth rate from this interconnectivity and data driven personalization are numerous and they’re meaningful.

We’re using our platform to help our clients move brokerage assets to managed accounts using our insights, scaling and client engagement tools and streamlining workflows. One particular client has seen an increase in their firm’s managed account flows by 35% quarter-over-quarter. Another client grew their converted assets by more than 100% year-over-year after enabling this powerfully connected program. These are just two examples of how our strategy is working. If you use an actual BD example, extrapolating the conversion rates that we’re seeing in asset pool size, we can model out the opportunity for Envestnet to translate into approximately $5 million of incremental organic revenue growth this year, but that will grow substantially over the next years.

Other focus points we’ve highlighted for you in the past, the number of managed accounts on our RIA platform has grown 150% year-over-year and the number of advisers utilizing this offering is up 44% since last year. The number of advisers selling overlay offerings is up 26%, while the number of accounts with overlay attached to the account is up 33% over the last year. In our direct index offering, accounts are up 30% year-over-year and the number of advisers have grown 48% year-over-year. This is an incredibly impressive growth in the face of the market we experienced last year and demonstrates our ability to execute on our strategy. We do anticipate asset growth in these solutions to be up nearly 50% in the year ahead. We’re having similar success through key initiatives that deliver efficiencies in automation internally.

We expect a lower recurring adjusted operating expenses, and this is meaningful given the inflationary pressures of the macro environment we’re in and also increasing volumes that we continue to serve. We reduced our non-people expenses in addition to lowering our head count in both US and India. On December 1st, we completed the transition of our data and analytics operations to Tata Consulting Services. As a result, we expect to realize savings this year of between $10 million to $13 million, a number that will increase over the coming years as our account base continues to grow. Since the beginning of 2022, we reduced our real estate footprint by 30%. By the end of first quarter ’23, we will be down by 45%. The scale we have created, a scale we believe no one can match, will deliver more efficiency as our clients continue to do more on our platform.

Here are some extraordinary examples. In 2022, we achieved a new milestone. We processed 220 million trade orders, representing a 31% increase from 2021, all while reducing our expense to serve this critical function. We helped our clients trade historically high volumes as we administered more portfolios than any client platform in the United States. We’ve created modernized scale that meets the critical needs of our clients. This is the objective of any company’s modernization efforts and yet it is hard to achieve. But this leverage is just beginning for us, there is so much more to come. Here’s another example. Every day, our system evaluates 233 million account details to identify instances where accounts are out of alignment with their firm’s investment policy rules.

This is the essence of scale, the essence of service, this is the power of investment, helping our clients in truly essential ways. Once again, our volumes are way up year-over-year while our cost to serve this function is down. In a regulated industry, these types of unique services have inherent essential value. As our clients rely on our platform more and more, we have created scale and while we are also driving meaningful cost efficiency in how we serve them. As part of our long term strategy, we’re achieving higher operating efficiency for our business, and we constantly look for new opportunities to strengthen our business model. A missing element of the Envestnet business model has been the ability to complete the service cycle for our clients and generate incremental ways to monetize our services.

Last quarter, we announced our partnership with FNZ, which will create a fully end-to-end digital environment that will automate and scale our clients’ engagement with our company. The technology integration is underway and we are on track to be in the marketplace by the second half of this year. This is a significant step forward for our clients, for the industry and allows us to go deeper and enable us to pursue new revenue opportunities that are associated with custody, which we’ve never had the opportunity to do before. Begin to size that opportunity, consider that over the last three years, Envestnet has averaged over $200 billion of gross flows onto our platform. In the future, for every 10% of these flows we capture, we believe we could earn an incremental $10 million to $20 million of revenue with very attractive margins.

During the quarter, we also strengthened our balance sheet by repurchasing the bulk of our 2023 convertible notes and issuing 2027 convertible notes, which we completed this past November. This extends our maturities, placing Envestnet in a strong financial position to continue executing our growth strategy and to prudently pursue attractive acquisitions and partnerships that may arise in the marketplace. In short, in 2021, Envestnet, we set our course. In 2022, we executed on it. We accelerated several investments to modernize the platform, to go deeper with our clients, to drive sustained revenue growth for the company and lift the ceiling for margin growth. We have strengthened our position in the marketplace and we are winning new mandates.

We’ve turned the corner towards the margin expansion we are committed to. Despite headwinds from the global capital markets, we will continue to drive towards accelerated growth and are committed to achieving adjusted EBITDA margins of 25% in 2025. We’re executing the strategy we set out for investors and we believe the results will create material value over the next quarters and next years ahead. I’d now like to turn the call over to Pete, who will provide details on this quarter’s performance and our outlook for 2023.

Pete D’Arrigo: Thank you, Bill, and good afternoon, everyone. Our fourth quarter and full year results continue to demonstrate the strength in our business model. For the fourth quarter, both revenue and adjusted EBITDA were essentially in line with our guidance, although modestly impacted by a 1 time customer correction with a long-standing client, which was unforeseen at the time we gave guidance this past November. Despite this, our results were solid, especially given the market headwinds and economic environment we faced throughout 2022. Adjusted revenue was $292.9 million for the fourth quarter and $1.240 billion for the year. Adjusted EBITDA was $53.8 million for the quarter and $220.1 million for the full year, while adjusted EPS was $0.45 in Q4 and $1.86 for the full year 2022.

Our guidance for 2023 is laid out in the earnings release and in the earnings supplemental presentation, but I want to provide some context for our outlook. Prior year comparable quarters in the wealth segment will be difficult for at least the first half of 2023, primarily due to the impact the markets had on asset based revenue. As asset values were coming down last year, the revenue impact flows through subsequent quarters, namely carrying through to this year. Using market levels as of December 31st, the annualization of the 2022 market impact would present roughly a 3 to 4 percentage point headwind to our 2023 growth rate relative to 2022. While industry flows remain under pressure, Envestnet continues to experience market share gains and positive net flows.

We expect to continue to see a modest uptick in our average fee rate over the course of this year along with flows weighted more toward our AUM solutions. The Data and Analytics segment continues to face headwinds within its revenue base that we have discussed previously, primarily in research. However, as this segment completes its transformation, we anticipate improved financial results later in 2023 with a robust pipeline of new and existing client firms. Despite the near term challenges to top line growth, we expect to increase our adjusted EBITDA margin in 2023 compared to 2022 by around 200 basis points. With that context in mind, we expect adjusted revenues to be between $1.240 billion and $1.260 billion in 2023. Adjusted EBITDA is expected to be between $242 million and $252 million in 2023, reflecting the margin expansion compared to 2022, Bill and I alluded to previously.

Our guidance, as always, does not assume any changes in the capital markets from prior quarter end and is based on market levels as of December 31st. Many sell side analysts include market contributions in their models. However, we do not assume any benefit from the market in our guidance. Given that, we estimate that the reported revenue growth rate assumed within our guidance is lower than the consensus revenue, primarily because of the difference in this assumption, which is always most pronounced early in the year. Bill discussed the number of actions we took during 2022 to reduce our overhead. Given the ongoing uncertainty in the economy, we have taken additional steps this year to prudently manage expenses where possible. As a result, we are extremely confident in our ability to deliver margin expansion in 2023.

The 80 basis point adjusted EBITDA margin increased year-over-year in Q4 compared to Q4 of 2021 is evidence of the progress we’re making and supports our view that we are well positioned for increasing profitability as we head into 2023 and beyond. Turning to the balance sheet. We ended December with $162 million in cash and debt of $938 million, making our net leverage ratio approximately 3.5 times EBITDA. In November, we completed a new five year convertible note issuance in the amount of $575 million. At the same time, we repurchased $300 million of our convertible notes due in 2023 and $200 million of notes due in 2025, effectively extending the maturity out to 2027. Thank you for your support of Envestnet. And before we open it up for Q&A, I’ll turn it back to Bill for his closing remarks.

Bill Crager: Thank you, Pete. We are succeeding in a challenging market by delivering what we’ve committed to. Our business is executing on the strategy we presented to investors two years ago. It is clear in the operating results we’re reporting this evening. We have furthered the resilience and value of the business by managing expenses alongside leveraging our investments in core capabilities and scale to propel organic growth and margin expansion. We’re doing this by modernizing the platform into the cloud, increasing our operating leverage by becoming more efficient, going deeper with clients and growing high margin businesses. We have turned the corner with a foundation for revenue growth and margin expansion, building on what we delivered in the fourth quarter of 2022, reestablishing our margin expansion in 2023 and reaffirming our goal of 25% adjusted EBITDA margins in 2025.

We’re doing what we said we would do. I want to close by thanking our clients for the amazing trust that they put in us. They recognize the value we provide for them for the long term, and it drives us. And finally, I want to thank the Envestnet team. Every day you deliver, you build, you innovate, you’re enhancing advice that drives the success of our clients and millions and millions of end consumers. It is extraordinary work and I’m very proud of it, and I want to thank you. Now I’ll hand the call back to the operator for questions. Thank you very much.

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Q&A Session

Operator: And our first question is from the line of Devin Ryan with JMP Securities.

Michael Falco: This is actually Michael Falco standing in for Devin. I wanted to start on the growth outlook. In the presentation, you highlighted a number of areas that are going to drive an acceleration in revenue growth to your mid teens target, including RIA, retirement and insurance on the AUM side and then wealth data aggregation and partnerships on the subscription side. So I’m curious within that, what do you view as the maybe couple of most compelling opportunities that you expect are going to drive the bulk of that growth?

Bill Crager: I look at the momentum that we exited 2022 with in some of these growth areas, and what we’ve seen is a pretty significant uptick in some key areas. Let me spotlight first, our high net worth offering. And that simply is an outsourced consulting service that we work with advisers to help them serve higher net worth clients. And in that area, where our basis point range is somewhere between 20 basis points to 35 basis points. We have more than doubled the number of advisers who have access to that program during 2022. Our flows are up significantly in that program as we enter 2023. Anecdotally, I’d just add that through the middle of February here, our flows are probably up 55% year-over-year early in the year in this solution.

And so it’s got a very high revenue contribution and a very significant EBITDA contribution. I spotlighted RIA managed accounts on the prepared remarks and how we’ve greatly enhanced the assets that we serve and accounts that we serve by 150% in that category in 2022 and also adviser growth of 44% last year. So we have more users utilizing that solution, which is driving from off of our sub base. So they’re using our technology, but now we’re introducing asset based product to them that they’re utilizing at an increasing rate. Again, as we turn the corner from ’22 to ’23, we exited the year with a lot of momentum, and we’re seeing continued uptake in RIA managed accounts. On the insurance business, which we spotlight there. We were working off a small base as we got into the year last year, but we were up 500 times in managed assets in our insurance platform, and we exited with the highest momentum of the year.

So we rolled into 2023 with pretty extraordinary momentum there. We’ve clearly kind of reached the corner on that business and becoming the foundational tool for annuity based, especially fee based annuity product in the industry. What’s so interesting there is that 98% of the assets that we’re serving today on that annuity platform, they’re fee based annuities. That’s the inverse of the entire market, and it’s where the industry really wanted to get to more aligned fee based type annuity products. So we’re — 98% of our assets that we grew last year are fee based and those are more valuable. They’ve got recurring revenue, they’re good for the adviser, they’re good for their relationship, they’re good for the manufacturer and they are also a good — a very strong contributor to Envestnet.

To give you a sense of kind of the opportunity pool that we believe we have in the insurance platform. In 2023, we’ll onboard our largest clients to use and have access to the insurance platform. And as part of that, what we do, Michael, is we bring the back book of insurance business onto Envestnet. We use our data engine to evaluate opportunities for advisers. And so by the end of last year, we had built that back book business up to about $27 billion. Our anticipation is that will grow by 3 times this year. So we’re seeing a lot of use across these solutions, growing use and growing availability to the number of advisers, and then growing use of these solutions by advisers. I think one of the headline numbers that I spend a lot of time thinking about, and I cited this in the prepared remarks.