Envestnet's (ENV) CEO Jud Bergman on Q1 2014 Results - Earnings Call Transcript

May. 8.14 | About: Envestnet, Inc. (ENV)

Envestnet, Inc. (NYSE:ENV)

Q1 2014 Earnings Conference Call

May 8, 2014 5:00 p.m. ET

Executives

Jud Bergman - Chairman and Chief Executive Officer

Pete D'Arrigo - Chief Financial Officer

Chris Curtis - SVP and Treasurer

Analysts

Peter Heckmann – Avondale Partners

Chris Shutler – William Blair

Chris Donat - Sandler O'Neill

Jennifer Dugan - Stern Agee

Jeff Houston - Barrington Research

Operator

Good day everyone. Welcome to the Envestnet First Quarter 2014 Earnings Conference Call. Today’s call is being recorded.

At this time I’d like to turn the conference over to Mr. Chris Curtis, Senior Vice President and Treasurer. Please go ahead sir.

Chris Curtis

Thank you. Good afternoon everyone. With me on today’s call are Jud Bergman, Chairman and Chief Executive Officer; and Pete D'Arrigo, Chief Financial Officer. Our first quarter earnings press release and associated Form 8-K can be found at envestnet.com under the Investor Relations section.

During this conference call, we will be discussing certain non-GAAP information, including adjusted revenues, adjusted EBITDA, adjusted net income and adjusted net income per share. This information is not calculated in accordance with GAAP and may be calculated differently than other companies’ similarly titled non-GAAP information. Quantitative reconciliations of our non-GAAP financial information to the most directly comparable GAAP information appear in today’s press release. During the call we will also be discussing certain forward-looking information. These discussions are not guarantees of future performance and therefore you should not put undue reliance on them. These statements are subject to numerous risks and uncertainties that could cause them to differ materially from what we expect. Please refer to our most recent SEC filings as well as our earnings press release, which are available on our website for more information on factors that could affect these matters.

This call is being webcast live and will be available for replay for one month on our website. All remarks made during the call are current at the time of the call. They will not be updated to reflect subsequent material developments. We will take questions after our prepared remarks.

And with that I will turn the call over to Jud.

Jud Bergman

Thank you, Chris. Hello everyone. I add my own welcome to you this afternoon.

Envestnet is enabling the transformation of wealth management. We believe our leadership in technology and services is improving how advisors render wealth management and empowering them to deliver better outcomes for their clients. We are pleased with our first quarter results and can report that we are executing on all aspects of our growth strategy. As a reminder, our organic strategy is fairly straightforward. We build our business within existing relationships through our ongoing sales activity. We [add] advisors, find solutions that allow those advisors to build their fee-based practices. This results in target revenue growth in the high teens. Periodic and regular enterprise conversions also contribute meaningfully to our topline organic growth target of 20% per year. We also look to benefit from the scale and operating leverage in our business to be able to deliver growth and adjusted cash flow of at least 25% for the year.

During the first quarter, we exceeded our goals. Advisors with assets under management or administration are up 48% from a year ago, up 30% on an organic basis and we now serve more than 24,000 advisors with our fee-based offerings, including licensing arrangements, more than 32,000 advisors use Envestnet to support their wealth management and investment advisory practices.

Total accounts with assets under management or administration are up 65% from a year ago. That’s 48% on an organic basis. These rates exceed our account in both targets, a result of advisors continuing to support our platform. Accounts per advisor are up 12% from just one year ago. Converting large books of business on to the platform is the final piece of our organic growth strategy. Looking back to our earnings call in February 2011, where we provided our first annual outlook, we identified at that point that conversion target of $12 billion to $14 billion that we hoped to convert within the next four to six quarters and we were able to deliver on that. At that time, what seemed like a very ambitious amount was met, but in the first quarter of this year alone, we on boarded $13.5 billion between assets based conversions and licensing conversions.

During the past four quarters, we’ve completed over $60 billion in conversions, including licensing arrangements. This type of organic growth has become a core competence and a competitive advantage for Envestnet as we compete for large new clients and go meaningfully deeper with our existing enterprises’ clients. It positions us to be the platform of choice as firms look to consolidate their fee based business on one platform and as we leverage a core competency of doing large and complex conversions. A central part of our strategy is to leverage this onboarding conversion competency and compliments our organic growth with disciplined acquisition activity. Our on boarding capabilities make us the [acquirer] of choice for wealth management platforms. And we have demonstrated experience working with clients to transition platforms that provide sellers a high degree of competence that they are doing what’s best for their clients.

With respect to WMS, the Wealth Management Solutions business we acquired from Prudential last year, the initial tranche of clients moved over during the first quarter and the necessary platform development is nearly complete. During the remainder of this year, the remaining WMS clients will be testing their new platform. We expect nearly all clients to migrate to the Envestnet platform by yearend, although we do expect one or two clients to not fully convert until sometime early in 2015. While this represents a longer implementation period than previously expected, we are managing the operational costs carefully and we expect to continue to find ways to reduce the expense burden during the development and migration phase. As a result, we’ve already started to generate some modest cash flow from WMS. And this is a positive development when compared to our original expectations. More promising still is we now expect WMS to generate cash flow of 15% to 20% higher than previously expected when the transition is complete.

While the WMS integration efforts are consuming a fairly significant amount of time and resources, we continue to be very focused on the other investments necessary to retain our industry leadership and sustain our strong growth profile. We continue to invest in business. Currently we are investing in the product rollout for quantitative portfolios, for investment intelligence, for investment retirement solutions and for client onboarding capacity, as well as platform development, both in general and specifically to sophisticated new clients like William Blair & Company. We believe these investments enhance and expand the platform capabilities and the solutions we offer our advisor clients, providing the necessary foundation for us to achieve our organic growth objectives in the years to come.

We are also focused during this time on merger and acquisition opportunities that can add further scale to our platform, consolidating transactions like WMS for [Conquest] or could add a significant strategic benefit like (inaudible). We are actively evaluating opportunities in the market. While completing the WMS integration is our top strategic priority, we remain both disciplined and opportunistic in our ongoing evaluation of these growth rope accelerators.

I will conclude with a few remarks in a moment. I would first I'd like to turn it over to Pete D'Arrigo, our Chief Financial Officer to discuss our financial performance in greater detail.

Pete D'Arrigo

Thank you Jud, good afternoon everyone.

In the first quarter of 2014, revenue from assets under management to administration grew 85% to $67.1 million compared to $36.3 million in the first quarter of 2013. Licensing and professional services revenue in the first quarter was $11.5 million, up 11% from $10.3 million a year ago. In total, adjusted revenue increased 68% to $78.5 million in the first quarter from $46.8 million in the first quarter of last year. Our cost of revenue increased to $34.4 million for the quarter from $16.8 million last year. As a percentage of revenue from assets under management or administration, the cost of revenue was 51%.

Adjusted EBITDA was $11.8 million for the first quarter, 43% higher than the 2013 first quarter. Adjusted earnings per share, was $0.17 in the first quarter, increasing 42% from $0.12 last year. This quarter’s earnings benefited by approximately $0.01 per share from a 31% effective tax rate. This lower than planned tax rate was primarily due to the reversal of uncertain reserves and a net benefit from foreign tax positions.

I’ll also point out our new adjustment, an adjustment for a loss attributable to a non-controlling interest. This represents the minority interest in Envestnet retirement solutions, which is now consolidated in our financial statements.

Our diluted share count during the first quarter was $36.6 million shares, up $2.3 million shares from the first quarter of 2013 due primarily to the impact of a higher stock price on the calculation of diluted shares.

Looking forward we expect our revenue from assets under management or administration to be up 67% to 70% in the second quarter compared to the second quarter of 2013. This reflects an effective fee rate of approximately 14 to 14.3 basis points on our beginning AUMA asset base of approximately $196 billion.

Licensing and professional services revenue in the second quarter of 2014, we expect to be up approximately 15% to 18% year-over-year.

Adjusted revenues for the second quarter should increase between 56% and 59% year over year.

We expect second quarter cost of revenue to be between 51% and 52% of AUMA revenue in line with the first quarter.

We expect our adjusted EBITDA to increase 33% to 36% in the second quarter compared to the second quarter of last year.

Regarding income taxes, we expect our effective tax rate for the second quarter and the rest of the year to be approximately 40%. Diluted shares outstanding should be approximately $37 million for the second quarter based on the current stock price. These expectations translate to adjusted earnings per share of approximately $0.17 in the second quarter 2014.

Thank you again for listening today and for your support of Envestnet. Now I will hand it back to Jud for his closing remarks.

Jud Bergman

Thank you, Pete. We are committed to taking full advantage of our extraordinary opportunity to act as an effective agent of fundamental and positive change in wealth management. Next week we are hosting more than 1,500 advisors and industry partners during our annual summit in Chicago. The event is sold out for the second year in a row and this three day even brings to life the transformation of wealth management and focused fully on the advisor and helping build their practice. As we support our advisor clients in this endeavor, we believe we are well positioned to deliver substantial revenue and tax flow growth this year and beyond, and to accelerate this organic growth over time by disciplined, strategic, merger and acquisition activity.

During 2014, we expect to exceed our long term targets on both the top and bottom line aided by a full year of revenue from WMS acquisition. So we iterate our guidance and to invest in on boarding resources for large enterprise clients as well as new initiatives like retirement solutions, including improved outlook for WMS, we now expect adjusted cash flow to grow between 35% and 40% compared to 2013 meaningfully above our long term target of 25%.

Thank you again for your time this afternoon. Thank you sincerely for your support of Envestnet. With the conclusion of these prepared remarks, we are happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we go first to Peter Heckmann with Avondale Partners.

Peter Heckmann – Avondale Partners

Good afternoon gentlemen, nice results.

Jud Bergman

Thank you, Peter.

Pete D'Arrigo

Thanks, Peter.

Peter Heckmann - Avondale Partners

Could you go into that the retirement piece again? I must have missed that. Is that a joint venture? And if so can you talk about who your development partners are?

Jud Bergman

Yes. It’s a majority owned subsidiary. Currently Envestnet owns about 64.5% of the subsidiary. We provide technology and related services to advisors who are focused on the small to midsized plan market place. This has been in development now for just over a year and we launched it February first. We think this is going to be an important growth driver for us in the future, but we are in the very early stages of it now with our first clients now signing up. And we’ve chosen to have this structure in order to provide for some important partners as equity partners as well as to fully align the interests of the business unit with the management of the business unit.

Peter Heckmann – Avondale Partners

Okay, that’s helpful. And then also inter quarter there was an announcement that Envestnet was selected to create or to help develop a data hub and I think that was an important endorsement of Envestnet technology. But I wasn’t sure if it was also could potentially be a larger revenue opportunity at some point. Could you review that announcement?

Jud Bergman

Sure. I think you are referring to the MMI or the Money Management Institute announcement. They are looking to create a central protocol for the dissemination of separately managed account manager model. So it’s a model management hub and have selected Envestnet as the enabling technology and service provider for that. Yes, it is certainly a very meaningful and valued endorsement of our model management capabilities. It’s just too early to make any kind of assessment of what the long term business opportunity is there. It could be very attractive but it’s just way too early to make an assessment of that, Peter.

Peter Heckmann – Avondale Partners

Fair enough. I'll get back in the queue. Thanks.

Operator

And we go next to Chris Shutler with William Blair.

Chris Shutler – William Blair

So first question, just given all the recent market volatility here, curious what you guys are seeing in terms of shift in advisor asset allocations and any changes in redemption rates.

Jud Bergman

So first quarter redemption rates, there’s some variation around the different types of product offerings, but overall it came in at regular 1.9%. Pretty much in keeping with what our expectations were. We are not seeing huge changes in allocations. Those are remaining pretty similar. There still is a demonstrated reluctance for advisors to put full allocations into fixed income or into bonds, but we are seeing some increase in VIX over certain periods of the last quarter. But we have not seen as of yet an increase in redemptions and that the market ended the quarter at about the same place that it started the quarter with respect to the overall asset level valuations.

Chris Shutler - William Blair

Okay. And does the comment about redemptions carry through April as well?

Jud Bergman

I’ve just provided through March and -- yes.

Chris Shutler - William Blair

Okay. Fair enough. And then Jud, in your prepared remarks you mentioned and we’ve talked about this in the past, firms looking to move all their fee based assets to one or two platforms from several. Are you actually seeing that happen now or are we closer to seeing that transpire?

Jud Bergman

Yeah. Chris, we’ve got a good window on that, a good pipeline. A lot of our organic growth over the next, I’ll say six to 12 months, but a good portion of it is from existing clients who are consolidating several programs into fewer programs. Yes. We are seeing it Chris and I think it’s going to be an important element of our growth in our most mature market segments, which are our independent broker dealer market segments and our insurance broker dealer segments.

Chris Shutler - William Blair

Okay, great. And then one last one just on WMS, so you said that you know expect it to be 15% to 20% higher I think increasing cash on cash than what you previously had stated. So can you just maybe walk me through the numbers? And I just want to make sure that I have the dollar figure that’s attached to that correct.

Jud Bergman

So I’m going to be relying on a little bit of recollection here because I don’t have access to what the original guidance was. But on the original guidance we had expected a 25% or higher internal rate of return once fully converted. And that amount, while we did not give a specific calculation, as I recall everyone made the calculation that that would mean at least $10 million of incremental cash flow for the company once fully consolidated. So now we are -- a couple of these large institutional clients who are multichannel organizations and have longer more structured testing and transition protocols which we are accommodating, on the good side which is deepening our relationships with these firms, but it will lengthen the time until we get the full benefit of the accretion. But that full accretion now we expect to be 15% to 20% higher than what we has initially indicated.

Operator

And we move next to Chris Donat with Sandler O'Neill.

Chris Donat - Sandler O'Neill

Just to follow up on that last question, so the full improvement in the cash flows you expect once WMS closes or the transition to WMS is complete, is just from these handful of clients who are going to be larger than we had originally expected. Is that the way to understand it?

Jud Bergman

No. I don’t think that’s quite -- it’s one or two clients that are very sophisticated and have multi-channel organizations. They have a longer transition period associated with them. The amount that we are seeing now which is more than what we had originally expected, we see that that will grow slightly to moderately through the rest of this year, which is also higher than what we had originally expected is because we are finding savings that are accruing at a little different pace. We didn’t expect much of any savings or accretion to occur at all in 2014. As I indicated there is some positive cash flow from it even now and we expect that that will grow through the rest of this year, particularly in the third and the fourth quarters. We expect there to be some step up in the first quarter of next year, but the full benefit we don’t expect until sometime late in the first half of 2015.

Chris Donat – Sandler O'Neill

Okay. I guess I get it on the timing, but the higher cash flows you expect, that’s more function of on the expense side than the revenue side.

Jud Bergman

There is a little bit of both. There is a little bit of both.

Chris Donat - Sandler O'Neill

Okay. And then just one question for Pete here. The revenue for the first quarter came in a little higher than you expected and I have very good visibility into a quarter out revenue, but just can you explain the variance between what the expectations were three months ago and how it came in a little bit higher?

Pete D'Arrigo

It was just largely the benefit of the flows, both organic and conversion activity during the quarter. We got a little bit more benefit from that as expected.

Chris Donat – Sandler O'Neill

Okay. And then just thinking about the net flows you had. Would you say anything was there around seasonality? And I know it’s lumpy so we’re never going to expect it to be completely smooth, but because looking back it doesn’t seem like the first quarter gets that much of a kicker seasonally. But I’m just wondering if you have any comments around seasonality.

Jud Bergman

I don’t. I would not read any trend or seasonality into it. There were a couple of fairly large conversions in the first quarter. That always creates a little bit of lumpiness in the numbers. And it did come in almost exclusively as assets under administration on the fee based side. There was very few assets under management on the conversion side, although our organic same store sales for AUM were up very nicely and very strongly when compared to the previous year. So I understand this over time we are trying to counsel the analyst community to see the inherent lumpiness or irregular aspect of the conversion business. And we had a good quarter. We are pleased with the quarter in terms of the flows, very pleased. But we are not expecting a repeat of that necessarily in the next two and three quarters.

Chris Donat - Sandler O'Neill

Right. Got it. Thanks very much.

Operator

(Operator Instructions) We’ll go next to Jennifer Dugan with Stern Agee.

Jennifer Dugan - Stern Agee

So I’m going to study UMS integration timing, giving stretch to a little further into 2015 than originally anticipated. Does that mean that that full platform licensing expense stays in place I guess for a longer stretch into 2015 than we had assumed previously?

Pete D'Arrigo

It does mean that we’ll stay in place until the conversion is complete. We are working to manage the interim cost during that period, but yes, it does mean that it will stay in place. That’s why as Jud mentioned, the full benefit or accretion related to the acquisition won’t occur until the complete conversion is finished.

Jennifer Dugan – Stern Agee

Okay. And how many months of a slip are we thinking this is going to be right now? Were you thinking it was going to be January and now it’s April? Any sense of that yet?

Jud Bergman

We don’t know for sure, but I’m expecting one to two quarters.

Jennifer Dugan - Stern Agee

An additional one to two quarters? Okay.

Jud Bergman

I still expect the full benefit on a run rate basis to be achieved by mid-2015.

Jennifer Dugan - Stern Agee

Okay. All right. Good to know. And then in terms of the sales pipeline, you already touched on with somebody else this question about vendor -- a need for vendor consolidation driving some incremental business. But if you look at the sales pipeline, where else are you seeing demand? Is it from broker dealers that are on a turnkey solution, broker dealers that are in house?

Jud Bergman

We are seeing demand in all of our core channels. We are seeing different types of demand and different dynamics driving that demand, but we are seeing strong demand across the board in the registered investment advisor channel. We are seeing that demand for Tamarac’s integrated solutions. That’s CRM rebalancing and advisor view reporting. We are seeing it among the more wealth advisor oriented RIA, who is trying to consolidate their business and get lift with access to unified managed account technology and all the benefits that derive from running a practice, running models, access to separately managed accounts on the unified managed account structure. With the RIA channel, we are finding strong demand for Envestnet and for Envestnet Tamarac.

In the independent broker dealer space, a lot of things are driving it. Number one is just the continued emphasis that’s being placed by the home office and management for advisors to grow their fee based business, to depend less on commission based accounts and more and more on fee based fiduciary accounts. That’s still the primary driver of the growth in that space. That primary driver is accelerated and enhanced by home offices that are trying to standardize and consolidate their fee based offerings. They are doing this so that they can have better compliance oversight, a better ability to manage and track what their advisors are doing and how they are growing their business. So that’s an important part of it.

Over on the insurance broker dealer side, again the fee based side is driving it. The fiduciary practice is driving it. A number of those firms are increasingly looking to incorporate insurance offerings, life insurance and retirement income guarantees into their wealth management practice. So they have a slightly different technology demand, where they are looking to leverage their fee based business, leverage their wealth management business, but also do that in a way as boomers enter retirement and are looking for more ways of giving guaranteed income, we are helping them do that as well.

And then the new channels opened up by the WMS acquisition, which is the bank and trust channel and then also the Canadian marketplace, a very strong demand for wealth management platform, our core offerings there. So going more into more detail, the specifics have slight nuances, but the overall theme is the same in all of these channels. There is growth, above market growth for advisors who A, focus on fee based fiduciary business. B, pursue this independent objective business model and C, outsource their technology for an integrated end to end platform to firms like Envestnet. And this last piece is the fundamental value proposition of Envestnet. I’ve mentioned before the studies that we’ve been a part of that show that an advisor that runs their fee based practice on a fully integrated technology platform will grow their practice at 110% of the rate that advisors who don’t use a fully integrated platform do. So we are seeing strong demand in all of the segments, driven by macro trends and then having important nuances within each of those segments that I think we do a very good job of helping advisors with in each of those segments grow their particular business.

Operator

And we go next to Jeff Houston with Barrington Research.

Jeff Houston - Barrington Research

Thanks for taking my questions. Hi guys. So I believe the stat is that you are in 40 of the top 50 independent brokers and 12 of the top 15 banks. A few questions on that. First, is that accurate? And second is how penetrated are you within those clients? Then for the clients that those numbers that you are not are already an Envestnet customer, what are they using and are any of them in your pipeline?

Jud Bergman

So a three part question there, Jeff. Your numbers are basically right. I think we are like 42 or 43 of the top 50 independent broker dealers, not 40. I think we’re at 12 of the top 15 banks. The penetration question is something that I’m happy to answer because I don’t think it’s fully understood. With respect to independent broker dealers, on average today, the typical independent broker dealer will have only 20% to 35% of their business fee based. They will have the majority of their business still commission based. So the level of penetration is a function of how advisors transform their practice overtime from commission based to fee based. And that’s a big part of why we see that there is a very long runway left for us in terms of achieving this growth in our core markets, in our core channels. So we typically we’ll support the majority of an advisor’s fee based business, but that majority of fee based business is still a minority of most advisors business.

So we see that there is tremendous runway in helping move advisors from commission based to fee based. And that’s the fundamental driver of our growth strategy of more advisors and then more advisors, more accounts per advisor. I mentioned in my prepared comments that accounts per advisor had grown by 12% over the last year. And that low double digit to mid double digit growth rate in accounts per advisor is one of the fundamental accelerators of our organic growth. So third part of the question is just are their other clients in our pipeline that represents banks and independent broker dealers? I would add registered investment advisors as well. Of course there are. We are looking to do more business with as many firms as possible and I expect that you’ll be hearing about some wins in the future from some of these targeted client prospects in our pipeline.

Operator

And it appears there are no further questions at this time. I will now turn the call back over to Mr. Bergman.

Jud Bergman

So I want to thank you very much for your participation, not only this afternoon, but as a support for the company continues to build. Very thankful for those of you who dialed in today and for your questions and we look forward to talking with you in three months or so if not before. Thank you.

Operator

And this concludes our call. We appreciate your attendance.

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