Envestnet, Inc. (NYSE:ENV) Q4 2023 Earnings Call Transcript
Envestnet, Inc. (NYSE:ENV) Q4 2023 Earnings Call Transcript February 24, 2024
Envestnet, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Greetings and welcome to the Envestnet Fourth Quarter 2023 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. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Josh Warren, Senior Advisor. Thank you. You may begin.
Josh Warren: Well, good afternoon, everyone. I'm Josh Warren, Chief Financial Officer of Envestnet. Thank you for joining us on today's Fourth Quarter 2023 Earnings Call. Before we begin, I'd like to point out that our earnings press release, supplemental presentation, and associated Form-10K can be found under the Investor Relations section of our website at envestnet.com. This call is being webcast live, and a replay will be available for one month under the Investor Relations section of our website as well. During the call, we will be discussing certain forward-looking information. This information is based on our current expectations and is not a guarantee of future performance. I encourage you to review the cautionary statement on slides two and three of the supplemental presentation 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 this call, we will be referring to certain as adjusted financial measures. Please refer to the appendix in our supplemental presentation for a reconciliation of these as adjusted financial measures to the most directly comparable GAAP measures. Joining me on today's call are Bill Crager, Envestnet's Chief Executive Officer; and Tom Sipp, Executive Vice President for Business Lines. On our call this afternoon, we will provide a company update as well as an overview of the company's Fourth Quarter and Full Year 2023 Results. After our prepared remarks, we will open the call to 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 questions.
I'd like to start the call today with a review of our Q4 and full-year 2023 results. Our results in Q4, each of which were above the high end of our range, represent our focus on disciplined execution. Q4 revenue was $317.6 million, representing 8% growth over Q4, 2022. Adjusted EBITDA was $75.5 million, representing a 24% adjusted EBITDA margin and nearly 600 basis points of margin expansion when compared to Q4, 2022. Our adjusted EPS for Q4 was $0.65, up 44% from the $0.45 reported in Q4 2022. For the full year 2023, our revenue was $1,246 million. Adjusted EBITDA was $251 million, representing a 20% overall adjusted EBITDA margin, and our adjusted EPS was $2.12. As we enter 2024 and the next chapter at Envestnet, we have a set of strong fundamentals that we will discuss on today's call that position us well.
I now like to turn the call over to Chief Executive Officer, Bill Crager. Bill?
Bill Crager: Thank you, Josh. As you know, this will be my final earnings call as Chief Executive Officer of Envestnet. For 25 years, it has been a privilege to be part of the amazing journey, that is our company. From an idea and a good dose of courage by applying a lot of resilience and creativity, we've built something that is extraordinary. I am proud of what we've accomplished and perhaps most proud of this. Envestnet is foundational to the financial guidance that advisors deliver to enhance the lives of millions and millions of families. Over the last couple of years, we've worked effectively to make Envestnet even better, taking the necessary steps to bring the company together to enable a highly connected, highly technology-driven, highly data-driven platform to serve the wealth management industry.
Today, Envestnet is in a very strong position because of the work that we've done. The company is the industry leader by assets, advisors, accounts, market share leader across financial planning, our turnkey asset management offering, and the data insights that we generate and offer to our clients. We are embedded with a great roster of clients and partners driving an industry ecosystem that powers growth and delivers value, and we have an exceptionally talented and aligned leadership team to deliver the next phase of Envestnet. The Envestnet strategy is aligned to our clients' needs to drive the growth and productivity of advisors by providing the most comprehensive and capable wealth management platform for our industry. We've created scale and competitive advantage with technology, data, and solutions.
We've connected the pieces, and we are able to serve all client workflows and business models. Doing this serves investors by delivering revenue growth, operating leverage, and improving free cash flow conversion. I look forward to helping Envestnet continue its leadership while advocating for our industry, road-mapping the future of financial advice, and the essential impact that it has while deepening relationships with our clients and our partners. I now want to turn the call over to Tom Sipp, who leads Envestnet's business lines, for an overview of the drivers of our business, and I'll be back at the end of the call for some closing comments. Tom?
Tom Sipp: Thank you, Bill. It has been an honor and one of the great experiences of my career to work alongside you. I am excited about the place we are in and where we are going. I'd like to spend our time today discussing four important topics: the market context and themes driving our business, our position in how it is translating into key metrics and financial results, recent proof points of our strategy winning with clients, and finally the key growth initiatives that drive us ahead in the medium and long term. First, the market context. Envestnet is uniquely positioned to serve every type of advisory business model across the industry, from standalone RIA to large institutional broker dealer or bank. We understand better than anyone the themes driving the overall industry, the themes that shape our technology offering, and how we bring solutions to market.
First, there is a greater push to achieve platform scale for both the advisor and for the firms that support them. Integrated technology and service are keys to greater efficiency. Another key trend is personalization of portfolio management investments and the digital experience. This is more important than ever. Personalization is driven by the fusion of data and insights, robust investment options, and technology capabilities. Next, our research shows that 60% of advisors and firms prefer to buy WealthTech from a single provider. Streamlining technology and maximizing the benefits of an end-to-end platform is imperative to a successful strategy and ultimately drives customers to consolidate providers. And finally, there is a continued evolution toward a more holistic view of advice powered by data and planning capabilities that serves all client types, which is then delivered through seamless connections to solutions.
We've been at the forefront of these trends with the scale and scope of our technology and solutions in the market for years. Our competitors often talk about their vision or product roadmaps, as demonstrated through static screenshots. Meanwhile, our platform is live, battle-tested, in handling billions of dollars across millions of accounts every day with the most robust features, and we are not standing still. We've rolled out a continuous series of enhancements to our platform with true open architecture, both within the connectivity and integration of our native modern experience and as part of our rich API and data library. We are enhancing, connecting, and delivering into the market. This has been our work over the last few years, and it will continue to drive competitive advantages.
Here's how that translates into key metrics and financial results. First, and most importantly, our Wealth business delivered Q4 revenue growth of 11% versus Q4 2022. Second, over the last two years, Envestnet delivered $116 billion of AUM/A net inflows, representing an average growth rate of 8%. We have delivered more than four times the net inflows of the second and third largest TAMs combined. Accounts grew 4% year-over-year, while AUM/A accounts grew 8%. Our gross fee rate in Q4 was approximately 9.8. It's been stable between 9.5 to 10.5 with lots of short-term variables across millions of accounts. Finally, our client service scores have gone from the low-40s to mid-60s over the last two years. Our leadership with a strong and stable client base is another competitive advantage.
We have over 4,500 clients in the broker-dealer and RIA channels, including 48 of the 50 largest wealth management and brokerage firms. Our top 25 clients have been with us for an average of 15 years. We have made fundamental improvements in both the technology and the service and delivery our clients experience with us. That puts us in a position to capitalize on the trend of vendor consolidation. I will provide you a couple of specific proof points. A large regional broker-dealer with over $50 billion of assets started to transition away from our platform but is now coming back. Because the promise of a custom platform with a fully integrated advisor ecosystem could not be delivered. Only Envestnet has the solution live and in market with the scale and maturity that can be relied upon.
A $15 billion RIA and longtime client recently adopted our managed account capabilities in Q4 moved $400 million of assets onto the platform, including a majority in overlay services or direct indexing. As a result, the recurring revenues from this client has more than tripled with potential for significant growth. So we're very focused on our clients delivering the platform that helps them grow. This is a better position than where we were a few years ago and one that we are leveraging to further our leading position. Before we move on, I'd like to address the impact of M&A across the industry. Typically, Envestnet has been a net beneficiary as our extensive client footprint with both RIA aggregators and enterprise clients has supported additional growth.
However, consolidation over the last year or so has resulted in a negative impact to our wealth growth rate. Finally, I'd like to spotlight some of the important initiatives that will contribute to revenue growth over the medium term. Some of these are further along and included in our outlook. Others are underway and will start to contribute to our growth in 2025 and beyond. First, we have achieved robust year-over-year growth across several of our solutions business lines where personalization and technology drive differentiation, including high net worth, direct indexing, tax overlay, and managed accounts to RIAs. We believe these accelerated growth rates will continue for an extended period. Second, pricing initiatives are accelerating with specific progress in the RIA channel where we package our technology with a broad set of fiduciary solutions, analytics, and planning, deepening our client relationships.
Enterprise pricing initiatives will take longer due to the long-term nature of our contracts. Third, our strategy to deliver deeply integrated custody capabilities completes a missing piece in the fully digital and connected advisor and client experience. We are delivering the account opening, funding, and servicing workflows between our wealth management platform and custody back office functions in one single experience. We will launch this solution as previously announced with FNZ. Finally, our Retirement business continues to gain momentum. The team is focused on efficiently delivering Retirement solutions to wealth advisors utilizing the best products, technology, and user experience in the marketplace, essentially providing the easy button for wealth advisors.
This business will then scale by leveraging distribution partnerships with Retirement and Asset Management industry leaders. What we have in the marketplace is meaningful for our clients in driving results. The continuous delivery of enhancements of our technology, tools, solutions, and service drive discrete revenue opportunities and furthers our competitively advantaged platform. We've connected the components to meet client needs and drive deeper relationships. That underpins our 2024 wealth revenue growth guidance of mid to high single digits. Thank you, and I'd like to turn the call back over to Josh.
Josh Warren: Thank you, Tom. I'll spend a few minutes discussing three things. First, our results. Second, our balance sheet, and third, our outlook and focus. As we enter 2024 and a new chapter at Envestnet, we look forward to continuing to deliver our connected ecosystem and our unique capabilities. Our model supports our attractive growth algorithm and enables operating leverage and free cash flow generation. As of the end of 2023, Envestnet served over 108,000 advisors, and those advisors are doing more business with Envestnet. During 2023, while our total number of advisors grew by nearly 3%, our number of accounts grew by over 4% to over 19 million, evidencing higher adoption. Taking a longer view, demonstrating the scalability of our platform, the number of accounts per advisor on Envestnet has grown approximately 50% between the start of 2020 and the end of 2023.
While historically, Envestnet expected to grow costs in line with accounts, the completion of our platform infrastructure investments means that account growth becomes increasingly beneficial to our ability to expand profitability and generate consistent operating leverage to deliver growing and robust free cash flow. To achieve this framework, we'll focus on both revenue growth across both of our segments and disciplined expense management. First, let me focus on our recurring revenue dynamics. As a reminder, our Wealth Solutions segment generates both asset-based and subscription-based revenues, while our Data and Analytics segment generates subscription-based revenues only. In Wealth Solutions, asset-based and subscription-based pricing constructs provide the breadth of solutions to fit the industry and enable investment growth.
I'll start by reviewing the asset-based revenues of our Wealth Solutions segment. During Q4, Envestnet recorded net inflows of $7.9 billion into AUM/A accounts. For the full year, Envestnet generated $58.5 billion in net flows into AUM/A accounts, representing 8% organic asset growth. We believe consistent net flows are one of the most enduring attributes of our business. Envestnet has not had an outflow quarter since going public in July 2010, meaning that Q4 2023 was the 54th quarter of inflows consecutively. This is because flows on the Envestnet platform are among products within a portfolio and are underpinned by multiyear contracts. Amidst this backdrop of strong and consistent asset growth, Envestnet has faced some headwinds from clients allocating more of their portfolios to cash due to the inverted yield curve environment.
Investors have responded to higher short-term rates by holding more of their money in deposit accounts, outside Envestnet, or in retail money market funds. Naturally, this has affected our results. We expect money invested in the debt or equity markets to produce a higher fee mix. During 2023, total asset-based revenue generated by Wealth Solutions was $745 million, representing a 1% increase over 2022. Our growth accelerated in the second half of the year. This was particularly pronounced during Q4 2023 when asset-based revenue grew 13% compared to Q4 2022 to nearly $189 million. The subscription-based revenues of our Wealth Solutions segment are generated by our software-as-a-service offerings which primarily serve RIAs and financial planning tools.
First, I'd like to cover one reporting item. As announced on our last earnings call to align our reporting with how we manage our business, we transferred our Wealth Analytics business, which generated about $4 million of revenue each quarter of 2023, to our Wealth Solutions segment. This contribution to the Wealth Solutions subscription business is reflected in the Q4 numbers provided. To facilitate comparability, I'll be describing our segment results on a recast basis, and historical financial information is available in our earnings supplement. In 2023, subscription-based revenue in our wealth in Wealth Solutions outgrew asset-based revenue, increasing 5% on a pro forma basis to $325 million. During Q4, our Wealth Solutions subscription-based revenue of over $84 million grew 4% on a pro forma basis over Q4 2022.
On an overall basis, Wealth Solutions revenue grew by 3% during 2023. During Q4 2023, our Wealth Solutions revenue of $279 million represented 11% growth over Q4 2022. As we look ahead, while double-digit growth remains our goal, we expect to deliver a Wealth Solutions growth rate in the mid to high single digits for the full year 2024. This growth outlook is premised on a flat market for the full year. As demonstrated by the margin expansion delivered during 2023, we believe we can continue to drive margins in 2024 as we leverage the investments we have made in our platform. Turning to our Data and Analytics business, which generates subscription-based revenues. In Q4, our revenue was $38.6 million. On a like-for-like basis, Q4 D&A revenue declined by 7% compared to Q4 2022 but was 3% higher sequentially versus Q3 2023.
For the full year, our D&A segment generated over $150 million of revenue, declining by 14% on a pro forma basis. In connection with this performance, we are taking a non-cash impairment charge of approximately $192 million during Q4 based on a reevaluation of Envestnet's goodwill related to the D&A segment. 2023 had several commercialization challenges for this segment, including banking turmoil and client delinquencies. While performance was less than Envestnet had anticipated, there are a variety of strategic and operational initiatives in process that we believe will position the business well going forward. We believe the sequential results in Q4 provide early evidence of the returns on these initiatives. Now, moving to expenses, the platform infrastructure investments we have made over the last few years enable us to achieve operating leverage by growing revenues ahead of costs to expand our profitability and grow our free cash flow.
As announced on our November call, we have successfully reduced our annual expense run rate by $60 million across compensation-related non-compensation expenses and CapEx since the start of 2023. We consider our costs to be manageable, as those three general categories constitute the majority of our total cost base. Envestnet also has certain non-controllable expenses which are common in the industry, consisting of payments to third parties for investment management, clearing, custody, and brokerage services. As of Q4 2023, we expanded adjusted EBITDA margins nearly 600 basis points from Q4 2022 and nearly 700 basis points from our Q1 2022 margin. We expect to continue to expand margins and improve free cash flow generation in 2024. I'll note that we revised our accounting treatment of certain cloud hosting arrangements with third-party infrastructure providers to be operating expenses and not capitalizable.
There is, of course, no cash impact from this adjustment, and our historical reporting has been revised to reflect this change. In addition to adjusted EBITDA as defined by our credit agreements, we're committed to providing greater transparency regarding our free cash flow. Three items that are not included in our 2023 adjusted EBITDA but did impact free cash flow were first, severance expenses of $35 million. Although we will continue to look for ways to optimize our organization, we do not anticipate these 2023 severance figures to be appropriate run rates going forward. Second, capitalized software development of $94 million. In aggregate, we expensed or capitalized $234 million of total technology development in 2023, including stock-based compensation.
We expect this overall total technology development spending to reduce in the mid to high single digits year-over-year because of the investments already made but will remain significant as part of our continued commitment to drive scale and ensure client success. Third, our 2023 CapEx was $19 million. CapEx for 2024 is expected to be approximately $10 million. When taken together, our free cash flow for Q4 2023 was $57 million, reflecting our strong performance and some working capital benefits. Envestnet's free cash flow during the first three quarters was negative. Following Q4, I'm pleased to report that for 2023, free cash flow was positive at $42 million. Our focus will be on improving this number in 2024. Turning to our balance sheet, cash on hand increased nearly $50 million during Q4 to $91 million.
Similar to the seasonality observed in previous years, we expect cash to decrease in the first quarter of 2024. Our first tranche of convertible debt, which we pay 75 basis points of interest on, is due in Q3 of 2025. As of December 31st, our leverage ratio, defined as our total debt less cash over trailing adjusted EBITDA, has been reduced to below 3.2 times. In total, we believe our liquidity position gives us flexibility. We expect to continue to be disciplined and prudent with our capital allocation as we look to further reduce our leverage ratio during 2024. Looking ahead to the first quarter of 2024, consistent with how we've provided information previously, we expect revenues to be between $320 million and $326 million, representing 8% growth over Q1 2023, assuming the midpoint of the range.
Adjusted EBITDA to be between $64 million and $69 million. Using the midpoint of the range, this represents approximately 250 basis points of margin improvement over Q1 2023, and adjusted EPS to be between $0.52 and $0.57. As we enter a new chapter at Envestnet, we have three areas of focus. First, our clients. Our clients are our compass and our commitment is unwavering. Second, we are committed to a growth algorithm for delivering more value to those clients and Envestnet. And finally, operating leverage where we can optimally balance revenue and profitability, supporting execution excellence with scale. So when we grow, we will generate compounding free cash flow per share, which can be utilized to drive even greater shareholder value. I'd now like to turn the call back to Bill for closing remarks.
Bill Crager: Thank you, Josh. The decisions that we've made, the work we have done over the last years to expand and connect the ecosystem, to align the organization has put Envestnet in a very strong position. We sit at the center of the wealth industry, creating unique opportunities for our clients, our partners, and for our company to drive value and to grow. The bedrock of that position is the client relationships that we have. These are tenured. These are aligned, and they're very deep relationships. This is because Envestnet is built around our clients' needs to drive the growth and productivity of advisors by providing the leading wealth platform in the industry. It creates a competitive advantage through connected technology, data, and solutions.
As we deliver like we have for the industry, it enhances the strategic and economic profile of the company by increasing revenue growth, operating leverage, and improving the free cash flow conversion. I'm incredibly thankful to all those who've been partners and my friends over this incredible journey that has been the history of Envestnet. Thank you to our clients who have supported us and have grown with us, to our partners who strengthen the ecosystem, to investors who have had long term conviction in us, and particularly to my colleagues at Envestnet, the thousands who have done such extraordinary work and made such a profound impact on our industry. And I will say this, such a profound impact on me. It has meant so much and I have nothing but gratitude and immense pride.
A 25-year journey. How can an idea, an effort, become something so substantial? It has been the blessing of my professional life. It has been an extraordinary ride, and I am incredibly grateful. I'll now turn it over to Josh and Tom and our operator, Camilla, for the Q&A session. Thank you very much.
Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Michael Cho with JPMorgan. Please proceed with your question.
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