Envestnet - Q2 2023

Transcript

Operator (participant)

Welcome to the Envestnet second 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. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Peter D’Arrigo CFO. Mr. D’Arrigo, you may begin.

Pete D’Arrigo (CFO)

Good afternoon, everyone. Thank you for joining us on today's second quarter 2023 earnings call. Before we begin, I'd like to point out that our earnings press release, supplemental presentation, and associated Form 10-Q 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 statements 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 non-GAAP financial measures. Please refer to the appendix in our supplemental presentation for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures. Joining me on today's call is Bill Crager, Envestnet's Chief Executive Officer. Bill and I will provide a company update as well as an overview of the company's second quarter 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. With that, I will turn the call over to Bill.

Bill Crager (CEO)

Thank you, Pete, and thank you everyone for joining us tonight. Envestnet is executing on its strategic plan that creates differentiated value for our customers and will continue to drive long-term value for our shareholders with industry-leading scale and operating efficiency. We're on the path we set forth for driving sustained revenue growth and margin expansion. In the second quarter, we posted adjusted revenue of $312,500,000, adjusted EBITDA of $57,800,000, and adjusted EPS of $0.46. We have intentionally invested, and today we are seeing the benefit of the integrated ecosystem. This is the future of our business. It has deepened our competitive advantage, deepened our relationships with our clients and our partners, and the investments are scaling our bottom line.

Pete will go into greater detail in his remarks, so let me spend a few moments on what we, as the largest scaled player in wealth tech, are seeing in the market and within our business. The wealth tech market is rapidly moving, and Envestnet has been ahead of the curve in investing in the environment and scale necessary to capture more of the economic opportunity. We've been exactly right in our focus of modernizing and expanding our ecosystem of intelligent data, integrated technology, networked to the broadest set of solutions. We're becoming more essential to our partners, driving their growth and productivity while creating more distance from our competitors. As industry consultant Joel Bruckenstein told InvestmentNews in May, "People underestimate how challenging it is to build something like Envestnet. Envestnet has finally made major strides bringing together all of their silos.

I don't think anybody else is close." I'd like to share an example of how this is playing out in the market and how it will benefit our clients and shareholders in the future. A client of ours, a broker-dealer, Independent Financial Group, which has $40,000,000,000 of assets and hundreds of advisors, has contracted to use the entirety of our platform and ecosystem of Envestnet solutions. This includes all of our platforms and services, our data and analytics, our complete suite of financial planning technology, our investment solutions and related technologies, and our broader network of exchanges. This is a great example of the value created by putting the pieces of Envestnet together into an integrated environment, and it expands our revenue opportunity with clients that go all in with us by about 25% before factoring the uptake of additional asset management and fiduciary solutions.

We're getting more of these types of engagements in our renewal pipeline. Sure, not every client will use every Envestnet solution. More and more are engaging deeply with our capabilities, providing continued and accelerated revenue opportunities for us. The headline for Envestnet is that we are leveraging the investments we've made. We're growing market share while benefiting from a stronger Q2 market. The market benefit was neutralized by overall challenging industry net flow environment, and our DNA research business has faced significant headwinds, but we are on the path to stabilization and restoration in this business. Tonight, we'll focus our prepared remarks to talk about the industry and market context and what it means in terms of revenue growth and why we are optimistic for the trajectory of our business....

We'll spend time on the DNA business to explain the dynamics, the challenges we're facing, and the progress the business is making to restore growth over the coming months. Importantly, we'll spend time on expenses. We're very focused on managing our bottom line, driving margin expansion and cash flow, and we'll discuss how we will exit 2023 as investments flow through to productivity and scale, resulting in greater profitability. Our wealth business is building share in an environment of stubbornly low net industry asset flows, a headwind that's carried over from 2022. We continue to execute, and we're doing what we said we would do, putting us in a powerful position, just as the wealth market accelerates to the more integrated environment that we had predicted.

There's real pressure on other participants in this space today as we move ahead into areas of significant impact, like data intelligence, while others are trying to solve problems that are scaled areas of advantage for us. Envestnet drives, we benefit from strong secular tailwinds that are powering the industry in the quarters and years ahead. Increasing demand for financial advice, growth of independent advisor channels, fee-based and managed accounts, and UMAs. These are the growth engines for the industry. In all industry segments, which also includes technology-enabled offerings and more and more industry utilization of data and insights, the market is moving in our direction. We are capitalizing by gaining share. In the second quarter, our net flows from AUM and A were $10,000,000,000, representing an organic asset growth rate of 5%. These flows are very healthy, especially in the context of the broader industry.

For example, long-term mutual fund and ETF flows across the industry were essentially flat once again in Q2, and multiple wealth firms reported seeing low investor buying activity, given the debt ceiling overhang and other factors, a trend that seemed most pronounced among high net worth investors. Looking at our annualized organic growth rates for public companies that have reported so far, the average growth was between 1% and 5%, compared to our 5% organic growth. I think it's very useful to look at longer-term trends regarding flows for some added perspective. Looking at our AUM net flows compared to those of the managed account industry overall, we've gained 70 basis points of share in the last few years.

Compared to our publicly traded TAM peers, our AUM and A flows in dollars have been about 7 times larger than their combined flows over the last 3 years. These types of flows get reflected in more activity by more advisors, utilizing more of our services. In the second quarter, the number of accounts on our platform grew 5% year-over-year to $18,700,000, and AUM and A accounts grew 7% year-over-year per advisor. The outperformance of the industry in flows and the growth activity on the platform are leading indicators of our business. Over the last couple of years, assets, accounts, and advisors are all up in our higher-margin tax, direct indexing, and high net worth solutions. Active advisors selling these solutions have grown 61% over the last 18 months.

In tandem, the gross profit is projected to grow by 26% from 2022 to 2023, and over the next few years, we expect a 40% CAGR for these solutions. As industry asset flows normalize, there's an important dynamic at play for us. The share gains, account advisor growth, will translate to accelerated revenue growth. The revenue story for Envestnet is grounded in these higher-margin solutions and data and technology-enabled adoption and cross-sell. Over time, we see fee rates expanding as we cross-sell more solutions. Let me share a few examples of this in practice. The promise of data in the wealth business is paying off. It is a leading capability for us, a differentiator, and it drives longer-term flows to higher-margin solutions.

Our enterprise-wide reporting solution, which aggregates both managed and held away accounts and generates them into opportunities, has meaningfully increased its pipeline into double-digit millions, while launching two firms this quarter with over $35,000,000,000 of assets collectively. The Envestnet Wealth data offering provides tremendous value by creating more visibility across more assets that ultimately will use our platform to be managed assets. The industry has taken notice. Our Insights Engine was named the best AI-based solution for financial services at the AI Breakthrough Awards. An important use case is one of our leading clients, who plans to share an additional $150,000,000,000 in off-platform assets through the data platform by the end of the year. This allows Envestnet to consolidate more assets and drive more cross-sell opportunities.

From a financial standpoint, every 10% of these assets we convert represents a roughly $9,000,000 gross profit opportunity for Envestnet, consuming a 6 basis point net fee. We're also working closely with our asset manager and client partners to drive mutually beneficial outcomes. The Insights Engine identifies engagement strategies for over $1 trillion of brokerage-to-managed and Advisor as Portfolio Manager opportunities on our platform. We're working with partners and their distribution teams to maximize this opportunity. For every $100,000,000,000 of brokerage-to-managed flows, that equates to roughly $60,000,000 of gross profit to Envestnet, assuming a 6 basis point net fee. We continue to innovate and connect all the pieces of Envestnet together to drive greater productivity and growth for the firms and advisors who use our platform.

Our modernized proposal tool is connected to the entire ecosystem of solutions, including PMC, portfolios, and services. It's connected to our exchanges, tax and FSP overlay, and analytics. This has opened more and more opportunities, and we see that client firms have turned on 25% more of these solutions this year versus the prior year. We continue to make progress on unique custody options through our partnership with FNZ. We talked a lot about this and the benefit it will provide our clients with an option for a more digital environment, and capturing the economics of cash through this partnership fills the gap we have had and creates a long-term benefit for Envestnet and our shareholders. As we've integrated the ecosystem, it is accelerating our pipeline, driving value for our clients, and creating bundling and pricing opportunities for Envestnet.

Our strategy, and more importantly, our execution, is working in the marketplace. We've created the most seamless operating system, networked to the broadest set of solutions with digital and data-driven engagement tools, is increasing client engagement, helping them be more productive, which drives more cross-sell and assets on the Envestnet platform. Now, let's spend a few moments on the data and analytics business. As I spoke about just a few moments ago, what we have created in the wealth market is competitively unique, is being well received and adopted, and is foundational to the long-term advantage as we serve the industry. While other participants in this space work to figure out and build feature sets and configurability, things that we have long delivered at scale to our customers, we're able to move to AI-driven insights that drive greater adoption for our vast set of solutions.

That said, in the non-wealth parts of the data business, we continue to see challenges, particularly in our data research business. This has been a resilient headwind for us. An increasingly competitive market, coupled with a decline in the quality of users in our dataset, has pressured revenue in the business for several quarters. We indicated we would experience weakness in the first half of 2023, with stabilization coming in the second half of the year. We've been focused and purposeful on restoring our datasets. We have made significant progress, and we'll be back in a position of strength with the best quality, the best quantity of data that we've ever seen. Those datasets are in production, and we're testing with clients and will be live by the end of this year.

This is why we feel good that the business is stabilizing and leading to stronger interest and higher renewals and pricing. The remainder of the year should have promising bookings for this business that will point to restoration of the revenue in 2024 and beyond. Next, I'd like to provide some thoughts around expenses and reiterate our conviction in achieving a 25% adjusted EBITDA margin in 2025. In 2022, our adjusted EBITDA margin was 17.8%. In the first half of 2023, we expanded the margin by 90 basis points compared to the first half of 2022, despite macro headwinds. This performance has been driven by a combination of expense, discipline, and investments we have made to modernize our platform. In the back half of 2023, we expect to drive even stronger margin expansion, helped by incremental efficiency initiatives.

For the full year of 2023, we're now expecting to generate margin expansion of 270 basis points, which is at the midpoint of our guidance range, putting us at around 20.5% for the year. On the expense side, the key takeaway is that we've exited the investment cycle and are focused on managing all expenses, which include personnel, vendors, G&A costs, while not wavering from our key strategic initiatives, client support, and product delivery commitments. As our investments take root, here are the specific expense actions we've taken and will continue to enact. Our onshore headcount is lower year to date by 5%. As we noted last quarter, we've taken action by restructuring, combining teams, now joined by the unified technology work that we've done, and we've been very judicious about selected hires.

We've reduced the first half real estate occupancy spend by 27% and marketing by 33%, as we use data and analytics to more efficiently target our efforts. Both areas are targeted for additional efficiency in the second half of the year. In total, adjusted expenses are down 3% in the first half of 2023, with 7% year-over-year reductions targeted in the second half of the year. All of this equates to full-year adjusted expenses, excluding costs of revenue being down 5% year-over-year. The entire organization is focused on managing our expenses while making sure our priorities are fully aligned with the needs of our clients and drivers of financial results for the company. Looking beyond 2023, there is additional room to expand margins. We are confident in revenue growth acceleration via our solutions and more normalized industry flows.

Despite challenges in the market and in the non-wealth DNA segments, we continue to make considerable progress on our plan and remain committed to our 25% adjusted EBITDA margins in 2025. We've modernized our platform, expanded our solutions, connected the pieces of Envestnet to drive greater adoption and engagement from our clients. As we operate in this stage of our cycle, we continue to focus on our core strategy while we review areas that are non-core to the business. We're disciplined in our expense and capital allocation to accelerate our earnings and free cash flow in the coming quarters. I'd now like to turn the call over to Pete, who will provide details on this quarter's performance and our outlook for the rest of the year.

Pete D’Arrigo (CFO)

Thank you, Bill. Our second quarter results provide evidence of how the business is progressing through this phase of our investments. As expected, we are seeing margins expand compared to 2022, while we are effectively managing our expenses. While the macroeconomy performed well in the quarter, the wealth industry continued to experience dampened flows, while advisors and firms remained cautious during this recovery. Our expectations for 2023 were that the year was to be one of execution and delivery, with the anticipated result of margin expansion, which we are demonstrating. Further, as Bill described, we are continuing to see positive signs for future revenue growth in both segments. For the second quarter, revenue came in at the low end of our guidance range. Adjusted EBITDA was above the high end of the range. Adjusted revenue was approximately $312,500,000.

Adjusted EBITDA was $57,800,000, while adjusted EPS was $0.46. Our guidance for Q3 and for the full year is laid out in the earnings release and in the supplemental presentation. Overall, the environment in Q2 continued to present challenges for clients and prospective clients, impacting both segments of our business, as well as both asset-based and subscription revenue. While industry-wide flows remain under pressure, our wealth segment continued to experience positive net flows in our asset-based products, although the mix of flows has not been as favorable for our average fee rate. Our guidance for the rest of the year reduces our outlook for net flows and mix from what we had previously expected. At this point, these updated assumptions for the rest of the year are offsetting higher revenue from Q2 capital markets increases.

We expect subscription revenue in the wealth segment to grow at mid to upper single digits organically for 2023. The data analytics segment had challenges in research, as well as delays with bank and tech clients. The emerging wealth channel is showing positive signs, but is still a relatively smaller part of that segment. While we have lowered our DNA forecast for the rest of 2023, there are positive signs in the segment's bookings and client pipeline. For the third quarter, we expect adjusted revenue to be between $316,000,000 and $319,000,000, adjusted EBITDA to be between $64,000,000 and $66,000,000, and adjusted EPS to be between $0.52 and $0.54.

For the full year, we are modifying our adjusted revenue guidance to be between $1,252,000,000 and $1,259,000,000, adjusted EBITDA to a range of $255,000,000 and $260,000,000, and adjusted EPS of $2.09 and $2.15. 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 June 30th. Turning to the balance sheet, we ended March with $59,000,000 in cash and debt of $913,000,000, making our net leverage ratio just below 3.9 times adjusted EBITDA. In June, we paid down the remaining $45,000,000 outstanding on our 2023 convertible notes, using our revolving credit facility.

As of June 30th, only $20,000,000 remained drawn on the revolver. That $20,000,000 has been paid down in July. We expect our high point for the leverage ratio to be March 31st of this year, dropping below 3.5x EBITDA by the end of the year. We expect to continue to reduce our leverage ratio and improve our balance sheet with growing EBITDA going forward. One last point to note, we expect to see an increase in cash taxes paid in 2023 related to the legislative change, eliminating the immediate deductibility of research and development expenses, effective for tax year 2022. We'll have an estimated payment in Q3 of approximately $13,000,000, which is higher than our quarterly expectation going forward in the near future.

We paid cash taxes of around $2,000,000-$3,000,000 quarterly over recent years, and we expect that to go up to $4,000,000-$6,000,000 quarterly for the near term. Again, all related to this legislative change from 2022. Thank you again for your support of Envestnet. Before we open it up for Q&A, I'll turn it back to Bill for his final remarks.

Bill Crager (CEO)

Thank you, Pete. Envestnet is executing on our strategic plan. We're on the path we set forth for driving sustained revenue growth and margin expansion while creating greater demand and engagement from our clients in a significant competitive advantage in the marketplace. We continue to gain share with industry-leading flows and are addressing the challenges in the data research business. We will continue to be laser-focused on our expenses and have confidence in the revenue upside through our network of solutions, data, and technology. As always, I'd like to thank every member of the Envestnet team. Hard work, dedication to our clients, industry-leading innovation, these are the hallmarks of a great organization, and I'm appreciative every day for your excellence. To our clients, thank you for the trust you put in us and the partnership to drive greater growth for your business and better outcomes for your clients.

It is extraordinary what we are doing together. Now, I'll hand it back to the operator for questions.

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. Thank you. Our first question comes from the line of Michael Chell with J.P. Morgan. Please proceed with your question.

Michael Chell (Equity Research Analyst)

Hi, Bill and Pete. Good evening, and thanks for taking my question here. My, my first question, I, I just wanted to touch on kind of the industry flow trends that, that you highlighted, Bill. You know, you, you talked about kind of that sentiment bleeding into, into investment as well, I guess, and, and really carrying on from 2022. I guess, in, in your mind and, and from your seat, I mean, what, what do you think is, is, is prolonging that, that friction in the space and, and for Envestnet as well, in terms of kind of industry, advisor and AUM flows? Really, what, what causes it to normalize from here? What does normalized mean in, in your mind?

Bill Crager (CEO)

Yep. Thank you, Michael. Hope, hope you're doing well. It has been a stubborn... I think in my prepared remarks, I used the word stubborn, and it's been a very stubborn dynamic. Yeah, the first half of the year has been a healthy first half for the capital markets. As you know, it's been pretty narrow, right? The leaders of the market are concentrated in a couple of, you know, stocks and, so that the broader market really hasn't participated along with that, that narrow group. You know, what's been interesting, because whenever we've had a healthier market, it correlates to, you know, increased flows, increased account openings, and that has not been the case this time.

You know, I think it, it goes back, and it really tells you very clearly that, you know, there, there's an alternative out there, and that alternative are yield assets, whether that's cash, fixed income, you know, the, the yields are higher, with a, with a, with a higher interest rate. We spend a lot of time focused on, you know, the industry data. The industry data, you know, Q2, ICI Mutual Fund, ETF data, you're, you're negative in Q2, which is surprising, given, given the health of the, the, you know, the overall market or the returns of the headline return of the overall market. We dig in, we look at a lot of survey data, and, you know, surveys, particularly around the high net worth category, are even more deeply negative.

You dig in, and you look at some of the public comps that we that we study, whether that's a wealth management firm or whether that's an asset management firm, and those growth rates have been really kind of suppressed. You know, it's not an Envestnet issue, it's an industry issue. I speak to a lot of leaders in the business, whether leading asset management firms, wealth management firms, and, you know, there's some head rubbing out there on, okay, what is that catalyst? How does it begin to turn?

I think it turns, Michael, as you broaden out the participation in the overall market, and there's, you know, the, the, the, the, the rate overhangs there, the question of, you know, the, the, the, the, the government's, debt issue was there in the quarter. You've got, you've got, you know, kind of this recessionary overhang that certain banks are continue to, to, to, to talk about. So there's a risk off. You've got an alternative in cash, and you need to broaden out the participation of, of market, i-in the market for the, flows to, to respond. All of that said, I look at how Envestnet has performed, and I'm looking at, you know, our organ- overall organic growth rate, which is at the upper tier of any firm that we really take a close look at.

Then I look particularly in some of these higher value services. Yes, they're not meeting our expectation as to what we thought when the market began to turn. That would be a quicker restoration towards flows, but we're doing really well there. We've enrolled or have active advisors over the last 18 months of 61% growth in number of advisors using these solutions. You know, if I dig in and I look at each of these types of capabilities, the direct index capability, for instance, you know, 41% growth in assets, 26% in accounts, 47% in advisors, year to date or year-over-year growth rates, that's impressive. So we're, we're chipping away. We're doing what we're doing.

I think we're, we're at the upper tier of the growth in, in the flows, in the industry. Returning back to the conversations I have with, you know, the asset manager partners who distribute with us, you know, a lot of the feedback is that we continue to lead. You know, when they look at the flow rates that are coming into different environments across the wealth industry, Envestnet has performed probably at the top tier of those types of opportunities or distribution points for the asset manager community. You know, it's on a comparative basis that we're doing well. It's not on the, on the actual basis compared to what we were hopeful as the market began to restore, you'd see a restoration of flows.

Michael Chell (Equity Research Analyst)

... Great. No, thank you for that, Bill. I guess just for my follow-up, just kind of to switch gears on the other side of the business, on your DNA business. I appreciate all the commentary there and some of the near-term puts and takes you walked through. I'm just kind of curious what you're hearing from clients as well. I mean, is it kind of clients kind of delaying purchasing decisions, or just is it really just a matter of product pipeline? Just kind of curious on again, from your seat in terms of what you're hearing from clients and sentiment there for investments products.

Bill Crager (CEO)

Great. Thank you, Michael. I'll spend a minute on the DNA business, and I'll kind of walk through what we're seeing. In the wealth market, with our wealth data product, there's high demand, there's a deep pipeline, there are really good bookings, there's good adoption. Firms that are adopting, particularly in this brokerage-to-managed, where we're looking at kind of the firm's broadest set of data, and we're moving assets into beginning to move assets into more managed account environments. Those firms are, you know, top-tier growers for us. It's having an effect, and that effect is great data to return back to the marketplace and say, "Hey, firms that are using this are growing at a faster rate.

Here, here are some numbers." We're very bullish there. Again, I'd reiterate that the pipeline's strong and the bookings are strong. The usage as it goes up, is driving a faster result for our clients. We're very enthusiastic about the wealth data offering. The bank market, as you know, has had a tough, very difficult first half of the year. There's some delays on a particular client deployment, and that's impacted our outlook for the rest of the year. In the fintech market, particularly the larger fintech type companies which utilize our verification business, there's lower volume, and that's also had an impact and impacts our outlook for the rest of the year. The real challenge, though, I'll put a circle around the research business.

In that research business, what we do is we de-identify data. We use, we look at underlying consumer activity, separated from, you know, separated into kind of generic datasets. We share that with a universe of asset managers who utilize that to help understand momentum or activity for a particular company. It's been a very useful capability and something that we, you know, really innovated in that space, and we're a leader in that space. Over the years, there's been competition, and the competition began to match our dataset, and in fact, our dataset was degrading over the last couple of years, given, given, you know, the, the, the data makeup and the characteristic makeup that we were able to utilize and share with our research clients.

That said, that's been a focus of ours. A, a focus of ours has been to restore that dataset, to improve it, and to create a characteristic set that was once again unique and preferenced or, or, or, you know, kind of, more competitive than, than what was in the marketplace. That can't happen overnight. It happens over quarters, and I would tell you that as we get to this year versus the beginning of the year to when we end the year, a contracted in the door, being processed and beginning to be shared with our research data clients, is a dataset that is profoundly been enhanced in, in the, in the many, many, many millions of users and many, many, many millions of characteristics that have real value because of geographic reasons, because of demographic reasons.

It is now, I believe, the, the high watermark for the quality of data that we're able to provide to our research clients and the high watermark for the, the quantity of data that we'll be able to share with our research clients. That doesn't solve the short-term, you know, revenue headwind that we faced in the first half of the year. I believe, you know, over the last couple of earnings calls, I, I've, I've called out that the first half was gonna be weak, and that we'd begin to see stabilization and restoration as we got to the back half of the year. I'm reiterating that outlook, that the first half of the year was, was, you know, was a challenge in that research business.

That now, as we've, you know, acquired, processed, beginning to share that level of data with our research clients, we believe that that business will be stabilized and that towards the end of the year, we'll start to see a restoration in the revenue for that research business. I hope that's helpful.

Michael Chell (Equity Research Analyst)

Thanks. Thanks, Bill. Appreciate it.

Operator (participant)

Thank you. Our next question is from Devin Ryan with JMP Securities. Please proceed with your question.

Bill Crager (CEO)

Hey, Devin, how are you?

Devin Ryan (Managing Director and Director of Financial Technology Research)

Hey, good, Bill. How are you? Hey, Pete. I guess first question, just, you know, kind of hitting on expenses, you know, if I look at the guidance for the third quarter, I think it implies for the fourth quarter, something like $0.64-$0.70 for fourth quarter EPS. It'd imply pretty nice step up in EPS from the third quarter, it sounds like that's expense-driven primarily. I-- just trying to think about some of the moving parts there. There's kind of two things going on. There's these efficiencies you're driving, but then I think there's also a little bit of timing or seasonal dynamics.

Just trying to think about the, the kind of pieces to getting to a better expense level at the end of the year based on some of the things you said, and then maybe it's a little bit earlier, but just thinking about a jumping-off point for 2024, just given that expenses are obviously in focus.

Pete D’Arrigo (CFO)

Yeah. This is Pete. Thanks, Devin. You've, you've caught kind of the highlights on the expense side. It's not entirely expense-driven. There is some, some revenue growth assumptions that, that kind of meet sort of our ongoing growth trajectory, although we've, we've obviously pulled things down a little bit from what our prior expectations were. On the expense side, it's a couple of things. It's, it's, it's the activities that Bill mentioned, that, that is going to kinda lower our run rate. Then there is that seasonality aspect, where we typically see the fourth quarter come in a little bit lower, then probably in Q1, comes in a little bit higher.

Still, a, a general run rate is gonna be significantly lower, compared to where we have been in 2022. I'll let Bill get into the higher level.

Bill Crager (CEO)

Yeah

Pete D’Arrigo (CFO)

strategy of that.

Bill Crager (CEO)

Right. Devin, a couple of things that will happen between now and the end of the year. As you know, we've kind of, you know, we're factoring in the, the overall flow rates, and, and, and it's just not the flow rate, it's kind of the, the fee dynamic to that flow rate, where the assets are coming from and, and kind of what solutions they're, they're coming into, and, and that really modified our, our guidance for the rest of the year. There, there are real kind of interesting and notable revenue opportunities that, that will begin to come to fruition as we get to the, to the fourth quarter of the year.

Included in that are how we're partnering with asset managers and, and pulling them in a little bit more closely to the engagement strategy that we have across the span of our business, that will generate, begin to generate additional revenue, a high margin revenue, as we get, get to 4Q. The other, the other dynamic as we get to 4Q on the revenue side, will be our partnership with Empower for the retirement business, begins towards the end of the year. Those are, those are dynamics that, that, that are kind of the pluses, where some of the headwinds that we're, we're factoring in on our guide are very much industry flow assumption that we've experienced in the first half of the year.

We don't want to be ahead of whenever that begins to transition. We're gonna be observers and say, "Hey, this is the overall health of the marketplace," and then we'll modify to make sure that we're in line with when the restoration of flows begins to happen. But I do want to highlight or call out some of these other revenue opportunities that we see coming before the end of the year, and then will be ongoing as we roll into 2024. On the expense side, look, this is a very focused organization. We're focused on a couple of things.

One is that the wealth market, we believe that we are deeply establishing a competitive advantage given the integration work we've done and how we've injected the data into that environment to help power the growth and efficiency of our clients. That's a big deal. The focus on the wealth market, we think, creates material and long-term competitive advantage for Envestnet to continue to win share and continue to grow, will power our growth. You know, connected to that is the you know, the focus on the execution of strategy. A couple of years ago, we said this is where the industry was headed, and it is exactly where the industry is headed.

It's a more integrated, holistic wealth environment, and, and, and, and utilizing data technology and the connection to broader set of solutions, and that's exactly what we're delivering to our clients. Clients are reflecting that back to us, and they're utilizing us more in a holistic way. Really very important, important, important is our focus on margin and expenses. So we're, we're focused. Our priority list is pretty sharp. It's pretty tight. We're delivering on it. When we look around the, the firm, we're managing expenses in every corner to make sure that we are going to deliver on that 25% adjusted EBITDA by 2025. That's a high-water mark that we believe that we can sustain from a profitability standpoint, and we're making progress.

We're gonna make progress this year, despite some of the headwinds, but we're gonna make, you know, important progress as well in 2024. We'll roll into 2024 in a strong position to make that progress.

Devin Ryan (Managing Director and Director of Financial Technology Research)

Okay, terrific. Thank you. Just a follow-up on, you know, some of the cross-sell opportunities. Obviously, you guys have been talking a lot about Insights Engine and, you know, it does seem like a differentiated offering and a win-win for, for both of you and, and advisors, and so, and, and ultimately clients as well. I'm just trying to think about the ability to really, I don't know, get more traction there to kind of accelerate the cross-sell opportunity. You know, is it just more an education aspect of just getting in front of folks and making sure they understand the, the capability?

Again, it seems like it would sell itself, but at the same time, yeah, how do you accelerate that growth and, and, you know, how do you get it to, you know, another, you know, step function higher, if you will?

Bill Crager (CEO)

Yeah, that's awesome, Devin. you know, I, I said it there when I was talking about the data business: high degree of interest in it, the pipeline's strong, the bookings are strong, and usage is beginning to. You know, usage is picking up, and as the usage picks up, you get some really great return data, meaning, you know, firms that are utilizing the, the Insights Engine are just growing faster than other firms. It's a great, you know, there's a great marketing story there, and it's an important one. It's, it's, it's fact-based and data-based, we're, we're excited about that. One of the things that we are also, this is connected to another important, you know, focus of ours, which is pricing.

You know, as we move forward on renewals for our clients and contracts, you will see the Insights Engine bundled in with an increased fee from a licensing standpoint on the licensing contracts in those renewals. What we're doing is we're bundling that data into our base products, whether it's trading, rebalancing, reporting, et cetera. The value add for us is incremental higher subs rate. The real kind of objective there is to drive more and more usage of the data platform, which will drive more and more kind of adoption of these higher value fiduciary solutions that we provide. It is embedded in the strategy, it's embedded in the platform, it's embedded in our go-to-market. It's going to be embedded in our pricing.

Devin Ryan (Managing Director and Director of Financial Technology Research)

Okay. Thanks, appreciate the color.

Bill Crager (CEO)

All right. Thank you, Devin.

Operator (participant)

Thank you. Our next question is from Pete Heckmann with D.A. Davidson. Please proceed with your question.

Bill Crager (CEO)

Hi, Pete, how are you?

Pete Heckmann (Managing Director and Senior Equity Research Analyst)

Good, good. Thanks for taking my question. Listen, I just wanted to follow up a little bit on the custody opportunity. We're getting closer to that. I just wanted to see, you know, the, the, the feedback you're getting from clients, you know, where you're getting the most interest, and, and if possible, if you can, you know, help us start to handicap or size the opportunity and, and, and how that might roll on, and kind of what it looks like in terms of, of, you know, maybe the amount of revenue and, and, and kind of the incremental margins involved.

Bill Crager (CEO)

Great. Thank you, Peter. Yeah, no, it's been, you know, so we're continuing to be leaned in, and, you know, I talked about focused on priorities. One of those focuses is clearly the integration work and work that we're, have going on with FNZ, which I've spoken about in the past. Just for those of you who are not completely up to speed, FNZ is a new U.S. entrant, a global firm, have done a really great work at creating a more digital environment for the custody for the custody business, and we're partnering with them. Today, we trade, Peter, as you know, to the industry, right? Every sort of custodian or trust system that's out there, we're connected to, and our clients are able to utilize those.

FNZ is another option, but it's an interesting option because in that option, it is fully digital, real-time account opening, real-time, exchange of data versus a batch, process, which is how much of the industry works today. In the relationship with FNZ, we'll be able to garner economics, that we have not been able to participate in the past. Those are from a custody standpoint, but they're also from, you know, cash management and other feature sets that, that come along with, a custody offering. You know, I, I've said this in the past, kind of, in the past, is, "Hey, look, I feel very, very good about the Envestnet position.

I feel very good about the Envestnet business model, but our Achilles heel has been that we have not been able to serve cash, and that this is going to resolve that for us, and that'll become a revenue generator versus assets or, or, or, you know, dollars that, that, that are, are moved away to be served outside of our ecosystem. This, this is, this is a good opportunity for us. I would also say, I, I, I think I've, I've said it maybe on a prior earnings calls, is I believe that the digital nature of what FNZ is doing in the marketplace will bring other firms along. That has been the case.

As we lean in with FNZ, we have very strong and very deep partnerships with the other custodians, and working with the other custodians to figure out how to digitally connect to the Envestnet world to streamline account opening, administration, et cetera, I think is all, you know, very interesting and work that we're excited to engage with those partners. You know, I think the way to think about the economics really is that, you know, if you look at a gross sale number, a gross assets, the flow between the Tamarac platform and the Envestnet platform during the course of a year, you know, it's been running at about $1 trillion between the Tamarac platform and the Envestnet core platform.

$200,000,000,000 of that would be on the, on the kind of the Envestnet platform. If we're able to convert 10% of that, those dollars on the $200,000,000,000, then you're talking about a $10,000,000-$20,000,000 run rate of revenue that we'll be able to generate, you know, there. It's meaningful. It's also very high margin, you know, as, as, as, as we're successful there. In the market, I would say there's been a lot of interest, and it, it, it, it's one of the service challenges our industry has in a multi-custody world is, hey, I've got to, I've got to operate these different ways of opening accounts and servicing, administrating.

This is more turnkey, it's purely digital, it's real time, and, you know, that's a promise or a, or a, or a perspective that has not been presented really to the advice industry before. There's a lot of interest. We'll have early successes in 2024. It's definitely a 2024 story, not a 2023 story. We'll get going, you know, beginning to build business there in 2024.

Pete Heckmann (Managing Director and Senior Equity Research Analyst)

... Great, great, that's helpful. You know, I, I assume custody is one of these buckets, but, but can you just remind us of some of the, the larger buckets of, of, of how you're thinking about returning to 25% EBITDA margins by 2025? I think that's something like 400-500 basis points. You know, I, I guess, how, how do you think about, you know, expense controls, expense reductions versus high incremental revenue in terms of, of hitting that goal?

Bill Crager (CEO)

Yeah. you know, we're gaining share. We're driving more into these high-value solutions. Those carry a higher gross net for us. As we get a normalization or restoration of some degree of flows into the wealth markets, it'll be there. There's a lot of cash on the sideline. There's a lot of money that is waiting to be put to work. That will be, from a percentage and market share standpoint, more likely to be in the investment in environment than kind of competing platforms. We feel very good about the position that we've put ourselves in, because the work that we've done is advantage the platform, made it easier to open accounts and to drive towards these higher value solutions.

We're using the data insights to really kind of motivate them to be more and more adoption of those over the next two years. Our growth will be ahead of market, and we believe long term with a restoration, we're not going to back away from this idea that we'll be a strong teens grower, you know, in a normalized market. In the meantime, we'll grow ahead of the market, and that growth will drop more meaningfully over time to the bottom line. Why? Because we're created in the investment cycle and in the modernization cycle, we've created a tremendous amount of efficiency in our operations. I'll give you an example. Last quarter, we had a, you know, one of our largest trading quarters in our history, you know, top five or so.

We did that with exactly flat headcount. Didn't add any headcount, as the volumes are very significant, and we had 25% fewer traders. We're, we're doing what we're doing, the scale is growing, and we're doing it on normalized lower headcount across the business, and we're doing it more effectively. That you can see it in our trading, you can see it in our, you know, across the administrative parts of our business. We'll be able to do more because of the AI and the cloud work that we've done with fewer personnel costs to serve the business, which will drive higher margin.

The last thing I'd say is that I said it just before, is a focus, focus, focus on prior- prioritization and focus on where we're spending money. You know, again, the modernization of the platform has connected our operating environments. We don't need three trading teams. We don't need three performance reporting teams. You can start to consolidate those groups into best, best in the industry talent and get the real scale and quality that the, you know, that Envestnet is known for. There is, you know, as we normalize markets, we're, we're, we're going to grow the EBITDA and profitability of the company. That'll, that'll be delivered. I will reiterate that the 25% adjusted EBITDA will come no matter what the top line does.

We will deliver on that, that commitment to investors, and so there is the, the flexibility and room to do it. We don't want to disrupt the work that we're doing, so we're very focused on executing on it, but we're also very committed to the 25 adjusted, % adjusted EBITDA.

Pete Heckmann (Managing Director and Senior Equity Research Analyst)

Okay. Okay, Bill. Well, good. It's great to hear the confidence, and, and we'll look forward to seeing that progress.

Operator (participant)

Thank you. As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from the line of Surinder Thind with Jefferies. Please proceed with your question.

Bill Crager (CEO)

Hi, Surinder.

Surinder Thind (Senior Equity Research Analyst)

Hi, Bill. Hi, I guess for the first question, I'm just trying to get a sense of. You talked about having exited the investment cycle and you're now focused on the managing expenses. As you move forward in trying to, you know, sell more of your high value add the fiduciary solutions, is it just that there's a bit more handholding that's kind of required at this stage with clients? Is it, is it a bit of a macro issue? How should we think about the dynamic of where growth is currently versus where you want it to be?

Bill Crager (CEO)

Yeah, it's, it's, it's very market related, Surinder. You know, exiting 2022, you've got, as I said, a, a, a healthier market from a headline standpoint. You know, the returns are positive. It's green, right? It's very narrow. When advi- advisors look at it, at portfolios in a holistic way, and they're thinking about diversification and not concentration. When you're thinking about the financial advice and how it ties to a financial plan, you're, you're, you, you automatically have a, a reasonably conservative posture. On the other hand, you've got alternatives now. You've got cash yielding, you've got other fixed income kind of yields that are pretty steady, that are, you know, much, higher than they've, they've been for more than a decade, and, you know, they're, they're also safer....

Advisors are waiting for that catalyst. They're waiting for that moment where the market broadens out, and they put the money to work. All that said, I'm gonna give you a couple of statistics. In our direct index business, which we're one of the leaders in the industry, we're significantly growing assets, year-over-year growth, 41%. Account numbers are up 26% year-over-year, and advisor usage, new advisors using that platform, advisors are up 47%. In the market environment, we continue to chip away. We've broadened our footprint and opportunity set by contracting with more firms, have access to the product. Advisors are using it, you know, 47% more advisors year-over-year, but the account flow isn't all there.

I think that, that when the, the catalyst occurs, you're going to see the benefit, an accelerated benefit across our platform, particularly in these high-value, personalized solutions, which is exactly where the market is headed, and that's how we've positioned ourselves.

Surinder Thind (Senior Equity Research Analyst)

That's helpful. Then, you also made a comment, I only caught part of it, so apologies if it's, just a clarification question here. I heard you mention something about reviewing non-core areas of the business. Can you elaborate on that, please?

Bill Crager (CEO)

Sure. Thank you, Surinder. You know, we're, I'd use the word focus in that, you know, we're, we're focused on the wealth market. We're, we're focused on bringing the parts of our business together to really exert the competitive advantage that we've invested in. That, that is the, that is, you know, what we've got the company tuned into and tuned onto. That is what we're delivering and focused on. As we go through that, and you get to this stage of an investment cycle, you start to really, again, the word focus.

What are those areas that contribute to that mission, and what are the areas that might not really participate and not be closely, closely aligned enough from an adjacency to be focused on, to be investing in, you know, to build markets outside of that core focus? That, that's exactly where we're at at the moment, is really doing those evaluations and thinking through, okay, what adds to the competitive long-term advantage of what we've built from a wealth standpoint and what is not not core? That's, that's exactly what, what it is.

Surinder Thind (Senior Equity Research Analyst)

Thank you. That's it for me.

Bill Crager (CEO)

Great. Thank you, Surinder.

Operator (participant)

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Bill Crager, CEO, for closing comments.

Bill Crager (CEO)

Thank you, Camilla. I just want to, as we wrap up, I just want to again thank all of my colleagues at Envestnet. You do an extraordinary job, and the work that we're doing is making a difference. Thank our partners, thank our customers and clients for your partnership. Together, we're changing the way advice is offered to millions and millions of households. I also wanted to thank our shareholders for your commitment to Envestnet, and I'm looking forward to seeing you and talking to you all next quarter. Thank you.

Operator (participant)

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.