Blucora, Inc. (NASDAQ:BCOR) Q3 2022 Earnings Conference Call November 1, 2022 8:30 AM ET
Dee Littrell – IR
Christopher Walters – President, CEO & Executive Director
Marc Mehlman – CFO
Conference Call Participants
Joshua Siegler – Cantor Fitzgerald & Co.
Daniel Kurnos – The Benchmark Company
Alexander Paris – Barrington Research Associates
Good morning, and welcome to the Third Quarter 2022 Blucora Earnings Conference Call. [Operator Instructions].
I would now like to turn the conference over to Dee Littrell, Director of Investor Relations, Blucora. Please go ahead.
Thank you, and welcome, everyone, to Blucora’s Third Quarter 2022 Earnings Conference Call. This morning, we posted the earnings release and supplemental information on the Investor Relations section of our website at blucora.com. I’m joined today by Chris Walters, Chief Executive Officer; and Marc Mehlman, Chief Financial Officer.
Before we begin, let me remind everyone that today’s discussion contains forward-looking statements that speak only as of the current date. As such, they include risks and uncertainties, and actual results and events could differ materially from our current expectations. Please refer to our press release and our SEC filings, including our most recent 10-K and Form 10-Q for more information on these specific risks and uncertainties. We assume no obligation to update our forward-looking statements, except as required by law.
We will discuss both GAAP and non-GAAP financial measures today. Our earnings release and supplemental financial information are available on the Investor Relations section of our website at blucora.com and include full reconciliations of each non-GAAP financial measure discussed to the nearest applicable GAAP measure.
With that, let me hand the call over to Chris.
Good morning. Before we share our third quarter results, Marc and I will discuss the announcement we made earlier this morning. Yesterday, we signed an agreement to sell our software business, TaxAct to an affiliate of Cinven for $720 million in cash. We expect to close the transaction by the end of the year. While the decision to sell TaxAct may come as a bit of a surprise for some of you, the Board has been consistent in its position to remain open to opportunities to create or unlock value for shareholders.
We commenced the process to explore such a transaction and Cinven’s offer validates the extraordinary work our TaxAct team has done to grow the business by enhancing our products and customer care approach as well as the significant strides made acquiring customers by increasing the sophistication of our marketing efforts and scaling partnerships.
A few of the team’s numerous accomplishments over the last few years include increasing NPS scores, providing exemplary customer care with free access to TaxAct Xpert and having TaxAct’s products rated as the best in market by multiple third-party reviewers, including Business Insider. We believe the sale of the Cinven, a highly respected private equity firm with deep experience in the tax space is the right next step for TaxAct to continue to scale.
Through our discussions, we recognize that we are completely aligned with Cinven on the importance of meeting customers’ needs including delivering exceptional software combined with best-in-class customer care for the upcoming tax year and in the future. Cinven has indicated that it intends to operate TaxAct independently during the transition period, expected to be 6 to 9 months post-closing.
On a business-as-usual basis and prepare for the upcoming tax season to ensure our customers are not impacted by the transaction. Following the closing, we will rebrand Blucora to Avantax and focus solely on executing our long-term sustainable growth strategy for our tax-focused wealth business, which has delivered impressive results over the last couple of years. This means aligning the company’s operations and enabling strategic investment in high-return initiatives to best support the needs of our financial professionals and CPA firms and their clients.
Additionally, the transaction should allow us to return significant capital to shareholders. Looking ahead, we see many opportunities for our wealth business. As a pure-play wealth management company, we will be laser focused on further differentiating ourselves as the partner of choice for tax-focused financial professionals, tax professionals and CPAs.
Now I’ll turn it over to Marc to discuss some of the other details regarding both capital return and a long-term growth algorithm for Avantax.
Thank you, Chris. As Chris shared, the sale of the TaxAct business is compelling for a number of reasons. First, we will create a differentiated, pure-play, tax-focused wealth management company by monetizing TaxAct and a meaningful valuation following a successful turnaround by the management team. Second, the proceeds of the transaction totaling expected after-tax net cash proceeds of roughly $620 million will be used to paydown existing debt. With the go-forward net debt-to-EBITDA target of 2 to 3 turns, we will be in a position to return significant capital to shareholders, which is expected to be in the range of $400 million to $450 million post close.
Moving forward, Avantax will have the focus and cost structure to invest for growth and deliver strong adjusted EBITDA margins, which following the transition services period, we would expect to be in the 16% to 18% range, assuming a more streamlined corporate structure. This transaction will position each of our businesses to operate from a position of strength after both turned in peak performances this year across the most critical KPIs.
To focus on Avantax, given it will be the go-forward company, through the first 9 months of this year, it has delivered record-breaking results across the following metrics: $1.3 billion in newly recruited assets on a year-to-date basis. It’s roughly $329 million more than our record performance in all of 2021. $380 million in Q3 positive net flows, our highest result since Q1 2018, roughly $810 million in year-to-date positive net flows, the highest since at least 2015 when we acquired HD Vest. A 99% plus average quarterly production retention rate year-to-date considered best-in-class in the industry.
And lastly, advisory assets representing 48.8% of overall assets with 10 straight quarters of upward movement. With this strong foundation in place, we project Avantax to grow revenue annually in the 8.5% to 11% range over the medium term with an assumption of the market growing at 4% and additional growth drivers of newly recruited assets, net growth on existing assets; and lastly, high-value mix shifts towards advisory and our RIA business rounding out our growth algorithm.
As stated earlier, our profitability expectations of 16% to 18% adjusted EBITDA margins for the go-forward company are grounded in a streamlined corporate structure, the current interest rate environment, and our ability to focus our attention on growing Avantax in an efficient and scalable manner. The TSA period is likely to last between 6 to 9 months, after which we would expect the new margin profile to begin to take hold.
With that, let me turn it back to Chris to discuss our third quarter results.
Thanks, Marc. Now I’ll highlight our third quarter results, beginning with our tax software segment. As we have mentioned before, our plan to drive TaxAct to profitable, sustainable long-term growth has been built on a base of unit growth, fueled by new customer acquisition and customer retention, enabling market share gains combined with higher ARPU through delivering more value to customers.
Now that we are past the October tax extension window and with the overall positive third peak performance, we have better visibility across the entirety of the tax season. The DIY market has performed in line with expectations for the second half of the year. We have maintained our market share gains and our forecast for the balance of the year has us coming in slightly higher on revenue and stable at the midpoint of our segment income guidance.
With tax year ’21 now largely behind us, the TaxAct team will shift their efforts to fully prepare for the upcoming tax season. This season, the team will focus on a few key areas. Investing in tools and technologies to further improve the efficiency of our industry-leading customer care and tax expert teams. Enhancing our products, including an improved mobile offering for consumers, and enhanced data import capabilities and forms coverage for Tax Pros, continuing to scale our partnership efforts and refine our marketing approach to acquire new customers.
Overall, we had a strong season despite the headwind of market declines. We met or exceeded most operating metrics. We accelerated top line growth, gained market share ahead of schedule, increased ARPU by utilizing bundling of various products and enhanced our value proposition by providing free access to experts. I am confident that TaxAct will carry this momentum into next season and continue to deliver the best full-featured value software and exceptional customer care in the market.
Now turning to our Wealth Management business. As has been the case over the past several quarters, underperformance in the equity markets negatively impacted either driven revenue as assets associated with equities have declined with the market. However, this was partially offset by an increase in cash sweep revenue, driven by the portion of assets held in cash and increased interest rates.
In addition, we saw a lower payout for financial professionals, due to decreased market levels. Beyond these financial metrics, we have continued to reach new heights across a range of our most important key indicators. First, our net positive flows. For the third straight quarter, we have seen net positive asset flows. In Q3, we had $380 million in net new assets, the highest since Q1 2018. Our year-to-date net flows have now topped $810 million.
Second, recruiting. We also continued to successfully recruit financial professionals away from larger firms with over $200 million in newly recruited assets this quarter and have a great pipeline for the remainder of the year. Third, firm acquisitions and succession plans. This quarter, we closed 4 acquisitions in our RIA business totaling 20 acquisitions since we began the program.
Fourth, on financial professionals attrition, we had fewer departures than anticipated, and this, combined with recruited financial professionals allowed us to virtually stay flat quarter-over-quarter. Of the financial professionals who departed during the quarter, about 81% were nonproducing financial professionals with less than 50,000 enrolling gross production.
Finally, our production retention rate. We maintained our consistently high production retention rate coming in at 98.6% for the quarter.
Now I’ll turn it over to Marc, and we’ll be happy to answer any questions after the prepared remarks.
Thank you, Chris. I’ll provide some additional detail on our third quarter results and our outlook for the remainder of the year, starting with third quarter results. Total revenue of $171.7 million, a decrease of 1% versus the third quarter of the prior year. Total revenue was driven primarily by the Wealth Management business.
GAAP net loss of $21.8 million or a loss of $0.46 per diluted share which are 21% and 20% better than prior year, respectively. Adjusted EBITDA, which excludes certain other factors, was $7.7 million, meaningfully better than the prior year third quarter figure loss of $800,000. Non-GAAP net loss of $9.8 million or a loss of $0.20 per diluted share, both 23% better than prior year.
Turning now to the Tax Software segment. Tax Software segment revenue for the third quarter was $6.7 million, a $1.6 million improvement versus prior year, driven by greater extensions volume versus prior year. We expect this trend to continue into the fourth quarter, resulting in a slight improvement at the midpoint for TaxAct full year revenue. Segment operating loss was $12.5 million, better than the prior year by $1.3 million driven primarily by the improved revenue performance.
Moving on to Wealth Management. Third quarter reported Wealth Management segment revenue was $165 million, up 1% sequentially despite a meaningfully lower asset base on which we build for advisory assets, offset by the impact of the rising interest rate environment. Transaction-based commission revenues were flat quarter-over-quarter, coming in at $17.9 million.
On a year-over-year basis, total third quarter wealth management revenue was down 2%. Wealth Management segment operating income came in at $27.6 million for the third quarter, up 74% sequentially driven by the rising interest rate environment and up 41% versus the third quarter of the prior year.
Segment operating expenses were down $9.4 million sequentially and $12.2 million year-over-year. Changes in operating expenses included declines in cost of revenue, which is highly variable and dependent on changes in advisory and commission revenue of $8.2 million and $15.1 million, respectively.
On a year-over-year basis, our other operating expenses increased at a lower rate than compared to the first and second quarters of the year as the investments made in the second half of 2021 began to normalize. We saw net inflows in advisory assets of $514 million with total client assets having net inflows of $380 million, the third straight quarter of driving positive net flows for both advisory and total assets. Our year-to-date net flows of $810 million is the highest value since at least 2015.
Newly recruited assets continued to be another bright spot for the business. In the third quarter, we added another $214 million of total client assets bringing the year-to-date total to $1.3 billion. Total client assets decreased 16% year-over-year to $72.6 billion, reflecting broader market declines partially offset by successful recruiting efforts. Fee-based advisory assets were down 11% year-over-year to $35.4 billion with advisory assets as a percentage of total client assets ending the quarter at 48.8%, an increase of 80 basis points versus last quarter and up 290 basis points versus Q3 of 2021.
We ended the quarter with cash and cash equivalents of $91.1 million and net debt of $434.3 million. Our reported net leverage ratio at the end of the quarter was 3.3x. In the quarter, we paid down $35 million on our term loan balance as well as paid the final installment of the earn-out related to the HKFS acquisition in the amount of $23 million.
With that, let’s turn to our full year 2022 outlook. For the full year, we expect our Tax Software segment revenue of between $249 million to $250 million and segment income of $89 million to $91 million. For our Wealth Management segment, we now expect full year revenue of between $660 million to $665 million, with segment income of $93 million to $95 million, reflecting an uptick in more profitable sweep income. This translates to a consolidated full year outlook of revenue of between $909 million and $915 million, adjusted EBITDA of $152 million to $156.5 million. GAAP net income attributable to Blucora of $36 million to $41 million or $0.73 to $0.83 per diluted share and non-GAAP net income of $86 million to $90.5 million or $1.75 to $1.84 per diluted share. This outlook includes $30 million to $29.5 million in corporate unallocated expense.
Expectations for next year continue to be robust based on current Fed rate expectations. I shared last quarter that based on rate expectations and, of course, market levels we could see Wealth Management segment income approach $120 million to $150 million in 2023. While market levels are down somewhat from the end of Q2 and commission revenues continue to show weakness, we estimate that an improved outlook for rates of 4% by year-end would now have us delivering roughly $135 million of segment income at an S&P level of 3,000 which is another 16% decline from the S&P close as of September 30th, and upwards of $170 million at market levels above 4,250.
This concludes our prepared remarks. We will now turn the call over to the operator for Q&A. Operator?
[Operator Instructions]. The first question comes from Dan Kurnos with the Benchmark Company.
Great. Just in, I thought I’d seen everything from you guys, Chris. So the sale of Tax, maybe can you just give us some thoughts on timing? Obviously, the market’s message right now. I think you guys had a really good momentum. You were clearly taking share. I know that you guys have the debt stack coming up. So obviously, this takes care of all of that. And Marc, you gave some good color on capital return in your prepared remarks. But just kind of why now, can you talk a little bit about the bidding process, how competitive was it, and just maybe some initial thoughts around that would be helpful.
Sure. We’ve been monitoring the business and market conditions for selling TaxAct for a number of years, right? We’ve shared publicly that we have constantly been reviewing our strategic options. Until now, there were a number of obstacles to achieving an attractive value for the business, including the pandemic and the unusual revenue and expense variations associated with 2020 and 2021 seasons with the shift in timing.
So we decided earlier this year that it was the right time to commence a more deliberate process to explore such a transaction. Cinven’s offer validates the extraordinary work of the team over the last couple of years that you were highlighting. We do feel good about the progress in the business, and that progress in the business allowed us to get an evaluation that we thought, it was a good number for the business.
Going forward and just — how do we think about — and maybe this is for Marc, how do we think about where leverage should be, now that you’ll be in a net cash position. I mean, we can kind of do the math you read out for us. But I just want to get a sense from you of how much cash you want to keep on the balance sheet here? Obviously, you talked last quarter, I’ll get Chris into this to about the environment being maybe a little bit harder to make to do M&A in. But with sort of the streamlined business to have and a net cash position, you have an interesting opportunity that makes you more attractive potentially to others to go out there and really aggressively add, especially on the RIA front? Just how do we think about kind of those puts and takes?
Sure. And thanks for the question this morning, Dan. So I’m not going to get into exact cash balances that we expect to hold. We have a lot of work to do getting from sign to close and working through transitions and what have you. But what I did share is that we’re targeting a 2x to 3x net leverage ratio for this business going forward based on where we expect to end this year, you would expect that, that leverage ratio would be closer to the high end of that range and that next year with the expected improvement in profitability as well as cash generation. We would, in essence, grow our way down to the lower part of that range.
And that range finds the right balance between allowing us to return a significant amount of capital to our shareholders, the $400 million to $450 million, obviously dependent on leverage markets when this deal closes. And leveraging the financing markets and having something that just feels like a right balance considering the macroeconomic picture today.
We will continue to pursue our capital allocation strategy. As I’ve stated publicly, buybacks always serve as that benchmark by which we make capital allocation decisions. We are still extremely excited about the on-platform acquisitions and the profile that helps our business develop over time. And so it just comes down to balance Dan going forward.
Got it. That’s helpful. And maybe just last one, and I’ll step aside for others. I mean, the wealth management business continues to do well. You gave us underlying market assumption in your long-term outlook. I think Marc, you’ve said historically that rates probably closer to 3% or 3.25% are more sustainable in there. I assume you’re taking kind of that longer-term trajectory and assuming that you guys can continue to, kind of, drive productivity and net inflows to get you kind of the balance of the way to your organic numbers. Is that the right way to look at it?
I would say the revenue guidance figures or long-term outlook that we provided is really in a static environment, one in which rates are not moving around. So I would look at that ex rates. So it’s a 4% baseline market growth assumption with the difference coming from those other elements that I spoke about.
Okay. Well, congratulations on selling Tax and another good quarter for Wealth. So I will step aside guys.
[Operator Instructions]. The next question comes from Josh Siegler with Cantor Fitzgerald.
Congratulations on the results as well as the sales. I’m curious about learning a little more on your vision for realizing repetitive advantages on Avantax moving forward without TaxAct. Will Avantax still focus on generating Tax Alpha. And how do you see your client funnel evolving without the potential to cross-sell and TaxAct?
Yes. Fortunately, our team has been executing on a sustainable growth strategy for multiple years, and the business results have been quite strong. And so the plan going forward is to continue to execute that strategy, which is a tax-focused wealth strategy. We want to be the best provider who works with tax firms, CPAs, right, those who want to align with those firms to offer wealth management.
And so it will be a continued focus on providing best-in-class service, supporting our financial professionals with the right growth and marketing efforts to help them grow their businesses. And then we also have the mix shifts that are going on in our business, which is the gradual transition to advisory as well as a slightly faster growth fueled by some of the on-platform M&A into the RIA business, which is margin enhancing for us.
And so we believe that we can continue to execute that strategy and with a heightened level of focus, we can see some really strong results going forward. In terms of anything that will be lost with the departure of the TaxAct business, we have built over the last couple of years, a really strong tech and marketing functions or capabilities within the Avantax business that has leveraged a lot of know-how and capability that has — and processes that have come from the TaxAct business, given that we’ve built a very strong team, we do not expect any degradation in the performance associated with the separation.
I appreciate that color. That’s very helpful. And then diving a little further into Avantax, has the ongoing macro slowdown have any impact on your outlook for the wealth management business? Specifically, are there recessionary risks from the business model perhaps aside from poor equity market performance such as net flows or mix shift towards advisory if we do experience this global gross flow down?
Yes. We feel really fortunate, right? Clearly, in an uncertain kind of macro environment, there are some risks you highlighted the biggest one, which is the equity market risk, as we’ve talked about historically. The interest rate impact, right, on cash sweep tend to trump the impacts of the equity market weakness. And what you’ve seen is — even in this kind of current economic environment, virtually all of our operating metrics are very strong. And so we’re quite optimistic about the outlook of the business even in a potential recessionary environment.
Understood. Congratulations once again.
[Operator Instructions]. The next question comes from Alex Paris with Barrington Research.
Congratulations on the outperformance in the quarter and the sale of TaxAct. Just a couple of questions, clarifying questions, I guess. Net debt as of 9/30 was $430 million, and you’re expecting $620 million in after-tax proceeds from the sale of TaxAct by year-end. That leaves you about million in net debt by year-end. You want to run the business at 2x to 3x. What’s the — I don’t have the 10-Q open. What’s the debt maturity schedule kind of going forward? And it sounds like you’re implying that you’re not going to pay off all the debt which leaves more to return to shareholders and to fund organic growth and inorganic growth initiatives.
And so the expectation, Alex, would be to basically refinance at the point of close, whether that takes the form of paying down the entire debt completely and then just basically refinancing back up to 2x to 3x, that enables us to return the number I mentioned earlier, between $400 and $450 million back to shareholders, which is our expectation to return a significant majority, if not all, of the excess capital back to shareholders. We’re fortunate to operate a business that generates meaningful cash flow, especially going into next year, which will allow us on an ongoing basis to continue doing the things that we do to grow this business, whether it be capital investments on platform acquisitions, regular ordinary course buybacks allowing us to basically return all this capital back.
Great. And then you said that there will be a temporary services agreement that Blucora is going to provide services to the new owner of TaxAct, is that correct?
Yes. So we’ll be providing a variety of services to facilitate a really smooth transition, right? They’re excited about the business. They wanted to operate incredibly effective way through the tax season and then beyond. And so we do have some shared services that operate across the business. And so we’ll be providing those services for some period of time.
And then your compensation for providing those services would come in through another line in the P&L, I assume?
Yes, we’ll work through the actual mechanics of we’re able to show up, Alex, but we’ll make sure to create some clarity for those.
Okay. And then last and associated question, over the medium term, the pure-play broker-dealer and wealth management business is expected to return 8.5% to 11% organic growth and adjusted EBITDA margins in the 16% to 18%. What assumption are you making for overhead or corporate costs in that forecast?
Yes. So it’s an all-inclusive number. So as we — first and foremost, our goal is to get from signing to close. After that, we have this transition services period where we need to ensure that TaxAct has all the tools that it needs in order to continue delighting its customers. It’s after that where a lot of the savings or efficiencies will start to take hold. And so it’s an all-encompassing number. It’s the core wealth management business plus what we call today unallocated corporate coming together to create that margin profile.
As we get closer to close, we share the next quarter’s earnings, we’ll be able to share in a bit more detail.
Okay. Well, that sounds great. Again, congratulations on the quarter, and thanks for the additional color.
This concludes our question-and-answer session. I would like to turn the conference back over to Chris Walters for any closing remarks.
Thank you all for joining us today and for your interest in Blucora. We’ll speak to you next quarter.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.