Avantax Inc (AVTA) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Blucora third quarter conference call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Bill Michalek, Vice President of Investor Relations. Thank you. Please go ahead, sir.

Thank you, and welcome, everyone, to Blucora's Third Quarter 2020 Earnings Conference Call. By now, you should have had the opportunity to review a copy of our earnings release and supplemental information. If you have not yet reviewed these documents, they're available 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 based on the environment as we currently see it and 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 other SEC filings, including our forms 10-K, 10-Q and other reports for more information on the specific risk factors. 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, supplemental information and earnings presentation are available on blucora.com and include full reconciliations of each non-GAAP financial measure discussed to the nearest applicable GAAP measure.

With that, let me hand it over to Chris.

Thanks, Bill, and good morning, everyone. I'm pleased to report that our third quarter results showed incremental improvement and came in higher than expected on a number of metrics that Marc will cover shortly.

In addition, we closed the acquisition of HKFS, adding a historically fast-growing high-margin business to our company, and we made progress in setting ourselves up for future growth. I continue to be impressed by our employees and their commitment to executing on the strategy we have put in place. I'm also proud of our financial professionals who have worked tirelessly to position their clients for success, both from a tax and wealth management perspective through an uncertain time. Having met with financial professionals regularly since joining, I can see the passion they have for their work, and it makes us want to work even harder to position them for success. More on that in a moment.

I'll start this morning with an overview of our TaxAct business. We're very focused on executing all that is required to best position us for tax year 2020 in the shortened offseason. As discussed, we made significant progress last year on our product; however, we were challenged by being out of position on marketing at the start of the season and not having an assisted offering available for all interested customers.

To prepare for a strong upcoming tax season, we are focused on several things: ensuring that we have our entire marketing approach optimized, including our team structure and capabilities, media partners, messaging and technology; continuing to enhance our core product offering with an emphasis on areas that prove to be most challenging for users last year as well as our landing pages, which are the intersection point between product and marketing and are critical to start rate; launching our hybrid-assisted offering to all users who may have interest, our testing over the last couple of years gives us confidence that we will be able to execute this effectively; improving our tax pro software in targeted waves, including coverage for more tax situations and an improved onboarding experience.

We have a solid plan to accomplish a great deal and a shortened offseason with a number of talented new additions to our team. All aspects of what we are trying to accomplish are tracking well to enable us to start next season with both marketing and product further optimized and working in concert. This combination is focused on enabling us to make progress in the early stages of executing our sustainable growth strategy for the business.

I'll now move to Wealth Management. There's been a great deal of change in the business over the last 2 years. We transitioned to a new clearing platform and completed the acquisition of First Global and began to integrate the businesses. The change continued this quarter with the completion of the HKFS acquisition and rolling out of new advisory pricing.

I'm pleased with the progress we are making. However, the amount of change has been significant for our financial professionals and their teams. We need to improve on multiple fronts in the coming year, including improved service level, a better technology experience for both financial professionals and their customers, completing the integration of all core systems and processes and increasing stability so that future changes are focused primarily on better experiences for our financial professionals and their customers.

It has been a busy quarter with us making progress on many fronts, including adding a new product management team that will be the architect for improved financial professional and end customer technology experiences, rolling out a regional service model that is focused on improving the service experience for our valued financial professionals, consolidating and refining our advisory programs and pricing, consistent with regulation BI, which we believe will drive an incremental shift to advisory services. We also expect to see a decrease in the distribution of paper statements. Upgrading our operational approach, which has improved processing times. Adding 3 new large HKFS affiliated accounting practices and recruiting 60 new financial professionals to be affiliated with Avantax during the quarter. We are confident in our differentiated tax-focused wealth management strategy and our market position is compelling for the right financial professionals and their customers. That said, we have work to do in the coming year to solidify the foundation for long-term organic growth.

We plan to focus on improving our service and operational performance, aligning systems, processes and technology to improve efficiency and scalability, maximizing financial professional performance by providing improved tools, and completing the integrations of First Global and HKFS. These efforts will take some time to show impact. Over the course of the coming year, we anticipate that our efforts will lead to decreasing risk of financial professional departures and an increasing share of advisory assets. The combination of actions will put us in a stronger position from which we expect to deliver organic asset growth in future years.

Let's now turn to Blucora as a whole. It's been a challenging year with the start of the global pandemic following closely after my start in the CEO role. External forces had large impacts on both sides of our business, including the extension of the tax season and the equivalent of 625 basis point interest rate cuts. I'm proud that we've been able to keep our teams safe while delivering for our customers and financial professionals in this challenging environment and making significant progress on repositioning the company to enable sustained growth in coming years.

Near-term financial results have been adversely impacted by events of this year; however, we are fortunate to have 2 strong profitable businesses with positive cash flow and ongoing demand during these challenging times. A number of challenges became clear after I stepped into the CEO role 9 months ago, including the need for more sustainable growth strategies for the company and our businesses, a leadership structure that didn't provide the necessary clarity and ownership needed to drive performance, skill gaps across a number of important areas, a lack of cultural alignment across the organization, an underinvestment in technology resulting in challenges for our financial professionals, customers and employees, and potentially high-value synergies between the businesses had not been meaningfully tested.

We've addressed these challenges by taking the following actions: Shifted to sustainable growth strategies for each business and across Blucora, including establishing priorities for realizing value across the businesses. We've aligned the organization toward common goals and priorities down to every individual team member. Adjusted leadership structure, most notably consolidating operations within the business units and combining our software efforts under 1 leader in Curtis Campbell, and our Wealth Management efforts under Todd Mackay. We also separated our CIO and CTO teams to bolster our technology efforts. Expanded the roles of a number of our talented team members and added many new members to our team with the required skill sets. We believe we now have the right team in place to deliver going forward. We rolled out a culture initiative to ensure one common sense of purpose.

While we are early on in the process, our employee engagement has shown significant improvement in terms of alignment on priority, clarity of objectives and overall satisfaction. We increased our investment in technology teams and efforts at Blucora and at the business unit level to more effectively meet the needs of financial professionals, customers and employees. We've committed to testing the highest value potential synergies in the coming year, which are a few things: Improving the tools needed to make our financial professionals more productive by leveraging the product and technology leadership and approaches from TaxAct. It will be about 12 months before we expect to see material benefit from these efforts.

The second is converting TaxAct Pro users into Avantax's financial professionals, or into HKFS referral partners. We're in the early stages of engaging tax pros now to test and refine our approach before a planned rollout in the middle of next year.

The final area is helping financial professionals acquire more customers. Most tax and financial professionals have limited time and marketing sophistication or scale. Our financial professionals can leverage the marketing capabilities within our TaxAct organization to help them drive new customer acquisition, resulting in higher asset flows. We expect to begin to define our service offerings in early 2021 and test the service offering in the second half of the year.

I'm more enthusiastic now than ever about the opportunity in front of Blucora. We believe our tax-focused software and wealth management company has a compelling position in large and growing markets. We have made significant progress in the midst of a very challenging environment, to best position the company to deliver sustained organic growth in the coming years. We have an execution-focused team in place to deliver on the promise.

With that, I'll turn it over to Marc to review our Q3 performance and full year 2020 and tax season outlooks.

Thank you, Chris, and good morning, everyone. I'd like to provide some additional detail on our third quarter results, an updated outlook for the full year 2020 as well as a preliminary outlook for the upcoming year in tax preparation.

Starting with third quarter results. Our acquisition of HKFS closed on July 1 and, therefore, has been included in our results for the full quarter. On this basis, consolidated third quarter results were as follows: total revenue of $175.4 million, which is toward the upper end of our guidance range. A GAAP net loss of $26.2 million, or $0.55 per share, which includes acquisition and integration costs of $10.3 million, primarily related to the closing of the HKFS acquisition. Our GAAP net loss and GAAP EPS were both below our target ranges due to a higher-than-forecasted tax expense. And I'd like to offer more perspective on this.

Our GAAP reported net income figure is greatly impacted by the variability in our tax rate, which can be volatile, especially on an intraperiod basis as profitability estimates are adjusted throughout the year. Small movements in pretax income caused larger swings in the tax rate due in part to changes in NOL utilization, which is one of the reasons why we also present non-GAAP financial measures, which we believe provides investors with a more complete understanding of our underlying operations when viewed as a supplement to GAAP results.

Now moving on to revenue. Adjusted EBITDA was $27 million, above the high end of our target range. Non-GAAP net income was $15.1 million or $0.31 per share, both also above the high end of our target range.

Turning now to tax preparation. TaxAct revenue for the third quarter was $39.4 million, just above the high end of our target range. This was driven by better overall performance in third peak, leading up to the October 15 deadline, including ancillary product sales that came in a bit better than our forecast. Segment operating income was $16.2 million, also above our target range due to the flow-through from revenue.

Moving on to Wealth Management. Third quarter Wealth Management revenue was $135.9 million, which is right about at the midpoint of our target range and included about $9.2 million of revenue related to HKFS. Relative to last quarter, the total revenue number represents an improvement of 17%, driven by a 25% increase in advisory revenue. This growth was also driven by a number of additional factors, including market improvement, the addition of HKFS, including net inflows within that business and a 12% increase in trailing revenue and 14% increase in transaction revenue.

Excluding the addition of HKFS, which again contributed $9.2 million of revenue this quarter, revenue grew 9% relative to last quarter. On a year-over-year basis, total Wealth Management revenue was down 7%. This was primarily driven by a 90% decrease in sweep revenue and a 27% decline in transaction-based commission revenue, the latter driven by the factors we mentioned last quarter. These factors include the extended tax season and limited ability to meet in person, making it difficult to drive business development activities, both within -- with existing customers as well as attracting new ones. Excluding HKFS revenue of $9.2 million, revenue declined 13% year-over-year.

Wealth Management segment operating income came in at $17.5 million, above the high end of our target range, primarily due to prudent expense management. Total client assets increased 13% year-over-year to $76.2 billion, which includes approximately $5 billion from the addition of HKFS. Fee-based advisory assets were up 23% year-over-year to $32.4 billion. This is a new record for advisory assets, even excluding HKFS. And advisory assets as a percentage of total client assets ended the quarter at 42.6%, up about 370 basis points from the same quarter last year, also hitting a high watermark.

Net inflows into advisory assets were about $125 million, consisting of about $70 million in outflows at Avantax, boosted by net inflows at HKFS of about $200 million. We saw net outflows in total client assets of about $300 million, which represents an improvement from last quarter's result and consists of about $500 million of outflow at Avantax, partially offset by the $200 million inflow at HKFS.

Finally, in Wealth Management, HKFS contributed, as I mentioned earlier, revenue of about $9.2 million and contributed $3.1 million to Wealth Management segment operating income, which represents a 34% margin on a stand-alone basis. Total client assets at HKFS ended the quarter at about $5 billion, up from about $4.5 million in Q2, with net inflows of about $200 million during the quarter. More than 90% of HKFS client assets are in an advisory billing structure. As of the end of the quarter, HKFS served about 75 CPA firms, 4,400 RIA clients and over 13,000 retirement plan participants.

Finishing up on third quarter performance, unallocated corporate expenses came in at $6.7 million, slightly better than the midpoint of our range. During the quarter, we had about $5.4 million in transaction and integration costs related to HKFS, $1.8 million in integration costs related to the acquisition of First Global and a $4.1 million impairment charge related to exiting the former First Global headquarters building. Finally, the HKFS transaction included 2 potential earn-out payments to be paid based on ending asset balances in June 2021 and June 2022, which could potentially total up to $60 million and which are contingent upon certain performance metrics.

The earn-out potential stemmed from a renegotiation of the upfront purchase price of $160 million down to $100 million. This contingent consideration is recorded on our balance sheet and in other current liabilities and other long-term liabilities. The estimated fair value of this liability will be reevaluated each quarter until the second earn-out measurement date, and the change in the fair value will be reflected in operating income. This will be highlighted in the change in fair value of acquisition-related contingent consideration line of the P&L and excluded for purposes of calculating our non-GAAP net income. It is important to understand that this quarterly evaluation will add uncertainty in estimating our GAAP net income.

For the third quarter, the fair value of the liability declined to $26.6 million which resulted in a gain of $1 million. It's important to note that valuation methodology aligns with best practice and includes assumptions for a number of market-based discount factors. This results in a much lower earn-out valuation than what is estimated on an undiscounted basis. We hope that HKFS business continues to perform favorably over the next 2 years, which would result in the payout of the earn-out, as the achievement of the earn-out metrics would bring very positive growth in this business.

As we provide guidance over the next 2 years, we will do our best to incorporate our latest thinking into non-GAAP expectations resulting from what we expect to ultimately pay out.

Turning now to liquidity. At the start of the quarter and in connection with the HKFS acquisition, we entered into a $175 million add-on term loan to our existing credit facility. We used approximately $100 million of the proceeds of the term loan increase to fund the purchase price of the HKFS acquisition with the remainder of the proceeds, net of fees currently remaining on the balance sheet.

We ended the quarter with cash and cash equivalents of $151.2 million, and our net debt was $412 million. Our reported net leverage ratio at the end of the quarter was 4.5x compared to 4.4x in the prior quarter. As we look forward, from a capital allocation perspective, we will continue to be prudent. We have not engaged in any share repurchase activity and have no near-term plans to do so. With the HKFS acquisition completed, our ongoing priorities for cash deployment aside from unique opportunities will be to support organic growth and pay down debt. Our long-term net leverage goal remains to be below 3x.

With that, let's turn to our updated full year outlook for 2020. For the full year, we expect TaxAct revenue of between $207 million and $208 million and segment operating income of $47.5 million to $48.5 million. For our Wealth Management business, we expect full year revenue, which includes HKFS for the period of July 1 through year-end of $535.5 million to $540.5 million and segment operating income of $68.5 million to $70.5 million. This translates to consolidated full year outlook, again, including HKFS for the partial year of revenue between $742.5 million to $748.5 million, adjusted EBITDA of $88.5 million to $92.5 million. Non-GAAP net income of $46 million to $51 million or $0.95 to $1.05 per diluted share. GAAP net loss attributable to Blucora of between $339 million to $333 million or $7.05 to $6.94 per diluted share and corporate unallocated expenses to be between $26.5 million and $27.5 million.

As you can see, third quarter results were ahead of our targets, and our full year estimates at the midpoint have also increased, we plan to reinvest some of the improved results and accelerating opportunities for tax season readiness. The change in corporate-level expenses relates in part to managing discretionary spend based on performance of the overall business. The new spend forecast now takes into consideration our upwardly revised revenue target as we held off on certain investments until we had more confidence in business performance. On a net basis, that results in our adjusted EBITDA target for the year, improving by $1 million at the midpoint relative to our prior 2020 outlook with non-GAAP EPS improving by $0.10 per share.

In these 2020 results, you have COVID-related impacts, which are discrete, including the costs of the extended season at TaxAct, and some of those will be longer lasting, such as the decline in sweep revenue that we experienced in the second quarter on that will likely persist beyond 2021.

Finally, at this time of year, it has become customary to provide a preliminary outlook for the first half of the upcoming tax season. Given that this year's tax season was extended into the third quarter, we feel that it may be more helpful to provide a preliminary outlook for the entire year for TaxAct. A few things I'll note as it relates to this guidance. Our product enhancements showed significant improvements in conversion, retention and customer satisfaction this past season. The decline in consumer units seen in prior seasons was significantly improved. The marketing improvements implemented during this past season showed a significant improvement in second peak unique site visits, and we've continued to enhance our marketing team and plan for next season.

And as discussed earlier, we plan to launch our commercial version of hybrid-assisted product offering in January. These factors, among others, give us confidence as we head into the upcoming season; however, we were also entering into a transition year as we move from price-based growth to unit and ARPU-based growth. This transition as well as the fact that we are guiding over a longer time frame, yields less certainty.

Incorporating these factors and assuming normal start and end dates for a typical tax season, we are preliminarily targeting TaxAct revenue to grow in low single digits relative to full year 2020. In terms of segment operating income, consistent with our prior commentary, we expect a healthy rebound next year and expect a minimum of $20 million of additional segment operating income versus 2020. This preliminary guidance does include maintaining a higher-than-historical level of marketing spend, although lower than last tax season. However, if we are not getting the desired returns on this marketing spend, we can certainly dial it back in line with performance. We believe this to be a high confidence outlook as we drive our strategy of positive monetized unit growth, the launch of our hybrid-assisted model and anticipate a strong improvement in our marketing capability, all while driving improvements in product quality. When grouped together, these initiatives are exciting, and we believe we'll set the stage for long-term sustainable growth.

Now before I turn it over to the operator, I wanted to make known to you that Bill Michalek, who has been with Blucora since early 2017, has accepted a new role outside of the company. As such, this will be his last earnings call with us. I'd like to sincerely thank Bill for his fine work in many, many contributions to Blucora. We will miss him and wish him well and every success in this new endeavor.

Another member of our team, Dee Littrell, who has been working in Avantax and has many years of IR experience with the former Cash America will be stepping in on an interim basis while we search for a new full-time Investor Relations leader. His contact information is on our website. This concludes our prepared remarks.

We will now turn the call over to the operator for Q&A. Operator?

(Operator Instructions) Our first question comes from the line of Chris Shutler from William Blair.

First, I want to ask on TaxAct, just your confidence in monetized unit growth in 2021. And I guess, what's assumed in your expectation for low single-digit revenue growth?

So we haven't done any breakout or provide any more granular breakdown into that, so I'm not sure we can provide more detail. In terms of our confidence level, right, we're doing all of the right things in the offseason, which was focusing our investments in areas of the product where there were friction points in the last year. We also have done a great deal ensuring that we've got our marketing messaging, our media partners, our approach, our teams all right. And we think the combination of those things as well as launching the hybrid-assisted offering more broadly, making it available to all consumers who may want it, the combination of those things gives us confidence that we'll have paid unit growth.

Got it. Okay. And then, Chris, TaxAct pricing gap versus the market leader has narrowed considerably in recent years, as you've noted. At this point, what would you point to as kind of the main value for opposition of TaxAct relative to your key competitors?

Well, so we think it's a combination of things. One, as was just noted, we continue to make some compelling enhancements in the product, really around ease of use, and Marc referenced what we shared last quarter, which was meaningfully increasing satisfaction with our product from customers. And so with that real focus on ease of use and demonstrated results in terms of the improvements year-over-year, in terms of customer satisfaction, we think that's something that we can really kind of latch on to. We also think that with the right positioning, there are many consumers in the market who ultimately want to align with brands -- challenger brands, and we think with the right positioning, there are consumer segments out there that will respond very favorably to TaxAct.

And then we will also work on differentiated features, some of which we launched last year that through testing with consumers, we found that they actually have great value or they place great value. So an example of that would be a tax plan. So at the end of the experience, we give consumers the opportunity to understand the kinds of actions they should take in the offseason to be best prepared for the coming year. And so we think the combination of a simple intuitive user experience that consumers are rating more favorably year-over-year, coupled with the right positioning, that connects with the consumer segments that are interested in TaxAct. And finally, some differentiated features. We think all 3 actually give us a really compelling position to build from.

Great. And then just a couple on the Wealth Business. The operating expense number in Wealth came in lower than expected. I think it was only up -- and correct me if I'm wrong, but I think it was up $2 million sequentially despite HKFS coming into the fold, which I think added around $6 million. So first, am I reading that correctly? And if so, how sustainable is the current level of expense.

And Marc, do you want to take that?

Sure. So there are a number of things that we've done in light of the fact that the macroeconomic picture, placements and position where we just need to be prudent from an expense management perspective. So we continue to look forward on how we plan to maintain an expense profile that aligns with the revenue growth that may start going forward. So the way I would look at it going forward is we'll continue to be prudent. We'll continue to manage expense in line with expected revenue growth. But yes, you are viewing the numbers correctly.

Are there any areas, Marc, you can point to where expenses were notably down sequentially?

Well, as you can imagine, this year, T&E is down quite dramatic as our folks are staying at home as it relates to conferences with our financial professionals. That's another thing this year that is different from years past. I think time will tell how next year plays out to the extent that people start traveling more and if it's possible for people to come together. I think those are the sorts of expenses that you would see go up relative to this year because we do value that face-to-face interaction. But it really has to do with those controllable factors associated with paying just a different year than is typical.

Okay. And then lastly, just the guidance, it assumes markets as of when, as of September 30?

That's correct.

(Operator Instructions) Our next question comes from the line of Dan Kurnos from Benchmark. Dan Kurnos from Benchmark, your line is open.

Our next question comes from the line of Will Cuddy from JPMorgan.

Sure. Starting on the tax EBITDA guide for next year. On our last call, it was indicated that there was $20 million of COVID-related spending in 2020. So it seems like the guide is essentially like adding that back in for next year, which with revenue growth would imply that EBITDA margins would be declining next year. And I'm trying to understand, is that a function of conservativeness due to the unusual nature of this year and the planning for next year? Is it a reflection of greater marketing spend? I'm trying to piece back why the normalized margins excluding COVID would be declining?

Sure. Marc, do you want to take it?

Sure. Thanks for the question. Well, as we did indeed guide that COVID-related spend last year was about $20 million and we are keeping our segment income outlook consistent with what we shared last quarter, which is that it will be at least $20 million better than 2020, which with that alone would be a significant rebound next year from the low 20% range this year to below 30%. As I mentioned on the call, we do have the ability to throttle our marketing spend based on performance. And we believe that growth in excess of our guidance range would drive incremental profit.

We mentioned on the call that next year or tax year '20 is a transition year, right? There are many exciting opportunities ahead. And so the question becomes, what is the right time frame over which these actions really take hold, and that's really the driver of the statement that I made during the prepared remarks around the confidence expectation for next year and the guidance that we provided on the margin, and we really do look forward to sharing more results as the season unfolds.

Okay. Turning to Avantax, what do you think is driving the continued outflows at Avantax? And how long do you think it will take for the investments that you're making now to translate into flows getting closer to breakeven?

Sure. So as were mentioned during the prepared remarks, the amount of change over the last couple of years for our financial professionals has been very significant. So we need to improve on multiple fronts in the coming year, including improved service levels, and better technology experience for financial professionals and their customers. And so ultimately, as we make those improvements, I think we'll actually see a risk of departures or outflows decrease. I'll reiterate the actions that we're taking that we think will actually position us for a long-term growth, right? We've added a new product management team. We've consolidated and refining the advisory and pricing programs in line with regulation BI, we're upgrading our operational approach to continue improvements in processing times and we're rolling out a regional-based service model. And so all of these things are in flight, and we believe they'll have a positive impact in the coming year and, ultimately, enable us to turn this.

Okay. So it's fair to think about this, I guess, as like a year or so of having to have some of these investments come to fruition and then actually seeing the benefit. Is that a fair way to think about it?

Yes. That's a fair way to think about it.

Great. And then my last question on the debt. So historically, Blucora has paid down debt in the first half of the year to align with cash flow from TaxAct. Should we be thinking about it similarly for this year that we can expect debt pay down, consistent with how it has been paid down in the past?

Marc, do you want to comment?

Sure. So we're going to continue to find the right balance between paying down debt and investing in the areas that drive continued growth. Further as we enter into next year, there's still a little bit of uncertainty as it relates to the timing of tax season. We fully expect that the tax season is going to begin on January 1, and it's going to end on April 15. Should that play out, that gives us more and more confidence to be able to pay down debt as we have historically, but also to balance that priority with any sort of organic growth opportunities that are in front of us as well. So it really just comes down to -- let's get to January, make sure that we return to some bit of normalcy. And I think we can -- there's a better chance of seeing historical norms in terms of our debt paydown.

(Operator Instructions) At this time, I'm showing no further questions. I would like to turn the call back over to management for closing remarks.

Great. Thank you all for joining us today and for your interest in Blucora. We'll speak to you next quarter.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.