LPL Investment Holdings Inc. — Q1 2012 Form 10-Q Summary
Reporting period: Three months ended March 31, 2012. The filing presents unaudited consolidated results for LPL Investment Holdings Inc. and subsidiaries and compares them with the three months ended March 31, 2011. The company provides brokerage, investment advisory, custody, clearing, technology and related services to independent and institution-affiliated financial advisors.
Key business and financial metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Net revenues | $901.8 million | $873.9 million | +3.2% |
| Net income | $41.2 million | $49.0 million | -16.0% |
| Diluted EPS | $0.37 | $0.43 | -$0.06 |
| Gross margin | $274.9 million | $269.5 million | +2.0% |
| Gross margin percentage | 30.5% | 30.8% | -0.3 percentage points |
| Adjusted EBITDA | $125.0 million | $124.3 million | +0.5% |
| Adjusted EBITDA margin | 13.9% | 14.2% | -0.3 percentage points |
| Adjusted earnings | $63.2 million | $59.4 million | +6.4% |
| Adjusted diluted EPS | $0.56 | $0.52 | +7.7% |
Revenue growth was led by commissions of $463.7 million, advisory fees of $251.0 million and asset-based fees of $97.2 million. Recurring revenue was $569 million, or 63% of net revenue, versus 60.2% in the prior-year period. Advisors increased to 12,962 from 12,554; advisory and brokerage assets increased to $354.1 billion from $330.1 billion; and advisory assets under management increased to $110.8 billion from $99.7 billion.
Operating expenses increased 3.6% to $802.4 million. Production expenses increased 3.7%, and the production payout ratio increased to 86.39% from 85.45%. Compensation and benefits increased 5.8% to $89.0 million, while depreciation and amortization declined 5.5% to $17.2 million. Restructuring charges increased to $1.7 million from $0.5 million.
Cash flow, liquidity and capital structure
- Cash and cash equivalents were $688.8 million at March 31, 2012, compared with $720.8 million at December 31, 2011.
- Operating cash flow was negative $28.1 million, compared with positive $189.5 million in Q1 2011. The change primarily reflected timing and settlement-related changes in client activity, including a $42.5 million net use of funds from client trading activity.
- Investing cash flow used $1.8 million, including $4.3 million of capital expenditures and $2.0 million of proceeds from matured held-to-maturity securities.
- Financing cash flow used $2.1 million, including $4.4 million of debt issuance costs and $37.5 million of share repurchases, partly offset by $37.7 million of excess tax benefits.
- Total senior secured debt was $1.350 billion at March 31, 2012, compared with $1.333 billion at December 31, 2011. The company refinanced its prior facilities on March 29, 2012 with a $735 million Term Loan A, a $615 million Term Loan B and a $250 million revolving facility, which was undrawn except for letters of credit.
- The refinancing produced a $16.5 million loss on extinguishment of debt from writing off unamortized issuance costs. Management anticipated approximately $10 million of interest savings over the first twelve months, based on the disclosed borrowing-rate assumptions.
- The company reported compliance with debt covenants. At March 31, 2012, the leverage ratio was 2.28 versus a 4.00 maximum and interest coverage was 7.32 versus a 3.00 minimum.
- Broker-dealer regulatory capital remained well above minimums. LPL Financial LLC had $108.4 million of net capital versus a $6.1 million minimum requirement; UVEST had $20.1 million versus a $0.3 million minimum.
Material changes versus the prior comparable period
- Revenue increased 3.2%, supported by higher advisory and asset-based fees, stronger alternative-investment and insurance commissions, increased advisor and asset levels, and benefits from the UVEST platform conversion.
- Commission revenue increased 2.6%; alternative-investment commissions rose 37.3%, while fixed-annuity commissions declined 32.7% and fixed-income commissions declined 4.2% amid low interest rates.
- Advisory fees increased 2.8%, despite lower net new advisory assets of $2.5 billion versus $3.7 billion in Q1 2011.
- Net income declined 16.0% primarily because of the $16.5 million debt-extinguishment charge, higher production and compensation costs, and higher restructuring expense.
- Adjusted EBITDA was broadly stable, while adjusted earnings increased because the refinancing charge and other excluded items were treated as non-core adjustments.
- The company declared a special dividend of $2.00 per share on March 30, 2012. A liability of $220.6 million was recorded at quarter-end; payment was scheduled for May 25, 2012, subject to the May 15 record date and additional share issuances.
- The company distributed shares under its deferred compensation plan and repurchased 1,149,896 shares for $37.5 million to satisfy tax withholding requirements.
Outlook, management commentary and risks
Management stated that operating cash flow and available borrowing capacity were expected to be adequate for working capital, obligations and anticipated capital expenditures for the foreseeable future. The company expected approximately $10 million in annualized pre-tax profitability improvements after completing the UVEST integration. It also expected to incur additional UVEST-related restructuring costs; total expected restructuring costs were approximately $31.6 million, excluding approximately $12.0 million of internally developed software costs that were being capitalized.
On April 23, 2012, after quarter-end, the company completed its acquisition of Fortigent for total consideration of $39.5 million, including $9.9 million placed in escrow. Fortigent provides high-net-worth solutions and consulting services to RIAs, banks and trust companies.
Key risks include sensitivity to equity-market levels and advisory assets, low interest rates affecting cash-sweep and fixed-income-related revenue, competition for advisors, regulatory and legislative changes, operational and technology failures, client margin and settlement exposure, litigation and contingent consideration, integration risk related to Fortigent and prior acquisitions, and the substantial portion of floating-rate debt that was not hedged. The company’s $65 million interest-rate swap was scheduled to mature on June 30, 2012, leaving approximately $1.3 billion of term debt unhedged at quarter-end.
The company had contractual cash obligations of approximately $2.0 billion, including $1.35 billion of senior secured term-loan principal, estimated variable interest payments, lease and other obligations. It also had a fifteen-year future San Diego office lease commitment beginning in 2014.
Important facts for investors to verify
- Confirm the final amount and funding impact of the $2.00 per share special dividend, including any increase from option or warrant exercises.
- Assess whether the refinancing’s anticipated interest savings offset the higher leverage and refinancing-related charges.
- Monitor covenant compliance, scheduled principal amortization and the company’s ability to refinance or repay debt.
- Evaluate recurring revenue trends, market-sensitive asset levels, cash-sweep balances and the effect of sustained low interest rates.
- Track remaining UVEST restructuring costs, expected integration savings and the completion of the UVEST broker-dealer withdrawal process.
- Review the financial and operating contribution of the Fortigent acquisition following its April 2012 closing.
- Consider the large gap between GAAP net income and adjusted earnings, and review the company’s non-GAAP reconciliation when comparing performance.
- Review legal, regulatory, clearing, margin-lending and operational contingencies, although management stated that pending litigation was not expected to have a material adverse effect.