LPL Financial Holdings Inc. — Form 10-Q Summary
Business context and reporting period
LPL Financial is an independent broker-dealer and investment advisory platform serving more than 16,000 advisors, including advisors at approximately 800 financial institutions. The filing covers the quarter and six months ended June 30, 2018; the financial statements are unaudited and prepared under U.S. GAAP.
The company provides brokerage, advisory, custody, clearing, technology, compliance, practice-management, and related financial product services. The National Planning Holdings acquisition, completed in waves through the first quarter of 2018, materially expanded the advisor and asset base.
Financial performance and key metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total net revenues | $1,298.8 million, up 21.9% | $2,540.4 million, up 20.9% |
| Pre-tax income | $162.9 million, up 44.5% | $282.8 million, up 50.4% |
| Net income | $118.8 million, up 73.5% | $212.3 million, up 82.0% |
| Diluted EPS | $1.30 versus $0.74 | $2.30 versus $1.27 |
| Gross profit | $482.8 million, up 24.2% | $946.7 million, up 23.8% |
| Gross profit as a percentage of net revenue | 37.2% versus 36.5% | 37.3% versus 36.4% |
| Recurring gross profit rate | 84.7% versus 81.1% | 84.7% versus 81.1% |
Revenue growth was led by advisory revenue of $438.9 million in the second quarter, up 26.7%; asset-based revenue of $238.6 million, up 37.6%; and commission revenue of $488.1 million, up 16.0%. Cash sweep revenue benefited from higher short-term interest rates, while advisory and trailing commission revenue benefited from asset growth, market appreciation, improved investor engagement, and the NPH acquisition.
The effective tax rate declined to 27.1% in the quarter and 24.9% for the six months, compared with 39.3% and 38.0%, respectively, in the prior-year periods, primarily reflecting the Tax Cuts and Jobs Act, stock option exercises, and lower settlement contingencies.
Assets, cash flow, debt, and liquidity
- Total brokerage and advisory assets served were $659.1 billion at June 30, 2018, up 21.6% from the prior year. Advisory assets were $291.5 billion, up 23.1%, and brokerage assets were $367.5 billion, up 20.4%.
- Six-month net new assets were $41.4 billion, compared with $3.0 billion in the prior-year period. Net new advisory assets were $17.5 billion; net new brokerage assets were $23.9 billion.
- Total cash sweep balances were $28.6 billion, up 3% year over year. Cash, cash equivalents, and restricted cash were $1.45 billion at June 30, 2018, compared with $1.52 billion at June 30, 2017.
- Operating cash flow was $60.1 million, down from $104.8 million. Investing cash flow was an outflow of $49.9 million, and financing cash flow was an outflow of $188.3 million, primarily reflecting share repurchases and dividends.
- Long-term borrowings had a net carrying value of $2.38 billion, consisting primarily of a $1.49 billion Term Loan B and $900 million of 5.75% senior unsecured notes due 2025. The debt carrying amount was approximately $2.39 billion and fair value was approximately $2.37 billion.
- The company had no revolving credit facility balance and was in compliance with its debt covenants. Actual leverage was 2.34 versus a maximum of 5.00, and interest coverage was 8.11 versus a minimum of 3.00.
- LPL Financial, the broker-dealer subsidiary, had net capital of $130.4 million versus a $7.5 million minimum requirement. Management stated that available operating cash flow, credit facilities, and other sources should satisfy foreseeable liquidity needs.
Material changes versus the prior comparable period
- Profitability increased substantially, with second-quarter net income up 73.5% and diluted EPS up 75.7%.
- The NPH acquisition increased revenues, advisor and client assets, employee and contingent labor costs, promotional expenses, amortization, and ongoing support requirements. The company paid $325 million at closing and no contingent payment was due after the conversion period.
- Operating expenses increased 19.2% in the quarter and 19.3% for the six months. Promotional expense increased 35.6% in the quarter, and amortization of intangible assets increased 65.9%, primarily due to NPH-related costs and acquired intangible assets.
- The company repurchased 2.76 million shares for $177.6 million during the first six months and paid $44.9 million in dividends. At June 30, $322.4 million remained authorized for repurchases.
- The prior-year six-month results included a $21.1 million loss on extinguishment of debt; no comparable loss occurred in 2018.
- Cash flow from operations declined despite higher earnings, principally due to increased client receivables, advisor loans, and payments of client payables.
Guidance, outlook, commentary, and risks
The filing does not provide formal earnings or revenue guidance. Management expects continued growth from advisor recruiting, advisory assets, the expanded NPH platform, technology initiatives, and higher interest-sensitive cash sweep revenue, but results remain dependent on market levels, short-term interest rates, investor activity, and advisor retention.
Key regulatory matters include a settlement structure with the North American Securities Administrators Association concerning historical state “blue sky” compliance. The company expects administrative orders in 53 jurisdictions with aggregate fines of approximately $26.4 million, plus customer remediation, consultant, and review costs over the next several years. Management expects most related costs to be covered by its captive insurance subsidiary or expense plans, but losses could exceed accruals and insurance.
The company also faces uncertainty regarding retirement-account regulation following nationwide vacatur of the Department of Labor fiduciary rule and the SEC’s proposed best-interest standard. Other material risks include regulatory enforcement, litigation, cybersecurity and operational failures, third-party service providers, market declines, interest-rate changes, margin and client credit exposure, competition, and execution of NPH-related synergies.
A putative class action lawsuit alleges misstatements and omissions concerning share repurchases and financial performance in late 2015. The company intends to defend the lawsuit vigorously. Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether NPH integration costs decline as expected and whether projected savings and synergies are realized.
- The ultimate cost, timing, insurance coverage, and customer remediation obligations related to the blue sky settlement and other regulatory matters.
- The sensitivity of cash sweep revenue and floating-rate debt expense to future Federal Reserve actions, LIBOR changes, and bank fee negotiations.
- The sustainability of asset-based revenue growth, net new assets, advisory assets, and market-dependent trailing commissions.
- Liquidity after share repurchases, dividends, capital expenditures, advisor loans, and regulatory reserve requirements.
- Compliance with debt covenants and broker-dealer capital requirements, particularly during adverse market or operating conditions.
- Potential effects of retirement-account regulation, litigation, cybersecurity incidents, and other legal or operational contingencies.