LPL Financial Holdings Inc. quarterly report, Q3 FY2021

LPL Financial Holdings Inc. — 2021 Q3 Form 10-Q Summary

Business context and reporting period

LPL Financial provides brokerage, investment advisory, custody, clearing, technology and related services to independent financial advisors, financial institutions and registered investment advisers in the United States. The filing covers the unaudited quarter and nine months ended September 30, 2021, compared with the comparable 2020 periods.

At quarter-end, LPL supported 19,627 advisors, approximately 800 institution-based investment programs and 450 RIA firms. The April 2021 acquisition of the wealth management business of Waddell & Reed Financial materially expanded the company’s advisor and asset base.

Financial performance and key metrics

Metric	Q3 2021	Q3 2020	Change
Total revenue	$2,020.8 million	$1,460.3 million	38.4%
Net income	$103.1 million	$103.8 million	(0.7%)
Diluted EPS	$1.26	$1.29	(2.3%)
Gross profit	$631.1 million	$505.7 million	24.8%
EBITDA	$225.0 million	$204.9 million	9.8%
Core G&A	$270.9 million	$227.1 million	19.3%

For the nine months ended September 30, 2021, revenue was $5.63 billion versus $4.29 billion, net income was $351.8 million versus $361.1 million, diluted EPS was $4.30 versus $4.48, gross profit was $1.81 billion versus $1.57 billion, and EBITDA was $711.6 million versus $692.2 million.

• Q3 gross profit margin was approximately 31.2%, compared with approximately 34.6% in Q3 2020. Net income margin was approximately 5.1%, compared with approximately 7.1%.
• Advisory revenue increased 63.5% to $959.7 million, commission revenue increased 29.1% to $610.4 million, asset-based revenue increased 19.0% to $301.7 million, and transaction and fee revenue increased 17.2% to $140.4 million.
• Asset growth was strong: total advisory and brokerage assets reached $1.13 trillion, up 40% year over year. Advisory assets were $594.0 billion, up 46%, and brokerage assets were $538.6 billion, up 33%.
• Q3 total net new assets were $29.0 billion, including $21.7 billion of net new advisory assets and $7.3 billion of net new brokerage assets. Organic net new assets were $26.7 billion.
• Client cash balances were $50.7 billion at September 30, 2021, compared with $46.6 billion a year earlier. Lower short-term interest rates continued to pressure client cash revenue.
• The payout rate increased to 87.15% from 86.62%, primarily because of higher production bonuses and product mix changes.

Cash flow, balance sheet, debt and liquidity

• Net cash provided by operating activities for the first nine months was $199.7 million, down from $463.7 million in 2020. The decline primarily reflected higher advisor loans, receivables and other operating asset requirements.
• Investing cash outflow was $379.6 million, including $241.6 million for acquisitions and $140.0 million of capital expenditures.
• Financing cash inflow was $255.7 million, reflecting new senior note issuances, debt refinancing activity and stock-based proceeds, partly offset by debt repayments, dividends and share repurchases.
• Cash, cash equivalents and restricted cash totaled $1.875 billion at September 30, 2021. Corporate cash was $265.7 million, compared with $279.9 million at December 31, 2020; management targets approximately $200 million of corporate cash.
• Long-term borrowings, net, were $2.726 billion, compared with $2.345 billion at December 31, 2020. Debt included a $1.051 billion Term Loan B, $400 million of 2027 senior notes, $900 million of 2029 senior notes and $400 million of 2031 senior notes.
• In March 2021, LPL redeemed its $900 million of 2025 senior notes, issued $900 million of 2029 senior notes and expanded its senior secured revolving credit facility to $1.0 billion. In May 2021, it issued $400 million of 2031 senior notes. The refinancing generated a $24.4 million loss on extinguishment of debt during the first quarter.
• No borrowings were outstanding under the company’s external credit facilities at September 30, 2021. Available committed and uncommitted facilities included the $1.0 billion parent revolver, a $300 million broker-dealer revolver and additional lines of credit.
• The leverage ratio was 2.18 versus a maximum covenant of 5.00, and interest coverage was 12.42 versus a minimum covenant of 3.00. The company reported compliance with its debt covenants.
• LPL Financial had $133.3 million of net capital against a $14.1 million minimum requirement, providing $119.2 million of excess net capital.

Material changes versus the prior comparable period

• Revenue and assets increased substantially, driven by market appreciation, advisor recruiting, organic asset flows and the Waddell & Reed acquisition.
• Despite higher revenue and gross profit, net income and diluted EPS were slightly lower because operating expenses grew faster than revenue. Total operating expense increased 42.8%, including higher advisory payouts, compensation, promotional spending, technology investment, depreciation and amortization, and acquisition costs.
• Q3 2021 included $35.9 million of acquisition costs, compared with none in Q3 2020. Amortization of intangible assets increased to $21.5 million from $16.8 million.
• Adjusted EPS before amortization of intangible assets and acquisition costs increased to $1.77 from $1.44. This non-GAAP measure should not be viewed as a substitute for GAAP EPS.
• Share repurchases resumed in Q3 2021, with $40.0 million used to repurchase 276,800 shares. The company also paid a $0.25 per share quarterly dividend, or $20.1 million in total.
• The company adopted a new 2021 Omnibus Equity Incentive Plan and discontinued new grants under the prior 2010 plan.

Outlook, management commentary, risks and unusual items

The filing does not provide a specific numerical earnings or revenue forecast. Management stated that available operating cash flows and external liquidity sources were expected to be adequate for working capital, obligations and anticipated capital expenditures for the foreseeable future. The company expects to continue share repurchases with an initial focus on offsetting dilution, subject to liquidity, covenant and investment considerations.

• Results remain sensitive to financial market levels, advisory and brokerage asset balances, net new assets, trading activity, retail investor sentiment and interest rates.
• Low short-term rates reduce revenue from client cash programs; higher rates could increase interest expense on the $1.051 billion floating-rate Term Loan B. The filing estimates that a 100-basis-point increase would add approximately $10.4 million to annual interest expense, before considering rate locks.
• The company faces regulatory and legal risks involving SEC, FINRA, state regulators, Regulation BI, retirement-account fiduciary standards and supervisory and compliance systems. Losses could exceed recorded accruals and available insurance.
• Self-insurance liabilities increased to $68.8 million from $51.5 million at December 31, 2020.
• COVID-19 continued to create uncertainty, including potential effects on operations, markets, employees, vendors and financial results. The company maintained remote-work, enhanced cleaning and business-continuity measures.
• Operational, cybersecurity, third-party service-provider, margin lending, client collateral and market risks remain material. At September 30, 2021, approximately $495.1 million of client margin loans were collateralized by securities with a fair value of approximately $693.1 million.
• The company expected to dissolve the Waddell & Reed broker-dealer during Q4 2021. A $0.25 per share dividend was declared on October 28, 2021 for payment on November 29, 2021.

Most important facts for investors to verify

• Whether asset growth and net new assets remain strong after the initial contribution from Waddell & Reed and as market conditions change.
• Whether expense growth, payout rates and acquisition-related costs moderate sufficiently to improve GAAP margins.
• The continuing impact of short-term interest rates on client cash revenue and floating-rate debt expense.
• Integration progress, retention and profitability of the Waddell & Reed business, including final purchase-accounting adjustments.
• Debt reduction, covenant headroom, corporate cash levels and the sustainability of dividends and share repurchases.
• The adequacy of reserves and insurance coverage for regulatory, legal, customer restitution and self-insurance exposures.
• Changes in cybersecurity, operational continuity, third-party-provider and COVID-19 risks.