LPL Financial Holdings Inc. — FY2013 Form 10-K
Business context and reporting period
The filing covers the fiscal year ended December 31, 2013, with unaudited quarterly data for the fourth quarter. LPL Financial is an independent broker-dealer, investment adviser, custodian and technology platform serving more than 13,600 advisors, approximately 4.4 million client accounts and more than 700 financial institutions. The company also provides retirement, trust and high-net-worth services through subsidiaries including Fortigent and The Private Trust Company.
Financial performance and key metrics
| Metric | FY2013 | FY2012 | Change |
|---|---|---|---|
| Net revenues | $4.141 billion | $3.661 billion | 13.1% |
| Income before taxes | $291.3 million | $250.6 million | 16.2% |
| Net income | $181.9 million | $151.9 million | 19.7% |
| Diluted EPS | $1.72 | $1.37 | 25.5% |
| Adjusted EBITDA | $511.4 million | $454.5 million | 12.5% |
| Adjusted EPS | $2.44 | $2.03 | 20.2% |
| Operating cash flow | $160.1 million | $254.3 million | Decrease |
| Cash and cash equivalents | $516.6 million | $466.3 million | Increase |
| Total debt | $1.535 billion | $1.318 billion | Increase |
Revenue was led by commission revenue of $2.078 billion, advisory revenue of $1.187 billion, asset-based revenue of $431.0 million and transaction and fee revenue of $361.3 million. Recurring revenue was approximately 65% of net revenue. Gross margin was $1.248 billion, or 30.1% of net revenue, compared with 30.4% in 2012. Adjusted EBITDA margin was approximately 12.4%; reported net income margin was approximately 4.4%.
Advisory and brokerage assets reached $438.4 billion, up from $373.3 billion, while advisory assets under custody increased to $151.6 billion from $122.1 billion. Net new advisory assets were $14.6 billion. Insured cash account balances were $17.4 billion and money market balances were $7.5 billion at year-end.
Capital expenditures were $78.2 million. Cash used in investing activities was $74.8 million and cash used in financing activities was $35.0 million. The company repurchased $219.1 million of stock and paid $68.0 million in dividends during 2013.
Fourth-quarter and year-over-year changes
Fourth-quarter 2013 net revenue was $1.094 billion versus $944.2 million in the fourth quarter of 2012. Net income was $44.4 million versus $36.9 million, and diluted EPS was $0.43 versus $0.34.
- Commission revenue increased 14.1%, supported by higher activity in alternative investments, equities and mutual funds, as well as stronger trailing commissions.
- Advisory revenue increased 11.8%, reflecting market appreciation, advisor productivity and net new advisory assets.
- Asset-based revenue increased 6.9%, although cash sweep revenue declined 13.4% to $119.6 million because of contract repricing and persistently low interest rates.
- The total payout ratio increased modestly to 87.24% from 87.06%, while the base payout rate declined 12 basis points.
- Operating expenses increased 13.5%, including higher compensation, depreciation and amortization, and restructuring costs.
- Operating cash flow declined substantially because client trading and settlement activity used $161.2 million of cash in 2013, compared with providing $51.6 million in 2012.
Guidance, outlook, unusual items and risks
Management expected the Service Value Commitment to be completed in 2015, with total program charges of approximately $65 million and annual pretax savings of approximately $30 million by 2015. Cumulative costs incurred through December 31, 2013 were $27.9 million. The program includes technology transformation, outsourcing, labor repositioning and additional reliance on third-party providers.
The company closed NestWise in September 2013. Related charges included derecognition of $10.2 million of goodwill, $8.4 million of fixed assets and a $9.3 million reduction in contingent consideration. Restructuring charges were $30.2 million, and the company recorded an $8.0 million loss on extinguishment of debt related to the May 2013 refinancing.
In May 2013, the company refinanced its debt, increasing Amended Term Loan B and ending the year with $1.535 billion of floating-rate debt. The company had a $250 million revolving facility, of which $228.6 million was undrawn at year-end, excluding $21.4 million supporting letters of credit. Leverage was 2.34x against a 4.25x covenant maximum, and interest coverage was 10.91x against a 3.00x minimum. The company reported compliance with all debt covenants.
LPL Financial had $130.4 million of regulatory net capital and $123.5 million of excess net capital at year-end. Management stated that operating cash flow and available borrowing capacity were expected to fund working capital, obligations and anticipated capital expenditures for the foreseeable future.
Key risks include sensitivity to equity markets, asset values and interest rates; declining cash sweep economics; advisor retention and recruiting; regulatory and litigation exposure; technology, cybersecurity and business-continuity failures; dependence on outsourced service providers; floating-rate debt; debt covenant restrictions; and the ability to achieve projected Service Value Commitment savings. The filing also discloses contingent consideration, unrecognized tax benefits of $19.5 million, contractual obligations of approximately $2.224 billion and legal matters that management did not expect to have a material effect based on information available at filing.
Important facts for investors to verify
- Confirm the reconciliation and ongoing comparability of GAAP results with Adjusted EBITDA, Adjusted Earnings and other non-GAAP measures.
- Assess whether the Service Value Commitment achieved the projected $30 million of annual pretax savings and whether transition or outsourcing risks increased.
- Monitor cash sweep pricing, short-term interest rates and their effect on asset-based revenue.
- Review debt maturities, floating-rate exposure, covenant headroom and the availability of the revolving facility.
- Evaluate the sustainability of cash flow after advisor payouts, capital expenditures, dividends and share repurchases.
- Verify the effect of the NestWise closure, contingent consideration payments and the $39.3 million NRP payment made in February 2014.
- Consider market-sensitive growth in advisory and brokerage assets, including the portion attributable to market appreciation versus net new assets.
- Review subsequent events: the $0.24 per-share dividend declared, the $150 million expansion of repurchase capacity and the $100 million TPG-related share repurchase completed in February 2014.