LPL Financial Holdings Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2020. The unaudited filing covers LPL Financial Holdings Inc. and subsidiaries, a provider of brokerage, advisory, custody, clearing, technology and compliance services to independent financial advisors and financial institutions.
Financial performance and key metrics
| Metric | Q3 2020 | Q3 2019 | Change | Nine months 2020 | Nine months 2019 | Change |
|---|---|---|---|---|---|---|
| Total net revenues | $1,460.3 million | $1,415.5 million | 3.2% | $4,290.4 million | $4,177.0 million | 2.7% |
| Pre-tax income | $135.3 million | $178.0 million | (24.0%) | $480.2 million | $576.8 million | (16.7%) |
| Net income | $103.8 million | $131.7 million | (21.2%) | $361.1 million | $433.2 million | (16.6%) |
| Diluted EPS | $1.29 | $1.57 | (17.8%) | $4.48 | $5.07 | (11.6%) |
| Gross profit | $505.7 million | $542.5 million | (6.8%) | $1,569.5 million | $1,634.1 million | (4.0%) |
| Gross profit as % of revenue | 34.6% | 38.3% | (370 bps) | 36.6% | 39.1% | (250 bps) |
- Revenue mix: Q3 advisory revenue increased 14.1% to $586.9 million, while commission revenue declined 0.5% to $472.6 million. Asset-based revenue declined 13.2% to $253.6 million, primarily because lower interest rates reduced client cash program revenue. Transaction and fee revenue declined 1.2% to $119.7 million.
- Expenses and margins: Total operating expenses increased 7.8% in Q3 and 6.5% for the nine-month period. Commission and advisory expense increased 9.4% in Q3, while compensation and benefits increased 9.4%. The total payout ratio was 86.62% in Q3 versus 86.66% in the prior-year quarter.
- Assets and growth: Advisory and brokerage assets served were $810.4 billion at September 30, 2020, up 13% year over year. Advisory assets rose 20% to $405.9 billion and brokerage assets rose 6% to $404.4 billion. Nine-month net new assets totaled $38.4 billion, compared with $23.8 billion under the filing’s updated definition for the comparable 2019 period.
- Client cash: Total client cash balances were $46.6 billion, up 49% year over year. Insured sweep balances increased 59% to $42.7 billion, while money market account balances declined 42% to $1.5 billion.
- Cash flow: Nine-month operating cash flow was $463.7 million versus $509.8 million in 2019. Investing cash flow was $(132.1) million, including $112.0 million of capital expenditures and $18.9 million for acquisitions. Financing cash flow was $(260.1) million, including $150.0 million of share repurchases completed before the repurchase suspension and $59.3 million of dividends.
- Cash and liquidity: Cash, cash equivalents and restricted cash totaled $1.543 billion at September 30, 2020, compared with $1.509 billion at September 30, 2019. Management stated that operating cash flow and available funding sources should satisfy foreseeable working-capital, obligation and capital-expenditure needs, including under reasonably likely stress scenarios.
- Debt: Net carrying value of borrowings was $2.348 billion at September 30, 2020, consisting primarily of a $1.062 billion Term Loan B and $1.3 billion of senior unsecured notes. The earliest principal maturity was in 2025; the revolving facilities mature in 2024. Debt carrying value was approximately $2.362 billion before certain presentation adjustments, with estimated fair value of $2.381 billion.
- Regulatory capital: LPL Financial had net capital of $129.4 million against a $10.7 million minimum requirement. The company reported compliance with applicable capital requirements and debt covenants. Actual leverage was 2.15x versus a maximum 5.00x, and interest coverage was 9.4x versus a minimum 3.00x.
Material changes versus the prior comparable period
- Revenue grew modestly, but profitability declined because operating expenses and advisor payouts grew faster than revenue, while asset-based and net interest-related revenue contracted in the low-rate environment.
- Advisory revenue and advisory assets continued to expand, reflecting net new assets, advisor recruiting and market appreciation. Advisory assets represented approximately half of total advisory and brokerage assets served.
- Client cash balances increased substantially, but the associated revenue declined because the federal funds rate was substantially lower.
- COVID-19-related market volatility increased trading activity and affected transaction revenues, while advisor conferences were canceled or moved to virtual formats.
- The company suspended share repurchases in mid-March 2020. It continued to pay a quarterly dividend of $0.25 per share and returned $19.8 million through dividends in Q3.
- The company acquired certain assets of Lucia Securities, LLC and E.K. Riley Investments, LLC on August 18, 2020, for a combined $18.4 million, with potential future contingent payments. It also acquired Blaze Portfolio Systems LLC for approximately $12 million on October 26, 2020, after quarter-end.
Guidance, outlook, risks and unusual items
- The filing does not provide formal quantitative revenue or earnings guidance. Management expects low interest rates to continue depressing client cash program revenue through the remainder of 2020.
- Management stated that the full future financial impact of COVID-19 could not yet be determined. Risks include lower financial markets and asset-based revenues, reduced client activity, operational disruption from remote work, vendor or technology failures, cybersecurity incidents and weaker advisor recruiting.
- Regulation BI procedures were implemented by the June 30, 2020 compliance date. Future federal, state and Department of Labor fiduciary or standards-of-conduct rules may increase compliance, technology and litigation costs and affect products and services.
- The company remains subject to legal and regulatory inquiries, potential fines, customer restitution and remediation. The previously disclosed $26.4 million blue-sky settlement was covered by captive insurance reserves, and customer remediation was substantially complete and not expected to be material.
- Interest-rate exposure remains material: approximately $1.1 billion of debt was subject to floating-rate risk at quarter-end. A 100-basis-point increase was estimated to increase annual interest expense by approximately $10.6 million before considering rate locks or offsets.
- Other notable items include adoption of the credit-loss standard ASU 2016-13, which had no material impact; $84.7 million of loan forgiveness included in operating cash-flow adjustments; and a $7.3 million cumulative-effect reduction to retained earnings from accounting changes.
Important facts for investors to verify
- Whether sustained low interest rates continue to pressure client cash program revenue and overall gross profit.
- Whether advisory asset growth and net new assets offset pressure on commissions, asset-based revenue and margins.
- The timing and amount of any resumption of share repurchases, subject to liquidity needs and debt-document restrictions.
- Integration performance and contingent consideration associated with Lucia Securities, E.K. Riley Investments and Blaze Portfolio Systems.
- Changes in COVID-19 conditions, financial markets, trading volumes, advisor recruiting and operating or cybersecurity risks.
- Developments in regulatory matters, including Regulation BI, fiduciary standards, customer remediation and potential legal or regulatory reserves.
- Debt maturities, floating-rate exposure, covenant compliance and the availability of the stated $1.1 billion of combined revolving capacity.