LPL Financial Holdings Inc. — 2Q 2014 Form 10-Q Summary
Business context and reporting period
LPL Financial provides brokerage, investment advisory, custody, clearing, technology, trust, and related services to independent financial advisors, financial institutions, registered investment advisors, and their clients. The unaudited report covers the three and six months ended June 30, 2014, compared with the corresponding 2013 periods.
- Supported 13,840 advisors at June 30, 2014, up 3.2% year over year.
- Advisory and brokerage assets were $465.4 billion, up 17.3%; advisory assets under custody were $167.3 billion, up 26.4%.
- Net new advisory assets were $8.7 billion for the first six months, up from $6.7 billion.
Financial performance and key metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net revenues | $1,092.7 million, up 7.2% | $2,180.2 million, up 9.4% |
| Net income | $43.1 million, down 4.4% | $96.2 million, down 3.6% |
| Diluted EPS | $0.42, unchanged | $0.94, up from $0.93 |
| Adjusted EBITDA | $128.2 million, down from $131.0 million | $269.7 million, up from $267.0 million |
| Adjusted earnings | $61.8 million; adjusted diluted EPS $0.61 | $132.8 million; adjusted diluted EPS $1.29 |
| Recurring revenue | 67.6% of net revenue | 67.1% of net revenue |
Revenue growth was led by advisory revenue, which increased 10.8% in the quarter and 13.5% year to date; asset-based revenue, up 10.3% and 10.4%, respectively; and commission revenue, up 5.3% and 7.6%. Trailing commissions increased 13.8% in the quarter and 14.6% year to date, while sales-based commissions were comparatively modestly higher.
Gross margin was $328.7 million in the quarter and $659.5 million year to date. Gross margin as a percentage of net revenue was 30.1% and 30.2%, compared with 30.0% and 30.6% in the prior-year periods. Adjusted EBITDA margin was 11.7% in the quarter and 12.4% year to date, down from 12.9% and 13.4%.
Profitability was pressured by higher operating expenses, including general and administrative expense up 26.4% in the quarter and 24.0% year to date, restructuring charges up 25.8% and 23.8%, and depreciation and amortization up 17.6% and 15.2%. The approximate GAAP net margin was 3.9% for the quarter and 4.4% year to date, versus approximately 4.4% and 5.0% in the comparable 2013 periods.
Cash flow, debt, and liquidity
- Cash provided by operating activities was $116.5 million in the first six months, compared with cash used of $4.3 million in 2013.
- Capital expenditures were $45.9 million, compared with $32.2 million in the prior-year period; investing cash outflow was $41.2 million.
- Financing cash outflow was $153.3 million, primarily reflecting $125.0 million of share repurchases and $48.1 million of dividends.
- Cash and cash equivalents were $438.6 million at June 30, 2014, down from $516.6 million at December 31, 2013.
- Senior secured debt was $1.530 billion, consisting of Term Loan A of $459.4 million due 2017 and Term Loan B of $1.070 billion due 2019. All outstanding debt had floating rates.
- The $250.0 million revolving facility had $228.6 million of undrawn availability, net of $21.4 million of letters of credit. The company also maintained three uncommitted credit lines with no outstanding balances.
- Total leverage was 2.49x versus a 4.25x maximum covenant; interest coverage was 10.68x versus a 3.00x minimum. The company reported compliance with all debt covenants.
- LPL Financial’s broker-dealer net capital was $187.5 million versus a $6.8 million minimum requirement, providing $180.7 million of excess net capital.
Material changes, outlook, risks, and unusual items
- The Service Value Commitment is expected to be completed in 2015. Total expected charges approach $65.0 million; $43.6 million had been incurred cumulatively through June 30, 2014, including $15.7 million in the first six months. Management expected approximately $30.3 million of expense in 2014 and annual pretax savings approaching $30.0 million by 2015.
- Low short-term interest rates and fee compression reduced cash sweep revenue, which declined 20.1% in the quarter and 22.0% year to date. Management stated that the low-rate environment continued to pressure cash sweep revenue and demand for fixed-income products and fixed annuities.
- Professional services expense increased substantially, partly due to investigations, settlements, and remediation of several regulatory matters. The company stated that pending matters were not expected to have a material financial impact after considering accruals, insurance, and indemnifications.
- The company repurchased 2.46 million shares for $125.0 million during the first six months, including a $100.0 million private repurchase of 1.9 million shares from a TPG Capital-affiliated fund. The remaining authorization at June 30 was $92.9 million.
- Quarterly dividends increased to $0.24 per share from $0.135 in 2013. On July 29, 2014, the board declared another $0.24 per share dividend payable August 29, 2014.
- Foreign-exchange hedges were used for contractual exposure to an outsourcing provider whose pricing is linked to the Indian rupee. Three remaining hedges had aggregate USD notionals of approximately $23.4 million.
- Key risks include market declines affecting asset-based and advisory revenue, persistently low interest rates, competition, regulatory and legal developments, cybersecurity and technology failures, reliance on third-party service providers, execution of the outsourcing and technology transformation program, and floating-rate debt exposure.
- There were no material acquisitions, integrations, or divestitures during the six months. The filing reported no legal proceedings deemed material and no material changes to previously disclosed risk factors, other than an amended anti-takeover risk factor.
Investor verification checklist
- Verify whether the Service Value Commitment achieves the projected 2015 savings and whether restructuring costs remain within the $65.0 million estimate.
- Monitor cash sweep revenue, interest rates, contract repricing, and the effect of rate changes on both revenue and floating-rate debt expense.
- Assess whether asset growth and net new advisory assets translate into sustained advisory revenue growth, particularly as Independent RIA assets grow faster than assets under management.
- Review operating expense growth, professional fees, regulatory remediation costs, and San Diego relocation costs for evidence of ongoing margin pressure.
- Track leverage, covenant headroom, capital expenditures, share repurchases, dividends, and available liquidity in light of the $1.53 billion debt balance.
- Evaluate execution and operational risks associated with outsourcing, technology transformation, cybersecurity, and third-party service providers.