LPL Investment Holdings Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2011, compared with the corresponding 2010 periods. The filing identifies the registrant as LPL Investment Holdings Inc. The unaudited statements were filed November 2, 2011.
Business Context
The company provides technology, brokerage, custody, clearing, and investment advisory platforms to independent financial advisors and advisors at financial institutions. It reported approximately 12,799 advisors, approximately 2,700 employees, $316.4 billion of advisory and brokerage assets, and $96.3 billion of advisory assets under management at September 30, 2011.
Key Financial Metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net revenues | $882.9 million | $760.0 million | $2.651 billion | $2.294 billion |
| Net revenue growth | 16.2% | 8.2% | 15.6% | 13.8% |
| Net income | $36.4 million | $26.1 million | $130.9 million | $59.7 million |
| Net margin | 4.1% | 3.4% | 4.9% | 2.6% |
| Diluted EPS | $0.32 | $0.26 | $1.15 | $0.59 |
| Adjusted EBITDA | $111.6 million | $98.6 million | $358.9 million | $314.0 million |
| Adjusted EBITDA margin | 12.6% | 13.0% | 13.5% | 13.7% |
| Gross margin | $259.0 million | $234.3 million | $788.4 million | $698.2 million |
| Gross margin percentage | 29.3% | 30.8% | 29.7% | 30.4% |
Revenue was led by commissions, advisory fees, asset-based fees, and transaction and other fees. Nine-month recurring revenue was $1.641 billion, or 61.9% of net revenue, compared with 60.2% in the prior-year period.
Cash Flow, Liquidity, Debt, and Capital
- Cash and cash equivalents increased to $663.2 million at September 30, 2011, from $419.2 million at December 31, 2010.
- Operating cash flow was $363.7 million for the first nine months, compared with $107.8 million in 2010. The increase included a $193.2 million tax-receivable change and $57.3 million of excess tax benefits from stock-option exercises; these items may not recur at comparable levels.
- Investing cash flow was negative $46.3 million, including $37.2 million for acquisitions and $24.3 million of capital expenditures.
- Financing cash flow was negative $73.5 million, including $50.5 million of debt repayment and $89.0 million of share repurchases.
- Senior secured credit facilities totaled $1.336 billion, down from $1.387 billion at year-end 2010. Debt fair value was approximately $1.323 billion.
- Debt maturities include $14.0 million within 12 months, $310.1 million in 2013, $467.7 million in 2015, and $530.0 million thereafter. The company had no outstanding balance on its revolving credit facility at quarter-end.
- The company was in compliance with debt covenants. The September 30 leverage ratio was 1.87 versus a maximum of 3.00; interest coverage was 6.83 versus a minimum of 3.00.
- Broker-dealer excess net capital was $120.0 million for LPL Financial LLC and $22.3 million for UVEST. All applicable regulatory capital requirements were met.
Material Changes Versus the Prior Comparable Period
- Q3 net revenue increased 16.2%, while net income increased 39.3%. For the first nine months, net revenue increased 15.6% and net income increased 119.3%.
- Advisory fees rose 26.2% in Q3 and 22.5% year to date, supported by asset growth and net new advisory assets of $9.8 billion during the first nine months.
- Commissions increased 13.8% in Q3 and 13.0% year to date, with particularly strong variable-annuity revenue. Fixed-annuity and fixed-income revenue declined in Q3.
- Production expenses grew faster than revenue in Q3, and the production payout ratio increased to 87.0% from 86.6%. Consequently, gross margin percentage declined to 29.3% from 30.8%.
- Interest expense declined 14.9% in Q3 and 26.0% year to date, reflecting debt refinancing, matured interest-rate swaps, and a $40.0 million debt repayment.
- The prior-year nine-month period included a $38.0 million loss on extinguishment of debt; no comparable charge was recorded in 2011.
- Adjusted earnings increased to $51.6 million in Q3 and $169.7 million year to date, compared with $40.5 million and $128.0 million, respectively. Pro forma adjusted EPS, using 2011 diluted shares for both periods, increased 27.8% in Q3 and 32.5% year to date.
Guidance, Outlook, Risks, and Unusual Items
- Management described the market outlook as cautiously optimistic but noted substantial volatility related to European sovereign debt, U.S. fiscal uncertainty, the U.S. Treasury downgrade, and weak economic growth.
- Low short-term interest rates pressured cash-sweep revenue. Approximately $1.3 billion of debt remained exposed to floating rates, while only $65.0 million was hedged with an interest-rate swap.
- The UVEST consolidation is expected to generate approximately $10 million to $12 million of annual pretax profitability improvement after completion. Total restructuring expenditures are estimated at approximately $47.6 million; $13.0 million was recorded during the first nine months, including a $2.6 million intangible-asset impairment.
- UVEST conversion activities included 52 institutions and 141 advisors in July 2011. A further 85 institutions and approximately 185 advisors were converted in October, with final conversions expected in December 2011.
- The company completed acquisitions of National Retirement Partners and Concord Wealth Management for provisional total consideration of approximately $25.3 million and $33.8 million, respectively. Contingent consideration and purchase-price allocations remain subject to adjustment.
- Potential future contingent consideration includes an estimated $5.9 million remaining for NRP and up to $15.0 million for Concord. The recorded fair value of acquisition-related contingent consideration was $15.8 million at September 30, 2011.
- The company repurchased approximately $89.0 million of common stock during the first nine months under programs authorizing total repurchases of up to $150.0 million.
- Material risks include sensitivity to market values and advisor activity, interest-rate changes, regulatory and capital requirements, operational and technology risks, margin-loan credit exposure, litigation, debt covenants, and the execution of acquisitions and the UVEST restructuring.
- The company disclosed litigation involving a disputed third-party indemnification obligation. Management stated that, based on available information, the matter was not expected to have a material adverse effect, although the ultimate loss or range of loss could not be predicted.
Investor Verification Checklist
- Verify the sustainability of revenue growth given Q3 market volatility and the 29.3% gross margin, down from 30.8%.
- Separate recurring operating cash generation from the unusually large tax-related cash benefit.
- Review debt maturities, floating-rate exposure, covenant headroom, and the planned expiration of the $54.7 million revolving-credit tranche.
- Track the cost, timing, and expected savings from the UVEST consolidation, including the remaining estimated restructuring expenditures.
- Assess acquisition-related contingent consideration and the finalization of provisional goodwill and intangible-asset valuations.
- Monitor advisory and brokerage assets, net new advisory assets, advisor retention, and the effect of market movements on fee-based revenue.
- Consider the limitations of Adjusted EBITDA and Adjusted Earnings, which are non-GAAP measures and exclude expenses that may require cash or affect future performance.