LPL Financial Holdings Inc. — Q1 2019 Form 10-Q Summary
Business context and reporting period
LPL Financial Holdings Inc. is an independent broker-dealer and provider of brokerage, advisory, custody, clearing, technology, compliance, and practice-management services to financial advisors and financial institutions. This unaudited Form 10-Q covers the three months ended March 31, 2019, compared primarily with the three months ended March 31, 2018.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total net revenue | $1,371.7 million | $1,241.6 million | 10.5% |
| Pre-tax income | $203.8 million | $119.9 million | 69.9% |
| Net income | $155.4 million | $93.5 million | 66.1% |
| Diluted EPS | $1.79 | $1.01 | 68.0% |
| Gross profit | $555.8 million | $464.0 million | 19.8% |
| Gross profit as a percentage of net revenue | 40.5% | 37.4% | Up 310 bps |
| Effective tax rate | 23.7% | 22.0% | Up 170 bps |
- Revenue growth was led by asset-based revenue of $296.4 million, up 35.1%, advisory revenue of $453.9 million, up 7.5%, and transaction and fee revenue of $122.5 million, up 5.0%.
- Commission revenue declined 2.8% to $461.4 million, as trailing commissions fell 6.0%, partly offset by a 2.0% increase in sales-based commissions.
- Interest income, net of interest expense, increased 58.3% to $12.3 million, primarily reflecting higher interest rates.
- Other revenue increased to $25.2 million from $0.6 million, primarily due to unrealized gains and dividend income related to the advisor non-qualified deferred compensation plan.
- Total operating expenses increased 4.0% to $1,135.2 million. Compensation and benefits increased 10.8% with higher headcount, while promotional expense declined 23.8% as prior-year NPH onboarding costs subsided.
- Recurring gross profit rate, measured on a trailing-twelve-month basis, was 86.3%, compared with 83.9% in the prior-year period.
Assets, growth, liquidity, and capital allocation
- Total brokerage and advisory assets served were $684.0 billion at March 31, 2019, up 6% from $647.5 billion a year earlier. Advisory assets increased 10% to $311.9 billion, while brokerage assets increased 2% to $372.1 billion.
- Total net new assets were $4.0 billion, down from $38.9 billion in Q1 2018. Net new advisory assets were $4.6 billion versus $13.1 billion; net new brokerage assets were an outflow of $0.7 billion versus an inflow of $25.8 billion. The prior-year period included approximately $36.0 billion of NPH onboarding assets.
- Total cash sweep balances were $30.7 billion at quarter-end, up 4% year over year. Average cash sweep balances were $31.3 billion versus $29.3 billion.
- Net cash provided by operating activities was $35.2 million, compared with cash used of $22.3 million in Q1 2018. Investing cash flow was negative $30.3 million, including $30.3 million of capital expenditures. Financing cash flow was negative $139.1 million.
- Cash, cash equivalents, and restricted cash ended at $1.428 billion, down from $1.526 billion at March 31, 2018 and $1.562 billion at December 31, 2018.
- Long-term borrowings had a net carrying value of $2.369 billion. Debt consisted principally of a $1.478 billion senior secured term loan and $900.0 million of senior unsecured notes. The revolving credit facility had no outstanding borrowings.
- The company repurchased 1,747,116 shares for $125.0 million at an average price of $71.57 per share and paid $21.1 million of dividends, returning $146.1 million to shareholders. The remaining repurchase authorization was $875.0 million at March 31, 2019.
- LPL Financial reported net capital of $159.0 million against a minimum requirement of $8.1 million. The company stated that it met applicable regulatory capital requirements.
Material changes versus the prior comparable period
- Profitability improved substantially, with net income up 66.1% and diluted EPS up from $1.01 to $1.79, supported by revenue growth, higher asset-based revenue, lower promotional costs, and market appreciation.
- Market recovery materially increased assets: brokerage market impact was positive $26.8 billion and advisory market impact was positive $25.3 billion, compared with negative impacts in Q1 2018.
- Organic asset gathering slowed considerably after excluding the prior-year NPH onboarding benefit, with brokerage net flows turning negative.
- Share count declined: diluted weighted-average shares fell to 86.7 million from 92.8 million, reflecting repurchases and other equity activity.
- The company adopted the new lease accounting standard on January 1, 2019, recording operating lease assets of $106.8 million and operating lease liabilities of $147.3 million. The company also adopted revised non-employee share-based compensation guidance.
- Average employees increased 11.6% to 4,267, contributing to higher compensation expense.
- AdvisoryWorld, acquired in December 2018 for $28.1 million, added technology capabilities in proposal generation, investment analytics, and portfolio modeling.
Guidance, outlook, risks, contingencies, and unusual items
- The filing does not provide formal quarterly or full-year earnings guidance. Management stated that operating cash flow and available borrowing capacity are expected to satisfy working capital, obligations, and anticipated capital expenditures for the foreseeable future.
- Management’s outlook remains sensitive to market levels, interest rates, cash sweep pricing, advisory and brokerage asset balances, net new assets, advisor recruiting and retention, competition, and transaction activity.
- The company is subject to extensive SEC, FINRA, state, and other regulatory oversight. Regulatory and compliance costs, customer restitution, remediation, fines, and litigation could exceed recorded reserves or insurance coverage.
- Under the Blue Sky Settlement, the company expects aggregate fines of approximately $26.4 million across 53 jurisdictions. Historical transaction reviews were incomplete at the filing date, and potential customer remediation costs could not yet be estimated and could exceed reserves.
- Regulatory uncertainty continued regarding standards of conduct for retirement and non-retirement accounts, including the proposed SEC best-interest rule and related state initiatives.
- The company was in compliance with its debt covenants. Actual leverage was 2.05x against a maximum of 5.00x, and actual interest coverage was 8.35x against a minimum of 3.00x.
- Key risks include market and interest-rate exposure, cash sweep fee changes, cybersecurity and technology disruptions, third-party service-provider failures, advisor and client attrition, margin lending and counterparty risk, and legal or regulatory developments.
- A putative federal class action lawsuit against the company and certain executives was dismissed with prejudice on April 22, 2019. The board declared a $0.25 per-share dividend on April 30, 2019, payable June 3, 2019.
Important facts for investors to verify
- Whether the strong earnings growth is sustainable after the favorable Q1 2019 market rebound and unusually large increase in other revenue.
- Trends in net new brokerage and advisory assets, particularly the reversal from strong Q1 2018 brokerage inflows to a Q1 2019 outflow.
- The future effect of interest rates and cash sweep pricing on asset-based revenue and interest expense.
- The ultimate cost and timing of Blue Sky Settlement customer remediation, including whether captive insurance reserves are sufficient.
- Execution of technology investments and integration of AdvisoryWorld, including associated expenses and expected benefits.
- Debt reduction, covenant headroom, floating-rate exposure, and the balance between share repurchases, dividends, acquisitions, and liquidity.
- Potential effects of SEC, state, FINRA, and other regulatory changes on product offerings, pricing, compliance costs, and advisor practices.