LPL Financial Holdings Inc. quarterly report, Q3 FY2015

LPL Financial Holdings Inc. — Q3 2015 Form 10-Q Summary

Business context and reporting period

LPL Financial provides brokerage, investment advisory, custody, clearing, trust, technology, and related services to independent financial advisors and financial institutions in the United States. The unaudited report covers the three and nine months ended September 30, 2015, compared with the corresponding 2014 periods.

More than 14,000 advisors as of September 30, 2015, up 1.2% year over year.
Advisory and brokerage assets served were $461.8 billion, down 0.6% year over year, while advisory assets under custody increased 6.0% to $179.7 billion.
Net new advisory assets were $4.2 billion in the quarter and $13.7 billion year to date.

Financial performance and key metrics

Metric	Q3 2015	Q3 2014	9M 2015	9M 2014
Total net revenue	$1,054.7 million	$1,089.2 million	$3,254.7 million	$3,269.4 million
Net income	$41.1 million	$33.3 million	$142.0 million	$129.5 million
Diluted EPS	$0.43	$0.33	$1.46	$1.26
Gross profit	$339.8 million	$331.1 million	$1,035.3 million	$990.6 million
Adjusted EBITDA	$118.4 million	$108.9 million	$388.8 million	$378.6 million
Operating cash flow	Not separately provided	Not separately provided	$230.4 million	$224.3 million

Q3 revenue declined 3.2%, while nine-month revenue declined 0.4%.
Q3 net income increased 23.4%; nine-month net income increased 9.6%. Diluted EPS benefited from lower share counts following repurchases.
Gross profit margin was 32.2% in Q3 and 31.8% for the nine-month period, compared with 30.4% and 30.3%, respectively, in 2014.
Adjusted EBITDA margin was 11.2% in Q3 and 11.9% year to date, compared with 10.0% and 11.6% in the comparable periods.
Recurring revenue represented 72.4% of Q3 net revenue and 71.1% of nine-month net revenue, versus 70.2% and 68.1% in 2014.
Commission revenue declined 7.7% in Q3 and 4.8% year to date, primarily due to lower sales-based activity in alternative investments, variable annuities, mutual funds, and fixed annuities.
Advisory revenue increased 0.2% in Q3 and 3.0% year to date; asset-based revenue increased 2.2% and 4.3%, respectively; transaction and fee revenue increased 11.5% and 10.4%.

Cash flow, liquidity, debt, and capital management

Cash and cash equivalents were $410.0 million at September 30, 2015, compared with $412.3 million at December 31, 2014.
Year-to-date operating cash flow was $230.4 million. Investing activities used $75.2 million, primarily for capital expenditures and restricted cash deposits; financing activities used $157.6 million.
Capital expenditures were $51.6 million year to date, compared with $69.8 million in 2014.
Senior secured credit facilities totaled $1.666 billion, including $150.0 million drawn on the revolving facility. The company also recorded a $43.2 million leasehold financing obligation related to its Fort Mill, South Carolina build-to-suit project.
All outstanding credit-facility debt was subject to floating interest rates. Management estimated that a 100-basis-point increase would increase annual interest expense by approximately $13.9 million.
The company was in compliance with debt covenants. The actual leverage ratio was 2.70 versus a maximum of 4.00, and interest coverage was 10.50 versus a minimum of 3.00.
The company repurchased 3.325 million shares for $140.8 million during the first nine months and paid $72.1 million of dividends. On October 25, 2015, the Board declared a $0.25 per-share dividend.
On October 29, 2015, the company announced an increase in its share-repurchase authorization to $500 million and intended to amend its credit agreement to increase borrowing capacity by up to $700 million and potentially extend certain maturities.
LPL Financial, the broker-dealer subsidiary, had $153.1 million of net capital against a $6.5 million minimum requirement at September 30, 2015. Regulatory capital requirements were satisfied.

Material changes versus the prior comparable period

Profitability improved despite lower revenue, reflecting lower production expenses, lower restructuring charges, and reduced regulatory-related charges.
Regulatory-related charges decreased by $14.4 million in Q3 and $5.4 million year to date versus 2014, as the company reached agreements resolving several significant regulatory matters.
The total production payout ratio decreased to 85.40% in Q3 from 86.67% and to 85.76% year to date from 86.68%.
Cash sweep revenue declined because of repricing of certain underlying contracts, falling 4.8% in Q3 and 7.8% year to date.
Restructuring charges declined 69.1% in Q3 and 56.6% year to date. The Service Value Commitment program had incurred $65.0 million cumulatively and was expected to reach approximately $68.0 million of total costs by completion in 2015.
Advisory assets under custody grew, but market declines reduced total advisory and brokerage assets. Hybrid RIA assets increased 30.6% to $60.6 billion and represented a growing portion of custody assets.

Outlook, commentary, risks, and unusual items

Management stated that operating cash flow, available borrowing capacity, and other funding sources were expected to be adequate for working capital, obligations, and anticipated capital expenditures for the foreseeable future.
No specific earnings or revenue guidance was provided in the filing.
Management expected continued benefits from the Service Value Commitment initiative, including technology, service, and operating-efficiency improvements, but execution and realization of savings remained uncertain.
Key sensitivities include equity-market levels, investor sentiment, advisory and brokerage asset values, net new advisory assets, short-term interest rates, cash-sweep pricing, product demand, competition, and advisor recruiting and retention.
Regulatory matters remain material. Accruals included estimated costs for probable and reasonably estimable matters; reasonably possible losses were estimated at up to $6 million above accrued liabilities, although additional exposure could be unpredictable or not yet estimable.
The company faces risks from regulatory enforcement, compliance and supervisory controls, client claims, margin lending, clearing obligations, cybersecurity and technology failures, third-party service providers, and potential changes such as the proposed Department of Labor fiduciary rule.
The company uses foreign-currency hedges for exposure related to an outsourcing agreement denominated in U.S. dollars but indexed to the Indian rupee. Remaining hedged notional exposure was approximately $15.3 million at September 30, 2015.
A $43.2 million Fort Mill build-to-suit project was recorded as fixed assets with an offsetting leasehold financing obligation; the company may bear construction cost-overrun risk.
Internal controls and disclosure controls were evaluated as effective, with no material changes to internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether the planned debt-capacity increase, refinancing, maturity extensions, and covenant amendments were completed on the announced terms.
The timing and ultimate cost of remaining regulatory matters, including potential restitution, fines, remediation, and securities repurchases.
Whether the Service Value Commitment program achieved its approximately $68 million total-cost estimate and delivered the projected savings.
The sustainability of advisory-asset growth and the effect of market volatility on assets under custody and recurring revenue.
The impact of cash-sweep repricing and any future interest-rate changes on asset-based revenue and interest expense.
Future share repurchases and dividends relative to leverage, liquidity, debt covenants, and regulatory-capital requirements.
The accounting and completion status of the Fort Mill build-to-suit project and related lease obligations.