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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to
Commission File Number: 001-34963
LPL Financial Holdings Inc.
(Exact name of registrant as specified in its charter)
Delaware
20-3717839
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
75 State Street, Boston, MA 02109
(Address of Principal Executive Offices) (Zip Code)
(617) 423-3644
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes     o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes     o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
 
 
Smaller reporting company o
 
 
 
Emerging growth company o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes     x No
The number of shares of Common Stock, par value $0.001 per share, outstanding as of April 27, 2018 was 89,136,179.




TABLE OF CONTENTS
Page
 
 

i


WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly, and current reports, proxy statements, and other information required by the Securities Exchange Act of 1934, as amended (“Exchange Act”), with the Securities and Exchange Commission (“SEC”). You may read and copy any document we file with the SEC at the SEC’s public reference room located at 100 F Street, N.E., Washington, D.C. 20549, U.S.A. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our SEC filings are also available to the public from the SEC’s internet site at http://www.sec.gov.
On our internet site, http://www.lpl.com, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our annual reports on Form 10-K, our proxy statements, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. Hard copies of all such filings are available free of charge by request via email (investor.relations@lpl.com), telephone (617) 897-4574, or mail (LPL Financial Investor Relations at 75 State Street, 22nd Floor, Boston, MA 02109). The information contained or incorporated on our website is not a part of this Quarterly Report on Form 10-Q.
When we use the terms “LPLFH”, “we”, “us”, “our”, and the “Company”, we mean LPL Financial Holdings Inc., a Delaware corporation, and its consolidated subsidiaries, taken as a whole, unless the context otherwise indicates.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Statements in Item 2 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of this Quarterly Report on Form 10-Q regarding the Company’s future financial and operating results, outlook, growth, plans, business strategies, liquidity, future indebtedness, future share repurchases, and future dividends, including statements regarding future resolution of regulatory matters, legal proceedings and related costs, future revenues and expenses, and projected savings and anticipated improvements to the Company’s operating model, services, and technologies as a result of its initiatives, programs and/or acquisitions, as well as any other statements that are not related to present facts or current conditions or that are not purely historical, constitute forward-looking statements. These forward-looking statements are based on the Company’s historical performance and its plans, estimates, and expectations as of May 4, 2018. The words “anticipates,” “believes,” “expects,” “may,” “plans,” “predicts,” “will,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Forward-looking statements are not guarantees that the future results, plans, intentions, or expectations expressed or implied by the Company will be achieved. Matters subject to forward-looking statements involve known and unknown risks and uncertainties, including economic, legislative, regulatory, competitive, and other factors, which may cause actual financial or operating results, levels of activity, or the timing of events, to be materially different than those expressed or implied by forward-looking statements. Important factors that could cause or contribute to such differences include: changes in general economic and financial market conditions, including retail investor sentiment; changes in interest rates and fees payable by banks participating in the Company’s cash sweep program, including the Company’s success in negotiating agreements with current or additional counterparties; the Company’s strategy in managing cash sweep program fees; fluctuations in the levels of brokerage and advisory assets, including net new assets, and the related impact on fee revenue; fluctuations in the number of retail investors served by the Company; effects of competition in the financial services industry; the success of the Company in attracting and retaining financial advisors and institutions, and their ability to market effectively financial products and services; changes in the growth and profitability of the Company’s fee-based business; the effect of current, pending, and future legislation, regulation, and regulatory actions, including with respect to retail savings and disciplinary actions imposed by federal and state regulators and self-regulatory organizations; the costs of settling and remediating issues related to past, pending or future regulatory matters or legal proceedings; changes made to the Company’s offerings and services in response to current, pending, and future legislation, regulation, and regulatory actions, and the effect that such changes may have on the Company’s gross profit streams and costs; execution of the Company’s capital management plans, including its compliance with the terms of its credit agreement and the indenture governing its senior notes; the price, the availability of shares, and trading volumes of the Company’s common stock, which will affect the timing and size of future share repurchases by the Company; execution of the Company’s plans and its success in realizing the synergies, expense savings and service improvements and efficiencies expected to result from its initiatives and programs, including its acquisition of the broker-dealer network of National Planning Holdings, Inc. ("NPH") and its expense plans and technological initiatives; the performance of third-party service providers to which business processes are transitioned; the Company’s ability to control operating risks, information technology systems risks, cybersecurity risks, and sourcing risks; and the other factors set forth in Part I, “Item 1A. Risk Factors” in the Company’s 2017 Annual Report on

ii


Form 10-K, as amended by Amendment No. 1 on Form 10-K/A filed on February 27, 2018 (collectively, the "2017 Annual Report on Form 10-K"), as may be amended or updated in the Company’s Quarterly Reports on Form 10-Q. Except as required by law, the Company specifically disclaims any obligation to update any forward-looking statements as a result of developments occurring after the date of this quarterly report, even if its estimates change, and you should not rely on statements contained herein as representing the Company’s views as of any date subsequent to the date of this quarterly report.

ii


PART I — FINANCIAL INFORMATION
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business Overview
We are a leader in the retail financial advice market and the nation's largest independent broker-dealer. We enable independence for financial advisors by providing the capabilities, technology, and service they need, so they can focus on serving their clients. Our services include advisory and brokerage platforms, portfolio construction, integrated technology and services, comprehensive clearing and compliance services, practice management programs and training, and independent research. We provide our brokerage and investment advisory services to more than 16,000 independent financial advisors, including financial advisors at approximately 800 financial institutions across the country, enabling them to provide their retail investors with objective financial advice through a lower conflict model. Through our advisors, we are one of the largest distributors of financial products and services in the United States.
We believe that objective financial guidance is a fundamental need for everyone. We enable our advisors to focus on what they do best—create the personal, long-term relationships that are the foundation for turning life’s aspirations into financial realities. We do that through a singular focus on providing our advisors with the front-, middle-, and back-office support they need to serve the large and growing market for independent investment advice. We believe that we are the only company that offers advisors the unique combination of an integrated technology platform, comprehensive self-clearing services, and open architecture access to a wide range of non-proprietary products, all delivered in an environment unencumbered by conflicts from product manufacturing, underwriting, and market-making.
We believe investors achieve better outcomes when working with a financial advisor. We strive to make it easy for advisors to do what is best for their clients, while protecting advisors and investors and promoting independence and choice through access to a wide range of diligently evaluated non-proprietary products.
Executive Summary
Financial Highlights
Net income for the first quarter of 2018 was $93.5 million or $1.01 per share, which compares to $48.2 million, or $0.52 per share, in the first quarter of 2017. Increased cash sweep revenue and advisory fee revenue contributed to the earnings per share growth.
Asset Growth Trends
Total brokerage and advisory assets served were $647.5 billion as of March 31, 2018, up 22.1% from $530.3 billion as of March 31, 2017. Total net new assets were $38.9 billion for the three months ended March 31, 2018, compared to $2.6 billion for the same period in 2017.
Net new advisory assets were $13.1 billion for the three months ended March 31, 2018, compared to $6.0 billion in the same period in 2017. As of March 31, 2018, our advisory assets had grown to $283.5 billion from the prior year balance of $225.7 billion and represented 43.8% of total brokerage and advisory assets served.
Net new brokerage assets were $25.8 billion for the three months ended March 31, 2018, compared to an outflow of $3.4 billion for the same period in 2017. The increase in net new brokerage asset inflows primarily reflected the impact from the second wave of advisors ("Wave 2") onboarded in connection with our acquisition of the broker-dealer network of National Planning Holdings, Inc. (“NPH”) and its four broker-dealer subsidiaries (the “NPH Acquisition”). As of March 31, 2018, our brokerage assets had grown to $364.1 billion from $304.6 billion as of March 31, 2017.
Gross Profit Trends
Gross profit, a non-GAAP financial measure, was $464.0 million for the three months ended March 31, 2018, an increase of 23.3% in comparison to $376.2 million for the quarter ended March 31, 2017. Management presents gross profit, which is calculated as net revenues less commission and advisory expenses and brokerage, clearing, and exchange fees, because we believe that measure may be useful to investors in evaluating the Company’s core operating performance before indirect costs that are general and administrative in nature. See footnote 8 to the Financial Metrics table within the “How We Evaluate Our Business” section for additional information on gross profit. The increase in period-over-period gross profit was primarily due to increases in cash sweep revenue from the impact of the increases in the target range for the federal funds effective rate in 2017 and March 2018, increases in

1


advisory revenues resulting from net new assets and market gains as represented by higher levels of the S&P 500 index.
NPH Update
On August 15, 2017, we entered into an asset purchase agreement (the “Asset Purchase Agreement”) with NPH, and its four broker-dealer subsidiaries (collectively with NPH, the “NPH Sellers”) to acquire certain assets and rights of the NPH Sellers, including business relationships with financial advisors who become affiliated with our broker-dealer subsidiary LPL Financial LLC (“LPL Financial”). We paid $325 million to the NPH Sellers at closing and agreed to a potential contingent payment of up to $122.8 million. The conversion period under the Asset Purchase Agreement concluded in the first quarter of 2018, and no resulting contingent payment was due to the NPH Sellers. For the three months ended March 31, 2018, we onboarded $36.0 billion in brokerage and advisory assets from NPH.
Capital Management Activity
We returned $83.4 million of capital to shareholders during the three months ended March 31, 2018, including $22.6 million of dividends and $60.8 million of share repurchases, representing 967,500 shares.
Our Sources of Revenue
Our revenues are derived primarily from fees and commissions from products and advisory services offered by our advisors to their clients, a substantial portion of which we pay out to our advisors, as well as fees we receive from our advisors for the use of our technology, custody, clearing, trust, and reporting platforms. We also generate asset-based revenues through our cash sweep program and the access we provide to a variety of product providers with the following product lines:
• Alternative Investments
 
• Retirement Plan Products
• Annuities
 
• Separately Managed Accounts
• Exchange Traded Products
 
• Structured Products
• Insurance Based Products
 
• Unit Investment Trusts
• Mutual Funds
 
 
Under our self-clearing platform, we custody the majority of client assets invested in these financial products, for which we provide statements, transaction processing, and ongoing account management. In return for these services, mutual funds, insurance companies, banks, and other financial product manufacturers pay us fees based on asset levels or number of accounts managed. We also earn interest from margin loans made to our advisors’ clients.
We regularly review various aspects of our operations and service offerings, including our policies, procedures, and platforms, in response to marketplace developments. We currently expect to implement changes to aspects of our operations and service offerings in order to position our advisors for long-term growth and to align with competitive and regulatory developments. For example, we regularly review the structure and fees of our advisory programs, including related disclosures, in the context of the changing regulatory environment for retirement accounts.


2


How We Evaluate Our Business
We focus on several key operating and financial metrics in evaluating the success of our business relationships and our resulting financial position and operating performance. Our key operating and financial metrics are as follows:
 
Three Months Ended March 31,
 
 
Operating Metrics (balances may not foot due to rounding)
2018
 
2017
 
% Change
Advisory assets (in billions)(1)(2)
$
283.5

 
$
225.7

 
26
%
Brokerage assets (in billions)(1)(3)
364.1

 
304.6

 
20
%
Total Brokerage and Advisory Assets served(in billions)(1)
$
647.5

 
$
530.3

 
22
%
 
 
 
 
 
 
Net new advisory assets (in billions)(4)
$
13.1

 
$
6.0

 
n/m

Net new brokerage assets (in billions)(5)
25.8

 
(3.4
)
 
n/m

Total Brokerage and Advisory Net New Assets (in billions)
$
38.9

 
$
2.6

 
n/m

 
 
 
 
 
 
Insured cash account balances (in billions)(1)
$
22.6

 
$
22.0

 
3
%
Deposit cash account balances (in billions)(1)
4.2

 
4.2

 
%
Money market account balances (in billions)(1)
2.9

 
3.8

 
(24
)%
Total Cash Sweep Balances
$
29.6


$
30.0

 
(1
)%
 
 
 
 
 
 
Advisors
16,067

 
14,354

 
12
%
 
Three Months Ended March 31,
Financial Metrics
2018
 
2017
Total net revenues (in millions)
$
1,241.6

 
$
1,035.4

Recurring gross profit rate (trailing twelve months)(6)
83.9
%
 
80.9
%
Pre-tax income (in millions)
$
119.9

 
$
75.3

Net income (in millions)
$
93.5

 
$
48.2

Earnings per share, diluted
$
1.01

 
$
0.52

 
 
 
 
Non-GAAP Financial Measures(7)
 
 
 
Gross profit (in millions)(8)
$
464.0

 
$
376.2

Gross profit growth from prior period(8)
23.3
%
 
5.8
%
Gross profit as a % of net revenue(8)
37.4
%
 
36.3
%
_______________________________
(1)
Brokerage and advisory assets are comprised of assets that are custodied, networked, and non-networked and reflect market movement in addition to new assets, inclusive of new business development and net of attrition. Insured cash account balances, money market account balances, and deposit cash account balances are also included in brokerage and advisory assets served. Our brokerage and advisory assets does not include retirement plan assets, which are custodied with various third-party providers and supported by advisors licensed with LPL Financial. The Company estimated such assets at $140 billion, representing approximately 44,000 retirement plans, at March 31, 2018.
(2)
Advisory assets consists of total advisory assets under custody at LPL Financial, consisting of total assets on LPL Financial's corporate advisory platform serviced by investment advisor representatives of LPL Financial and total assets on LPL Financial's independent advisory platform serviced by investment advisor representatives of separate investment advisor firms (“Hybrid RIAs”) rather than that of LPL Financial. See “Results of Operations” for a tabular presentation of advisory assets.
(3)
Brokerage assets consist of assets serviced by advisors licensed with LPL Financial.
(4)
Net new advisory assets consists of total client deposits into custodied advisory accounts less total client withdrawals from custodied advisory accounts. We consider conversions from and to brokerage accounts as deposits and withdrawals, respectively.

3


(5)
Net new brokerage assets consist of total client deposits into brokerage accounts less total client withdrawals from brokerage accounts. We consider conversions from and to advisory accounts as deposits and withdrawals, respectively.
(6)
Recurring gross profit rate refers to the percentage of our gross profit, a non-GAAP financial measure, that was recurring for the period presented. We track recurring gross profit, a characterization of gross profit and a statistical measure, which is defined to include our revenues from asset-based fees, advisory fees, trailing commissions, cash sweep programs, and certain other fees that are based upon the number of client accounts and advisors, less the expenses associated with such revenues and certain other recurring expenses not specifically associated with a revenue line. We allocate such other recurring expenses, such as non-GDC sensitive production expenses, on a pro-rata basis against specific revenue lines at our discretion.  Because certain sources of recurring gross profit are associated with asset balances, they will fluctuate depending on the market values and current interest rates. Accordingly, our recurring gross profit can be negatively impacted by adverse external market conditions. However, we believe that recurring gross profit is meaningful despite these fluctuations because it is not dependent upon transaction volumes or other activity-based revenues, which are more difficult to predict, particularly in declining or volatile markets.
(7)
We believe that presenting certain non-GAAP financial measures by excluding or including certain items can be helpful to investors and analysts who may wish to use some or all of this information to analyze our current performance, prospects, and valuation. We use this non-GAAP information internally to evaluate operating performance and in formulating the budget for future periods. We believe that the non-GAAP financial measures and metrics presented above and discussed below are appropriate for evaluating the performance of the Company.
(8)
Set forth below is a calculation of gross profit (in millions), calculated as net revenues less commission and advisory expenses and brokerage, clearing, and exchange fees. All other expense categories, including depreciation and amortization of fixed assets and amortization of intangible assets, are considered general and administrative in nature. Because our gross profit amounts do not include any depreciation and amortization expense, we consider our gross profit amounts to be non-GAAP financial measures that may not be comparable to those of others in our industry. We believe that gross profit amounts can be useful to investors because they show our core operating performance before indirect costs that are general and administrative in nature.
 
Three Months Ended March 31,
Gross Profit (in millions)
2018
 
2017
Total net revenues
$
1,241.6

 
$
1,035.4

Commission and advisory expense
761.7

 
645.0

Brokerage, clearing, and exchange fees
15.9

 
14.2

Gross profit
$
464.0


$
376.2

Legal & Regulatory Matters
As a regulated entity, we are subject to regulatory oversight and inquiries related to, among other items, our compliance and supervisory systems and procedures and other controls, as well as our disclosures, supervision and reporting. The environment of additional regulation, increased regulatory compliance obligations, and enhanced regulatory enforcement has resulted, and may result in the future, in additional operational and compliance costs, as well as increased costs in the form of penalties and fines, investigatory and settlement costs, customer restitution, and remediation related to regulatory matters. In the ordinary course of business, we periodically identify or become aware of purported inadequacies, deficiencies, and other issues. It is our policy to evaluate these matters for potential securities law or regulatory violations, and other potential compliance issues. It is also our policy to self-report known violations and issues as required by applicable law and regulation. When deemed probable that matters may result in financial losses, we accrue for those losses based on an estimate of possible fines, customer restitution, and losses related to the repurchase of sold securities and other losses, as applicable. Certain regulatory and other legal claims and losses may be covered through our wholly-owned captive insurance subsidiary, which is chartered with the insurance commissioner in the state of Tennessee. Assessing the probability of a loss occurring and the timing and amount of any loss related to a regulatory matter or a legal proceeding is inherently difficult and requires judgments based on a variety of factors and assumptions. There are particular uncertainties and complexities involved when assessing the potential liabilities that are self-insured by our captive insurance subsidiary.

4


Our accruals, including those established through the captive insurance subsidiary at March 31, 2018, include estimated costs for significant regulatory matters, generally relating to the adequacy of our compliance and supervisory systems and procedures and other controls, for which we believe losses are both probable and reasonably estimable. For example, on May 1, 2018, we agreed to a settlement structure with the North American Securities Administrators Association (“NASAA”) related to our historical compliance with certain state “blue sky” laws. NASAA represented a coalition of 52 U.S. states and territories, each of which is subsequently expected to enter a separate administrative order against LPL Financial that tracks the terms of the settlement structure. As part of the settlement structure, we agreed to pay a fine in the amount of $499,000 per jurisdiction and engage independent third party consultants to conduct a historical review of certain equity and fixed income securities transactions, as well as an operational review of our systems for complying with blue sky securities registration requirements. We also agreed to offer remediation to customers who purchased certain equity and fixed-income securities since October 2006. We expect to incur costs related to this matter over the next few years, and we expect the majority of these costs to be covered by our captive insurance subsidiary.
The outcome of regulatory matters could result in legal liability, regulatory fines, or monetary penalties in excess of our accruals and insurance, which could have a material adverse effect on our business, results of operations, cash flows, or financial condition. For more information on management’s loss contingency policies, see Note 9. Commitments and Contingencies, within the notes to the unaudited condensed consolidated financial statements.
In June 2017, the U.S. Department of Labor’s (“DOL”) final rule on conflicts of interest (Definition of the Term "Fiduciary"), Conflicts of Interest Rule-Retirement Investment Advice (“DOL Rule”) and related exemptions became applicable. The DOL Rule broadens the circumstances in which we and our advisors may be considered a “fiduciary” with respect to certain accounts that are subject to the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and the prohibited transaction rules under section 4975 of the Internal Revenue Code. These types of accounts include many employer-sponsored retirement plans and individual retirement accounts (“IRAs”). The DOL also finalized certain prohibited transaction exemptions that allow investment advisors to receive compensation for providing investment advice under arrangements that would otherwise be prohibited due to conflicts of interest. Although the full implementation date for conditions under related exemptions was delayed until July 1, 2019 as the DOL undertook a study and reconsideration of the rule and its impacts, the U.S. Court of Appeals for the Fifth Circuit vacated the DOL Rule and related exemptions in March 2018, with an effective date of on or around May 8, 2018. The DOL or a third party could continue to defend the rule in court. The DOL also could seek to redraft a new rule proposal to address the court’s findings. In April 2018, the SEC introduced a proposal for a best interest standard for brokerage accounts (the “SEC Rule”). Notwithstanding the status of the DOL Rule and the proposed SEC Rule, it is unclear how and whether other regulators, including FINRA, banking regulators, and the state securities and insurance regulators may respond to, or enforce elements of, the DOL Rule, the proposed SEC Rule or develop their own similar laws and regulations. Because ERISA plans and IRAs comprise a significant portion of our business, we continue to expect that compliance with current and future laws and regulations with respect to retail retirement savings and reliance on prohibited transaction exemptions under such laws and regulations will require increased legal, compliance, information technology, and other costs and could lead to a greater risk of class action lawsuits and other litigation. Moreover, uncertainty regarding the status of the DOL Rule, as well as pending and future laws and regulations, including the SEC Rule, relating to retail retirement savings, impact the degree and timing of the effect of such laws and regulations on our business in ways which cannot now be anticipated or planned for, which may have further impact on our products and services, and results of operations.
Acquisitions, Integrations, and Divestitures
From time to time we undertake acquisitions or divestitures based on opportunities in the competitive landscape. These activities are part of our overall growth strategy, but can distort comparability when reviewing revenue and expense trends for periods presented.
On August 15, 2017, we entered into the Asset Purchase Agreement with the NPH Sellers to acquire certain assets and rights of the NPH Sellers, including the Sellers' business relationships with financial advisors who become affiliated with LPL Financial. We paid $325 million to the NPH Sellers at closing, which occurred on August 15, 2017, and agreed to a potential contingent payment of up to $122.8 million. The conversion period under the Asset Purchase Agreement concluded in the first quarter of 2018, and no resulting contingent payment was due to the NPH Sellers. We expect to continue to incur increased costs related to this transaction, including: compensation and benefits expense related to the additional staffing, as well as contingent labor costs, needed to support the onboarding of the NPH advisors and their clients to our systems, as well as to provide ongoing support to the increased number of advisors, clients and total assets served on our platform; fees for account closure and transfers that we agreed to pay on behalf of NPH financial advisors under the Asset Purchase Agreement;

5


onboarding financial assistance costs for advisors joining LPL Financial; and technology capacity investments to support the increase in demands on our systems. We expect the incurrence of these costs to be largely complete by mid-2018. We also anticipate an increase to amortization related to the purchased intangibles under the Asset Purchase Agreement. See Note 4 Acquisitions, within the notes to the unaudited condensed consolidated financial statements for further detail. There have been no other material acquisitions, integrations, or divestitures during the three months ended March 31, 2018 or March 31, 2017.

6


Economic Overview and Impact of Financial Market Events
Our business is directly and indirectly sensitive to several macroeconomic factors and the state of the United States financial markets. In the United States, economic data continued to point to fairly steady economic growth over the first and second quarter of 2018. According to the most recent estimate by the Bureau of Economic Analysis, real gross domestic product (“GDP”) had an overall growth rate in 2017 of 2.6%, with the advance estimate of 2.3% GDP growth in the first quarter of 2018 suggesting continued growth at a similar rate, given seasonal and temporary factors weighing on first quarter data. Growth has been supported by a largely healthy labor market, generally steady consumer spending, signs of improved business investment, and continued low interest rates. Stronger global growth has also provided support, with global GDP growth picking up from 2.4% in 2016 to an estimated 3.0% in 2017, with further acceleration expected in 2018. U.S. business and consumer confidence have remained elevated, with only modest declines since the run-up following the U.S. elections in November 2016. Despite economic stability and a healthy labor market, core inflation has remained below the Federal Reserve’s (“Fed”) 2% target.
Economic expectations for 2018 shifted following the passage of the Tax Cut and Jobs Act ("Tax Act"), signed into law by President Trump on December 22, 2017. A report by Congress’ Joint Committee on Taxation estimated the new law would add an average of 0.7% growth to annual GDP compared to the current law baseline over the next 10 years while adding approximately $1.1 trillion to the deficit. In the Fed’s most recent projections, the median forecast of 2018 GDP growth was 2.7%, up from 2.5% in the December projections, while the non-partisan Congressional Budget Office’s most recent projection for 2018 growth, released in early April, was 3.3%. While a prospective rise in U.S. economic growth approaching 3% or more may seem modest by historical standards, such a rise would still be above the Congressional Budget Office’s estimate of potential GDP growth and could be enough to further tighten the labor market, push wages higher, and increase the probability of the Fed following through on its median projection of three rate hikes in total in 2018.

Stock market volatility rose meaningfully in the first quarter of 2018 compared to 2017, with the S&P 500 experiencing its first correction of more than 10% since early 2016. Catalysts for market declines changed over the quarter, but included concerns that inflationary pressure would lead to a more aggressive Fed, negative headlines for technology companies, and rising trade tensions. Market strength in January offset most of the decline over the rest of the quarter, with the S&P 500 index falling 0.8% over the entire quarter, including dividends. The 10-year Treasury yield rose sharply over the first half of the quarter as both growth and inflation expectations rose, but moderated somewhat over the second half as market volatility drove some market participants to the relative safety of Treasury securities. Rising rates pushed bond prices lower, the broad Bloomberg Barclays Aggregate Bond Index falling 1.5% over the quarter.
Our business is also sensitive to current and expected short-term interest rates, which are largely driven by Fed policy. Please consult the Risks Related to Our Business and Industry section within Part I, “Item 1A. Risk Factors” in our 2017 Annual Report on Form 10-K for more information about the risks associated with significant interest rate changes, and the potential related effects on our profitability and financial condition. Following the conclusion of its March 20 - 21, 2018 policy meeting, the Fed’s policy arm, the Federal Open Market Committee (“FOMC”) raised the target range of the federal funds rate to 1.50 - 1.75%, its first hike of the year and the sixth of the expansion. Projection materials that accompanied the statement indicated a median expectation of two additional rate hikes in 2018, the same number of 2018 hikes as was projected in December 2017. Growth expectations for 2018 rose, but core inflation expectations held steady. The FOMC statement indicated that the current policy of gradual rate increases was expected to continue but would remain data dependent.


7


Results of Operations
The following discussion presents an analysis of our results of operations for the three months ended March 31, 2018 and 2017. Where appropriate, we have identified specific events and changes that affect comparability or trends, and where possible and practical, have quantified the impact of such items.
 
Three Months Ended March 31,
 
 
(In thousands)
2018
 
2017
 
% Change
REVENUES
 
Commission
$
474,811

 
$
421,164

 
12.7
 %
Advisory
422,387

 
329,859

 
28.1
 %
Asset-based
219,336

 
157,223

 
39.5
 %
Transaction and fee
116,649

 
108,162

 
7.8
 %
Interest income, net of interest expense
7,781

 
5,793

 
34.3
 %
Other
593

 
13,226

 
(95.5
)%
Total net revenues    
1,241,557

 
1,035,427

 
19.9
 %
EXPENSES
 
 
 
 

Commission and advisory
761,697

 
645,063

 
18.1
 %
Compensation and benefits
123,517

 
113,212

 
9.1
 %
Promotional
67,427

 
36,654

 
84.0
 %
Depreciation and amortization
20,701

 
20,747

 
(0.2
)%
Amortization of intangible assets
13,222

 
9,491

 
39.3
 %
Occupancy and equipment
27,636

 
25,199

 
9.7
 %
Professional services
22,172

 
15,537

 
42.7
 %
Brokerage, clearing, and exchange
15,877

 
14,186

 
11.9
 %
Communications and data processing
11,174

 
11,014

 
1.5
 %
Other
28,586

 
22,563

 
26.7
 %
Total operating expenses    
1,092,009

 
913,666

 
19.5
 %
Non-operating interest expense
29,622

 
25,351

 
16.8
 %
Loss on extinguishment of debt

 
21,139

 
(100.0
)%
INCOME BEFORE PROVISION FOR INCOME TAXES
119,926

 
75,271

 
59.3
 %
PROVISION FOR INCOME TAXES
26,396

 
27,082

 
(2.5
)%
NET INCOME
$
93,530

 
$
48,189

 
94.1
 %
 

8


Revenues
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers: Topic 606, to supersede nearly all existing revenue recognition guidance under accounting principles generally accepted in the United States ("GAAP"). We adopted the provisions of this guidance on January 1, 2018 using the modified retrospective approach. The adoption did not have a material impact on the timing or amounts of our revenue recognition but impacted the disclosures within the notes to the consolidated financial statements.
Commission Revenues
We generate two types of commission revenues: sales-based commissions and trailing commissions. Sales-based commission revenues, which occur when clients trade securities or purchase various types of investment products, primarily represent gross commissions generated by our advisors. The levels of sales-based commission revenues can vary from period to period based on the overall economic environment, number of trading days in the reporting period, and investment activity of our advisors’ clients. Trailing commission revenues (commissions that are paid over time, such as 12(b)-1 fees) are recurring in nature and are earned based on the market value of investment holdings in trail eligible assets. We earn trailing commission revenues primarily on mutual funds and variable annuities held by clients of our advisors. See Note 3. Revenue, within the notes to the unaudited condensed consolidated financial statements for further detail regarding our commission revenue by product category.
The following table sets forth our commission revenue, by sales-based and trailing commission revenue (dollars in thousands):
 
Three Months Ended March 31,
 
 
 
2018
 
2017
 
$ Change
 
% Change

Sales-based
$
187,233

 
$
186,577

 
$
656

 
0.4
%
Trailing
287,578

 
234,587

 
52,991

 
22.6
%
Total commission revenue
$
474,811

 
$
421,164

 
$
53,647

 
12.7
%
Sales-based commission revenue remained relatively flat for the three months ended March 31, 2018, compared with the same period in 2017.
The increase in trailing revenues for the three months ended March 31, 2018, compared with the same period in 2017 was due to additional assets onboarded from NPH advisors, improved investor engagement, and strong market conditions resulting in an increase in the market value of the underlying assets.
The following table summarizes activity in brokerage assets for the periods presented (in billions):
 
Three Months Ended March 31,
 
2018
 
2017
Balance - Beginning of period
$
342.1

 
$
297.8

Net new brokerage assets
25.8

 
(3.4
)
Market impact(1)
(3.8
)
 
10.2

Balance - End of period
$
364.1

 
$
304.6

_______________________________
(1)
Market impact is the difference between the beginning and ending asset balance less the net new asset amounts, with the remainder representing the implied growth or decline in asset balances due to market changes over the same period of time.
Advisory Revenues
Advisory revenues primarily represent fees charged on our corporate RIA platform provided through LPL Financial to clients of our advisors based on the value of their advisory assets. Advisory fees are billed to clients on either a calendar quarter or non-calendar quarter basis of their choice, at the beginning of that period, and are recognized as revenue ratably during the quarter. The majority of our accounts are billed in advance using values as of the last business day of each immediately preceding calendar quarter. The value of the assets in an advisory account on the billing date determines the amount billed, and accordingly, the revenues earned in the following three month period. Advisory revenues collected on our corporate RIA platform are proposed by the advisor and

9


agreed to by the client and average 1.1% of the underlying assets, and the maximum fees charged for these accounts as of March 31, 2018 was 3.0%.
We also support Hybrid RIAs, through our Hybrid RIA platform, which allows advisors to engage us for technology, clearing, and custody services, as well as access to the capabilities of our investment platforms. The assets held under a Hybrid RIA's investment advisory accounts custodied with LPL Financial are included in our brokerage and advisory assets, net new advisory assets, and advisory assets under custody metrics. However, we charge separate fees to Hybrid RIAs for technology, clearing, administrative, oversight, and custody services. The administrative fees collected on our Hybrid RIA platform vary and can reach a maximum of 0.6% of the underlying assets as of March 31, 2018.
Furthermore, we support certain financial advisors at broker-dealers affiliated with insurance companies through our customized advisory platforms and charge fees to these advisors based on the value of assets within these advisory accounts.
The following table summarizes activity in advisory assets (in billions):
 
Three Months Ended March 31,
 
2018
 
2017
Balance - Beginning of period
$
273.0

 
$
211.6

Net new advisory assets
13.1

 
6.0

Market impact(1)
(2.6
)
 
8.1

Balance - End of period
$
283.5

 
$
225.7

_______________________________
(1)
Market impact is the difference between the beginning and ending asset balance less the net new asset amounts, with the remainder representing the implied growth or decline in asset balances due to market changes over the same period of time.
Net new advisory assets for the three months ended March 31, 2018 and 2017 had a limited impact on our advisory fee revenue for those respective periods. Rather, net new advisory assets are a primary driver of future advisory fee revenue. The revenue for any particular quarter is primarily driven by each of the prior quarter’s month-end advisory assets under management.
The growth in advisory revenue for the three months ended March 31, 2018 compared to the same period in 2017 was due to net new advisory assets resulting from our recruiting efforts, the NPH Acquisition, and strong advisor productivity, as well as market gains as represented by higher levels of the S&P 500 index and brokerage to advisory conversions by our existing advisors.
The following table summarizes the composition of total advisory assets as of March 31, 2018 and 2017 (in billions):
 
 
March 31,
 
 
 
 
 
 
2018
 
2017
 
$ Change

 
% Change

Corporate platform advisory assets
 
$
167.7

 
$
133.6

 
$
34.1

 
25.5
%
Hybrid platform advisory assets
 
115.7

 
92.1

 
23.6

 
25.6
%
Total advisory assets(1)
 
$
283.5

 
$
225.7

 
$
57.7

 
25.6
%
_______________________________
(1)
Balances may not foot due to rounding.

10


Asset-Based Revenues
Asset-based revenues are comprised of our sponsorship programs with financial product manufacturers, omnibus processing and networking services, collectively referred to as recordkeeping, and fees from our cash sweep program. We receive fees from certain financial product manufacturers in connection with sponsorship programs that support our marketing and sales education and training efforts. Omnibus processing revenues are paid to us by mutual fund product sponsors and are based on the value of custodied assets in advisory accounts and the number of brokerage accounts in which the related mutual fund positions are held. Networking revenues on brokerage assets are correlated to the number of positions we administer and are paid to us by mutual fund and annuity product manufacturers. Pursuant to contractual arrangements, uninvested cash balances in our advisors’ client accounts are swept into either insured cash accounts at various banks or third-party money market funds, for which we receive fees, including administrative and recordkeeping fees based on account type and the invested balances.
Asset-based revenues for the three months ended March 31, 2018 increased to $219.3 million, or 39.5%, from $157.2 million for the three months ended March 31, 2017. The increase is due primarily to increased revenues from our cash sweep program and our omnibus processing revenues.
Cash sweep revenue increased to $104.1 million for the three months ended March 31, 2018, from $59.7 million for the three months ended March 31, 2017, due to the impact of increases in the target range for the federal funds effective rate. As of March 31, 2018, our cash sweep balances decreased slightly compared to March 31, 2017, with average cash sweep balances of $29.3 billion and $29.9 billion during the three months ended March 31, 2018 and 2017, respectively.
Revenues for our recordkeeping and sponsorship programs, which are largely based on the market value of the underlying assets, increased due to the impact of market appreciation on the value of those underlying assets and additional assets onboarded from NPH advisors.
Transaction and Fee Revenues
Transaction revenues primarily include fees we charge to our advisors and their clients for executing certain transactions in brokerage and fee-based advisory accounts. Fee revenues primarily include IRA custodian fees, contract and licensing fees, and other client account fees. In addition, we host certain advisor conferences that serve as training, education, sales, and marketing events, for which we charge a fee for attendance.
Transaction and fee revenues increased for the three months ended March 31, 2018 compared to the same period in 2017 primarily due to higher transaction volumes in trades in advisory accounts that generate transaction-based revenue, which resulted from an increase in market volatility as well as the impact from the NPH Acquisition.
Interest Income, Net of Interest Expense
We earn interest income, net from client margin accounts and cash equivalents. Period-over-period variances are not material and correspond to changes in the average balances of assets in margin accounts and cash equivalents.
Other Revenues
Other revenues primarily include marketing allowances received from certain financial product manufacturers, primarily those who offer alternative investments, such as non-traded real estate investment trusts and business development companies, mark-to-market gains or losses on assets held by us for our advisor non-qualified deferred compensation plan and our model research portfolios, interest income from client margin accounts and cash equivalents, net of operating interest expense, and other miscellaneous revenues.
Other revenues decreased for the three months ended March 31, 2018, compared to the same period in 2017 primarily due to a decrease of $14.1 million in realized and unrealized losses on assets held in our advisor non-qualified deferred compensation plan, which are based on the market performance of the underlying investment allocations chosen by advisors in the plan.


11


Expenses
Commission and Advisory Expenses
Commission and advisory expenses are comprised of the following: base payout amounts that are earned by and paid out to advisors and institutions based on commission and advisory revenues earned on each client’s account (referred to as gross dealer concessions, or “GDC”); production bonuses earned by advisors and institutions based on the levels of commission and advisory revenues they produce; the recognition of share-based compensation expense from equity awards granted to advisors and financial institutions based on the fair value of the awards at each reporting period; and the deferred commissions and advisory fee expenses associated with mark-to-market gains or losses on the non-qualified deferred compensation plan offered to our advisors.
The following table shows the components of our production payout and total payout ratios, each of which is a statistical or operating measure:
 
Three Months Ended March 31,
 
Change
 
2018
 
2017
 
Base payout rate(1)
82.60
%
 
82.99
%
 
(39 bps)
Production based bonuses
2.05
%
 
1.72
%
 
33 bps
GDC sensitive payout
84.65
%
 
84.71
%
 
(6 bps)
Non-GDC sensitive payout(2)
0.25
%
 
1.18
%
 
(93 bps)
Total payout ratio
84.90
%
 
85.89
%
 
(99 bps)
_______________________________
(1)
Our production payout ratio is calculated as commission and advisory expenses, divided by GDC (see description above).
(2)
Non-GDC sensitive payout includes share-based compensation expense from equity awards granted to advisors and financial institutions and mark-to-market gains or losses on amounts designated by advisors as deferred.
Our total payout ratio, a statistical or operating measure, decreased for the three months ended March 31, 2018 compared with the same period in 2017 primarily due to a decrease in non-GDC sensitive payout, which includes advisor deferred compensation and advisor share-based compensation.
Compensation and Benefits Expense
Compensation and benefits expense includes salaries and wages and related benefits and taxes for our employees (including share-based compensation), as well as compensation for temporary employees and consultants.
 
Three Months Ended March 31,
 
 
 
2018
 
2017
 
Change
Average number of employees
3,823
 
3,316
 
15.3%
Compensation and benefits expense increased for the three months ended March 31, 2018 compared with the same period in 2017 due to an increase in salary expense resulting from an increase in headcount and an increase in contingent labor costs to support the NPH Acquisition.
Promotional Expense
Promotional expenses include costs related to our hosting of certain advisor conferences that serve as training, sales, and marketing events, as well as business development costs related to recruiting, such as transition assistance and amortization related to forgivable loans issued to advisors.
The increase in promotional expense for the three months ended March 31, 2018 compared with the same period in 2017 was primarily driven by increases in costs associated with advisor transition assistance and recruiter and advisor promotions related to the onboarding of NPH advisors.

12


Depreciation and Amortization Expense
Depreciation and amortization expense represents the benefits received for using long-lived assets. Those assets consist of fixed assets, which include internally developed software, hardware, leasehold improvements, and other equipment.
Depreciation and amortization expense for the three months ended March 31, 2018 compared with the same period in 2017, remained relatively flat, as increases in internally developed software were offset by decreases in purchased hardware and software for the period.
Amortization of Intangible assets
Amortization of intangible assets represents the benefits received for using long-lived assets, which consist of intangible assets established through our acquisitions.
The increase in amortization of intangible assets for the three months ended March 31, 2018 compared with the same period in 2017 was due to the intangible assets recorded as part of the NPH Acquisition.
Occupancy and Equipment Expense
Occupancy and equipment expense includes the costs of leasing and maintaining our office spaces, software licensing and maintenance costs, and maintenance expenses on computer hardware and other equipment.
The increase in occupancy and equipment expense for the three months ended March 31, 2018 compared with the same period in 2017 was primarily due to an increase in costs related to non-capitalized computer hardware and software as well as software licensing fees in support of our service and technology investments.
Professional Services
Professional services includes costs paid to outside firms for assistance with legal, accounting, technology, regulatory, marketing, and general corporate matters, as well as non-capitalized costs related to service and technology enhancements.
The increase in professional services for the three months ended March 31, 2018 compared with the same period in 2017 was primarily due to an increase in costs related to service and technology enhancement projects.
Brokerage, Clearing, and Exchange Fees
Brokerage, clearing, and exchange fees include expenses originating from trading and clearing operations as well as any exchange membership fees. Changes in brokerage, clearing and exchange fees fluctuate largely in line with the volume of sales and trading activity.
The increase in brokerage, clearing, and exchange fees is relatively consistent with the volume of sales and trading activity for the three months ended March 31, 2018, compared with the same period in 2017.
Communications and Data Processing
Communications expense consists primarily of the cost of voice and data telecommunication lines supporting our business, including connectivity to data centers, exchanges, and markets. Data processing expense consists primarily of customer statement processing and postage costs.
Communications and data processing expense remained relatively flat for the three months ended March 31, 2018, compared with the same period in 2017.
Other Expenses
Other expenses include the estimated costs of the investigation, settlement, and resolution of regulatory matters (including customer restitution and remediation), licensing fees, insurance, broker-dealer regulator fees, and other miscellaneous expenses. We expect other expenses to increase in 2018 compared to 2017, including as a result of the greater size and scale of our business resulting from the NPH Acquisition. There are particular uncertainties and complexities involved when assessing the potential costs and timing of regulatory matters, including the availability of self-insurance coverage through our captive insurance subsidiary. Our other expenses in 2018 will depend on the size and timing of resolving regulatory matters and the availability of self-insurance coverage, which depends in part on the amount and timing of resolving historical claims.

13


The increase in other expenses of $6.0 million for the three months ended March 31, 2018, compared with the same period in 2017, was primarily driven by higher costs associated with the investigation, settlement, and resolution of regulatory matters.
Non-Operating Interest Expense
Non-operating interest expense represents expense for our senior secured credit facilities and senior unsecured notes issued in March and September 2017 (the "Notes"). Period over period increases correspond to higher LIBOR rates and the issuance of the Notes.
Loss on Extinguishment of Debt
In March 2017, we closed a refinancing of our senior secured credit facilities with a new seven year Term Loan B facility. The refinancing led to the extinguishment of the previous Term Loan A and B facilities, which required that we accelerate the recognition of $21.1 million of related unamortized debt issuance costs as a loss on extinguishment of debt in our unaudited condensed consolidated statements of income in the first quarter of 2017.
Provision for Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (H.R. 1), the tax reform bill (the "Tax Act"), was signed into law. The Tax Act includes numerous changes in existing tax law, including a permanent reduction in our federal corporate income tax rate from 35% to 21%. The rate reduction took effect on January 1, 2018. We will continue to analyze the Tax Act to determine the full effects that the new law, including the new lower corporate tax rate, has on our financial statements.
We estimate our full-year effective income tax rate at the end of each reporting period. This estimate is used in providing for income taxes on a year-to-date basis and may change in subsequent interim periods. The tax rate in any quarter can be affected positively and negatively by adjustments that are required to be reported in the quarter in which resolution of a particular item occurs. The effective income tax rates reflect the impact of state taxes, settlement contingencies, tax credits, and other permanent differences in tax deductibility of certain expenses.
Our effective tax rate was 22.0% and 36.0% for the three months ended March 31, 2018 and 2017, respectively.
The decrease in our effective income tax rate for the three months ended March 31, 2018, compared with the same period in 2017, was primarily due to the tax benefit associated with the federal rate reduction under the Tax Act, stock option exercises under ASC 718, and the reduction of settlement contingencies.
Liquidity and Capital Resources
Senior management establishes our liquidity and capital policies. These policies include senior management’s review of short- and long-term cash flow forecasts, review of capital expenditures, and daily monitoring of liquidity for our subsidiaries. Decisions on the allocation of capital are based upon, among other things, projected profitability and cash flow, risks of the business, regulatory capital requirements, and future liquidity needs for strategic activities. Our Treasury Department assists in evaluating, monitoring, and controlling the business activities that impact our financial condition, liquidity, and capital structure and maintains relationships with various lenders. The objectives of these policies are to support our corporate business strategies while ensuring ongoing and sufficient liquidity.
A summary of changes in our cash flow is provided as follows (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017
Net cash flows (used in) provided by:
 
 
 
Operating activities
$
(22,331
)
 
$
7,227

Investing activities
(21,684
)
 
(28,961
)
Financing activities
(55,831
)
 
(16,291
)
Net decrease in cash, cash equivalents and restricted cash
(99,846
)
 
(38,025
)
Cash, cash equivalents and restricted cash — beginning of period
1,625,655

 
1,558,608

Cash, cash equivalents and restricted cash — end of period
$
1,525,809

 
$
1,520,583


14


Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing.
Net cash provided by/used in operating activities includes changes in operating assets and liabilities, including balances related to the settlement and funding of client transactions, receivables from product sponsors, and accrued commission and advisory expenses due to our advisors. Operating assets and liabilities that arise from the settlement and funding of transactions by our advisors’ clients are the principal cause of changes to our net cash from operating activities and can fluctuate significantly from day-to-day and period-to-period depending on overall trends and clients’ behaviors.
The increase in cash flows used in operating activities for the three months ended March 31, 2018 compared to the same period in 2017 was primarily attributable to an increase in clients and other receivables as a result of an increase in revenue and the timing of payments received, an increase in advisor loans and an increase in payments of drafts payable. These were partially offset by an increase in accounts payable and accrued liabilities, accrued commission, payables to clients and broker-dealers and clearing organizations due to the timing of payments made to our vendors, clients, and broker-dealers and clearing organizations.
The decrease in cash flows used in investing activities for the three months ended March 31, 2018 compared to the same period in 2017 was due to a decrease in capital expenditures.
The increase in cash flows used in financing activities for the three months ended March 31, 2018 compared to the same period in 2017 was primarily attributable to an increase in repurchases of our common stock, partially offset by a decrease in proceeds from stock option exercises.
We believe that based on current levels of operations and anticipated growth, cash flow from operations, together with other available sources of funds, which include three uncommitted lines of credit available and the revolving credit facility established through our senior secured credit agreement (the "Credit Agreement"), will be adequate to satisfy our working capital needs, the payment of all of our obligations, and the funding of anticipated capital expenditures for the foreseeable future. In addition, we have certain capital adequacy requirements due to our registered broker-dealer subsidiary and bank trust subsidiary and have met all such requirements and expect to continue to do so for the foreseeable future. We regularly evaluate our existing indebtedness, including refinancing thereof, based on a number of factors, including our capital requirements, future prospects, contractual restrictions, the availability of refinancing on attractive terms, and general market conditions.
Share Repurchases
We engage in share repurchase programs, which are approved by our board of directors (“Board of Directors”), pursuant to which we may repurchase our issued and outstanding shares of common stock from time to time. Purchases may be effected in open market or privately negotiated transactions, including transactions with our affiliates, with the timing of purchases and the amount of stock purchased generally determined at our discretion within the constraints of our Credit Agreement, the indenture governing our Notes, and general liquidity needs. See Note 10. Stockholders’ Equity, within the notes to unaudited condensed consolidated financial statements for additional information regarding our share repurchases.
During the three months ended March 31, 2018, we repurchased a total of 967,500 shares of our common stock at a weighted-average price of $62.84 per share for a total cost of $60.8 million. As of March 31, 2018, the Company was authorized to purchase up to an additional $439.2 million of shares pursuant to the share repurchase programs approved by the Board of Directors.
Dividends
The payment, timing, and amount of any dividends are subject to approval by the Board of Directors as well as certain limits under our Credit Agreement and the indenture governing our Notes. See Note 10. Stockholders’ Equity, within the notes to the unaudited condensed consolidated financial statements for additional information regarding our dividends.
Operating Capital Requirements
Our primary requirement for working capital relates to funds we loan to our advisors’ clients for trading conducted on margin and funds that we are required to maintain for regulatory capital and reserves based on the requirements of our regulators and clearing organizations, which also consider client balances and trading activities. We have several sources of funds that enable us to meet increases in working capital requirements that relate to increases in client margin activities and balances. These sources include cash and cash equivalents on hand, cash segregated under federal and other regulations, and proceeds from re-pledging or selling client securities in margin

15


accounts. When an advisor’s client purchases securities on margin or uses securities as collateral to borrow from us on margin, we are permitted, pursuant to the applicable securities industry regulations, to repledge, loan, or sell securities, up to 140% of the client’s margin loan balance, that collateralize those margin accounts. As of March 31, 2018, we had approximately $266.0 million of client margin loans, collateralized with securities having a fair value of approximately $372.3 million that we can re-pledge, loan, or sell. Of these securities, approximately $51.8 million were client-owned securities pledged to the Options Clearing Corporation as collateral to secure client obligations related to options positions. As of March 31, 2018, there were no restrictions that materially limited our ability to re-pledge, loan, or sell the remaining $320.5 million of client collateral.
Our other working capital needs are primarily related to advisor loans and timing associated with receivables and payables, which we have satisfied in the past from internally generated cash flows.
Notwithstanding the self-funding nature of our operations, we may sometimes be required to fund timing differences arising from the delayed receipt of client funds associated with the settlement of client transactions in securities markets. These timing differences are funded either with internally generated cash flow or, if needed, with funds drawn on our uncommitted lines of credit at our broker-dealer subsidiary LPL Financial, or under our revolving credit facility.
Our registered broker-dealer, LPL Financial, is subject to the SEC’s Uniform Net Capital Rule, which requires the maintenance of minimum net capital. LPL Financial computes net capital requirements under the alternative method, which requires firms to maintain minimum net capital, as defined, equal to the greater of $250,000 or 2.0% of aggregate debit balances arising from client transactions. At March 31, 2018, LPL Financial had net capital of $87.5 million with a minimum net capital requirement of $7.2 million.
LPL Financial’s ability to pay dividends greater than 10% of its excess net capital during any 35 day rolling period requires approval from the Financial Industry Regulatory Authority (“FINRA”). In addition, payment of dividends is restricted if LPL Financial’s net capital would be less than 5% of aggregate customer debit balances.
LPL Financial also acts as an introducing broker for commodities and futures. Accordingly, its trading activities are subject to the National Futures Association’s (“NFA”) financial requirements and it is required to maintain net capital that is in excess of or equal to the greatest of NFA’s minimum financial requirements. The NFA was designated by the Commodity Futures Trading Commission as LPL Financial’s primary regulator for such activities. Currently, the highest NFA requirement is the minimum net capital calculated and required pursuant to the SEC’s Net Capital Rule.
Our subsidiary, The Private Trust Company, N.A. (“PTC”), is also subject to various regulatory capital requirements. Failure to meet the respective minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have substantial monetary and non-monetary impacts on PTC’s operations.
Debt and Related Covenants
See Note 8. Debt, within the notes to the unaudited condensed consolidated financial statements for further detail regarding the Credit Agreement.
The Credit Agreement and the indenture governing the Notes contain a number of covenants that, among other things, restrict, subject to certain exceptions, our ability to:
incur additional indebtedness or issue disqualified stock or preferred stock;
declare dividends, or other distributions to shareholders;
repurchase equity interests;
redeem indebtedness that is subordinated in right of payment to certain debt instruments;
make investments or acquisitions;
create liens;
sell assets;
guarantee indebtedness;
engage in certain transactions with affiliates;
enter into agreements that restrict dividends or other payments from subsidiaries; and
consolidate, merge or transfer all or substantially all of our assets.

16


Credit Agreement EBITDA, a non-GAAP financial measure, is defined in, and calculated by management in accordance with, the Credit Agreement as “Consolidated EBITDA”, which is Consolidated Net Income (as defined in the Credit Agreement) plus interest expense, tax expense, depreciation and amortization, and adjusted to exclude certain non-cash charges and other adjustments (including unusual or non-recurring charges) and gains, and to include future expected cost savings, operating expense reductions or other synergies from certain transactions, including the NPH Acquisition. We present Credit Agreement EBITDA because we believe that it can be a useful financial metric in understanding our debt capacity and covenant compliance. However, Credit Agreement EBITDA is not a measure of our financial performance under GAAP and should not be considered as an alternative to net income or any other performance measure derived in accordance with GAAP, or as an alternative to cash flows from operating activities as a measure of profitability or liquidity. In addition, our Credit Agreement-defined EBITDA measure can differ significantly from adjusted EBITDA calculated by other companies, depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate, capital investments, and types of adjustments made by such companies.
Set forth below is a reconciliation from our net income to Credit Agreement EBITDA for the trailing twelve months ended March 31, 2018 (in thousands):
Net income
$
284,204

Non-operating interest expense
111,296

Provision for income taxes
125,021

Loss on extinguishment of debt
1,268

Depreciation and amortization
84,025

Amortization of intangible assets
42,024

EBITDA
647,838

Credit Agreement Adjustments:
 
Employee share-based compensation expense(1)
19,790

Advisor share-based compensation expense(2)
9,358

NPH run-rate EBITDA accretion(3)
90,000

Realized NPH EBITDA Offset(4)
(4,500
)
NPH onboarding costs
67,516

Other(5)
20,769

Credit Agreement EBITDA(6)
$
850,771

_______________________________
(1)
Represents share-based compensation for equity awards granted to employees, officers, and directors. Such awards are measured based on the grant-date fair value and recognized over the requisite service period of the individual awards, which generally equals the vesting period.
(2)
Represents share-based compensation for equity awards granted to advisors and to financial institutions based on the fair value of the awards at each reporting period.
(3)
Represents estimated potential future cost savings, operating expense reductions or other synergies included in Credit Agreement EBITDA in accordance with the Credit Agreement relating to the acquisition of NPH. Such amounts do not represent actual performance and there can be no assurance that any such cost savings, operating expense reductions or other synergies will be realized.
(4)
Represents the portion of Credit Agreement EBITDA that management estimates to be attributable to the NPH Acquisition, which is added back to offset NPH run-rate EBITDA accretion, in accordance with the Credit Agreement.
(5)
Represents items that are adjustable in accordance with the Credit Agreement to calculate Credit Agreement EBITDA, including employee severance costs, employee signing costs, employee retention or completion bonuses, and other non-recurring costs.
(6)
Under the Credit Agreement, management calculates Credit Agreement EBITDA for a trailing twelve month period at the end of each fiscal quarter.

17


Our Credit Agreement and the indenture governing the Notes prohibit us from paying dividends and distributions or repurchasing our capital stock except for limited purposes or in limited amounts. In addition, our revolving credit facility requires compliance with a maximum Consolidated Total Debt to Consolidated EBITDA Ratio ("Leverage Test", as defined in the Credit Agreement) and a minimum Consolidated EBITDA to Consolidated Interest Expense Ratio ("Interest Coverage", as defined in the Credit Agreement), tested as of the last day of each fiscal quarter. The breach of this covenant is subject to certain equity cure rights.
As of March 31, 2018, we were in compliance with both of our financial covenants. The maximum permitted ratios under our financial covenants and actual ratios were as follows:
Financial Ratio
Covenant Requirement
 
Actual
Ratio
Leverage Test (Maximum)
5.00
 
2.46
Interest Coverage (Minimum)
3.00
 
8.18
Off-Balance Sheet Arrangements
We enter into various off-balance-sheet arrangements in the ordinary course of business, primarily to meet the needs of our advisors’ clients. These arrangements include Company commitments to extend credit. For information on these arrangements, see Note 9. Commitments and Contingencies and Note 16. Financial Instruments with Off-Balance-Sheet Credit Risk and Concentrations of Credit Risk, within the notes to the unaudited condensed consolidated financial statements.
Contractual Obligations
During the three months ended March 31, 2018, there have been no material changes in our contractual obligations, other than in the ordinary course of business, from those disclosed in our 2017 Annual Report on Form 10-K. See Note 8. Debt and Note 9. Commitments and Contingencies, within the notes to the unaudited condensed consolidated financial statements, as well as the Contractual Obligations section within Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2017 Annual Report on Form 10-K, for further detail on operating lease obligations and obligations under noncancelable service contracts.
Fair Value of Financial Instruments
We use fair value measurements to record certain financial assets and liabilities at fair value and to determine fair value disclosures. See Note 5. Fair Value Measurements, within the notes to the unaudited condensed consolidated financial statements for a detailed discussion regarding our fair value measurements.
Critical Accounting Policies and Estimates
In the notes to our consolidated financial statements and in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2017 Annual Report on Form 10-K, we have disclosed those accounting policies that we consider to be significant in determining our results of operations and financial condition. For the Company’s significant accounting policies affecting revenue from contracts with customers, see Note 3. Revenue, in the Company's unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. There have been no other material changes to those policies that we consider to be significant since the filing of our 2017 Annual Report on Form 10-K. The accounting principles used in preparing our unaudited condensed consolidated financial statements conform in all material respects to GAAP.
Recently Issued Accounting Pronouncements
Refer to Note 2. Summary of Significant Accounting Policies, within the notes to the unaudited condensed consolidated financial statements for a discussion of recent accounting pronouncements or changes in accounting pronouncements that are of significance, or potential significance, to us.

18


Item 1. Financial Statements (unaudited)
LPL FINANCIAL HOLDINGS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(Unaudited)
(In thousands, except per share data)
 
 
Three Months Ended March 31,
REVENUES
 
2018
 
2017
Commission
 
$
474,811

 
$
421,164

Advisory
 
422,387

 
329,859

Asset-based
 
219,336

 
157,223

Transaction and fee
 
116,649

 
108,162

Interest income, net of interest expense
 
7,781

 
5,793

Other
 
593

 
13,226

Total net revenues
 
1,241,557

 
1,035,427

EXPENSES
 
 
 
 
Commission and advisory
 
761,697

 
645,063

Compensation and benefits
 
123,517

 
113,212

Promotional
 
67,427

 
36,654

Depreciation and amortization
 
20,701

 
20,747

Amortization of intangible assets
 
13,222

 
9,491

Occupancy and equipment
 
27,636

 
25,199

Professional services
 
22,172

 
15,537

Brokerage, clearing, and exchange
 
15,877

 
14,186

Communications and data processing
 
11,174

 
11,014

Other
 
28,586

 
22,563

Total operating expenses
 
1,092,009

 
913,666

Non-operating interest expense
 
29,622

 
25,351

Loss on extinguishment of debt
 

 
21,139

INCOME BEFORE PROVISION FOR INCOME TAXES
 
119,926

 
75,271

PROVISION FOR INCOME TAXES
 
26,396

 
27,082

NET INCOME
 
$
93,530

 
$
48,189

EARNINGS PER SHARE (Note 12)
 
 
 
 
Earnings per share, basic
 
$
1.04

 
$
0.54

Earnings per share, diluted
 
$
1.01

 
$
0.52

Weighted-average shares outstanding, basic
 
89,997

 
89,868

Weighted-average shares outstanding, diluted
 
92,784

 
92,004

See notes to unaudited condensed consolidated financial statements.

19

LPL FINANCIAL HOLDINGS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
(In thousands)

 
 
Three Months Ended March 31,
 
 
2018
 
2017
NET INCOME
 
$
93,530

 
$
48,189

Other comprehensive income, net of tax:
 
 
 
 
Unrealized gain on cash flow hedges, net of tax expense of $0, and $194 for the three months ended March 31, 2018 and 2017, respectively
 

 
251

Reclassification adjustment for realized gain on cash flow hedges included in the condensed consolidated statements of income, net of tax expense of $0, and $48 for the three months ended March 31, 2018 and 2017, respectively
 

 
(18
)
Total other comprehensive income, net of tax
 

 
233

TOTAL COMPREHENSIVE INCOME
 
$
93,530

 
$
48,422

See notes to unaudited condensed consolidated financial statements.

20

LPL FINANCIAL HOLDINGS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Financial Condition
(Unaudited)
(In thousands, except share data)

ASSETS
 
March 31,
2018
 
December 31, 2017
Cash and cash equivalents
 
$
820,056

 
$
811,136

Cash segregated under federal and other regulations
 
650,335

 
763,831

Restricted cash
 
55,418

 
50,688

Receivables from:
 
 
 
 
Clients, net of allowance of $514 at March 31, 2018 and $466 at December 31, 2017
 
384,215

 
344,230

Product sponsors, broker-dealers, and clearing organizations
 
216,733

 
196,207

Advisor loans, net of allowance of $3,446 at March 31, 2018 and $3,264 at December 31, 2017
 
232,904

 
219,157

Others, net of allowance of $7,283 at March 31, 2018 and $6,115 at December 31, 2017
 
245,120

 
228,986

Securities owned:
 
 
 
 
Trading — at fair value
 
16,255

 
17,879

Held-to-maturity — at amortized cost
 
10,585

 
11,833

Securities borrowed
 
6,663

 
12,489

Fixed assets, net of accumulated depreciation and amortization of $445,555 at March 31, 2018 and $427,344 at December 31, 2017
 
411,272

 
412,684

Goodwill
 
1,476,775

 
1,427,769

Intangible assets, net of accumulated amortization of $432,288 at March 31, 2018 and $419,066 at December 31, 2017
 
513,592

 
414,093

National Planning Holdings acquisition
 

 
162,500

Other assets
 
308,095

 
285,269

Total assets
 
$
5,348,018

 
$
5,358,751

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
LIABILITIES:
Drafts payable
 
$
136,936

 
$
185,929

Payables to clients
 
917,506

 
962,891

Payables to broker-dealers and clearing organizations
 
62,156

 
54,262

Accrued commission and advisory expenses payable
 
151,141

 
147,095

Accounts payable and accrued liabilities
 
447,943

 
461,149

Income taxes payable
 
23,425

 
469

Unearned revenue
 
96,410

 
72,222

Securities sold, but not yet purchased — at fair value
 
334

 
1,182

Long-term borrowing, net of unamortized debt issuance cost of $21,989 at March 31, 2018 and $22,812 at December 31, 2017
 
2,381,719

 
2,385,022

Leasehold financing and capital lease obligations
 
106,076

 
107,518

Deferred income taxes, net
 
15,879

 
16,004

Total liabilities
 
4,339,525

 
4,393,743

Commitments and contingencies (Note 9)
 
 
 
 
STOCKHOLDERS’ EQUITY:
 
 
 
 
Common stock, $.001 par value; 600,000,000 shares authorized; 124,037,616 shares issued at March 31, 2018 and 123,030,383 shares issued at December 31, 2017
 
124

 
123

Additional paid-in capital
 
1,592,436

 
1,556,117

Treasury stock, at cost — 34,270,821 shares at March 31, 2018 and 33,262,115 shares at December 31, 2017
 
(1,373,457
)
 
(1,309,568
)
Retained earnings
 
789,390

 
718,336

Total stockholders’ equity
 
1,008,493

 
965,008

Total liabilities and stockholders’ equity
 
$
5,348,018

 
$
5,358,751

See notes to unaudited condensed consolidated financial statements.

21

LPL FINANCIAL HOLDINGS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Stockholders’ Equity
(Unaudited)
(In thousands)

 
 
 
 
 
Additional
Paid-In
Capital
 
 
 
 
 
Accumulated Other
Comprehensive
Income (loss)
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Common Stock
 
 
Treasury Stock
 
 
 
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
BALANCE — December 31, 2016
119,918

 
$
120

 
$
1,445,256

 
30,621

 
$
(1,194,645
)
 
$
315

 
$
569,949

 
$
820,995

Net income and other comprehensive income (loss), net of tax expense
 
 
 
 
 
 
 
 
 
 
233

 
48,189

 
48,422

Issuance of common stock to settle restricted stock units, net
205

 

 

 
65

 
(2,527
)
 
 
 
 
 
(2,527
)
Treasury stock purchases
 
 
 
 
 
 
567

 
(22,492
)
 
 
 
 
 
(22,492
)
Cash dividends on common stock
 
 
 
 
 
 
 
 
 
 
 
 
(22,620
)
 
(22,620
)
Stock option exercises and other
1,541

 
2

 
40,957

 
(21
)
 
745

 
 
 
(183
)
 
41,521

Share-based compensation


 
 
 
6,971

 
 
 
 
 
 
 
 
 
6,971

BALANCE — March 31, 2017
121,664

 
$
122

 
$
1,493,184

 
31,232

 
$
(1,218,919
)
 
$
548

 
$
595,335

 
$
870,270

BALANCE — December 31, 2017
123,030

 
$
123

 
$
1,556,117

 
33,262

 
$
(1,309,568
)
 
$

 
$
718,336

 
$
965,008

Net income and other comprehensive income (loss), net of tax expense
 
 
 
 
 
 
 
 
 
 

 
93,530

 
93,530

Issuance of common stock to settle restricted stock units, net
197

 

 

 
55

 
(3,598
)
 
 
 
 
 
(3,598
)
Treasury stock purchases
 
 
 
 
 
 
968

 
(60,797
)
 
 
 
 
 
(60,797
)
Cash dividends on common stock
 
 
 
 
 
 
 
 
 
 
 
 
(22,561
)
 
(22,561
)
Stock option exercises and other
811

 
1

 
28,722

 
(14
)
 
506

 
 
 
85

 
29,314

Share-based compensation
 
 
 
 
7,597

 
 
 
 
 
 
 
 
 
7,597

BALANCE — March 31, 2018
124,038

 
$
124

 
$
1,592,436

 
34,271

 
$
(1,373,457
)
 
$

 
$
789,390

 
$
1,008,493

See notes to unaudited condensed consolidated financial statements.

22


LPL FINANCIAL HOLDINGS INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)

 
 
Three Months Ended March 31,
 
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net income
 
$
93,530

 
$
48,189

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Noncash items:
 
 
 
 
Depreciation and amortization
 
20,701

 
20,747

Amortization of intangible assets
 
13,222

 
9,491

Amortization of debt issuance costs
 
1,038

 
1,286

Share-based compensation
 
7,597

 
6,971

Provision for bad debts
 
1,708

 
833

Deferred income tax provision
 
(125
)
 
(14
)
Loss on extinguishment of debt
 

 
21,139

Loan forgiveness
 
15,870

 
12,977

Other
 
111

 
(1,992
)
Changes in operating assets and liabilities:
 
 
 
 
Receivables from clients
 
(40,034
)
 
45,926

Receivables from product sponsors, broker-dealers, and clearing organizations
 
(20,526
)
 
11,403

Advisor loans
 
(29,025
)
 
(18,605
)
Receivables from others
 
(17,302
)
 
(2,761
)
Securities owned
 
358

 
(1,907
)
Securities borrowed
 
5,826

 
(12,644
)
Other assets
 
(31,960
)
 
(6,281
)
Drafts payable
 
(48,993
)
 
(41,613
)
Payables to clients
 
(45,385
)
 
(93,189
)
Payables to broker-dealers and clearing organizations
 
7,893

 
(5,892
)
Accrued commission and advisory expenses payable
 
4,046

 
(6,934
)
Accounts payable and accrued liabilities
 
(7,177
)
 
(19,751
)
Income taxes receivable/payable
 
22,956

 
23,214

Unearned revenue
 
24,188

 
16,627

Securities sold, but not yet purchased
 
(848
)
 
7

Net cash (used in) provided by operating activities
 
$
(22,331
)
 
$
7,227

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Capital expenditures
 
(22,934
)
 
(30,711
)
Proceeds from maturity of securities classified as held-to-maturity
 
1,250

 
1,750

Net cash used in investing activities
 
$
(21,684
)
 
$
(28,961
)
Continued on following page
 
 
 

23

LPL FINANCIAL HOLDINGS INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows - Continued
(Unaudited)
(In thousands)

 
 
Three Months Ended March 31,
 
 
2018
 
2017
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Repayment of senior secured term loans
 
(3,750
)
 
(2,197,360
)
Proceeds from senior secured term loans and senior notes
 

 
2,197,360

Payment of debt issuance costs
 

 
(13,936
)
Tax payments related to settlement of restricted stock units
 
(3,598
)
 
(2,527
)
Repurchase of common stock
 
(53,794
)
 
(18,290
)
Dividends on common stock
 
(22,561
)
 
(22,620
)
Proceeds from stock option exercises and other
 
29,314

 
41,521

Payment of leasehold financing obligation
 
(1,442
)
 
(439
)
Net cash used in financing activities
 
$
(55,831
)
 
$
(16,291
)
NET DECREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH
 
(99,846
)
 
(38,025
)
CASH, CASH EQUIVALENTS AND RESTRICTED CASH — Beginning of period
 
1,625,655

 
1,558,608

CASH, CASH EQUIVALENTS AND RESTRICTED CASH— End of period
 
$
1,525,809

 
$
1,520,583

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
 
Interest paid
 
$
41,671

 
$
23,737

Income taxes paid
 
$
3,564

 
$
3,884

NONCASH DISCLOSURES:
 
 
 
 
Capital expenditures included in accounts payable and accrued liabilities
 
$
11,865

 
$
13,960

Debt issuance cost included in accounts payable and accrued liabilities
 
$
8

 
$
3,091

Discount on proceeds from senior secured credit facilities recorded as debt issuance cost
 
$

 
$
2,640

Pending settlement of treasury stock purchases
 
$
7,003

 
$
4,202


The following table provides a reconciliation of cash, cash equivalent, and restricted cash reported within the statement of financial condition that sum to the total of the same such amounts shown in the statement of cash flows.
 
 
March 31,
 
 
2018
 
2017
Cash and cash equivalents
 
$
820,056

 
$
797,293

Cash segregated under federal and other regulations
 
650,335

 
682,662

Restricted cash
 
55,418

 
40,628

Total cash, cash equivalents, and restricted cash shown in the statement of cash flows
 
$
1,525,809

 
$
1,520,583


See notes to unaudited condensed consolidated financial statements.

24


LPL FINANCIAL HOLDINGS INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)



1.    Organization and Description of the Company
LPL Financial Holdings Inc. (“LPLFH”), a Delaware holding corporation, together with its consolidated subsidiaries (collectively, the “Company”), provides an integrated platform of brokerage and investment advisory services to independent financial advisors and financial advisors at financial institutions (collectively “advisors”) in the United States. Through its custody and clearing platform, using both proprietary and third-party technology, the Company provides access to diversified financial products and services, enabling its advisors to offer independent financial advice and brokerage services to retail investors (their “clients”).
Description of Subsidiaries
LPL Holdings, Inc. (“LPLH”), a Massachusetts holding corporation, owns 100% of the issued and outstanding common stock or other ownership interest in each of LPL Financial LLC (“LPL Financial”), Fortigent Holdings Company, Inc., and LPL Insurance Associates, Inc. (“LPLIA”). LPLH is also the majority stockholder in PTC Holdings, Inc. (“PTCH”), and owns 100% of the issued and outstanding voting common stock. Each member of PTCH’s board of directors meets the direct equity ownership interest requirements that are required by the Office of the Comptroller of the Currency. The Company has established a wholly-owned series captive insurance entity that underwrites insurance for various legal and regulatory risks.
LPL Financial, with primary offices in San Diego, California; Fort Mill, South Carolina; and Boston, Massachusetts, is a clearing broker-dealer and an investment advisor that principally transacts business as an agent for its advisors and financial institutions on behalf of their clients in a broad array of financial products and services. LPL Financial is licensed to operate in all 50 states, Washington D.C., Puerto Rico, and the U.S. Virgin Islands.
Fortigent Holdings Company, Inc. and its subsidiaries (“Fortigent”) provide solutions and consulting services to registered investment advisors, banks, and trust companies serving high-net-worth clients.
PTCH is a holding company for The Private Trust Company, N.A. (“PTC”). PTC is chartered as a non-depository limited purpose national bank, providing a wide range of trust, investment management oversight, and custodial services for estates and families. PTC also provides Individual Retirement Account custodial services for LPL Financial.
LPLIA operates as an insurance brokerage general agency that offers life, long-term care, and disability insurance products and services for LPL Financial advisors.
2.    Summary of Significant Accounting Policies
Basis of Presentation
The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), which require the Company to make estimates and assumptions regarding the valuation of certain financial instruments, intangible assets, allowance for doubtful accounts, share-based compensation, accruals for liabilities, income taxes, revenue and expense accruals, and other matters that affect the consolidated financial statements and related disclosures. The unaudited condensed consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to present fairly the results for the interim periods presented. Actual results could differ from those estimates under different assumptions or conditions and the differences may be material to the consolidated financial statements.
The unaudited condensed consolidated financial statements do not include all information and notes necessary for a complete presentation of results of income, comprehensive income, financial position, and cash flows in conformity with GAAP. Accordingly, these financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the related notes for the year ended December 31, 2017, contained in the Company’s Annual Report on Form 10-K, as amended by Amendment No. 1 on Form 10-K/A filed on February 27, 2018 (collectively, the "2017 Annual Report on Form 10-K"), as filed with the SEC.

25


LPL FINANCIAL HOLDINGS INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)


For the Company’s significant accounting policies affecting revenue from contracts with customers, see Note 3. Revenue, in the Company's unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. A summary of other significant accounting policies are included in Note 2. Summary of Significant Accounting Policies, in the Company’s audited consolidated financial statements and the related notes for the year ended December 31, 2017. There have been no other significant changes to these accounting policies during the first three months of 2018.
Consolidation
These unaudited condensed consolidated financial statements include the accounts of LPLFH and its subsidiaries. Intercompany transactions and balances have been eliminated. Equity investments over which the Company exercises significant influence, but does not exercise control and is not the primary beneficiary are accounted for using the equity method.
Reportable Segment
Management has determined that the Company operates in one segment, given the similarities in economic characteristics between our operations and the common nature of our products and services, production and distribution processes, and regulatory environment.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with an original maturity of 90 days or less that are not required to be segregated under federal or other regulations. The Company's cash and cash equivalents are composed of interest and noninterest-bearing deposits, money market funds, and United States government obligations.
Cash Segregated Under Federal and Other Regulations
The Company's subsidiary, LPL Financial, is required to maintain cash or qualified securities in a segregated reserve account for the exclusive benefit of its customers in accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and other regulations. Held within this account is approximately $100,000 for the proprietary accounts of introducing brokers.
Restricted Cash
Restricted cash primarily represents cash held by and for use by the Company’s captive insurance subsidiary.
Fair Value of Financial Instruments
The Company’s financial assets and liabilities are carried at fair value or at amounts that, because of their short-term nature, approximate current fair value, with the exception of its held-to-maturity securities and indebtedness, which the Company carries at amortized cost. The Company measures the implied fair value of its debt instruments using trading levels obtained from a third-party service provider. Accordingly, the debt instruments qualify as Level 2 fair value measurements. See Note 5. Fair Value Measurements, for additional detail regarding the Company’s fair value measurements. As of March 31, 2018, the carrying amount and fair value of the Company’s indebtedness was approximately $2,392.5 million and $2,392.0 million, respectively. As of December 31, 2017, the carrying amount and fair value was approximately $2,396.3 million and $2,422.0 million, respectively.
Recently Issued Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases, which establishes a right-of-use model that requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations. The Company expects to adopt the provisions of this guidance on January 1, 2019. The Company has identified the affected population of its leases and is evaluating the impact that ASU 2016-02 will have on its consolidated financial statements and related disclosures.
Recently Adopted Accounting Pronouncements
In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers: Topic 606, to supersede nearly all existing revenue recognition guidance under GAAP. ASU 2014-09 also requires new qualitative and

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LPL FINANCIAL HOLDINGS INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)


quantitative disclosures, including disaggregation of revenues and descriptions of performance obligations. The Company adopted the provisions of this guidance on January 1, 2018 using the modified retrospective approach. The Company has performed an assessment of its revenue contracts as well as worked with industry participants on matters of interpretation and application and has not identified any material changes to the timing or amount of its revenue recognition under ASU 2014-09. The Company's accounting policies did not change materially as a result of applying the principles of revenue recognition from ASU 2014-09 and are largely consistent with existing guidance and current practices applied by the Company. Refer to Note 3. Revenue, for additional disaggregation of revenue in accordance with ASU 2014-09.