LPL Financial Holdings Inc. (LPLA) FY 2021 MD&A

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes to those consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth under “Risk Factors” and elsewhere in this Annual Report on Form 10-K, our actual results may differ materially from those anticipated in these forward-looking statements. Please also refer to the section under heading “Special Note Regarding Forward-Looking Statements.”

Business Overview

We are a leader in the retail financial advice market and the nation’s largest independent broker-dealer. We serve independent financial advisors and financial institutions, providing them with the technology, research, clearing and compliance services and practice management programs they need to create and grow their practices. We enable them to provide personalized financial guidance to millions of American families seeking wealth management, retirement planning, financial planning and asset management solutions. Please consult Part I, “Item 1. Business” for additional information related to our business activities.

Our Sources of Revenue

Our revenue is 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 revenue through our insured bank sweep vehicles, money market programs and the access we provide to a variety of product providers with the following product lines:

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 sponsors pay us fees based on asset levels or number of accounts managed. We also earn interest from margin loans made to our advisors’ clients. A portion of our revenue is not asset-based or correlated with the equity financial markets.

We regularly review various aspects of our operations and service offerings, including our policies, procedures and platforms, in response to marketplace developments. We seek to continuously improve and enhance 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 products and services, including related disclosures, in the context of the changing regulatory environment and competitive landscape for advisory and brokerage accounts.

Significant Events

Completed the acquisition of Waddell & Reed Financial, Inc. and surpassed $1.0 trillion in assets

On April 30, 2021 we completed the acquisition of the wealth management business of Waddell & Reed Financial Inc. (the “Waddell & Reed Acquisition”). Concurrent with the closing of the Waddell & Reed Acquisition, we surpassed $1.0 trillion in total advisory and brokerage assets. We completed the onboarding of $71.2 billion of client assets representing 99% of assets from the Waddell & Reed Acquisition during the third quarter of 2021.

Generated $118.8 billion of organic net new assets

We generated $118.8 billion of organic net new assets during 2021, which included the onboarding of approximately $35.0 billion of combined total assets from M&T Bank and BMO Harris to our platform. This translated to an annual organic net new asset growth rate of 13.2%. We also signed an agreement with CBSI to join our platform. CBSI

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supports over 500 advisors serving approximately $32 billion in brokerage and advisory assets, which we expect to onboard during 2022.

Business Solutions subscriptions more than doubled, driving revenue of approximately $28 million on an annualized run rate basis

Total active and contracted Business Solutions subscriptions more than doubled to end the year at 3,022, driving revenue of approximately $28 million on an annualized run rate basis.

Refinanced our highest cost debt, increased capacity under our Credit Agreement, and issued senior notes

On March 15, 2021, we took advantage of the low interest rate environment to issue $900.0 million in aggregate principal amount of 4.00% senior unsecured notes due in 2029 (“2029 Senior Notes”). We used the proceeds from the 2029 Senior Notes to redeem our existing 5.75% senior unsecured notes due in 2025 (“2025 Senior Notes”), reduced our annual interest expense by $13.0 million, and created additional borrowing capacity under our Credit Agreement, which was increased to $1.0 billion. Additionally, on May 18, 2021, we issued $400.0 million in aggregate principal amount of 4.375% senior unsecured notes due in 2031 (“2031 Senior Notes”). Proceeds from the 2031 Senior Notes were used to repay borrowings under the Credit Agreement, which were used to finance the Waddell & Reed Acquisition.

Earned a spot on the Fortune 500 list

In June 2021 the Company earned a spot in the Fortune 500 ranking for 2021 based on our revenue of $5.9 billion for the year ended December 31, 2020, placing us on the list of largest U.S. companies as ranked by revenue.

Resumed share repurchases during the third quarter of 2021 and repurchased $90.0 million of shares

We resumed share repurchases during the third quarter of 2021 with an initial focus on repurchasing amounts to offset dilution. We repurchased 579,771 shares during the third and fourth quarters of 2021 for a total of $90.0 million.

Executive Summary

Financial Highlights

Results for the year ended December 31, 2021 included net income of $459.9 million, or $5.63 per diluted share, which compares to $472.6 million, or $5.86 per diluted share, for the year ended December 31, 2020.

Asset Growth Trends

Total advisory and brokerage assets served were $1.2 trillion at December 31, 2021, up 33.6% from $903.1 billion at December 31, 2020. Total net new assets were $190.0 billion for the year ended December 31, 2021, compared to $60.2 billion for the same period in 2020.

Net new advisory assets were an inflow of $123.5 billion for the year ended December 31, 2021, compared to $52.1 billion in 2020. Advisory assets were $643.2 billion, or 53.3% of total advisory and brokerage assets served, at December 31, 2021, up 39.5% from $461.2 billion at December 31, 2020.

Net new brokerage assets were an inflow of $66.6 billion for the year ended December 31, 2021, compared to $8.1 billion in 2020. Brokerage assets were $563.2 billion at December 31, 2021, up 27.4% from $441.9 billion at December 31, 2020.

Gross Profit Trends

Gross profit, a non-GAAP financial measure, was $2,454.7 million for the year ended December 31, 2021, an increase of 16.7% from $2,103.3 million for the year ended December 31, 2020. See the “Key Performance Metrics” section for additional information on gross profit.

Common Stock Dividends and Share Repurchases

During the year ended December 31, 2021, we paid shareholders cash dividends of $80.1 million and repurchased 579,771 of our outstanding shares for a total of $90.0 million.

COVID-19 Response

In response to the COVID-19 pandemic, we have taken measures to protect the health and safety of our employees, as well as the stability and continuity of our operations. For example, we have equipped and enabled a

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substantial majority of employees to work remotely, enhanced cleaning protocols throughout our corporate offices, and worked closely with our vendors to maintain service continuity throughout the market volatility and increased operational volumes that have occurred from time to time during the pandemic. We also made extra support available to our advisors by extending service hours and providing additional resources to enable them to deliver differentiated services to their clients. Please consult the “Risks Related to our Business and Industry” section within Part I, “Item 1A. Risk Factors” for more information about the risks associated with COVID-19.

Key Performance Metrics

We focus on several key metrics in evaluating the success of our business relationships and our resulting financial position and operating performance. Our key operating, business and financial metrics are as follows:

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(1)Totals may not foot due to rounding.

(2)Advisory and brokerage assets consist 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. Client cash balances are also included in total advisory and brokerage assets.

(3)Advisory assets consist of total advisory assets under custody at LPL Financial and Waddell & Reed, LLC (“Waddell & Reed”). Please consult the “Results of Operations” section for a tabular presentation of advisory assets.

(4)Brokerage assets consist of brokerage assets serviced by advisors licensed with LPL Financial.

(5)Net new advisory assets consist of total client deposits into custodied advisory accounts less total client withdrawals from custodied advisory accounts, plus dividends, plus interest, minus advisory fees. We consider conversions from and to brokerage accounts as deposits and withdrawals, respectively.

(6)Net new brokerage assets consist of total client deposits into brokerage accounts less total client withdrawals from brokerage accounts, plus dividends, plus interest. We consider conversions from and to advisory accounts as deposits and withdrawals, respectively.

(7)Total net new assets include $71.2 billion of assets related to the Waddell & Reed Acquisition during the year ended December 31, 2021. Total net new assets during the year ended December 31, 2020 include $2.5 billion of net new assets related to the acquisition of E.K. Riley Investments, LLC (“E.K. Riley”) and $1.5 billion of net new assets related to the acquisition of Lucia Securities, LLC (“Lucia”). Organic net new assets and related growth rates exclude these assets in both periods.

(8)Calculated as annualized current period organic net new assets divided by preceding period assets in their respective categories of advisory assets or total advisory and brokerage assets.

(9)Represents the amount of securities purchased less the amount of securities sold in client accounts custodied with LPL Financial and Waddell & Reed. Reported activity does not include any other cash activity, such as deposits, withdrawals, dividends received or fees paid.

(10)Calculated based on the end-of-period total advisory and brokerage assets divided by end-of-period advisor count.

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(11)The leverage ratio is a financial metric from our Credit Agreement and is calculated by dividing Credit Agreement net debt, which equals consolidated total debt plus corporate cash, by Credit Agreement EBITDA. Credit Agreement EBITDA, a non-GAAP measure, is defined by the Credit Agreement as “Consolidated EBITDA,” which is Consolidated Net Income (as defined in the Credit Agreement) plus interest expense on borrowings, provision for income taxes, depreciation and amortization, and amortization of other intangibles, and is further 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. Please consult the “Debt and Related Covenants” section for more information. Below is a reconciliation of corporate debt and other borrowings to Credit Agreement net debt and net income to EBITDA and Credit Agreement EBITDA (in millions):

(†)    Totals may not foot due to rounding.

(12)EPS prior to amortization of intangible assets and acquisition costs is a non-GAAP financial measure defined as adjusted net income, a non-GAAP financial measure defined as net income plus the after-tax impact of amortization of other intangibles and acquisition costs, divided by the weighted average number of diluted shares outstanding for the applicable period. The Company presents adjusted net income and EPS prior to amortization of intangible assets and acquisition costs because management believes that these metrics can provide investors with useful insight into the Company’s core operating performance by excluding non-cash items and acquisition costs that management does not believe impact the Company’s ongoing operations. Adjusted net income and EPS prior to amortization of intangible assets and acquisition costs are not measures of the Company's financial performance under GAAP and should not be considered as alternatives to net income, earnings per diluted share or any other performance measure derived in accordance with GAAP. Below is a reconciliation of net income and earnings per diluted share to adjusted net income and EPS prior to amortization of intangible assets and acquisition costs for the periods presented (in millions, except per share data):

(†)    Totals may not foot due to rounding.

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(13)Gross profit is a non-GAAP financial measure defined as total revenue less advisory and commission expense and brokerage, clearing and exchange expense. All other expense categories, including depreciation and amortization of property and equipment and amortization of other intangibles, are considered by management to be 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 provide investors with useful insight into our core operating performance before indirect costs that are general and administrative in nature. Below is a reconciliation of gross profit for the periods presented (in millions):

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(†)    Totals may not foot due to rounding.

(14)EBITDA is a non-GAAP financial measure defined as net income plus interest expense on borrowings, provision for income taxes, depreciation and amortization, and amortization of other intangibles. The Company presents EBITDA because management believes that it can be a useful financial metric in understanding the Company’s earnings from operations. EBITDA is not a measure of the Company's 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. Below is a reconciliation of EBITDA to net income for the periods presented (in millions):

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(†)    Totals may not foot due to rounding.

(15)Core G&A is a non-GAAP financial measure defined as total expense less the following expenses: advisory and commission; depreciation and amortization; interest expense on borrowings; brokerage, clearing and exchange; amortization of other intangibles; loss on extinguishment of debt; promotional; acquisition costs; employee share-based compensation; and regulatory charges. Management presents Core G&A because it believes Core G&A reflects the corporate expense categories over which management can generally exercise a measure of control, compared with expense items over which management either cannot exercise control, such as advisory and commission expense, or which management views as promotional expense necessary to support advisor growth and retention, including conferences and transition assistance. Core G&A is not a measure of the Company’s total expense as calculated in accordance with GAAP. Below is a reconciliation of Core G&A against the Company’s total expense for the periods presented (in millions):

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(†)    Totals may not foot due to rounding.

(16)M&A accretion is an adjustment to reflect the annualized expected run rate EBITDA of an acquisition as permitted by the Credit Agreement for up to eight fiscal quarters following the close of the transaction.

(17)Acquisition costs include the cost to setup, onboard and integrate acquired entities and primarily include $36.4 million of compensation and benefits expense, $18.7 million of professional services expense, $14.3 million of promotional expense, and other expenses that were incurred during the year ended December 31, 2021 that are included in the respective line items in the consolidated statements of income.

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Acquisitions, Integrations and Divestitures

We continuously assess the competitive landscape in connection with our capital allocation framework as we pursue acquisitions, integrations and divestitures. These activities are part of our overall growth strategy but can distort comparability when reviewing revenue and expense trends for periods presented. Our recent acquisitions include the following:

•Waddell & Reed Financial, Inc. - In April 2021, we acquired the wealth management business of Waddell & Reed Financial, Inc.

•Blaze Portfolio Systems LLC - In October 2020, we acquired Blaze, a technology company that provides an advisor-facing trading and portfolio rebalancing platform.

•E.K. Riley Investments, LLC - In August 2020, we acquired business relationships with advisors from E.K. Riley, a broker-dealer and RIA.

•Lucia Securities, LLC - In August 2020, we acquired business relationships with advisors from Lucia, a broker-dealer and RIA.

See Note 4 - Acquisitions, within the notes to the consolidated financial statements for further detail.

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. According to the most recent estimate from the U.S. Bureau of Economic Analysis, the U.S. economy grew at an annualized pace of 6.9% in the fourth quarter of 2021 after growing at an annualized pace of 2.3% in the third quarter of 2021. The equity markets were generally strong in 2021 with the S&P 500 and Russell 2000 and 3000 indices gaining year over year. Non-U.S. stocks continued to trail their U.S. counterparts and rising interest rates made it a challenging year for fixed income markets, contributing to a near flat return for the Bloomberg U.S. Aggregate Bond Index for the fourth quarter and a 1.6% loss for the year.

Our business is also sensitive to current and expected short-term interest rates, which are largely driven by Federal Reserve (“Fed”) policy. At the January 2022 policy meeting, Fed policymakers maintained the target range for the federal funds rate at 0% to 0.25%. Fed officials also signaled they would make a decision on whether to raise the federal funds rate at the March 2022 meeting and announced an intent to end net asset purchases in early March.

Please consult the “Risks Related to Our Business and Industry” section within Part I, “Item 1A. Risk Factors” for more information about the risks associated with significant interest rate changes and the potential related effects on our profitability and financial condition.

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Results of Operations

A discussion of changes in our results of operations during the year ended December 31, 2020 compared to the year ended December 31, 2019 has been omitted from this Annual Report on Form 10-K, but may be found in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed with the SEC on February 23, 2021.

The following discussion presents an analysis of our results of operations for the years ended December 31, 2021 and 2020 (in thousands):

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Revenue

Advisory

Advisory revenue represents fees charged to advisors’ clients’ advisory accounts on our corporate RIA advisory platform and is based on a percentage of the market value of the eligible assets in the clients’ advisory accounts. We provide ongoing investment advice and act as a custodian, providing brokerage and execution services on transactions, and perform administrative services for these accounts. Advisory fees are primarily billed to clients in advance, on a quarterly basis, and are recognized as revenue ratably during the quarter. The performance obligation for advisory fees is considered a series of distinct services that are substantially the same and are satisfied daily. As the value of the eligible assets in an advisory account is susceptible to changes due to customer activity, this revenue includes variable consideration and is constrained until the date that the fees are determinable. The majority of our client accounts are on a calendar quarter and are billed using values as of the last business day of the preceding quarter. The value of the eligible assets in an advisory account on the billing date is adjusted for estimates of contributions and withdrawals to determine the amount billed, and accordingly, the revenue earned in the following three-month period. Advisory revenue collected on our corporate advisory platform is proposed by the advisor and agreed to by the client and averaged 1% of the underlying assets for the year ended December 31, 2021.

We also support Hybrid RIAs through our hybrid advisory 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 total advisory assets and net new advisory assets. The advisory revenue generated by a Hybrid RIA is not included in our advisory revenue. We charge separate fees to Hybrid RIAs for technology, clearing, administrative, oversight and custody services, which may vary and are included in our service and fee revenue in our consolidated statements of income.

Advisory revenue is generated from advisory assets. The following table summarizes the composition of advisory assets for the periods presented (in billions):

Net new advisory assets are generated throughout the quarter, therefore, the full impact of net new advisory assets to advisory revenue is not realized in the same period. The following table summarizes activity impacting advisory assets for the periods presented (in billions):

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(1)Net new advisory assets consist of total client deposits into custodied advisory accounts less total client withdrawals from advisory accounts, plus dividends, plus interest, minus advisory fees. We consider conversions from and to advisory accounts as deposits and withdrawals, respectively.

(2)Market impact is the difference between the beginning and ending asset balance less the net new asset amounts, representing the implied growth or decline in asset balances due to market changes over the same period of time.

The growth in advisory revenue from 2020 to 2021 was due to increases in net new advisory assets resulting from our recruiting efforts, advisor productivity and acquisitions, as well as market gains as represented by higher levels of the S&P 500 Index.

Commission

We generate two types of commission revenue: (1) sales-based commissions that are recognized at the point of sale on the trade date and are based on a percentage of an investment product’s current market value at the time of purchase and (2) trailing commissions that are recognized over time as earned and are generally based on the

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market value of investment holdings in trail-eligible assets. Sales-based commission revenue, which occurs when clients trade securities or purchase various types of investment products, primarily represents gross commissions generated by our advisors and 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. We earn trailing commission revenue primarily on mutual funds and variable annuities held by clients of our advisors. See Note 3 - Revenue, within the notes to the consolidated financial statements for further detail regarding our commission revenue by product category.

The following table sets forth the components of our commission revenue (dollars in thousands):

The increase in sales-based commission revenue in 2021 compared to 2020 was primarily driven by increases in sales of annuities, mutual funds and fixed income products. The increase in trailing commission revenue in 2021 compared to 2020 was primarily due to the increase in value of annuities and mutual funds as a result of market increases.

Commission revenue is generated from brokerage assets. The following table summarizes activity impacting brokerage assets for the periods presented (in billions):

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(1)Net new brokerage assets consist of total client deposits into brokerage accounts less total client withdrawals from brokerage accounts, plus dividends, plus interest. We consider conversions from and to brokerage accounts as deposits and withdrawals, respectively.

(2)Market impact is the difference between the beginning and ending asset balance less the net new asset amounts, representing the implied growth or decline in asset balances due to market changes over the same period of time.

Asset-Based

Asset-based revenue consists of fees from our client cash programs, fees from our sponsorship programs with financial product manufacturers, and fees from omnibus processing and networking services (collectively referred to as “recordkeeping”). Client cash revenue is generated on advisors’ clients’ cash balances in insured bank sweep accounts and money market programs. We also receive fees from certain financial product manufacturers in connection with sponsorship programs that support our marketing and sales force education and training efforts. Compensation for these performance obligations are either a fixed fee, a percentage of the average annual amount of product sponsor assets held in advisors’ clients’ accounts, a percentage of new sales or a combination. Omnibus processing revenue is paid to us by mutual fund product sponsors or their affiliates and is based on the value of mutual fund assets in accounts for which the Company provides omnibus processing services and the number of accounts in which the related mutual fund positions are held. Networking revenue on brokerage assets is correlated to the number of positions we administer and is paid to us by mutual fund product sponsors and annuity product manufacturers.

Asset-based revenue for the year ended December 31, 2021 increased by $103.6 million compared to 2020, primarily due to increases in revenue from recordkeeping and sponsorship programs, partially offset by a decrease in client cash revenue.

Revenue for our recordkeeping and sponsorship programs for the year ended December 31, 2021, which is largely based on the market value of the underlying assets, increased compared to 2020 due to organic growth in our assets under management and the impact of market appreciation on the value of the underlying assets.

Client cash revenue for the year ended December 31, 2021 decreased compared to 2020 due to the impact of a lower federal funds effective rate, partially offset by higher average client cash balances. For the year ended December 31, 2021, our average client cash balances increased to $49.8 billion compared to $44.7 billion for the year ended December 31, 2020.

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Service and Fee

Service and fee revenue is generated from advisor and retail investor services, including technology, insurance, conferences, licensing, Business Solutions, IRA custodian, and other client account fees. We charge separate fees to RIAs for technology, clearing, administrative, oversight and custody services, which may vary. We host certain advisor conferences that serve as training, education, sales and marketing events for which we charge sponsors a fee. Service and fee revenue for the year ended December 31, 2021 increased by $54.0 million compared to 2020, primarily due to increases in contract and licensing fees, Business Solutions subscription fees, IRA custodian fees, conference fees, and other client account fees.

Transaction

Transaction revenue includes transaction charges generated in both advisory and brokerage accounts from products including mutual funds, ETFs, and fixed income products. Transaction revenue for the year ended December 31, 2021 increased by $8.0 million compared to 2020, primarily due to increased transaction volume related to fixed income trading.

Other

Other revenue primarily includes unrealized gains and losses on assets held by us in our advisor non-qualified deferred compensation plan and model research portfolios and other miscellaneous revenue, which is not generated from contracts with customers.

Other revenue for the year ended December 31, 2021 increased by $14.4 million compared to 2020, primarily due to increases in realized and unrealized gains on assets held in our advisor non-qualified deferred compensation plan, which assets are based on the market performance of the underlying investment allocations chosen by advisors in the plan, partially offset by a decrease in dividend income on assets held in our advisor non-qualified deferred compensation plan.

Expense

Advisory and Commission

Advisory and commission expense consists of the following: payout amounts that are earned by and paid out to advisors and institutions based on advisory and commission revenue earned on each client’s account; production based bonuses earned by advisors and institutions based on the levels of advisory and commission revenue 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 grant date; and the deferred advisory and commission fee expense associated with mark-to-market gains or losses on the non-qualified deferred compensation plan offered to our advisors.

The following table sets forth our payout rate, which is a statistical or operating measure:

Our payout rate increased slightly for the year ended December 31, 2021 compared to 2020, primarily due to higher production bonus payouts and the impact of onboarding large financial institutions.

Compensation and Benefits

Compensation and benefits include salaries, wages, benefits, share-based compensation and related taxes for our employees, as well as compensation for temporary workers and contractors. The following table sets forth our average number of employees for the year ended December 31, 2021 as compared to 2020:

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Compensation and benefits for the year ended December 31, 2021 increased by $131.7 million compared to 2020, primarily due to an increase in salary and employee benefit expenses resulting from an increase in headcount.

Promotional

Promotional expense includes business development costs related to advisor recruitment and retention, costs related to hosting certain advisory conferences that serve as training, sales and marketing events and other costs that support advisor business growth. For the year ended December 31, 2021 promotional expense increased by $94.0 million compared to 2020, primarily due to increases in recruited assets and advisors that led to higher costs to support transition assistance and retention, as well as increases in conference spend as we returned to in-person events.

Occupancy and Equipment

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. Occupancy and equipment expense for the year ended December 31, 2021 increased by $19.1 million compared to 2020, primarily due to increases in expenses related to software licenses and our technology portfolio.

Depreciation and Amortization

Depreciation and amortization relates to the use of property and equipment, which includes internally developed software, hardware, leasehold improvements and other equipment. Depreciation and amortization for the year ended December 31, 2021 increased by $41.7 million compared to 2020, primarily due to our continued investment in technology to support the integration of Waddell & Reed, enhance our advisor platform and end-client experience and support large financial institution onboarding.

Brokerage, Clearing and Exchange

Brokerage, clearing and exchange fees include expenses originating from trading or clearing operations as well as any exchange membership fees. These fees fluctuate largely in line with the volume of sales and trading activity. Brokerage, clearing and exchange fees increased by $14.8 million for the year ended December 31, 2021 compared to 2020, primarily due to an increase in the volume of sales and trading activity.

Amortization of Other Intangibles

Amortization of other intangibles represents the benefits received for the use of long-lived intangible assets established through our acquisitions. Amortization of other intangibles for the year ended December 31, 2021 increased by $11.9 million compared to 2020, primarily due to increases in intangible assets resulting from the Waddell & Reed Acquisition on April 30, 2021, as well as amortization related to an acquisition during the fourth quarter of 2020. See Note 4 - Acquisitions and Note 9 - Goodwill and Other Intangibles, Net for additional information.

Professional Services

Professional services expense includes costs paid to outside firms for assistance with legal, accounting, technology, regulatory, and general corporate matters, as well as non-capitalized costs related to service and technology enhancements. Professional services expense for the year ended December 31, 2021 increased by $16.2 million compared to 2020, primarily due to increases in non-capitalized costs related to the use of consultants.

Communications and Data Processing

Communications and data processing expense consists primarily of the cost of voice and data telecommunication lines supporting our business, including connectivity to data centers, exchanges and markets, as well as customer statement processing and postage costs. Communications and data processing expenses for the year ended December 31, 2021 increased by $7.9 million compared to 2020, primarily due to increases in costs associated with client statement production due to growth in our advisors, which led to an increase in the customer base.

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Loss on Extinguishment of Debt

On March 15, 2021, we issued the 2029 Senior Notes and redeemed the 2025 Senior Notes. In connection with these transactions, we incurred a $24.4 million loss on extinguishment of debt for the year ended December 31, 2021.

Other Expense

Other expense includes the costs of the investigation, settlement and resolution of regulatory matters (including customer restitution and remediation), licensing fees, insurance, broker-dealer regulator fees, travel-related expenses and other miscellaneous expenses. Other expense will depend in part 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. Other expense for the year ended December 31, 2021 increased by $30.5 million compared to 2020 primarily due to costs related to Waddell & Reed transitional support and an increase in licensing fees.

Provision for Income Taxes

Our effective income tax rate was 23.5% and 24.5% for the years ended December 31, 2021 and 2020. The decrease in our effective tax rate for the year ended December 31, 2021 was primarily due to an increased benefit from share-based compensation recognized during the year.

COVID-19 Impact

On March 11, 2020, the World Health Organization designated the spread of COVID-19 as a pandemic. As of the date of this Annual Report on Form 10-K, the COVID-19 pandemic has had a significant impact on global financial markets, and we continue to monitor its effects on the overall economy and our operations. We are not yet able to determine the full impact of the pandemic; however, should it continue, there could be a material and adverse financial impact to our results of operations. Please consult the “Risks Related to our Business and Industry” section within Part I, “Item 1A. Risk Factors” for more information about the risks associated with COVID-19.

Liquidity and Capital Resources

We have established liquidity and capital policies intended to support the execution of strategic initiatives, while meeting regulatory capital requirements and maintaining ongoing and sufficient liquidity. We believe liquidity is of critical importance to the Company and, in particular, to LPL Financial, our primary broker-dealer subsidiary. The objective of our policies is to ensure that we can meet our strategic, operational and regulatory liquidity and capital requirements under both normal operating conditions and under periods of stress in the financial markets.

Liquidity

Our liquidity needs are primarily driven by capital requirements at LPL Financial, interest due on our corporate debt and other capital returns to shareholders. Our liquidity needs at LPL Financial are driven primarily by the level and volatility of our client activity. Management maintains a set of liquidity sources and monitors certain business trends and market metrics closely in an effort to ensure we have sufficient liquidity. We believe that based on current levels of cash flows from operations and anticipated growth, together with available external liquidity sources, we have adequate liquidity to satisfy our working capital needs, the payment of all of our obligations and the funding of anticipated capital expenditures for the foreseeable future.

Parent Company Liquidity

LPL Holdings, Inc. (“Parent”), the direct holding company of our operating subsidiaries, considers its primary source of liquidity to be corporate cash. We define corporate cash as the sum of cash and equivalents from the following: (1) cash held at the Parent, (2) excess cash at LPL Financial per the Credit Agreement, which is the net capital held at LPL Financial in excess of 10% of its aggregate debits, or five times the net capital required in accordance with Exchange Act Rule 15c3-1, and (3) other available cash, which includes cash and equivalents held at PTC, in excess of Credit Agreement capital requirements, and cash and equivalents held at non-regulated subsidiaries.

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We believe corporate cash is a useful measure of the Parent’s liquidity. The following table presents the components of corporate cash (in thousands):

Corporate cash is monitored as part of our liquidity risk management. We target maintaining $200.0 million in corporate cash, which covers approximately 24 months of principal and interest due on our corporate debt. The Company maintains additional liquidity through a $1.0 billion secured committed revolving credit facility. The Parent has the ability to borrow against the credit facility for working capital and general corporate purposes. Dividends from and excess capital generated by LPL Financial are the primary sources of liquidity. Subject to regulatory approval or notification, capital generated by LPL Financial can be distributed to the Parent to the extent the capital levels exceed both regulatory requirements and internal capital thresholds. As of December 31, 2021, LPL Financial maintained excess regulatory capital of $15.9 million over Credit Agreement requirements. During the twelve months ended December 31, 2021 and 2020, LPL Financial paid dividends of $465.0 million and $635.0 million to the Parent, respectively.

Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing. We actively monitor changes to our liquidity needs caused by general business volumes and price volatility, including higher margin requirements of clearing corporations and exchanges, and stress scenarios involving a sustained market downturn and the persistence of current interest rates, which include the impacts of the COVID-19 pandemic. We believe that based on current levels of operations and anticipated growth, our cash flow from operations, together with other available sources of funds, which include six uncommitted lines of credit, the revolving credit facility established through our Credit Agreement and the committed revolving credit facility of LPL Financial, will provide us with adequate liquidity to satisfy our working capital needs, the payment of all of our obligations and the funding of anticipated capital expenditures for the foreseeable future.

We regularly evaluate our existing indebtedness, including potential refinancing opportunities, 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. The earliest principal maturity date for our corporate debt is in 2026 and our revolving credit facilities mature between 2022 and 2026, which makes us less dependent on capital markets in the near-term.

Share Repurchases

We engage in share repurchase programs, which are approved by our 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. Our current capital deployment framework remains focused on investing in organic growth first, pursuing acquisitions where appropriate, and returning excess capital to shareholders. In the first half of 2021, the majority of our capital deployment was focused on supporting organic growth and acquisitions. While we continue to see opportunities to deploy capital in this manner, we resumed share repurchases in the third quarter of 2021 with the initial focus on an amount to offset dilution. We repurchased $90.0 million, representing 579,771 shares, during the year ended December 31, 2021. The timing and amount of share repurchases, if any, is determined at our discretion within the constraints of our Credit Agreement, the Indentures, applicable laws and consideration of our general liquidity needs. See Note 15 - Stockholders’ Equity, within the notes to the consolidated financial statements for additional information regarding our share repurchases.

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Common Stock 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 Indentures. See Note 15 - Stockholders’ Equity, within the notes to the consolidated financial statements for additional information regarding our dividends.

LPL Financial Liquidity

LPL Financial relies primarily on client payables to fund margin lending. LPL Financial maintains additional liquidity through external lines of credit totaling $575.0 million at December 31, 2021. LPL Financial also maintains a line of credit with the Parent.

External Liquidity Sources

The following table presents amounts outstanding and available under our external lines of credit at December 31, 2021 (in millions):

(1)Outstanding balances were repaid in January 2022.

Capital Resources

The Company seeks to manage capital levels in support of its business strategy of generating and effectively deploying capital for the benefit of our shareholders.

Our primary requirement for working capital relates to funds we loan to our advisors’ clients for trading conducted on margin and funds 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 equivalents on hand, cash segregated under federal or other regulations, the committed revolving credit facility of LPL Financial and proceeds from repledging or selling client securities in margin 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.

Our other working capital needs are primarily related to loans we are making to advisors and timing associated with receivables and payables, which we have satisfied in the past from internally generated cash flows.

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 flows or, if needed, with funds drawn on our uncommitted lines of credit at LPL Financial or one of our revolving credit facilities.

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 equal to the greater of $250,000 or 2% of aggregate debit balances arising from client transactions. At December 31, 2021, LPL Financial had net capital of $87.5 million with a minimum net capital requirement of $14.3 million.

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LPL Financial’s ability to pay dividends greater than 10% of its excess net capital during any 35-day rolling period requires approval from 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 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.

In April 2021, the Company acquired a broker-dealer as part of the Waddell & Reed Acquisition (the “Waddell & Reed broker-dealer”). The Waddell & Reed broker-dealer was required to maintain net capital of $250,000, which represents the greater of 2% of its aggregate debits or the minimum net capital requirement of $250,000. In December 2021 the SEC and FINRA approved the Form BDW filed by the Waddell & Reed broker-dealer, which terminated its broker-dealer registration with FINRA, all other self-regulatory organizations, the SEC and all jurisdictions on such date.

Our subsidiary, PTC, is also subject to various regulatory capital requirements. Failure to meet the respective minimum capital requirements can result in certain mandatory and discretionary actions by regulators that, if undertaken, could have substantial monetary and non-monetary impacts on PTC’s operations.

Debt and Related Covenants

The Credit Agreement and the Indentures 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 stockholders;

•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.

Our Credit Agreement and the Indentures allow us to pay dividends and distributions or repurchase our capital stock only when certain conditions are met. In addition, our revolving credit facility requires us to be in compliance with certain financial covenants as of the last day of each fiscal quarter. The financial covenants require the calculation of Credit Agreement EBITDA, as defined in, and calculated by management in accordance with, the Credit Agreement. The Credit Agreement defines Credit Agreement EBITDA as “Consolidated EBITDA,” which is Consolidated Net Income (as defined in the Credit Agreement) plus interest expense, tax expense, depreciation and amortization, and is further 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.

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As of December 31, 2021, we were in compliance with both financial covenants, a maximum Consolidated Total Debt to Consolidated EBITDA Ratio (as defined in the Credit Agreement) or “Leverage Ratio” and a minimum Consolidated EBITDA to Consolidated Interest Expense Ratio (as defined in the Credit Agreement) or “Interest Coverage”. The breach of these financial covenants would be subject to certain equity cure rights. The required ratios under our financial covenants and actual ratios were as follows:

See Note 11 - Corporate Debt and Other Borrowings, Net, within the notes to the consolidated financial statements for further detail regarding the Credit Agreement and the Indentures.

Contractual Obligations

The following table provides information with respect to our commitments and obligations as of December 31, 2021 (in thousands):

____________________

(1)Represents future payments under operating leases. See Note 12 - Leases, within the notes to the consolidated financial statements for further detail.

(2)Represents future payments under finance leases. See Note 12 - Leases, within the notes to the consolidated financial statements for further detail.

(3)Includes future minimum payments under service, development and agency contracts, and other contractual obligations. See Note 14 - Commitments and Contingencies, within the notes to the consolidated financial statements for further detail on obligations under non-cancelable service contracts.

(4)Represents principal payments on our corporate debt and other borrowings. The Company repaid $90.0 million in January 2022, which related to amounts outstanding under our external lines of credit at December 31, 2021. See Note 11 - Corporate Debt and Other Borrowings, Net, within the notes to the consolidated financial statements for further detail.

(5)Represents interest payments under our Credit Agreement, which include a variable interest payment for our senior secured credit facilities and a fixed interest payment for senior unsecured notes. Variable interest payments assume the applicable interest rates at December 31, 2021 remain unchanged. See Note 11 - Corporate Debt and Other Borrowings, Net, within the notes to the consolidated financial statements for further detail.

(6)Represents commitment fees for unused borrowings on the revolving credit facility under our Credit Agreement. See Note 11 - Corporate Debt and Other Borrowings, Net, within the notes to the consolidated financial statements for further detail.

As of December 31, 2021, we have a liability for unrecognized tax benefits of $57.0 million, which we have included in other liabilities in the consolidated statements of financial condition. This amount has been excluded from the contractual obligations table because we are unable to reasonably predict the ultimate amount or timing of future tax payments.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with GAAP, which requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We believe that of our critical accounting policies, the following are noteworthy because

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they require management to make estimates regarding matters that are uncertain and susceptible to change where such change may result in a material adverse impact on our financial position and reported financial results.

Revenue Recognition

Revenue is recognized when control of the promised service is transferred to customers in an amount that reflects the consideration that we expect to be entitled to in exchange for those services. Management exercises judgment to estimate revenue accruals. In particular, our trailing commission revenue, included in commission revenue on the consolidated statements of income, is generally received in arrears and therefore requires our management to estimate accrued amounts based on revenue received in prior periods, market performance and payment frequency of each product type or sponsor. See Note 2 - Summary of Significant Accounting Policies and Note 3 - Revenue, within the notes to the consolidated financial statements for more details on our policies and disclosures related to revenue.

Commitments and Contingencies

Liabilities related to loss contingencies are recognized when we believe it is probable a liability has occurred and the amount can be reasonably estimated by management. We have established an accrual for those legal proceedings and regulatory matters for which a loss is both probable and the amount can be reasonably estimated.

We also accrue for losses at our captive insurance subsidiary for those matters covered by self-insurance. Our captive insurance subsidiary records losses and loss reserve liabilities based on actuarially determined estimates of losses incurred, as well as specific reserves for proceedings and matters that are probable and estimable. Assessing the probability of a loss occurring and the timing and amount of any loss related to a legal proceeding or regulatory matter is inherently difficult and requires management to make significant judgments. For additional information, see Note 2 - Summary of Significant Accounting Policies and Note 14 - Commitments and Contingencies - “Legal & Regulatory Matters,” within the notes to the consolidated financial statements.

Valuation of Goodwill and Other Intangibles, Net

Goodwill is recognized as a result of business combinations and is measured as the excess of the purchase price over the fair value of the net assets acquired. The valuation of goodwill and other intangibles, net requires management to apply judgment and assumptions when estimating future earnings and performance. Management also applies judgment when testing for impairment of goodwill and other indefinite-lived intangible assets, including estimating fair values. Goodwill and other indefinite-lived intangible assets are tested annually for impairment in the fourth fiscal quarter and between annual tests if certain events occur indicating that the carrying amounts may be impaired.

Intangible assets that are deemed to have definite lives are amortized over their useful lives or the estimated period the intangible asset will provide economic benefit. Definite-lived intangible assets are reviewed for impairment when there is evidence that events or changes in circumstances indicate that the carrying amount may not be recoverable. For additional information on our policies and disclosures related to goodwill and other intangibles, net, see Note 2 - Summary of Significant Accounting Policies and Note 9 - Goodwill and Other Intangibles, Net within the notes to the consolidated financial statements.

Income Taxes

In preparing the consolidated financial statements, we estimate income tax expense based on various jurisdictions where we conduct business. This requires management to estimate current tax obligations and to assess temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. These temporary differences result in deferred tax assets and liabilities, which we must then assess the likelihood that the deferred tax assets will be realized. A valuation allowance is established to the extent that it is more likely than not that such deferred tax assets will not be realized. Changes in the estimate of tax assets and liabilities occur periodically due to changes in the tax rates, changes in the business operations, implementation of tax planning strategies, resolution with taxing authorities of issues where we had previously taken certain tax positions and newly enacted statutory, judicial and regulatory guidance. For more information on our policies and disclosures related to taxes, see Note 2 - Summary of Significant Accounting Policies and Note 13 - Income Taxes, within the notes to the consolidated financial statements.

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Recently Issued Accounting Pronouncements

Refer to Note 2 - Summary of Significant Accounting Policies, within the notes to the consolidated financial statements for a discussion of recent accounting pronouncements or changes in accounting pronouncements that are of significance, or potential significance, to us.