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Item 7. Management’s Discussion and Analysis

2021-02-23 compared with 2020-02-21 · 414 added, 237 removed, 218 unchanged (75% of the section changed)

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 of this Annual Report on Form 10-K.

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.

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We enable them to provide objective financial guidance to millions of American families seeking wealth management, retirement planning, financial planning and asset management solutions.

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.

Please consult Part I, “Item 1.

Business” for additional information related to our business activities.

Executive Summary

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Asset Growth Trends

Total brokerage and advisory assets served were $764.4 billion as of December 31, 2019 , up 21.7% from $628.1 billion as of December 31, 2018 .

Total advisory and brokerage assets served were $903.1 billion as of December 31, 2020, up 18.1% from $764.4 billion as of December 31, 2019.

Total net new assets were $60.2 billion for the year ended December 31, 2020, compared to $36.3 billion for the same period in 2019.

Net new advisory assets were $30.0 billion for the year ended December 31, 2019 , compared to $27.6 billion in 2018 .

As of December 31, 2019 , our advisory assets had grown to $365.8 billion from the prior year end balance of $282.0 billion and represented 47.8% of total advisory and brokerage assets served.

Net new brokerage assets totaled outflows of $3.4 billion for the year ended December 31, 2019 , compared to inflows of $24.1 billion in 2018 , driven by the onboarding of assets from our acquisition of the broker-dealer network of National Planning Holdings, Inc.

As of December 31, 2019 , our brokerage assets had grown to $398.6 billion from the prior year end balance of $346.0 billion .

Net new advisory assets were an inflow of $52.1 billion for the year ended December 31, 2020, compared to $34.3 billion in 2019.

As of December 31, 2020, our advisory assets had grown to $461.2 billion from the prior year end balance of $365.8 billion, an increase of 26.1%, and represented 51.1% of total advisory and brokerage assets served.

Net new brokerage assets were an inflow of $8.1 billion for the year ended December 31, 2020, compared to $2.0 billion in 2019.

As of December 31, 2020, our brokerage assets were $441.9 billion, up from $398.6 billion as of December 31, 2019, an increase of 10.9%.

Gross Profit Trends

Gross profit, a non-GAAP financial measure, of $2,172.2 million for the year ended December 31, 2019 , increased 11.5% from $1,947.7 million for the year ended December 31, 2018 .

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 provide useful insight in evaluating the Company’s core operating performance before indirect costs that are general and administrative in nature.

Gross profit, a non-GAAP financial measure, of $2,103.3 million for the year ended December 31, 2020, decreased 3.2% from $2,172.2 million for the year ended December 31, 2019.

Gross profit is calculated as total net revenues, less advisory and commission expenses and brokerage, clearing and exchange fees.

Management presents gross profit because we believe that measure may provide useful insight to investors in evaluating the Company’s core operating performance before indirect costs that are general and administrative in nature.

See footnote 9 to the Financial Metrics table within the “How We Evaluate Our Business” section for additional information on gross profit.

Stockholder Capital Returns

We returned $583.0 million of capital to stockholders during the year, including $82.6 million of dividends and $500.4 million of share repurchases, representing 6,418,542 shares.

Shareholder Capital Returns

We returned $229.1 million of capital to shareholders during the year ended December 31, 2020, including $79.1 million of dividends and $150.0 million of share repurchases, representing 1,809,553 shares.

COVID-19 Response

In response to the coronavirus disease 2019 (“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 substantial majority of employees to work remotely, implemented physical distancing and enhanced cleaning protocols throughout our corporate offices, and have worked closely with our vendors to maintain service continuity throughout the increased market volatility and operational volumes that occurred during the year.

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.

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 vehicles and money market programs and the access we provide to a variety of product providers with the following product lines:

We also generate asset-based revenues through our bank sweep vehicles and money market programs and the access we provide to a variety of product providers with the following product lines:

• Alternative Investments

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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 brokerage and advisory accounts.

How We Evaluate Our Business

We focus on several key metrics in evaluating the success of our business relationships and our resulting financial position and operating performance.

In April 2020, we updated our definition of net new assets to make our figures more comparable with other companies.

Our updated definition now includes dividends and interest, and subtracts advisory fees.

All net new asset figures below align with our new definition.

Our key operating, business and financial metrics are as follows:

Operating and Business Metrics (dollars in billions)

As of and for the Years Ended December 31,

Operating Metrics (dollars in billions) (1)

Advisory assets (2)(3)

$ 461.2 $ 365.8

Brokerage assets (2)(4)

Total Brokerage and Advisory Assets served (1)(4)

Total Advisory and Brokerage Assets (2)

$ 903.1 $ 764.4

Advisory Assets % of Total Advisory and Brokerage Assets 51.1 % 47.8 %

Net New Assets

Net new advisory assets (5)

$ 52.1 $ 34.3

Net new brokerage assets (6)

Total Brokerage and Advisory Net New Assets (4)

Total Net New Assets $ 60.2 $ 36.3

Organic Net New Assets (7)

Net new advisory assets $ 49.6 $ 33.3

Net new brokerage assets 6.6 0.2

Total Organic Net New Assets $ 56.2 $ 33.5

Total Organic Net New Assets Annualized Growth Rate (8)

Client Cash Balances (2)

Insured cash account balances $ 37.3 $ 24.4

Deposit cash account balances 8.2 5.0

Total Insured Sweep Balances (4)

Total Bank Sweep Balances 45.5 29.4

Money market account balances 1.5 1.9

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Total Client Cash Balances $ 48.9 $ 33.7

Years Ended December 31,

Financial Metrics (dollars in millions, except per share data)

Net Buy (Sell) Activity (9)

$ 34.3 $ 41.4

As of and for the Years Ended December 31,

Business and Financial Metrics (dollars in millions, except per share data) 2020 2019

Advisors 17,287 16,464

Average Total Assets per Advisor (10)

$ 52.2 $ 46.4

Employees 4,756 4,343

Share Repurchases $ 150.0 $ 500.4

Dividends $ 79.1 $ 82.6

% of Capital Returned to Shareholders (11)

44.0 % 96.1 %

Leverage Ratio (12)

For the Years Ended December 31,

Total net revenues $ 5,871.6 $ 5,624.9

Recurring gross profit rate (trailing twelve months) (7)

Pre-tax income

Earnings per share, diluted

Non-GAAP Financial Measures (8)

Net income $ 472.6 $ 559.9

Earnings per share (“EPS”), diluted $ 5.86 $ 6.62

EPS prior to amortization of intangible assets (13)

$ 6.46 $ 7.17

Gross Profit (14)

Gross profit growth from prior period (9)

Gross profit as a % of net revenue (9)

$ 2,103.3 $ 2,172.2

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, deposit cash account balances, money market account balances and purchased money market fund balances are also included in brokerage and advisory assets served.

$ 908.9 $ 1,036.1

EBITDA as a % of Gross Profit 43.2 % 47.7 %

Core G&A (16)

$ 925.1 $ 868.4

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(1) Totals may not foot due to rounding.

(2) Advisory and brokerage assets consists 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, deposit cash account balances, money market account balances and purchased money market fund balances are also included in total advisory and brokerage assets.

(3) Advisory assets consists of total advisory assets under custody at our broker-dealer subsidiary, LPL Financial LLC (“LPL Financial”).

See Results of Operations for a tabular presentation of advisory assets.

Brokerage assets consists of assets serviced by advisors licensed with LPL Financial.

Balances may not foot due to rounding.

Net new advisory assets consists of total client deposits into custodied advisory accounts less total client withdrawals from custodied advisory accounts.

Please consult the “Results of Operations” section for a tabular presentation of advisory assets.

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

(5) Net new advisory assets consists 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.

Net new brokerage assets consists of total client deposits into brokerage accounts less total client withdrawals from brokerage accounts.

Figures for net new advisory assets reported prior to April 2020 did not include dividends and interest or subtract advisory fees.

The figure previously reported for the year ended December 31, 2019 was an inflow of $30.0 billion.

(6) Net new brokerage assets consists 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.

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 asset-based revenues, advisory revenues, trailing commission revenues, and certain other fee revenues 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 other recurring 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

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.

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.

Our management uses 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.

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.

Figures for net new brokerage assets reported prior to April 2020 did not include dividends and interest.

The figure previously reported the year ended December 31, 2019 was an outflow of $3.4 billion.

(7) Consists of net new assets excluding the acquisitions of Lucia Securities, LLC and E.K.

Riley Investments, LLC.

Acquired assets include $2.5 billion of net new assets related to E.K.

Riley Investments, LLC in November 2020, $1.5 billion of net new assets from Lucia Securities, LLC in October 2020 and $2.8 billion of net new assets from Allen & Company in August 2019.

(8) Calculated as annualized current period organic net new assets divided by preceding period 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.

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.

(11) Percentage of capital returned to shareholders is calculated as the ratio of total shareholder capital returns per diluted share count to EPS prior to amortization of intangible assets.

EPS prior to amortization of assets is a non-GAAP financial measure.

For a reconciliation of EPS prior to amortization of intangible assets to the Company’s GAAP EPS for the periods presented, see footnote 13.

(12) A financial covenant from our credit agreement calculated as consolidated total debt to consolidated EBITDA.

Please consult the “Debt and Related Covenants” section for more information.

(13) EPS prior to amortization of intangible assets is a non-GAAP financial measure defined as GAAP EPS plus the per share impact of amortization of intangible assets.

The per share impact is calculated as amortization of intangible assets expense, net of applicable tax benefit, divided by the number of shares outstanding for the applicable period.

The Company presents EPS prior to amortization of intangible assets because management believes that the metric can assist investors in comparing our performance to that of other companies on a consistent basis without regard to certain items which do not directly affect our ongoing operating performance.

EPS prior to amortization of intangible assets is not a measure of the Company's financial performance under GAAP and should not be considered as an alternative to GAAP EPS or any other performance measure derived in accordance with GAAP.

Below is a reconciliation of EPS prior to amortization of intangible assets to the Company’s GAAP EPS for the periods presented:

Years Ended December 31,

EPS Reconciliation (in millions, except per share data) 2020 2019

GAAP EPS $ 5.86 $ 6.62

Amortization of intangible assets $ 67.4 $ 65.3

Tax benefit $ (18.9) $ (18.3)

Amortization of intangible assets, net of tax benefit $ 48.5 $ 47.0

Diluted share count 80.7 84.6

EPS impact $ 0.60 $ 0.56

EPS prior to amortization of intangible assets $ 6.46 $ 7.17

(14) Set forth below is a calculation of gross profit, calculated as total net revenues less advisory and commission 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 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.

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Total net revenues $ 5,871.6 $ 5,624.9

Commission and advisory expense

Advisory and commission expense 3,697.1 3,388.2

Brokerage, clearing and exchange fees 71.2 64.4

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$ 2,103.3 $ 2,172.2

Balances may not foot due to rounding.

Legal & Regulatory Matters

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(†) Totals may not foot due to rounding.

(15) EBITDA is a non-GAAP financial measure defined as net income plus interest and other expense, income tax expense, depreciation and amortization, and amortization of intangible assets.

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, or as an alternative to cash flows from operating activities as a measure of profitability or liquidity.

In addition, the Company’s EBITDA can differ significantly from EBITDA calculated by other companies, depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate, and capital investments.

Below is a reconciliation of EBITDA to net income for the periods presented:

Years Ended December 31,

EBITDA Reconciliation (in millions) 2020 2019

Net income $ 472.6 $ 559.9

Non-operating interest expense and other 105.8 130.0

Provision for income taxes 153.4 182.0

Depreciation and amortization 109.7 95.8

Amortization of intangible assets 67.4 65.3

Loss on extinguishment of debt — 3.2

EBITDA $ 908.9 $ 1,036.1

(16) Core G&A is a non-GAAP financial measure.

Core G&A consists of total operating expenses, excluding the following expenses:

advisory and commission, regulatory charges, promotional, employee share-based compensation, depreciation and amortization, amortization of intangible assets, and brokerage, clearing and exchange.

Management presents Core G&A because it believes Core G&A reflects the corporate operating 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 expenses, 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 operating expenses as calculated in accordance with GAAP.

Below is a reconciliation of Core G&A against the Company’s total operating expenses for the periods presented:

Years Ended December 31,

Operating Expense Reconciliation (in millions) 2020 2019

Core G&A $ 925.1 $ 868.4

Regulatory charges 29.4 32.3

Promotional 208.3 205.5

Employee share-based compensation 31.6 29.9

Total G&A 1,194.4 1,136.1

Advisory and commission 3,697.1 3,388.2

Depreciation and amortization 109.7 95.8

Amortization of intangible assets 67.4 65.3

Brokerage, clearing and exchange 71.2 64.4

Total operating expenses $ 5,139.8 $ 4,749.9

Legal and 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.

We review these items in the ordinary course of business in our effort to adhere to legal and regulatory requirements applicable to our operations.

Nevertheless, 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.

Nevertheless, additional regulation 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.

For additional information, see the “Risks Related to Our Regulatory Environment” and the “Risks Related to Our Business and Industry” sections within Part I, “Item 1A.

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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 our policy to evaluate these matters for potential legal 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.

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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.

For more information, see Note 2 .

Summary of Significant Accounting Policies - “ Commitments and Contingencies,” within the notes to the consolidated financial statements.

Assessing the probability of a loss occurring and the timing and amount of any loss related to a regulatory matter or a legal proceeding, whether or not covered by the Company’s captive insurance subsidiary, is inherently difficult and requires judgments based on a variety of factors and assumptions.

For more information, see Note 2 - Summary of Significant Accounting Policies - “ Commitments and Contingencies,” within the notes to the consolidated financial statements.

Assessing the probability of a loss occurring and the timing and amount of any loss related to a regulatory matter or legal proceeding, whether or not covered by our captive insurance subsidiary, is inherently difficult and requires judgments based on a variety of factors and assumptions.

There are particular uncertainties and complexities involved when assessing the adequacy of loss reserves for potential liabilities that are self-insured by our captive insurance subsidiary, which depends in part on historical claims experience, including the actual timing and costs of resolving matters that begin in one policy period and are resolved in a subsequent period.

Our accruals, including those established through the captive insurance subsidiary at December 31, 2019 , 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 that related to our historical compliance with certain state “blue sky” laws and resulted in aggregate fines of $26.4 million , all of which were covered by our captive insurance subsidiary loss reserves.

As part of the settlement structure, we engaged independent third party consultants to conduct a historical review of securities transactions and an operational review of our systems for complying with blue sky securities registration requirements, each of which has been completed.

We also agreed to offer customers remediation in the

form of reimbursement for any actual losses, plus interest.

As of the date of this annual report, customer remediation remains in process, although the cost is not expected to be material.

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 14 .

Commitments and Contingencies , within the notes to the consolidated financial statements.

Our accruals, including those established through our captive insurance subsidiary at December 31, 2020, include estimated costs for significant regulatory matters or legal proceedings, 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 that related to our historical compliance with certain state “blue sky” laws and resulted in aggregate fines of $26.4 million, the majority of which were covered by our captive insurance subsidiary loss reserves.

We also agreed to offer customers remediation in the form of reimbursement for any actual losses, plus interest, and these costs were not material.

The outcome of regulatory or legal proceedings 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 14 - Commitments and Contingencies, within the notes to the consolidated financial statements.

In June 2018, the U.S.

Court of Appeals for the Fifth Circuit issued a mandate invalidating regulations previously enacted by the U.S.

Department of Labor (“DOL”) that expanded the definition of “fiduciary” and would have resulted in significant new restrictions on our servicing of certain retirement plan accounts subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and individual retirement accounts (“IRAs”), including compliance with expanded prohibited transaction requirements under section 4975 of the Internal Revenue Code (the “DOL Rule”).

The DOL has indicated that it may propose a new fiduciary rule with regard to such accounts.

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.

Court of Appeals for the Fifth Circuit invalidated regulations previously enacted by the U.S.

Department of Labor (“DOL”) that expanded the definition of “fiduciary” and would have resulted in significant new prohibited transaction exemption requirements for our servicing of certain retirement plan accounts subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and individual retirement accounts (“IRAs”).

In December 2020, the DOL finalized a new investment advice fiduciary prohibited transaction exemption with regard to such accounts that became effective on February 16, 2021.

Because ERISA plans and IRAs comprise a significant portion of our business and 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.

In June 2019, the SEC adopted a new standard of conduct applicable to retail brokerage accounts (“Regulation BI”) with a compliance date of June 30, 2020.

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Certain state securities and insurance regulators have also adopted, proposed or are considering adopting similar laws and regulations.

In addition, it is unclear how and whether other regulators - banking regulators, and the state securities and insurance regulators - may respond to or attempt to enforce similar issues addressed by the former DOL Rule and Regulation BI.

Uncertainty regarding pending and future laws and regulations, including with regard to the implementation of Regulation BI, a potential new rule proposed by the DOL and state rules, relating to the standards of conduct applicable to both retirement and non-retirement accounts, may have impacts on our business in ways which cannot be anticipated or planned for, and which may have further impact on our products and services, and results of operations.

In addition, it is unclear how and whether other regulators, including banking regulators and state securities and insurance regulators, may respond to or attempt to enforce similar issues addressed by the newly proposed DOL Rule and Regulation BI.

As of June 30, 2020, we implemented new procedures in accordance with Regulation BI.

Future laws and regulations, including the new rule proposed by the DOL and state rules relating to the standards of conduct applicable to both retirement and non-retirement accounts, may affect our business in ways that cannot be anticipated or planned for, and may have negative impacts on our products, 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.

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.

In August 2019, we acquired all of the outstanding equity interests of Allen & Company of Florida, LLC (“Allen & Company”), a broker-dealer and registered investment adviser, for a total purchase price of $34.9 million.

Our recent acquisitions are as follows:

• Waddell & Reed Financial, Inc.

(“Waddell & Reed”) - In December 2020, we entered into an agreement with Macquarie Management Holdings, Inc.

(“Macquarie”) to acquire the wealth management business of Waddell & Reed upon completion of Macquarie’s acquisition of all of the issued and outstanding common shares of Waddell & Reed.

The transaction is expected to close in the middle of 2021, subject to satisfaction of closing conditions.

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

Riley Investments, LLC (“E.K.

Riley”) - In August 2020, we acquired business relationships with advisors from E.K.

Riley, a broker-dealer and registered investment adviser (“RIA”).

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

• Allen & Company of Florida, LLC (“Allen & Company”) - In August 2019, we acquired Allen & Company, an RIA.

Allen & Company advisors and staff became employees of the Company.

In December 2018, we acquired all of the outstanding common stock of AdvisoryWorld, a technology company, for a total purchase price of $28.1 million.

AdvisoryWorld provides proposal generation, investment analytics and portfolio modeling capabilities in the wealth management industry.

During 2017, LPL Financial paid $325.0 million to acquire certain assets and rights of NPH, including business relationships with financial advisors.

We completed the onboarding of NPH advisors and client assets in the first quarter of 2018.

Acquisitions , within the notes to the consolidated financial statements for further detail.

• AdvisoryWorld - In December 2018, we acquired AdvisoryWorld, a technology company that provides proposal generation, investment analytics and portfolio modeling capabilities in the wealth management industry.

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

Economic Overview and Impact of Financial Market Events

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financial markets.

According to the most recent estimate by the Bureau of Economic Analysis, real gross domestic product (“GDP”) grew at an annualized rate of 2.1% in the third quarter of 2019, with fourth quarter data consistent with continued growth at a similar rate, numbers that are roughly in line with the expansion average of 2.3%.

Growth has generally moderated over the last several quarters from growth of over 3% in mid-2018, due in part to headwinds from slower global growth, uncertainty around trade policy, and the declining impact of fiscal stimulus.

Forward expectations point to modest slowing in 2020:

the Federal Reserve’s (“Fed”) most recent median GDP projections, released following its December 10-11, 2019 policy meeting, put expected U.S.

growth at 2% in 2020, compared to 2.2% in 2019 (including fourth quarter projections).

economy continues to be supported by strong household spending, healthy labor markets, and low interest rates.

Business investment, however, has remained soft amid trade uncertainty and manufacturing has slowed.

Global growth, which has weakened over the past two years, has started to stabilize, while trade tensions have deescalated following the successful completion of an initial trade agreement between the United States and China.

Global economic conditions in the fourth quarter of 2020 continued to be dominated by the COVID-19 pandemic and the economic impact of containment efforts.

Significant mitigation efforts through supportive central bank policy (monetary stimulus) and government spending (fiscal stimulus) have helped the global and U.S.

economies take meaningful steps toward recovery, but the results have been uneven and uncertainty remains elevated in the near term.

The fall / winter surge in cases slowed fourth quarter growth after a strong rebound in the U.S.

economy in the third quarter, but the start of vaccine distribution increases the prospects of a more durable recovery emerging by the middle of 2021.

According to the most recent estimate by the U.S.

Bureau of Economic Analysis, the U.S.

economy contracted an annualized 31.4% in the second quarter of 2020, extending the recession that began in the first quarter, but then rebounded strongly, growing at an annualized 33.4% in the third quarter of 2020.

Data received during the fourth quarter of 2020 suggests that the U.S.

economy continued to expand, but at a much slower rate.

Despite growth slowing, there are continued signs of progress.

The unemployment rate, which had spiked to 14.8% in April 2020, has declined steadily to 6.7% in December 2020.

Consumer spending on goods has rebounded sharply, although spending on the services industries most impacted by COVID-19 remains depressed.

Business investment has continued to rebound and industrial production has strengthened but remains below pre-pandemic levels.

The Federal Reserve’s (“Fed”) most recent median gross domestic product projections, released following its December 15-16, 2020 policy meeting, saw the economy contracting 2.4% for all of 2020, a meaningful improvement from its September projection of a 3.7% contraction, followed by 4.2% growth in 2021.

Equity markets posted solid gains in the fourth quarter.

The S&P 500 Index returned 9.1% over the quarter, pushing its total return for the year to 31.5%.

The MSCI Emerging Markets Index outpaced the S&P 500 over the fourth quarter, while the MSCI EAFE Index, a broad index of stocks in foreign developed economies, trailed the United States.

Both international developed and emerging market stocks participated in a strong year overall for equities, but trailed U.S.

stocks by a wide margin, posting gains of 22.7% and 18.9%, respectively.

Bonds were near flat over the quarter hindered by a modest rise in yields, the benchmark 10-year Treasury yield climbing about 0.2% to just over 1.9% (bond prices rise when yields falls).

The broad Bloomberg Barclays U.S.

Aggregate Bond Index posted just a 0.2% gain over the fourth quarter, bringing its total return for the year to 8.7%.

The S&P 500 Index returned 12.2% for the quarter, bringing the full-year return to 18.4%.

Small cap stocks had a particularly strong quarter, as the Russell 2000 Index returned 31.4%.

stocks outperformed their U.S.

counterparts in the fourth quarter, led by emerging markets’ 19.8% return compared to 16.1% for developed international equities, based on the MSCI EM and MSCI EAFE Indexes.

The Bloomberg Barclays U.S.

Aggregate Bond Index returned 0.7% during the quarter, with rising interest rates weighing on returns but narrowing credit spreads helping corporate bonds.

The 10-year Treasury yield rose 0.24% over the fourth quarter, to end the quarter at 0.93%.

Nevertheless, 2020 was a solid year for bonds overall, with the U.S.

Aggregate Bond Index climbing 7.5%.

More economically sensitive bonds were rewarded in the fourth quarter, with the Bloomberg Barclays U.S.

High Yield Index climbing 6.5%.

Our business is also sensitive to current and expected short-term interest rates, which are largely driven by Fed policy.

The Fed held the target range for federal funds rate steady at 1.5% - 1.75% at its December 2019 meeting after lowering the range by 0.25% at each of its previous three meetings.

The policy statement released at the meeting’s conclusion characterized growth as rising at a moderate pace while removing language that appeared in the October 2019 statement that had highlighted uncertainty around the Fed’s outlook, signaling some decrease in concerns about downside risks.

While signaling an intention not to reduce rates further, at his press conference following the meeting Fed Chair Jerome Powell indicated he would want to see a rise in inflation that is “significant” and “persistent” before considering a rate increase in the future.

During the fourth quarter, Fed policymakers maintained the target range for the federal funds rate at 0.0 to 0.25%.

According to projection materials released following the conclusion of the December 15-16, 2020 policy meeting, the median expectation among meeting participants was that the Fed will not begin raising rates until after 2023, although one participant projected the Fed raising rates as early as 2022 and several in 2023.

The Fed also enhanced guidance on how long it would continue its bond purchase program at current levels, highlighting the need for “substantial further progress” toward inflation and unemployment goals.

The updated language signaled extended potential support for the economy.

Please consult the “Risks Related to Our Business and Industry” section within Part I, “Item 1A.

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Years Ended December 31,

(Dollars in thousands)

Percentage Change

(Dollars in thousands) 2020 2019 % Change

Advisory $ 2,327,519 $ 1,982,869 17.4 %

Commission 1,906,560 1,892,407 0.7 %

Asset-based 1,044,517 1,165,979 (10.4) %

Transaction and fee 506,071 480,328 5.4 %

Interest income, net of interest expense 29,412 46,508 (36.8) %

Other 57,561 56,765 (1.4) %

Total net revenues

Commission and advisory

5,871,640 5,624,856 4.4 %

Advisory and commission 3,697,147 3,388,186 9.1 %

Compensation and benefits 609,257 556,128 9.6 %

Promotional 208,250 205,537 1.3 %

Depreciation and amortization 109,732 95,779 14.6 %

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Communications and data processing 52,399 49,859 5.1 %

Other 101,018 114,546 (11.8) %

Total operating expenses

Non-operating interest expense

5,139,802 4,749,864 8.2 %

Non-operating interest expense and other 105,765 130,001 (18.6) %

Loss on extinguishment of debt — 3,156 100.0 %

INCOME BEFORE PROVISION FOR INCOME TAXES

626,073 741,835 (15.6) %

PROVISION FOR INCOME TAXES

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, 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.

Revenues , within the notes to the 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, included in our consolidated statements of income (dollars in thousands):

Years Ended December 31,

Total commission revenue

The increase in sales-based commission revenue in 2019 compared with 2018 was driven by market volatility that led to an increase in sales of mutual funds and fixed income, partially offset by a decrease in equities.

The decrease in trailing revenues in 2019 compared with 2018 was primarily due to market volatility impacting the underlying market value of mutual funds.

The following table summarizes activity in brokerage assets for the periods presented (in billions):

Years Ended December 31,

Beginning balance at January 1

Net new brokerage assets

Market impact (2)

Ending balance at December 31

153,433 181,955 (15.7) %

Includes assets attributable to the NPH acquisition.

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.

Advisory Revenues

Advisory revenues primarily represent fees charged on our corporate RIA platform provided to clients of our advisors based on the value of their advisory assets.

$ 472,640 $ 559,880 (15.6) %

Advisory revenues primarily represent fees charged to clients of our advisors for the use of our corporate RIA advisory platform, and are based on the value of their advisory assets.

Advisory fees are billed to clients in advance, on a quarterly basis, and are recognized as revenue ratably during the quarter.

The majority of our accounts are on a calendar quarter and are billed using values as of the last business day of the preceding quarter.

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 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 advisory platform are proposed by the advisor and agreed to by the client and average 1.0% of the underlying assets with a maximum of 2.5% of the underlying assets as of December 31, 2019 .

We also support separate investment adviser firms (“Hybrid RIAs”), through our independent 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 our brokerage and advisory assets, net new advisory assets, and advisory assets metrics.

The advisory revenue generated by a Hybrid RIA is not included in our advisory revenues, although we charge separate fees to Hybrid RIAs for technology, clearing, administrative, oversight, and custody services.

The administrative fees collected on our independent advisory platform vary and can reach a maximum of 0.2% of the underlying assets as of December 31, 2019 .

Advisory revenues collected on our corporate advisory platform are proposed by the advisor and agreed to by the client and averaged 1.0% of the underlying assets for the year ended December 31, 2020.

We also support separate investment adviser firms (“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 revenues.

We charge separate fees to Hybrid RIAs for technology, clearing, administrative, oversight and custody services, which are included in our transaction and fee revenues in our consolidated statements of income.

The administrative fees collected on our hybrid advisory platform vary and can reach a maximum of 0.2% of the underlying assets as of December 31, 2020.

The following table summarizes the composition of advisory assets for the periods presented (dollars in billions):

2020 2019 $ Change % Change

Corporate platform advisory assets

$ 291.9 $ 228.3 $ 63.6 27.9 %

Hybrid platform advisory assets

169.3 137.5 31.8 23.1 %

Total advisory assets

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.

$ 461.2 $ 365.8 $ 95.4 26.1 %

Net new advisory assets in a particular quarter drive advisory revenues in future quarters, due to billing quarterly in advance.

Therefore, the full impact of net new advisory assets to advisory revenues is not realized in the same period.

The following table summarizes activity in advisory assets for the periods presented (in billions):

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____________________

Includes assets attributable to the NPH acquisition.

(1) Net new advisory assets consists 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.

Previously reported figures for net new advisory assets did not include dividends and interest or subtract advisory fees.

The figure previously reported for the year ended December 31, 2019 was an inflow of $30.0 billion.

(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.

Net new advisory assets in a particular quarter drive advisory revenue in future quarters, due to our advanced quarterly billings.

Therefore, the full impact of net new advisory assets to advisory revenue is not realized in the same period.

The growth in advisory revenue from 2018 to 2019 was due to net new advisory assets resulting from our recruiting efforts and strong advisor productivity, as well as market gains as represented by higher levels of the S&P 500 index.

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 client cash programs.

We receive fees from certain financial product manufacturers in connection with sponsorship programs that support our marketing and sales education and training efforts.

The growth in advisory revenues from 2019 to 2020 was due to net new advisory assets resulting from the acquisitions and our recruiting efforts and strong advisor productivity, as well as market gains as represented by higher levels of the S&P 500 Index.

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, which are paid over time, are recurring in nature and are earned based on the market value of investment holdings in trail-eligible

We earn trailing commission revenues primarily on mutual funds and variable annuities held by clients of our advisors.

See Note 3 - Revenues, within the notes to the consolidated financial statements for further detail regarding our commission revenues by product category.

The following table sets forth our commission revenues included in our consolidated statements of income (dollars in thousands):

Years Ended December 31,

2020 2019 $ Change % Change

Sales-based $ 770,764 $ 782,852 $ (12,088) (1.5) %

1,135,796 1,109,555 26,241 2.4 %

Total commission revenues

$ 1,906,560 $ 1,892,407 $ 14,153 0.7 %

The decrease in sales-based commission revenues in 2020 compared to 2019 was primarily driven by the low interest rate environment impacted by the COVID-19 pandemic, which led to a decrease in sales of annuities, partially offset by an increase in sales of equities.

The increase in trailing commission revenues in 2020 compared to 2019 was primarily due to the increase in value of annuities as a result of the market increases during the second half of the year, partially offset by the decline in value of other trail eligible assets as a result of the market downturn during the first quarter of 2020.

The following table summarizes activity in brokerage assets for the periods presented (in billions):

Years Ended December 31,

Beginning balance at January 1 $ 398.6 $ 346.0

Net new brokerage assets (1)

Market impact (2)

Ending balance at December 31 $ 441.9 $ 398.6

____________________

(1) Net new brokerage assets consists 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.

Previously reported figures for net new brokerage assets did not include dividends and interest or subtract advisory fees.

The figure previously reported for the year ended December 31, 2019 was an outflow of $3.4 billion.

We are uncertain, as of the date of this Annual Report on Form 10-K, of the effect of the COVID-19 pandemic on our future commission revenues.

We cannot predict how the ongoing COVID-19 pandemic and foreign and domestic responses to it will impact our future sales-based or trailing commission revenues.

While domestic equity markets have started to recover, COVID-19 cases remain widespread in the United States and many other parts of the world, and significant market disruptions and volatility remain possible.

Asset-based revenues consist of fees from omnibus processing and networking services (collectively referred to as “recordkeeping”), our sponsorship programs with financial product manufacturers and fees from our client cash programs.

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.

Client cash-based revenues are generated on advisors’ clients’ cash balances in insured sweep accounts and money market programs at various banks.

We receive fees from certain financial product manufacturers in connection with sponsorship programs that support our marketing and sales education and training efforts.

Client cash-based revenues are generated on advisors’ clients’ cash balances in insured bank sweep accounts and money market programs.

Pursuant to contractual arrangements, we receive fees based on account type and invested balances for administration and recordkeeping.

Asset-based revenues for the year ended December 31, 2019 increased by $193.5 million compared to the same period in 2018 , primarily due to increased revenues from our client cash programs, sponsorship programs and recordkeeping revenues.

Client cash revenues for the year ended December 31, 2019 increased compared to the same period in 2018 due to an increase in cash balances and the impact of a higher federal funds effective rate during the first half of 2019 offset by a decrease in the second half of 2019 .

Asset-based revenues for the year ended December 31, 2020 decreased by $121.5 million compared to 2019, primarily due to decreased revenues from our client cash programs, partially offset by an increase in recordkeeping revenues and sponsorship programs.

Revenues for our recordkeeping and sponsorship programs for the year ended December 31, 2020, which are largely based on the market value of the underlying assets, increased compared to 2019 due to the impact of market appreciation on the value of the underlying assets.

Client cash revenues for the year ended December 31, 2020 decreased compared to 2019 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, 2020, our average client cash balances increased to $44.7 billion compared to $31.0 billion for the year ended December 31, 2019.

Revenues for our recordkeeping and sponsorship programs for the year ended December 31, 2019 , which are largely based on the market value of the underlying assets, increased compared to the same period in 2018 due to the impact of market appreciation on the value of the underlying assets.

Transaction and Fee Revenues

Transaction and Fee

Transaction revenues primarily include fees we charge to our advisors and their clients for executing certain transactions in brokerage and fee-based advisory accounts.

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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 for the year ended December 31, 2019 increased by $9.0 million compared to the same period in 2018 , primarily due to the expansion of advisor and client-based fee revenue driven by advisor growth, offset by a decrease in revenue generating trade volumes.

Transaction and fee revenues for the year ended December 31, 2020 increased by $25.7 million compared to 2019, primarily due to increased transaction volume in response to the market volatility caused by the COVID-19 pandemic, partially offset by a decrease in conference service revenues as a result of advisor-related conferences being cancelled or held in a virtual format in 2020 in response to the COVID-19 pandemic.

Interest Income, Net of Interest Expense

We earn interest income from client margin accounts and cash equivalents, net of operating expense.

Period-over-period variances correspond to changes in the average balances of assets in margin accounts and cash equivalents as well as changes in interest rates.

Interest Income, net of interest expense for the year ended December 31, 2019 increased by $6.3 million compared to the same period in 2018 , primarily due to the increased client cash balances and higher average interest rates in 2019 .

Other Revenues

We earn interest income from client margin loans and cash equivalents, net of interest expense.

Period-over-period variances correspond to changes in the average balances of margin loans and cash equivalents as well as changes in interest rates.

Interest income, net of interest expense for the year ended December 31, 2020 decreased by $17.1 million compared to 2019, primarily due to lower average interest rates.

Other revenues primarily include mark-to-market gains or losses on assets held by us in our advisor non-qualified deferred compensation plan and model research portfolios, 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 and other miscellaneous revenues.

Other revenues for the year ended December 31, 2019 increased by $65.6 million compared to the same period in 2018 , primarily due to unrealized gains 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, and increases in dividend income on assets held in our advisor non-qualified deferred compensation plan.

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;

production based 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.

Other revenues for the year ended December 31, 2020 increased by $0.8 million compared to 2019, primarily due to realized and unrealized gains 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, partially offset by decreases in dividend income on assets held in our advisor non-qualified deferred compensation plan.

Advisory and Commission

Advisory and commission expenses consist of the following:

base payout amounts that are earned by and paid out to advisors and institutions based on advisory and commission revenues earned on each client’s account;

production based bonuses earned by advisors and institutions based on the levels of advisory and commission 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 grant date;

and the deferred advisory and commissions 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 payout ratio, which is a statistical or operating measure:

Years Ended December 31,

2020 2019 Change

Base payout rate (1)

Production based bonuses

82.22 % 83.05 % (83) bps

Production based bonuses 3.90 % 3.22 % 68 bps

Total payout ratio (2)

86.12 % 86.27 % (15) bps

____________________

Our base payout rate is calculated as commission and advisory expenses less production based bonuses and mark-to-market gains or losses on the non-qualified deferred compensation plan, divided by commission and advisory revenues.

Our total payout ratio, a statistical or operating measure, increased for the year ended December 31, 2019 compared with the same period in 2018 , primarily due to an increase in production based bonuses, driven by broader price reductions on our corporate advisory platform.

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.

(1) Our base payout rate is calculated as advisory and commission expenses less production based bonuses and mark-to-market gains or losses on the non-qualified deferred compensation plan, divided by advisory and commission revenues.

(2) Totals may not foot due to rounding.

Our total payout ratio decreased slightly for the year ended December 31, 2020 compared to 2019, primarily due to a decrease in base payout rate, which was driven by increases in the sale of equities and a shift from brokerage to advisory business, each of which results in lower payouts, partially offset by an increase in production based bonuses, which was driven by broader price reductions on our corporate advisory platform.

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 employees and contractors.

The following table sets forth our average number of employees for the year ended December 31, 2020 as compared to 2019.

Years Ended December 31,

2020 2019 % Change

Average number of employees 4,560 4,327 5.4%

Compensation and benefits for the year ended December 31, 2019 increased by $49.5 million compared to the same period in 2018 , primarily due to an increase in salary and employee benefit expenses resulting from an increase in headcount.

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 and retention, such as transition assistance and expenses associated with loans issued to advisors.

Promotional expense for the year ended December 31, 2019 decrease d by $3.1 million compared to the same period in 2018 , primarily due to higher 2018 recruiter and advisor costs related to the onboarding of advisors from NPH, offset by an increase in expense associated with advisor loans.

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 for the year ended December 31, 2019 increased by $8.1 million compared to the same period in 2018 , primarily due to increases in internally developed software and computers, partially offset by decreases in building depreciation.

Compensation and benefits for the year ended December 31, 2020 increased by $53.1 million compared to 2019, primarily due to an increase in salary and employee benefit expenses resulting from an increase in headcount.

Promotional expenses include 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, 2020 promotional expenses increased by $2.7 million compared to 2019, primarily due to an increase in costs associated with advisor loans, which are driven by larger recruitment and retention, partially offset by a decrease in advisor conference expenses due to conferences being cancelled or held in a virtual format in 2020 in response to the COVID-19 pandemic.

Depreciation and Amortization

Depreciation and amortization relates to the use of fixed assets, which include internally developed software, hardware, leasehold improvements and other equipment.

Depreciation and amortization for the year ended December 31, 2020 increased by $14.0 million compared to 2019, primarily due to an increase in internally developed software.

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.

Amortization of intangible assets for the year ended December 31, 2019 increased by $5.1 million compared to the same period in 2018 , primarily due to the intangible assets recorded as part of the AdvisoryWorld and Allen & Company acquisitions.

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.

Occupancy and equipment expense for the year ended December 31, 2019 increased by $20.6 million compared to the same period in 2018 , primarily due to an increase in costs related to software licensing fees in support of our service and technology investments.

Amortization of intangible assets relates to intangible assets established through our acquisitions.

Amortization of intangible assets for the year ended December 31, 2020 remained relatively flat compared to 2019.

Occupancy and Equipment

Occupancy and equipment expenses include the costs of leasing and maintaining our office spaces, software licensing and maintenance costs and maintenance expenses on computer hardware and other equipment.

For the year ended December 31, 2020 occupancy and equipment expenses increased by $30.2 million compared to 2019, primarily due to an increase in costs related to 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.

Professional services for the year ended December 31, 2019 decrease d by $11.8 million compared to the same period in 2018 , primarily due to a decrease in non-capitalized costs related to our service and technology projects during the period.

Professional services expenses include 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.

Professional services expenses for the year ended December 31, 2020 decreased by $16.8 million compared to 2019, primarily due to the Company temporarily bringing certain services in-house as a result of the COVID-19 pandemic.

Brokerage, Clearing and Exchange Fees

Brokerage, clearing and exchange fees include expenses originating from trading or 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.

Brokerage, clearing, and exchange fees remained relatively flat for the year ended December 31, 2019 compared to the same period in 2018 .

These fees fluctuate largely in line with the volume of sales and trading activity.

Brokerage, clearing and exchange fees increased by $6.7 million for the year ended December 31, 2020 compared to 2019, primarily due to an increase in the volume of sales and trading activity.

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 year ended December 31, 2019 compared to the same period in 2018 .

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.

Communications and data processing expenses consist 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 remained relatively flat for the year ended December 31, 2020 compared to 2019.

Other expenses include 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 expenses 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.

There are particular uncertainties and complexities involved when assessing the potential costs and timing of regulatory matters, including the adequacy of loss reserves for potential liabilities that are self-insured by our captive insurance subsidiary.

Other expenses for the year ended December 31, 2019 decrease d by $4.7 million compared to the same period in 2018 , primarily driven by lower costs associated with investigation and settlements and lower insurance costs.

Other expenses for the year ended December 31, 2020 decreased by $13.5 million compared to 2019, primarily due to a decrease in travel expenses as a result of the COVID-19 pandemic and lower costs associated with the investigation of regulatory matters.

Non-Operating Interest Expense and Other

Non-operating interest expense and other represents expense from our senior secured credit facilities, senior unsecured notes, finance leases and other non-operating expenses.

Period over period increases correspond to higher LIBOR rates.

Non-operating interest expense and other represents expenses from our senior secured credit facilities, senior unsecured notes, finance leases and other non-operating expenses.

Non-operating interest expense and other for the year ended December 31, 2020 decreased by $24.2 million compared to 2019, primarily due to a lower outstanding principal balance and a lower interest rate on our senior secured term loan, partially offset by the issuance of additional senior unsecured notes in 2019.

Loss on Extinguishment of Debt

On November 12, 2019, we closed a refinancing transaction pursuant to which we increased the borrowing capacity of our existing senior revolving credit facility, issued senior unsecured high yield notes and paid down a portion of our senior secured term loan B (“Term Loan B”).

In connection with the refinancing, we accelerated the recognition of $3.2 million of unamortized debt issuance costs as a loss on extinguishment of debt.

On November 12, 2019, we closed a refinancing transaction and accelerated the recognition of $3.2 million of unamortized debt issuance costs as a loss on extinguishment of debt.

There were no refinancing transactions during the year ended 2020.

Provision for Income Taxes

Our effective income tax rate was 24.5% and 25.8% for 2019 and 2018 , respectively.

The decrease in our effective income tax rate for the year ended December 31, 2019 compared to the same period in 2018 was mainly due to a decrease in non-deductible expenses.

Our effective income tax rate remained consistent at 24.5% for the year ended December 31, 2020 and 2019.

COVID-19 Impact

On March 11, 2020, the World Health Organization designated the spread of the 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 the COVID-19 pandemic.

Liquidity and Capital Resources

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Financing activities (275,186) (533,225)

Net decrease in cash and cash equivalents

Net increase (decrease) in cash, cash equivalents and restricted cash

327,256 (90,341)

Cash, cash equivalents and restricted cash — beginning of year 1,471,778 1,562,119

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Cash requirements and liquidity needs are primarily funded through our cash flow from operations and our capacity for additional borrowing.

Net cash provided by operating activities includes net income and adjustments for non-cash expenses, 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 provided by operating activities for 2019 compared to 2018 was primarily due to increases in net income, cash provided by payables to client, receivables from clients and accounts payable and accrued liabilities, partially offset by an increase in outflows from advisor loans.

The increase in cash flows used in investing activities for 2019 compared to 2018 was primarily attributable to an increase in capital expenditures.

The increase in cash flows used in financing activities for 2019 compared to 2018 was primarily attributable to an increase in repurchases of our common stock, offset by proceeds from our revolving line of credit.

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, the revolving credit facility established through our senior secured credit agreement (the “Credit Agreement”) and the committed revolving credit facility of LPL Financial, 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 related 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.

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.

Net cash flows provided by operating activities includes net income and adjustments for non-cash expenses;

changes in operating assets and liabilities, including balances related to the settlement and funding of client transactions;

receivables from product sponsors;

and accrued advisory and commission expenses due to our advisors.

In addition to net income, 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 provided by operating activities for 2020 compared to 2019 was primarily due to increases in inflows to receivables from and payables to clients, partially offset by a decrease in net income.

The increase in cash flows used in investing activities for 2020 compared to 2019 was primarily attributable to increases in acquisition costs and purchases of held-to-maturity securities.

The decrease in cash flows used in financing activities for 2020 compared to 2019 was primarily attributable to the suspension of repurchases of our common stock, partially offset by repayments of our revolving line of credit.

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 senior secured credit agreement (the “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.

The following table presents our external lines of credit at December 31, 2020 (dollars in millions):

Description Borrower Maturity Date Outstanding Available

Senior secured, revolving credit facility LPL Holdings, Inc.

November 2024 $ — $ 750

Broker-dealer revolving credit facility LPL Financial LLC July 2024 $ — $ 300

Secured, uncommitted lines of credit LPL Financial LLC March 2022 $ — $ 75

Unsecured, uncommitted lines of credit LPL Financial LLC September 2021 $ — $ 75

Unsecured, uncommitted lines of credit LPL Financial LLC September 2021 $ — $ 50

Unsecured, uncommitted lines of credit LPL Financial LLC None $ — $ 75

Secured, uncommitted lines of credit LPL Financial LLC None $ — unspecified

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 long-term borrowings is 2025 and our revolving credit facilities mature in 2024, which makes us less dependent on capital markets in the near-term.

We have certain capital adequacy requirements related to our registered broker-dealer subsidiary and bank trust subsidiary.

As of December 31, 2020, we were in compliance with all such requirements.

Share Repurchases

We engage in share repurchase programs, which are approved by our board of directors (the “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 indentures governing our senior unsecured notes (the “Indentures”), and general liquidity needs.

See Note 15 .

Stockholders’ Equity , within the notes to the consolidated financial statements for additional information regarding our share repurchases.

Purchases may be effected in open market or privately negotiated transactions.

We suspended share repurchases in early 2020 in light of the business and financial uncertainties created by the COVID-19 pandemic.

The resumption, timing and amount of future share repurchases, if any, will be determined at our discretion within the constraints of our Credit Agreement, the indentures governing our senior unsecured notes (the “Indentures”) 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.

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.

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

Operating Capital Requirements

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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 LPL Financial or under one of our revolving credit facilities.

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 under one of our revolving credit facilities.

LPL Financial is subject to the Securities and Exchange Commission’s (“SEC”) 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.

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, 2020, LPL Financial had net capital of $119.0 million with a minimum net capital requirement of $11.1 million.

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(“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.

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

See Note 11 .

Debt , within the notes to the consolidated financial statements for further detail regarding the Credit Agreement and the Indentures.

The Credit Agreement and the Indentures contain a number of covenants that, among other things, restrict, subject to certain exceptions, our ability to:

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• create liens;

• sell assets;

• guarantee indebtedness;

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• consolidate, merge or transfer all or substantially all of our assets.

Our Credit Agreement and the Indentures 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 certain financial covenants as of the last day of each fiscal quarter.

The financial covenants require the calculation of Credit Agreement EBITDA, 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 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.

As of December 31, 2019 we were in compliance with both of our financial covenants, 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).

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 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.

As of December 31, 2020, 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.

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December 31, 2020

Financial Ratio

Covenant Requirement

Leverage Test (Maximum)

Financial Ratio Covenant Requirement Actual Ratio

Leverage Ratio (Maximum) 5.0 2.16

Interest Coverage (Minimum) 3.0 9.81

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

Off-Balance Sheet Arrangements

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These arrangements include Company commitments to extend credit.

For information on these arrangements, see Note 14 .

Commitments and Contingencies and Note 21 .

Financial Instruments with Off-Balance-Sheet Credit Risk and Concentrations of Credit Risk, within the notes to consolidated financial statements.

For information on these arrangements, see Note 14 - Commitments and Contingencies and Note 21 - Financial Instruments with Off-Balance-Sheet Credit Risk and Concentrations of Credit Risk, within the notes to the consolidated financial statements.

Contractual Obligations

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Payments Due by Period

Total < 1 Year 1-3 Years 3-5 Years > 5 Years

Operating leases (1)

$ 185,905 $ 22,025 $ 44,799 $ 43,748 $ 75,333

Finance leases (2)

269,480 9,735 17,379 17,606 224,760

Purchase obligations (3)

105,528 47,187 44,755 13,258 328

Long-term borrowings (4)

2,359,300 10,700 21,400 921,400 1,405,800

Interest payments (5)

502,855 90,279 179,950 179,137 53,489

Commitment and other fees (6)

11,397 3,002 6,005 2,390 —

Total contractual cash obligations $ 3,434,465 $ 182,928 $ 314,288 $ 1,177,539 $ 1,759,710

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(1) Represents future payments under operating leases.

See Note 12 .

Leases within the notes to the consolidated financial statements for further detail.

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.

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 consolidated financial statements for further detail on obligations under noncancelable service contracts.

See Note 14 - Commitments and Contingencies , within the notes to the consolidated financial statements for further detail on obligations under noncancelable service contracts.

(4) Represents principal payments under our Credit Agreement.

This also includes $45.0 million borrowings under the revolving credit facility.

See Note 11 .

Debt , within the notes to consolidated financial statements for further detail.

Represents interest payments under our Credit Agreement, which includes a variable interest payment for our senior secured credit facilities and a fixed interest payment for senior unsecured notes.

See Note 11 - Long-term and Other Borrowings , 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, 2020 remain unchanged.

See Note 11 .

Debt , within the notes to consolidated financial statements for further detail.

Represents commitment fees for unused borrowings on the revolving credit facility under our Credit Agreement and interest payments for our letters of credit.

See Note 11 .

Debt , within the notes to consolidated financial statements for further detail.

See Note 11 - Long-term and Other Borrowings , 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 - Long-term and Other Borrowings , within the notes to the consolidated financial statements for further detail.

As of December 31, 2020, we have a liability for unrecognized tax benefits of $54.4 million, which we have included in income taxes payable in the consolidated statements of financial condition.

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We use fair value measurements to record certain financial assets and liabilities at fair value and to determine fair value disclosures.

Fair Value Measurements, within the notes to the consolidated financial statements for a detailed discussion regarding our fair value measurements.

See Note 5 - Fair Value Measurements, within the notes to the consolidated financial statements for a detailed discussion regarding our fair value measurements.

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 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:

We believe that of our critical accounting policies, the following are noteworthy because 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

Revenues are 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 revenues, included in commission revenues on the consolidated statements of income, are generally received in arrears and therefore require our management to estimate accrued amounts based on revenues 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 - Revenues , within the notes to the consolidated financial statements for more details on our policies and disclosures related to revenues.

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 Intangible Assets

Summary of Significant Accounting Policies, within the notes to the consolidated financial statements for discussion of each of these accounting policies.

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 intangible assets 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 intangible assets, see Note 2 - Summary of Significant Accounting Policies and Note 9 - Goodwill and Other Intangible Assets , within the notes to the consolidated financial statements.

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.

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.

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.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis