LPL Financial Holdings Inc (LPLA) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the LPL Financial Holdings third-quarter earnings conference call.

At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Trap Kloman, head of Investor Relations. Please go ahead.

Thank you. Good morning and welcome to the LPL Financial third-quarter earnings conference call. On the call today is Mark Casady, our Chairman and Chief Executive Officer, who will provide his perspective on our performance. Following his remarks, Dan Arnold, our Chief Financial Officer, will speak to our financial results and capital deployment. Following the introductory remarks, we will open the call for questions. We would appreciate it if each analyst would ask no more than two questions each.

Please note that we have posted a financial settlement on the Events section of the Investor Relations page on LPL.com.

Before turning the call over to Mark, I would like to note that comments made during this conference call may incorporate certain forward-looking statements. This may include statements concerning such topics as earnings growth targets, operational plans and other opportunities we foresee. Underpinning these forward-looking statements are certain risks and uncertainties. We refer our listeners to the Safe Harbor disclosures contained in the earnings release and our latest SEC filings to appreciate those factors that may cause results to differ from those contemplated in such forward-looking statements.

In addition, comments during this call will include certain non-GAAP financial measures governed by SEC Regulation G. For a reconciliation of these measures, please refer to our earnings press release. With that, I'll turn the call over to Mark Casady.

Thank you Trap. And thank you, everyone, for joining today's call. This quarter's strong revenue growth and ongoing share repurchases contributed to adjusted earnings per share growing 19% year-over-year to $0.56 per share. Revenue grew 16% year-over-year driven by improved advisor productivity as annualized commissions per advisor reached $156,000 and net new advisory assets were a record $4 billion.

Our results were further aided by our continued success in supporting and retaining our existing advisors, reflected by our year-to-date production retention of 97%. As a result, through the dedicated effort of our advisors and employees, we crossed a notable milestone this quarter, exceeding $400 billion in advisory and brokerage assets.

The rate of net new advisor growth improved after a subdued first half of the year. Advisor headcount increased by 154 net new advisors over the past three months, and 393 over the past 12 months, demonstrating the quality of our offering, and advisors sustaining desire to migrate to an independent business model. Our pipeline remains strong and we are optimistic about the remainder of the year.

Turning to our G&A, we experienced a sequential increase in expenses this quarter, primarily due to an increase in regulatory investment and an elevated level of discrete expenses that were incurred in September that will not remain in our expense base going forward. We remain committed to managing our costs and strive to realize the scalability of our platform to drive bottom-line growth to create shareholder value. Dan will share greater detail on the drivers behind our expense growth.

Our capital light business model continued to generate robust free cash flow with which we repurchased 3.3 million shares in the third quarter and paid $20 million in dividends. Since our IPO, we have invested $472 million in capital to repurchase 14.3 million shares at a weighted average price of $32.94.

I'd like to now share insight into how our investments to enhance productivity and growth in the business are progressing. This quarter, we made the decision to close our NestWise operations. We recognize that the amount of investment relative to the trajectory of growth was not in line with our expectations. We will look to leverage the knowledge and tools we gain from this experience as we seek alternative methods to effectively train advisors. The closing of NestWise occurred late in the quarter third quarter, and so we will realize incremental expense savings of approximately $2 million in the fourth quarter.

I'm pleased to report that our investment in our retirement plan capabilities is driving success for our advisors in the marketplace. Year-to-date, we have attracted $11.6 billion in new retirement plan assets raising the total to over $92 billion. These assets are incremental to the $415 billion of retail client assets for which we provide custody and clearing services today. The key to our strategy is to generate incremental revenue from these retirement plan assets in addition to the plan sponsored fees we receive.

In order to create value for all parties and capitalize on these assets, we developed our Worksite Financial Solutions program. This program enables participants in employer-sponsored retirement programs to receive tailored financial advice and education throughout their employment careers and beyond for a fee. We see opportunity for our advisors to expand the value they provide to their 3 million participants and over 32,000 plans that could benefit from this program.

Further, when participants exit from these defined contributions plans, there is a unique opportunity to provide advice on the various alternatives available. Our IRA rollover program was recently launched and currently over 190 company plans with $2 billion in assets have enrolled. To date, the program has referred over $15 million in assets to our advisors, who are turning these referrals into new accounts at LPL at a capture rate of approximately 35%.

Finally, the broadening of our footprint in the retire plan marketplace has allowed us to significantly increase our recruitment of retirement plan advisors who previously would not have considered LPL. While we are in the early stages of our retirement plan strategy, we see this as a smart and profitable approach to growing the business with near-term benefits and long-term opportunity, creating value for shareholders.

Turning to our efforts in the high net worth and RIA space, we continue to make progress evolving Fortigent's value proposition. This quarter, we launched a new integrated platform which links Fortigent research offerings, portfolio management, and performance reporting tools into a consolidated workflow solution. By combining the online service offerings into a single unified end-to-end platform, Fortigent can now provide advisors with the full range of tools and technology necessary to serve the entire spectrum of high net worth clients' needs. At the same time, Fortigent is able to enhance its recurring revenue streams. Since launching the platform on July 15, 2013, Fortigent has already added four new advisor practices and has shifted over $700 million of existing client assets to the new platform.

I will now turn to an update on our service value commitment, which is about creating a more efficient operating environment, allowing us to commit capital and resources effectively to areas where we differentiate ourselves and generate positive returns. This also builds the conditions for a sustainable cost structure that can thrive with normalized expense growth while fully supporting the evolution of the business.

Savings are already being derived by the launch of our outsourcing relationship with Accenture, and implementation of foundational changes to our technology platform. To date, we have successfully transferred certain functions in finance and insurance processing. By year-end, we expect Accenture to add activities and compliance in other back-office support areas. We expect to achieve our full savings target of approximately $30 million to $35 million in 2015.

I will now provide a brief update on the pace and approach we are taking to evaluate the bank opportunity. As indicated, this process will take months, not weeks, to properly analyze due to the complexity of operating a bank in today's regulatory environment and the impact this may have on our capital structure. We have a dedicated group of employees partnering with outside subject matter experts to fully inform our view. We will provide insight into our diligence process by early 2014.

Finally, this August, we hosted over 5000 attendees at our annual advisor conference in San Diego, the largest of its kind in the industry. We utilize this conference to reinforce our strategy and the broad rollout of several new technologies that we have previously highlighted. These technologies represent the investment we have been making in the business, and now create the opportunity for advisors to drive productivity in their businesses. These new technology resources include an enhanced trading and rebalancing platform which will drive greater efficiency in the advisor's office and propel transaction volumes.

We propelled LPL to the forefront of mobile technology with the launch of our new Account View, which help strengthen the relationship and conductivity between advisor and client. We are also the first independent broker-dealer to introduce remote deposit which will increase advisor efficiency and cut costs. I'm excited by the opportunities before us to deliver a differentiated solution and support the growth of our advisors.

With that, I'll turn the call over to our CFO, Dan Arnold, who will review our financial results and outlook in greater detail.

Thanks Mark. This morning, I'll be discussing four main themes. First, I'll address our strong topline results for the quarter and highlight the fundamental drivers behind our growth. Second, I'll review various components of our expense structure. Next, I'll discuss our profitability as measured by adjusted EBITDA and adjusted earnings per share. Lastly, I'll conclude my remarks with insight into our capital management.

In the third quarter, we generated record revenue of $1.1 billion, representing 16% growth year-over-year. Total brokerage and advisory assets rose 12% to a record $415 billion, or $31 million per advisor. This growth was driven by increasing advisor productivity, improving equity market levels, and accelerating production of 393 net new advisors added over the last 12 months.

The advisory asset growth and commission related activities contributed to gains in advisor productivity. The strength and flexibility of our corporate advisory and independent RIA solutions are clear as over 50% of gross sales now float to advisory accounts. As a result, net advisory flows in the third quarter grew to a record $4 billion or 11% annualized growth.

In the quarter, annualized commissions per advisor were $156,000, an increase of $4000 over the second quarter. Commissions from alternative investments grew 75% sequentially, which contributed to this growth and mitigated the summer slowdown in commissions that we typically experience in the third quarter. This activity also contributed to a lift in other revenue which was up 76% sequentially to $21 million as a result of marketing reallowances we receive from product manufacturers related to non-traded REIT sales.

The increase in alternative investment sales occurred as several large non-traded REITs held by our customers became publicly traded equities. As a result, those investors who held these securities as an income producing alternative investment class opted to rebalance their portfolios by divesting of their REIT equity positions and purchasing new income producing non-traded REITs.

We expect strong sales of non-traded REITs to continue through the fourth quarter and into next year. However, it is unlikely this level of activity in non-traded REITs will be maintained over the long-term.

Asset-based fees grew 7% year-over-year to $107 million. This growth was due to sponsor revenue increasing 19%, but then partially offset by cash sweep revenues declining by 15% due to interest rate pressure. The pressure on rates overall was driven by several macroeconomic factors, including reduced borrowing by the federal government and corporations taking advantage of low interest rates to finance debt through longer-term facilities. As a result, there is simply more short-term liquidity in the marketplace. Due to this liquidity, the effective funds rate declined year-over-year 6 basis points to nine. Thus the decline in Fed funds reduced fees on our ICA product by 6 basis points and contributed to a reduction in our money market fund fees from 12 to 6 basis points. The impact of the decline in the effective funds rate and the fee compression on our bank contracts in our ICA program lowered the ICA fee for the quarter to 65 basis points from 88 basis points in the prior year.

We continue to retain the upside when the Fed funds rate increases. For example, if the Fed funds rate increases to approximately 2.5%, we would optimize our cash sweep rate, generating incremental revenue and pretax earnings of approximately $240 million.

I'd like to now focus on our expenses, including our payout rate, trends in our core expenses, promotional expenses for the quarter, and those expenses in our GAAP results that we exclude from our determination of adjusted earnings.

Our third-quarter payout rate was up 28 basis points year-over-year to 87.7%. The growth in production expense was primarily driven by a 23 basis point increase in non-GDC sensitive factors related to our advisor deferred compensation and stock option programs that are marked to market. As a reminder, the deferred compensation portion of our non-GDC production expense is offset in other revenue. On a trailing 12-month basis, the payout rate remains steady at approximately 87%, in line with results from the past six quarters.

In the third quarter, core G&A expenses, defined as compensation and G&A expenses excluding promotional expense, depreciation and amortization, and items excluded in our determination of adjusted earnings, increased $11 million sequentially to $161 million. $2 million of this increase was related to investment in regulatory and compliance capabilities in response to the regulatory environment. This included incremental resources to supervise complex products and enhance our fraud detection capabilities.

In addition, we launched our home office supervision initiative announced last quarter. That will be responsible for the oversight of 2200 single advisor offices. Beginning in 2015, we will charge $4800 per office for this enhanced service.

We incurred another $2 million in revenue generating related expense, of which the majority was for temporary personnel, overtime, and other related expenses to process the increased volume from alternative investment sales. We expect to incur an outweighed level of expense into 2014 as we anticipate sales and revenue to remain elevated in this product category. $4 million of the sequential increase was incurred in September and driven by an elevated level of cost that will not remain in our expense base going forward. This included $2 million in increment a legal expense and $2 million for extraordinary medical claims in our self-insured benefits program for employees. This is the portion of our expense increase that fell outside of our guidance in September.

Sequentially, fourth-quarter G&A expense is expected to decline by approximately $6 million due to the run-off of the nonrecurring items and the closure of NestWise. This will partially be offset by the expected increase in the processing of alternative investments, which at this point is expected to be approximately $1 million.

There is a degree of uncertainty in our core expense across any one quarter due to the variability of technology development, legal and medical claims. Based upon these factors, we expect core G&A expense to be down sequentially by about $5 million, but could vary plus or minus $5 million.

For 2014, we anticipate achieving core G&A growth in the 6% range, which is primarily driven by the full-year absorption of investments made in 2013 and volume-based growth. This impact should be offset by productivity and simplicity gains in service value commitment savings.

I will now turn to our promotional expense, which increased $12 million or 48% sequentially to $37 million. Similar to past years, this was driven by a $12 million increase in our conference spending related to our annual focus conference in August. As we look forward, we anticipate a $12 million decline in conference spend in the fourth quarter, and a corresponding $7 million decline in transaction and other fees that are generated by this conference.

Transition assistance expense increased marginally over the second quarter despite a much larger increase in net new advisors. Three factors influenced this expense -- number of advisors and their historical production, the cost to recruit as measured by the cash paid as a percentage of the historical production, and the number of large advisors or financial institutions joining LPL. Larger advisors and financial institutions typically receive transition packages in the form of forgivable loans or recoverable advances that are amortized over time, while smaller advisors receive payments that are expensed in the current period by LPL.

In the third quarter, we recruited a higher percentage of large practices using forgivable loans which offset the growth in volume, keeping our transition expense relatively flat sequentially. Please refer to the expanded disclosure in our financial supplement for additional insight into our transition assistance.

I will now provide some commentary on the drivers behind third-quarter GAAP expenses of $24 million that were excluded in our adjusted results. $3 million related to employee share-based compensation. $11 million arose from the closure of NestWise, and $3 million was for additional acquisition earnout expense based upon the strong performance of retirement partners. The remaining $7 million of expense was related to a previously communicated investment to launch our service value commitment. Of this $7 million, approximately $3 million was for establishing outsourcing capabilities and temporarily parallel processing, an additional $3 million was related to the implementation of foundational changes to our technology platform and outsourcing of our disaster recovery facilities.

I will now turn to adjusted EBITDA and adjusted earnings performance. For the quarter, adjusted EBITDA grew 11% to $120 million year-over-year. The adjusted EBITDA margin as a percent of net revenue declined 50 basis points year-over-year to 11.4%. The $4 million decline in our cash sweep revenue driven by contract repricing and the decline in Fed funds primarily drove this margin decline.

Adjusted earnings per share grew 19% year-over-year to $0.56 per share, supported by share repurchases over the past 12 months, reducing fully diluted shares outstanding by $6 million, or 5%. Sequentially, we reduced our fully diluted share count by 2 million shares, which contributed $0.01 in earnings per share.

I'll now turn to our capital management activity. In the third quarter, we invested $18 million in capital expenditures, paid $20 million in total dividends and conducted $127 million of share repurchases, buying back 3.3 million shares. Looking forward, we remain authorized by our board to repurchase, as of quarter end, $103 million of shares from time to time, and may add to this capacity to continue to opportunistically pursue share repurchases in 2014.

Over the past 18 months, the PE firms have reduced their ownership from 63% at the time of the IPO to 17% today with Hellman and Friedman completely exiting the stock and departing our board. As a result, the market absorbed almost three times the amount of shares offered through our IPO, and we've capitalized on the opportunity to create additional shareholder value by repurchasing shares during this period. Since the first PE distribution in second quarter of 2012, we repurchased 10.6 million shares at a weighted average price of $32.71 as of quarter end.

With that, Mark and I look forward to answering your questions. Operator, please open up the call.

(Operator Instructions). Chris Shutler, William Blair.

Good morning. So first on a strong net new advisor number, just hoping you can delve into that a little bit more in terms of were there certain pockets of strength in that number, so was it -- I think you talked about larger practices, but was retirement a big part of that? And then was the increase through the first half of the year, was that more due to gross advisor additions, or better advisor retention? Thanks.

I think your question is why did it (technical difficulty) pick back up again, right?

Yes, exactly.

In the first half of the year, we had what we have experienced before, more recently about eight years ago, which is you have really strong same-store sales that kick up, and after a drought of time in which they hadn't been there in practices, then commence to do two things. One is they focus on their existing clients and process the business because they have been waiting for the drought to end. Or B, what happens is they can used to that level of volume and then they start to add staff to deal with the new normal, which is the higher amount of revenues they have. And that's exactly what we saw happen in the first half of this year. And therefore, the amount of practices that move around the industry goes down and our retention goes up.

In the third quarter, what we saw was essentially a return somewhat to normal, not quite to normal but somewhat to normal in terms of recruiting. It was from all over, as it's traditionally been, and it fits exactly the pattern we saw, again, about eight years ago with the similar kind of circumstances, both with market activity and same-store sales. So, we would believe that we are back to a little more normalized amount of movement across the industry. Again, we see it from banks, credit unions, from insurance broker-dealers, from independent broker-dealers coming here to of course the wire houses as well. We see it in the hybrid RIA area as well as the more traditional commission-based brokerage. So, it was a good, solid quarter in terms of source of advisors and a solid quarter in terms of more return to normal.

The only thing I would add to that is we've maintained a retention of about 97% from the beginning of the year through the third quarter. So, it was more on attracting new advisors that really made the difference in the third quarter.

The other thing that I would add is you do have one bit of lumpiness in that there was a large bank that was recruited inside the quarter that was about 35 to 40 advisors. So, that was certainly helpful within the quarter.

Great. And then the bigger picture question, guys, I wanted to get the latest thoughts given the whole fiduciary issue has been in the news a lot recently. So let's just assume for a second, I know there's a lot of questions, but let's assume that what's being talked about by the DOL actually would be put into place and there is a fiduciary standard. But the fiduciary isn't necessarily defined as fee-only, which I think is something you have supported in the past. So just help us think through the positives and negatives from that type of a scenario for LPL.

So there's a couple of ways to think about it as we thought about it. And we've done some math around this as well, although the math is a bit dated because we last did it about 18 months ago.

Let's take the extreme case, which is that the fiduciary standard for many regulators, whether it's Department of Labor for the SEC, or FINRA were to make it essentially commission-free. In other words, you couldn't go to commissions. It would be what most people would see in the UK. It happened in Australia; it's happened in a number of countries.

What would happen in our world is we have the platform to convert advisors to an advisory-based program, fee-for-service. And in our view, what would end up happening is, number one, smaller consumers would not be able to get advice in that world, because there just wouldn't be the economics behind that type of model to support them. But what would happen is your actual yield per client goes up because it's actually a little more expensive to have them in the advisory platform, and presumably there's lots of people who don't need an advisory platform services to get there.

So our economic model would tell us that conversion to a total advisory model would work just fine. It would be profitable, it would be profitable in terms of what the outcome would come for the company but there would also be enormous changeover costs and enormous changes in the industry. So, that's the most extreme.

But out the other side of it, we actually modeled it in a way we believe our models would tell us it would be more profitable for LPL than not. But we don't think it's good public policy, because it would tend to concentrate advice to wealthier individuals, and it would tend to provide only one way of servicing someone which is through an ongoing fee for advice.

In your example, which I agree with you is probably the more likely outcome which is it doesn't get rid of commissions, it just limits it in some way, again what we think would happen in that case with the Department of Labor is IRA rollovers. So rollovers coming out of 401(k) plans will be regulated by the fiduciary standard, and the DOL will provide a number of exemptions that would allow for commissionable business to occur, so really no change from what we see today, and would probably at the margin push a bit more of the relationships into an advice for fee on an ongoing basis, which again will have better economics for us as a result of just the differences in the platforms.

So I think it's something to worry about more from a public policy standpoint, and more from an availability of service models that would economically -- with the one big change being the actual changeover process still would take a lot of training. It would divert a lot of attention as we went through that process.

That's really helpful. Thanks, Mark.

Bill Katz, Citi.

Thank you so much. It might just be timing, but I'm sort of curious if you -- you had some very strong net new asset growth in the advisory line, and the assets themselves were up very nicely, obviously helped by markets, but yet the related fees were basically flat sequentially. Is that just a timing element on billables or is there any kind of mix shift underway that's tempering some of the AUM lift?

You've got several things that are occurring. You've got about a 19% lift in overall AUM from advisory. Certainly 9% of that is driven approximately by market, so the remaining 11% is net new assets being gathered. And the difference is that roughly 50% of those net new assets gathered are going to the hybrid RIA platform or solution, which obviously we account for in a different way. So it's an apples-to-oranges comparison between the growth in assets and the growth in the advisory fees.

Which line item is capturing the hybrid RIA solutions then? The commission line?

A little bit of it is in the commission line. The majority of it is in the attachment revenue areas, like trading and things of that nature.

That's helpful. And the second question is I'm sort of curious. It sounds like you're more consolidating your operations than expanding these days in terms of efficiencies. How are you thinking about dealer appetite right now? And then I guess the converse part of that question would be, if not, what would stop the buyback program? Thank you.

Good questions, and certainly part of what our evaluation is in terms of the best use of shareholder capital. No doubt that we like organic growth the best because it gives us the best return. Then if we see correctly priced, obviously in our view, acquisitions, we like those next year. We have not seen properties that have come on the market that makes sense to us strategically, or we think are priced in the right zone. But we continue to look and will continue to really explore whether those are possible for us. So, we have an appetite for acquisitions. We have an appetite for deploying capital in that way. We just did not see anything we think is priced at a level that would make sense to be able to add value to shareholders.

Obviously, with the discussion around the bank, that would consume capital in a way that we have not ever had to consume capital in the business, so we want to be prepared for that. So I think, given particularly the capital discussion around the bank, that would tend to have us be slightly slower on share repurchases, because it would be nice to build up some cash capital in the business for the obvious reason, not indicating that we're going to do a bank, but probably better to be a little more on the cautious side than you might have seen in our buyback behavior in the past quarter.

We certainly are committed to buying back shares for dilution purposes, and that you would see us continue to do. And then we would like to continue to opportunistically reduce share count overall. We've certainly made good progress on that in the roughly three years that we have been public, and we obviously have shown that we are aggressive returners of capital to shareholders in the form of buybacks or dividends.

Thank you.

Joel Jeffrey, KBW.

Good morning guys. Just thinking about the increase in the interest rate sensitivity, it looks like it's up about $40 million from when you disclosed it the last quarter. Is this just being driven by the lower fed funds rate during the quarter, and a better shift in terms of the assets held at the IPA program versus money market funds?

Yes. You've got it. The adjustment in the Fed funds obviously impacts our calculation, and just the mix shift between ICA and money market balances and the growing disproportionate growth of the ICA versus the money market impacts that calculation.

Typically, in a year, just given new account growth, it will pick up $1 billion of cash, then you're going to have the normal adjustments that come along due to asset allocation or people funding accounts with cash, so we're going to always generally be a net grower of cash, and that was to grow the opportunity set for us.

In fact, if you look at it on a year-on-year basis, we picked up about $3 billion in ICA year-over-year and about $1 billion in money market funds over that period of time. So it's that consistent, traditional sort of what I call up and to the right growth in terms of our cash balances across those two vehicles.

And then just to follow-up in your commentary about the nontraded REITs and expectations that sales will continue to be relatively strong in the near term, will we also see stronger returns in the other revenue line as well in that period, or is this more of a one-time situation?

Yes, there is definitely a correlation between the growth in the alternative investments and the commission dollars that are generated and with the other revenue line item. Those are for marketing reallowances that we get from the non-traded REIT companies for the distribution of those products.

I think what's also important is you will see some continued expense elevation because what we want to make sure of is that we are doing the right job in terms of regulatory oversight of those sales, in terms of review, so we've added a significant amount of staff to help us with the processing. Remember this is an entirely paper-based process for -- some of these transactions are not automated at all.

Number two, we want to make sure we are reviewing transactions that are going through the system from a standpoint of regulatory compliance. We are strong believers in making sure these sales are good sales and they are done and processed correctly, even though they are paper-based.

Yes, and that's where you saw sequentially a $2 million increase in the cost associated with that in the third quarter and we expect another $1 million increase in the fourth quarter. That was in my comments.

I appreciate you taking my questions.

Chris Harris, Wells Fargo.

So the productivity ratio was clearly very strong in the quarter. Just wondering -- it sounds like there's a lot of moving parts to that -- whether you guys think that there is really a lot of pent-up demand among the client base of the advisors. How much of that is really influencing the increase we've seen? And maybe you can help us think about that as to maybe what inning do you think we are as far as investors may be getting a little bit more reengaged.

So, in terms of the overall general reinvestment in the mix of business, etc., I think a couple of things have been occurring. One, fundamentally and underlying, we see investor engagement continue to be strong. And that has lifted overall baseline productivity on a year-on-year basis. I think if you even go back and look at the comps in third and fourth quarter of last year in front of some of the challenges at the end of the year like the uncertainty around tax policy, it had a real drag on that baseline productivity. So, we've seen great investor re-engagement. We see that's continuing to sustain itself. And absent any big deal, political or macro, unexpected occurrence, we think that's probably in the fourth to fifth inning in terms of a nine-inning game.

I think what you've seen added on top of that this summer that offset the traditional summer slowdown that we would expect across the board in terms of productivity is this upweight or uplift in alternative investment for the reasons that we said earlier. You just had a situation and a circumstance where advisors are helping their clients reallocate assets that were once income-generating vehicles. But once they transition into an equity status, they lose that characteristic and they just reposition them back into an income-generating vehicle. And so very logical that that reposition is occurring, and we think the conditions are such that that will continue on into next year.

Okay. That's really helpful. And my follow-up question is on an unrelated topic. The fee for advice for the retirement plans, Mark, you talked about, where are you guys today with this and how should we be thinking about the total revenue opportunity for LPL?

Yes, very good question. And we've got models that lay out different revenue and earnings characteristic so we are not quite prepared to talk about those specifically just yet. So we will plan on having those in future discussions to give more insight into what we have.

What we've essentially been able to do is now connect to the record keepers that system, to go out and see the first few clients sign up. We are seeing the early returns of how the individual plan participants use it. We do think it will be a very nice stream of income and highly profitable for us. And we will give you some more dimensions on that as we go forward, if that's all right.

Okay, fair enough.

Devin Ryan, JMP Securities.

Thank you. Good morning. I just want to circle back on the opportunity within your institution services business. I know you guys have highlighted this business as an area with some pretty significant potential, just given the large amount of addressable assets. And then obviously you enhanced the offering with the Concord acquisition in 2011. So I just wanted to get a sense of if you have been seeing any increased traction in that business, and just an update on how you're thinking about the opportunity there.

Yes, I think we have definitely seen an uptick in activity there, and it's been related to a number of things. One is looking at sort of segments that are near the segments that have that we have historically been strong in. Number two, it's been continuing to refine the offer in terms of materials that are unique or capabilities and technologies that are unique to advisors and institutions where you need a lot of sales reporting at company level reporting. And that was an area that was weaker for us a couple of years ago. That started to have a positive impact.

And then if you take Concord's capabilities and part of what Fortigent has, that really helps us bring together the trust department opportunity. And we are seeing lots of interest by existing clients and by prospects to bring together both their brokerage business as well as their trust business. And that will allow us, we think, to have a very unique offer in the marketplace. That will allow us to win more brokerage business, and will allow us to raise assets in the trust departments.

And remember the trust department assets to us will look just like advisory assets. They will be very profitable. They have really wonderful solutions for the trust side of the financial institution to help them manage those more effectively and to provide more choice to their client, which will make them stronger competitors in the marketplace. We do see that redevelopment, if you will. That's one of the reasons why we are winning business, some of which had an impact here in Q3.

And being able to service those trust assets would obviously be a new market, if you will, inside that space for us.

The only other thing I would add to Mark's comments is we do see a good, strong trend of banks who were previously their own broker-dealer who are contemplating transitioning out of running and operating that broker-dealer and outsourcing it. And so given our market leadership in that space and our capability set to uniquely serve larger institutions, that's created a nice, competitive advantage and good pipeline of business for us.

Great, appreciate all that color. And then just a follow-up, you highlighted your current capital light business model in the prepared remarks, and a bank conversion would clearly change that. And so I know there's a number of gives and takes in the analysis of looking into becoming a BHC, but if you have the capital and charter today, would it be an easy decision, or from a structural perspective are there some other things that we should be thinking about from the outside that could have a big impact on the decision?

I think, if we had a license, I don't know that it would make any difference, because in the end, right, it's about the return you get. That's what you're going to care about. That's what we are going to care about for us. Or is there some compelling set of services that we'd like to have in the marketplace? Let's start with that one first.

As we do know that within our advisory platform for assets that have rolled out of 401(k) plans, so the retirement assets on the advisory platform, today we can only use a money market fund for those clients. We know those clients would like to have access to an FDIC insured product, and the only way to provide that today is through having your own bank. There's a specific exemption for your own bank. So that would allow us to access then -- was it $4.4 billion?

$4 billion.

-- worth of assets that today are in money funds. That would be a compelling reason to do it for the client and a compelling reason to do it for the shareholders. That's the market opportunity that we would identify as the strongest one among several that are there.

Next would be at what cost are we able to do that and at what return. And that's the work that we're doing now. So there's no doubt there would be -- significant is the right word -- amount of capital needed to both capitalize the bank and to remind ourselves that we are a non-investment-grade company. So we would have some capital requirements that are unique to our current structure for the company. And that's what we've got to really do the math and discussions with regulators about, is to understand at what cost does one get those $4 billion of assets and others put onto our balance sheet of a new bank, and then therefore what's the return to the shareholders. So that's the math we are doing now, and we will have more to talk about as we enter into 2014.

Okay, great, appreciate it. Looking forward to the update there.

Alex Blostein, Goldman Sachs.

Thanks. Good morning, guys. So just taking a step back on expenses and the way you guys disclose them, I guess we could explain line by line the drivers behind the GAAP versus the adjusted. But at the end of the day, that gap keeps widening. And I was wondering if you guys had a view over the next year or so if you expect to see any additional kind of expenses that you could kind of consider one-time in nature over and above from what you already typically exclude.

This is Dan. I don't anticipate anything as we look out today. I think you've got the continued service value commitment, and as we experience expenses, that will transition through the end of next year as we had originally targeted. And that was, if you recall, about a $70 million to $75 million total spend, of which about $8 million to $9 million of that occurred last year. And year-to-date about $18 million to $19 million we have incurred thus far. So, certainly, you will see that continue. You'll see how we treat employee-based compensation, which is a reoccurring quarterly charge. And there may be a few small things that come up that are not overly material, but I don't see those as we look out today.

And then a lot of the adjustments that we've made associated with prior acquisitions or transactions will be cleaned up this year. Whether that's related to (multiple speakers) --

Retirement partners, Concord (multiple speakers) some of Fortigent was done already. So there's really not much beyond [FDC] (multiple speakers)

(multiple speakers) -- transition out of NestWise. So most of that will be cleaned up.

Got you. And then just to follow up on the cash product, sorry if I missed your comment. But I think you guys guided to kind of a 14% decline in the fee rate on ICA year-over-year. so, I think that would put you at a low 70s kind of number for the fourth quarter. Right now, I believe you are at 65, so any updated thoughts assuming, again, kind of the standard no rates change view, where this will end this year and next year?

So on that number, you've got to add an additional 6 basis points of Fed funds adjustment year-over-year. It gets you down from the low 70s into around the 67 basis points number. And the 65 was targeted for fourth quarter, of which we still think we are in that right zone.

So, 65 for the next quarter is flat. And then how should that fall into 2014?

I think from a guidance standpoint on 2014, we had forecast an additional 7 to 8 basis points of pressure in 2014, and I believe we still think that trend is in place. And we see it like the guidance we have given you.

Understood. Great. Thanks a lot.

Ken Worthington, JPMorgan.

Good morning. A couple of questions, maybe first one or two on the industry. Last year, the Department of Labor put in place new rules on fee transparency for 401(k) plans. The question is are you seeing increased movement in 401(k) plans from administrators and managers to others? And does this somehow present an opportunity, maybe an increasing opportunity, for LPL?

The simple answer to that is yes, and large would be the other word to use, meaning that -- so just to be clear, I'm being very optimistic about this part of our business because for exactly that reason. We stand for objective conflict-free advice and transparency around what the cost is of investing in any number of fronts, starting at retail, but have now moved that into the 401(k) space. We do believe there is a wholesale change occurring in which the more costly administrative structures that were there before are put under tremendous pressure and the consultant approach, which we have in which the advisor has a fiduciary obligation, is the less expensive and better choice for a plan to be served today. We think our results this quarter alone demonstrate that with roughly $11 billion moved in of new plan assets. That's not from recruiting. That's new wins in the business off of our existing clients, quite powerful no matter how you look at it. And we think it all comes from what we thought was very well-crafted and smart transparency from the Department of Labor on the 401(k) front. So, we are big supporters of that, believe that they've gotten that part of their work done quite correctly, and we think it provides a very strong tailwind to the gathering of plan assets.

Now, on the cautious side of that, plan assets have a certain value to us. It's not nearly as valuable from a shareholder standpoint as assets are in the retail business. They are probably half as profitable to us as a retail asset would be. But as we mentioned in my part of the script, is what we are looking for is how we help bring new services to those plans, like in-plan advice, or automated rollover advice, in order to essentially capture the retail asset. And we're starting to see the very beginning signs of that strategy showing some results. And we obviously are hoping that will build over the next several years into something more significant from an earnings standpoint.

Okay. And from the industry side, are you seeing increased movement, though, industry-wide, or do you think it's more idiosyncratic to you?

We think it is a bit idiosyncratic to us, because we put together both the idea of the acquisition of retirement partners, which was the premier independent broker-dealer in this space which we had identified about four years before it became for sale as the right way to enter into the space. So there wasn't a strong, to be honest, number two in that space. The number two broker-dealer stalled out a bit, because they're too small, as was National Retirement Partners. Then we combined with it this in-plan advice which is a joint venture with Morningstar, which has taken us 2.5 years to build, which, frankly, was longer than we wanted it to be, probably twice as long as we wanted it to be, but it's done. And now it's being installed in the record keepers. And then the bowl-over part of it was actually straightforward. And again, we are starting to see plan assets go into the top of the funnel and retail assets come out of the bottom of the funnel, so we starting to see the throughput that we wanted to see there. So we think that is a very unique combination of the marketplace of plan consulting as a fiduciary, in-plan advice in our partnership with Morningstar, and rollover. Rollover is pretty normalized in the industry these days, but that combination of all three is a unique value proposition in the market for us.

Remember, this is a huge market, though, so there's plenty of people who run record-keeping systems who might be in the mutual fund industry or others that have plenty of success. I don't want to take anything away from that. But we think, in the terms of the way we're approached in the market, it's a very unique offer and has already demonstrated its success through the growth that we are seeing.

In terms of asset mix, I think the at least investment community has been anticipating some sort of rotation. Have you seen any migration away from fixed income and protection and maybe towards equity, as I'll call it, like leading indicators? And then just your opinion, would you anticipate that kind of change next year, given the returns we've seen this year?

And then the tack-on is do better market conditions impact the migration away from brokerage to advisory? Because that's been a theme for you guys, and I was just wondering if market conditions either improve that migration to advisory or impede the migration to advisory.

A couple of things here, and if I don't answer both those questions, just re-ask them. I think, from the overall -- the rotation of assets, we have more planning-oriented advisors who use diversification strategies. So different changes in the economic or market cycles, we don't see big swings in our asset classes. You may see it on the 2%, 3%, 4% level, but nothing greater than that.

So have we seen the risk on trade in more equity allocations? Yes. But, again, we're talking about 3% to 4% shifts. So if our average portfolio may have 55% equity, 45% fixed income, perhaps it stretches up to 60/40, but that's the typical range we would see. So it flexes a little bit with cycle changes. So that's the thought on the overall mix.

Relative to advisory versus brokerage, I think we are fundamentally seeing a shift in the industry, and more specifically inside LPL, where advisors are using a higher proportion of advisory solutions to meet their clients' needs. And in fact, in this year, if you look at new assets gathered, over 50% of assets, new assets gathered are allocated to advisory solutions versus brokerage solutions. And the first time we passed through that 50-50 mark was last year. So that shows an ongoing trend towards advisors using more advisory oriented solutions, just because we've given them robust tools and flexibility and capability to meet the needs of the full spectrum of their clients. And at the end of the day, we see more demand from the client level for that type solution.

It has let us -- just to build on that a moment, in the advisory platform, to think about the way we are priced there. And one of the changes we've made recently is to make sure that we are pricing explicitly across the platform for the outside strategy there. So we have essentially two varieties. One of rep (technical difficulty) portfolio manager which is the SAM platform, the other one where we do centralized rebalancing in which LPL research or BlackRock or JPMorgan or Cougar among many others are basically there to provide strategic oversight of the assets and do the asset allocation Dan was just speaking about.

So an example of where advisors growth is beneficial to the advisor is using that central platform allows them to not have the expenses of doing local money management. What we realize, though, is the strategist part of that wasn't priced appropriately (technical difficulty) the marketplace and made that change, which is effective in 2014, our advisors -- understandably it's a change, which is always tough, but they've done a nice job of understanding how to have that help their business by allowing them to outsource the work to us. And those are all ways we're trying to evolve the platform to allow advisors to create more and more efficiency at the local level, which is really why you're seeing that increase that Dan mentioned to 55% of flows going to advisor. We think it will just continue to grow over the years. And we are committed to reinvesting heavily in the business, and appropriately pricing the activities that go on in the advisory platform to drive efficiency at the local level.

Okay, great. And just to be a pig here, one more. Maybe, Dan, you talked about G&A saying I think you expected 6% growth in 2014 offset by the service value commitment. As we kind of do the numbers there, does that mean we should expect the net impact of G&A growth to be zero, or maybe even shrink a little bit, given the size of the value commitment?

It was a net number, sorry. So, if you look at expense growth pulled from the absorption of this year's investments plus just normal inflation and growth oriented characteristics next year, less the benefits of service value commitment, you'll end up in a net range of around 6%.

Okay, awesome. Thank you.

Ken Leon, S&P Capital IQ.

Good morning. The first question I have was just related to acquisition of talent. There is proposed regulation, a similar rule, regarding signing bonuses and disclosures which would impact broker-dealers and others. What are your thoughts on that, and the impact maybe on your acquisition program?

So, we think it's very wise legislation coming from FINRA related to the way we want to have transparency in our industry around essentially what are contracts for movement. My argument as to why it makes sense is if an advisor sold their practice to a large wire house firm or sold their practice to another practitioner, they would actually disclose to their client what they received in consideration for that practice, and the client would have that knowledge and transparency.

We know that an individual moving from one employment situation at a wire house to another, the sums we're talking about certainly approach and in some cases exceed what they could sell that business for in the open marketplace. So, we think that it's quite wise of FINRA to have transparency around that activity so consumers can be well informed of the change, and therefore that they're fully informed as to why the advisor may be moving. We are in complete support of movement of advisors freely across any business model they choose.

We do think, though, that the practice of having an employment model pay a significant -- and we would describe it as off-market price, that this likely transparency will drive that value. You've seen some press reports that two of the major wire houses have said they are unlikely to continue that practice. That means that the non-economic choice for the company, for LPL, goes away. And therefore, an advisor is really there free to consider what is truly a market-based solution to their needs. We think independence of course is the best choice for them. It creates current income that's better than where they are today, creates a business that grow significantly that they can then resell at a future date, and allows them to build a better solution for their clients through objective advice in an organization like LPL where there's no proprietary products or products created in an investment bank. So, we think it just clears the market of non-economic or unusually driven compensation packages.

And recurring revenue is highlighted fairly front end of the release. How important a metric is recurring revenue? And do you have -- it was 64%. Do have a target looking out?

We don't have a target. My experience is we've been generally trying to drive it up over time, and that's really, as Dan was mentioning earlier, mainly through the provision of the advisory platforms. That's why we invest heavily there. We really try to give thoughtful consideration on what's on offer to help drive advisors use of those platforms and to drive solutions that work for investors. We obviously work with them. We look at it both from a cost basis. Our platforms, when you look at the retail, so price if you will, compared to other choices they have, are really quite reasonable. They are anywhere from 5% to as much as 20% less expensive all-in to the retail consumer. We know that that's a winning strategy for the investor and that's a winning strategy for the advisor and it's a winning strategy for LPL. That will drive our recurring revenue.

If I go back 10 years, our recurring revenue would've been slightly over 50% as I recall. And today, it's 64%. Whether it can get 74%, I don't know. But more recurring revenue is better because it just creates certainty and predictability in our topline stream, as it creates the same for an advisor and their practice.

My last question on the service side of your commitment, it looks like two-thirds of the spend is going to be next year. And I guess the question is why is more of it related to next year either on the components or possibly it's not going to be $65 million, it might be $45 million for the two years.

From a timing standpoint, it more is triggered by when the different waves of outsourcing occur, and so you actually transition to an outsourced model and you experience, as an example, severance costs, or you experience the parallel processing. So it's just more about the timing of us executing the different ways of transitions. The scope of work that we have identified early on hasn't changed.

And then finally, I think there's always the opportunity to optimize the efficiency of which we do this. And so certainly to the extent there is an opportunity to reduce or mitigate that overall spend, we will capitalize on that. At this point, we are not projecting that, but we certainly look for those opportunities.

Okay, thank you.

Douglas Sipkin, Susquehanna.

Thank you and good morning. Two questions. First, just really trying to understand the accounting around one item. I guess it looks like for Veritat there was close to an $8 million decrease in contingent consideration. Just curious. How did that flow, if at all, through the income statement this quarter?

Yes, so in terms of the determination of adjusted earnings, obviously which is non-GAAP, it doesn't flow through there. And you had several different moving parts that occurred in order to ultimately drive to what was about a $10 million or $11 million I think offset associated with the closing of NestWise.

The specific line item it flows through on the income statement is in other expenses. And the drivers associated with that was the write-down of goodwill, the write-down of fixed assets associated with some of the Veritat technology we acquired as well as some of the technology we developed, and then that was offset -- those were collectively offset by the reduction in the potential earnout that we would've paid associated with that acquisition.

Great. That's helpful. And then just to follow-up, appreciate some of the color around the potential longer-term initiative to start a bank. I guess just two questions around that. One, do you guys have any rough idea what sort of the capital ratios you would need to maintain for that bank are?

And two, how does that factor in with some of these ICA contracts do you have? Can you get out of those early or are those like variable and not fixed financially? Because I guess when I look, you guys say 601% expire between 2016 and 2019. Would you be able to get out of those earlier than that?

Let's answer that question first. That really won't matter to us in terms of contract renewal. Number one, as Dan said, we have a $3 billion increase in deposit levels year-over-year, so we'd have more than sufficient capacity to deal with meaning to fund a bank, in essence to give it deposits at a rate that would likely match with what regulators would want to see. We've always described this as a bank that would have to grow at very reason's pace because that's what the regulatory environment would require and that's what we want to do as prudent managers of capital for the firm from a risk management standpoint. So that's really the answer to that question is we don't need to worry about that run-off. It's a good question, but you couldn't capitalize it that quickly.

The second question is we have a whole range of discussions going on with experts around what the capitalization rate is, so we don't know yet well enough to know what that would look like. That is really the key question, though, in that we agree that what cap rate matters a lot in terms of of course what earnings you drive. So we are being very thoughtful and cautious about exploring further exactly how one could capitalize a bank, what would be unique to our situation in capitalizing a bank, what sort of the standard operating practice is. Because that question will absolutely drive whether there is much value creation as we'd like or any value creation informing or acquiring a bank.

Great, thank you for answering both questions.

I'm not showing any further questions. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.