LPL Financial Holdings Inc (LPLA) 2014 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the LPL Financial Holdings second-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 conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Trap Kloman. Sir, you may begin.

Thank you. Good morning, and welcome to the LPL Financial second-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 supplement 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, our ability to realize benefits from the pending business opportunities with Financial Telesis and Global Retirement Partners, and our abilities to capitalize on the shift toward fee-based business and to lower our expense growth rate as well as 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.

Thanks Trap, and thank you, everyone, for joining our call. Today I'll provide commentary on our second-quarter performance, our success attracting and retaining advisors, and our agreement with Financial Telesis to expand our presence in the retirement plan market. I'll also share insight into the progress of transformation of our compliance and risk management capabilities that is designed to lower our risk profile. In addition, each quarter this year, we are providing color into areas of long-term growth for LPL, and this quarter I'll share thoughts on the growth trajectory of our advisory platform and the drivers of LPL's success in supporting fee-based businesses.

Starting with our financial performance, in the second quarter, adjusted earnings per share of $0.61 was flat year-over-year. Earnings per share benefited from revenue growing 7% to $1.1 billion, as well as our repurchase of 6.7 million shares over the past 12 months. We experienced increased spend for the resolution of regulatory issues which raised our expenses 14% year-over-year, which Dan will speak to further.

Turning to advisor headcount, over the past four quarters, the Firm added 431 net new advisors. This trend builds off of our success in 2013 where we led the market in capturing over 6% of advisors in motion as recently reported by the industry research firm [Radian IQ]. In the second quarter, we recruited 114 net new advisors and year-to-date we have retained 97% of our existing production. We continue to be a leader in the industry in these key metrics, affirming our compelling value proposition to advisors. We attracted a variety of advisor practices this quarter, primarily from the independent and wire houses channels, and saw a growing number affiliate with our unique hybrid RIA solution. We believe that our pipeline for Q3 is solid and we see positive conditions for continued success.

In addition to our typical recruiting activity, in the third quarter, we have the opportunity to attract advisors as a result of our recent agreement with Financial Telesis and Global Retirement Partners. Financial Telesis is a premier retirement plan provider in the industry and its decision to partner with LPL reflects the strength of our capabilities to provide industry-leading technology, marketing, and research support to advisors to serve retirement plans. As of the second quarter, our platform supported over $110 billion of retirement planned assets across 40,000 plans. Advisors from Financial Telesis will begin to join LPL in mid-August and ramp over the remainder of the year. Once fully transitioned, we expect to capture approximately $25 million in commissions on an annual basis.

In addition to the value of the retirement plan commission revenue, this transaction creates greater opportunity to provide in-plan advice to plan participants and capture retirement accounts that are transitioned into IRA accounts. We'll provide greater insight next quarter on the overall growth in our retirement plan business and how we are capitalizing on this opportunity.

Turning to our efforts in compliance and risk management, LPL has always been committed to setting a high standard to protect the interests of investors and support the independent advisors who served them. As a baseline, we dedicate investment in people and technology to help ensure that our compliance and risk management approach is commensurate with our growth and changing regulatory expectations.

In 2013, we began an effort to transform our legal, risk and compliance teams to improve the efficacy of our risk management and supervision. This resulted in an increase in our investment and attracting new leadership. The costs associated with this expansion were anticipated and included in our 2014 expense guidance. Under the direction of David Bergers and Michelle Oroschakoff, we expect this transformation to continue through 2015 as we have identified opportunities to develop more specialized functions and automate more capabilities to improve our risk profile.

We've made meaningful progress evolving our capabilities over the past 18 months. We have grown the number of personnel in our legal, risk and compliance functions by 41% since the beginning of 2013 to 636 employees. We have deployed those resources to support a variety of functions, including the expansion of our home office supervision capabilities to work more closely with small advisor practices on compliance oversight. We've expanded the number of personnel in our centralized supervisory function to over 70 employees to enhance processes and procedures for reviewing the sale of complex products such as variable annuities and real estate investment trusts.

We've also improved our underlying technology and processing capabilities. For example, we've upgraded our email retention and review capabilities to enhance our surveillance, and are improving our variable annuity and alternative investment order entry systems to speed processing and provide greater controls. Ultimately, we believe the combination of our objective, independent business model and our efforts to expand efficacy of our compliance and risk management capabilities will lower our risk profile and create value for advisors and ultimately can be a competitive advantage in the industry.

I'd now like to share perspective on how LPL is positioned to drive outside growth in our advisory business in the years ahead. I'll discuss how the breadth of our differentiated offering creates value for advisors, how we grow and monetize this business, and conclude with perspective on the expanding market opportunity.

LPL's history of innovation and leadership in the advisory marketplace dates back to 1991. This commitment has led to the evolution of a fully integrated platform that provides advisors access to a wide array of choices to meet investor needs. We've developed several turnkey solutions oriented towards advisors who are focused on robust financial planning, offering them access to our research team and eight leading investment firms who provide asset allocation strategies for investment implementation.

Alternatively, advisors who serve as a portfolio manager can leverage our enhanced trade and rebalancing technology and in-house product research to seamlessly manage their own models. These scalable solutions drive efficiency for the advisor and allow them to spend more time with clients, focusing on broader planning and wealth management opportunities.

We complement our investment solutions with a variety of services which we believe are unparalleled in the market in order to drive advisory adoption and fuel asset accumulation. As a result, we have an advisory consulting team with 34 dedicated personnel who regularly conduct field appointments in advisors' offices and local training events to help advisors grow their fee-based practices. Our 50-person research team assists with the portfolio strategy, product diligence, manager selection, asset allocation and rebalancing models.

We further differentiate our services by offering advisors a choice of affiliation by providing the only integrated RIA custodial platform in the industry. Before we entered this market in 2008, independent RIA's who wished to maintain their brokerage business had to operate their practices using at least two service providers. This meant two advisor workstations, multiple custodians, and they needed to engage third-party service providers to produce consolidated statements and performance reporting. This complexity reduces advisor productivity and increases administrative expenses.

Through our hybrid solution, LPL is only provider in the marketplace who has solved for this need with a fully integrated brokerage advisory platform. Our success in accumulating $78 billion in hybrid platform assets in just six years reflects the market's demand for our solution.

The strength and competitiveness of our overall fee-based solution has led to rapid growth. Our platform is appealing to investors because it provides them with financial planning, professional management and access to a wide variety of investment options and a range of strategists, all for a fixed fee.

Today, 36% of our assets are fee-based, and approximately 70% of our advisors are licensed to conduct advisory business. This momentum creates the conditions for steady growth with net new advisory assets consistently increasing 8% to 11% a year before the benefit of market appreciation.

Since 2008, we've outpaced the industry and accumulated advisory assets with 21% annual advisory growth, including market appreciation, compared to 18% for the industry.

From a financial standpoint, the trend towards advisory business is valuable because advisory assets generate margins greater than brokerage assets. In addition, our fee-based business has helped to raise our recurring revenue from 59% in 2008 to approximately 68% today, which has increased the revenue predictability of our business.

Looking at how industry trends will shape the future, we believe we are uniquely positioned to capitalize on the increasing demand for a fully integrated solution that really projects the fee-based advisory market to nearly double to over $5 trillion by 2016. Within this market, Cerulli projects hybrid RIA's will be the fastest-growing channel, expanding their market share of assets between 2012 and 2016 by 3.6% to 12.2%. This projected growth compares favorably to the projections for pure RIA's who are forecasted to grow market share by only 1.2%. In both cases, this growth is expected to come largely at the expense of the wire house channel, which is forecasted to lose nearly 5% of the market.

Building upon this unique value proposition, we are focused on execution to capture market share. We will win based on the breadth of our affiliation, our array of investment solutions, and leading support services that create the flexibility and value advisors seek at a best in breed business partner.

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 will discuss four main themes. First, I'll address the fundamental drivers behind our revenue growth in the second quarter, including details on advisor production and activity in our cash sweep program. Second, I'll provide insight on our expense structure and share our outlook going forward. I'll then discuss our bottom-line results and conclude with an update on our capital management activity.

In the second quarter, revenue grew 7% year-over-year to $1.1 billion, driven by a combination of newly recruited advisors, the productivity of existing advisors and market appreciation. These factors also lifted asset levels 17% year-over-year to a record $465 billion. Underlying this growth were positive trends in two key performance indicators, advisory net new assets and commissions per advisor.

Advisors attracted $16.5 billion in net new advisory assets over the past 12 months, including $4.2 billion in the second quarter, which represents 10% annualized growth. This Marks the 10th straight quarter that growth in net new advisory assets has exceeded 8%, reflecting our sustained ability to gather advisory assets. Notably an increasing percentage of assets continue to flow to our hybrid RIA platform, demonstrating the increasing demand for this unique solution.

In the second quarter, we continued to see sustained investor engagement. Overall, we achieved moderate commission growth as alternative investment sales returned to near normalized levels. For the quarter, annualized commissions per advisor of $155,000 increased 2% year-over-year and declined 0.5% sequentially. Excluding elevated levels of alternative investment sales, commissions per advisor was flat on a sequential basis at $152,000.

Looking forward, absent a dramatic change in market or economic sentiment, we expect the strength in advisory asset flows to continue in the third quarter. We anticipate a mid-single-digit percentage decrease in commissions per advisor on a sequential basis due to seasonality and alternative investment sales remaining at near normalized levels.

The low interest rate environment continued to be a headwind to our growth and revenue as cash sweep revenue for the quarter declined $6 million year-over-year to $25 million. This was driven by two factors, a 15 basis point reduction in ICA fees due to the pricing compression in bank contracts, and a 3 basis points decline in fed funds. Since the majority of ICA contract repricing occurred in the first quarter, we do not anticipate meaningful bank compression in the remainder of the year.

Cash sweep balances declined $900 million sequentially to $22.8 billion for the quarter. The underlying business drivers that contribute to our cash sweep balances remain strong as we continue to generate net positive inflows from new accounts. In the quarter, the additional cash gathered was offset by increasing client investment activity, primarily directed to our advisory platforms. Cash sweep assets represent 4.9% of total customer assets, which is below our historical range of approximately 6%. Based on our prior experience, we expect cash sweep asset levels to grow in the latter half the year as we attract new deposits and account rebalancing activity occurs.

With respect to our ICA pricing in 2015, we affirm our prior guidance of an incremental 13 basis points step down on contract pricing below the 2014 ending rate. We retain the upside from rising rates and will benefit immediately as fed fund rate increases, which could offset the effects of the contract pricing decline. Based on current balances, fed funds rate and bank contract fees, we believe we unlock approximately $245 million in adjusted EBITDA if we maximized our economics in a rising rate environment.

Looking forward to 2016, contracts which represent 27% of our current deposits are up for renewal. As we have previously shared with you, a portion of these contracts currently are in above market fees. As a result, we anticipate further contract pricing compression which may be mitigated in part by improving market conditions potentially leading to rising demand for broker deposits in the coming quarters. We are maintaining flexibility in our commitments and will provide an update in the third quarter on our progress managing these contracts.

I'd like to now focus on expenses. In the second quarter, core G&A expenses were $171 million, up $9 million sequentially. $7 million of this increase stems from the resolution of regulatory and legal matters. Our strong recruiting results account for the remaining $2 million of the increase due to higher incentive compensation costs for our recruiters and related travel expenses.

After growing 12% in each of the past two years, our core G&A growth rate would be on track for 4.5% growth in 2014, excluding the up-weighted cost for regulatory matters. As we factor in this incremental regulatory expense, we are raising our full-year forecast for 2014 to 7%.

The 2.5% or $15 million increase to our guidance can be directly attributed to the cost to manage and resolve regulatory matters. We expect the regulatory environment we are operating in to persist into 2015. We have seen regulators over the last several years broaden the scope, frequency and depth of their examinations to include greater emphasis on the quality and consistency of the industry's execution of policies and procedures. As a result, the additional $15 million of up-weighted regulatory spend occurred in 2014 will be maintained in our baseline expense for 2015. With these costs added to our run rate for 2014, we expect our 2015 core G&A expense growth to be within our stated target of 4% to 6%.

Turning to promotional items, expenses grew $5 million year-over-year as our annual Masters conference moved from the first quarter of 2013 to the second quarter of this year. Transition assistance expense increased $1 million year-over-year as the growth in recruited advisors was partially offset by the greater use of forgivable loans.

Consistent with past years, we will host our Annual Advisor Training and Education National Conference in the third quarter, which will raise promotional expense by an additional $5 million sequentially. We expect this event to generate approximately $4 million in incremental fee revenue to partially mitigate these additional expenses.

GAAP expenses that are excluded from our adjusted EBITDA results were $20 million this quarter, primarily consisting of $5 million in employee share-based compensation and $9 million in restructuring charges associated with the service value commitment. In addition, there was $4 million related to parallel rent and facilities expenses as we transition from our old San Diego facilities to our new office tower. We have fully exited our former facility, so the parallel cost will not recur.

Turning to our bottom-line results, we generated $128 million in adjusted EBITDA in the second quarter, down 2% year-over-year, driven by declining cash sweep revenue, the timing of our conference, and the increase in regulatory expense. These factors also served to lower our margins by 1% to 11.7% year-over-year.

Despite the decline in adjusted EBITDA, second-quarter adjusted earnings per share of $0.61 remained flat year-over-year, primarily due to our repurchase of 6.7 million shares over the past 12 months.

I will now turn to our capital management activity. In the second quarter, we continued to leverage our capital light model to opportunistically repurchase shares, conducting $25 million of buybacks in the quarter. As of quarter end, we retained authorization to repurchase up to $93 million in shares which we will deploy to opportunistically buyback shares in the market. In addition, during the second quarter, $23 million was allocated to capital expenditures and we maintained our dividend, distributing $24 million to shareholders.

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

(Operator Instructions). Chris Harris, Wells Fargo.

Thanks. Good morning guys. So, first question on the expenses. You guys gave a lot of good color there, but just wondering if you could expand on that a little bit more. I know just kind of as recently as June, you thought that 5.5% growth for this year was still kind of okay. And so just wondering exactly what happened since that time frame to move it up to 7%.

And then related to that, for next year, kind of curious if you could expand on how you're comfortable in hitting that 4% to 6% because it sounds like a lot of these expenses are going to be kind of reoccurring. And based on, Mark, what you were saying, some of the risk management buildout is still going to be in effect going to 2015.

This is Dan. I'll make a few comments and then certainly Mark can add any color to that. So if you look at this year's expenses outside of the up-weight in regulatory spend, we are tracking to the 4.5% targeted growth in expenses year-on-year. And if you look at the ramp throughout the year in core G&A, it's very different than last year's ramp where we increased spend over the year by about 18%. It's much flatter this year, so that sets up a different dynamic going into next year relative to meeting that 4% to 6% range.

And the shift in guidance from 5.5% back in the quarter to 7% now is just -- it's based on a couple of things. It's regulatory related in terms of the resolution of these matters and it's just there was a bit of an increased scope in some of the matters we were working on this quarter, as we closed the quarter. And I think we've got good line of sight on the rest of the year in these matters and hence the increase from the 4.5% at the beginning of the year up to the 7% now for guidance for full year.

Mark, do you want at anything to that?

No, I think that covers it well. Just to emphasize a couple of things, one is that you do see an ability to really manage forward expenses by being clear about the source of these expense increases, which we view as not permanent to the cost structure of the business because of the investments we are making, particularly in risk management and compliance oversight. That should give us a return that lets us run an organization in which those surprises are not there. And that's the philosophical thing of what we're trying to do as an expense matter.

Okay, very helpful guys. And then my one follow-up would be related to new advisors, the recruiting effort. It sounds like, from your comments there, that things are tracking nicely there. And we've heard kind of constructive things from others as well that are targeting the independent channel. Wondering if that might potentially lead to a little bit better margin for you guys. And what I'm getting at is if all of a sudden there's a lot of demand to get into the independent channel as some of these retention packages are rolling off, might you guys be able to have a little bit of pricing power in bringing in new advisors to your platform?

We certainly see an uptick in activity, so advisors in motion are what we want to be able to capture a large part of the share. We have captured the market leading share, so we obviously have a great history of knowing what to do when advisors are in motion.

Just to remind you, our cost for transition systems are among the lowest. They really are the lowest among the top broker-dealers in the country already. And so that already demonstrates the pricing power we have in moving advisors to our platform.

I think it's generally correct that when we see more movement than normal, generally what we find is transition assistance doesn't need to be more robust, and in fact could be less robust.

We know that also what we are selling isn't transition assistance. It's the value proposition that we have and an advisor's practice will be more profitable moving onto the LPL platform, whether it's a hybrid RIA or in the more conventional business, because of the investments we've made in technology, in services, in capabilities that lets that advisor have a less costly footprint locally.

PWC did a study a few years ago and that was roughly 18% more profitable. And that's the value we are selling when we are doing recruiting. So we think that -- affirming a few things. One is the increase in interest in movement. Two is our ability to capture that. We feel as good as ever about our ability to do that and generally agree that that should come at a cost that's pretty close to where you've seen it most recently.

Understood. Thank you.

Alex Kramm, UBS.

Good morning. Just first I've got an understanding question. My line dropped earlier, so maybe you covered this already, but the production expense, could you talk about that, why that non-GDC related one was lower than usual? And maybe you could give us some color about what the outlook there, how that might be ramping over the course of the year?

Yes, this is Dan. I'm happy to do that. So just to make sure there's clarity, the GDC related portion of payout is based on two things, your base payout rate which consistently runs around the 84% range, and then your production bonus. If you look at it on a trailing 12-month basis, it typically runs in the 2.7% range.

The non-GDC related piece we typically see it range somewhere in the 20 to 40 basis point range and that's driven off of two things. One, it's the deferred comp plan for advisors, which is marked to market at the end of each quarter and is based on -- typically a good proxy for that is the movement in the S&P 500 as an example.

And then you also have -- the second thing that drives that non-GDC related portion is the stock plan that we have, the equity-based plan that we have for our advisors. And that is driven off of the LPLA trading price, which again is marked to market at the end of each quarter. And so this quarter, you saw it down relative to the prior two quarters because actually LPLA was off about $3 over the quarter and second quarter. And you saw a bigger move up in fourth quarter and first quarter, so that helps you at least understand why that sequential change over those three quarters.

That's very helpful. And then maybe a bigger picture question, and I think you addressed a lot of this in your prepared remarks and in the questions that were already answered before. But I just want to kind of ask from a broader perspective, the management team, if you look at the results this quarter and you think about the environment out there with equity markets up 22% year-over-year, your revenue growth trailing that by a decent amount, like 7% or so, but still growing pretty nicely. But then EBITDA being down and obviously stock in terms of EPS flattish, I mean obviously you have a lot of stuff going on in a lot of the expense growth. But when I look at that from a big picture perspective, it doesn't create a great picture in this rate environment. And obviously the environment can change again, so I'm just wondering. Like as you think about the next few years and maybe the environment changing for the worst again, how do you feel about creating any sort of operating leverage on the positive side, or being really hurt when things go south? So sorry about the big question, but I just kind of want to get some big feedback on that.

It's the right question. I would completely agree it's the right question. So just to be clear, we are not happy with these results. We should be getting leverage and gearing into the P&L in a way that you don't see in the second quarter, so just affirming what I hear in a little bit of your voice is the frustration I can only affirm for you is the same here. What causes us not to get the leverage that we should be getting in the P&L, sort of up and down the P&L, is essentially costs that we did not foresee or we would've talked about our expense profile differently in a regulatory environment that is much more difficult than we anticipated. We own that, and that's our problem. What I do feel strongly about is our ability to control our expenses going forward and our ability to understand the dynamics of the underlying cost.

The only thing I can point to give you proof points of that, because at this point I'm sure what you'd like to see is proof of it, not our words of it, is if you take out the cost that Dan outlined in the discussion part of our call related to regulatory expenses, our run rate has come down dramatically from where it was. That's the way the performance should be running. It's the result of our SBC work and removing costs in our ongoing basis. It's procurement work. It's all the things we should be doing. So the fundamentals of the business are looking as good as I've seen them in my 12 years here.

The issue that we run into is that we've needed to invest heavily in risk management and compliance resources, and we are a bit behind the curve. As a result of being behind the curve in that, we are getting the regulators appropriately, making sure that we understand that we should have been ahead of the curve, and therefore they're fining us, and that's the fines traveling through the P&L. Our goal is to get those fines to go away, not because they go away but because we do a great job in risk management and compliance work. And so that's how we know we can then get the P&L to operate the way it has traditionally operated in all cycles of the market, Alex, which will let us be able to control the levers of cost, whether the markets start to go down as sales slow or whether they are robust and therefore not have to increase expenses as a run rate matter when we see volumes increase.

So, Alex, just to add to that, so if you think about the second half of the year, if you were to create a similar type revenue growth characteristic in the 7.5% range, and you look at the expenses in the second half of the year roughly maintaining flat what they were in the first half of the year, then you're going to end up with low single digit expense growth year-on-year, and you're going to then start to see what we would expect how the model would operate where you get 7.5% revenue growth, and you're getting low single digit expense growth. You're going to start to see that margin expansion come back.

All right. That's helpful. Thanks for that.

Chris Shutler, William Blair.

Hey guys. How are you doing? I apologize upfront for following up on this, but it's important. So, on the regulatory expense issue and the up-weighted expenses, to the extent you guys can disclose the issues, what have the issues been? And then what specifically are you doing to mitigate those issues?

Let's start with what they are. Basically, we have, as you know, a variety of regulators we work with. FINRA is our primarily regulator. So you've seen some of the releases related to fines for matters for securities such as nontraded REITs or variable annuities. We also of course regulate in all 50 states, so we've had a number of matters with the states, Massachusetts being the one as I sit here in Boston that's easiest to point to. We've also had matters from the state of Illinois and a variety of states related to REIT matters.

So, what we're doing to make sure that we are, number one, making sure than investors are protected, which is our primary goal here, number two, making sure advisors are fully compliant and doing the right thing by clients, which we generally see that they are. These are for the most part home-office record-keeping and processing matters that we've needed to shore up. So let's just rattle off some of the things we are doing. We've created a centralized review team. That's the 70 people that I mentioned in my remarks that are looking at all activities in those areas for products that are just more complex, either because of the nature of how they are built or the nature of how they are processed. Remember, alternative investments are still a manual paper process, which means it's hard to automate that work.

But we are spending -- the second thing I would say is we are spending money and working in partnership with the industry to create a solution for processing nontraded REITs just as we helped create a solution for variable annuities which helped the process quite a bit.

We also are making sure that we are doing a great deal more in terms of training of our own employees, the supervisors who oversee them, the supervisors in local offices and advisors as well, either on product complexity, different areas of the rules that we oversee, and so forth. And we are also making sure that we have plenty of disclosure and good processes for making sure investors understand what it is they are buying and how they are buying it.

And so as we look across the totality of what we're trying to do, we are trying to move a lot of activities at once. That's why you're seeing just the sheer increase in number of people across legal, our compliance group as well as audit. I think the good news in that is once you've got the right people in place and you've got good technology in place, which we are about halfway through at this stage, then that should start to create an environment in which those exceptions are more unusual than they are today. And it's the exceptions and the documentation of them that's leading to this higher level of settlements with the regulators. And so it's not -- not that that's an excuse. Again, we should have come into this part of the cycle stronger than we did, but what we want to make sure our shareholders understand is that we are going to invest in this. It's a smart investment for us to make, and it's the right thing to do as it relates the industry and the investors who are trying to save for their retirement and their financial futures.

Okay, great. And then I guess on an unrelated topic, I remember going back probably nine months or a year ago, you guys were talking about how Robert Moore was spearheading some efforts to segment your advisor base a little bit more to try to increase productivity and provide different types of support to each group. I was just hoping to get an update on those efforts.

Thank you for that question. It's nice to turn to that. We are making good progress on segmentation and understanding the dynamics of what different groups of advisors need to be. So how does that show up? It shows up, for example, in our upcoming national conference where advisors who might be smaller in production but have good growth trajectory will be brought to the conference as part of our training and development of them to help them with their business. That would be the simplest example I can give you. More complex would be some of the pricing work we are doing around how to make that simpler for advisors, and thinking about the practices that it affects, and then also thinking about how we deal with transition advisors into the Company and what type of practice they have sort of pre-segmentation if you will, and how best to help them with that activity. That's also combined with our data management, or big data is the common term in the world. We're doing some really fascinating work that I'd like Dan to speak about there, because it's not segmentation per se but it's the same idea. How do we make sure we are creating better outcomes in terms of growth and profits for the Company through being smarter about and more personalized to the advisors that we serve and their investors, and also sponsors in the case of big data. So you might want to speak to that, Dan.

Yes, so in the spirit of leveraging big data and turning it into business intelligence, we look at the opportunities across our entire ecosystem, so you start with the product sponsors as an example, and how can we create efficiency and efficacy in their efforts to position products and ideas and solutions to our advisors in a more effective way that will drive productivity of our advisors and reduce their overall cost of distribution. And to the extent we are successful at doing that, that's obviously a real value we are creating in their overall models, which helps improve our overall economics in those product sponsor relationships. So, that's one body of work around business intelligence.

The second one that I think ties back to your question around segmentation, it allows us to leverage that insight and information to be able to better support our advisors and their growth opportunities, whether that's gathering new clients or new assets with their existing clients. And how do we help them better understand where that opportunity set is within their practice, and then provide them the solutions in an efficient way so they are very on target and on point in leveraging where their opportunity is with the right solution. Again, all in the spirit of helping them grow their practices. So those are two applications, if you will, across the ecosystem of where we would leverage business intelligence to drive value.

All right, thank you.

Joel Jeffery, KBW.

Good morning guys. Just a question on the nontraded REITs. I appreciate the color you gave on the performance this quarter and sort of expectations for the third quarter. If I recall, in the last conference call, you guys had talked a little bit about the potential for increased liquidity events happening in the back half of the year. Are you now thinking this could occur in the fourth quarter or is this just not likely to occur at all?

So, again, these are, as we've said all along, a little tough to predict because I think some of the product manufacturers will state they have a plan, and then ultimately there's a variety of different reasons why they may shift that plan. And so I think what we do know is there's a couple of larger nontraded REIT sponsors who have suggested that they are contemplating a liquidity event. And when those occur, obviously the repositioning of those assets back into a nontraded REIT ought to achieve the same yield characteristics as they had before the liquidity event. You see some up-weight in commissions that occur. And so the second half of the year, we had anticipated a bigger opportunity set associated with that. I think there's still some potential for activity, from a liquidity standpoint, but as we look out and look forward, we don't see the big variance, if you will, that you saw in the second half of last year.

In fact, I would say this to you. If you look at the inflated level of AI, which was about $40 million inside the quarters, the second half of last year, at most it would represent about 25% of that inflated amount in the second half of the year this year.

Okay, great. And just a quick -- I just want to make sure I understand this. In the Financial Telesis deal, you're talking about potentially $25 million -- or $20 million to $25 million in annual incremental revenue?

Yes.

And are there any costs associated with that, or is that -- sort of what was the bottom line impact that you got for those revenues?

You'd want to think about this just like we are recruiting a new client. So the costs that were inherent inside Financial Telesis will be maintained in the new practice that is created, Global Retirement Partners. And so the only incremental expenses that we get are the normal traditional growth expenses relative to that $20 million to $25 million of incremental revenue coming on board. And because this retirement business is not typically custodied here, it has a slightly different revenue trajectory and ultimately margin associated with it in the short run. Like the opportunity set is now we see a larger practice that can effectively leverage two things, our rollover program that we've created and our in-plan advice capabilities in this retirement space. And that's a way to, as they more effectively and holistically leverage those capabilities, you will see the margins drive up on that business and the economics improve.

Great. Thanks for answering my questions.

Devin Ryan, JMP Securities.

Thank you. Good morning. I'd just like to get an update on acquisition opportunities, and really your appetite there, specifically around independent broker roll ups. Is the opportunity any better today? I know that you guys haven't done one in a while. Or is the timing better for any reason, whether it be better pricing or something else that could just lead to more inorganic activity expanding FA headcount?

We look at what's available in the marketplace. Our general assessment is the prices of today and the quality of what's on offer are not the right transactions for us. As simple as that. I don't see that outlook changing in the foreseeable future for us, and so that lets us put capital work in a different way. We've obviously been buying our own shares, which we see as a screaming bargain. And therefore what we have is an ability to make sure get a good return on that cash by being able to buy back our own shares and use that free cash flow effectively to return to our shareholders. We have about a third of our free cash flow that we used to pay dividends, and that's given us a nice yield on the stock, which certainly has been helpful as we look at the different buyers of it and so forth. So at this point, we like no better investment than our own and are happy with that. We will continue to look for inorganic possibilities, but don't see anything on the horizon that looks particularly interesting.

Of course, we like the organic growth that comes from recruiting as well, and so we continue always to assess that balance around maximizing the opportunity set with the right balance and the cost to acquire that business. And so it's something that we are constantly working on and assessing within an organization who is very adept at capitalizing on the recruiting opportunities, and has 60-plus people that's been full-time focused on trying to make sure that the marketplace is aware of the capability sets of our model, and ultimately and successfully bringing in those new advisors. As you've heard us talk about before, that's -- we generate some of the best returns that we can off of that investment.

Okay, great. And then just a different topic. We've been hearing in recent months that there's been a bit of increase in demand from third-party banks for cash, and that is driving actually a little bit better pricing power on cash balances. So I just wanted to get a sense. Is that the case? Are you guys seeing -- that doesn't sound like the yield guidance for next year has changed at all. And I get that there's some timing around which programs roll off and what they're on at. But do you expect any upward pressure there based on what's happening in the competitive market right now?

Yes, we are beginning to see certainly characteristics of improved pricing power for the reasons that you said. There's certainly, as the lending environment is enhanced, there's a growing demand for deposits. We are also seeing some capacity in banks for these types of deposits, and so that creates a greater demand for them to attract new deposits. And even some of the clarity that comes with Basel III and the LCR rates relative to these deposits are all three things that we believe and are beginning to see signs of that pricing power changing a bit. Too early to tell you exactly what that is. We've maintained our flexibility to continue to let those market dynamics evolve a bit before we ultimately make commitments or land on how to reposition the portfolio in the future.

Yes, that's shortening it up to the portfolio from a maturity standpoint is trying to take advantage of that, Devin, exactly as you're stating. Let's see if we can't -- hopefully see demand rise a bit more as the economy improves and as liquidity is obviously coming out of the market as the Fed starts to slow its QE programs. So we like the idea of shortening up a little bit, as much as you can in this kind of portfolio.

Okay, got it. So I guess with that as a backup, are you still examining the industrial bank charter, or have you determined that that might not be the best course, especially if there's any shift in possibilities from other cash programs?

We are certainly still investigating it to understand what the possibilities are, but obviously what we are trying to do is we know that placing deposits into the banking system and the way we're doing it says it works well for the banking system, works well for us, works well for shareholders, so that is our preferred because there's no capital involved with it unless it's continued to be a capital light model, which is the preference. We just want to understand whether there's optionality or does it help us for example in some way in the future as we think about what an ILC might look like.

Okay, great. Thank you.

Ken Worthington, JPMorgan.

Good morning. It's [Amita Yah] for Ken Worthington. Price yield and ICA were up 4 basis points this quarter, more than Fed funds increased on average for the quarter. (inaudible) balances are also down a little. Can you talk about the dynamics that drove the yield higher?

Yes, it's what you just said. The reduction in some of the lower priced balances create a slight sequential tick-up in that yield or rate.

Okay. Thank you for taking my question.

Bill Katz, Citigroup.

Thanks very much. Just coming back to the regulatory backdrop, how much of your incremental spend is idiosyncratic to catching up to I guess the pace of growth versus an industry dynamic?

I think 100% of it is unique to us in the sense that it's our particular journey in terms of what's happening. So 100% of it is related to fines for us for activities that have occurred. That's the difference between what we thought our expense run rate would be to what it actually is.

Certainly, across the board, what we are seeing in the industry is heightened regulatory review in all financial services industries, not just broker-dealers, that's there. But obviously those are individual items to our firm that relate to our practices in and of itself. But we've seen actions by the regulators to our competitors in this space that are similar to what is happening here. They just don't happen to be public. And so it's a different dynamic in terms of how they make their way into the world.

I guess that leads me to my second question. And maybe, Dan, you could just sort of requalify what you mentioned in terms of where the nontraded REITs are in terms of the contribution to commissions and production. I guess the broader question is, is there any behavioral change you are making with your FAs to reduce the regulatory risk on that side of the equation as well and as a result would that have any kind of lasting impact on production levels?

Yes, it's a great question. So, I think what we want to start with is first things first, which is the vast majority of advisors are doing a fantastic job for their investors. I get to look at all the detail here, and if I look at activity that's there, it is a rare situation in which someone is doing something that we would all agree was bad, you know, selling, falsifying records, whatever else it might be. That is by far the far exception. The vast majority of these issues really relate to the way processing occurs, and our ability to oversee that process and have certainty as to outcome. A best example would be in a particular state where there's a limit to the amount one can sell, you can imagine how easy it would be to say, gee, that limit comes out to $942. And what I want to do is round to the nearest dollar and I round it up instead of rounding down. That actually is a violation of the state's limits. And in the matters that we've settled, it would be fair to say 80-ish% are rounding errors, maybe 70%, that are there. That's not acceptable, so it's still a violation. But it's not bad behavior that's causing it. It's a lack of an automated system that lets us catch that in a way that then prevents the sale from going through. That's what we are building.

So what we've done in the interim as we've added people to look at those transactions, 100% of them, make sure the math works correctly, which is our job, and then if it doesn't work correctly, go back to the advisor and work through a solution. So is it having some effect? Yes, just because some newer processes are being built, but not enough to move the revenue line significantly that's there.

I think the other important thing to state is if you look at the totality of products that have been put on the platform, again they really have all performed quite well. So it's again not a product problem where we are approving a product that turns out not to be a good thing for investors. In fact, our processes there are quite good. So this really is the mechanics of how one documents and reviews the sale of alternative investments. Varied annuities have a version of the same thing because, again, these are all for the most part paper-based products for settlement. And that's really where the issues arise and overseeing them.

So, I would describe all of that as a little bit slower to revenues, not necessarily permanent. It actually mirrors what we saw in the mutual fund industry in the early 2000 post the market break when A, B, and C shares really dramatically changed. And essentially what happened was A shares became the dominant share class, but it used to be much more mixed than that prior to the regulatory actions in the early 2000s as I recall, so 2004, 2003. And what happened then was essentially a sort of similar path, which is the realization that processes that weren't being reviewed as well as they should across the entire industry, not just at LPL, the industry changed a series of its policies just as I see it doing right now in REITs and annuities. And that led to some temporary slowdowns, but actually created a much stronger outcome for investors, which creates more sales when you achieve what it is they're trying to achieve through the planning and activity that you are doing with them.

Thanks for taking my questions.

Alex Blostein, Goldman Sachs.

Great, thank you very much. Good morning. The first question, just a quick follow-up on the commissions. I was wondering if you could break down the contribution to commission parfait kind of from the fee-based component versus more transactional, because it seems like the transactional piece parfait I guess was down not as much as some would have thought. So I would imagine that the trend might continue into the back half of the year, given how good activity was in the second half of 2013. So maybe just parse that out for us a little bit and give us a sense of where the activity kind of like the true commission activity rate number could go in the back half of the year versus the second half of 2013.

This is Dan. Let me see if I can help you with that. So, I would look at it this way. Your average productivity across both advisory and brokerage in the second quarter this year was $251,000, of which $155,000 of that was commission-based and $96,000 of that was advisory based. So if you look at that on a year-on-year basis, you see that good consistent, steady A-plus percent growth in advisory. And you see your commissions, as you would expect, being up slightly year-over-year from $155,000 to $152,000. But if you back out the incremental, small amount of inflated alternative investment or nontraded REIT activity that we had in the second quarter, then your productivity levels on what I would call your baseline goes back to the $152,000 level. So on a year-over-year basis, it would be flat, and pretty flat on a sequential basis from January -- I'm sorry, from first quarter to second quarter. So, that just gives you the characteristics around how advisory is moving and how brokerage or commissions are moving and how they relate to the total productivity in the quarter. Again, that was $251,000.

If you look at the second half of the year, to the extent that, as we've said, we see consistent flow of net new assets, so you would think there would be a correlation in productivity related to the advisory piece with those net new assets coming in.

And then from a commissions-related standpoint, I think what we were saying earlier is if you maintain the same amount of alternative investments, sort of inflated amount of business, your jumping off point is $155,000 and you've got some seasonality adjustment from second quarter to third quarter that you would adjust for that's typically in the low single digits to mid single digit range from second quarter to third quarter. So hopefully that helps you at least break it down and think about it from an advisor productivity standpoint.

Got it. That's really helpful. Thanks Dan. And the second question I had real quick is just on the rate sensitivity. It's fairly minor, but I guess when you look at your table when you guys disclose the upside, it did come down a little bit for the first year to 25 basis points from I guess 1700 to 16. Anything in particular driving that? I would imagine maybe some of that is the balances being lower, but that probably would carry through the rest of the buckets as well. Is there any reason for that?

No, that's the right instinct. It was a combination of two things. Fed funds actually moved up 2 basis points, and so that's some of it. And then you don't have as much upside just because of that end, and then the balances were down. So that's correct.

Okay, thanks.

I am showing no questions in the queue. At this time, ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a wonderful day.