LPL Financial Holdings Inc (LPLA) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the LPL Financial Holdings fourth-quarter 2015 earnings conference call.

(Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Chris Koegel, Head of Investor Relations.

Please go ahead, sir.

Thank you, Abigail.

Good afternoon and welcome to the LPL Financial fourth-quarter 2015 earnings conference call.

On the call today are Mark Casady, our Chairman and Chief Executive Officer, and Matt Audette, our Chief Financial Officer.

Mark and Matt will offer introductory remarks, and then we will open the call for questions.

We ask that each analyst limit their questions to one question and one follow-up.

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 include certain forward-looking statements concerning such topics as our future revenue, expenses and other financial and operating results, improvements in our risk management and compliance capabilities, the regulatory environment and its expected impact on us, industry growth and trends, our business, strategies and plans, 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 actual financial or operating results or the timing of matters 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.

Thank you, Chris, and thank you, everyone, for joining our call.

Today, I would like to talk to you about our 2015 results and our plans for 2016.

I will then turn the call over to Matt to cover our fourth-quarter results.

The market environment was volatile and challenging in 2015, particularly in the fourth quarter.

Through the year, we grew our advisory fees, trailing commissions, and attachment revenues, and lowered our share count.

However, these results were more than offset by slower brokerage sales and our planned core G&A investments in legal and compliance.

Adjusted earnings per share totaled $2.22 in 2015, a decrease of $0.22 from 2014, and our GAAP earnings per share totaled $1.74, a decrease of 1% versus the prior year.

The fourth quarter brought greater challenges.

Brokerage sales were the slowest of the year, and advisory fees were down due to the equity market decline at the end of the third quarter.

Alternative investments were a large factor as commissions were down by about 75% from year ago.

At the same time, we managed our expenses below the low-end of our outlook as you would expect in this environment, and we did settle on currents and charges for severance and real estate consolidation that will make us more efficient in 2016.

These nonrecurring costs increased our core G&A and depreciation by $7 million and reduced our fourth-quarter adjusted earnings per share by $0.04.

Adjusted earnings per share totaled $0.37 in the fourth quarter, a decrease of $0.18 sequentially.

Matt will cover the fourth quarter in greater depth.

Before I talk about our plans for 2016, let me talk more about 2015.

Like many of our peers, we saw a drop in brokerage sales activity across products throughout the year as volatile markets led to uncertainty.

We would expect to see cash from retail investors build up and we did.

We believe this lower level of brokerage sales is likely to continue.

But another more important trend continued in 2015: our transition to becoming a predominantly advisory business.

Let me start by talking about what this transition means for our advisors.

The past year has, of course, been tough.

When we talk to most advisors, their businesses are strong, in spite of the slowdown in brokerage commissions.

This is because they are following retail client preferences and gradually transitioning their businesses to advisory.

By providing higher levels of service on advisory assets, our advisors are able to generate the same or better long-term income and are less dependent on brokerage commissions.

And their advisory assets are already managed to a fiduciary standard, which should make the upcoming DOL rule transition smoother.

Now let's talk about what this ongoing transition towards advisory means for LPL.

Our advisory assets have doubled in the last five years.

They are now nearly 40% of our total assets.

This transition is very good for the long-term stability and profitability of our business.

It also makes the DOL fiduciary rule transition easier for us.

So while the slowdown in brokerage has been challenging, our transition to advisory continues to increase our long-term value.

Let me now turn to 2016 and begin by acknowledging how remarkable this year has been so far.

At the beginning of January, the S&P was around 2000, and many people were projecting two or more rate hikes this year.

Just six weeks later, things have gotten a lot less clear and more challenging.

We now find the S&P bouncing around 1840, and we know -- we really don't know whether we will have more rate hikes in store for this year or not.

Institutions and individuals are taking risk off as you would expect.

In this environment, it is important for us to stay dynamic and flexible as we manage our business and support our advisors and their clients.

When we think about 2016, we know we have much to accomplish.

We are squarely focused on growth, delivering on our expense and capital plans, and managing the transition for the upcoming Department of Labor's fiduciary rule.

I want to discuss how we are positioning ourselves to accomplish these goals.

Let's discuss growth first.

As context, we had modest asset and advisor count growth in 2015.

Flat markets certainly didn't help our asset levels, though we continued to have strong net new advisory asset flows and nearly $17 billion or an annualized rate of growth of 10%.

As for our advisor count, not all advisors generate the same level of production, and the average new advisor joining in 2015 had meaningfully more historic production than advisors who joined in prior years.

We did experience elevated departures of low producing advisors in 2015, and we continue to have production retention above 96%.

In 2016, we are investing for growth in many areas who will improve advisors experience and productivity with a focus on service and technology.

These include ClientWorks, relationship management, robo advice, and the list goes on.

We are focused on executing these initiatives well to enable our growth.

Of course, we're excited about the long-term potential of our cash sweep revenue.

One of the great things about it is that it provides nice diversification for many other market-sensitive gross profit streams.

With some investors on the sidelines given market uncertainty, our cash sweep balances and revenues have grown.

And in December, the Fed raised rates for the first time in nearly a decade.

Our gross profit benefits nicely from rising rates and Matt will discuss in more detail but certainly having $30 billion in client cash sweep balances is a valuable asset.

Turning to our expense plans, we are well-positioned for lower expense growth in 2016 than last year.

Last quarter, we announced efficiency plans with a focus on this year's core G&A being $715 million to $730 million or up 2% to 4% from our estimated 2015 spend at the time.

That outlook included executing on some cost savings initiatives in Q4, and we completed those actions.

We remain on track for our core G&A outlook.

As for the rest of our G&A, we continue to expect our regulatory related charges will be meaningfully lower in 2016 than last year as we have lowered our risk profile.

And if we are successful on our growth plans, our promotional costs this year will be above our 2015 levels.

These costs are dependent on how successful we are in recruiting, which is hard to predict, but we anticipate growth supported by increasing promotional costs.

As for our capital plan, we completed our debt transaction in November, and since then, we repurchased $250 million of our shares in December and an additional $25 million in January.

These repurchases make up $275 million of our $500 million share repurchase program and have reduced our share count by more than 6% since our last call.

As you know, the Department of Labor delivered their rule to the Office of Management and Budget for review.

We are preparing for the work ahead, and we're waiting to see and understand the final rule.

Brokerage retirement accounts make up about 30% of our assets.

We continue to believe that the final rule will make brokerage retirement more challenging and costly.

We think those with scale and a wide range of solutions to help advisors and retail clients make the transition will have an advantage, and we have both of those things.

We also believe the final rule could present opportunity as the more challenging environment can give industry leaders like us more chances to play offense.

As a last topic, I want to discuss bottom-line accountability.

Over the past five years as a public company, we have reported adjusted results.

We did so to demonstrate the strong cash flow that our business is capable of generating.

However, we've come to realize that this approach has led to questions from the investment community about our earnings quality.

Now is a good time for us to help clear up those questions.

First, we did not adjust out the $7 million of nonrecurring G&A and depreciation in the fourth quarter, which we would've done historically.

Second, starting in the first quarter of 2016, we will report bottom-line GAAP results and stop reporting adjusted results.

We hope the investment community views this as one of many important steps we're taking towards transparency and clarity.

I want to close by announcing that Dick Boyce will be retiring from the Board in May.

I'm grateful to Dick for his over six years of service which span the end of his tenure at TPG Capital and beyond, and I wish him well in his future endeavors.

I'll now turn the call over to Matt.

Thank you, Mark.

It's good to speak with everyone on the call today.

Let's talk about our fourth-quarter results and the environment which was no doubt challenging.

Our adjusted earnings per share were $0.37, a decline of $0.18 versus the prior quarter.

The biggest driver of this decline was a reduction of our brokerage sales activity and advisory fees and greater expenses for seasonal and nonrecurring items.

While we will walk through the Q4 results in greater depth, I want to emphasize upfront that the core G&A increase during the quarter was as planned and actually slightly below the outlook we gave last quarter.

So we kept our expenses in line.

In addition, I plan to give you some perspectives on 2016.

Keep in mind, my comments are not intended to be targets or guidance.

I just want to give some color given the macro environment we are in right now and how we see that impacting our results directionally.

Turning to our businesses, we need to keep our focus on driving long-term value, especially in these volatile times.

And while there are many things we are doing, one critical goal is to grow assets.

I want to talk about that first.

Our Q4 end of period total assets increased to $476 billion or by 3% in Q3.

Net new advisory assets were $3.1 billion for the quarter, down from $4.2 billion last quarter.

For the year, net new advisory assets were $16.7 billion, down from $17.5 billion in 2014.

Moving to how these asset levels and growth rates impact our results.

Assets, both brokerage and advisory, are the key driver of our gross profit.

And as everyone is well aware, the macro environment in Q1 has been quite challenging so far.

The S&P ended 2015 at 2044 and closed today at 1829, which is down 10.5% in just a matter of weeks.

As the S&P remains at these levels, there is no doubt it will pressure our gross profit going forward.

Let's move on to gross profit.

In Q4, we generated $322 million, down $17 million or 5% from Q3.

The primary drivers were lower sales commissions, advisory fees and marketing allowances.

Sales commissions were $229 million, down $15 million or 6% from the prior quarter.

Trailing commissions were relatively flat to $234 million.

The slow sales commissions were consistent with the transition to advisory that Mark discussed, and alternative investment commissions and marketing allowances declined, driven by a maturing real estate cycle and upcoming FINRA regulatory changes.

Looking ahead at 2016, we think these brokerage trends are likely to continue and are planning accordingly.

Turning now to advisory fees, they were $324 million for Q4, down $17 million or 5% from Q3.

As a reminder, advisory fees are mostly billed off the prior quarter's asset balances.

At the end of Q3, asset balances declined along with the S&P 500.

Next, let's talk about asset based fees, which are primarily driven by sponsor revenues and cash sweep.

Sponsor revenues were $97 million in Q4, down $3 million from Q3, due to a modest decrease in billable asset balances.

Cash sweep revenue was $27 million, up $3 million from last quarter driven by both higher balances and rates.

One of the primary benefits of volatile markets like this is that our cash balances tend to grow.

We saw this in Q4 as balances ended at $29 billion, up $1.3 billion from Q3.

In addition, the Fed raised the target range for the Federal Funds rate by 25 basis points in December.

While this had a small impact on our Q4 results, it will have a more positive impact on our 2016 results.

Let me talk about that a bit more.

Our ICA deposits totaled $21 billion at the end of the year.

We had long discussed the benefits that will come from rising rates.

We have outlined an approach to pass through 50% of increases to retail investors through higher deposit rates while retaining 50% in the form of higher gross profit.

That said, we are not alone in the view that these deposits generally represent all balances awaiting investment and are not rate sensitive.

While we will continue to analyze the price sensitivity of these deposits, as well as the competitive environment, we do believe that our 50-50 split assumption is conservative in that there could be further upside.

More specifically, on our ICA rate going forward, recall that we had expected to step down in one of our long-term anchor bank contracts with favorable rates that would have reduced our yield by 22 basis points in January.

Notably, the Fed Funds rate increased, and we kept 100% of the rate increase.

This more than offsets the step down, and our run rate yield actually increased slightly above 50 basis points going forward.

Note also that our Q1 yield is likely to be a bit higher than our run rate as the anchor bank step down is now expected to occur over the first half of the year, rather than all at once on January 1.

As for money market funds, we ended the year with about $8 billion.

While we don't set the yield, these balances also benefit from rising rates.

An average yield increased from 13 basis points in Q4 to a run rate of around 20 basis points.

Turning now to transaction and fee revenues, which were $97 million in Q4, down $9 million from Q3, $6 million of this sequential decline was due to conference timing, and $3 million was due to lower Q4 transaction volumes after elevated volatility in Q3.

Let's now move on to expenses, starting with core G&A.

In Q4 core G&A expense was $179 million, slightly under our plans.

This was up $8 million from Q3 from two sources.

First, core G&A increased $4 million from nonrecurring costs, which were mostly severance payments from role eliminations.

Second, the remaining increase was primarily driven by annual discloses and investments in service and technology, offset by a reduction in performance-based compensation.

For the year, we ended with core G&A of $695 million, up 7.2% from 2014 and below the low end of our planned range of 7.5% to 8.5%.

Now looking ahead to 2016 core G&A, our plans are the same as we announced last quarter.

We are focused on funding several critical service and technology investments while getting more efficient elsewhere.

We are planning for 2016 core G&A of $715 million to $730 million, and this includes assumed costs to implement the final new DOL rule.

However, I do want to reemphasize that we have the least amount of precision in our estimates on these DOL costs as the rule isn't final.

And just to remove any doubt, I am simply restating our view from last quarter.

Nothing has happened that gives us any indication that costs will be more or less than we previously thought.

Moving to Q1 core G&A, please keep in mind that there is a bit of seasonality.

Payroll-related costs, including taxes, are typically higher in Q1, and we took some additional efficiency actions in January.

So Q1 will likely be one of the higher quarters of core G&A for the year.

Our promotional expenses were $35 million in Q4, down $7 million from Q3.

This was due to an expected $13 million decline from conference timing, offset by a $6 million increase primarily for transition assistance and other seasonal marketing efforts.

Looking ahead to 2016, if we are successful in our recruiting, transition assistance is likely to increase.

As for Q1, we expect our Masters advisory conference will drive about $5 million sequential increase in conference fees.

Our regulatory-related charges, which were primarily due to ongoing remediation and restitution from past settlements, were $8 million in Q4, flat versus Q3.

This brings our total to $34 million for 2015, down $2 million for the prior year.

We continued to expect that total 2016 charges will be meaningfully lower than total 2015 charges.

Please also keep in mind that individual quarters can vary given the nature of regulatory charges.

Depreciation and amortization was $32 million in Q4, an increase of $5 million from Q3.

Most of the increase was from about $3 million of real estate consolidation costs, which we do not expect to recur in Q1.

I will also highlight that our nonrecurring core D&A and depreciation costs historically would have been excluded from our adjusted earnings results.

In the spirit of what Mark said earlier about reporting bottom-line results, we did not adjust these expenses this quarter.

This combined $7 million reduced our adjusted earnings per share by $0.04.

Let's turn now to capital management.

We spent a lot of time on our last call discussing our plans to increase our leverage to about 4 times and repurchased $500 million of our own shares.

In November, we completed a $700 million debt transaction that raised our leverage ratio to 3.7 times and our maximum net leverage covenant to 5 times.

Following the transaction, interest expense increased $18 million in Q4, an increase of $5 million from Q3.

We would expect interest to increase to about $24 million in Q1 with current balances and rates.

Since then, we repurchased $250 million worth of our shares in Q4 and an additional $25 million in Q1.

Together, these $275 million of share repurchases reduced our share count by $6.2 million.

This leaves us with $225 million to deploy from our debt transaction last quarter.

Our plans, as I discussed last quarter, were to deploy the first $250 million quickly, which we ended up doing even faster than we had assumed.

And we had planned to stay flexible in deploying the second $250 million to adjust to opportunities that we may see.

And given the volatile environment we are in now, that only strengthens our resolve to be slow, steady and cautious on deploying this capital.

Finally, I want to talk a little bit about our financial reporting: what we release, how we release it and how we talk about it.

Overall, we aim to make our financial reporting and investor communications more straightforward and clear over time.

We own our successes and failures and aim to make our financial reporting and results reflect those, whether they are good or bad.

Let me touch on just a few of the things we are focused on in the near term.

Beginning in Q1, we will report EPS with no adjustments.

A couple things to keep in mind then.

Our debt capacity is determined by a credit agreement defined EBITDA metric, which is not too different from our current management defined adjusted EBITDA.

We will continue to report the credit agreements defined EBITDA, but as a metric to give you context on our debt capacity and covenant compliance.

Also, we are likely to have unique items in any given quarter, but the severance-related and real estate consolidation costs we had this quarter.

We will continue to provide the appropriate amount of color, including highlighting items like this, but only in the spirit of giving context to the results.

We hope that this will make our results clearer and more direct.

Second, I just wanted to acknowledge the time of day we are speaking, after market.

I suspect this time of day is much better for our West Coast listeners.

We will aim to keep our calls after market going forward.

Third, monthly metrics.

This is not something we've done in the past, but we recognize it can be helpful to provide intra-quarter updates.

We plan to release monthly metrics going forward, and we will start next week by releasing January metrics.

Lastly, we want our investors and analysts to get to know our broader management team better.

Therefore, we will be hosting an investor and analyst day in New York on May 25.

These are just a few early changes on our list, and we look forward to sharing our progress over time.

In closing, it was a challenging quarter, no doubt.

Given what we were seeing already in Q1, it has become even more challenging.

As a management team, we are keeping our eye on the ball and doing the things that we believe will drive long-term value: growing the business, improving technology and service, and preparing for the DOL rule, all while staying disciplined and flexible on expenses and capital.

While our industry might be in rough waters right now, we feel confident this course will drive value over the long term.

With that operator, please open the call for questions.

(Operator Instructions) Steven Chubak, Nomura.

So first I had a question on the prospects, Mark, you were speaking to about potential advisory conversion, which is something that's been ongoing for at least the last couple of years.

You had spoken to it last quarter in the event that the DOL proposal is more challenging or I guess using your words, unworkable.

Is that still a viable option under the amended credit agreement given that the debt covenants as written would presumably make that increasingly challenging as we drive the rebasing and the adjusted EBITDA?

I just wanted to make sure that that's still a viable option, that's still on the table, even in the context of the debt covenants that you're in.

It's absolutely a viable option.

I don't see that it has any impact to what the debt covenants are.

We have plenty of room and plenty of wiggle room, if you will, in the covenants.

You will recall that we added extra leverage covenants, not necessarily anticipating this much of a drop in the world, but anticipating that there's always rough waters ahead.

So it has nothing to do with that at all.

It's all about what the end investor needs to have to be able to be successful in their retirement goals for those types of assets and what the practical way of dealing with those needs are.

And so it's also just the process itself.

It would obviously be a significant conversion of assets and accounts in a relatively short time given we're hearing the implementation period will probably be about eight months or so once the information is released.

We are planning basically for multiple scenarios here and working through our systems and service and operational activities, if you will and spending, again, a pretty wide range of outcomes once we see the regulations come out from the DOL.

Thanks.

And just one more follow-up from me, just digging into the commission breakdown, it was nice to see actually the surprising resiliency in variable annuity commissions.

Just given what we're seeing in the 10-year, what is your outlook for that at least in 1Q, and what trends are you seeing thus far?

And you can give us an update on what your expectations are given some of the rhetoric that's come out of DC that's highlighting hurdles to that product, that would be much appreciated.

Yes, so just a reminder that the Department of Labor allows for variable annuities under their new proposed rulemaking.

It is an allowed product.

There are some changes in the way -- it's exemptions around -- without getting too geeky on you here -- that relate to using the best interest contract as a way of making sure the consumer understands the expenses involved.

So we see it as a very workable and viable product.

We know consumers want it because they are trying to create their own pension plan, and we know that they want it because they are trying to get exposure to equities but also protect themselves on the downside.

The lesson the last six weeks makes particularly clear.

And they are trying to create some guaranteed income streams.

So I think there's really two sources of change that could come.

One is that the best interest contract isn't workable, and therefore, we switch over to advisory as a primary way of solving for retirement assets.

And variable annuities are a commissionable brokerage product, and therefore, for a retirement account, you would want to use a non-commissionable VA.

We actually were an innovator many years ago -- several years ago of creating VAs without commissions in our advisory platform.

We raised several hundred million dollars worth of assets that way, and so we would basically dust off those capabilities and get them going again, if that is the outcome.

So one is just structurally related to that.

And the other one, of course, is, as you say with the 10 year so low, what will the insurance companies do from here?

I think part of the rhetoric that we certainly hear is insurance companies are evaluating what they can or can't do and continue to issue variable annuity capabilities.

Certainly the market has recognized that based on stock performance.

So we'll just have to see and see what they continue to offer to consumers.

There's other product lines that are available.

There's equity indexed annuities, and there's also more immediate annuities and fixed annuities that work quite well for certain features that are there that just aren't -- that basically don't offer as much of a hedge as VAs do.

So there's other places we see advisors using products that aren't straight VAs that solve some of the same problems consumers have that they are trying to work towards.

So I certainly think we're seeing the impact of advisors changing to advisory, and so that's why you are seeing brokerage sales down across the board whether it's mutual funds, VAs, or alternatives, and so that condition will still hold true.

But I do think that there's a way of imagining how the market continues to satisfy what consumers need in terms of their long-term time retirement needs.

Thanks, Mark.

I will hop back in the queue.

Alex Kramm, UBS.

Anyways, just following up on the whole transition to advisory, which you are obviously ongoing process, but obviously recognizing that that could accelerate with the DOL.

I think this has been asked before, but how do attachment revenues compare under advisory versus brokerage?

I assume brokerage products -- you got a lot of fees from mutual funds, and you made some comments around those attachment revenues being down a little bit.

If people go to advisory and they use more ETFs like -- other wrap products and things like that, how do the attachment revenues, the transaction fees and the asset base fees change potentially for you?

Yes, and it's actually -- let me simplify it because I think it's the best way to look at it.

Effectively the same capabilities that we provide doing transfer agency work, supplying and reporting all those things that are the mechanics of providing distribution stay the same whether the asset is in a brokerage account or whether it's in an advisory account.

And that's by far the majority of the revenues that we receive in this category.

You can't have sponsorship in advisory assets, so we don't have that today.

And you do have effectively sponsorship that's within marketing charges that are within the brokerage world.

So already existing is the fact that you have that difference in the way revenues are created on the attachment side.

Remember, though, that in addition to those attachment revenues, we receive an account charge -- as you say, transaction fees and the like, and those fees are basically higher in advisory account when you think about it as an ongoing collection of revenues.

So we've often said that a dollar of client assets and an advisory account is more valuable than a dollar of assets in a brokerage account, and that's why we like the movement to advisory over the long term.

So that dynamic remains, even though that march to advisory may be faster.

And the final question he asked is really around essentially ETFs.

ETFs really do only show up in advisory in volume and don't exist in the brokerage world per se, and we've had a clip over the last several years of about 2% of assets moving to ETFs over time, and that's a clip that's quite manageable.

Even if it were to double, that's a quite manageable clip because ETFs are a security.

They are not a fund, so they don't pay a transfer agency type fee.

But we do get transaction revenues from them, and of course, we still get the account revenues that we talked about before.

And then finally, if you look at it in terms of what works for consumers, we created centrally managed platforms that -- ours is particularly called model wealth portfolios.

Have been very popular.

We repriced them a bit last year, effective January this year.

And what those do is allowed advisors to outsource the investment management and oversight of trading of an account, so it's very cost-effective for them.

It also allows them to choose from a wide variety of asset allocators from LPL to BlackRock to others, and so it's a good selection of capabilities for them.

And that product line, that's where the majority of our ETF assets go because we have an all ETF solution there, and the account fee basically pays for the transaction fees and essentially pays for the transfer agency work as well.

So we have good ways of dealing with no doubt the march towards ETFs and lower cost products that deal with some of the structural differences in the way they pay.

All right.

That's very helpful.

And then I guess just a small one for me for Matt.

I think you gave some color here just now on the cash sweep and what you are seeing so far this year.

I think you said low 50s on the ICA, so maybe you can be a little bit more specific there.

I don't know -- is it 52, I guess?

And then what you are seeing right now -- you said in the second half, it's coming down a bit.

So can you just be a little bit more specific to what level as some of those arrangements move -- roll off, do you think you will be in this kind of rate environment.

And then sorry, I missed the number on the money market fees.

I think you said where those are also running for this quarter as well.

That would be helpful, again.

Thanks.

Yes, so 20 basis points on the money market fees.

On sweep, the -- so they are just above 50 basis points or slightly above 50 basis points is all the precision I have for you there.

But to clarify, that's the run rate post the anchor bank rundown, if you will.

So that rundown is going to happen over the first half of the year.

So everything else being equal will be biased to be above that low 50s for the first half of the year.

And the low 50s was just the run rate once that's done.

So hopefully that gives you a little bit perspective on that.

And then there's nothing thereafter as we get into 2017, or are we basically completely done just with that issue -- the runoffs?

Yes, it's a large portfolio with a lot of different banks.

By far that is the biggest and really the only material one worth noting.

All right.

Thank you.

Ken Worthington, JPMorgan.

(technical difficulty)

Ken, you are breaking up I'm afraid.

Ken, are you there?

Chris Shutler, William Blair.

As you transition more to advisory, keeping on that theme, where do you think, Mark, looking out a few years, three to five years, what percentage of your total assets do you think could be advisory, and how do you guard against the issue of reverse churning which has been brought up by regulators?

Boy, that is like a 30,000 foot question followed by a 1 foot question.

(laughter) So a reversed churning just for those who aren't in the know means that you don't trade the account enough, and that is a concern of us as the organization that oversees the activities of advisors.

It is a concern for investors where their money may not be managed to the level that they need it to be in particularly volatile markets, and we have a process for reviewing every advisory account here and making sure that we can see if it's on the corporate RIA -- LPL's RIA -- that we can see the activity that's going on.

If we are a custodian for the RIA, then they have their own compliance process that looks for reverse churning, and they own the liability that comes from the lack of adherence to the rules of the SEC.

So not particularly worried about it.

In my experience, it is a relatively limited problem because most of the time you have volatility in markets.

We have more than we all would like right now, and we are certainly coming off a period of very low volatility.

So that isn't a concern.

And if we see it, we can deal with it quite readily.

It's also one of the reasons why advisors who are long-term hold advisors might be well served to use the central platforms because those platforms review accounts every quarter basically and will rebalance based on market movements, particularly a movement like you are seeing happen now.

So I think we have plenty of tools to make that work.

And then if you look at the march towards advisory, I don't know that I can predict if we're going to go from 40% to 60% or 40% to 50%.

That's not possible, at least for me.

There is no doubt that we are on a march towards being predominantly advisory in assets.

We're already predominantly advisory in gross margin, and we're already predominantly advisory in sales.

I believe the number is around 65% of product sales in 2015 were advisory related.

Gross margin would have been about 55%, if I remember right, or just over 50% directionally.

And, therefore, what you have is we are already moving that way through the way assets are growing today.

We just have a large embedded base of brokerage assets given our historic leadership in the independent broker-dealer space.

So I won't predict where we are going to get, but clearly we will be higher over time given the sales numbers of today and given that march towards advisory.

Okay.

Thanks.

And then on a totally different topic, Mark, you mentioned the robo offering I think earlier.

I think, correct me if I'm wrong, you believe that small accounts were going to be disadvantaged by the DOL rule.

So I guess first, is this going to be a buyer build for LPL?

How do you see that eventual offering being rolled out to these advisors?

Is it your goal that when the DOL rule is actually live, that you will be live with a Robo?

Thanks.

I don't think they need to be concurrent with the live rule.

The rule is likely to come out here in April.

So that's pretty quick, and we will have at least eight months to adhere to it.

And so we certainly plan to have our robo advisor as a solution, but remember, it's not the only solution.

We already have the model wealth portfolios that can take accounts down to $15,000, and we have Optimum market portfolios, which I believe go down to $10,000, and will probably lower minimums in those programs to accommodate smaller accounts.

In any case, whether the rule -- even if the rule has a workable best interest contract, we would likely lower the minimums there.

And then robo advice is really about client self-service and being able to also deal with small accounts.

But I don't know that it would have balance requirements that are less than what we're talking about in the other programs.

So it's really meant for opening up a new market, which has allowed advisors to work with the children of their current clients or to allow advisors who are in the millennial generation.

There's one just up the road from San Diego in LA, for example.

It does a great job of having millennial advisors who serve millennial clients, and they want to have that technology as part of their offering.

So it is a little different, Mark, than DOL, but completely agree it would be one of several solutions that we plan on having on offer as the DOL rule becomes clear.

All right.

Thank you.

I'm sorry.

You asked one other question, which is are we going to build or buy it.

We are actually renting it.

We haven't announced who the rental partner is, but just so we're clear.

Got it.

Thanks.

Chris Harris, Wells Fargo.

First question relates to the balance sheet.

If we run rate your current EBITDA based on my calculations, you guys are at 4.3 times leverage now already over your target.

So from there, it seems like it would only take another 15% or so decline in EBITDA, and then you were up against the 5 times leverage limit in your covenants.

So wanted to get your thoughts about what point might you actually need to start paying debt down with excess cash flow as opposed to thinking about buybacks.

Yes, Chris.

This is Matt.

I'll take that one.

I think a few things to keep in mind.

First, I'm sure you are looking at it, but keep in mind that from a covenant standpoint, it's the credit defined EBITDA.

So that's the metric that we negotiated.

It's got a little bit of more flexibility than the management defined adjusted EBITDA that we've had.

So if you look at the quarter, it's just north of $110 million or $111 million for that metric.

Second, I think you know them well because you just stated them, but we did negotiate them as covenant capacity in the new debt.

And the other thing that I would keep in mind is it's a trailing four quarters test.

So when we entered into the deal, we were at 3.7 times.

We ended this quarter at 3.8 times.

So it's not something that happens overnight.

With respect to the quarter, so just annualizing the quarter the way you did, I would keep some seasonality items in mind.

And maybe just starting on the gross profit side -- so from a payout standpoint -- I'm sure you know this as well, but the bonus production payouts build throughout the year.

So Q4, just by the nature of the path is the highest quarter of the year.

So annualizing that is going to have a disproportionate impact.

And then all the things that I highlighted on the expense side that had some seasonality, the core G&A with some year-end disclosures, our typical year-end service ramp-up on the promotional aside, the year-end marketing push, and then on the regulatory side where we expect the decline from here.

So there's just a lot of things that I think I would caution in annualizing Q4.

But then to your point, just thinking through the environment, there's no doubt, as I said a little bit earlier, the commissions and advisory fees are going to be pressured in this environment.

But at the same time, just some natural offsets, right?

Transactions would typically be higher.

Our cash sweeps would tend to be higher.

They grew in the fourth quarter.

You'll see next week we will release January metrics where January came out, but there's definitely some natural offsets there.

Putting all that together, the environment is not lost on us.

Our covenant and our debt is not lost on us.

We need to be dynamic and flexible, making sure we're balancing, focusing investments for growth, but also being efficient and smart here.

So hopefully that gives you a bunch of color and context on how we're thinking about that.

It does, yes.

Thank you for that.

The follow-up I had really had to do with the buyback, and I know you guys tend to have a pretty good line of sight in your business.

And so I would imagine when you guys had some idea that the fourth quarter was going to be pretty challenging.

So not sure why then you buy so much stock ahead of that print as opposed to waiting until after the fact and then you have all kinds of dry powder.

So maybe you could help us understand the timing associated with the buyback and maybe what happened during the quarter that perhaps is a surprise.

Well, I think the surprise is the market downturn.

No one predicted the Spanish Inquisition.

So, as you look at it, you have the six weeks of relentless market drop including today, and that is the issue.

So I think as you look at it, what we saw was an opportunity to get the first wave of buyback done at pace, and we have always been an aggressive buyer of our shares.

So this is no different in terms of our behavior, and certainly we had insight into the quarter.

And you knew we would have challenges, but didn't feel we would be that far off from the rest of the market, and I think the rest of the market's reporting shows that we're not that far off.

And so on a relative basis, we would have said that the price is going to be somewhere around a number not too different than we used, and therefore, it makes sense to do it sooner rather than later in terms of reducing share count.

It was no more complex than that.

Okay.

Thank you.

Bill Katz, Citigroup.

So can you talk a little bit about how much flexibility you have on the core G&A?

What I've heard so far is a lot of pressure on the top line against investment spend.

So I'm just trying to understand how much offset there might be for margin pressure if this environment does not improve?

Yes, we have plenty of room for adjusting expenses, and we've had a history as an organization of adjusting expenses where needed.

Unfortunately we all get to remember 2008 and 2009 in moments like this when we had a significant reduction in our run rate of costs back then.

Without going into the details, it was a significant change in our run rate costs.

We obviously view that if the market is going to continue this way.

We will have to do something somewhat similar.

We do believe it's important for us to stay focused on particularly our technology projects and the work we're doing to continue to attract and retain advisors, and we need to understand, as anybody does, what this market is going to hand us in terms of both market performance and activity.

But we have plenty of levers to pull that I would describe as low, medium and high, and we have no problem pulling on those levers when we need to.

Okay.

The second question is just as you think about your mix shift, you know, the ongoing migration toward advisory, if we had a positive environment of flat interest rates for the next couple of years as the forward curves are increasingly suggesting, how does the profitability play out if you, in fact, do migrate more to advisory?

And then the second correlation to that is, what compass do you have as that business migrates that you are -- what your capture rate would be?

So, in other words, would there be some leakage in your assets as a result of that migration?

Yes, great question.

So I think as you look at the dynamic of that business and the assets in flux, you would expect that if it's a greater push towards advisory, let's say particularly predicated on Department of Labor, that we're going to see that particularly harming our independent broker-dealer competitors, and we would then see assets in motion both from advisors moving to places that are really under severe pressure, into places like LPL as a market leader, and you would expect to see consumers making decisions about what they want, and we have a very wide variety of ways we can solve their problems.

We talked about a few of them like Optimum market portfolios, model wealth portfolios, robo advice, our SAM programs where it's rep as the portfolio manager on the advisory side.

So I don't -- we certainly would have some leakage.

We always have leakage out of any program from existing advisors.

That's 96% retention rather than 100%.

But as you look at it, that leakage would be more than overwhelmed from other assets coming in through those other sources.

So we don't particularly see that as a worry in and of itself.

I think you always have the body of work that it takes to get advisors and investors to understand their choices, make those choices, and then execute on them.

And so I think you always have some execution risk, particularly when you're talking about a sizable movement if it's motivated by the Department of Labor in particular.

If it's not that, it's just the normal process we've seen today, then no worries at all on really any of those fronts.

And just one last one.

I appreciate you taking all my questions this evening.

When you look at your net new advisors down for the second quarter in a row, number of your peers are just talking about very strong pipelines and very good asset growth, etc.

Can you tease out from that number how much of this might be ongoing attrition from some of your lower-cost producers versus maybe what might be going on at the macro level that could be stolen -- sort of growth in that line, if you will?

Thank you.

Yes, absolutely.

So it really continued in the fourth quarter what we saw in the third quarter, which is producers who have very low production levels, zero to $10,000 or $20,000 worth of production that are going out, and we basically have the new classes coming in at much higher asset levels or production levels than, say, the previous year as we mentioned in our script, and that change over is what's happening.

And so the headcount has always been an easy proxy over the years just to say, hey, use headcount times an average production number, and that will get you assets.

That formula just doesn't work at this size because you are getting a flushing out of the lower end producers, you are bringing in the higher producer, and you can't see that in the headcount.

Where you have to feel comfortable that that number is correct, as you look at the advisory asset flows, you look at the overall asset levels, and you take out market, you can see there's asset growth there, which would be predicated on advisors adding assets who are already with us and obviously advisors who are joining us.

And then I think you can see there's a number of industry consultants and others who report on movement of assets, and of course, those press releases we don't do them for every single one, but many in the industry do a lot of them that show movement of teams into LPL and the like.

And so we feel like we are in very good shape vis-a-vis our competitors and very good shape in terms of movement of assets, and I would say that as we look forward, similar to our competitors, we do see a pipeline that's building nicely.

I do think we have to be concerned about this market movement.

Typically when you get this kind of extreme, advisors slow down the movement process just because they are busy helping clients feel okay about these markets.

But with that said, just in terms of the pipeline build, we see a good pipeline build probably better than we've had in a couple of years, which is obviously good foreshadowing to movement.

All right.

Thanks very much.

Devin Ryan, JMP Securities.

Just a couple of follow-ups for me.

The first, clearly a number of fee structures across the RIA custodian space -- and I know that you guys aren't necessarily trying to be the low-cost provider there given all the services you provide -- but just with some firms seeming to give more away for free today, how are you guys thinking about pricing?

Meaning do you think about changing pricing or maybe reducing pricing to accelerate asset gathering into the RIA channel maybe in the context of some movement around the DOL rule implementation, for example?

Yes, I do think that -- so there's really two types of pricing with an advisor that are important to distinguish.

You talked about essentially RIA custody pricing, and we feel like that pricing is pretty much at stasis when we look at the custodian competitors.

That's come down over the years, as you say.

But generally speaking, it seems to have found its point of distinction between the major custodians, and we feel like we are quite competitive there.

As you say, we have additional services and features, and so for a little bit higher price premium as an RIA, you can use LPL to outsource a fair amount of the work that you have and use our middle office technologies at lower costs than you would having to do that on your own.

So that's the value proposition.

It's clearly working because two-thirds of this year's -- last year's class was in the hybrid RIA market.

Where we do see an area that we can continue to build is in the central platforms like model wealth portfolios and in the corporate RIA where basically if you look at prices there, we changed a few things last year really in anticipation of the DOL rule, removing the $40 per year IRA fee, for example, in model wealth portfolios, and we would continue to look at making price changes in those two areas, which are different than custody of RIA assets where we feel prices are good.

And we would obviously look for things to help offset those kind of changes.

But it has been our tradition to do that for exactly the reason you stated.

It just doesn't take much to overwhelm any price cut in volume.

And because the world is heading to advisory and the more we can do to make practices efficient by letting advisors outsource to the central platforms or outsource to the corporate RIA where they don't have the legal liability and we can oversee their activities, the better everyone will be in that equation.

Got it.

Very helpful a quick housekeeping one on the covenant calculations.

The net debt portion of the leverage ratio calculation, is there any limitation on the cash balance that can be netted against the debt?

Yes, it's $300 million.

So we've got cash available for corporate use of $500 million.

So $300 million of that is netted against the covenant calc.

Got it.

Thanks very much.

Joel Jeffrey, KBW.

Had a quick question on your advisory revenue.

I know in your brokerage business you generate -- you get the 12b-1- fees in the trailer line.

Do you generate those under the advisory accounts as well?

Yes, you do, and you basically -- there -- this is where it gets a little complex.

You have to take again that same breakdown of where do assets sit.

So you have assets that sit where we are the RIA custodian, and there are 12b-1 fees that can be paid there.

all the custodians, including LPL, receive those, it is part of the offset of the costs.

Those are all disclosed and understood at the retail level and obviously by the RIA.

So that is an area that that happens, but for a different reason than it happens within the brokerage world.

And then you have within the corporate RIA, you have qualified and nonqualified accounts, and qualified accounts are, of course, taxable -- excuse me, tax-free accounts, and in those cases, we rebate the 12b-1 fees to investors to offset things like their $40 fee per year for their trusteeship of their IRA or whatever else it might be.

And then in the taxable accounts, the 12b-1 fee is received again fully disclosed to the investor, fully disclosed through the advisor through the corporate RIA and, again, a practice in which that change has been made.

Does that explain that breakdown?

It does.

Can you give us a sense for the magnitude of fees you generate off of this?

I don't have the number in front of me in terms of the total of 12b-1s, but if you go to I think probably where you are trying to head to is a little bit related to the Waddell & Reed announcement that occurred last week or the week before, where they are eliminating 12b-1 fees, and you have to be careful because we are talking oranges and they are talking apples.

They have their own fees of a 12b-1 nature in their own funds sold through their own employees through an advisory account.

That is not our dynamic.

We only do outside funds.

We don't have any of our own product, and these are not our employees.

They are advisors who own their own practices or are part of a financial institution.

And so what they are actually focused on, as I understand it, are the 12b-1 payments that they make through their fund complex to their employees in advisory accounts.

The equivalent in our world would be deminimis in terms of the -- it would have to be the taxable accounts, and the corporate RIA would be the equivalent, and that 12b-1 line is deminimis.

Most of those are I-shares today, that's why.

They are using an A share with a load waive, we're using I-shares for the most part in that world.

Great.

That's helpful.

And then as we think about rate sensitivity going forward, appreciate the comments you gave on the first quarter, but have you guys thought about a scenario in which rates go negative?

Well, you have to think through, I think, every possibility.

Having lived through a world where we went long on rates at the end of 2008 and that's just coming off now here in 2016, we do try to think through any possibility.

Generally where rates go negative aren't so much in the Fed Funds rate, but they are in the way that essentially T-bills or the like payout which is a little different scenario.

So that would affect a treasury only money market fund, for example, that would go negative or would affect an investor who buys a T-bill which would have a negative rate on it.

And so those are -- there are systems issues that relate to that, and we have a fine partner in our money fund world, JPMorgan, who we have worked with over the years to talk about different scenarios where fund rates may go negative.

So that really is fairly isolated to that world, and that's really just a matter of having to do some relatively straightforward systems changes to be able to report out what would be a negative rate on a fund.

More than likely it would show up in the short T-bill market in the way that assets are accrued there.

Just so, in terms of what you are getting on the ICA account, that wouldn't necessarily be impacted by that.

Is that what you are saying?

Well, I'm not an expert in what the Fed policy is by any stretch of the imagination, although I certainly am a fan of their current policy.

And I don't believe from everything that I've read that what they're talking about is going negative on rates.

That would be a long change from where they are today or where they've been over the last 10 years.

What I believe the discussion is is more of rate payment for essentially safekeeping of assets that a consumer wants from a governmental asset, whether that's in Germany or Japan.

That's the scenario, as I understand it, is there.

Thanks for taking my questions.

Conor Fitzgerald, Goldman Sachs.

So most of my questions have been answered, but just a couple of follow-ups.

One just for (inaudible) technical.

If Fed Funds effective goes negative, you aren't down by zero in your ICA calculation, correct?

I don't believe we could -- our contracts with banks are basically a number -- Fed Fund plus a number, if you will.

So if the Fed fund number goes from [38] or whatever it is to negative [5], it would be still plus a number that's there.

So that's the way it's calculated if that's helpful.

Yes, that is helpful.

Thanks.

And there -- your covenant goes to 475 as of January 1, 2017, is that correct?

Yes, so we've got 5 times for basically a year.

So 2016, that's down to [475], that's correct.

Okay.

And I'm just trying to get -- understand your thought process on pursuing a buyback just given some of the risks that Joel talked about on rates and what's happened to markets versus preserving cash.

Just trying to get a better sense of how you are viewing the risk reward for buying shares here.

Obviously stuff lower than it was, but just trying to better understand that risk reward in your eyes.

Right.

Going forward from here?

Yes, exactly.

Yes.

Hopefully that came across loud and clear in the prepared remarks.

A lot has changed, and we're going to be very slow, deliberate, and think through what the best way to deploy the capital is in a similar thought process on the expense side.

We've got to have the right balance of deploying capital in an effective way for our shareholders, but at the same time recognizing the environment we're in.

So there's a lot of balance that needs to happen there, and a lot of recognition that things are changing really fast.

Six weeks ago, this was a totally different world.

So I think that's all these things we need to keep in mind.

Okay.

And then just on the 12b-1 piece follow-up, I understand there's higher costs related to retirement accounts.

I am trying to better understand why you have the different pricing structure between retirement versus non-retirement accounts.

It's all in the regulation that governs each type of account, and the other structural change or difference is when you are a custodian versus being the RIA.

So our world is a little bit more complex than most because we are both a broker-dealer -- broker-dealer and corporate RIA, and we are an RIA custodian.

And so you have, of course, sets of rules from different regulators that govern each account type.

And some regulators will have a ban on certain types of payments.

Others will have a disclosure rule for it and the like.

Okay.

That's helpful.

Thanks.

So just to be clear as day for everybody is that there is no difference in what we're doing than anybody else is doing in the industry.

And so again, Waddell & Reed in particular, which, again, I believe is the source of some of these questions, it really is quite a unique circumstance for them as a company and for the way they structure their programs, at least as I understand it.

Obviously I don't speak for them, but their circumstance is completely different than ours, and we look more like the custodians and more like other corporate RIAs.

It would be right in step with what they're doing.

Ken Worthington, JPMorgan.

So sorry to beat a dead horse here.

I wanted to actually hopefully close the 12b-1 fee debate.

What portion of your 12b-1 fees are charged -- and trailer fees -- are charged in advisory accounts, how much are in brokerage accounts with retirement assets, and how much are in brokerage accounts of nonretirement assets?

How does trailer fees split out between those three buckets?

So I definitely don't have that in front of me, Ken, and happy to -- thanks for that -- we look through it.

Essentially you have 12b-1 fees that are received in brokerage in which there is no question about being able to receive those, and just to be clear as day, some people make the distinction between retirement and nonretirement and brokerage because of the pending DOL rule.

But if you look at their rule, they allowed 12b-1 fees to be paid on those retail retirement accounts in brokerage.

So there's no question that that remains in place.

The SEC has approved 12b-1 fees -- the allow 12b-1 fee payments to be made.

So they are approving the product in essence right with (inaudible) those fees.

They oversee the taxable accounts through FINRA and then basically the tax-free accounts overseen by FINRA and soon the Department of Labor.

And in the Department of Labor rules, they allow 12b-1 fees as the SEC and FINRA do today.

So don't see any changes coming there, and I would describe that the majority -- vast majority of what we're seeing in 12b-1 fees are there.

But I look to Chris or Matt to correct me if I'm wrong.

Yes, just add on to tie everything you said together, the vast majority of the 12b-1 fees are on the brokerage platform.

And the corporate advisory platform that you are talking about earlier, which I think was the core of the question are deminimis.

So it's a vast majority on the brokerage side.

Okay.

And on the trailers that go to the advisory side, what portion do you keep versus what is paid to the broker versus what is rebated back to the customer account?

Does LPL keep any of them, or does it all go somewhere else?

Very little is kept by LPL, and basically it's because in the retirement accounts of advisory in the corporate RIA, those fees are rebated in essence -- or not in essence, they are rebated to the consumer through their account.

And then within the taxable accounts with an advisory working corporate RIA, those 12b-1s for the most part have gone away over the years as I-Shares have been introduced.

So mutual fund company a -- that's not a good example.

Mutual fund company SAM basically creates an A, B and C share.

Over the years, the B share went away.

Over the years, the A share became load-waived, meaning that you didn't pay the upfront fee, but you still had a 25 basis point 12b-1 fee on it, and that payment continued to be made as it went into the advisory programs.

Smith Fund Family then created something called an I-Share, mainly for the retirement account business for 401(k) plans and the like, and those I-Shares worked really well in an advisory account.

What's happened is, as those I-Shares get introduced, we basically introduce them into the advisory platform as a way to lower the cost for consumers across the board that are there.

So that happens regularly that mutual fund companies make those changes.

They've changed an awful lot over the last decade.

So to my mind, most of them have I-Shares at this point, and we followed the fashion of what will go to the lower cost level in advisory because we want to make sure we're providing good value to consumers.

So there still are some A-shares load waived that are in the system that pay a 12b-1 fee.

It's deminimis, and either the fund company will introduce an I-Share and it will be eliminated or however that works.

So, as you look at it, it's just not a big impact.

So again, you are not -- you can't compare the Waddell & Reed situation at all with what it is that you are doing within these programs.

We would look much more like the Raymond James, the Ameriprises of the world in terms of how these programs work -- Schwab for that matter.

Great.

Thank you very much.

Douglas Sipkin, Susquehanna.

Thank you.

Good afternoon.

I apologize.

I know you guys have hit on this, but I missed it, but I think it's important.

Can you review some of the pricing dynamics in the money market and the insured cash account fees?

The guidance around where the money market fee is going and then the guidance around where the insured cash account fee is going?

It sounded like it was going to be stable or even trending up, despite the fact that you have that repricing.

So I guess what happened there, and why has that repricing maybe shifted out to the second half of the year?

Have you renegotiated with that large customer?

Thanks.

Yes, sure.

So the money market's pretty simple.

It's the run rate at 20 basis points with a set increase.

On the ICA side, there's a few things going on.

The first and foremost is that the recent Fed move -- we kept 100% of that increase.

So just assuming there at the midpoint of the 25 to 50 range, that would flow through.

On the anchor bank step down, that largely offsets that, and our prior estimate was that would happen all on January 1. As we've gotten to the point of actually winding that down, our estimate now is that will wind down over the first half of the year.

So it would be slightly above 50 basis points is our estimate of the run rate once that wind down happens, meaning that we will likely be above that slightly above 50 basis points in the first half of the year.

So for the first half of the year, you are above 50 basis points.

For the second half the year, you're at around 50 basis points?

Right.

Assuming no change in the Fed Fund rate

Yes, assuming the Fed Fund stays the same.

Okay.

Great.

Okay.

I appreciate that.

Thanks.

That's all I got.

Thanks so much.

Thank you.

That does conclude our Q&A session for today.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program.

You may all disconnect.

Everyone have a great day.