LPL Financial Holdings Inc (LPLA) 2016 Q1 法說會逐字稿

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

(Operator Instructions)

As a reminder this conference call is being recorded. I would now like to introduce your host for today's conference, Mister Chris Koegel. Sir, you may begin.

Thank you Kaylee. Good afternoon and welcome to the LPL Financial first quarter 2016 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 in contrast to past quarters we have not posted a financial supplement on lpl.com. We have included information that previously would have appeared in the financial supplement in our earnings release.

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, gross profit, expenses and other financial and operating results, improvements in our risk management and compliance capabilities, the regulatory environment and its expected impact on us, including the final Department of Labor rule, 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 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 briefly summarize our first-quarter results, and then talk about our business going forward. I will then turn the call over to Matt to cover our first-quarter results and financial outlook.

While the market environment was extremely volatile the first quarter, we are pleased that our balanced business model performed well. We delivered strong quarterly earnings per share of $0.56, double our fourth-quarter EPS. Increased cash sweep revenue, seasonally lower advisor production bonuses, tight expense management, and lower share count all contributed to EPS growth. These benefits exceeded the impact of lower commissions, advisory fees and sponsor revenues. Matt will discuss our financial results in greater depth.

Our asset growth was consistent with the volatile environment in the quarter. Brokerage and advisory assets ended at $479 billion, up $3 billion from the prior quarter. Our asset mix continued its beneficial trend towards advisory, which makes up nearly 40% of our total assets. Net new advisory assets were $2 billion, or an annualized growth rate of 4%. Similar to extremely volatile periods we've seen in the past, January and February net new advisory assets were low, but March results were in line with our 2015 average.

Our advisor headcount also increased by 39 from the prior quarter, and production retention was 97%. At the same time we are being disciplined and managing our expenses and capital. Building on Q4 efficiency efforts we continue to take action this year, which helped us lower our core G&A expenses. These actions helped enable our key investments in service, technology, and implementing the DOL rule. Additionally, we kept our regular quarterly dividend the same, and our net leverage ratio decreased as our trailing EBITDA grew. We're off to a good start for the year.

Let's now discuss the DOL fiduciary rule and what it means for us and our plan. As a reminder, the rule is focused on brokerage retirement assets and accounts, which will soon be serviced under a fiduciary standard. Those accounts make up 30% of our assets. The rule is over 1,000 pages long, so it will take time for us and the industry to work through it. That said, we spent a lot of time preparing over the past year, which helps our efforts.

Our initial view is the DOL made a number of changes that reflect industry feedback. We feel the final rule and the best interest contract, or BIC, are improvements over the April 2015 re-proposal in several ways, including a longer implementation period, grandfathered and existing assets permitting all products to be sold under the BIC, negative consent for existing accounts, and streamlined disclosures at the point of sale. With these improvements we are now working to implement the DOL rule.

As for DOL implications for our business, let me start by discussing upfront implementation costs. We expect that several of the changes in the BIC will make the work more manageable. Additionally, over the past few years we've invested significantly in our compliance organization and technology, providing a strong foundation to build on. At the same time I want to note that the two implementation dates in April 2017 and January 2018, we expect to incur implementation costs in 2016 and 2017.

Given all of this, and keeping in mind that this is based on our initial read of the rule, we are comfortable with the implementation costs that we have included in our 2016 core G&A outlook. We also need to do more work to better understand the ongoing financial impact. This is true both for the annual cost to comply and the gross profit implications. We look forward to sharing updates as we make progress.

Now I will discuss some business changes we are making which will help with the DOL rule transition, and further strengthen our value proposition for advisors and their clients. One of the areas that we are most excited about is making our centrally-managed platforms more accessible and lower cost. As we've discussed before, we believe they are a win-win for our advisors, their clients, and LPL. Advisors can dedicate more time to in-person advice with existing and new clients by handing over portfolio allocation to LPL, and providing additional services for those accounts. LPL can generate better economics than the rest of our advisory assets.

Today more than 10% of our advisory assets are on centrally-managed platforms. Most of these assets are in model wealth portfolios, or MWP. Growth was strong on MWP for several years, but it plateaued in 2014. Last summer we announced that we would lower some MWP fees in January 2016, and we recently announced our plans to further lower fees in January 2017. And later this year we plan to lower account minimums on optimum market portfolios to $10,000. We have heard many positive responses from advisors and we think these changes could help drive growth. We'll keep you updated on our progress.

Another area we are excited about is our robo advice solution in development with BlackRock Solutions' FutureAdvisor, which will be integrated with LPL's technology. Our offering is intended to be a great way for our advisors to expand their reach into new markets such as millennials and small advisory accounts, and also to improve productivity with existing clients. A retail client receives advice from an LPL advisor about their goals and plans, and they can choose to use the web portal to invest in portfolios developed by LPL's research team and custodied at LPL. This offering aims to lower cost for investors, and helps advisors to spend more time providing financial advice to their clients.

As part of our work on the DOL rule, we are planning to introduce a mutual-fund-only brokerage account. As background, some LPL advisors have placed brokerage mutual fund investments directly with sponsors rather than with LPL to lower some investor costs. Our new mutual-fund-only brokerage accounts will have no maintenance fee, and all new mutual fund assets will be custodied with LPL. We believe this will lower costs for investors while also lowering sponsor costs and complexity by outsourcing custody to LPL. We expect it will be more operationally efficient and profitable for us to have these mutual fund assets in our custody.

In closing, we had a good start to the year in a very challenging first-quarter environment. We plan to continue to manage our finances conservatively, while investing for growth and continuing to improve our offering. We now feel well-positioned in our industry following the DOL rule announcement and our past year of preparation. We are working hard to make positive changes to benefit our advisors and their retail clients, grow our business, and create shareholder value.

I now turn the call over to Matt.

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

It was quite a start to the year. The S&P 500 index, after ending 2015 at 2044, dropped down to 1829 midway through the first quarter. And then ended the quarter up nearly 1%. After December's increase in the fed fund's effective rate, for the first time in about a decade the 2016 outlook went from multiple projected rate hikes to a dialogue around the possibility of negative interest rates in just a matter of weeks. And as we sit here today, the possibility of 2016 rate hikes are again part of the dialogue. It is clear the macro environment is quite volatile. We will keep this top of mind as we manage our expenses and capital going forward.

Despite the challenging environment, we are pleased with the performance of our diverse gross profit streams combined with disciplined expense management. In volatile times like these, growth and cash balances and transaction volume provides a nice offset to pressures on other areas. We delivered quarterly earnings per share of $0.56, double our fourth-quarter EPS. And our EBITDA was also up and our net leverage ratio decreased. We feel good about these strong P&L and balance sheet results to start 2016.

Let's now discuss our Q1 results in more detail, starting with gross profit. As you know, assets, both brokerage and advisory are the key driver of our gross profit. Our assets finished Q1 at $479 billion, up 0.7% from the prior quarter. It's also important to note that much of our gross profit, trailing commissions, and sponsor revenues, is primarily driven by average assets. And while our assets are up at the end of Q1, markets were down for most of the quarter. Therefore average Q1 assets were down sequentially, which impacted some our gross profit results in the quarter. Gross profit was $356 million in Q1, up $33 million or 10% from Q4. The largest drivers were higher cash sweep revenues following the December rate hike, and seasonally lower advisor production bonuses.

Turning to commissions, there were $437 million in Q1 down $27 million or 6% sequentially. This was driven by declines in both sales and trailing commissions. Sales commissions were down 6%, as some retail investors stayed in cash during the first-quarter market volatility. We also had three fewer trading days in Q1 than in the prior quarter. Trailing commissions were down 5% sequentially due to lower average asset levels.

Turning to advisory fees there were $319 million for Q1, down $5 million or 1% from Q4. As a reminder, advisory fees are mostly billed off of the prior quarter's asset balances. At the end of Q4, asset balances increased along with the S&P 500, which drove advisory fee growth. However, this growth was offset primarily by some assets that converted to our hybrid advisory platform.

I also want to highlight our advisor production bonus expense which typically grows through the year. As a reminder, in 2015 our Q1 production bonus was 1.8% of GDC and by Q4 it increased to 3.5%. That equated to a $12 million increase from Q1 to Q4. And $6 million of that increase was from Q1 to Q2. As we look at 2016 in Q1 we had production bonus of 1.7% or $13 million, and we expect to see similar trends this year as we saw in 2015.

Additionally, let me note our advisor share-based compensation expense, which is included in non-GDC payout, and varies based on movements in our share price. It was a $2.5 million expense last quarter, but it was actually $1.4 million of income in Q1 driven primarily by the decline in our share price.

Next let's talk about asset base fees, which include sponsor and cash sweep revenues. Sponsor revenues were $93 million in Q1, down $4 million from Q4. Sponsor revenues are more correlated to average assets, rather than end-of-period asset balances. In Q1 average assets were down from Q4, as I said earlier. Cash sweep revenues were $43 million in Q1 up $16 million from Q4, driven both by larger balances and higher yields. As we discussed last quarter, our client cash sweep balances tend to increase when markets are volatile. As a result our cash sweep balances ended the quarter at $30.4 billion, up $1.4 billion from the end of Q4.

As for first-quarter yields, both our ICA and money market yields increased following the Fed rate hike in December. Our ICA average yield was 69 basis points, and our money market average yield was 29 basis points. As we look forward to the rest of 2016, changes in our yields will primarily be a function of Fed rates. If Fed rates stay where they are, we would expect money market yields to average in the mid- to high-20 basis point range. We also expect our ICA yield will decrease as we experience the rest of the 22 basis point decrease, due to the wind down of an anchor bank contract. This means we expect our ICA yield to average in the mid- to high-50 basis point range in Q2, and be in the low-50 basis point range in Q3 and Q4.

Turning now to transaction and fee revenues, they were $103 million in Q1, up $6 million from Q4. This is primarily due to increased transaction volume from the volatility in the quarter.

Let's now move on to expenses, starting with core G&A. We announced last quarter that we'd taken some efficiency actions in Q4, and had more planned for Q1. We have now taken more actions in both Q1 and Q2. Together, these efforts reflect our plans to prudently manage our expenses, while continuing to make our planned investments in service and technology, and implementing the DOL rule. In Q1 core G&A expense was $175 million, a decrease of $4 million from Q4. The decrease was primarily driven by our expense management actions, and Q4 items that did not repeat. These were partially offset by an increase in employee performance-based compensation, which was reduced in the prior quarter. Additionally we had typical compensation-related expense increases in Q1.

As we look forward, we expect core G&A to increase primarily in the second half of the year, as we expect to incur DOL implementation costs. And while we are still working to assess the final rule, we anticipate that we will have DOL implementation costs in both 2016 and 2017, with the majority likely being in 2016. Given our strong start to the year on expenses, combined with our initial thinking on DOL implementation costs, we feel good about our 2016 core G&A expense range of $715 million to $730 million.

As for our promotional expenses, there were $36 million in Q1, up by $1 million from Q4. Conference expenses increased by $4 million sequentially, offset by seasonally lower marketing and transition assistance. As we think about Q2 promotional expenses, transition assistance depends on our level of recruiting success in the quarter, so this item is more variable in nature. Our conference expenses should be relatively similar to Q1 levels as we also have a large conference in Q2.

Moving to regulatory expenses, Q1 totaled $1 million, down $7 million from Q4. Lower activity decreased our regulatory expense to $4 million, which was offset by recoveries from prior matters where our costs ended up being $3 million less than estimated. Looking forward, these expenses are quite difficult to predict, especially on a quarterly basis. That said, we do not anticipate having additional [loss] recoveries like those we had during those of Q1. And the $4 million of regulatory expense during the quarter was on the low-end of our expectations. Given this, we anticipate the remaining quarters of 2016 will have expenses higher than the $1 million in Q1. However, we continue to expect full-year 2016 regulatory expenses to decline meaningfully from 2015 levels.

Depreciation and amortization was $19 million in Q1, a $4 million decrease from the prior quarter. This decline was primarily driven by nonrecurring costs in Q4, most of which was accelerated depreciation from real estate consolidation. As we look forward to Q2, we expect expenses at a relatively similar level to this quarter. Amortization and purchase intangibles was $10 million in Q1, flat from Q4. This is a non-cash expense mostly driven by the intangibles established from our LBO in 2005, so this should be relatively flat each quarter.

Let's turn now to capital management. Our primary focus right now is maintaining balance sheet strength. While we believe our shares are trading well below their intrinsic value, and that share purchase -- repurchases would provide an attractive return, the volatile environment in January and February has made balance sheet strength a higher priority today. Therefore, we have paused our share repurchases for now and are focused on prudent expense and capital management and implementing the DOL rule. Once we have more comfort in the macro environment and a better sense of the DOL rule impact, we will revisit deploying our excess cash.

Turning now to our leverage ratio, at the end of Q1 our net leverage ratio was 3.7 times. This is down from 3.8 times at the end of Q4, as our trailing 12-month credit agreement EBITDA grew by $8 million from Q4 to Q1. As for our credit agreement net debt, it is equal to our total debt of $2.2 billion, less cash available for corporate use up to $300 million. At the end of Q1 we had $527 million of cash available for corporate use. This left an additional $227 million of cash available for corporate use that, if applied to our debt, would reduce our net leverage ratio to 3.3 times.

Let me also spend a minute commenting on the seasonality of our business and trends going forward. Strong Q1 EBITDA and EPS were encouraging. However, as I discussed our ICA yields will likely decline in Q2 and Q3, as our anchor bank contract runs off. Production bonus will likely increase throughout the year, regulatory expenses will likely increase from the $1 million in Q1, and other seasonal costs vary throughout the year. Therefore, I would just emphasize with the nature and seasonality of our business, Q1 is typically one of our higher EPS quarters of the year.

In closing, we are pleased that our business performed well in an extremely challenging environment. Looking ahead, we plan to continue to be disciplined in managing our expenses, and focused on keeping our balance sheet strong. We believe this approach is appropriate given the volatility in the markets as we assess the potential impact of the DOL rule. We will stay flexible as the environment changes, always keeping our focus on maximizing shareholder value.

With that operator, please open the call for questions.

(Operator Instructions)

Ken Worthington JPMorgan

I am sure this will surprise you, but I'm going to ask a question on DOL. After seeing the draft rules last year, LPL and others in the industry contemplated moving brokerage retirement accounts over to advisory accounts as a potential solution, or an attractive solution based on that information. Based on the final rule, does that option still seem at least potentially attractive, or is it obviously unattractive?

Why don't we start a little bit higher-level than that, and then I'll be happy to get to that question specifically. I think what's important is that we've already announced a number of changes in anticipation of the DOL, including the changes we talked about on the call here around MWP and optimum market portfolios, and our robo advice platform, and the new mutual fund brokerage platform as well. As you know, it's 1,000 pages, so there's a lot to review and understand. But we are pleased it allows us more flexibility to serve retirement brokerage accounts than the initial proposal did, so it was better than we thought it would be coming into it. And it does preserve choice for the consumer for brokerage or advisory accounts. One of the things we think is helpful is to think about, one of the principles that we are operating under, under this new world, which will guide us to a question like yours.

Number one is transparency. Fees and services that get disclosed and are available via websites, and materials such as confirms, account opening information, and other investor disclosure; so that transparency is really critical to consumers understanding what they are paying for.

Number two is reasonable compensation. Investors should pay reasonable fees for the services they receive, and advisors are entitled to receive reasonable compensation for the services they provide.

Number three, that we want to use our scale to drive value, and we plan to use our industry-leading position to benefit retail investors as well as advisors, because we can add services and keep costs down. And that will grow our business, and that benefits our shareholders, as we think about changes like the Department of Labor rule change.

Finally, we want to preserve choice. That's the heart of what independence is all about. It's our mission to enable advisors to make independent recommendations that are in the best interest of their clients. That's our guiding principles around which we're thinking about the changes that are here.

It's important to understand, now related specifically to your question Ken, that advisory is certainly a good option for many, but we want to only have the advocacy or change of moving to advisory when it is in the best interest of the client. So, while we talked about mechanics of movement and others in the industry have done the same, we're always guided by what is best for the client and their situation. In one example, you can have a client that needs occasional advice, who has just received a rollover as a move from one job to another. And they basically need a quick check, and probably not even a financial plan so much as an asset allocation idea, if they're long-term investors, those can be done very nicely in brokerage at a relatively low cost over time. And ongoing advice may not be appropriate if it's a relatively small amount or they are very early in their careers, and just don't have the kind of complexity and needs of a financial plan.

In another case, it could be someone much later in their career with a sizable rollover, or needing to have ongoing financial planning advice and an advisory account might make more sense because they are paying ongoing fees every year for those services. It's a complex question that really has to be answered by the client and by what's best for them.

That said, the mechanics of moving accounts is relatively straightforward. And part of what we certainly have been working on, are making that easier. Things like being able to keep an account number when an account moves from one type of account to another, that's a good thing to have in any case. So certainly we'll continue to do that.

But I think at this stage what's attractive is, how do we best serve consumers, and what the DOL has done is create a solution to the issue of creating a fiduciary brokerage account by preserving choice, and that's the most important thing of all.

Great thank you. Hopefully as a follow-up this is not too in the weeds, but the BIC, which I think the industry thought was unworkable now seems to be, at least from an operational perspective, workable. From a functional perspective, however, is the big exemption something that is attractive either broadly, or maybe more finely to LPL?

I think a big exception is attractive because it preserves choice. And therefore allows us to really engage -- an advisor to engage with a client or prospect around what is best in their particular situation. And so, by the changes that were made it certainly made it quite workable. And again we thought they would make a number of changes, they made more than we planned, so we are quite pleased with the fact that they listened and really acted in the best interest of keeping choice available for consumers. It is something that is workable, it is something we intend to support and feel comfortable with working our way through the details of it.

Thank you very much.

Christian Onwugbolu Credit Suisse

Good afternoon Mark, good afternoon Matt. Another question on DOL, unfortunately. I guess you get revenue share from product manufacturers in your hybrid RIA business, that similar to peers like Schwab, so nothing unique to LPL. I'm curious how that gets impacted by the DOL proposal.

It does appear from everything we read in the very large document that's come out, is that all third-party compensation can continue to be received. On the brokerage side the BIC is used, and on the advisory side, as has been the practice in the industry, there's still a lot more to sort through and understand and make sure things are reasonable. In terms of how compensation is paid, and that is still work before us as we go to spend more time on the details.

Maybe for my follow-up a couple of financial questions. I guess Matt, promotional expenses $1 million up sequentially, this is your guidance, last quarter of $5 million growth, you mentioned lower transition assistance. What drove that? Was there some sort of pause in hiring because of DOL? Or something else? And then also, on the advisory fee rate that fell from 110 basis points to 105 basis points. Any color on what drove that would be helpful.

Christian, on the transition assistance, more -- we talked about last quarter -- more seasonal, so Q4 tended to be seasonally higher. And I think that was -- so you see that decline into Q1. But keep in mind it's all -- it's a hard one to predict, because each quarter is going to be based on the recruiting that happens in that quarter. I think on the advisory fee, it's more just highlighting the transition of assets to the hybrid platform that moved some of the assets outside of that into the RIA category. That would be the key thing I would highlight on the advisory side.

Okay, thank you.

Bill Katz, Citi

Thanks so much. I appreciate you taking the questions. The first one is, as you go through the BIC, can you talk a little about how you are viewing the interpretation on tiered revenue, and what that might mean for your business and the ability to continue that, and how you might react strategically if you have to move to more of a uniform pricing for shelf space.

I think it's still too early to really fully understand all of the issues. With that said, I think it's important to understand that we have agreements in place with the product sponsors on our platform, and those standardized compensation around any number of factors with them, and they been in place for quite some time. Also important to understand that the agreements for the plus-level sponsors do have a tenure cancellation chart -- clause in them, it's been a feature since they were created in the early 90s.

We feel very comfortable with where we are today, and still need more time with the DOL regulations to really dig through them more deeply. But clearly, again, it does appear the third-party compensation was specifically mentioned by the DOL in their new regulation, and its there. As always disclosure is really critical in this process. We've disclosed today arrangements on our website, so that's easily found by both investors and others. So we understand that's an important feature of what the DOL wants, and one that we have supported for long time.

Okay. And then Matt, maybe this is getting a little too detailed, I guess, we were hoping you would have more disclosure on some of these other ancillary expense lines. More specifically a supplement, so forgive the question here. It seems like the delta of expenses was quite dramatic if you look beyond comp promotion, G&A, and the brokerage line. Could you carve out what, if anything, might have been unusual in the quarter or what might be more normalized run rate for those collective items?

Sure. Maybe speaking on the financial results overall, I think the things I would highlight looking forward from a one-timer perspective, the first and foremost is on the regulatory side. The $3 million of cost recovery items that I highlighted, that we don't expect to recur. And then secondarily, I would highlight on the production bonus side, the advisor share-based compensation which is really a mark-to-market item where it averages about $1.5 million a quarter of an expense. It was actually $1.5 million of income this quarter. I'd highlight those two things, call it from a one-timer standpoint. And then broadly and more on the revenue side, emphasizing the ICA yield rate I highlighted, from 69 basis points down to the -- as the anchor bank contract runs off, in the mid- to upper 50s in Q2, and then down to the low 50s for the second half of the year. And maybe just from a seasonality standpoint, highlighting that production bonus that does grow throughout the year. It would be the other big one I would highlight. Those are probably the most relevant ones.

Okay. Last one for me. One of your peers was out saying they think there is opportunity for some industry consolidation as smaller platforms cannot deal with the costs of implementating the new program, the fiduciary form. As you mentioned you are first and foremost you are protecting the balance sheet, and you went through -- you have those couple hundred million dollars of extra cash beyond the debt covenant. How are you thinking about M&A versus other uses of capital at this point in time? Are we in a sit tight mode as you work through the DOL over the next year plus? Or would you be willing to potentially use up some of that extra liquidity to do some deals?

The first and best use of capital we'd all agree is in organic growth of the platform, and we do think that these changes as we've been leading on our front feet in terms of making positive changes for our investors and advisors, can lead to more recruiting opportunities. That's first our first place to want to use capital. Second place would be M&A, and we agree that things like this tend to squeeze cost structures for smaller competitors. We're the market leader in the IBD space. But that does not tell us what prices are for M&A, and that is obviously part of what we need to understand in any transaction. All things being equal, we would agree that this is likely to lead to more opportunity for M&A, and M&A is a good use of capital at the right prices, Bill. I think we are aligned in that thinking. But Matt, I don't know if you'd add anything else.

No, it was well said. I would just add to any deployment of capital, the things we're focused on is making sure we're comfortable with where the macro environment is heading, and views on the impact of DOL. That's going to govern our comfort on deploying capital in general. But I agree with what you said on where we would deploy to.

Thank you so much.

Steven Chubak with Nomura

Good evening. One of your competitors recently announced that it will stop offering load mutual funds on its platform, and as you see some of your competitors take such actions, do you see a risk is that others ultimately follow suit? As a quick follow-up to that, can you disclose what percentage of your mutual fund commissions actually come from loads versus trails?

Let's start with the broad question. Basically the announcement was done by a firm that does very little load fund sales. Essentially our model is an employee model done through their branches, which essentially are selling advisory products, often with our own EPS as the answer, so it's an advisory-based solution [that is] there. As I understand it from an investment news article from today, that firm talked about that being less than 750 trades over the last two years. That's a diminimus amount of transactions. Sounds like they are just cleaning up their approach to the way they operate their branches. Other than that the news reports, I don't know more than that. I don't see this as anything relevant to the question of choice for consumers. And being able to offer what seems to work best, or what they would want, as they think about things like, roll over their IRA accounts or taxable savings or anything else. I think that is more about an individual firm's business model and what it is trying to do within that.

Got it, okay. Switching gears for a moment, I had a question on the impact of your lower share price in the quarter on the earnings. On the pay outside, the mark-to-market it's pretty clear resulted in a lower nonsensitive GDC payout. We've seen that quarters so it's to be expected, but I suppose what surprised me was the elevated other income, given that usually there's resulting negative mark-to-market on some of those deferred comp plans, which is an offset to that lower on GDC benefit. I would have also expected a lower marketing allowance as well, given the declines we saw in the alternative investments sales side. I didn't know if you can help reconcile the discrepancy.

I would highlight -- there are two things to think through on the mark-to-market. So the deferred comp plan, the one you are thinking of where there's a mark-to-market where it impacts both production expense and other. So in thinking through our management P&L, it has no impact on gross profit. The other plan which typically you don't see much noise in because it's the stock-based -- or stock compensation plan for advisors, that one is mark-to-market as well. With the drop in the stock price that mark-to-market falls to the bottom line. It's more that second one where you don't typically see that impact, that is impacting things.

Can you quantify the net benefit from the lower share price that we saw in the quarter?

It was a swing of about $4 million. It was an expensive $2.5 million last quarter, even though that was high, it's averaged to about $1.5 million, but it was $2.5 last quarter, and it was actually income of roughly $1.5 million this quarter. A quarter over quarter swing of around $4 million.

That's it for me.

Chris Harris Wells Fargo

Thanks. A couple of questions on DOL. The new initiatives you guys are talking about launching, robo, mutual fund brokerage, and I'm sure perhaps there are some other things you're thinking about. What are the economics of those to LPL relative to the legacy business? And if the goal of these initiatives is to reduce fees for the client, does that also mean lower fees for LPL? So that's the first part of the question. The second is, do you guys envision still generating revenue-sharing payments from these new initiatives? Thanks.

We'll take the second question first. It's a little too early to understand fully what the Department of Labor has brought to us in this 1,000 page document. We're still digging our way through it. It does appear though, that all third-party compensation is going to continue to be received on the brokerage side as long as the BIC is used, and that would be what we anticipate as we sit here today. It seemed be affirming to that situation. Important to understand that most of the changes we've talked about are on the advisory side, so that is different world in any case, as it goes.

Your question about the economics, which was your first question, important to understand that our experience has been that when we make changes in pricing, what happens is that we gain additional assets and additional market share, and that market share overcomes the cost of the changes that are made. And if it doesn't do it in the first year, it certainly does in the second or third.

And so given that our experience over many years of this kind of change, we see it as being a profitable choice from the shareholder standpoint and obviously a good solution for consumers and a good solution for advisors as well. It really helps grow the business, which is what we're all after. I think that's the best way to think about is, that while it certainly is less profitable than it was before, because you've made price change, in aggregate you are picking up additional assets that create additional profits.

Got it.

Alex Kramm with UBS

Good evening. I'm going to start with a non-DOL question and hopefully as wasn't mentioned before -- but I guess you talked about the payout and the bonuses. But you didn't talk about the base payout rate, which has nicely trickled down over the last couple of years. I think 82.5% this quarter, down a whole percent. Is that going to continue the trickling down? What you doing there exactly? I know in the past you've talked about lower producers, you're going to squeeze a little bit. What is going on there, and what is the trajectory going forward?

Alex, I'll start with that one and Mark, obviously feel free to jump in. At a very broad point, the payouts on advisors, or advisory business, is lower than the payout on brokerage. As we see the transition in advisory business grow, it's driving that payout down ever so slightly over time as you have observed. I think that's the key trend there.

The only thing I would add is, that it is not a result of a change of pricing, our production bonuses have stayed the same for quite some time on both the brokerage side and the advisory side. And what's important is they have break points that essentially work. So as you've seen our brokerage business slow down, as it obviously did last year, and continued to do here in the first quarter, you will see that it will naturally pay out less to individual practices as is the schedule, basically. That's also the other dynamic you are seeing. The switch that Matt mentioned from brokerage to advisory, and then just lower production per representative or per advisor will lower the payout rate as well.

Okay, great. And now to my DOL question, which is actually more big picture, so I'm not going to go into the weeds. I guess the question is now that we have the final rule, what happens next from your perspective? You have obviously some timelines here, but what does it actually mean for your business, when you are going to start implementing some of those things? Are you going to wait until April next year? When are you going to communicate with your advisors? When are you looking at some of the fee changes? You're obviously doing some things already, so the bigger question is, when do think some of the behavioral changes might start from the advisor perspective?

And the second question related to that is, obviously all this relates to retirement accounts. What I keep on hearing is, this is just going to be way too confusing for advisors and also for end clients. To what degree do think you're going to have a similar set of rules for both retirement and nonretirement going forward, and obviously that relates to, maybe the SEC is going to come and have their own rules anyways. Maybe you can address that from a big picture perspective. Thanks.

Thank you for that. Let's start with the harmonization of the rule first. Your last question. It is important to understand the SEC has had a mandate since Dodd-Frank was passed, that has been delayed in implementation, around setting that fiduciary standard. We have two commissioners have not been seated yet, so out of the five commissioners, two are not yet there. It does not appear that process is going terribly quickly.

Clearly what's important to understand is they've got to go through a process with the SEC, which Mary Jo White, I believe, herself has said will be a slow process. As they digest what the DOL has done and they understand the unique issues they face as an agency. My own belief is the SEC will probably let this move into the next administration as a practical matter since they are down two commissioners there. I do think that the DOL work is helpful, because it does set out a way of thinking about essentially the central conflict that occurs in a brokerage relationship. And how to think about disclosure remedies to that, a concept that comes from the securities regulators as well. And also, how to think about in general, what is reasonable compensation.

I do think it's smart, as you suggest, that an advisor will likely, and we're going to want to implement in a way, that tends to make those decisions across the entire platform around both taxable and tax-free accounts. A good example of that would be, with the way variable annuities have changed over time in terms of pricing. If you are adopting a new pricing structure, one would adopt that across all account types because you are really adopting by product. So we're still working through the issues to understand those, but we are taking into account taxable accounts because, why wouldn't we, while we're doing it. And something like the brokerage account that we've discussed, will work both for taxable and tax-free accounts. And that's an important part to consider as well.

I think if we think about it, we know that work then lays the ground -- on the DOL side, the work lays the ground for whatever the SEC will bring, which may or may not be all that unique from here. But I think we're in good shape given the thoughtfulness with which the DOL approached the issues that are there.

Your first question was really about, what is advisor behavior. We are seeing significantly lower brokerage activity, which we definitely see as somewhat seasonal, part of what's happening in markets. But also structural, where advisors are already making some changes. We saw an increased amount of smaller producers leaving the system in the fourth quarter. That abated a bit in the first quarter, and we know in talking to advisors that the fourth quarter activity was them thinking about the Department of Labor and thinking about their cost structure in a slower environment. We do think there is some behavior there to make sure they are thinking about those changes.

The last one you talked about is, how do we think about the way that advisors' practices may change over time, sort of their outlook going forward. I think they are working through those issues and what we're doing for them is holding weekly calls. We have a specialized telephone line for them to call anytime they'd like to, to talk through the issues. We've had extensive rollouts of our changes that we're making, and we have extensive materials for them to use to explain to their clients what is going on and how it's going on. We've seen this as a real opportunity to step up and use our capabilities and scale to help them answer this for themselves, and then answer for their clients as well. We're getting very positive feedback, very high use of the services that we have, and feel very good about that.

In the end we want to make sure they do what's right by the client, and that's what they want to do as well. And so we're all aligned in that interest. Part of is making sure we monitor activities or changes in product mix or changes in account types, as they are appropriate for clients and they are appropriate for building a good long-term business for everybody.

Excellent. Thanks for the lengthy answer.

Devin Ryan with JMP Securities

Great thanks. Good evening. I wonder if you talk a bit about the composition and size of the advisor recruiting backlog right now. How that is trended more recently and if relevant, how the DOL is impacting that? Meaning, is there more inbound from advisors, at other models maybe those focused more on proprietary products, or does uncertainty around the DOL slow movement for bigger -- maybe just because advisors are in a wait-and-see mode? Or maybe even you guys are in wait-and-see mode as you are assessing all the implications.

I think we are assessing all of the implications. We tend not to be wait-and-see type of people. As our actions, price changes we've made, features we're introducing like lower account balances, were all done because we knew that in any scenario they would work, and that's a good example of taking forward action. Part of taking the action also tells our existing advisors we are here to help them, and tells their investors we're here to help them. That's important positioning for the company to take. We know that it does influence people as they decide to move from a firm, perhaps from a proprietary model or employee model to independent. I would say anecdotally, we do hear that positive feedback on what we've announced in recruiting, but I don't want to put it as a wave just yet. I think it is just too early to tell how that is going to be.

I do think it's fair to say that when you've had the market we have, that is the bigger influence in the first six weeks of 2016. That's a much bigger influence on movement, and there's no doubt that slows down recruiting a bit. Inevitably as those advisors really pay attention to their investors who get concerned in those rapid selloff moments. We had a rapid recovery so that helps. But it is important that, that's probably the bigger factor in my view.

Got it okay. That's helpful. And maybe when you think about some of the costs that will be incurred, as the DOL rule is essentially enacted, and potentially a broader fiduciary standard by the SEC down the road. I know we are all focusing a lot on the costs and potential revenue pressures. As you add more resulting oversight and compliance capabilities for brokers, how much of that can you pass along to the brokers where there could maybe be some positive revenue implications as an offset. Should we be thinking about that as an offset to some of these higher costs?

It is still really early to tell what exactly is involved. If you think about it the mix change, just from brokerage going to advisory, advisory has a different set of principles for overseeing, it is a principles-based process. There's less activity-based review. Which implies less use of technology or less use of humans to do that. As that conversion occurs, as we get more and more advisory assets, you'd expect us to be more efficient at it. Changes that we make that put more assets in our custody at LPL also, are just easier to oversee and therefore more efficient. There's definitely some positive efficiency plays within the changes that are here as well.

And important to understand that as we think about the changes, we certainly want to think about how are we driving successful outcomes to investors, and really holding people to the right standards on the advisory side, and also holding the correct standards in the new DOL world as well, and that implies cost. I think today we feel comfortable with implementation costs, and the good news is we've got a couple of years to do it, as opposed to just one. And secondly, we are assessing the ongoing cost but because of DOL took a broader view and made the BIC more workable, that certainly feels better than before we had the new ruling.

Got it great. Thank you very much.

Chris Shutler with William Blair

Good afternoon. Another question on the base payout from earlier. Just curious what the floor is you think, on that rate of brokerage assets continues to decline?

This is Matt. I wouldn't give a floor. I think the trends you've seen over the last couple of years are very small declines on a quarterly basis. I think that's the best information to look at. I would not have a particular number to give you as a floor.

Okay. And then on the DOL, as we sit here today and I recognize it's early, but what changes do think need to be made to the way your advisors use some of the higher upfront commission products, I think that's the question a lot of people are wondering. And I'm just curious, what the conversations with advisors have been like to date, that may have VAs or load mutual funds and those types of products as a sizable percentage of their book? Do think for instance with VAs, that a good percentage of those will migrate over to a more level fee, higher trail type of product? And how do you get comfort with the legal risk you could be assuming there?

That's a good question. Again, it is awfully early to tell exactly the outcome. I think there's a few things that are important to understand in terms of the DOL's view of this. Number one, the DOL itself has acknowledged the rule does is not require the lowest cost product or service, it is not mandating that in any way. And that cost is one of several factors that go into a best-interest recommendation. Getting asset allocation right is an incredibly important part of investing money for the long-term, for example, in a rollover. There are other factors that might be the benefits and value of a product or service to that particular investor's goals or needs, when you're there. So there's a lot of complexity in the way to think about what product is correct when and where.

It's also important to understand that well before the DOL, there's a number of changes in the industry that were occurring anyway. One is a low interest rate environment, which makes it tough for the annuity companies to create features and benefits on VA, so we've seen a significant decline in VA volumes over the last several years. We don't particularly see any reason why that would change. And that is fine. But we do agree with you that we've seen helpful changes in terms of less upfront loads and more ongoing trail, and we certainly anticipate that they continue to make sure that's reasonable compensation as it relates to that product set, and a broader asset allocation.

And finally, federal 1502 as it relates to non-traded REITs, which was both pricing and to some degree compensation is an important part of what is already changed in the environment. And you saw in fourth quarter we had a significant annualized drop in non-traded REITs, that is also because the real estate sector is less interesting today than it was a year, or two years ago.

And so, what happened as a result of that is something called a t-share, which is exactly the characteristics that you described, which is a much lower upfront fee or compensation payment, and then an ongoing trail that goes with it, and that seems a very appropriate structure and quite wise on the part of FINRA to have gotten that work done several years ago. That was effective January 1 of this year, so it's in the market today.

Thank you.

Doug Mewhirter with SunTrust

Good evening. Most my questions have been answered. I guess adding to the VA question and also fixed-index annuities seem to have taken some market share from VA. I know you were actually talking about possibly dusting the cobwebs off of a fee-based shareable annuity. Do you think that would -- that momentum would continue or do you think that third-party VAs and fixed-index annuities would fit the bill under the slightly more relaxed guidelines of the DOL rule?

I think we have to learn and see what's best for the customer. There's a lot of innovation that is occurring in that part of the insurance market, because of the low rate environment. I think that is part of what we need to see how that works and how we can help influence it. I think that within the brokerage world, clearly what's happened is the DOL has taken a view that this really needs to be done under a reasonable compensation standard, not on a product-type standard, which I think is an incredibly thoughtful change on their part and very helpful to making sure consumers have choice and are able to get exposures to different products that are appropriate in their case. I think that helps us a lot in terms of serving their needs.

I do think relevant to your VA question, we were a very early innovator in bringing VAs into the advisory world. We just didn't find there was much demand then. Do I think will be more demand overtime? Yes. Because there a good product and providing hedging or providing income -- guaranteed is not the right word, but it is income protection, let's call it. And so more than likely you would see that be more over time. Because the BIC is workable, I think in the near-term there's not particularly a reason to move on that idea, but we're still examining it and seeing what our advisors tell us and what their clients tell them, are going to work best.

Okay. Thank you very much.

Conor Fitzgerald Goldman Sachs

Good evening. Maybe want to understand what you are seeing from clients as markets have normalized. I think you mentioned that activity was low in January and February, just with the volatility. Can you give us an update on what you are seeing in terms of activity levels for March and April?

Well, in March it was more normalized, and that's as far as we will go with our commentary in terms of it. We saw January, February -- we now are producing monthly information to try to make sure there's lots of good transparency around it, so we will have the April data out. I'm not sure quite when, Matt, that comes.

Yes, mid-May, and then I would just add if you notice the release on page 10 we did add the March-specific monthly data, and you saw what I think you would expect to see as markets calmed down and clients' cash sweep balances went down as that money was redeployed back into the market. Kind of the opposite trend you saw in the January and February volatility. I would highlight that to you, Conor.

That is helpful, thanks. And if you follow up on 401(k) rollovers. Can you help us size how big a driver that is for your asset growth? And how you think your advisors are going to have to adjust to the rule and how they have conversations with their clients around rollovers.

That's the heart of the DOL issue, isn't it? We're in the same boat, which is the BIC is more workable than we thought it would be, and that they are permitting any number of things that are helpful to make that rollover conversation successful with investors. I would say, we feel it is all workable and preserves choice. Not particularly concerned about the active and the individual working with a retail investor on a rollover specifically.

But we still have an awful lot more to learn about process. I think it is important -- one thing I would highlight here, is that because our model is an independent contractor model we don't face the issue some others face who have a record-keeping business, have their own employees as advisors. And then are trying to really essentially deal with that individual retail investor both as a 401(k) participant, and then moving to a rollover. We don't have that same construct. That construct is harder. It's always been difficult, but it's even more difficult under the Department of Labor as we understand the new rule. I'm sure they are going to evaluate that, and our model, that always worked well and should continue to work well because of the independent nature of each provider in that particular lineup. And so, I think what's important is, how do we think through that rollover in terms of education, disclosure, and recommendations for that consumer, and that's part of the details we need to work our way through.

That's helpful. Thank you.

I'm showing no further questions at this time.

Thank you very much.

Thank you.

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.