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TD AMERITRADE Holding Corp. (NYSE:AMTD)

F1Q07 Earnings Call

January 16, 2007 8:30 am ET

Executives

Joe Moglia - CEO

Bill Gerber - CFO

Bill Murray - IR

Analysts

Mike Vinciquerra - Raymond James

Rich Repetto - Sandler O'Neill

Prashant Bhatia - Citigroup

Patrick Pinschmidt - Merrill Lynch

Richard Herr - KBW

William Tanona - Goldman Sachs

Howard Chen - Credit Suisse

Roger Freeman – Lehman Brothers

Michael Hecht - Banc of America

Scott Appleby - Deutsche Bank

Michael Goldberg – Desjardins Securities

Presentation

Operator

Good day and welcome everyone to the TD AMERITRADE first quarter fiscal 2007 earnings results conference call. This call is being recorded. At this time, I would like to turn the call over to the Managing Director of Investor Relations, Mr. Bill Murray. Please go ahead, sir.

Bill Murray

Good morning, everyone and welcome once again to the TD AMERITRADE December earnings call. By now you have probably seen our press release that was made public this morning. You can also view a copy of the release, as well as submit any questions to us via our corporate website at AMTD.com.

We will be discussing a number of financial metrics on this call, so in order to more easily follow along with us, we strongly encourage you to download and print the presentation now from our home page at AMTD.com. Also, if you want to contact us directly after the conference call, please call investor relations at 800-237-8692.

Before we begin, I would like to note that this call contains forward-looking statements that are made pursuant to the Safe Harbor provisions of the federal securities laws. These statements involve risks, uncertainties and assumptions that may cause actual results to differ materially from those anticipated. Listeners are advised to review the risk factors contained in our most recent annual report on Form 10-K and quarterly report on 10-Q for descriptions of risks, uncertainties and assumptions related to the forward-looking statements.

On this call, TD AMERITRADE management will discuss some non-GAAP financial measures such as operating margins, EBITDA, non-GAAP EPS and liquid assets. Listeners to the call can find a reconciliation of these financial measures to the most comparable GAAP financial measures and other required disclosures in the slide presentation, again on the website at AMTD.com.

Please note this call is intended for investors and analysts and may not be reproduced in the media, in whole or in part, without prior consent of TD AMERITRADE. The call will cover the December quarter '06 earnings results for TD AMERITRADE Holding Company.

At this time I would like to turn the call over to TD AMERITRADE CEO Joe Moglia, who will be followed by our CFO, Bill Gerber.

Joe Moglia

Thanks very much, Bill. Good morning, everybody and Happy New Year as well to everybody. For us in our history as a firm we've had about 125 or so quarters. This one is the best in our history. We are certainly proud of that. We had record earnings EPS, record non-GAAP EPS. A reminder of that, that non-GAAP EPS does not count the amortization of the intangible or the interest on our borrowing. The reason why we provide that is to emphasize the potential of the earnings that our cash can generate.

Net income also came in at a record. We used about 90% of that to buy back our stock. Net revenues, $535 million. Of the net revenues, 61% of those were derived from our assets. Remember, over time our objective is to move toward being more of an asset gatherer. We think over time that will certainly help our multiple.

Pre-tax income is also at a record, it's 45%. Now if you recall, the September quarter had us at 41%. We still have a few months to go with regard to our integration and at the end of the integration, as we have told you, we anticipate our pre-tax margins moving back above 50%, where they were prior to the close of the deal.

EBITDA is also a record. If you annualize the debt to EBITDA ratio it is about 1.47. Our ROE came in at 34%; and finally, before I look at specific individual metrics, if you take a look at our pre-tax margin and our ROE, that puts us around the 90th percentile of the S&P 500.

Now if you go to slide 4 and take a look at our operating metrics specifically for the quarter, our average trades per day were 238,000. That's up about 16% from the September quarter. In general, I'd say investor sentiment is positive, but is by no means wildly bullish; good, but not great.

If you look at our January to-date numbers, it's around 271,000 but I would like to give a footnote to that. We had one day that was well above 300,000. If you exclude that single day, our numbers come in around 260,000 or so, so far for January.

Average investable assets, also a record. We worked on those assets for 378 basis points. Client assets are starting to approach $280 billion, also a record. Our cash and money market funds, around $40 billion, also a record.

Now with regard to new accounts, we opened up 109,000. We spent $39 million to do that, for a CPA of around $360. Now the CPA is higher than we would prefer it to be, but that may very well continue to be the case as long as we continue to spend incremental money to expand our brand, help us with our client segmentation strategy and with the long-term investor segment. That probably continues throughout the span of the integration.

Net new accounts were good at 69,000. Our retention continues to be excellent. When I look at qualified accounts, they come in at 3,255k; That’s about 13,000 above where we were last quarter, but the quality of our qualified accounts, in terms of actual assets per accounts, et cetera, is very good.

Now in general, when you look at these numbers from management's perspective, we're pleased with our revenues, our assets, our trades, our net new accounts. When you look at our gross new accounts and our qualified accounts, we'd like to see them improve; but realistically, I think that's not going to significantly happen until we finish our client segmentation strategy rollout and rollout the entire offering for our long-term investors, which happens post clearing conversion.

Now with all of that, we should go to slide 5 and I want to give you an update in terms of exactly where we stand with regard to the integration process and what we've done with regard to our clients and what we're looking at with regard to clearing, and our overall numbers.

First and foremost, what's going on with our client segmentation strategy. You may have already seen the press release that talks about an exclusive relationship that we've got with Suze Orman. Suze is coming out with a new book called Women and Money. We will have an exclusive relationship with her. Her goal in that book is to have not just every woman, but every family start to plan on savings as part of their regular financial lives. She wants to see every family in this country starting to save. As we all know, savers ultimately over time become investors. She will be recommending TD AMERITRADE as the brokerage firm of choice for all of the people that she happens to be talking to. We're really excited about that.

New Guidance Solutions team. That's a fancy name for a group of people that are totally focused on service and sales with regard to our clients. Now, this team is going to replace the original investment centers that we had in Beverly Hills, Orlando and New York. The investment centers, were basically full commission groups that focused basically on fixed income. Having looked at this for a long time, we feel that we can deliver a comparable or better experience at a better value by moving to these solutions teams. We also think that the ability to scale will be better with regard to the solutions teams so consequently, we are in the process of making that transition.

The new web experience, as you know, was rolled out over the span of the quarter. Today that is specifically for legacy AMERITRADE clients. That will be available for the Waterhouse clients at the end of the clearing conversion. Clearly, if you haven't had a chance to look at it, I would ask you to. It's certainly easier to navigate through and you've got extended research on that.

Now with regard to investment tools specifically related to the three client segments that we want to serve, we have been aggressive over the span of the last few months looking at things where it was more prudent for our firm to go out and buy rather than build. We did so. So there were four smaller acquisitions that were done over the span of the last few months that are critical to that strategy. We bought [Krone], which is the power behind our strategy desk and, in effect, provides us with [back testing]. ICTC, which allows us to do a better job of providing custody for 401K assets. [iRebound], which allows us to do a better job of managing and administer multiple portfolios at the same time; and Quote Tracker, which is really an updated version of Streamer that allows for realtime quotes. So we're excited about everything that's been going on so far with regard to the client part of our overall integration.

Now, with regard to the clearing conversion, we are going to move the clearing conversion date to May. If you recall, the date that we had set, that we had been talking about the last couple of quarters has been March. Let me explain specifically why we're going to do that.

First, it's taken us a little longer than we originally expected to be able to complete and fill some of the functionality with regard to some of our product gaps. We will have that functionality completed by March. That will be done, but it's possible we may not have finished all of the testing that we need by the March date. As most of you are aware, as we start to get into the middle of March and April we're in the middle of tax season. That is, with regard to call center activity, by far our busiest time of year for our call center reps. The last thing we would want to do is hold off, even a week or two, to complete our testing and then try to do the integration over a weekend when we're in the middle of a tax season. Consequently, we feel that it was in everybody's best interest, without question, to push that to May; consequently, we've done that.

Now, a year ago June 2005, I reminded all of you then and I've done that time and time again since then, that the real key to a successful integration for the new TD AMERITRADE is not going to be whether or not we have a good quarter or two. It is going to be whether or not we retain our clients, whether we hit our revenue opportunity numbers, whether we hit our expense synergy numbers, whether we finish the integration with a strong run rate and whether we go into 2008 on all cylinders, really ready to go.

All of those things are far more important to us than anything else associated with a month or two months or three months with regard to the overall integration. Having said that, by the end of this integration we are excited about what we're going to look like for 2008. We are reaffirming again today our numbers for 2007. We are still on target to hit our expense synergy numbers. As you know, we've already blown away the revenue opportunity numbers and we expect that September quarter run rate to come in around that $1.28 number as we said we would anticipate to hit for that quarter. So we feel good and are excited about where we stand there. Frankly, making the decision to move the clearing conversion out to May for our shareholders and our clients was a simple, easy decision for us.

Now one thing I'd like to add before we go to corporate matters, if you take a look at our numbers -- and I know some of you are aware of this -- by the end of this year, we talked about being able to move from a firm that was almost totally based on transactions to one that's becoming more and more of an asset gatherer. By the end of 2007, we will be generating more revenues based on our assets alone than 100% of all of our expenses -- and that includes our advertising numbers. I want to repeat that. I think that's a big deal. Our revenues generated from assets alone will exceed -- by a lot, 100% -- of 100% of the expenses of TD AMERITRADE. We are very proud of that.

Slide 6. At our last board meeting the board authorized us to expand our share repurchase program by 20 million, that brings us to a total number of 32 million. So far, we've purchased about 12 million, and for the quarter we've taken $130 million of our money and bought 7.7 million shares.

I want to give you an update with regard to new board members. We have two new independent members that are replacing Glenn Hutchins and Michael Fleisher. Mark Mitchell, who was a board member for us from 1996 to January '06. He's cofounder of CNH Partners, a money management firm in New York. We are delighted to have Mark back.

Allan Tessler, the former CEO of Interactive Data Corp., he is also the chairman of Epoch Investment Partners and International Financial Group, and he’s the lead director at Limited. We welcome Alan as well to our board. And Bill Hatanaka, who's the head of TD Wealth Management business, he replaces Dan Marinangeli as one of the TD seats on our board.

I want to take a moment to thank all three of our board members that are stepping down for having provided the service they have to TD AMERITRADE shareholders. I want to give a special thanks to Glenn Hutchins. Without Glenn, we would not have ultimately done either the Datek deal or the TD Waterhouse deal. And Michael Fleisher certainly was a critical part of the board post the Datek integration. Thank you, Dan Marinangeli, for the time and effort that he put in while he was on our board.

Finally, some more good news with regard to the $6 dividend. Not only was it one of the largest paid in the history of Wall Street, but we have some positive news with regard to the taxability. It's about a 50/50 breakdown as we look at it, with regard to what will be qualified dividend and what will be return of capital. The return of capital as, you know, will lower your ultimate basis. So I think net-net, when you think about the cost of money, we would look at that -- and I think most of you would certainly look at that -- as a positive. The specifics on that will be finalized and the 1099s will be sent out at the end of January, the beginning of February.

With that, let me turn it over to Bill.

Bill Gerber

Thanks, Joe. As Joe said, December was a record quarter for the company, coming in at $0.24. Let’s go now to slide 7 and I'll take you through the quarter and through the outlook.

The EPS at $0.24 came in at the upper end of the range of the outlook statement and represents a 14% increase over the September 2006 quarter. This was primarily driven by a 10% increase in revenues, or $46 million, which was offset by a $7 million increase in expenses.

On the revenue side, the increase consisted of three things:

  1. $29 million in transaction-based revenues as a result of 33,000 more trades per day. As a side note, this was a 16% increase in trades per day from the September quarter.
  2. $10 million more asset-based revenues that were driven mostly by higher balances.
  3. Finally, $8 million higher other revenues, principally caused by increased reorganization fees this quarter.

As a side note, before we leave the revenue changes, if you look at our income statement on the press release you will see a shift in the mix of our asset-based revenues between the December and the September 2006 quarters. This mix change is primarily between the line items ‘net interest revenue’ and ‘money market deposit account fees’. As we discussed during the last call, legacy Ameritrade clients moved $6 billion of cash off of our balance sheet and into the MMDA product late in the September quarter. The change on the press release between net interest and MMDA fees is primarily due to this $6 billion client cash movement.

On the expense side, the primary driver of the $7 million increase was $5 million more advertising spend, as we seasonally increase our spend for the December quarter. Additionally, we had 7 million fewer average shares outstanding in December, primarily as a result of our share repurchase program.

On slide 8, you can graphically see how our revenue mix between transaction-based and asset-based revenues has changed from fiscal 2005 to fiscal 2007. The primary driver here is the TD acquisition, which brought with it significantly higher asset-based revenues. The important point to note is that our asset-based revenue, which represents a more stable revenue stream, has increased dramatically from '05 to the midpoint of the outlook for ’07 and now stands at 60% of our revenue stream. Over the same time period, revenues were more than double from $1 billion to $2.2 billion.

To add a point to what Joe just mentioned, our asset-based revenues for fiscal 2007 at the outlook midpoint is likely to exceed our total expenses, including advertising, by over $200 million for the year. This increase in asset-based revenue demonstrates the power of the asset gathering. We expect this trend to continue as we are delivering on our client segmentation strategy.

Now let's look at the actual December quarter results and our outlook midpoint on slide 9. In general, $535 million of revenues were $8 million higher due to more than anticipated asset-based and other revenues, offset by lower transaction-based revenues. So let's go through this slide. Transaction revenues were impacted primarily by 10,000 fewer trades per day than anticipated. Commission per trade of $12.92 was at the lower end of our outlook range, principally as a result of the mix of our business with more trades at the $9.99 price point, as well as additional free promotional trades from new accounts. These factors resulted in $11 million lower commission revenue versus the outlook.

Our asset-based revenues were $12 million higher, principally driven by higher stock lending business, which aggregated $10 million more revenue than anticipated. Stock lending is difficult to model, since it is quite dependent upon market conditions. All of the other components of asset-based revenues were quite close to the outlook midpoint. Finally, other revenues were $8 million higher than anticipated, primarily driven by the increased reorganization fees described earlier.

So let's talk on the expense side. As you can see, expenses before advertising came in almost right on the mark. Although only $1 million lower expenses than anticipated, there are a few one-time items I want to give you a little color on. In the employee compensation line item, we had $5 million of unusual reductions, $3 million related to reductions in bonuses as we did not achieve the targets we had set for ourselves in the quarter and $2 million related to lower health insurance costs based on recent favorable claims experience.

In the clearing and execution line item, we had a benefit of an NASD fee reimbursement of $1 million which was not included in our forecast. Offsetting these two items was a $2 million occupancy and equipment expense related to a lease expense true-up on legacy TD Waterhouse properties. As well as in other expense, we had a $1 million increase in our D&O insurance.

One other item to note, our tax rate for the quarter came in at 39.2%, below our 40% expectation. We expect our tax rate to approximate 40% in 2007, but the ultimate tax rate depends upon which states our revenue is generated in so the rate will likely fluctuate slightly.

Slide 10 reflects the change in our October outlook to the current outlook. The midpoint stays at $1.10 with the following changes: we have an increase of $0.02 a share due to exceeding the December midpoint with our actual results; the timing of the conversion and the build out of products and services as Joe discussed impacted EPS by $0.02. Additionally, as we continue our share repurchase, we expect that to positively impact EPS by $0.01. Offsetting that will be additional interest expense on the debt since we expect to use excess cash to repurchase stock.

So we are reaffirming our midpoint for 2007 at $1.10. However, I do want to point out that the September quarter 2007 annualized is at a run rate of $1.28 per share and represents the first full quarter with full realization of merger synergies between legacy AMERITRADE and TD Waterhouse. This $1.28 run rate has not changed.

To illustrate the quarterly expense trends, let's go to slide 11. This slide shows our September quarter run rate expenses in green, once we have achieved our synergy targets; and the redundant expenses in orange, which we expect to eliminate through our synergy efforts. Cost reductions will begin immediately after the conversion in May, with some of the impact occurring in the June quarter, but the majority won't be seen until September.

Expense reductions will come primarily through compensation as we reduce headcount, clearing expense as we eliminate the ADP outsourcing service, and professional services as we eliminate the extra technology contractors who are assisting in the integration and build out efforts.

It should be noted that the $194 million of expenses in the September 2007 quarter are virtually identical to those in the prior outlook. The only difference is the interest expense on the debt described earlier. We expect to hit our synergy target by the end of 2007, as we've told you.

So, now let's go to liquid assets on slide 12. We are a very strong generator of cash and do have tremendous financial flexibility. Let me walk you through the changes. We started the December quarter with $499 million in liquid assets. We added $146 million of net income and $21 million of depreciation and amortization; as you know, this is a non-cash item. During the quarter, we used $31 million to support the additional net capital required at the broker dealer as a result of the increase in margin balances; some additional CapEx and other working capital items.

We made a mandatory debt payment of approximately $6 million, which I want to pause and note a couple things here. One is that we have approximately $1.7 billion of debt outstanding, or a 49% debt to debt plus equity ratio. Two, remember we have repaid 25% of our debt in one year and it is a seven-year facility. Finally, we utilized approximately 90% of our net income, or $130 million, to repurchase 7.7 million shares of our stock at an average price of approximately $16.80. As a result, we ended up with $499 million again of liquid assets, a coincidence of numbers.

We will continue to review our capital structure with the board and determine the optimal uses of our free cash flow between repurchasing stock and paying down the debt. We want to note that we do have great financial flexibility and will ensure we are best utilizing our cash.

So the summary on slide 13. This was a great quarter. It was a record quarter in a lot of areas, most notably the $0.24 per share. We did utilize 90% of our net income to repurchase 7.7 million shares of our stock. Our expense synergies are on track, our client segmentation strategy is on track and our asset-based revenues continue at over 60% of our revenue stream. Finally, the run rate EPS for the September quarter annualized remains at $1.28 per share.

With that, Peter, I will turn the call over to you for questions and answers.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Mike Vinciquerra - Raymond James.

Mike Vinciquerra - Raymond James

Thank you, good morning. Joe, can you give us a little more detail? When you talk about the clearing side and the push back – forgetting the cost synergies, we know they are going to come here in the next several months – does it hurt you at all in terms of new product rollouts, any of your marketing plans? Are any of those delayed such that the revenue side might be hurt a little bit, at least in the near term?

Joe Moglia

No, Mike, I don’t think so. The bottom line is our functionality with regard to the product set will be all set and ready to go by around the middle of March. We will begin testing, certainly, well prior to that. Remember, if there is any reason at all to delay it, even a week or two, we get into the middle of tax season and that is going to put undue stress on our call center reps and it is going to back up our queues, and therefore have a bad client experience.

We have said all along that realistically, for us to be effective with regard to the long-term investor we need to get the clearing conversion done so we can roll out the entire product suite to both the TD Waterhouse and the AMERITRADE clients. Today, we are rolling out most of that to the legacy AMERITRADE clients; the TD Waterhouse clients have not quite seen that yet.

Now, I think it is fair to say though if we got that done in March we would begin that process a little bit earlier. I agree with that. But other than that, it has no change whatsoever in terms of any of our product rollout, our launches, our plans, our advertising, et cetera except instead of doing it at the end of March, we're going to be doing it sometime in May.

If you call that part a delay with regard to potential incremental revenues, that'd be a fair comment, but I'm not worrying about that having any significant impact, as I said earlier, with regard to what we're trying to do, what we're trying to achieve.

Mike Vinciquerra - Raymond James

Thanks, that's exactly what I was looking for. Secondly, the Suze Orman deal, just curious; without getting into too many specifics obviously, can you tell us how the deal is structured in terms of how she's compensated? Is it just going to roll through marketing expenditures where every referral that comes from one of her sources, there will be a fee paid for that? How does that work?

Joe Moglia

What happens is, Suze is basically asking all of her readers that if you haven’t seriously begun saving for your future/investing for your future, you really need to do that. She's encouraging them to do that specifically with us. What happens is, her readers would expect to open up an account with us, there'll be a special code in effect to that, and they've got to deposit at least $50 a month – certainly we would hope that would be more – but at least $50 a month for a period of 12 months. At the end of the 12 months, if the reader -- now our client -- has in effect done that, we would deposit $100 to that particular account.

Suze gets nothing for this. We think we extend our brand, I think we get a lot of PR and a lot of advertising, and I think we're going to have a chance, hopefully, to open up many, many, many, many new accounts. Some of those accounts, we believe, will be great long-term accounts for us. All of that remains to be seen, but that's basically how it works. Every account that gets opened, if they fund that account monthly, if they put money into that account on a monthly basis over the span of 12 months, we'll contribute $100 to it at the end. There's no financial agreement between Suze and TD AMERITRADE.

Mike Vinciquerra - Raymond James

Great. Thanks very much.

Operator

Your next question comes from Rich Repetto - Sandler O'Neill.

Rich Repetto - Sandler O'Neill

Hi, Joe. First question, as you exit the fourth quarter if you just rough cut it numbers, it looks like a 58%, 59% margin. Two things: as you push back the conversion, is there still the same confidence level that you get to that 59% margin? Second, when do we get to track the revenue side in regard to net new assets and how you're doing as you transition the model to more asset-driven revenues?

Joe Moglia

First, when you talk about the fourth quarter, I assume you're talking about the September quarter for '07 right, Rich?

Rich Repetto - Sandler O'Neill

Exactly.

Joe Moglia

As you anticipate or as you run your model and you come up with significantly north of a 50% pre-tax margin, whatever those numbers are, those numbers are not going to change. We're committed to 50% plus pre-tax margins and hopefully they'll be significantly higher than that. I don't disagree with your 58% number as you run the model. So there will be no change as far as that goes and we're still confident we'll be able to hit that.

Secondly, with regards to what extent we are going to track net new assets for everybody, we have not made that decision, even though it comes up every quarter for the last year-and-a-half or so. We have not made decisions, we're not going to seriously think about it until after the conversion and the integration wind up getting done. We do believe we provide a tremendous amount of information, we do believe we provide a lot of transparency and we'll make that decision in terms of how much more we're going to give later on. But we're not going to do that now. I don't blame you for asking though, Rich.

Rich Repetto - Sandler O'Neill

I've asked the last four quarters, so we've got to keep on asking. I just want to ask the CFO, what is the reorganization fee in the other revenue line?

Bill Gerber

A reorganization fee is when Lucent or JDSU or somebody like that does a reverse stock split or a regular stock split, that's a reorganization. So when that happens, there's a fee that involves a lot of work and there's a fee that goes to the clients who have that stock that we then ultimately reorganize.

Rich Repetto - Sandler O'Neill

Another follow-up to Bill is, you can clearly see the Suite moving into the MMDA. Could you just review -- I know you've gone over this before -- but now that you've got $6 billion incrementally more in MMDA, how does that position you for both a change in interest rates and a change in the yield curve?

Bill Gerber

Most of that money is invested at about a little over two years, two-and-a-half year average duration. A movement in the interest rate market right now would have virtually zero impact on our yield there. So of course, over the period of two-and-a-half years, the reinvestment would go in at probably a lower rate. But right now, we're seeing virtually zero impact from a 25% increase or decrease in the rate environment.

Rich Repetto - Sandler O'Neill

It seems like slide 14, that's probably the most accurate forecast, I would imagine. I was just trying to see, was there and dissention, any pushback from the team on that one?

Joe Moglia

Slide 14, the Super Bowl prediction?

Rich Repetto - Sandler O'Neill

Exactly.

Joe Moglia

In all honesty to the group, for those of you who don't see this, we have a little bit of a tradition trying to call the Super Bowl here. So in the AFC, we expect the Patriots to beat the Colts; in the NFC we expect the Bears to beat the Saints, and then the Patriots will beat the Bears for the Super Bowl Championship. Now, there were a lot of versions of this slide, in fairness, as far as the team goes, and not everybody agreed with this. So at the end of the day, this was my call. I'm sure if it's accurate, everybody will forget that they were thinking about somebody else and everybody will say that this was their call. If it's wrong, they will say they were thinking about something else. But this is my call represented by some of the members of the team here, not all.

Rich Repetto - Sandler O'Neill

It's good to be the king.

Bill Gerber

Very safe call, I believe.

Rich Repetto - Sandler O'Neill

Thank you.

Joe Moglia

Thanks, Rich.

Operator

Your next question comes from Prashant Bhatia – Citigroup.

Prashant Bhatia – Citigroup

Just real quick on the MMDA, I think you earned about 3.6% this past quarter and it looks like based on your guidance, you're going to grow the amount that's extended out by $1 billion next quarter?

Bill Gerber

Right.

Prashant Bhatia – Citigroup

So I would have thought that the yield would grow somewhat higher, but you've got it going lower over the next few quarters. I am just trying to reconcile that.

Bill Gerber

We think that it is a little bit conservative. We are leaving room for tiering of clients in different payment tiers within the Suite program. So you're right, we certainly hope that it's going to be higher than that, but we wanted to put out what we think could happen. I don't think it's worst case, but we do believe the number could be a little bit conservative.

Prashant Bhatia – Citigroup

That’s great. Second, in terms of CapEx, I think your budget is around $40 million now. That's two to three times higher than what you thought it was last quarter. What's the driver there?

Bill Gerber

The biggest driver is the branch renovations that are going to go on to accelerate all of the branches so that they have the same look and feel throughout the country.

Prashant Bhatia – Citigroup

Finally in terms of the repurchases, the 20 million shares you have left, is it safe to assume that you'll use almost all of the net income that you generate to just continue repurchasing?

Bill Gerber

We are going to use a substantial portion of our net income to continue to repurchase, yes. It is a balance between paying down the debt and buying back the stock. Yes, we fully expect to act on the 20 million share authorization that the board gave to us.

Prashant Bhatia – Citigroup

One last one. Joe, you had mentioned a new solutions team. I didn't exactly get that. Is that a new group that you're starting up? How many people, and what's the role there?

Joe Moglia

The objective of that group, Prashant, is to replace the Wealth Investment centers that we had. We had about 100 people in Orlando, Beverly Hills, and New York that dominantly were commissioned salespeople and the vast majority of the business that they did was fixed income. We think we can be far more effective with around the same amount of people in our call centers focused on the specific needs of our long-term investors being able to provide a better portfolio allocation services like Amerivest, fixed income will be part of that, et cetera. So it will be a bonus-based sales and service group that we think will be a little bit more focused across the needs of the clients and across what we're trying to do with TD AMERITRADE and ultimately have greater scale.

Bottom line is, we think we'll provide a comparable -- if not a better -- experience to our clients at a better value. That turns out to be better for both clients and shareholders.

Prashant Bhatia – Citigroup

That sounds great, thank you.

Operator

Your next question comes from Patrick Pinschmidt - Merrill Lynch.

Patrick Pinschmidt - Merrill Lynch

Good morning, guys. Joe, as you mentioned, your CPA acquisition cost came in at $360 in the December quarter. You noted that was at the high end and you didn't really see it ticking down. Is it fair to say then that the range for your projected advertising spend will probably come in at the low end of that range, to average out the higher cost per account acquisition?

Joe Moglia

Patrick, I wouldn't assume that. I think right now you ought to assume that we're going to come in at the midpoint or thereabouts, of our range that we've given you as far as the year goes. We'll give you greater clarity on that every quarter. But I would not make that assumption.

Patrick Pinschmidt - Merrill Lynch

A quick question on Amerivest. I read somewhere -- I can't remember where -- I think last weekend in Dow Jones they were talking about a potential JV that you guys were exploring with [XShares] to launch your own family of ETFs. Is there anything you can say on that, or would you like to say anything on that?

Joe Moglia

The bottom line is as we get more involved with the long-term investor segment, we've got to be able to provide better overall products and services to be able to provide them with the wherewithal to achieve their financial goals. That ETF is meant to be a life cycle concept. We can't talk too much about it now, but you should assume that we'll be doing more and more things along that line to take care of the long-term investor as we go down the road.

Patrick Pinschmidt - Merrill Lynch

Okay. So stay tuned. Great. Thank you, guys.

Operator

Your next question comes from Richard Herr – KBW.

Richard Herr – KBW

Hi, good morning. The first question, and I was surprised it hasn’t come up yet, Joe, the new account growth is really strong. I was curious, what are you seeing there? We've had a few months now with the Bank of America offer, despite them giving away trades it looks like it hasn’t dented your account growth. Maybe you could talk a little bit about what you're seeing competitively?

Joe Moglia

Rich, frankly we have not seen much at all with regard to the Bank of America. Now remember, we spent a little time talking about this in the past. One, it has been done before, so there's some historical precedence here where there hasn't been a major impact.

Secondly, I think you've got to look at what's going on specifically with regard to the client. The individual trader does very much care about excellent execution, he cares about risk managing tools. I think we and The Street in general provide them with that. For example, six out of ten of every one of the trades that we do at TD AMERITRADE get price improvement. That’s better than twice the national average. If you're a long-term investor, I think you think in terms of portfolio allocation services and I think most of the times you think in terms of broker dealer as opposed to a bank. So far to date, the impact to us has been negligible, if even that. That is probably true around the entire Street as well.

Richard Herr – KBW

Thanks. That's helpful. Any progress, any updates you can give us on what you're seeing in terms of growth in the RIA business?

Joe Moglia

The RIA business continues to grow very nicely. We have said that one of the reasons why we're in that business is because within financial services we think it's a fast-growing sector. More and more the typical financial consultant that works for a full commission firm recognizes that he or she does not use anywhere near the full plethora of products and services that particular institution provides them, so why not do this on our own and really do a great job of focusing specifically on what their particular client wants?

So the RIA market in general continues to grow and we're getting more than our fair share of that. Now we don't disclose specificity with regards to those numbers. We give you an update on that once a year or so, Rich, but we're pleased with what we see there.

Richard Herr – KBW

Thanks, that is helpful. Just one last question and this is for Bill. First of all, I heard you had a birthday recently -- if you want to disclose what your age was -- happy birthday.

Secondly, the reorg fees, just so we are clear, that is not recurring, right?

Bill Gerber

I'll do them in reverse order. The reorg fees, certainly any time there is a reorg -- it is a common occurrence -- we probably have one a quarter. But at any rate, they were a little bit higher this quarter. I would agree that this quarter was a little bit higher, stronger than normal, but they do occur.

I want to say I forget your second question, but actually I should tell everybody I'm really 49, I just turned 49 yesterday, everyone's probably going to say that's a bunch of garbage, you are really 50 saying you are 49, but honest engine, I am 49 years old as of yesterday. Thank you for the birthday wishes.

Richard Herr – KBW

Happy Birthday, Bill. Thanks a lot.

Joe Moglia

By the way, Bill is 50.

Operator

Your next question comes from William Tanona - Goldman Sachs.

William Tanona - Goldman Sachs

Good morning. I'm looking at the expenses, we obviously saw an uptick in terms of the full-year guidance for all of your non-comp expenses; the new low end of the range is higher than the old high end of the range. Part of that you obviously say is because of the delay in conversion. I can understand that. But then I look at certain quarters and I see that the expenses in the next two quarters are actually higher as well.

Why, if it's just the delay of the conversion, wouldn't you see those expenses pop out to June and why are you seeing the overall non-comp expenses increase here in these next two quarters?

Bill Gerber

I'm going to have think about that one a little bit, Bill, but it is mostly related to the delay in the clearing conversion. We are looking at the run rate in our December quarter and then looking at what we think is going to happen in the following couple of quarters. It was just re-looking at all of the numbers and setting the new baseline.

Unidentified Corporate Participant

The other thing I think we have is the ADP fee is extended. That would be non-comp.

Bill Gerber

That's a non-comp, that's correct.

William Tanona - Goldman Sachs

Okay. But it seemed pretty uniform across all of the non-comp line items, whether it was clearing, whether it was communications, going across the board they all seemed to be higher. I was just wondering if there was something else going on other than just the delay in the timing of the conversion.

Bill Gerber

No, it was really just truing up each quarter going forward based upon the best information we had.

William Tanona - Goldman Sachs

Thanks.

Operator

Your next question comes from Howard Chen - Credit Suisse.

Howard Chen - Credit Suisse

Good morning, Joe, good morning, Bill. Joe, following on a question before, you've been somewhat hard on yourself in the past with regard to the current state of account growth of the company and the potential to accelerate that when you have these two great product sets in place. Given you're now doing the conversion in May but the systems go into place a few months before that, does this change your thinking at all on the ability to accelerate that account growth or wallet share at some point?

Joe Moglia

No, I'm not sure if this is different than what Mike Vinciquerra asked at the very, very beginning of the Q&A period. So we're clear, taking the clearing conversion and pushing it out a couple of months clearly provides a couple of months potential revenue opportunity costs. If we were going out with our full product suite to all of our clients and all prospects at the end of March let's say, as opposed to April, that would be a revenue opportunity, in effect, forgone.

Having said that though, there is no change at all in terms of what we're trying to do; there is no change at all in terms of the product rollout; there is no change at all with regards to moving to a marketing and a sales organization or service and sales organization, or our overall advertising. So there are no changes in terms of what we're trying to do.

The only reason why we're pushing back the clearing conversion is because we did not want to risk too much stress on our call center, possibly during the busiest time of our year and that would create a negative client experience. So foregoing a little bit of revenue opportunity for two months, I think is a small, small, small price to pay for a successful overall integration for the entire deal, the fourth quarter run rate and what we want to look like going into 2008.

Howard Chen - Credit Suisse

Makes sense. Thanks. You purchased a good amount of stock during the December quarter and highlighted that in the release. We know TD is at or very near its ownership cap. If you want to continue to buy in the market, does TD necessarily need to sell?

Joe Moglia

There may be a possibility where we will continue to buy, and if indeed that violates where TD is, then TD would have to sell to in effect bring their position back in line. But they are certainly aware of that.

Howard Chen - Credit Suisse

Right. Could you refresh us on exactly where their ownership is right now?

Joe Moglia

For two more years they have the right to be at 39.9% with regard to full voting rights, et cetera. Today though, because of the derivative that they entered into, they have around 45% ownership from an economic perspective, but not from a voting perspective. Now, remember, at the end of three years from the time of the close of the deal, they have the right to get to 45%; they just wanted to get 45% sooner, but they don't have 45% with regard to voting rights.

Howard Chen - Credit Suisse

Great. A final one, Joe. Any updated high level thoughts on industry consolidation? I know you and the management team are maniacally focused on finishing this clearing conversion. Any thoughts here? Any updates?

Joe Moglia

Yes. Howard, when I got to Ameritrade, there were about 200 firms that had online presences in the United States. There were around 16 firms that everybody knew, today that number is around 60 and five. I still think that there is some excess capacity in the industry and I think that there is still probably some more consolidation to go.

Because so much has already taken place, I think what remains to take place probably trades a little bit more thoughtfully, perhaps at a premium. As far as TD AMERITRADE goes, as we have always said, we will always be looking at things and if we think they are in the best long-term interest of our shareholders and the best long-term interest of our clients, we will seriously try to see what we can do there; but we are not going to do anything because (a) somebody else is doing it; (b) because it's in the paper; (c) because it seems to be a popular thing or a hot thing to do. We are only going to do what we think ultimately winds up making sense for us.

Howard Chen - Credit Suisse

Great. Following up on that, I remember from the Analyst Day you hosted last year, Asif spoke to one side, the company's opportunities to move away from the scale-driven deals and more towards more interesting JVs, white label opportunities, et cetera. Anything in particular this quarter or recently you think fits within that category? I'm just trying to get a sense of what's in that very broad bucket that Asif spoke to.

Joe Moglia

I think there certainly can be bigger opportunities than what we're talking about now, but keep in mind some of the smaller acquisitions that were done as far as this last quarter goes, the [Krone] the Quote Tracker, the ITTC, would all be part of that. We would also look at something strategically that could be a JV that could be far bigger and more significant than that, if indeed we thought that made sense as well.

So you should assume, Howard, that we are looking at all of those different opportunities -- small are large, tactical or strategic, scalable or not -- that we think ultimately makes sense. Bottom line is if we think it's smart for us and it helps us accomplish what we're trying to do, we'll try to figure out a way to do it.

Howard Chen - Credit Suisse

Thanks, Joe.

Joe Moglia

Thanks, Howard.

Operator

Your next question comes from Roger Freeman – Lehman Brothers.

Roger Freeman – Lehman Brothers

Good morning. Could you follow-up a bit on the revenue opportunity associated with the clearing delay? Can you clarify what the impact is in terms of product that you can't roll out until that's done?

Joe Moglia

First of all, welcome aboard in terms of covering us. In terms of what's going on specifically, a big part of the next level of our development as we become an asset gatherer is to be effective for the long-term investor in the United States. We want to be the provider of choice for the affluent family in this country as far as their long-term investment needs go, period.

Now, up until the last several months or so, we really didn't have a competitive long-term investor offering. With the acquisition of TD Waterhouse, we got a base to be able to build on that, but we're trying to significantly improve that. So as we combine that with our Amerivest service, our portfolio allocation service, we think we're going to have a pretty significant and very competitive offering in general for our long-term investor.

Now, while we do the vast majority of all of our clients' trades, we have less than 20% of their assets. This gives us an opportunity not only to bring in new prospects and clients, but to grow the share of clients we have.

We can offer that today, just recently, for the legacy Ameritrade clients. Until we get the clearing conversion done, we can't really do that for the Waterhouse clients. In effect, if we got the clearing conversion done tomorrow, we could be more aggressive about offering a long-term investor solution to all of the long-term investors out there. Since we're not going to get that done for a couple of months, it will take a little longer for us to offer that.

So that's what I meant by a postponement or a potential revenue opportunity. It doesn't impact our numbers, not going to impact our numbers long-term, but if we rolled out the clearing conversion tomorrow I would like to think we would be more aggressive with the long-term investor segment in the marketplace sooner, that's all.

Roger Freeman – Lehman Brothers

Got it. That's helpful. In terms of the Amerivest product, the new and improved version you were rolling out last fall to your legacy AMERITRADE customer base, how's the response to that been? Any metrics you can provide there?

Joe Moglia

We're not going to provide specific metrics on that. We're pleased with the progress that we're seeing and it's starting to take reasonable traction.

Roger Freeman – Lehman Brothers

On another topic, with respect to pricing, there have been some new offerings in the market, trades as low as $2.50; specifically, options trading at a flat rate. Obviously there's been ongoing competitiveness in pricing, but are you seeing in acceleration in new offerings trying to go after the active trader and really pushing pricing down further?

Joe Moglia

I don't think we've seen anything different than what already exists. In the online brokerage industry, competitive pricing is part of our mantra. We understand that exists. I think pricing in our industry, while aggressive, is rational and a lot of the stuff that you're seeing now, frankly, you would have seen a year ago or two years ago or three years ago. So there really is no change as far as that goes.

I think the key for us is to be effective rolling out the client segmentation strategy and becoming more and more of an asset gatherer which is our goal, our objective and our plan.

Roger Freeman – Lehman Brothers

Do you think there's any risk around options pricing going to a flat pricing instead of a per contract structure?

Joe Moglia

I don't see that at all near term, Roger. I mean, we're very pleased with what we're seeing with regard to our options business. We think we're very fairly priced. Again, it’s not only a matter of price, it’s a matter of the overall value proposition, products and services in effect that you provide the client and the relationship you have with the client. So it's all of those things.

Roger Freeman – Lehman Brothers

Lastly, have there been any changes in the rates that you're paying on cash balances in the past quarter? I think last quarter you said you were considering whether you needed to increase that to be more competitive.

Joe Moglia

We are offering CDs now that are competitive relative to what's going on in the marketplace, to try to track more long-term investor money. There have been a couple of minor changes with regard to actually what we pay as far as cash balances go. For the most part, as we move the money into the MMDA product what the clients get there is better than what they were getting with regard to their cash balances. So we feel reasonably good with where we are today as far as where we stand competitively in the marketplace and what that looks like. If you have a more specific question you may want to call us and we can go over our tiering.

Roger Freeman – Lehman Brothers

Thank you very much.

Operator

Your next question comes from Michael Hecht - Banc of America.

Michael Hecht - Banc of America

Good morning, guys. Thanks for taking my question.

Joe Moglia

Michael, why wouldn't we take the Banc of America guy's call?

Michael Hecht - Banc of America

No comment. A quick question on the average rates you guys paid to clients on MMDA balances. If you can review for me the value proposition the clients hear, as you moved over $6 billion of balances in the quarter. Any pushback you saw from clients in any cases? Are you moving funds from money market mutual funds into the MMDAs?

Joe Moglia

No, we really haven’t seen any pushback at all. It’s been a relatively easy process for the most part. Some of the questions that we had gotten from clients that actually called the call center were all very, very simple and positive for the most part. So it's almost – I mean, I am not going to go as far as saying it was a non-event, but it was pretty much a non-event.

Michael Hecht - Banc of America

Anything on the average rate you pay on those balances to the clients?

Bill Gerber

I think it's about 50 basis points higher than what we pay. So 150-ish.

Michael Hecht - Banc of America

150 basis points?

Bill Gerber

Right.

Michael Hecht - Banc of America

So that's about the same as what they get on the free credit side?

Bill Gerber

Well, no -- I'm missing one. It's 50 basis points higher than what we pay.

Michael Hecht - Banc of America

Higher than the free credit rate?

Bill Gerber

Correct.

Michael Hecht - Banc of America

So closer to -- it was 157 or something like that. From the revenue synergy or pure economic perspective, clearly it seems the TD Waterhouse deal has exceeded expectations. Any color on the level of account attrition you are seeing on the TD Waterhouse side?

Joe Moglia

Yes our retention frankly, from the beginning of the announcement or from the time we closed the deal has exceeded our expectations and continues to do so. I'm very pleased with that. If there's going to be any issue whatsoever, that type of issue would normally take place when the clearing conversion takes place. That's why we want to be so diligent with regard to what we're doing as far as that goes. But we are very, very pleased with what we are seeing with regard to the retention.

Michael Hecht - Banc of America

Just a quick housekeeping question. Any update on assets in the RIA business at the end of the quarter, and how that compared to last quarter?

Joe Moglia

We don’t break out the RIA assets quarter to quarter, but the RIA business continues to grow very nicely for us and we are pleased with the growth. As I was saying earlier, I think the RIA business is a growing market segment. There are really only three players in that segment, we are one of those and we are growing share.

Michael Hecht - Banc of America

Thanks.

Operator

Your next question comes from Scott Appleby - Deutsche Bank.

Scott Appleby - Deutsche Bank

Thanks the taking the call. Bill, a long overdue congratulations.

Bill Gerber

Thank you very much.

Scott Appleby - Deutsche Bank

One of the things I just wanted to touch on was back to the consolidation picture and more high level. It seems as if you and others of the more established, older online brokers are moving up the channel. Does it make you more attractive to the larger firm, say a firm that you came from, Joe?

Joe Moglia

I think we're more attractive. I think we have been more attractive for a while. I think the TD Waterhouse acquisition just makes us that much more attractive. I think we're incredibly proud of what we've accomplished. I think we still have a significant challenge in front of us, but we are confident we're going to be able to achieve that.

Frankly, if I am any one of those other firms and I look at my overall portfolio business, whether I'm an international entity with a U.S. footprint or whether I'm really a U.S. headquartered entity with a global footprint, there is no way any of those firms can come near going after the mass affluent nearly as well as what we can. So I would think we would be an attractive candidate to pretty much anybody that's interested in going after the mass affluent in the United States.

To a great extent, isn't that Toronto Dominion’s strategy as well, with both banking and brokerage with regard to the United States. I think that they've seen that opportunity and certainly want to be part of that. So does that answer your question, Scott?

Scott Appleby - Deutsche Bank

Perfect. Perfect. Just a follow-up question for Bill. As you know, the options world is going to be quoting in pennies soon. What percentage of your commission revenue is payment for order flow through options? Second, where do you think that goes?

Joe Moglia

Okay. I've got that, Scott. One, we don't disclose payment for order flow and we specifically don't disclose payment for order flow as far as options go. You should assume all of that payment for order flow in general is certainly well under 10% of the overall revenues based on transactions. The option payment for order flow would certainly be a part of that.

Now where does it go? I think one of my first earnings call when we were still AMERITRADE, I was told probably for four or five or six quarters in a row, payment for order flow was going to go to zero. My response to that: we are always going to have pristine enough flow that it's going to be in significant demand and sought after by the rest of Wall Street, whether that's our option flow or whether that’s our equity flow.

Having said that, payment for order, that flow will be worth something whether it comes in specific dollars that are paid to you in quotes payment for order flow, or whether it's handled some other way ultimately remains to be seen. But I think there'll always be a value to our flow. Near term, I don't expect too much to happen with regard to payments for order flow and options. We’ll keep an eye on that.

Scott Appleby - Deutsche Bank

Great.

Operator

Your next question comes from Michael Goldberg – Desjardins Securities.

Michael Goldberg – Desjardins Securities

Good morning. I just wanted to clarify one point. You moved $6 billion of client balances to MMDA and my understanding is that of the legacy Waterhouse client balances, these were already in MMDA. Is that correct?

Bill Gerber

That's correct.

Michael Goldberg – Desjardins Securities

How much were those legacy Waterhouse balances that were in MMDA? How much in total is there of your combined client balances that are in MMDA?

Bill Gerber

About $14 billion.

Michael Goldberg – Desjardins Securities

Thank a lot.

Operator

Your next question comes from Rich Repetto - Sandler O'Neill.

Rich Repetto - Sandler O'Neill

One last quick follow-up on the consolidation question. Do you feel your strategy as well as others movement towards asset accumulation quickly, do you think you're really at scale even after your complete the conversion in regard to asset accumulation? Even if you contrast yourselves to the Fidelity and Schwabs because it looks like there's other models out there that are complementary and way more compatible than they were a year or two years ago, to potentially merge with.

Joe Moglia

First of all, remember when it comes to the trading marketplace, that has been our focus for a long time. We are 25% of that market. While it has always been part of our long-term strategy to get involved with the RIA space and the long-term investor space, we're realistically only able to go after that aggressively as both the sales and marketing organization now. That really takes place post conversion.

When you look at the long-term assets that are out there or the assets in effect that are out there, we're only 3% of that. So with regard to being able to get to scale, remember we're going after specifically mass affluent, there are only three segments we're going after.

We wouldn't be going after those if we didn't think we had competitive advantages. So in effect, that's going to be our absolute prime focus. We think that we can do that, the mass affluent. We think we can do that as well as full commission firms and we think we can do that, frankly, as well as anybody else with our ability to scale and our overall operating leverage that I think are competitive advantages.

Having said that, we are nowhere near scale yet and I think that we've got tremendous upside as far as that goes. So when you look at consolidation opportunities it's pretty clear as to what we're doing and where we're headed. As I've said before, our shareholders and our clients just care about us trying to do the right thing for them and that's what our focus is going to be.

So down the road, if something makes sense for all of our shareholders, if something makes sense for our clients, we will look hard at being able to do that. But we're not going to get emotional on it, we're not going to do something because somebody else is doing it or because it seems to be cool at that particular point in time.

So there are other firms clearly that have been focused on the high net worth business in the United States or the long-term investor business in the United States. When I say we're going to be focused, we are really truly going to be focused on that.

Rich Repetto - Sandler O'Neill

Okay. Thank you very much, Joe.

Operator

There are no further questions. At this time, I would like to turn the call over to Mr. Moglia for any additional or closing remarks.

Joe Moglia

Again, Happy Birthday to Bill. Happy New Year to all of you. Thanks for being with us on our record quarter. If nobody had asked about the Super Bowl predictions, I would have gone over them now anyway. Thanks very much for joining us and have a great rest of the week.

Operator

This does conclude today's conference.

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Source: TD AMERITRADE F1Q07 (Qtr End 12/31/06) Earnings Call Transcript
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