LPL Financial Holdings (LPLA) Mark Stephen Casady on Q1 2016 Results - Earnings Call Transcript

| About: LPL Financial (LPLA)

LPL Financial Holdings, Inc. (NASDAQ:LPLA)

Q1 2016 Earnings Call

April 28, 2016 5:00 pm ET

Executives

Chris Koegel - Senior Vice President-Investor Relations

Mark Stephen Casady - Chairman & Chief Executive Officer

Matthew J. Audette - Chief Financial Officer

Analysts

Kenneth B. Worthington - JPMorgan Securities LLC

Christian Bolu - Credit Suisse Securities (NYSE:USA) LLC (Broker)

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Steven J. Chubak - Nomura Securities International, Inc.

Chris M. Harris - Wells Fargo Securities LLC

Alex Kramm - UBS Securities LLC

Devin P. Ryan - JMP Securities LLC

Chris C. Shutler - William Blair & Co. LLC

Doug R. Mewhirter - SunTrust Robinson Humphrey, Inc.

Conor Fitzgerald - Goldman Sachs & Co.

Operator

Good day, ladies and gentlemen, and welcome to the LPL Financial Holdings First Quarter Earnings Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

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

Chris Koegel - Senior Vice President-Investor Relations

Thank you, Kelly. 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'll 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've 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 may include certain forward-looking statements concerning such topics as our future revenue, expenses and other financial and operating results; improvements in our risk management and compliance capabilities; the regulatory environment and its expected impact on us; 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 these factors that may cause actual financial or operating results or the timing of matters to differ from those contemplated in such forward-looking statements.

In addition, comments during this call will include certain non-GAAP financial measures governed by SEC Regulation G. For a reconciliation of these measures, please refer to our earnings press release.

With that, I'll turn the call over to Mark.

Mark Stephen Casady - Chairman & Chief Executive Officer

Thank you, Chris, and thank you, everyone, for joining our call. Today, I'd like to briefly summarize our first quarter results and then talk about our business going forward. I'll then turn the call over to Matt to cover our first quarter results and financial outlook.

While the market environment was extremely volatile in the first quarter, we're 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 are $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 on 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 head count also increased by 39 from the prior quarter and production retention was 97%. At the same time, we're being disciplined in 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 in 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 rules are over 1,000 pages long, so it will take time for us and the industry to work through it. That said, we spend a lot of time preparing over the past year, which helps our efforts.

Our initial view is that DOL made a number of changes that reflect industry feedback. We feel the final rule and the best interest contract are big. Our improvements over the April 2015 re-proposal in several ways, including longer implementation period, grant provident of 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're now working to implement the DOL rule. As for DOL implications for our business, let me start by discussing upfront implementation cost. 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 cost in 2016 and 2017.

Given all this and keeping in mind that this is based on our initial read of the rule, we're comfortable with the implementation cost that we've included in our 2016 core G&A outlook. We also need to do more work to better understanding 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 for 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 at 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 end 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've heard many positive responses from advisors and we think these changes could help drive growth. We will keep you updated on our progress.

Another area we're excited about is our robo advice solution and 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.

Our 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 custody in 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 the 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 cost. 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 cost for investors while also lowering sponsor cost 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 and 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 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'll now turn the call over to Matt.

Matthew J. Audette - Chief Financial Officer

Thank you, Mark, and 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 $2,044, dropped down to $1,829 midway through the first quarter, and then ended the quarter up nearly 1%.

And after December's increase and the Fed funds effective rate, for the first time in about a decade, the 2016 outlook went from multiple projected rate hikes to a dialogue around the profitability 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. So what is clear is the macro environment is quite volatile. And 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 in cash balances and transaction volume provides a nice offset to pressures on other areas, and 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 the 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 were up at the end of Q1, markets were down for most of the quarter. Therefore, average Q1 assets were down sequentially, which impacted some of 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, they 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, they were $319 million for Q1, down $5 million or 1% from Q4. As a reminder, advisory fees are mostly billed off the prior quarter's asset balances. And 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 have 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 non-GDC payout and varies based on movements in our share price. It was a $2.5 million expense last quarter but 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. And 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 points range in Q3 and Q4.

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

Let's now move onto expenses, starting with core G&A. We announced last quarter that we've 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 in 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 cost. And while we are still working to assess the final rule, we anticipate that we will have DOL implementation cost 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 cost, we feel good about our 2016 core G&A expense range of $715 million to $730 million. As for our promotional expenses, they 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 a quarter. So this item is more variable in nature. But 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 cost 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 cost recoveries like those we had during Q1. In 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, we'll have high – net expense is 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 non-recurring cost 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 intangible was $10 million in Q1 flat from Q4. This is a non-cash expense mostly driven by the intangibles established from our LPL 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. And while we believe our shares are trading well below their intrinsic value and that share 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 in 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'll 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 months 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 cost vary throughout the year. Therefore, I would just emphasize that 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 market as we assess the potential impact of the DOL rule. And we'll stay flexible as the environment changes always keeping our focus on maximizing shareholder value.

With that, operator, please open the call for questions.

Question-and-Answer Session

Operator

Our first question comes from the line of Ken Worthington with JPMorgan. Your line is open.

Kenneth B. Worthington - JPMorgan Securities LLC

Hi, I'm sure this will surprise you, but I'm going to ask a question on DOL.

Mark Stephen Casady - Chairman & Chief Executive Officer

No, Ken.

Kenneth B. Worthington - JPMorgan Securities LLC

After seeing the draft rules last year, LPL and others in the industry contemplated moving brokerage retirement accounts over to advisory accounts as sort of a potential solution, maybe an attractive solution based on that information. Based on the final rules, does that option still seem at least potentially attractive or is it obviously unattractive?

Mark Stephen Casady - Chairman & Chief Executive Officer

Well, Ken, I think when we started a little bit higher levels than that and I'll be happy to get to that question specifically. I think what's important is that we've already announced a number changes in suspicion of the DOL, including the changes we talked about in the call here around MWP and aftermarket portfolios and our robo advice platform and the new mutual fund brokerage platform as well. As you know, it's 1,000 pages, there is a lot to review and understand, but we are pleased that 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. So one of the things that we think is helpful as I think about one of the principles that we are operating under this new world, which will guide us to the question like yours.

Number one is transparency, fees and services that get disclosed and are available via websites and materials such as conference accounting opening information and other investor disclosures. 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 that we plan to use our industry leading position to benefit retail investors as well as advisors as 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.

And then finally, we want to preserve choice, that's the heart of what independence is all about. And it's our mission to enable advisors to make independent recommendations that are in the best interest of their clients. So that's our guiding principles around which we're thinking about the changes that are here. It's important to understand, now really to specifically your question, Ken, 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.

And so while we talked about mechanics of movement and others in the industry have done the same, they were always guided by what's best for the client in their situation. And one example, you can have a client who needs occasional advise, who has just received a rollover as they move from one job to another, and they basically need a quick check, 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 overtime.

And ongoing advice may not be appropriate if it's a relatively small amount or they're very early in their careers and just don't have the kind of complexity and needs of a financial plan. And in other case, it can be someone much later in their career with a sizable rollover or meeting that have ongoing financial planning advice and advisory account might make more sense, because their pain ongoing fees every year for those services. So it's a complex question that really as we answer by 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 an account to another, that's a good thing to have in any case, so certainly 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.

Kenneth B. Worthington - JPMorgan Securities LLC

Great, thank you. Hopefully, as a thought 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 BIC exemption something that is attractive either broadly or maybe more finely to help you.

Mark Stephen Casady - Chairman & Chief Executive Officer

Yes. I think a BIC exemption is attractive, because it preserves choice, and therefore allows us to really engage – advisor to engage with a client or a prospect around what's 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 consumer.

So it is something that is workable, it's something that we intend to support and feel comfortable with working our way through the details of it.

Kenneth B. Worthington - JPMorgan Securities LLC

Okay, awesome. Thank you very much.

Mark Stephen Casady - Chairman & Chief Executive Officer

Sure, absolutely, Ken.

Operator

Our next question comes from the line of Christian Bolu with Credit Suisse. Your line is open.

Christian Bolu - Credit Suisse Securities (USA) LLC (Broker)

Good afternoon, Mark. Good afternoon, Matt. So, yeah, another question on DOL unfortunately. So, I guess, you get revenue share from product manufacturers in your Hybrid RIA business, and that's similar to peers like SWOTs, so nothing unique to LPL, but curious kind of how that gets impacted by the DOL proposal?

Mark Stephen Casady - Chairman & Chief Executive Officer

Well, it does appear from everything we read and again a very large document that's coming 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 are still a lot more to sort through and understand and make sure things are reasonable in terms of how compensation is paid. And that's, I think, still the work before as we go to spend more time on the details.

Christian Bolu - Credit Suisse Securities (USA) LLC (Broker)

Okay. And then maybe couple of – for my follow-up, couple of clean-up financial questions. I guess, from promotional expenses, I guess $1 million up sequentially versus your guidance last quarter of $5 million growth, you mentioned lower transition assistance. What drove that, is there some sort of a 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, so any color on what drove that would be helpful.

Mark Stephen Casady - Chairman & Chief Executive Officer

Yes. So it's a question on transition assistance. More – we've 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 a hard one to predict, right, because each quarter is going to be based on recruiting that happens in that quarter.

And then I think on the advisory fee, I think it's more just highlighting the transition of assets of the hybrid platform that moves some of the assets outside of that into the RIA category. It will be the key thing to highlight on, on the advisory side.

Christian Bolu - Credit Suisse Securities (USA) LLC (Broker)

Okay, thank you.

Operator

Our next question comes from the line of Bill Katz with Citi. Your line is open.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Okay, thanks so much. Appreciate you taking questions kind of bunch of them. And the first one is, as you go through via BIC, can you talk a little bit about how you sort of viewing the interpretation on shared revenue and what that might mean or your business and the ability to continue that and how might react strategically if you had to move to more of a uniform pricing per shelf space?

Mark Stephen Casady - Chairman & Chief Executive Officer

Well, I think it's still too early to really fully understand all 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 standardize compensation around any number of factors with them and have been in place for quite some time. Also important to understand that the agreements for the PLUS (29:18) level sponsors do have a 10-year cancellation clause in them, and has been a feature since they were created in the early 1990s.

So 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 and their new regulation that's there. As always, disclosure is really critical. In this process, we disclose today arrangements on our website. So that's easily found by both investors and others. And so we understand that that is an important feature what the DOL wants and one that we've supported for a long time.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Okay. And then, Matt, maybe this is getting a little too detailed. I guess, we were hoping that you'd have a little more disclosure on some of these other ancillary expense lines, what was consistent with your supplement. So forgive the question here, it seems like the delta of expenses was quite dramatic. If you look beyond comp, promotion, D&A and the brokerage line, could you sort of carve out what if anything might have been unusual in the quarter or what might be a more normalized run rate for those collective line items?

Matthew J. Audette - Chief Financial Officer

Well, sure, I mean, I think that maybe speaking on the financial results overall, I think the things that I would highlight looking forward from a – call it from one-timer perspective, I think the first and foremost is on the regulatory side and the $3 million of cost recovery items that I highlighted that we don't expect to recur. And then secondarily, I'd 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 on this quarter. So, I'd highlight those two things, call it from a one-timer standpoint.

And then broadly and more on the revenue side just emphasizing the ICA yield rate that I highlighted from 69 basis points down to the – as the anchor bank contract runs off, in the mid-to-upper 50%s in Q2 and then down to the low 50s for the second half of the year. And maybe just from a seasonality standpoint just highlighting that production bonus that does grow throughout the year would be the other big one that I highlight. So I think those are probably the most relevant ones.

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Okay. Last with me, thanks for taking the questions. I think one of your peers is out sort of saying that hey look, they think there's an opportunity for some industry consolidation as smaller platforms can't deal with the costs here of implementing the new program fiduciary reform. So as you mentioned, first and foremost, you're sort of protecting the balance sheet and you sort of went through yeah, there's some extra – a couple million dollars (32:11) 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 sort of 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 the extra liquidity to do some deals?

Mark Stephen Casady - Chairman & Chief Executive Officer

So the first and best use of capital, I think, we'd all agree is in organic growth of platform. And we do think that these changes as we've been leading on our front feet in terms of making positive changes for investors and advisors can lead to more of recruiting opportunities that's 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 IBD space, but that doesn't tell us what prices are for M&A. And that's obviously part of what we need to understand in any transaction. So all things being equal, we would agree that this is likely to lead to more opportunity for M&A, and M&A as a good use of capital at the right prices, Bill, there. So I think we're aligned in that thinking. But Matt, I don't know if you'd add anything else?

Matthew J. Audette - Chief Financial Officer

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

William Raymond Katz - Citigroup Global Markets, Inc. (Broker)

Okay. I'd like to follow-up offline. Thanks so much.

Matthew J. Audette - Chief Financial Officer

Thanks, Bill.

Operator

Our next question comes from the line of Steven Chubak with Nomura. Your line is open.

Steven J. Chubak - Nomura Securities International, Inc.

Hi, good evening.

Mark Stephen Casady - Chairman & Chief Executive Officer

Hi, Steve.

Steven J. Chubak - Nomura Securities International, Inc.

So 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 that others ultimately follow suit? And as a quick follow-up to that, do you – can you disclose what percentage of your mutual fund commissions actually come from loads versus trails?

Mark Stephen Casady - Chairman & Chief Executive Officer

Well, let's start with the broad question. Basically the announcement was done by a firm that does very little load fund sales. So, essentially their model is an employee model done through their branches, which essentially are selling advisory products often with their own ETFs as the answer, so it's an advisory-based solution that's 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. So that's a de minimis amount of transactions. So I think it sounds like there're just cleaning up their approach to the way they operate their branches. But other than that the news reports, I don't know more than that.

So 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 want as they think about things like rollover their IRA accounts or taxable savings or anything else. So I think that's more about an individual firm's business model and what it's trying to do within that.

Steven J. Chubak - Nomura Securities International, Inc.

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

Mark Stephen Casady - Chairman & Chief Executive Officer

Yeah, I'd highlight on the – there's kind of two things I think through on the mark-to-market. So the deferred comp plan, I think the one is, is the one you are thinking of whether it's a mark-to-market where it impacts both production expense and other.

So when thinking through our management P&L, it has no impact on gross profit. On the other plan which typically you don't see much noise in because it's the stock based, or stock competition plan for advisors that was mark-to-market as well. And with a drop in stock price that mark-to-market falls to the bottom line. So I think it's more that second one where you don't typically see that impact that's impacting things.

Steven J. Chubak - Nomura Securities International, Inc.

And can you qualify the net benefit from the lower share price that we saw in the quarter?

Matthew J. Audette - Chief Financial Officer

Yeah, it was a swing of about $4 million. So it was an expense of $2.5 million last quarter, even though that was high, it's averaged about $1.5 million, but it was $2.5 million last quarter and was actually income of roughly $1.5 million this quarter. So a quarter-over-quarter swing of around $4 million.

Steven J. Chubak - Nomura Securities International, Inc.

All right. Great. That's it from me. Thank you for taking my questions.

Mark Stephen Casady - Chairman & Chief Executive Officer

Thanks, Steven.

Operator

Our next question comes from the line of Chris Harris with Wells Fargo. Your line is open.

Chris M. Harris - Wells Fargo Securities LLC

Thanks. Hey, guys. 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 as a goal of these initiatives to route these for the client, does that also mean lower fees for LPL? That's the first part of the question. Second is, do you guys envision still generating revenue sharing payments from these new initiatives? Thanks.

Mark Stephen Casady - Chairman & Chief Executive Officer

I will take the second question first. Again, it's a little too early to understand fully what the Department of Labor has brought to us in the 1,000-page document. So we're still digging our way through it. It does appear though that our third-party compensation is going to continue to be received on the brokerage side as well as biggest used and that would be what we have space as we sit here today. So it seems to be affirming to that situation. Important to understand that most of the changes we talked about on the advisory side in the different world and in that case, as it goes. So on the your question about the economics, which was your first question, important to understand that our experience has been that we make changes in pricing what happens as we gain additional assets from 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 it in the second or third. And so, given that our experience over many years of this kind of change, we see it is as being a profitable choice from a shareholder standpoint, and obviously a good solution for consumers and a good solution for advisors as well. This just really helps us grow the business, which is what, of course, we're all after.

So, I think, the best way to think about it is that well, certainly is less profitable than it was before, because you've made a price change. In aggregate, you are picking up additional assets that create additional profits.

Chris M. Harris - Wells Fargo Securities LLC

Okay. Got it.

Operator

Our next question comes from the line of Alex Kramm with UBS. Your line is open.

Alex Kramm - UBS Securities LLC

Hey, good evening. I'm going to start with a non-DOL question, and hopefully, it was mentioned before, but, I guess, you talked about the payouts and the bonuses, but you didn't talk about the base payout rate, which has nicely trickles down over the last couple years. I think 82.5% this quarter, down a whole percent. So, is that going to continue the trickling down? What are you doing there exactly? I know, in the past you've talked about kind of like lower producers given a squeeze a little bit. So, what's going on there and what's the trajectory going forward on the base?

Matthew J. Audette - Chief Financial Officer

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

Mark Stephen Casady - Chairman & Chief Executive Officer

Yeah. I think the only thing I'd add to that is that it's not 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 breakpoints that essentially works. So, as you've seen our brokerage business slow down, as it obviously did last year and continue doing here in the first quarter, you will see that it'll naturally payout less to individual practices as is the schedule basically. So that's also the other dynamics you're seeing the switch that not mention from brokerage advisory, and then just lower production per rep or per advisor will lower the payout rate as well.

Alex Kramm - UBS Securities LLC

Okay, great. And then now to my DOL question, which is actually a little bit more big picture, so I'm not going to going to weed, but, I guess, the question is, now that we have the final rules, what happens next from your perspective? And because you have obviously some timelines here, what is it actually mean for your business? Like, when are you going to actually 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 may be looking at some of the fee changes, I mean, you're obviously doing some things already, right.

So, the bigger question here is like, when do you think some of the behavioral changes might start from the advisor perspective, I guess, also. And then the second question related to that is, obviously all this relates to retirement accounts, but what I keep on hearing is, this is just going to be way too confusing for advisors and also for end client. So, to what degree do you think you're going to have a similar set of rules for both retirement and non-retirement going forward? And then obviously that's related to maybe the SEC is going to come and have their own rules anyway. So, maybe that you can address it from a big picture perspective. Thanks.

Mark Stephen Casady - Chairman & Chief Executive Officer

Yeah. Thank you for that. So, let's start with the harmonization of the rule first, your last question. It is important to understand that the SEC has basically had a mandate since Dodd-Frank was passed, has been delayed in implementation around setting the fiduciary standard. We have two commissioners who have not been ceded yet. So, out of the five commissioners two are not yet there. And so, it doesn't appear that process is going terribly quickly.

And clearly, what's important to understand is, they've got to go through a process with the SEC, which Mary Jo White, I belief, herself has said will be a slow process as they digest what the DOL has done and they understand the unique issues that they face as an agency. So, my own belief is, the SEC will probably let this move into the next administration, as a practical matter since they're down two commissioners there.

I do think the DOL work is helpful because it does set out a way of thinking about a 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, just in general, what's reasonable compensation. So, I do think it's smart as you suggest, but an advisor is going to 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.

So, a good example of that would be, with the way variable annuities have changed over time in terms of pricing. If you're adopting a new pricing structure, one would adopt that across all account types because you're 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 rewrite while we're doing it. And something like the brokerage account that we discussed will work both for taxable and tax free accounts, and that's an important part to consider as well.

And I think if we think about it, we know that that work then lays ground – the deal started 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 deal, I'll approach the issues that are there.

Then your first question was really about what's advisor behavior, and we are seeing a 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 when taking 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. So, we do think that there's some behavior there to make sure that they're thinking about those changes.

And the last one that you talked about is that how do we think about the way that advisors prices may change over time and sort of their outlook going forward. And I think they're 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 any time they 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. So, 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 it for their clients as well. On that, 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 that they do what's right by the clients, and that's what they want to do as well. And so, we're all lined to that interest. And so part of it is, just making sure that we monitor activities or changes in product mix or changes in account type as they are appropriate for clients and they're appropriate for building a good long-term business for everybody.

Alex Kramm - UBS Securities LLC

Excellent. Thanks for the lengthy answer.

Operator

Our next question comes from the line of Devin Ryan with JMP Securities. Your line is open.

Devin P. Ryan - JMP Securities LLC

Hey, great. Thanks. Good evening. Just love if you could talk a bit about the composition and size of the advisor recruiting backlog right now. How that's trended more recently? And if relevant, how the DOLs impact in that? Meaning, is there more imbalance from advisors at other models, maybe those more focused on proprietary products or it does uncertainty around the DOLs, slow movement for video or maybe just get advisors are kind of an wait and see mode or maybe even you guys are in the wait and see mode just as you are assessing all implications.

Mark Stephen Casady - Chairman & Chief Executive Officer

Well, I think we are assessing all the implications. We tend not to be wait-and-see type of people. And so as our actions of price – the changes we've made, the features we're introducing like lower comp 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 that action also tells our existing advisors were here help them and what tells their investors were here to help them. Well that's an important positioning for the company to take. And we know that it does influence people as they decide to move from a firm, perhaps from a proprietary model or an employee model to independent.

I'd say anecdotally we do hear that 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's just too early to tell how that's going to be. I do think it's fair to say that that when you've had the market we have that's the bigger influence in the first six weeks of 2016. That's a much bigger influence on movement. And there's no doubt that that slows down recruiting a bit inevitably as those advisors really pay attention to their investors who get concerned in those kind of rapid sell off moments. So, we had a rapid recovery so that helps, but it is important that that's probably the bigger factor in my view.

Devin P. Ryan - JMP Securities LLC

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

Mark Stephen Casady - Chairman & Chief Executive Officer

Yes. It's still really early to tell, what exactly is involved. I mean, if you think about it, the mix change, just from brokerage going to advisory, advisory has a different set of principles for overseeing, it's a principles-based process. So, there's less activity based review, which implies less use of technology or less use of humans to do that. So, as that conversion occurs, as we get more and more advisory assets, you'd expect us to be just 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. So, 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 some cost. So, I think, today, we feel comfortable with implementation cost. And the good news is, we've got a couple years to do it as opposed to just one. And secondly, we're assessing the ongoing cost, but because the DOL took a broader view and made the BIC more workable that certainly feels better than before we had the new ruling.

Devin P. Ryan - JMP Securities LLC

Got it. Great. Thanks very much, Mark.

Mark Stephen Casady - Chairman & Chief Executive Officer

Sure.

Operator

Our next question comes from the line of Chris Shutler with William Blair. Your line is open.

Chris C. Shutler - William Blair & Co. LLC

Hey, good afternoon. Another question on the base payout from earlier. Just curious what the floor is you think on that that rate if brokerage assets continue to decline?

Matthew J. Audette - Chief Financial Officer

Yeah. Hey, Chris. This is Matt. I wouldn't give a floor. I mean, I think the trends you've seen over the last couple years, they're very small declines on a quarterly basis. I think that's the best information to look at. I wouldn't have a particular number to give you as a floor though.

Chris C. Shutler - William Blair & Co. LLC

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

Mark Stephen Casady - Chairman & Chief Executive Officer

Yes. It'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 this. Number one, the DOL itself has acknowledged rule doesn't require the lowest cost product or service, it's not mandating that in any way. And the 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.

And there are other factors that might be the benefits and value of a product and service to that particular investor's goals or needs, you're there. So, there is a lot of complexity in the way to think about what product is correct when and where. I think 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, and we don't particularly see any reason why that would change, and that's fine.

But we do agree with you that we've seen, I think, a couple changes in terms of less upfront loads and more ongoing trail. And we certainly intend to continue to make sure that that's reasonable compensation as it relates to that product set and a broader asset allocation.

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

And so what happens as a result of that is something called a T-share, which is exactly the characteristics that you describe, 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 from 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.

Chris C. Shutler - William Blair & Co. LLC

Okay. Thank you.

Operator

Our next question comes from the line of Doug Mewhirter with SunTrust. Your line is open.

Doug R. Mewhirter - SunTrust Robinson Humphrey, Inc.

Hi. Good evening. Most of 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. But I know that you were actually talking about possibly dusting the cobwebs off of a fee-based variable annuity. Do you think that momentum would continue or do you think that third-party VAs and fixed index annuities would fit the bill under maybe the slightly more relaxed guidelines of the DOL rule.

Mark Stephen Casady - Chairman & Chief Executive Officer

I think we have to learn and see what's best for the customer. There's a lot of innovation that's occurring in that part of the insurance market, because of the low rate environment. And I think that's part of what we need to see how that works and how we can help influence it. So, I think 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. So, I think that helps us a lot in terms of serving their needs.

I do think relevant to your VA question, and 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 there'll be more demand over time? Yes. Just because they're a good product for providing hedging or providing income – guarantee is not the right word, but income protection let's call it. And so that more than likely you'd see that be more interesting (55:45) over time. I think 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.

Doug R. Mewhirter - SunTrust Robinson Humphrey, Inc.

Okay. Thank you very much.

Mark Stephen Casady - Chairman & Chief Executive Officer

You're welcome.

Operator

Our next question comes from the line of Conor Fitzgerald with Goldman Sachs. Your line is open.

Conor Fitzgerald - Goldman Sachs & Co.

Good evening. Just maybe warn us on kind of what you're seeing from clients as markets have normalized. I think you mentioned that activity was low in January and February just the volatility. Can you give us an update just on what you're seeing in terms of activity levels for March and April?

Mark Stephen Casady - Chairman & Chief Executive Officer

Well, in March, it was more normalized. And that's as far as we'll go in our commentary in terms of it. So we saw January, February, we're now producing the monthly information just trying to make sure there's a lots of good transparency around it. So we'll have the April data out, I'm not sure quite when, Matt, that comes.

Matthew J. Audette - Chief Financial Officer

Yeah. Mid-May. And then I would just add if you notice in 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 calm down on the clients cash sweet balances went down as that money was redeployed back into the market kind of opposite trend you saw in the January and February volatility. So, I would just highlight that to you, Conor.

Conor Fitzgerald - Goldman Sachs & Co.

Yeah. That's helpful. Thanks. And then maybe just a follow-up on 401(k) rollover, I guess. Can you help us maybe size how big a driver that is for your asset growth, and how you think kind of your advisors are going to have to adjust to the rule and how they've conversations with their clients around rollovers?

Mark Stephen Casady - Chairman & Chief Executive Officer

Well, that's the heart of the DOL issue as an instant. So, I afraid we're in the same boat, right, which is that the BIC is more workable than we thought it would be. And they are permitting any number of things that are very helpful to make that rollover conversation successful with an investor. So, I would say that we feel it is all workable and preserves choice. So, not particularly concerned about the act of an individual working with the retail investors on a rollover specifically that we still have an awful lot more to learn about process.

And I think it's an important, one thing I would highlight here is that because our model is an independent contractor model, we don't face the issue at some other state who have a recordkeeping business, have their own employees as their 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 the 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. But I'm sure they're wanting to evaluate that.

In our model that has 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 the important is, how we think through that rollover in terms of education disclosure and recommendations for that consumer and that's part of the detail that we need to work our way through.

Conor Fitzgerald - Goldman Sachs & Co.

That's helpful. Thanks for taking my questions.

Mark Stephen Casady - Chairman & Chief Executive Officer

Absolutely.

Operator

Thank you, and I'm showing no further questions at this time.

Chris Koegel - Senior Vice President-Investor Relations

Thank you very much.

Mark Stephen Casady - Chairman & Chief Executive Officer

Thank you.

Operator

Ladies and gentlemen, thank you for participating in the today's conference. This does conclude the program, and you may all disconnect. Everyone have a wonderful day.

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