LPL Investment Holdings' Management Presents at UBS Asset Gathering Conference (Transcript)

| About: LPL Financial (LPLA)
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LPL Investment Holding, Inc. (NASDAQ:LPLA) UBS Healthcare Services Conference March 23, 2012 8:10 AM ET


Robert J. Moore – Chief Financial Officer & Treasurer


Alex Kramm – UBS Investment Bank

Alex Kramm – UBS Investment Bank

Well, welcome to day two of the Asset Gathering Conference. We are going to get started with, I guess a new addition to this conference. Having heard from some other wealth management firms, it will be interesting to hear from I guess the largest independent provider of such services, so delighted to have LPL Financial here and hear more about their story.

Robert J. Moore

Thank you Alex, good morning. I am Robert Moore, the Chief Financial Officer for LPL Financial and I am joined by colleague Trap Kloman, who is Head of our Investor relations. I would like to thank UBS for inviting us along to this conference.

The corporate mission that we’re on is to ensure that investment advice is delivered to all Americans by an investment advisor, who operates in a conflict free environment supported by leading edge technology and a highly motivated business partner.

The advisor is our customer and we help them manage the complexity of their business. We are the leader in the industry and have been for more than 15 years. We now rank number four by a number of advisors and number five by revenue. We are number one in supporting community banks and credit unions with a nearly 40% market share. And most recently, through our acquisition of National Retirement Partners, we have become a major provide to 401(k) plans.

As noted in the upper portion of this slide, we are able to attract advisors from across all industry channels. This is a strong contributor to future growth and distinctive to our model in terms of the diversity we are able to support.

The left hand chart shows the strong growth in our advisor base since the year 2000 when we went self-clearing. 70% of the growth has been organic with most of the acquisition growth occurring in 2006 and 2007. Self-clearing is a critical differentiator to our business model and reinforces our value proposition and ability to further grow the business. It is an investment that can be made only by firms at scale, but once made it is highly leverageable in both service and economic terms.

Shown here on the upper left hand side of this slide is the basis for the economic rationale for why an advisor would joint LPL. Obviously there are other factors leading to us attracting advisors, but the opportunity to double income and establish equity in their own business is compelling.

Importantly, we also create enhanced economics for our advisors and other independent firms. A 2010 PWC Study which we commissioned concluded that our advisors are approximately 18% more profitable than their peers and other independent broker dealers.

The four pillars of our business model are shown on the right hand side of the slide. We are a leading technology provider, fully integrated to meet the rising complexity involved in delivering advice. We are unparalleled in our ability to support our advisors through ongoing training and best practices.

Our independent research draws from the collective capabilities of more than 40 investment professionals, delivering due diligence, market commentary, asset allocation recommendations and daily dialog in support of our advisors. Finally, we are a clear leader in conflict-free compliance, driving low levels of complaints and an exemplary regulatory track record.

These four pillars are unmatched in the independent channel and are at the heart of our distinctive offering, all this results in strong net promoter scores and high rankings in the J.D. Power Full Service Investor Satisfaction Survey.

Sometimes it’s helpful to discuss the things that we don’t do, in helping you understand who we are and what we stand for. We don’t have proprietary trading or product manufacturing. We don’t own a bank or have investment bankers. We don’t compete against our customers by going directly to their clients and offering online trading.

And by working with more than 500 partner firms and providing access to over 10,000 investment products, we are the standard in giving the word, ‘open’ to architecture. What our customers and investors receive in LPL is a dedicated mission-driven business that is capital light, free to grow and positioned for success. This makes LPL the partner of choice for advisors that want the freedom of true independence.

The combination of the information that I provided thus far is a strong operating model which has the highest retention rates in the industry, a well diversified customer base, comparatively low levels of interest rate sensitivity and high levels of recurring revenue.

We see opportunities to continue to improve our operating margins through our service value commitment initiative. This will enhance our already strong free cash flow generation and our low consumption of capital allows us to have higher pay-outs for our advisors, strong reinvestment in technology and service, while maintaining flexibility for acquisitions.

It is worth highlighting that the majority of our higher margin attachment revenues are derived from our move to self-clearing. There’s rightly been a fair amount of attention given to our cash products program. With more than $22 billion in assets, our cash program is a valuable and valued activity for the company and our customers.

For competitive reasons, we do not provide specific information about the underlying contracts with our depository partners. However, we have been highly transparent about the allocation of balances and yields between our money market options and the insured cash account offering, as well as their sensitivity to changes in interest rates.

We continue to add new partners for the program, given the consistent growth we are experiencing. Our recent efforts have led us to extending capacity to 2018 for a significant portion of the ICA program and we have been able to reset the spreads to Fed funds without incurring any material impact on earnings and maintaining the full retention of upside for future interest-rate movements. We remain well positioned for this program to support our advisors, create shareholder value, and drive better relative performance than our competitors.

We have recently filed an 8-K describing developments and future intentions for optimizing our capital structure. The company’s journey has evolved form sole proprietorship to PE firm sponsored supported management buy out to publicly listed firm to now stating our intention to establish a more permanent capital structure that will address our optimal level of debt with a clear pathway towards de-leveraging, the introduction of a regular ongoing dividend, and the opportunity to return capital through a special dividend paid solely through cash on hand. This is all subject to us completing the proposed refinancing and obtaining board approval.

I want to emphasize that these steps are all approached with our ability to continue to strongly support the organic growth of our business as well as allow for acquisitions and share repurchases that will mitigate dilution from our ongoing share option programs. This level of financial flexibility is largely driven by the presence of strong and growing recurring revenues and the absence of activities that inefficiently consume capital.

We have an established track record of both topline and bottom line profitable growth. Since the year 2000, we have had two down years of revenue with no declines in adjusted EBITDA. In 2009, we experienced a 2% drop in revenues and we were able to expand profitability by nearly 2%. We did not require any capital infusion or any external support.

We demonstrated all the values that underlie independence. In 2008 and 2010 for instance, we had essentially the same levels of revenues while profits were nearly 20% higher in 2010, demonstrating the benefit of efficiencies and lower run rate expenses. We are on a positive trajectory of sustainable and profitable growth.

I can confirm that we remain committed to our 20% adjusted earnings per share growth rate target with a three to five year investment horizon. The key drivers of our growth remain intact, supporting and expanding same-store sales growth, which is the highest priority and most important contributor to our growth.

Continuing to attract advisors who wish to affiliate with the industry leader and independents will remain also a vital contributor to future growth. We believe that modest growth from market appreciation is likely and we intend to achieve our guidance for improving margins by 30 to 50 basis points annually.

And with that, I would like to thank you for your attention during the presentation. I will open it up for Q&A.

Question-and-Answer Session

Alex Kramm – UBS Investment Bank

I guess we can get start in the room.

Unidentified Analyst


Robert J. Moore

Yeah. Okay, so the question was to expand a little bit on our service to 401(k) plans and to comment a bit on the PWC study about enhanced profitability for our advisors. So with respect to the 401(k) market, the acquisition of National Retirement Partners, which we did a year ago, was essentially the bringing on of capabilities as well as advisors who specialize in providing advice to plan sponsors. Through that group, and through that acquisition, in conjunction with some established advisors that we already had, we now service over 25,000 plans across the United States.

This has been an area of opportunity for us in terms of servicing the plan sponsored level, in-plan advice and ultimately access to the rollover market. So we’re quite encouraged about the addition of those capabilities to our overall set of capabilities that we have.

With respect to advisor efficiency and profitability, the PwC study essentially looked at a side by side comparison of advisors within our platform relative to other independent advisors and cost for office space, the level of resourcing they needed and expand their entire expense base, and was able to conclude that when you look at the full contour of advisor cost, we are able to essentially provide them those same services, and importantly, consult with them on ways to drive down cost in a way that leads to greater profitability.

So essentially what that is saying is that for another independent advisor, we know the economics if somebody is coming from an employee model, but for somebody coming from another independent model, there is also the expectation of improved efficiency.

Alex Kramm – UBS Investment Bank

Let me add just something real quick. Now, more from a macro perspective, can you maybe remind everyone in terms of how the environment would impact you specifically, we have a firm just made this call, this is the beginning of the bear market in bonds and obviously we’ve seen interest rate rise recently here.

Can you just talk about from an environment perspective, how you as the firm, I think you’ll benefit equity market clearly couldn’t come back, but also maybe from an advisor perspective, I know this is new have you seen any changes in behavior already over the last, maybe year-to-date from what advisors are doing for the client?

Robert J. Moore

Well, the presence of the advisor in the relationship of course is meant to be a sort of steadying influence. So we did see a deceleration in system wide activity during the fourth quarter and we talked about that during our earnings call that we held in February. We have seen a redemption of better levels of activity coming into this year against the backdrop of more favorable market conditions et cetera.

The firm at the top line revenue level is about 60% correlated to equity market movement and that reflects a sort of underlying asset allocation that we see across the overall activity level within the advisors businesses themselves.

So and as it relates to interest rates of course, we are a benefactor in raising short-term interest rates through the cash reprogram that I mentioned longer-term interest rates and the moments there will cost some downward mark-to-market depending on how bigger move that is, but it’s not that bigger contributor overall to the asset allocation mix that sits within the advisor activity itself.

So we’ll continue as everyone else will to watch conditions and see how 2012 unfolds, but the important thing to know that there is good alignment between our advisor business and their activity and our set of priorities as well, given the way the production pay-out works. Yes sir.

Unidentified Analyst


Robert J. Moore

Yes, so the question was around adding new products for advisors kind of what, if there is any trends or things we’ve done over the last couple of years. So innovation is important to us and I mentioned we’re not a product manufacturer, but we partner closely with firms on addressing the needs of our advisors and the end clients.

A good example of that would be centrally managed platforms in the ETF space where we saw the trends in terms of utilization of ETFs, recognize that the input cost was going down, meaning the cost to trade ETFs was going down and that has become relatively commoditized in the marketplace.

So for us what we wanted to do is isolate the vale of the advice that goes in using ETF as opposed to the price of the ETF itself. And we introduced a centrally managed platform for our advisors to use with their clients that range across a variety of strategies including absolute return and other types of strategies and introduce the use of the outside strategist as well.

So BlackRock and Cougar, Quantitative Analytics for instances are providers of outside strategies in addition to our internal research team. So that’s a good example of where we see market trends and we are able to provide value to the advisors themselves protect the economics in terms of not seeing them a road through commoditization behavior that you see in the broader marketplace and position advisors to receive the kind of advise and kind of access that you wouldn’t ordinarily see if you didn’t have the kind of relationships we do with manufacturers.

Similarly, we have work going on in retirement income, solutions that will be very important to do. All of us know the sort of needs that exist out in the marketplace to address those types of issues that we see, and also health and wealth-type of insurance-related activities would be good examples of where we are, augmenting our existing product mix or existing product offerings for advisors.

Unidentified Analyst

Hi, I would be curious to hear about how you are winning in the shift with wirehouses and advisors, the leading wirehouses and how the trends there have been going, how that’s been progressing over the last couple of years? And also be curious what the profile of advisors, the wirehouses that come to LPL are, because when you talk to the wirehouses, often they say, oh these are guys that we jettisoned anyway. So is it a matter of different economics, or is it just that they are speaking their own book and it’s not really representative?

Robert J. Moore

Well, I’ll address that by saying. We attract across a very wide range or very wide spectrum of advisor types, all the way from those who are lower producing within the systems that are establishing kind of those thresholds. So if you use an example of a $400,000 a year type producer, in some systems that person’s not valued and not viewed as particularly profitable. In our system, they have a value, definite value to our sort of core operating model and it’s one of our strengths that we’ve found a way to operate profitably across that kind of continuum of production.

That having been said, and we have talked about this in various venues and on earnings call about the mix shift versing towards higher producing advisors. And we’re seeing that from various sectors, other independents, from wirehouses, from other employee-based models. And so the attractiveness of what we bring is meant to draw from a variety of channels, including the wirehouse channel.

We don’t really comment specifically on where the attribution of advisors is coming from, because it shifts through time and it has a tendency to de-emphasize the fact that we draw from such a wide range of different channels out in the marketplace, and there is a big ebb and flows to that, when there is closures of other independent firms or there is kind of some event that’s going on, that may cause a spike from one channel relative to another.

Over time we’ve observed that literally there are about a third from wirehouse-type models, a third from other independents and then a third from insurance companies, regionals, other, sort of other category. And we don’t have any reason to believe that over time that allocation or attribution will change materially.

But the attractiveness is increasing your day one economics, being a part of kind of creating your own equity. And then lastly, but in growing importance is this notion of independence and operating in an environment where you are non-conflicted and you don’t have any sort of brand problems relative to your own aspirations for your book. And I think those kinds of trends are accelerating. Does that help? Okay, great, thank you.

Alex Kramm – UBS Investment Bank

The second item on your growth drivers new and maturing advisors. Can you just give us a little perspective on how to think about how these advisors mature and what the dynamics are for growth, sort of the class of 2010, 2011, how you model that, how you think of a maturity date in terms of their natural accelerated growth rate when you bring them on the system? And how we want to think about modeling advisor growth versus some maturation of their book of business where it naturally slows?

Robert J. Moore

Okay, thank you. So we have a very specific definition of what constitutes a mature advisor. That is someone who has been on our platform for three years. So the first three years we regard as kind of the ramp up period where you’re in the first instance dealing with the immediate transition of them from wherever they were to where they are and that ramp varies if they are coming from another independent for instance versus an employee-based model.

There are different issues that are involved in the transition itself, but give or take that three year period is the period from which they go from making the initial decision to being at or above their prior production levels to when they joined LPL and that’s where we get to that, that three-year horizon and/or definition of what a mature advisor is.

When we think about the growth of the already matured advisors, we think about them deepening relationships to their existing clients. We think about lead generation for them attracting new clients. We think about enhancing the efficiency and sort of running of their practice to improve capacity and allow them additional head room to grow and so we have talked about something on the order of a 3% annualized growth rate for that collective pool ex-market.

So that’s stripping out all effects from just reevaluation of underlying assets. And of course at that level, that top line revenue, the translation of that into profitability is significantly higher because that is highly profitable incremental business. Last year, it was low double digits same-store sales growth.

And so we do comment on this throughout the course of the year as we do our earnings release and talk about the sort of impact and factors that were at work in looking at our existing advisor base in same-store sales. Earlier last year, they were running significantly above that sort of threshold of double-digits. By the last quarter, given market volatility et cetera that has decelerated to almost flat. And as I mentioned earlier, we are seeing some resumption of activity into the first part of this year.

Alex Kramm – UBS Investment Bank

If I can jump in just again for a second. If we go back to the slide, you had the slide up on the suite program extended to 2018. Can you just comment maybe real quick, did everything now get repriced and I guess extended or are there still programs that are expiring I think over the next couple of years there were a couple of programs that are expiring. Are you basically done with this process or is there still some risk of maybe some resetting down to maybe more market-based returns?

Robert J. Moore

Well, I would encourage everyone to step back and think about it in a portfolio approach. I mean, there are 15 underlying counterparties within the ICA program at present. That’s been as high as 23%, that’s been low as 12%. There is constant activity in there and it’s managed like a portfolio.

So, at any point in time or any point in time as in a year type of horizon, we can have maturing contracts or rollover negotiations et cetera. The point we were trying to make is that we are proactively engaged in that portfolio management. We are aware of the kind of environment that may happen, we don’t know, right, in terms of if we got a Fed Chairman it’s declared low interest rates for the foreseeable future and then some.

But we all know that that can and will change if they decide they want to change it. He doesn’t have necessarily any better insight to 2014 and the rest of us do. So, but our job of course is to maximize the utility function of that program overall, and what’s distinctive about it is that because we are growing and because we have established levels of baseline balances.

We’re in a position to go to counterparties, do a more extended term type of contract where you assure a certain balance level and you are able to then provide them with funding that isn’t wholesale funding, complete wholesale funding are actually able to with their regulators determine that these funds are considered to be sticky enough to allow them to reinvest further out on the asset side of their own balance sheet.

And that increases the value of it in addition to the tenor taking you off of just a base Fed funds, daily liquidity kind of resets. There are some programs in the overall program that are designed for that kind of liquidity and they do have much lower spreads to them because they kind of occupy that functionality within the portfolio mix.

So what we’re saying is, we’ve taken a significant portion of the program and engaged in that renegotiation out to 2018, reset the spread, but not to kind of what most people would call current market level, but they are sort of normal market levels when you consider the tenor and the agreement of underlying commitment to maintain balances et cetera.

So, it was just our way of defusing some of the speculation that we’ve done about how much kind of variability or what kind of cliff do we really have in that portfolio. And that was at the heart of us bringing this forward and talking about it a little more specifically while still preserving our competitive advantage. Any other question?

Alex Kramm – UBS Investment Bank

I’ll just ask one more quick, just moving up on a presentation we had yesterday, you’re obviously (inaudible). But like one comment that one firm made was that on the asset management side, you’ve seen some of the large, well, maybe a couple of wirehouses and maybe some other players, pressure the asset managers on the fee side in terms of revenue share.

So when I go back to the IPO, I remember a slide in terms of where you are in terms of number two, three, some firms even higher in terms of being one of the biggest, I guess conduits for some of these asset management firms. So are there opportunities for getting better economics? I mean, the managers still have pretty good margins out there, so there it doesn’t seem like they’re struggling out there. And obviously you’re looking at margin expansion, is that part of the opportunity or is this a non-discussion?

Robert J. Moore

Well, it’s always part of the discussion because it’s one of the attributes of our model that warrants attention and we believe, we do command the kind of relationship and positioning and growth that would encourage us to have the very best sort of leading edge type of economics in those relationships, and we feel we do. Whether the trend towards improving those or not is really going to emerge. Yeah, we’ll continue to monitor that and we’ll continue to be at the forefront of those types of discussions.

But we feel very good about our existing positions and we feel very good about our existing relationships, but we will always look for opportunities to grow those partnerships and particularly given the diversity of feedback that we see and trends that we’re able to talk to product manufacturers and asset managers about. It is a unique facet of our relationship in that we can work with them on innovation as we talked about earlier on the product side.

But importantly they also know we’re never growing to compete with them. So the shelf space for us is truly open shelf. And that is of meaning and particularly when you are talking about variable annuities and other type of products where you’re consuming balance sheet on behalf of the provider.

Alex Kramm – UBS Investment Bank

So you wouldn’t say that there are any I guess low hanging fruit or any firm…

Robert J. Moore


Alex Kramm – UBS Investment Bank

We would think like the economics could be better, okay?

Robert J. Moore

No, we’ve already dealt with that.

Alex Kramm – UBS Investment Bank

Close those gaps. Okay, anything else in the room?

Unidentified Analyst

Okay. The pool of advisors over the last three years, we’ve had a dramatic period in the market and now a little bit more stable. How many less the system in each of those periods, is that make sense for whatever reason whatever retirement or anything else and I am just trying to….

Robert J. Moore

Are you talking within our system or the total market place?

Unidentified Analyst


Robert J. Moore

Well as we mentioned, we tend to look at attrition in terms of revenue as opposed to number of advisors and the reason we do that of course is there are a certain number of advisors who drop below $100,000 in production or some, some level like that where we will kind of asked them to go because it’s clear either their other business activities or something else is a driver there.

And we haven’t disclosed sort of aggregate levels of advisor, number of attrition as much as we disclose net new advisors and in the case of when we do a movement of a portion of our businesses as we did with the affiliated entity broker dealers or UVEST where we announced that we were migrating them from parsing on to the LPL platform.

We do talk about the attrition levels that were created from those two decisions where you are proactively creating a repapering and a movement of an advisor from one platform to the other and the combination of us using that as a chance to really sort of think through who we want to come over, and their thought about whether they want to come over kind of intersect and we will see heightened levels of advisor attrition during those types of restructurings.

The reality is thought that the level of retention of revenue is quite high in both instances. And so that to us is the key metric we tend to look at. And there has not been any discernible shift in either number of advisors or type of advisor practice leaving over the last few years that warrants comment from us.

Alex Kramm – UBS Investment Bank

All right, any last questions in the room? All right, Robert, thank you very much.

Robert J. Moore

Thank you.

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