News Column

LPL FINANCIAL HOLDINGS INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

April 28, 2014

Overview

We are the nation's largest independent broker-dealer, a top custodian for registered investment advisors ("RIAs"), and a leading independent consultant to retirement plans. We provide an integrated platform of brokerage and investment advisory services to more than 13,700 independent financial advisors, including financial advisors at more than 700 financial institutions (our "advisors") across the country, enabling them to provide their retail investors ("clients") with objective financial advice through a lower conflict model. We also support approximately 4,400 financial advisors who are affiliated and licensed with insurance companies with customized clearing, advisory platforms, and technology solutions. Fortigent Holdings Company, Inc. and its subsidiaries ("Fortigent") are a leading provider of solutions and consulting services to RIAs, banks, and trust companies servicing high-net-worth clients, while The Private Trust Company, N.A. ("PTC") manages trusts and family assets for high-net-worth clients. Our singular focus is to provide our advisors with the front-, middle- and back-office support they need to serve the large and growing market for independent investment advice. We believe we are the only company that offers advisors the unique combination of an integrated technology platform, comprehensive self-clearing services, and open-architecture access to leading financial products, all delivered in an environment unencumbered by conflicts from product manufacturing, underwriting, or market making. For over 20 years, we have served the independent advisor market. We currently support the largest independent advisor base and we believe we have the fourth largest overall advisor base in the United States based on the information available as of the date this Quarterly Report on Form 10-Q has been issued. Through our advisors, we are also one of the largest distributors of financial products in the United States. Our scale is a substantial competitive advantage and enables us to more effectively attract and retain advisors. Our unique business model allows us to invest in more resources for our advisors, increasing their revenues and creating a virtuous cycle of growth. We have 3,267 employees, with primary offices in Boston, Charlotte, and San Diego. Our Sources of Revenue Our revenues are derived primarily from fees and commissions from products and advisory services offered by our advisors to their clients, a substantial portion of which we pay out to our advisors, as well as fees we receive from our advisors for the use of our technology, custody, clearing, trust, and reporting platforms. We also generate asset-based revenues through our platform of over 11,000 financial products from a broad range of product manufacturers. Under our self-clearing platform, we custody the majority of client assets invested in these financial products, for which we provide statements, transaction processing and ongoing account management. In return for these services, mutual funds, insurance companies, banks, and other financial product manufacturers pay us fees based on asset levels or number of accounts managed. We also earn interest from margin loans made to our advisors' clients. We track recurring revenue, a characterization of net revenue and a statistical measure, which we define to include our revenues from asset-based fees, advisory fees, trailing commissions, cash sweep programs, and certain other fees that are based upon accounts and advisors. Because certain recurring revenues are associated with asset balances, they will fluctuate depending on the market values and current interest rates. These asset balances, specifically related to advisory and asset-based revenues, have a correlation of approximately 60% to the fluctuations of the overall market, as measured by the S&P 500. Accordingly, our recurring revenue can be negatively impacted by adverse external market conditions. However, recurring revenue is meaningful to us despite these fluctuations because it is not dependent upon transaction volumes or other activity-based revenues, which are more difficult to predict, particularly in declining or volatile markets. 20



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The table below summarizes the sources of our revenue, the primary drivers of each revenue source and the percentage of each revenue source that represents recurring revenue: Three Months Ended March 31, 2014 % of Total Total Net Sources of Revenue Primary Drivers (millions) Revenue % Recurring Advisor-driven Commission - Transactions revenue with - Brokerage asset $535 49% 42% ~85%-90% levels payout ratio Advisory - Advisory asset $327 30% 99% levels Asset-Based - Cash balances - Cash Sweep Fees - Interest rates - Sponsorship Fees - Client asset $115 11% 97% - Record Keeping levels - Number of accounts Transaction and Fee - Client activity



Attachment - Transactions - Number of clients

revenue - Client (Investor) - Number of advisors

retained by Accounts - Number of accounts $90 8% 65% us - Advisor Seat and - Number of premium Technology technology subscribers Other - Margin account balances - Alternative $20 2% 28% investment transactions Total Net Revenue $1,087 100% 67% Total Recurring Revenue $724 67%



Commission and Advisory Revenues. Commission and advisory revenues both represent advisor-generated revenue, generally 85-90% of which is paid to advisors. Commission Revenues. We generate two types of commission revenues: transaction-based sales commissions and trailing commissions. Transaction-based sales commission revenues, which occur whenever clients trade securities or purchase various types of investment products, primarily represent gross commissions generated by our advisors from commissions earned on purchases by clients of various financial products and securities such as mutual funds, variable and fixed annuities, alternative investments, equities, fixed income, insurance, group annuities, and options and commodities. The levels of transaction-based commissions can vary from period to period based on the overall economic environment, number of trading days in the reporting period, and investment activity of our advisors' clients. We earn trailing commission revenues (a commission that is paid over time, such as 12(b)-1 fees) primarily on mutual funds and variable annuities held by clients of our advisors. Trailing commissions are recurring in nature and are earned based on the current market value of investment holdings in trail-eligible assets. Advisory Revenues. Advisory revenues primarily represent fees charged on our corporate RIA platform provided through LPL Financial LLC ("LPL Financial") to clients of our advisors based on the value of advisory assets. Advisory fees are typically billed to clients quarterly, in advance, and are recognized as revenue ratably during the quarter. The value of the assets in an advisory account on the billing date determines the amount billed, and accordingly, the revenues earned in the following three month period. The majority of our accounts are billed using values as of the last business day of each calendar quarter. Advisory revenues collected on our corporate RIA platform generally average 1.1% of the underlying assets, and can range anywhere from 0.5% to 3.0%. In addition, we support independent RIAs who conduct their advisory business through separate entities by establishing their own RIA ("Independent RIAs") pursuant to the Investment Advisers Act of 1940, rather than through LPL Financial. The assets held under these investment advisory accounts custodied with LPL Financial are included in our advisory and brokerage assets, net new

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advisory assets and advisory assets under custody metrics. The advisory revenue generated by an Independent RIA is earned by the Independent RIA, and accordingly is not included in our advisory revenue. However, we charge administrative fees to Independent RIAs for clearing and custody of these assets, based on the value of assets within these advisory accounts. The administrative fees collected on our Independent RIA platform vary, and can reach a maximum of 0.6% of the underlying assets. Furthermore, we support certain financial advisors at broker-dealers affiliated with insurance companies through our customized advisory platforms and charge fees to these advisors based on the value of assets within these advisory accounts. Asset-Based Revenues. Asset-based revenues are comprised of fees from cash sweep programs, our sponsorship programs with financial product manufacturers and omnibus processing and networking services. Pursuant to contractual arrangements, uninvested cash balances in our advisors' client accounts are swept into either insured deposit accounts at various banks or third-party money market funds, for which we receive fees, including administrative and record-keeping fees based on account type and the invested balances. In addition, we receive fees from certain financial product manufacturers in connection with sponsorship programs that support our marketing and sales-force education and training efforts. Our omnibus processing and networking revenues represent fees paid to us in exchange for administrative and record-keeping services that we provide to clients of our advisors. Omnibus processing revenues are paid to us by mutual fund product sponsors and based upon the value of custodied assets in advisory accounts and the number of brokerage accounts in which the related mutual fund positions are held. Networking revenues on brokerage assets are correlated to the number of positions we administer and are paid to us by mutual fund and annuity product manufacturers. Transaction and Fee Revenues. Revenues earned from transactions and fees primarily consist of transaction fees and ticket charges, subscription fees, Individual Retirement Account ("IRA") custodian fees, contract and license fees, conference fees and other client account fees. We charge fees to our advisors and their clients for executing certain transactions in brokerage and fee-based advisory accounts. We earn subscription fees for various services provided to our advisors and on IRA custodial services that we provide for their client accounts. We charge administrative fees to our advisors and fees to advisors who subscribe to our reporting services. We charge fees to financial product manufacturers for participating in our training and marketing conferences. In addition, we host certain advisor conferences that serve as training, sales and marketing events, for which we charge a fee for attendance. Other Revenues. Other revenues include marketing allowances received from certain financial product manufacturers, primarily those who offer alternative investments, such as non-traded real estate investment trusts and business development companies, mark-to-market gains or losses on assets held by us for the advisors' non-qualified deferred compensation plan and our model portfolios, revenues from our Retirement Partners program, interest income from client margin accounts and cash equivalents, net of operating interest expense, and other items. Our Operating Expenses Production Expenses. Production expenses are comprised of the following: base payout amounts that are earned by and paid out to advisors based on commission and advisory revenues earned on each client's account (collectively, commission and advisory revenues earned by LPL Financial are referred to as gross dealer concessions, or "GDC"); production bonuses earned by advisors based on the levels of commission and advisory revenues they produce; the recognition of share-based compensation expense from equity awards granted to advisors and financial institutions based on the fair value of the awards at each reporting period; a mark-to-market gain or loss on amounts designated by advisors as deferred commissions in a non-qualified deferred compensation plan at each reporting period; and brokerage, clearing and exchange fees. Our production payout ratio is calculated as production expenses excluding brokerage, clearing and exchange fees, divided by GDC. We characterize components of production payout, which consists of all production expenses except brokerage, clearing and exchange fees, as either GDC sensitive or non-GDC sensitive. Base payout amounts and production bonuses earned by and paid to advisors are characterized as GDC sensitive because they are variable and highly correlated to the level of our commission and advisory revenues in a particular reporting period. Payout characterized as non-GDC sensitive includes share-based compensation expense from equity awards granted to advisors and financial institutions based on the fair value of the 22



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awards at each reporting period, and mark-to-market gains or losses on amounts designated by advisors as deferred commissions in a non-qualified deferred compensation plan. Non-GDC sensitive payout is correlated either to market movement or to the value of our stock. We believe that discussion of production payout, viewed in addition to, and not in lieu of, our production expenses, provides useful information to investors regarding our payouts to advisors. Compensation and Benefits Expense. Compensation and benefits expense includes salaries and wages and related employee benefits and taxes for our employees (including share-based compensation), as well as compensation for temporary employees and consultants. General and Administrative Expenses. General and administrative expenses include promotional fees, occupancy and equipment, communications and data processing, regulatory fees, professional services, and other expenses. General and administrative expenses also include expenses for our hosting of certain advisor conferences that serve as training, sales, and marketing events. Depreciation and Amortization Expense. Depreciation and amortization expense represents the benefits received for using long-lived assets. Those assets consist of intangible assets established through our acquisitions, as well as fixed assets, which include internally developed software, hardware, leasehold improvements, and other equipment. Restructuring Charges. Restructuring charges primarily represent expenses incurred as a result of our expansion of our Service Value Commitment announced in 2013 (see Note 3. Restructuring, within the notes to unaudited condensed consolidated financial statements) and costs arising from our 2011 consolidation of UVEST Financial Services Group, Inc. ("UVEST"). For 2013, restructuring charges also include costs arising from our 2009 consolidation of Mutual Service Corporation, Associated Financial Group, Inc., Associated Securities Corp., Associated Planners Investment Advisory, Inc. and Waterstone Financial Group, Inc. (collectively referred to herein as the "Affiliated Entities"). 23



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How We Evaluate Our Business We focus on several business and key financial metrics in evaluating the success of our business relationships and our resulting financial position and operating performance. Our business and key financial metrics as of and for the three months ended March 31, 2014 and 2013 are as follows:

March 31, 2014 2013 % Change Business Metrics Advisors 13,726 13,377 2.6 %



Advisory and brokerage assets (in billions)(1) $ 447.1$ 394.0 13.5 % Advisory assets under custody (in billions)(2)(3) $ 158.0$ 130.2 21.4 % Net new advisory assets (in billions)(4) $ 4.4$ 3.0 46.7 % Insured cash account balances (in billions)(3) $ 16.6$ 15.6 6.4 % Money market account balances (in billions)(3) $ 7.1$ 7.5 (5.3 )%

Three Months Ended March 31, 2014 2013 Financial Metrics Revenue growth from prior period 11.6 % 8.1 %



Recurring revenue as a % of net revenue(5) 66.6 % 65.4 % Net income (in millions)

$ 53.1$ 54.7 Earnings per share (diluted) $ 0.51$ 0.51 Non-GAAP Measures: Gross margin (in millions)(6) $ 330.7$ 305.1 Gross margin as a % of net revenue(6) 30.4 % 31.3 % Adjusted EBITDA (in millions) $ 141.5$ 135.9 Adjusted EBITDA as a % of net revenue 13.0 % 13.9 %



Adjusted EBITDA as a % of gross margin(6) 42.8 % 44.6 % Adjusted Earnings (in millions)

$ 71.0$ 68.1



Adjusted Earnings per share (diluted) $ 0.69$ 0.64

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(1) Advisory and brokerage assets are comprised of assets that are custodied, networked, and non-networked and reflect market movement in addition to new assets, inclusive of new business development and net of attrition. Set forth below are other client assets at March 31, 2014 and 2013, including retirement plan assets, and certain trust and high-net-worth assets, that are custodied with third-party providers and therefore excluded from advisory and brokerage assets (in billions): March 31, 2014 2013 Retirement plan assets(a) $ 71.0$ 51.0 Trust assets(b) $ 11.2$ 11.6



High-net-worth assets(c) $ 74.9$ 64.4

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(a) Retirement plan assets are held in retirement plans that are supported by advisors licensed with LPL Financial. At March 31, 2014 and 2013, our retirement plan assets represent assets that are custodied with 34 third-party providers and 27 third-party providers, respectively, of retirement plan administrative services who provide reporting feeds. We estimate the total assets in retirement plans supported to be between $105.0 billion and $115.0 billion at March 31, 2014 and between $75.0 billion and $90.0 billion at March 31, 2013. If we receive reporting feeds in the future from providers for whom we do not currently receive feeds, we intend to include and identify such additional assets in this metric. During the three months ended March 31, 2014, we began receiving reporting feeds from four such providers, 24



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which accounted for $5.5 billion of the $20.0 billion increase in retirement plan assets since March 31, 2013. (b) Represent trust assets that are on the comprehensive wealth management platform of the Concord Trust and Wealth Solutions division of LPL Financial ("Concord"). (c) Represent high-net-worth assets that are on the comprehensive platform of performance reporting, investment research and practice management services of Fortigent. (2) Advisory assets under custody are comprised of advisory assets under management in our corporate RIA platform, and Independent RIA assets in advisory accounts custodied by us. See "Results of Operations" for a tabular presentation of advisory assets under custody. (3) Advisory assets under custody, insured cash account balances and money market account balances are components of advisory and brokerage assets. (4) Represents net new advisory assets consisting of funds from new accounts and additional funds deposited into existing advisory accounts that are custodied in our fee-based advisory platforms, less account attrition and funds withdrawn from advisory accounts. (5) Recurring revenue, which is a characterization of net revenue and a statistical measure, is derived from sources such as advisory revenues, asset-based revenues, trailing commission revenues, revenues related to our cash sweep programs, interest earned on margin accounts and technology and service revenues, and is not meant as a substitute for net revenues. (6) Gross margin is calculated as net revenues less production expenses. Because our gross margin amounts do not include any depreciation and amortization expense, we consider our gross margin amounts to be non-GAAP measures that may not be comparable to those of others in our industry. Adjusted EBITDA Adjusted EBITDA is defined as EBITDA (net income plus interest expense, income tax expense, depreciation, and amortization), further adjusted to exclude certain non-cash charges and other adjustments set forth below. We present Adjusted EBITDA because we consider it an important measure of our performance. Adjusted EBITDA is a useful financial metric in assessing our operating performance from period to period by excluding certain items that we believe are not representative of our core business, such as certain material non-cash items and other adjustments. We believe that Adjusted EBITDA, viewed in addition to, and not in lieu of, our reported GAAP results, provides useful information to investors regarding our performance and overall results of operations for the following reasons: • because non-cash equity grants made to employees, officers and non-employee directors at a certain price and point in time do not necessarily reflect how our business is performing at any particular time, share-based compensation expense is not a key measure of our operating performance; and • because costs associated with acquisitions and the resulting integrations, debt refinancing and restructuring and conversions costs can vary from period to period and transaction to transaction, expenses associated with these activities are not considered a key measure of our operating performance. We use Adjusted EBITDA: • as a measure of operating performance;



• for planning purposes, including the preparation of budgets and forecasts;

• to allocate resources to enhance the financial performance of our business;

• to evaluate the effectiveness of our business strategies;

• in communications with our board of directors (the "Board of Directors" or

the "Board") concerning our financial performance; and

• as a factor in determining employee and executive bonuses.

Adjusted EBITDA is a non-GAAP measure and does not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. Adjusted

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EBITDA is not a measure of net income, operating income, or any other performance measure derived in accordance with GAAP. Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are: • Adjusted EBITDA does not reflect all cash expenditures, future requirements for capital expenditures or contractual commitments; • Adjusted EBITDA does not reflect changes in, or cash requirements for, working capital needs; • Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt; and • Adjusted EBITDA can differ significantly from company to company depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate and capital investments, limiting its usefulness as a comparative measure.



Adjusted EBITDA should not be considered as a measure of discretionary cash available to us to invest in our business. We compensate for these limitations by relying primarily on the GAAP results and using Adjusted EBITDA as supplemental information. Set forth below is a reconciliation from our net income to Adjusted EBITDA, a non-GAAP measure, for the three months ended March 31, 2014 and 2013 (in thousands):

Three Months Ended March 31, 2014 2013 Net income $ 53,135$ 54,717 Non-operating interest expense 12,840 12,160 Provision for income taxes 34,412 35,834 Amortization of intangible assets 9,716 9,776



Depreciation and amortization of fixed assets 12,565 9,998 EBITDA

122,668 122,485



EBITDA Adjustments: Employee share-based compensation expense(1) 5,111 3,962 Acquisition and integration related expenses(2) 359 444 Restructuring and conversion costs(3)

7,271 6,263 Other(4) 6,068 2,766 Total EBITDA Adjustments 18,809 13,435 Adjusted EBITDA $ 141,477$ 135,920 __________________

(1) Represents share-based compensation for equity awards granted to employees, officers, and directors. Such awards are measured based on the grant-date fair value and recognized over the requisite service period of the individual awards, which generally equals the vesting period. (2) Represents acquisition and integration costs resulting from various acquisitions, including changes in the estimated fair value of future payments, or contingent consideration, required to be made to former shareholders of certain acquired entities. (3) Represents organizational restructuring charges, conversion, and other related costs resulting from the expansion of our Service Value Commitment, the 2011 consolidation of UVEST, and, prior to the three months ended March 31, 2014, the 2009 consolidation of the Affiliated Entities. (4) Results for the three months ended March 31, 2014 include approximately $5.3 million in parallel rent, property tax, and common area maintenance expenses incurred in connection with our relocation to our new San Diego office building. Results for the three months ended March 31, 2013 include $2.7 million of severance and termination benefits related to a change in management structure. Other amounts include certain excise and other taxes. 26



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Adjusted Earnings and Adjusted Earnings per share Adjusted Earnings represents net income before: (a) share-based compensation expense, (b) amortization of intangible assets, (c) acquisition and integration related expenses, (d) restructuring and conversion costs, and (e) other. Reconciling items are tax effected using the income tax rates in effect for the applicable period, adjusted for any potentially non-deductible amounts. Adjusted Earnings per share represents Adjusted Earnings divided by weighted-average outstanding shares on a fully diluted basis. We prepared Adjusted Earnings and Adjusted Earnings per share to eliminate the effects of items that we do not consider indicative of our core operating performance. We believe that Adjusted Earnings and Adjusted Earnings per share, viewed in addition to, and not in lieu of, our reported GAAP results provide useful information to investors regarding our performance and overall results of operations for the following reasons: • because non-cash equity grants made to employees, officers, and non-employee directors at a certain price and point in time do not necessarily reflect how our business is performing, the related share-based compensation expense is not a key measure of our current operating performance; • because costs associated with acquisitions and related integrations, debt refinancing, and restructuring and conversions can vary from period to period and transaction to transaction, expenses associated with these activities are not considered a key measure of our operating performance; and • because amortization expenses can vary substantially from company to company and from period to period depending upon each company's financing and accounting methods, the fair value and average expected life of acquired intangible assets and the method by which assets were acquired, the amortization of intangible assets obtained in acquisitions is not considered a key measure in comparing our operating performance.



We use Adjusted Earnings for internal management reporting and evaluation purposes. We also believe Adjusted Earnings and Adjusted Earnings per share are useful to investors in evaluating our operating performance because securities analysts use them as supplemental measures to evaluate the overall performance of companies, and our investor and analyst presentations, which are generally available to investors through our website, include references to Adjusted Earnings and Adjusted Earnings per share. Adjusted Earnings and Adjusted Earnings per share are not measures of our financial performance under GAAP and should not be considered as an alternative to net income or earnings per share or any other performance measure derived in accordance with GAAP, or as an alternative to cash flows from operating activities as a measure of our profitability or liquidity. Although Adjusted Earnings and Adjusted Earnings per share are frequently used by securities analysts and others in their evaluation of companies, they have limitations as analytical tools, and you should not consider Adjusted Earnings and Adjusted Earnings per share in isolation, or as substitutes for an analysis of our results as reported under GAAP. In particular you should consider: • Adjusted Earnings and Adjusted Earnings per share do not reflect our cash

expenditures, or future requirements for capital expenditures or contractual commitments; • Adjusted Earnings and Adjusted Earnings per share do not reflect changes in, or cash requirements for, our working capital needs; and • other companies in our industry may calculate Adjusted Earnings and Adjusted Earnings per share differently than we do, limiting their usefulness as comparative measures.



Management compensates for the inherent limitations associated with using Adjusted Earnings and Adjusted Earnings per share through disclosure of such limitations, presentation of our financial statements in accordance with GAAP and reconciliation of Adjusted Earnings to the most directly comparable GAAP measure, net income.

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The following table sets forth a reconciliation of net income to the non-GAAP measures Adjusted Earnings and Adjusted Earnings per share for the three months ended March 31, 2014 and 2013 (in thousands, except per share data):

Three Months Ended March 31, 2014 2013 Net income $ 53,135$ 54,717 After-Tax:



EBITDA Adjustments(1) Employee share-based compensation expense(2) 3,518 2,902 Acquisition and integration related expenses(3) 220 (1,079 ) Restructuring and conversion costs

4,464 3,864 Other 3,726 1,707 Total EBITDA Adjustments 11,928 7,394 Amortization of intangible assets(1) 5,966 6,032 Adjusted Earnings $ 71,029$ 68,143 Adjusted Earnings per share(4) $ 0.69$ 0.64



Weighted-average shares outstanding - diluted 103,339 107,297

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(1) Generally, EBITDA Adjustments and amortization of intangible assets have been tax effected using a federal rate of 35.0% and the applicable effective state rate which was 3.60% and 3.30%, net of the federal tax benefit, for the three months ended March 31, 2014 and 2013, respectively, except as noted below. (2) Represents the after-tax expense of non-qualified stock options for which we receive a tax deduction upon exercise, restricted stock awards for which we receive a tax deduction upon vesting and the full expense impact of incentive stock options granted to employees that qualify for preferential tax treatment and conversely for which we do not receive a tax deduction. Share-based compensation expense for vesting of incentive stock options was $1.0 million and $1.2 million for the three months ended March 31, 2014 and 2013, respectively. (3) Represents the after-tax expense of acquisition and related costs for which we receive a tax deduction. In addition, the results for the three months ended March 31, 2013 include a reduction of expense of $3.8 million relating to the fair value of contingent consideration for the stock acquisition of Concord Capital Partners, Inc., that is not deductible for tax purposes. (4) Represents Adjusted Earnings, a non-GAAP measure, divided by weighted-average number of shares outstanding on a fully diluted basis. Set forth below is a reconciliation of earnings per share on a fully diluted basis, as calculated in accordance with GAAP to Adjusted Earnings per share: Three Months Ended March 31, 2014 2013 Earnings per share - diluted $ 0.51$ 0.51 After-Tax: EBITDA Adjustments per share 0.12 0.07 Amortization of intangible assets per share 0.06 0.06 Adjusted Earnings per share $ 0.69$ 0.64 Service Value Commitment The Program In February 2013, we committed to an expansion of our Service Value Commitment, an ongoing effort to position us for sustainable long-term growth by improving the service experience of our advisors and delivering efficiencies in our operating model. We have assessed our information technology delivery, governance, organization and strategy and committed to undertake a course of action (the "Program") to reposition our labor force and invest in technology, human capital, marketing and other key areas to enable future growth. 28



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The Program is expected to be completed in 2015, and we estimate total charges of $65.0 million for technology transformation costs, outsourcing and other related costs, employee severance obligations and other related costs, and non-cash charges for impairment of certain fixed assets related to internally developed software. We expect to incur approximately $24.0 million of expense during 2014, of which we had incurred $6.9 million as of March 31, 2014, consisting of: $2.9 million for outsourcing and other services such as parallel processing provided by outside consultants; $3.3 million for the implementation of foundational changes to our technology platform and outsourcing of our disaster recovery facilities; and $0.8 million for employee severance and termination benefits related to approximately 15 positions that were outsourced in the first quarter of 2014 within accounting, data reconciliation, operations, and insurance processing. We remain focused on the next wave of outsourced functions in the remainder of 2014, including additional opportunities in compliance and back office processing activities. By 2015, we expect annual pre-tax savings of approximately $30.0 million. See Note 3. Restructuring, within the notes to unaudited condensed consolidated financial statements for additional information regarding the Program. Derivative Financial Instruments During the second quarter of 2013 and in conjunction with the Program, we entered into a long-term contractual obligation (the "Agreement") with a third-party provider to enhance the quality, speed and cost of our processes by outsourcing certain functions. The Agreement enables the third-party provider to use the services of its affiliates in India to provide services to us. The Agreement provides that we settle the cost of our contractual obligation to the third-party provider each month in U.S. dollars. However, the Agreement provides that on each annual anniversary date, the price for services (as denominated in U.S. dollars) is to be adjusted for the then-current exchange rate between the U.S. dollar and the Indian rupee. The Agreement provides that, once an annual adjustment is calculated, there are no further modifications to the amounts paid by us to the third-party provider for fluctuations in the exchange rate until the reset on the next anniversary date. The third-party provider bears the risk of currency movement from the date of signing the Agreement until the reset on the first anniversary of its signing, and during each period until the next annual reset. We bear the risk of currency movement at each annual reset date following the first anniversary. Upon completion of the Program, we estimate annual costs for our long-term contractual obligation with the third-party provider to be approximately $13.0 million to $14.0 million annually. We use derivative financial instruments consisting solely of non-deliverable foreign currency contracts, all of which have been designated as cash flow hedges. These instruments are operating effectively as intended and our use of them has mitigated foreign currency risk arising from a substantial portion of our contract obligation with the third-party provider arising from annual anniversary adjustments. We will continue to assess the effectiveness of our use of cash flow hedges to mitigate risk from foreign currency contracts. See Note 6. Derivative Financial Instruments, within the notes to unaudited condensed consolidated financial statements for additional information regarding our derivative financial instruments. Acquisitions, Integrations, and Divestitures From time to time we undertake acquisitions or divestitures outside the ordinary course of business based on opportunities in the competitive landscape. These activities are part of our overall growth strategy, but can distort comparability when reviewing revenue and expense trends for periods presented. There have been no acquisitions, integrations or divestitures during the three months ended March 31, 2014. See our 2013 Annual Report on Form 10-K for 2013 activity. Economic Overview and Impact of Financial Market Events Our business is directly and indirectly sensitive to several macro-economic factors, primarily in the United States. One of these factors is the current and expected future level of short-term interest rates, particularly overnight rates. Beginning in 2013, the Federal Reserve continues to provide additional liquidity to financial markets through its substantial purchases of fixed income securities. This liquidity continues to keep overall interest rates at historically low levels. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Federal Reserve began tapering their monthly bond purchases beginning in January 2014. The target range for the federal funds rate, as stated by the Federal Reserve, remains at 0.0% to 0.25% during the first quarter of 2014. Further, the Federal Reserve continues to reaffirm that it expects rates to remain in the range for as long as the unemployment rate remains above 6.5%, inflation continues to be as projected, which is no more than 0.5% above the Federal Reserve's 2.0% long-term goal, and inflation expectations continue to be well anchored. 29



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As a result of the tapering of bond purchases, the average Federal Funds effective rate was 7 basis points in the first quarter of 2014, a decrease from the average of 14 basis points in 2013. The low interest rate environment also continued to pressure our revenues from our cash sweep programs and continued to diminish investor demand for fixed-income securities and fixed annuities. Another macro-economic factor affecting our business is the valuation of equity securities across the various markets in the United States. The S&P 500 index closed the quarter at 1,872, up 1.3% from its close on December 31, 2013. Investor confidence rose in the first quarter of 2014 as economic factors continued to improve and the Federal Reserve's bond-buying program began to taper. This helped to lift stock valuations and prompted individual investors to put money into the market at the strongest pace in years. As a result, our advisors achieved record levels of productivity in the first quarter of 2014. While the equity markets continue to improve, lingering economic worries remain about spending cuts, U.S. and global growth rates, a persistent high unemployment level, and debt ceiling concerns. In the United States, economic growth continued during the first quarter of 2014 as the housing sector continued to show signs of further improvement, coupled with growth in consumer and business spending. The ongoing political disputes in Washington over the United States debt ceiling, credit rating and budget impasse, has increased domestic and international concerns, which could have an impact on financial markets and the broader economy.

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Results of Operations The following discussion presents an analysis of our results of operations for the three months ended March 31, 2014 and 2013. Where appropriate, we have identified specific events and changes that affect comparability or identification or monitoring of trends, and where possible and practical, have quantified the impact of such items.

Three Months Ended March 31, 2014 2013 % Change (In thousands) Revenues Commission $ 534,574$ 485,572 10.1 % Advisory 327,253 281,226 16.4 % Asset-based 114,674 103,766 10.5 % Transaction and fee 89,985 89,378 0.7 % Other 20,945 14,854 41.0 % Net revenues 1,087,431 974,796 11.6 % Expenses Production 756,718 669,723 13.0 % Compensation and benefits 106,348 98,780 7.7 % General and administrative 94,377 77,771 21.4 % Depreciation and amortization 22,281 19,774 12.7 % Restructuring charges 7,320 6,037 21.3 % Total operating expenses 987,044 872,085 13.2 % Non-operating interest expense 12,840 12,160 5.6 % Total expenses 999,884 884,245 13.1 % Income before provision for income taxes 87,547 90,551 (3.3 )% Provision for income taxes 34,412 35,834 (4.0 )% Net income $ 53,135$ 54,717 (2.9 )% 31



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Revenues

Commission Revenues The following table sets forth our commission revenue, by product category, included in our unaudited condensed consolidated statements of income for the three months ended March 31, 2014 and 2013 (in thousands):

Three Months Ended March 31, 2014 2013 $ Change % Change Variable annuities $ 198,196$ 202,443$ (4,247 ) (2.1 )% Mutual funds 148,755 140,903 7,852 5.6 % Alternative investments 55,681 40,411 15,270 37.8 % Fixed annuities 46,726 27,357 19,369 70.8 % Equities 29,110 22,147 6,963 31.4 % Fixed income 21,984 20,352 1,632 8.0 % Insurance 19,412 18,594 818 4.4 % Group annuities 14,610 13,137 1,473 11.2 % Other 100 228 (128 ) (56.1 )% Total commission revenue $ 534,574$ 485,572$ 49,002 10.1 % The following table sets forth our commission revenue, by sales-based and trailing commission revenue for the three months ended March 31, 2014 and 2013 (in thousands): Three Months Ended March 31, 2014 2013 $ Change % Change Sales-based $ 312,020$ 292,863$ 19,157 6.5 % Trailing 222,554 192,709 29,845 15.5 %



Total commission revenue $ 534,574$ 485,572$ 49,002 10.1 %

Commission revenue increased by $49.0 million, or 10.1%, for the three months ended March 31, 2014 compared with 2013, due primarily to an increase in sales-based activity for fixed annuities, alternative investments, and equities and increases in trail revenues for mutual funds and variable annuities. This growth reflects improved investor engagement and strong market conditions, resulting in the increase of the underlying assets. Additionally, commission revenues from fixed income, primarily driven by unit investment trusts and 529 college savings plans, and group annuities also contributed to the overall growth in commission revenue. Such overall growth reflects market-wide growth and increased investor engagement that has driven advisor productivity. The increase in fixed annuities is attributed primarily to increased sales of indexed annuities as well as a new three-year fixed annuity product that was introduced beginning in the fourth quarter of 2013, offering clients of advisors an attractive interest rate at a time when interest rates are expected to be relatively flat. The increase in commission revenues associated with alternative investments reflects investors' preferences for diversification, as income-producing alternative strategies continue to grow in popularity and investors continue to seek opportunities to earn returns outside of the traditional equity and fixed income markets.

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Advisory Revenues The following table summarizes the activity within our advisory assets under custody for the three months ended March 31, 2014 and 2013 (in billions):

Three Months Ended March 31, 2014 2013 Balance - Beginning of period $ 151.6$ 122.1 Net new advisory assets 4.4 3.0 Market impact and other 2.0 5.1 Balance - End of period $ 158.0$ 130.2 Net new advisory assets for the three months ended March 31, 2014 and 2013 have a limited impact on advisory fee revenue for those respective periods. Rather, net new advisory assets for those respective periods are anticipated to be a driver of advisory revenue in future reporting periods. Net new advisory assets were $4.4 billion for the three months ended March 31, 2014, resulting from the continued shift by our existing advisors from brokerage towards more advisory business. Advisory revenue for a particular quarter is predominately driven by the prior quarter-end advisory assets under management. Advisory revenues increased by $46.0 million, or 16.4%, for the three months ended March 31, 2014 compared to the same period in 2013. The growth in advisory revenue is due to net new advisory assets resulting from increased investor engagement and strong advisor productivity, newly recruited advisors that were added in the fourth quarter of 2013, as well as market gains as represented by higher levels of the S&P 500 index on the applicable billing dates in 2014 compared to 2013. The S&P 500 index closed at 1,848 on December 31, 2013, which is a 29.6% increase over the close of 1,426 on December 31, 2012. The Independent RIA model has continued to attract advisors as they seek the freedom to run their business in a manner which best enables them to meet their clients' needs. This continued shift of advisors to the Independent RIA platform (for which we custody assets but do not earn advisory revenues for managing those assets) has caused the rate of revenue growth of advisory assets under management to lag behind the rate of growth of advisory assets under custody. Advisory revenues do not include fees for advisory services charged by Independent RIA advisors to their clients. Accordingly, there is no corresponding payout. However, there are administrative fees charged to Independent RIA advisors including custody and clearing fees, based on the value of assets. The following table summarizes the composition of our advisory assets under custody as of March 31, 2014 and 2013 (in billions): March 31, 2014 2013 $ Change % Change Advisory assets under management $ 119.8$ 106.1$ 13.7 12.9 % Independent RIA assets in advisory accounts custodied by LPL Financial 38.2 24.1 14.1 58.5 %



Total advisory assets under custody $ 158.0$ 130.2$ 27.8 21.4 %

Growth of the Independent RIA assets in advisory accounts custodied by LPL Financial has outpaced the growth in advisory assets under management. This growth is consistent with the industry trend as more advisors shift their business toward the Independent RIA model. Asset-Based Revenues Asset-based revenues increased by $10.9 million, or 10.5%, to $114.7 million for the three months ended March 31, 2014 compared with the same period in 2013. Revenues for record-keeping services, which are largely based on the underlying asset values, increased due to the impact of the higher average market indices on the value of such underlying assets and net new sales of eligible assets. The S&P 500 index for the three months ended March 31, 2014 averaged 1,835, an increase of 21.2% over the average in the prior-year period. Asset-based revenues also include revenues from our cash sweep programs, which decreased by $7.5 million, or 23.8%, to $24.0 million for the three months ended March 31, 2014 from $31.5 million for the three months ended March 31, 2013. The decrease in our cash sweep revenues is a result of fee compression resulting from contract repricing, and a year-over-year 7 basis point decline in the average effective rate for federal funds to 0.07% for the three months ended March 31, 2014. The decrease was partially offset by an increase of 4.8% in average assets in 33



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our cash sweep programs, which were $24.2 billion and $23.1 billion for the three months ended March 31, 2014 and 2013, respectively. Transaction and Fee Revenues Transaction and fee revenues increased by $0.6 million, or 0.7%, for the three months ended March 31, 2014 compared with the same period in 2013, due to higher trade volumes in certain advisory accounts. Other Revenues Other revenues increased $6.1 million, or 41.0%, to $20.9 million for the three months ended March 31, 2014 compared with the same period in 2013. The primary contributor to such increase for the three months ended March 31, 2014 was alternative investment marketing allowances received from product sponsor programs, which increased by $4.6 million compared to the same period in 2013, driven primarily by increased sales of alternative investments. Other revenue includes gains or losses on assets held for the advisor non-qualified deferred compensation plan. Gains were $2.8 million for the three months ended March 31, 2014, compared to gains of $1.3 million for the three months ended March 31, 2013. The gains or losses on assets held for the advisor non-qualified deferred compensation plan are offset by increases or decreases in non-GDC sensitive production expenses as noted below. Expenses Production Expenses The following table shows our production payout ratio for the three months ended March 31, 2014 and 2013: Three Months Ended March 31, 2014 2013 Change Base payout rate 83.98 % 83.88 % 10 bps



Production based bonuses 1.69 % 1.70 % (1 bps) GDC sensitive payout 85.67 % 85.58 % 9 bps Non-GDC sensitive payout 0.72 % 0.43 % 29 bps Total Payout Ratio 86.39 % 86.01 % 38 bps

Production expenses increased by $87.0 million, or 13.0%, for the three months ended March 31, 2014 compared with the same period in 2013. The increase correlates with our commission and advisory revenues, which increased by 12.4% during the same period. Our GDC sensitive production payout ratio was 85.67% for the three months ended March 31, 2014, compared to 85.58% for the prior-year period. The base payout rate increased by 10 basis points in part due to the growth of our advisory platform, which on average has a lower base rate than our brokerage platform. The increase in non-GDC sensitive payout is attributable to increased advisor share-based compensation for the three months ended March 31, 2014 compared to the same period in 2013 correlating to market movement in our stock and the advisor non-qualified deferred compensation plan as noted above. Compensation and Benefits Expense Compensation and benefits expense increased by $7.6 million, or 7.7%, for the three months ended March 31, 2014 compared with the same period in 2013. This was primarily based on the fact that our average number of full-time employees increased 11.1% from 2,928 for the three months ended March 31, 2013 to 3,252 for the three months ended March 31, 2014, due to higher staffing levels in compliance, control and service to support increased levels of advisor and client activities. General and Administrative Expenses General and administrative expenses increased by $16.6 million, or 21.4%, to $94.4 million for the three months ended March 31, 2014 compared with the same period in 2013. The primary drivers behind the increase were increases of $4.4 million for professional fees, $3.5 million for business development and promotional expenses, and $5.3 million for parallel rent, property tax, and common area maintenance expenses incurred in connection with the Company's relocation to the new San Diego office building. 34



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Depreciation and Amortization Expense For the three months ended March 31, 2014, depreciation and amortization increased by $2.5 million, or 12.7%, compared with the same period in 2013. The increase is attributed primarily to capital assets attributed primarily to the new San Diego office building, that were placed into service during the latter half of 2013. Restructuring Charges Restructuring charges represent expenses incurred as a result of our expansion of our Service Value Commitment, our 2011 consolidation of UVEST, and, prior to the three months ended March 31, 2014, our 2009 consolidation of the Affiliated Entities. Restructuring charges increased by $1.3 million, or 21.3%, for the three months ended March 31, 2014 compared with the same period in 2013. These charges relate primarily to consulting fees paid to support our technology transformation and to develop our detailed outsourcing plans, as well as employee severance obligations and other related costs and non-cash charges for impairment incurred through our expansion of our Service Value Commitment. Refer to Note 3. Restructuring, within the notes to unaudited condensed consolidated financial statements for additional details regarding this matter. Interest Expense Interest expense represents non-operating interest expense for our senior secured credit facilities. Interest expense increased $0.7 million, or 5.6%, for the three months ended March 31, 2014 compared with the same period in 2013. The increase in interest expense for 2014 is primarily due to the increase in debt incurred in connection with the amendment to the credit agreement in May 2013. Provision for Income Taxes We estimate our full-year effective income tax rate at the end of each reporting period. This estimate is used in providing for income taxes on a year-to-date basis and may change in subsequent interim periods. The tax rate in any quarter can be affected positively and negatively by adjustments that are required to be reported in the quarter in which resolution of the item occurs. The effective income tax rates reflect the impact of state taxes, settlement contingencies and expenses that are not deductible for tax purposes. During the three months ended March 31, 2014, we recorded income tax expense of $34.4 million, compared with $35.8 million in the prior-year period. Our effective income tax rate was 39.3% and 39.6% for the three months ended March 31, 2014 and 2013, respectively. Liquidity and Capital Resources Senior management establishes our liquidity and capital policies. These policies include senior management's review of short- and long-term cash flow forecasts, review of monthly capital expenditures and daily monitoring of liquidity for our subsidiaries. Decisions on the allocation of capital are based upon, among other things, projected profitability and cash flow, risks of the business, regulatory capital requirements and future liquidity needs for strategic activities. Our Treasury Department assists in evaluating, monitoring and controlling the business activities that impact our financial condition, liquidity and capital structure and maintains relationships with various lenders. The objectives of these policies are to support the executive business strategies while ensuring ongoing and sufficient liquidity. A summary of changes in our cash flow is provided as follows (in thousands):


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