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LPL Financial Holdings Inc., (NASDAQ:LPLA)

Q2 2013 Earnings Conference Call

July 31, 2013 8:00 am ET

Executives

Trap Kloman - Senior Vice President of Investor Relations

Mark Casady - Chairman, Chief Executive Officer

Dan Arnold Jr. - Chief Financial Officer

Analysts

Alex Klam - UBS

William Katz - Citi

Chris Shutler - William Blair

Joel Jeffrey - KBW

Douglas Sipkin - Susquehanna

Alex Blostein - Goldman Sachs

Ken Worthington - JPMorgan

Chris Harris - Wells Fargo Securities

Operator

Good day ladies and gentlemen and welcome to the LPL Financial Holdings’ Second 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. (Operator Instructions)

As a reminder this conference is being recorded.

I would now turn the call over to your host Trap Kloman, Head of Investors Relations. Please go ahead.

Trap Kloman

Thank you, Stephanie. Good morning and welcome to the LPL Financials’ second quarter earnings conference call.

On the call today is Mark Casady, our Chairman and Chief Executive Officer, who will provide his perspective on our performance. Following his remarks Dan Arnold, our Chief Financial Officer will speak to our financial results and capital deployment.

Following the introductory remarks, we will open the call for questions. We would appreciate if each analyst would ask no more than two questions each.

Please note that we have posted a financial supplement on the Events section of the Investor Relations page on lpl.com.

Before turning the call over to Mark, I'd like to note that comments made during this conference call may incorporate certain forward-looking statements, this may include statements concerning such topics as earnings growth targets, operational plans and other opportunities we foresee.

Underpinning these forward-looking statements are certain risks and uncertainties. We refer our listeners to the Safe Harbor disclosures contained in the earnings release and our latest SEC filings to appreciate those factors that may cause results to differ from those contemplated in such forward-looking statements.

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

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

Mark Casady

Thank you, Trap. And thank you everyone for joining today’s call.

I’m pleased to report another solid quarter. The momentum that was established in the first three months of the year was maintained through Q2 as retail investors continue to reengage in stock market. This trend reflects a continued improvement underlying economic conditions as well as investors’ recognition they need to actively commit to an investment strategy in order to achieve their financial goals as such investor assets and brokerage and advisory counts posted double-digit growth.

Turning to our top-line results, net revenue grew 12% year-over-year exceeding $1 billion for the quarter for the first time in our company’s history. Our results year-to-date a representative of the growth trajectory LPL’s been on over the past decade and support our expectations for long-term growth going forward.

While advisors same-store sales growth and market appreciation drive low double-digit revenue growth, our model produces robust earnings growth. We capitalized on these dynamics this quarter as adjusted earnings per share grew 24% year-over-year to $0.61 per share.

Revenue growth was driven by advisor productivity. Annualized commissions per advisor increased to 11% year-over-year to $152,000 this quarter from $137,000 in the second quarter of 2012. Advisory asset growth remains strong increasing 11% on an annualized basis on $3.7 billion of net new assets for the quarter.

Our second quarter results were further aided by our continued success in supporting and retaining our existing advisors reflected by our production retention of 97%. However, growth of 32 net new advisors remain modest this quarter. As it is typical during periods of improving market conditions following a period of an extended investor disengagement advisors are particularly focused on supporting investor needs.

We are not in a unique position as the overall level of advisor movement remains muted across the industry. At the same time, we feel positive about our performance relative to our peers. Our pipeline continues to expand and we see excellent opportunities to convert these leads when the pendulum swings back to increased levels of advisor movement. While we are running below our historic average of net new advisors year-to-date and expect 2013 to be less than the previous year. And the street trends remain in our favor.

During the second quarter our management team spent a significant amount of time with employees and advisors discussing our strategic vision. Our strategy is focused on making LPL a smarter, simpler and more personal business partner for our advisors and institutions, which will improve loyalty and drive growth. In order to fully appreciate the focus of this effort, we believe it’s important to provide the context of a strategic journey we have been on that has let us to this stage.

In 2003, we were the 15th largest broker dealer in the marketplace by advisor count and larger than our closest independent peer by 11% in revenue. In order to control our destiny in a consolidated industry, we focused on building scale through recruiting as well as select acquisitions and emerged as leader not just in the independent channel but in the overall marketplace. We are now fourth overall in the industry by advisor count and are 33% larger than our next largest independent peer by revenue.

Our competitive presence is firmly established we began in 2008 to establish – to expand our scope of services for existing advisors and in doing so also attracted wider range of new advisors to our platform. This strategy began with a launch of our independent RAA platform which today remains the only fully integrated platform in the industry and has approximately $50 billion in assets.

In addition, we broadened and grew our presence in retirement plans, high net worth and trust marketplaces. We continue to refine our strategy to address the mass market to develop a training program for future advisors. We are reviewing if there is a more cost effective way to approach these areas.

While our steps thus far have been necessary to amass the resources and develop the industry leading services we offer today, we recognize that a growth trajectory such as ours inevitably produces complexity. With our scale and scope goals now largely met in 2012 we set out to leverage these assets to demonstrate how the resources that come with our growth can be delivered in a smarter and more personal way as ever been done before in our industry. Our strategic focus is simplicity.

Our service value commitment is the most recent example of this strategy and action that represents only a piece of the overall effort. We are streamlining processes to lien principles to reinforce the commonsense approach to what we do. We are transforming our technology from an IT department supporting our broker dealer to an area of innovation that creates value across the organization.

That has simply been a tool for execution our technology platform will reinforce and enhance engagement between our employees, advisors and their clients. We also seek to segment our communication and our offerings in ways that are more personal and relevant to our advisors need by leveraging the vast amount of data we have about our advisors and their clients.

This in turn generates creates loyalty with advisors and institutions having greater connectivity to LPL and clients better connected with their advisors. By making ourselves and advisors easier to do business with we can increase productivity of our advisors and employees to spur profit growth.

As we think about continuing the growth of our business we must continue to focus on removing the main obstacle, advisor space and expanding their business not obstacle of time. Our technology and services must reduce the complexity of managing a practice and the client portfolio and help advisors reduce times spent on administrative tasks. Adding time to our advisors lives will enable them to focus on growing their client base, provide more services and spend time giving back to their communities.

By successfully executing our strategy, LPL will continue to build on a reputation as the leading consultant partner to advisors and institutions with the most complete and seamless platform available in the market to grow and manage their businesses. This will ultimately increase our market share of assets significantly. As we continue to follow our roadmap the comparative that we have the management team in place that can execute.

We have a great bench strength including senior leaders who have grown and evolved with LPL over the years. We have also been working to expand the perspective and experience of our leadership team with management from outside LPL who bring an established track record of managing through change and introducing innovation and large complex organizations.

Our most recent announcements of Michelle Oroschakoff and David Bergers to lead our compliance and legal teams respectively underscores our commitment to these critical functions and also reflects LPL’s ability to attract top talent.

I’m excited about the opportunities and challenges that lie ahead of LPL and remain committed to the belief that every investor deserves sound, affordable financial advice. I look forward to leading this management team, implement this strategy and deliver greater value to our advisors, employees and shareholders.

In conclusion, I’m pleased with the results this quarter and believe they are an excellent illustration of how our company will continue to grow across cycles. As I think about driving long-term shareholder value in a rapidly evolving and consolidated industry we must bill the sustainable pathway for growth. We can now address challenges and issues through a series of isolated short-term reactions. Our industry is microcosm of our culture today that leaders will be defined by their ability to manage time, maintain simplicity and apply innovative technology. This will strengthen our loyalty, drive growth and ultimately reward our shareholders.

With that I will turn the call over to our CFO, Dan Arnold to review our financial results and outlook in greater detail.

Dan Arnold Jr.

Thanks Mark.

This morning I will be discussing five main themes. First, I will address top line results for the quarter and highlight the fundamental drivers behind our growth. I will then share insight into developments in our ICA program and what means for our related fees through 2015. Third, I will review various components of our expense structure, next I will discuss our adjusted earnings per share which grew 24% year-over-year to $0.61 per share. And finally, I will conclude my remarks with a review of our capital management activity.

With respect to the top line, in the second quarter we generated record revenue of $1 billion representing 12% growth year-over-year. Total brokerage and advisory assets rose 12% to $397 billion or $29.6 million per advisor. This growth was driven by improved advisor productivity, improving equity market levels and accelerating production of 2024 net new advisors added over the last 12 months.

Enhanced advisor productivity was reflected in both the growth of annualized commissions per advisor of $152,000 which is the highest levels since the second quarter of 2008 and in net new advisory flows of $3.7 billion or 11% annualized growth. In line with our advisor production growth transaction in other fee revenue increased 12% to $89 million year-over-year. This was primarily driven by increased trading activity that further reflects increased levels of advisor productivity.

I would like to now briefly review the drivers behind our cash sweep revenue. This quarter asset-based revenue growth moderated to 5% due to interest rate headwinds that affected our cash sweep programs. Cash sweep revenue declined by $3 million or 9% year-over-year through a combination of a 10 basis points decrease in our ICA bank contracts and the effective fund rate declining 3 basis points, our ICA fee was down 13 basis points year-over-year.

The 5 basis points decline in money market fees first experienced in the first quarter persisted through the second quarter. Short-term interest rates remain at historically low levels due to excess cash in the system reflecting reduced short-term borrowing by the government and corporations.

The decline in cash sweep fees partially offset by the $2.5 billion increase in cash sweep balances resulted in a net $0.02 headwind and adjusted earnings per share year-over-year.

I would now like to speak to our ongoing efforts to extend a significant ICA contract with the maturity in December of 2014. When we initially entered into these large scale ICA contracts in 2009, our goal was to minimize our fee risk in a low rate environment.

The duration of these advantageous contracts were set at five to six years with the belief that by the time the contracts were set to renew or expire, the underlying effective funds rate would have recovered to a more normalized level. We have reached an agreement with the counter-party to extend the majority of this contract for one year. An exchange for a reduction in the rate in 2013 and 2014, we maintain grades favorable to the market through 2015.

As a result, excluding changes in fed funds, we expect our ICA fee to decline 14 basis points from the end of the year of 2012 to the end of 2013. This is slightly above the high-end of the 10 to 12 basis points range we’ve previously shared. In 2014, we expect approximately a 7 basis points decline over 2013 instead of the 10 basis points we’ve previously provided again assuming no change to the fed funds rate.

For 2015 instead of facing a more significant decline in our fee, had the contract simply expired, we expect approximately a 13 basis points decline over 2014. Due to the number of contracts and growing balances in the program as well as market factors, it’s difficult to be precise beyond the current year but we believe this increase transparency provide helpful insight to investors. Importantly, we retain the upside to a rising fed funds environment and the potential to recapture approximately $200 million in pre-tax earnings based on current cash levels when the fed funds rate reaches between 225 and 250 basis points.

I would like to now turn to our expenses. Our second quarter payout rate increased 26 basis points year-over-year to 87%. The year-over-year increase and the totaled payout rate was primarily a result of non-GDC sensitive drivers related to our advisor deferred compensation and stock option programs that are mark-to-market.

As a reminder the deferred compensation portion of our non-GDC production expense is offset in other revenue and therefore reduces the net impact to earnings.

For the past four quarters on a trailing 12-month basis, the base payout rate and production bonus had been consistently running at approximately 86.7%. In the second quarter, core G&A expenses defined as compensation and G&A expenses excluding promotional expense depreciation and amortization and items excluded in our determination of adjusted earnings grew by $10 million or 7% to $150 million year-over-year. This increase was driven impart by the ramp in investment in the second quarter of 2012 represented by Fortigent, NestWise and our expanding retirement solution. By the third quarter of this year, these investments will be fully absorbed into the expense run rate. Sequentially core G&A grew by $4 million and was in line with expectations.

For the third quarter 2013, we expect $1 million to $2 million sequential increase in our core G&A. For full year 2013, we have previously anticipated 6% to 7% core G&A growth. We now expect that rate of growth to be closer to 8% due to two factors. First, we’re upgrading our investment in regulatory and compliance functions such as our expanded home office supervision structure. And second, some of the savings we anticipated from the service value commitment in the second half of 2013 would not be realized until the end of 2013. We remain on track to deliver the savings originally targeted for 2014 and 2015.

Separately, our promotional expense declined year-over-year by $1 million, primarily due to the timing of conferences. However, transition assistance expense increased compared to the second quarter of 2012 despite a decline in the number of new advisors. This is primarily due to the growing amortization from previously issued forgivable loans in prior periods.

Consistent with past years, in the third quarter, our annual advisor conference were driving an $11 million sequential increase in promotional expense. This event also generates an incremental $7 million in transaction and other fees to partially mitigate this expense.

Now, I’d provide some commentary on the drivers behind second quarter GAAP expenses of $23 million that were excluded in our adjusted results. $4.5 million is related to employee share-based compensation, $8 million to our debt refinancing which lower our cost of debt, and increase the flexibility of our capital structure. And finally, $7 million of expense was related to the service value commitment. Of this $7 million approximately $4.5 million was for outsourcing activities such as knowledge transfer and vendor transition development and approximately $2.5 million was related to our technology transformation.

I will now turn to adjusted EBITDA and adjusted earnings performance. For the quarter adjusted EBITDA grew 17% to $131 million year-over-year due to top line revenue growth of 12% and managing G&A to 5% growth. This led to adjusted EBITDA margin as a percent of net revenue expanding 60 basis points year-over-year to 12.9%.

Adjusted earnings per share grew 24% year-over-year to $0.61 per share supported by adjusted EBITDA growth of 17% and share repurchases reducing fully diluted shares outstanding by $5 million or 5%.

I will now turn to our capital management activity, we are in the second quarter we invested $18 million in capital expenditures paid $14 million in total dividends and conducted $53 million of share repurchases reflecting the strength and consistency of our free cash flow. Taking advantage of favorable market conditions, this quarter we successfully refinanced our debt lowering our cost of borrowing and increasing our capital resources. We shifted $221 million in scheduled amortization; it was due to occur over the next three years to 2016 and beyond and added an incremental $236 million in leverage. By freeing up $457 million of capital, we were able to dedicate a portion of the proceeds to additional share repurchases and increasing our quarterly dividend.

We continue to believe the company’s current value does not reflect its future earnings growth potential especially given where we are in the interest rate cycle. As a result following the refinancing we bought back 2.2 million shares through July 26 at a volume weighted average price of $37.47. Since our IPO, we have repurchased over 11.8 million shares.

Looking forward, we possessed $198 million in capacity in our Board approved share repurchase plan to opportunistically pursue share repurchases and help absorb some of the float of potential future distributions by our private equity shareholders. With the flexibility of our cash flow from the refinancing and ongoing operations we concluded an increase in our dividend payout was an attractive way to return capital to existing and perspective shareholders while still investing in the growth of the business. As a result, our Board has raised our quarterly dividend by $25 million or 40% to $0.19 per share.

With that Mark and I look forward to answering your questions.

Mark Casady

Stephanie, please open up the call.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions)

Our first question comes from Alex Klam with UBS. Your line is open.

Alex Klam - UBS

Okay. Good morning everyone. Just wanted to quickly talk about the recruitment trends I think Mark you said it again, I think you said it last quarter as well that recruitment is a little bit slower here and that’s the reflection of the current environment. One of your bigger competitors recently said that they don’t see really a change in their recruitment.

So, just wondering if you can maybe just flush it out a little bit more for us? Is it the advisors you are going at or are you walking away from teams or why do you – what do you think some of your bigger competitors are seeing other things?

Mark Casady

Yes. As a (matter), who are the competitors who are seeing other things item, I’m not sure whom you are referring to or what their read of the market situation. If we look at the discovery database information which is a good proxy for movement in the markets it’s not perfect that’s good. What you will see is that movement overall in the industry is down about half the level of what it would have been last year and so what I’m referring to is basically just movement in the industry is down. And we are going to reflect that through our recruiting efforts.

In the first quarter, where we have full view of the market we came at number 1 in terms of that new additions to the industry. So we stand by our short-term and long-term record that we are going to do well. We are going to be in the top three of net new additions vis-à-vis any competitor in the industry. So this second quarter we don’t have everybody’s data in yet, we look like we are strong versus the data that we see in terms of net new advisors.

We are definitely seeing the pipeline increase and maybe what you are referring to is the same thing we are seeing which is that there are lots of advisors who are interested in moving they just are not to the point of actually making the move and we actually have a 10 point chart that shows basically where somebody is, enquiry would be the first level of that all the way through to movement which should be number 10 in our chart.

And what we are seeing is a lot of good activity in the early part of the activity mapping that we do which are people responding to advertising, lease and so forth. I think leads are up 8.5% year-over-year here in the second quarter. So that tells us that there is a desire to move just not particularly a movement occurring at the current time.

Alex Klam - UBS

Okay. Fair enough. And actually, I was referring to swaps, so if you have anything else to say, please do. Let me just use my second question for Dan. Thanks for the update or the details on the expenses as we look at the remainder of 2013. Can you give us a little bit of early look on 2014, you obviously you have the efficiency program going on right now. But, you also just talked about higher regulatory spending and things like that. So may be just flushing out how all that should impact 2014 expense growth rates? Thank you very much.

Dan Arnold Jr.

Thanks for the question. We continue to work on 2014 and so what I would do is suggest that answering that later in this quarter and even in a more in-depth way at next earnings call will be the timing that we will address that.

Operator

Our next question comes from William Katz with Citi. Your line is open.

William Katz - Citi

Okay. Thanks very much. First question is, when you look at the sequential improvement in productivity, maybe to cover more sense deeper into the dynamics around that was there – general acceleration to activity as the quarter progress, what happened in June, was it just the mix of the advisors seasoning. If you are also so curious than I’m because as you mentioned it was pretty strong quarter for average productivity.

Dan Arnold Jr.

Yes. This is Dan. I think of course we saw a momentum building in Q1 with the investor reengagement that occurred at the very beginning of the first quarter. We saw that momentum sustain itself into the second quarter and continue in fact and if you look at the average commissions per advisor per year, it was up about 4% to 5% sequentially from Q1 to Q2. So it reinforced that momentum in that activity. And again, I think we saw that sustain itself through tax season. You always see a little seasonality just coming out of tax season that occurs in May and June but as we moved into third quarter, we have seen that momentum continue and are very encouraged by the continued productivity levels of our advisors moving into third quarter.

William Katz - Citi

That’s helpful. And then second question a little bit broader in scope and just still reflecting on your -- continue around your ICA contracts. When we look at some of your peers, you need space they are benefiting from the better bank opportunity here. I’m so curious have you contemplated, I recognize you have a pretty high ownership private equity sweep right now but to the extent that would have come down over time. What was your – what are the pros and cons if you want to develop a bank rather relying on third party because back of the envelop math, this just could be pretty powerfully accretive net of any kind of capital need and maybe give you the more strategic flex. What are your thoughts on that?

Mark Casady

Bill, it’s Mark. So absolutely agree with your assessment that a bank is the new area for us to think about for all the reasons you stated. It could be highly accretive and so forth. We don’t want to -- taking lightly because it brings with it other risks and other activities that we have to think about would bring us a new regulator and bring us some other activities that we want to understand better.

On the flip side, what it would do is certainly give us more capabilities for our advisors let me know they would like to have so that could be very helpful to us in terms of growing the business and helping them. And cost of capital would allow us to take deposits into your own bank and as you say there is math around what the trade-off is of how much capital it takes versus the earnings that accrete.

As you also said, our BE firm ownership is about 31% today precludes us from any activities, we will need a bank they would have to be below 25% for us to be able to consider that. So as we get to that point what we would do is then undertake a study there to look at the pluses and minuses fully of a bank and decide what we would do about it.

To be clear though for everyone in the call this would be, what I would describe as utility bank meant to do exactly as you described taking on deposits from cash sweep and then having a very safe and rather boring portfolio that would allow us to pick up the spread. I think those important factors for shareholders to understand, we have approximate $6 billion in deposits that are in money funds today for retirement accounts that were precluded from putting into bank sweep programs.

We know from our advisors, their clients would actually prefer to be in bank sweep programs for the FDIC coverage, if we had a bank there is a exemption that would allow you to basically move those sweep -- those monies into the bank. As you couldn’t do that overnight, it would take you several years to build the capital base and move those monies but that would be a perfectly smart reason to think about why you would do it Bill in addition to what we do in placing deposits in the banking system through ICA.

William Katz - Citi

Okay. Thanks for taking my questions.

Mark Casady

Sure.

Operator

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

Chris Shutler - William Blair

Yes, good morning.

Mark Casady

Good morning.

Dan Arnold Jr.

And good morning, Chris.

Chris Shutler - William Blair

First question is on the ICA, so you talked about $200 million revenue benefit there, I think Mark previously talked about $170 million. So is that just higher balances are helping me think about that change. And then on the ICA renewal, I was hoping you can just help me out with thinking about exactly what you gave up in order to renew -- to push it out by years, just yield is going to be a little bit lower within next year than it would have been?

Dan Arnold Jr.

So, Chris on the first question, $200 million EBITDA replacement is subsequent to just the increase in balances that we’ve seen over the year and so it’s nothing more than the simple math applying it to $25 billion to $26 billion cash balances base versus the lower base that we used previously relative to the renegotiation in what we gave up, we did give up some rate in 2013 and 2014 to extend out and have above market level rate in 2015. And I think what you are seeing is about a two basis point adjustment this year and we had previously gave guidance on about a 10 basis point drop next year of which we were able to secure only a 7 basis point drop and that’s point to point for fourth quarter to fourth quarter.

Another way to look at it is, over the first 2 years 2013 and 2014, we are giving guidance somewhere collectively over the those 2 years of about a 20 to 22 basis points drop and what you are doing is ultimately seeing that in the form of 14 in the first year and then 7 the second year. So based on our prior guidance, we are in line with that we are just getting there in a slightly different way.

Mark Casady

The one thing I had is that we still have all the way upside to fed fund, so this is, we talked about it before, is that fed funds parcel number and the adjustment to basis point that Dan speaking to are the plus number not fed funds. So fed funds will rise tomorrow this contracts deposits value would rise as well.

Chris Shutler - William Blair

All right, thanks. And then just one more, on the change to the home office to provision structure, which I know carries with it some increase in fees or spend a little bit of advisors. Just hoping you can help us better understand, how that structure will play out both from a business and financial perspective?

Mark Casady

Yes. So from a business standpoint, finance advisors definitely understand the changes are very supportive of it because they understand that the world has changed in terms of over site and review. And we had very productive conversations with literally 100s if not 1000s at this point of advisors and we very much appreciate their patience and thoughtfulness about the questions that they have asked.

So I don’t think as a matter of principle nor insight to the smartest way to oversee a system, I think everyone is in a agreement with that. I call things in (light) if it comes down to and what the expense of that. What we have laid out for our advisors is a very thoughtful program that says there is cost of this to us, what we would like to do is cover our costs and so that we can make sure that we are not letting one part of our systems support another part of our system that’s a fair stalker that we have between advisors because they have very different business models.

What we have also done is that for 2014 and the rest of this year we will absorb the cost of that as part of getting everyone into the program and thinking through their shoes and working together on it. Then started in 2015, we would have the actual charges in place. It will continue to look for ways to help advisors work that through. An example of that would be that the advisors could join together and decide to form a larger branch and then have the infrastructure for compliance oversight that’s necessary under our new guidelines and in working with our regulator. And we do probably have some of that activity occurs.

I think -- how I would look at it financially in answering where the analyst questions and Dan can correct me, there is a different way to think about it, it is effectively there will be some additional cost next year and then tend to be a wash in the year following as the expenses and the revenues match off, we can see each other, we don’t see it. As a profit maker, we don’t see it also as a big loss maker either what we are trying to do is, just get it to a point in which we are fairly charging each part of our system for the activities that we have received.

Dan Arnold Jr.

The only thing that I would add to that is, I think you do get a spectrum of different responses from the advisors. The large majority of them are seeing the opportunity that it gives them. In terms of driving efficiency into their own practice and reallocating their time from doing that administrative and supervisory or compliance work reallocating that to serving and supporting their existing customers prospecting for new customers et cetera. So I think they ultimately get the trade off and the value that they create for their practice in exchange for the cost of the charge or the price to be charged for.

Chris Shutler - William Blair

All right, thanks.

Mark Casady

True.

Operator

Our next question comes from Joel Jeffrey with KBW. Your line is open.

Joel Jeffrey - KBW

Good morning guys.

Mark Casady

Good morning.

Joel Jeffrey - KBW

I know recruiting has been down in the first half of the year but I would have imagine that’s also saved you guys some money in terms of transition payments but you got to pay out for these guys. Can you by any chance quantify how much you saved on the expense line from just low recruiting?

Dan Arnold Jr.

Yes. Let me take that one. First of all, when you think about the cost of recruiting we look at it many times and what that transition assistance would be on a percentage of the gross trailing 12 of the advisor being recruited. And year-on-year that number has been very stable and we haven’t seen an inflation if you will in the overall cost of recruiting.

So if you look at it purely from a non-GAAP way of looking at it, we haven’t seen rates go up and because the pace of recruiting has slowed obviously that you would see the downward trend in terms of the overall payment for transition assistance. Where they get a bit more complex is for a GAAP for accounting purposes, we have a mix of how we provide that transition assistance.

In some cases, it’s paid all upfront and expensed in other cases especially with lager practices we will give it in the form of a loan that’s amortized over a 3 to 5 year period of time. And in second quarter what you saw is a reflection of some of the larger practices that we have been successful at attracting over the past couple of years the amortization associated with those loans has been quicker to build in the loans that are actually maturing. And thus you see a increase or an up tick in terms of overall transition expenses as its measured by GAAP. So hopefully that helps you. It’s just a bit complex because of the accounting structure.

Joel Jeffrey - KBW

Okay. But there is now sort of, I guess (inaudible) absolute number but there is no way to sort of quantify given that you serve at it nearly 60 net new advisors versus how much lower run rate than you did last year, any kind of expense number or savings that came along with that?

Dan Arnold Jr.

Yes. We are reflecting the net number here so I don’t have that at hand but what you are seeing is the reduction in the expense of what we would have expensed upfront in terms of transition assistance for new recruits. It then is offset by the building amortization of the loans. And we can follow up with you and happy to give you more clarity. I just don’t have it at hand.

Joel Jeffrey - KBW

You might characterize it as – its not significant – its not at the half the level or even 20% less the level is that fair.

Dan Arnold Jr.

Yes. I think that’s right. And again, I think the important point is the rate of which we are paying transition is assistance year-on-year hasn’t shifted or hasn’t changed, consequently we are not seeing sort of any dynamic in terms of inflation but typically those same characteristics that we saw last year in terms of the determination of the value of the upfront in the transition assistance.

Joel Jeffrey - KBW

Okay. And then just lastly for me, commission revenue came in a bit stronger than what we were looking for, just, can you give a sense for how much to that was due to certain mutual fund trailers or was there anything else fairly that was driving that?

Dan Arnold Jr.

Yes. On the -- you got a combination of both good solid growth on advisory assets which obviously is driving sound growth from year-on-year advisory revenue growth. And then from a commission standpoint, you got a combination of that being driven by productivity which on a year-on-year basis was up 11% to 12%. So, I think in that the lower the trough you saw average commissions per advisor down in the 132 to 134 range. And so, the 152 reflected in last quarter gives you a good indication of the momentum and the strength it’s building in terms of share productivity.

And then your trial commissions typically we are about 1/3rd of the overall commissions revenue and you saw a commissions revenue year-on-year building in that same or similar trend of around 14%, 15%. So, overall, you get to commissions year-over-year growth in the 12% to 13% range.

Joel Jeffrey - KBW

Great. Thanks for taking my questions.

Mark Casady

Thank you.

Operator

Our next question comes from Douglas Sipkin with Susquehanna. Your line is open.

Douglas Sipkin - Susquehanna

Yes, thank you and good morning guys. Two questions, one, I was just hoping to get a little bit of color on sort of the client asset mix, obviously very strong flows in the quarter yet, I guess the total client asset level wasn’t up as much you would have expected, so I’m just trying to gain -- how much of that 397 is fixed income versus equity or sort of fixed income orientation versus equity?

Mark Casady

So, generally speaking, the best way to think about -- the investors or advisors and therefore their client assets is that those are typically, the non-income Americans who are saving for a long-term retirement and would basically have a very balanced portfolios. So, we do typically skew with a very reasonable amount of assets in fixed income, traditionally we would say its about 50/50 and when we see movement, so, we’re not necessarily a good indicator of the March factor equities, what we would tend to see and what we’re seeing in the second quarter was that a bit more than that the 50% going to the equity market a bit less than fixed income.

Because we also had June numbers where you had pretty significant downturn across all markets but particularly the fixed income market manufactured a little bit. So, what you definitely, premises quite correct which is that you’re going to see a more conservative result of asset growth as a result to that being a balanced portfolio that of course helps us in downturns because that same balanced portfolio protects us on the downside, it was just one of the things that we like about it.

Douglas Sipkin - Susquehanna

Great. And then just a follow-up, I appreciate the new color on the ICA fees, I guess, I’m trying to understand a little bit more about this renegotiation. Well, not likely, let’s just assume fed funds rate don't change by the end of 2014, how is that all, does that sort of change the negotiation you have or is it sort of the best way to think about it is kind of what you’ve said 2015 will be I guess you indicated 2013 bps below 2014 and I guess.

Mark Casady

And that is the right way to think about it. That’s assuming fed funds rate does not change, contractual arrangement right, geared over number of years this is what Dan given you the numbers that have frozen all other variable market.

Douglas Sipkin - Susquehanna

Yes.

Dan Arnold Jr.

And remember we maintain upside with fed funds. So, if fed funds rate moves up, obviously that improves the economics and its offsets that downward pressure caused the contractual pricing.

Douglas Sipkin - Susquehanna

Great. Thanks for taking my questions.

Mark Casady

Sure.

Operator

Our next question comes from Alex Blostein with Goldman Sachs. Your line is open.

Alex Blostein - Goldman Sachs

Good morning. Started to beat the dead horse but again on ICA, $200 million and (2013) number that you provide, any outside scenario. Can you just help us understand if there is anything at all that could change that with respect to the way you negotiate these contracts?

Mark Casady

The answer is no. I think it is simple and possible.

Alex Blostein - Goldman Sachs

Okay, simple enough. Now back to the business part of the equation I guess when you think about normalized expense growth in the business and you outlined a number of growth opportunity you guys see in front of you but it does also sound like did involve, little bit of catch up in that in investment stand to get you there but also perhaps some more -- a little bit of higher normalized level of expense run rate. So, when we think about you kind to getting through this investment stage, what do you think is a reasonable growth and kind of like your core G&A?

Dan Arnold Jr.

So, what we’ve talked about is targeting just normal expense growth in the mid-single digit range, let’s call it the 4% to 6% range. And I think as we’ve shared this year that number, it would be more in the 8% range a lot doing with the absorption of the up weighted cost from last year’s investment and things like Fortigent, NestWise et cetera. And so what you’ve seen is a balance of expense growth that started out at much higher levels throughout the year and then have moderated through the remaining quarters.

We do have some up weighted investment as we said and some of the newer initiatives around the regulatory and compliance front, great example being in the home office supervision. But again, those are more an opportunity of which to drive value in a certain area of the business and once absorbing that and I think you will get back into that normal mid-single digit range of 4% to 6%.

Alex Blostein - Goldman Sachs

Okay. Great. And lastly, on just the investment environment obviously seems like the retailer that has improved a bit in the second quarter. But, when we look at your cash balances just as a percentage of total assets, seems like it also picked up and I’m not sure if its just a June dynamic where the risk appetite might have done a little bit worse, so people look into cash and we should think about maybe some outflows from the cash balances heading into the third quarter or if not just trying to better reconcile the dynamic.

Dan Arnold Jr.

Yes, you did. You saw a pickup in balances beginning second half of May and into June which certainly had a lot to do with the conversation and the concerns around the fixed income market. That said, we’ve seen certainly some of those balances begin to flow out in July. But as you know our cash balances tend to be pretty sticky. And so on a net-net basis, at the end of July, you’ll see a balance that’s higher than you did at the end of May as an example.

And so the pace were increase of the cash that’s come into the account just flow it out at a much slower pace. We will see some rotation but I think overall, if you think about that trajectory of that cash balances over time, we typically would expect to see a positive trend up into the right and that overall balance of $1 billion to $2 billion a year.

Alex Blostein - Goldman Sachs

Got you. Thanks a lot.

Operator

Our next question comes from Ken Worthington with JPMorgan. Your line is open.

Ken Worthington - JPMorgan

Thank you for taking my question. First on productivity, you mentioned they were the highest level since 2Q 2008, based on the data I’ve seen 2Q 2008 was one of the peak levels for LPL. However, if you can help for the advisor mix change and then some of the acquisitions you’ve made, can you frame it how high productivity could realistically go. In other words, everything is kind of improved since 2008 and therefore, I would think the productivity would go higher in the future than it was in the past all is being equal. But I would love to get you to frame or somehow, help us think about the upside from where it was way back when?

Dan Arnold Jr.

There is three underlying dynamics that I think about just from the true math. And then certainly Mark, you can add any comments from a macro standpoint about thoughts about advisors activity and performance levels. But there is a couple of things that I think our helpful tailwinds in terms of creating a larger number than power that were set in the past. One, you have bigger asset levels per advisor and thus trials are factored into that number of a $152,000. And so if you just think about larger asset levels per advisor and a contribution of those larger assets to trials that – we tend to have an upward lift in that number.

I think you also have a mix of larger practices who have larger broader capabilities and skills that are helping them win and attract new customers and new assets which would tend to support and help that number go higher. And then something that might have pressure on it, downwardly would be just the fundamental bigger shift towards advisory that we see over time than what was historically used.

A great example being I think is, if you look back then, the average assets and advisory would have been in the 30% range and now they are closer to that 35% range in terms of overall assets and our advisors practices. And so again that’s a fundamental shift towards advisory which would then suggest that the more of their overall total revenue or fees would be -- being allocated to that advisory fee line in commissions. So, those are three drivers that I think that that sort of help you think about where that number could go and how it might trend over time.

Ken Worthington - JPMorgan

Okay, great, thank you. And then just on advisor growth. I guess in your comments you implied that the sales cycle has extended, can you talk about how the pipeline looks and maybe how effective the recent strategies being employed by the wirehouse and independents are advocating the talent.

And then if we go back to 2003, kind of just after that tech bubble burst, actually tech bubble burst certainly recover. How long did it take for broker recruitment to kind of return to a more normalized levels? Did it take a year, did it take two years, I do not even know if that’s a good gauge but I thought it would help frame this as well.

Mark Casady

Yes, let me take your last part of your question first. We will have to go back and look specifically but I was here and I do recall it being relatively slow and it was exactly the same dynamic which was that same-store sales were recovering for advisors until they -- therefore busy taking care of their clients and adding new clients. I don’t remember the exact magnitude of it. So many years ago, but do recall it being slower than it was slow in late 2002 in the second half because that was actually the beginning of the recovery back then.

So this to me does feel the same way, if we just take it to go, except that as a math proven answer to the question.

And so then coming to your first part of your question, so why would we be optimistic about future is, I think good way to think about it, is because we have seen a lift of leads mentioned before its about 8.5% year-over-year in terms of new leads coming in that’s a very significant lead database for us. That’s a very significant growth of leads for us historically and what we are saying are each system, whether it’s a wirehouse or an independent system, whatever it is, they all through different changes and so there are some that are quite specific their group make a change. There is some issues that goes on in their company and that tends to send people out or twice down attempt to people stay.

But we do recruit, two things remember about us is we recruited across a large number of broker dealers, over 200 typically are the numbers that broker dealers that we end up having end recruits from. So it’s a very large field. And number two, there are a lot of markets, they are A markets, the retirement markets, the retail market, the institutional market and that really serves us well. And we see different competitors in each of those markets. We don’t find somebody who is able to go across all those markets in a way that we are.

So I think we have a very good picture of where people are moving and which segment of the markets are doing well. So for example, this year is a little hidden in the numbers but our banking channels doing quite well, both in terms of recruiting within existing clients which is a nice source of growth for us and for those clients. And of course new clients themselves and that’s a good example of the mix shift that occurs and that’s one of the reasons we like this range and places that we can recruit from as a business. So, that maybe some background of color for you that to help win the details.

Ken Worthington - JPMorgan

Great. Thank you very much.

Mark Casady

Sure.

Operator

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

Chris Harris - Wells Fargo Securities

You guys mentioned that investors are kind of reengaging the market, I know this is a very hard question to answer but as you speak to advisors they speak to their customers, how far long would you guys say we are in the cycle of investors coming back to the market. And I know this question is kind of asked few times earlier, but trying to get a sense of maybe how this might affect productivity going forward?

Mark Casady

That’s a tough question. I think the answer is, we don’t know the answer. We are hopeful and we will point back to that 2003, 2004, 2005 period. They were very strong for a number of years. It’s a bankrupt and economy that recovered and political system that was working reasonably well. I would say these were extraordinary times that we have never been in a situation, I’m lying a bit, where we have the fed doing what it is doing, we have the government trade arms with each other and so forth. So there is always plenty of reasons to worry bout whether some aspect – the general economy will get affected which effect confidence of investors.

So it feels to me like there is more opportunities for volatility today than they would have been in the early 2000. But the last trend, I can look at like this one was what we saw on the early 2000s, we had a quite significant run about 3 years of improved productivity across advisors as the general economy was good and people reengaged in investment programs.

Dan Arnold Jr.

And Chris, maybe one added level of detail on that, I think what you do hear from our advisors when you talk to them in detail, is there is a fundamental shift in the conversation in the interest and in engagement of that client versus the past 3 years or prior three years, so you do have a sense of need that needs to be addressed and I think they are realizing and recognizing, it’s a very different conversation than they had the prior three years. And that I think because of the nature of that pent-up demand also helps smooth out if you will some of the volatilities that maybe occurring or potentially may occur in the marketplace because of the fundamental growing of the need itself.

So I do think that’s worth thinking about in terms of some of the stability if you will through fluctuations of potential change in geopolitical or economic conditions.

Chris Harris - Wells Fargo Securities

Okay. That’s real helpful guys. My follow up question would be maybe a strategy type question. In the recent past year you have really rounded out your capabilities, whether it’s in the high network channel and then more recently the mass market. As we sit here today, do you feel like there is any kind of holes in your service offering or areas you like to develop more and where do you think you are going to be spending most of your resources you are going forward?

Mark Casady

Great question. And I think as we look at it as part of our emphasis on the strategy that we have, is we actually think we have got all the greenfields we need to be able to do a great job with advisors and growing their businesses and then attracting additional advisors either to existing practices or on their own across a wide spectrum of types. So that were definitely signaling with our focus on simplicity both to our customers and to our shareholders is that we see an enormous opportunity for growth of what we have today, which means as the capital matter we wouldn’t need to use capital for acquisitions and it’s really about the fundamentals, the earlier question about the bank for example, the question about how we spend on IT and technologies spend in all the areas, we will continue to look at.

We certainly will look at broker dealers for acquisition opportunities merely as a financial matter and if they are in a range that makes sense and have that kind of brokerage participants that makes sense to us then we certainly will take a look and consider them. We have generally looked at properties that have come up and haven’t found them to be a lot interesting either from our price standpoint or from the type of brokers who were there to be very blunt about it.

So therefore, that leads us to the area that Dan highlighted so well which is that about a third free cash flow goes to just existing business uses, about a third to dividend and about a third therefore to share buyback. And that’s a lovely position to be as a company, that have that kind of strong cash flow and be able to return capital shareholders so well.

Chris Harris - Wells Fargo Securities

Thank you.

Operator

And our final question comes from Alex Klam with UBS. Your line is open.

Alex Klam - UBS

Hey, thanks again for the follow up. I’m not trying to drag the call, but just a couple of things. Mark, I think in your prepared remarks you made a very brief comment around your I guess mass market opportunities and that you continue to refine it and maybe even look for more efficiency. So, obviously you are talking about (inaudible) is a change in strategy or are you not hitting targets or you are just trying to do something different, or I am trying to read too much into that?

Mark Casady

You are not reading too much into it. I think what we are trying to say is that, we are very, very focused on return to shareholders. We made the significant investment here. What we want to make sure is that we are getting a return on that investment and understand how best to support that need. The need we should just make sure and point out; I want to make sure the subtlety of the languages it was. We enter the need to really think about training. And to think about how to provide training to advisors to get new people into this industry. We think it’s a great industry. We think we have got a bright future for individuals to join it, so anybody listening, great career choice for you. And that was really hard time to get there and what we have to evaluate is that the most cost effective way for us to do that or not that’s really what we are saying.

Alex Klam - UBS

Okay. That’s helpful. And then just lastly to wrap it up, I think you gave a decent review of transition even though there were a couple of questions on it but just in terms of the level, I think Dan, you said it’s fairly I guess stable right now. But on the other hand, I think from the wire house perspective it looks like they are not being as aggressive anymore so it’s the stable function of, now you are recruiting from 200 different brokers or is there actually potential for things to maybe come down a little bit and ensure this isn’t actually go down, as there is not of much competition maybe.

Dan Arnold Jr.

Yes, so, I think and again it is important to keep this into perspective that over the past couple of years we have seen a gradual and only slight up tick in terms of the overall cost of transition assistance. You remember, we look at it as really helping someone start a business. So we are making an investment and helping them in terms of transitioning into to starting a business. So, when we talk about transition a system its usually on a magnitude of call it 20% if you will on trailing 12 production versus what the lawyers may have been offering in the 200% to 300% range.

And so, we do believe that that number will continue to trend up slightly, no big volatility and other changes. I don’t see it coming down, but again, I think it’s important to think about how we look at it in context and the purpose of what our transition system stands for versus perhaps how the wires use it as a strategy to drive change or movement in any one short period of time.

Alex Klam - UBS

Fine. That’s helpful. Thanks again.

Mark Casady

Thank you.

Operator

Thank you, ladies and gentleman for your participation. This concludes the conference you may all disconnect. And have a wonderful day.

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