LPL Financial Holdings Inc (LPLA) 2013 Q2 法說會逐字稿

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 like to turn the call over to your host, Trap Kloman, Head of Investor Relations. Please go ahead.

Thank you, Stephanie. Good morning and welcome to the LPL Financial 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 not 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 would 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 a reconciliation of these measures, please refer to our earnings press release.

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

Thank you, Trap, and thank you everyone for joining today's call. I am 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 the stock market. This trend reflected a continued improvement of 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 in brokerage and advisory accounts posted double-digit growth.

Turning to our top line results, net revenue growth 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 are representative of the growth trajectory LPL has been on for the past decade, and support our expectations for long-term growth going forward. When advisor 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 11% year-over-year to $152,000 this quarter from $137,000 in the second quarter of 2012. Advisory asset growth remained 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 remained modest this quarter. As is typical during periods of improving market conditions following a period of an extended industrial disengagement, advisors are particularly focused on supporting investor needs. We are not in a unique position as the overall level of advisor movement remained 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, industry 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 the strategic journey we have been on that has led us to this stage.

In 2003, we are 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 consolidating industry, we focused on building scale through recruiting, as well as select acquisitions, and emerged as a 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.

While 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 a wider range of new advisors to our platform. This strategy began with the 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 to leverage these assets to demonstrate how the resources that come with our growth can be delivered in a smarter and more personal way than has ever been done before in our industry. Our strategic focus is simplicity.

Our service value commitment is the most recent example of this strategy in action that represents only a piece of the overall effort. We are streamlining processes through lean principles to reinforce a common sense approach to what we do. We are transforming our technology from an IT department supporting a broker-dealer to an area of innovation that creates value across the organization. Instead of simply being 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 communications and our offerings in ways that are more personal and relevant to our advisors' needs, by leveraging the vast amounts of data we have about our advisors and their clients. This in turn engenders greater loyalty, with advisors and institutions having greater connectivity to LPL and clients better connected with their advisors. By making ourselves and our 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 advisors face in expanding their business, and that obstacle is time. Our technology and services must reduce the complexity of managing a practice and a client portfolio, and help advisors reduce time 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 our reputation as the leading consultative 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, it's imperative 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've 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 by 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 to implement this strategy, and deliver greater value to our advisors, employees, and shareholders.

In conclusion, I am 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 consolidating industry, we must built a sustainable pathway for growth. We cannot address challenges and issues through a series of isolated short-term reactions. Our industry is a microcosm of our culture today, where the 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'll turn the call over to our CFO, Dan Arnold, who will review our financial results and outlook in greater detail.

Thanks, Mark.

This morning I'll be discussing five main themes. First, I'll address top line results for the quarter and highlight the fundamental drivers behind our growth. I'll then share insight into developments in our ICA program and what that 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'll 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 224 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 level 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 and 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'd 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 point 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 in adjusted earnings per share year-over-year.

I'd now like to speak to our ongoing efforts to extend a significant ICA contract with a 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 was set at five to six years, with the belief that by the time contracts were set to renew or expire, the underlying effective funds rate would have required to a more normalized level.

We have reached an agreement with a counterparty to extend the maturity of this contract for one year. In exchange for a reduction in the rate in 2013 and 2014, we maintained rates 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 had previously shared.

In 2014, we expect approximately a 7 basis points decline over 2013 instead of the 10 basis points we had 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 point decline over 2014. Due to the number of contracts and growing balances in the program, as well as market factors, it is difficult to be precise beyond the current year. But we believe this increased transparency provides helpful insight to investors. Importantly, we retain the upside to a rising Fed Funds environment and the potential to recapture approximately $200 million in pretax earnings based on current cash levels when the Fed Funds rate reaches between 225 basis points and 250 basis points.

I'd 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 in the total 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 have 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 in part 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 a $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 are upweighting 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 will 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 will drive 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'll 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 shared based compensation, $8 million to our debt refinancing, which lowered our cost of debt and increased 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 where 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 that 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 possess 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. Stephanie, please open up the call.

(Operator Instructions) Our first question comes from Alex Kramm with UBS. Your line is open.

Hey, good morning everyone. Just wanted to quickly talk about the recruitment trends. I think Mark you said it again and I think you said it last quarter as well that recruitment is a little bit slower here and that's a 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 that out a little bit more for us. Is it the advisors you're going at? Are you walking away from some teams or why do you think some of your bigger competitors are seeing other things?

Yes, I'm not aware of a bigger competitor who has seen other things. So I'm not sure who you're referring to or what they're read of the market situation is. If we look at the discovery database information, which is a good proxy for movement in the market, it's not perfect but it's good, what you'll 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 that basically just movement in the industry is down and we're going to reflect that through our recruiting efforts.

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

We're definitely seeing the pipeline increase. So maybe what you're referring to is the same thing we're seeing, which is that there are lots of advisors who are interested in moving, but 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. Inquiry would be the first level of that all the way through to movement, which would be number 10 on our chart. And what we're seeing is a lot of good activity in the early part of the activity mapping that we do, which are people responding to advertising, leads, and so forth. I think leads are up 8.5% year-over-year here in the second quarter. So that tells us that there's a desire to move, just not particularly a movement occurring at the current time.

Okay, fair enough, and actually I was referring to Schwab. So if you have anything else to say there, please do. But let me just use my second question for Dan. Thanks for the update or the detail on the expenses as we look at the remainder of 2013. Can you give us a little bit of a early look on '14 here? Obviously, you have the efficiency program going on right now, but you also just talked about higher regulatory spending and things like that. So maybe just flushing out how all that should impact 2014 expense growth rates? Thank you very much.

Thanks for the question and we continue to work on '14 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'll address that.

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

Thanks very much. First question is when you look at the sequential improvement in productivity, can you maybe go a couple more sentences deeper into the dynamics around that. Was there a general acceleration of activity as the quarter progressed? What happened in June? Was it just a mix of the advisor seasoning, if you will? Just sort of curious of the dynamics because as you mentioned, it was a pretty strong quarter for [average] productivity.

This is Dan. I think of course we saw 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, to give you a 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 and that activity. And again, I think we saw that sustain itself. Through tax season you always see a little seasonality dip coming out of tax season that occurs in May and June. But as we've moved into third quarter, we've seen that momentum continue and are very encouraged by the continued productivity levels of our advisors moving into third quarter.

That's helpful. And then second question, a little bit broader in scope and sort of reflecting on your commentary around your ICA contracts. When you look at some of your peers in the space, they're benefiting from a better bank opportunity here. And I'm sort of curious, have you contemplated -- I recognize you have a pretty high ownership, private equity included right now, but to the extent that that would come down over time, what's your -- what are the pros and cons, if you would, to develop a bank rather than relying on a third party? Because back of the envelope math suggests it could be pretty powerfully accretive net of any kind of capital need and maybe give you a little more strategic flex.

What are your thoughts on that?

Bill, it's Mark. So absolutely agree with your assessment that a bank is an interesting 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 enter any of that thinking lightly because it brings with it other risks and other activities that we have to think about. It 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 that we know that they would like to have. So that could be very helpful to us in terms of growing the business and helping them. And at a cost of capital, it would allow us to take deposits into our own bank. And as you said, there's math around what the tradeoff is of how much capital it takes versus the earnings that accrete.

As you also said, our BE firm ownership at about 31% today precludes us from any activities of owning 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 will do is then undertaken a study to look at the plusses and minuses fully of a bank and decide what we would do about it. To be clear, though, for everyone on the call, this would be what I would describe as a 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 the most important factor for shareholders to understand is we have approximately $6 billion in deposits that are in money funds today for retirement accounts that we're 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 an exemption that would allow you to basically move those monies into the bank. 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.

Okay, thanks for taking my questions.

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

Good morning.

Good morning, Chris.

My first question is on the ICA. So you talked about the $200 million revenue benefit there. I think, Mark, you previously talked about $170 million. So is that just higher balances or help 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 a year. Is it just the yield is going to be a little bit lower over the next year than it would have been?

So Chris, on the first question, the $200 million in 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 a $25 billion to $26 billion cash balances base versus the lower base that we used previously.

Relative to the renegotiation and what we gave up, we did give up some rate in '13 and '14 to extend out and have above market level rates in '15. And I think what you're seeing is about a 2 basis point adjustment this year. And we had previously given guidance on about a 10 basis point drop next year, of which we were able to secure only a 7 basis points drop, and that's point-to-point from fourth quarter to fourth quarter. Another way to look at it is over the first two years, '13 and '14, we had given guidance somewhere collectively over those two years of about a 20% to 22% -- sorry, 20 to 22 basis points drop. And what you're doing is ultimately seeing that in the form of 14 the first year and then 7 in the second year.

So based on our prior guidance, we're in line with that. We're just getting there in a slightly different way.

The other thing that I'd add is that we still have all the upside to Fed Funds. We had talked about it before is that it's Fed Funds plus a number and the adjustments to basis points that Dan is speaking to are the plus number, but not Fed Funds. So if Fed Funds were to rise tomorrow, this contracts, deposits value would rise as well.

All right, thanks. And then just one more. On the change to the home office supervision structure, which I know carries with it an increase in fees for standalone advisors, I was just hoping you can help us better understand how that structure will play out both from a business and financial perspective.

So from a business standpoint, what we're finding is advisors definitely understand the change and are very supportive of it because they understand that the world has changed in terms of oversight and review. And we've had very productive conversations with literally hundreds if not thousands at this point of advisors, and we very much appreciate their patience and thoughtfulness about the questions that they've 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 agreement with that. Like all things in life, it comes down to and what's the expense of that. What we've laid out for our advisors is a very thoughtful program that says there is cost of this to us. What we'd like to do is cover our costs so that we can make sure that we're not letting one part of our system support another part of our system. That's a fairness doctrine that we have between advisors because they have very different business models.

What we've also done is said 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 the issues, and working together on it. And then starting in '15, we would have the actual charges in place. And we'll continue to look for ways to help advisors work that through. An example of that would be that 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 working with our regulator [framework]. And we will probably have some of that activity occur.

So I think on a -- how I would look at it financially, answering more of the analysts questions, and Dan can correct me if there's a different way of thinking about it, is that effectively there will be some additional costs next year and then it will tend to be a wash in the year following as the expenses and the revenues match off against 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're trying to do is just get it to a point in which we're fairly charging each part of our system for the activities that we oversee.

The only thing that I would add to that I that I think you do get a spectrum of different responses from the advisor, but a 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, and reallocating that to serving and supporting their existing customers, prospecting for new customers, et cetera.

So I think they ultimately get the tradeoff in the value that it creates for their practice in exchange for the cost that we charge or the price that we charge for it.

Thanks a lot guys.

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

Good morning guys.

Good morning.

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

So 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 that gets a bit more complex is for GAAP accounting purposes, we have a mix of how we provide that transition assistance. In some cases, it's paid all up front and expensed. In other cases, especially with larger practices, we will give it in the form of a loan that's amortized over a three to five year period of time. And in second quarter, what you saw is a reflection of some of the larger practices that we've been successful at attracting over the past couple of years. The amortization associated with those loans has been quicker to build than the loans that are actually maturing, and thus, you see an increase or an uptick in terms of our overall transition expenses as it's measured by GAAP. So hopefully that helps you. It's just a bit complex because of the accounting structure.

Okay, but there's no sort of I guess -- not trying to put you on the spot for an absolute number, but there's no way to sort of quantify given that you've sort of added nearly 60 net new advisors [versus] at a much lower run rate than you did last year. Any kind of expense number or savings that came along with that?

Yes, we're reflecting the net number here so I don't have that at hand. But what you're seeing is the reduction in the expense of what we would have expensed up front in terms of transition assistance for new recruits that 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.

But you might characterize it as not significant? It's not as if it's half the level or even 20% less the level. Is that fair?

Yes, I think that's right, and again, I think the important point is the rate at which we're paying transition assistance year-on-year hasn't shifted or hasn't changed. Consequentially, we're not seeing sort of any dynamics in terms of inflation, but typically those same characteristics that we saw last year in terms of that -- the determination or the value of the up front, the transition assistance.

Great, and then just lastly from me, commission revenue came in a bit stronger than what we were looking for. Can you give a sense for how much of that was due to sort of mutual funds trailers? Or was there anything else particularly that was driving that?

Yes, on -- you've got a combination of both good, solid growth in advisory assets, which obviously is driving sound growth from a year-on-year advisory revenue growth. And then from a commission standpoint, you've got a combination of that being driven by productivity, which on a year-on-year basis was up 11% to 12%. So I think -- and at the lower the trough, you saw average commissions per advisor down in the $132,000 to $134,000 range. And so the $152,000 reflected in last quarter gives you a good indication of the momentum and the strength that's building in terms of pure productivity. And then your trail commissions typically are about one-third of the overall commissions' revenue. And you saw 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.

Great. Thanks for taking my questions.

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

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. You had I guess the total client asset level wasn't up as much you would have expected. So I'm just trying to gauge how much of that $397 billion is fixed income versus equity or sort of fixed income orientation versus equity?

So generally speaking, the best way to think about the investors of advisors, and therefore their client assets is that they are typically middle income Americans who are saving for long-term retirement, and would basically have a very balanced portfolio. So we do typically skew with a fairly reasonable amount of assets in fixed income. Traditionally, we'd say it's about 50-50 and when we see movement, so we're not necessarily a good indicator of the march back to equities, what we would tend to see and what we were seeing in the second quarter was a bit more than that, than 50% going into the equity market, a little bit less in fixed income. Of course, we also had June's numbers where you had pretty significant downturn across all markets, but particularly in the fixed income market and that affects it a little bit.

So what you definitely -- your premise is quite correct, which is that you're going to see a more conservative result of asset growth as a result of it being a balanced portfolio. That of course helps us in downturns because that same balanced portfolio protects us on the downside, which is one of the things that we like about it.

Great, and then just a follow-up. I appreciate the new color on the ICA fees. I guess I'm just trying to understand a little bit more about this renegotiation. While not likely, let's just assume Fed Funds' rates don't change by the end of 2014. How, if at 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 said, '15 will be, I guess you indicated, 13 BPS below 14, I guess.

And that is the right way to think about it. That's assuming Fed Funds' rate does not change.

This is a contractual arrangement, right, geared over a number of years. What Dan's given you are the numbers in a frozen all other variables market.

And remember, we maintained upside with Fed Funds. So if Fed Funds' rate moves up, obviously then that improves the economics and it offsets that downward pressure caused by the contractual pricing.

Great. Thanks for taking my questions.

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

Good morning. Sorry to beat a dead horse, but again on ICA, the $200 million sensitivity number that you provide in the upside scenario, can you just help us understand if there's anything at all that could change that with respect to the way you negotiate these contracts?

The answer is no. Make it as simple as possible.

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

So what we've talked about is targeting just normal expense growth in the mid-single digits range. So call it the 4% to 6% range. And I think as we have shared this year, that number will be more in the 8% range, a lot doing with the absorption of the upweighted cost from last year's investments in 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 upweighted investment, as we said, in some of the newer initiatives around the regulatory and compliance front, a great example being 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 in, I think you would get back into that normal mid-single digits range of 4% to 6%.

Okay, great. And lastly, on just the investment environment, obviously it seems like the retail appetite has improved a bit in the second quarter. But when we look at your cash balances just as a percentage of total assets, it seems like it also picked up. And I'm not sure if it's just a June dynamic where the risk appetite might have gotten a little bit worse, so people moved 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.

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 see a balance that's higher than you did at the end of May, as an example. And so the pace or increase of the cash that's come into the accounts has flowed out at a much slower pace.

We will see some rotation, but I think overall if you think about that trajectory of the cash balances over time, we typically would expect to see a positive trend up and to the right in that overall balance of $1 billion to $2 billion a year.

Got you. Thanks a lot.

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

Thank you for taking my question. First, on productivity, you mentioned they were the highest level since 2Q '08. Based on the data I've seen, 2Q '08 was one of the peak levels for LPL. However, if you account for the advisor mix change and some of the acquisitions you've made, can you frame how high productivity could realistically go? In ever words, everything has kind of improved since 2008 and therefore I would think that productivity would go higher in the future than it was in the past, all things 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.

There's three underlying dynamics that I think about just from the pure math, and then certainly, Mark, you can add any comments from kind of a macro standpoint about thoughts about advisors' activity and performance levels. But there's a couple things that I think are helpful tailwinds in terms of creating a larger number than bars that were set in the past. One, you have bigger asset levels per advisor and thus trails are factored into that number of $152,000. And so if you just think about larger asset levels per advisor and the contribution of those larger assets to trails, that would 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 toward advisory that we see over time than what was historically used, a great example being I think as if you look back then, the average assets in advisory would have been in the 30% range and now they're closer to that 35% range in terms of overall assets in our advisors' practices. So again, that's a fundamental shift towards advisory, which would then suggest that more of their overall or total revenue, or fees would be being allocated to that advisory fee line than commissions.

So those are three drivers that I think that sort of help you think about where that number could go or how it might trend over time.

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 wire-house and independents are at retaining the talent? And then if we go back to 2003, kind of just after the tech bubble burst, actually the tech bubble burst started to recover, how long did it take for broker recruitment to kind of return to more normalized levels? Did it take a year? Did it take two years? And I don't even know if that's a good gauge, but I thought it would help frame this as well.

Yes, let me take your last part of your question first. We'll 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, and so they were 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. And it was slow in late '02 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 -- if you'll accept 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 recruiting is I think a good way to think about it, is because we have seen a lift of leads. I mentioned before it's about 8.5% year-over-year in terms of new leads coming in. That's a very significant lead database for us and that's a very significant growth of leads for us historically. And what we're seeing are each system, whether it's a wire-house, or an independent system, or whatever it is, they all go through different changes. And so there's some that are quite specific. Their group makes a change. There's some issue that goes on in their company and that tends to send people out. Or it quiets down and it tends to have people stay.

But we do recruit. The two things to remember about us is we recruit across a large number of broker-dealers, over 200 typically are the numbers, broker-dealers that we end up having recruits come from. So it's a very large field. And number two, we're in a lot of markets, the RAA market, the retirement market, the retail market, the institutional market, and that really serves us well. And we see different competitors in each of those markets, so we don't find somebody who is able to go across all of those markets in the way that we are. So we think we have a very good picture of where people are moving and which segment of the market is doing well.

So for example, this year it's a little hidden in the numbers, but our banking channel is 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 it's one of the reasons we like this range of places that we can recruit from as a business.

So that's maybe some background and color for you to help fill in the details.

Great. Thank you very much.

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

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

That's a tough question. I think the answer is we don't know the answer. We're hopeful and we'll point back to that '03, '04, '05 period. They were very strong for a number of years against the backdrop of an economy that was recovered and political system that was working reasonably well. I would say these are extraordinary times. We've never been in a situation, or certainly, I haven't been, where we have the Fed doing what it's doing, we have the government essentially at arms with each other and so forth. So there's always plenty of reasons to worry about whether some aspect of sort of the general economy will get affected, which will affect the confidence of investors.

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

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 and the interest in the engagement of that client versus the past three years, or prior three years. So you do have a sense of a pent up 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 helped smooth out, if you will, some of the volatility that may be 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 or potential change in geopolitical of economic conditions.

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

Great question, and I think as we look at it, and as part of our emphasis on the strategy that we have is we actually think we've got all the greenfields we need to be able to do a great job with advisors in growing their businesses and then attracting additional advisors either to existing practices or on their own across a wide spectrum of types.

So what we're definitely signaling with our focus on simplicity both to our customers and to our shareholders is that we see there's enormous opportunity for growth with what we have today. Which means as a 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, a question about how we spend on IT and technology spend would all be areas that we would continue to look at.

We certainly will look at broker-dealers for acquisition opportunities, merely as a financial matter. And if they're in a range that makes sense and have the kind of brokerage (inaudible) 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 all that interesting, either from a price standpoint or from the type of brokers who are 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 of our free cash flow goes to just existing business uses, about a third to dividends, and about a third, therefore, share buybacks. And that's a lovely position to be in as a Company, to have that kind of strong cash flow and be able to return capital to shareholders so well.

Thank you.

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

Thanks again for the follow-up. I'm not trying to direct 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 will continue to refine it, and maybe even look for more efficiencies. So obviously, you're talking about NestWise there. So is it a change in strategy or are you not hitting targets? Or you're just trying to do something different? Or am I trying to read too much into that?

You're not reading too much into it. I think what we're trying to say is that we are very, very focused on return to shareholders. We've made a significant investment here. What we want to make sure is that we're 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 language isn't lost. We entered 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've got a bright future for individuals to join us. So for anybody listening, good career choice for you. And that was really our attempt to get there. And what we have to evaluate is that the most cost effective way for us to do that or not, and that's really what we're saying.

Okay, that's helpful. And then just lastly to wrap it up, I think you gave a decent review of some (inaudible) and then there were a couple 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 is the stable a function of your recruiting from 200 different brokers? Or is there actually potential for things to maybe come down a little bit and [transition assets] to actually go down as there's not as much competition maybe.

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

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

That's helpful. Thanks again.

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