SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
		OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2005

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                   to                  

 

Commission file number 001-13913

 

WADDELL & REED FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

 

6300 Lamar Avenue

Overland Park, Kansas

66202

(Address of principal executive offices)

(Zip Code)

 

(913) 236-2000

(Registrant's telephone number, including area code)

 

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý  No o

 

        Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).  Yes ý  No o

 

Shares outstanding of each of the registrant's classes of common stock as of the latest practicable date:

 

 

 

Waddell & Reed Financial, Inc.

 

Form 10-Q

Quarter Ended March 31, 2005

 

Index
Part I.		Financial Information
	Item 1.		Financial Statements
			Consolidated Balance Sheets at
			March 31, 2005 and December 31, 2004
			Consolidated Statements of Income
			for the three months ended
			March 31, 2005 and March 31, 2004
			Consolidated Statements of Comprehensive
			Income for the three months ended
			March 31, 2005 and March 31, 2004
			Consolidated Statements of Stockholders' Equity
			for the three months ended March 31, 2005
			,
			Consolidated Statements of Cash Flows for
			the three months ended March 31, 2005
			and March 31, 2004
			Notes to Unaudited Consolidated Financial Statements
	Item 2.		Management's Discussion and Analysis of Financial
			Condition and Results of Operations
	Item 3.		Quantitative and Qualitative Disclosures About Market Risk
	Item 4.		Controls and Procedures
Part II.		Other Information
	Item 1.		Legal Proceedings
	Item 2.		Changes in Securities, Use of Proceeds, and Issuer Purchases
			of Equity Securities
	Item 5.		Other Information
	Item 6.		Exhibits and Reports on Form 8-K
			Signatures

 

2

 

ITEM 1.  FINANCIAL STATEMENTS

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands)

 

		March 31,			December 31,
Assets		2005			2004
		(unaudited)
Assets:
Cash and cash equivalents		$	82,557		83,900
Investment securities		115,180			125,275
Receivables:
Funds and separate accounts		27,986			24,751
Customers and other		35,654			38,651
Deferred income taxes		34			24
Prepaid expenses and other current assets		6,266			6,469
Total current assets		267,677			279,070
Property and equipment, net		53,990			54,429
Deferred sales commissions, net		16,046			15,029
Goodwill		195,309			195,309
Intangible assets		54,999			54,984
Other assets		20,024			21,086
Total assets		$	608,045		619,907
Liabilities and Stockholders' Equity
Liabilities:
Accounts payable		$	46,044		56,744
Accrued sales force compensation		13,963			13,035
Accrued other compensation		8,717			10,767
Short-term notes payable		225,069			35,000
Income taxes payable		17,380			8,210
Other current liabilities		34,497			38,761
Total current liabilities		345,670			162,517
Long-term debt		—			202,899
Accrued pensions and post retirement costs		17,779			15,899
Deferred income taxes		12,859			13,438
Other		6,365			6,277
Total liabilities		382,673			401,030
Stockholders' equity :
Common stock - $0.01 par value: 250,000 shares authorized; 99,701 shares issued; 82,544 shares outstanding (82,798 at December 31, 2004)		997			997
Additional paid-in capital		236,347			236,313
Retained earnings		393,519			383,155
Deferred compensation		(29,349		)	(31,400	)
Cost of 17,157 common shares in treasury (16,903 at December 31, 2004)		(370,994		)	(365,892	)
Accumulated other comprehensive income		(5,148		)	(4,296	)
Total stockholders' equity		225,372			218,877
Total liabilities and stockholders' equity		$	608,045		619,907

 

See accompanying notes to unaudited consolidated financial statements

 

3

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(Unaudited, in thousands, except for per share data)

 

		For the three months
		ended March 31,
		2005			2004
Revenues:
Investment management fees		$	63,582		60,296
Underwriting and distribution fees		47,081			49,803
Shareholder service fees		19,810			18,967
Total revenues		130,473			129,066
Operating expenses:
Underwriting and distribution		54,025			51,759
Compensation and related costs		19,819			18,252
Equity compensation		2,790			1,240
Subadvisory fees		3,521			1,181
General and administrative		10,234			9,487
Depreciation		2,376			2,228
Total operating expenses		92,765			84,147
Operating income		37,708			44,919
Investment and other income		1,364			604
Interest expense		(3,254		)	(2,310	)
Income before provision for income taxes		35,818			43,213
Provision for income taxes		13,068			15,332
Net income		$	22,750		27,881
Net income per share:
- Basic		$	0.28		0.35
- Diluted		$	0.28		0.34
Weighted average shares outstanding:
- Basic		80,920			80,682
- Diluted		82,106			82,245
Dividends declared per common share		$	0.1500		0.1500

 

See accompanying notes to unaudited consolidated financial statements.

 

4

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)

 

		For the three months
		ended March 31,
		2005			2004
Net income		$	22,750		27,881
Other comprehensive income:
Net unrealized appreciation (depreciation) of investments during the period, net of income taxes of $(119) and $323, respecively		(204		)	720
Reclassification adjustment for amounts included in net income, net of income taxes of $(381) and $0		(648		)	—
Comprehensive income		$	21,898		28,601

 

See accompanying notes to unaudited consolidated financial statements.

 

5

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statement of  Stockholders’ Equity

For the Three Months Ended March 31, 2005

(Unaudited, in thousands)

 

																			Accumulated
							Additional												other			Total
		Common stock					paid-in			Retained			Deferred			Treasury			comprehensive			stockholders’
		Shares		Amount			capital			earnings			compensation			stock			income			equity
Balance at December 31, 2004		99,701		$	997		$	236,313		$	383,155		$	(31,400	)	$	(365,892	)	$	(4,296	)	$	218,877
													—			—			—
Net income		—		—			—			22,750			—			—			—			22,750
Recognition of equity compensation		—		—			(42		)	—			2,832			—			—			2,790
Issuance of restricted shares and other		—		—			72			—			(781		)	709			—			—
Dividends accrued		—		—			—			(12,386		)	—			—			—			(12,386		)
Exercise of stock options		—		—			(286		)	—			—			1,124			—			838
Tax benefit from equity awards		—		—			290			—			—			—			—			290
Other stock transactions		—		—			—			—						(938		)	—			(938		)
Treasury stock purchases		—		—			—			—						(5,997		)	—			(5,997		)
Reclassification for amounts included in net income		—		—			—			—			—			—			(648		)	(648		)
Unrealized loss on investment securities		—		—			—			—			—			—			(204		)	(204		)
Balance at March 31, 2005		99,701		$	997		$	236,347		$	393,519		$	(29,349	)	$	(370,994	)	$	(5,148	)	$	225,372

 

See accompanying notes to unaudited consolidated financial statements.

 

6

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited, in thousands)

 

		For the three months
		ended March 31,
		2005			2004
Cash flows from operating activities:
Net income		$	22,750		27,881
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,758			2,657
Recognition of deferred compensation		2,790			1,240
Gain on sale of available-for-sale investments		(1,029		)	—
Net purchases and sales of trading securities		28			—
Loss on trading securities		159			—
Loss on sale and retirement of fixed assets		42			24
Capital gains and dividends reinvested		(32		)	(33	)
Deferred income taxes		(89		)	(1,430	)
Changes in assets and liabilities:
Receivables from funds and separate accounts		(3,235		)	2,005
Other receivables		3,925			3,025
Other assets		(1,693		)	(315	)
Accounts payable		(11,484		)	(6,368	)
Other liabilities		6,080			2,959
Net cash provided by operating activities		20,970			31,645
Cash flows from investing activities:
Purchases of available-for-sale investment securities		—			(1,103	)
Proceeds from sales of available-for-sale investment securities		7,819			—
Proceeds from maturity of available-for-sale investment securities		599			293
Additions to property and equipment		(1,979		)	(1,423	)
Cash paid for acquisitions		(15		)	—
Net cash provided by (used in) investing activities		6,424			(2,233	)
Cash flows from financing activities:
Net short-term borrowings (repayments)		(11,000		)	25,000
Cash dividends		(12,424		)	(12,392	)
Purchase of treasury stock		(5,213		)	(21,766	)
Exercise of stock options		838			3,746
Other stock transactions		(938		)	—
Net cash used in financing activities		(28,737		)	(5,412	)
Net increase (decrease) in cash and cash equivalents		(1,343		)	24,000
Cash and cash equivalents at beginning of period		83,900			71,466
Cash and cash equivalents at end of period		$	82,557		95,466

 

See accompanying notes to unaudited consolidated financial statements.

 

7

 

WADDELL & REED FINANCIAL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1.              The Company and Significant Accounting Policies

 

        Waddell & Reed Financial, Inc. and Subsidiaries

 

        Waddell & Reed Financial, Inc. and subsidiaries (hereinafter referred to as the “Company,” “we,” “us,” or “our”) derive revenues primarily from investment management, investment product underwriting and distribution, and shareholder services administration provided to the Waddell & Reed Advisors Group of Mutual Funds (the “Advisors Funds”), W&R Target Funds, Inc. (the “Target Funds”), Ivy Funds, Inc. and the Ivy Funds portfolios (collectively, the “Ivy Funds”), and Waddell & Reed InvestEd Portfolios, Inc. (“InvestEd”) (collectively, the “Funds”), and institutional and separately managed accounts.  The Funds and the institutional and separately managed accounts operate under various rules and regulations set forth by the United States Securities and Exchange Commission (the “SEC”). Services to the Funds are provided under contracts that set forth the fees to be charged for these services. The majority of these contracts are subject to annual review and approval by each Fund's board of directors/trustees and shareholders. Our revenues are largely dependent on the total value and composition of assets under management, which include mainly domestic equity securities, but also include debt securities and international equities.  Accordingly, fluctuations in financial markets and composition of assets under management impact revenues and results of operations.

 

        Basis of Presentation

 

We have prepared the accompanying unaudited consolidated financial statements included herein pursuant to the rules and regulations of the SEC.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures are adequate to enable a reasonable understanding of the information presented.  The information in this Quarterly Report on Form 10-Q should be read in conjunction with Item 2 “Management's Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004. Certain amounts in the prior years' financial statements may have been reclassified for consistent presentation.

 

The accompanying unaudited consolidated financial statements have been prepared consistently with the accounting policies described in Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2004, which include use of estimates, disclosures about fair value of financial instruments, investment securities and investments in affiliated mutual funds, property and equipment, software developed for internal use, goodwill and intangible assets, deferred sales commissions, revenue recognition, advertising and promotion, stock-based compensation, income taxes, derivatives and hedging activities, and litigation contingencies. 

 

In our opinion, the accompanying unaudited consolidated financial statements reflect all adjustments (consisting of only a normal and recurring nature) necessary to present fairly our financial position at March 31, 2005 and December 31, 2004 and the results of operations and cash flows for the three months ended March 31, 2005 and 2004, in conformity with accounting principles generally accepted in the United States. 

 

Revenue Recognition

 

We recognize investment management fees as earned over the period in which services are rendered. We charge the Funds daily based upon average daily net assets under management in accordance with

 

8

 

management advisory contracts between the Funds and the Company. In general, the majority of investment management fees earned from institutional and separate accounts are charged quarterly based upon an average of net assets under management at the end of the months within the quarter in accordance with management advisory contracts.

 

Shareholder service fees are recognized monthly and are calculated based on the number of accounts or assets under management as applicable. Other administrative service fee revenues are recognized as contractual obligations are fulfilled or as services are provided.

 

Underwriting and distribution commission revenues resulting from the sale of investment products are recognized on the trade date.

 

Rule 12b-1 service and distribution fees are received predominantly from the Advisors Funds Class A shares under a sales and servicing reimbursement plan agreement, which allows reimbursement to us from the Advisors Funds Class A shares for certain Rule 12b-1 eligible expenses, not to exceed a maximum of 25 basis points of average daily net assets under management. Rule 12b-1 service and distribution fees are collected for costs related to the distribution and servicing of mutual fund shares such as sales commissions paid to financial advisors, advertising, sales brochures and costs for providing ongoing services for the mutual fund shareholders. We recognize the reimbursement paid by the Advisors Funds Class A shares monthly as a reduction to Rule 12b-1 eligible expenses paid by us on the mutual fund's behalf. We also have a compensatory Rule 12b-1 service and/or distribution plan for the Funds, excluding Advisors Funds Class A shares, which is recorded in a similar manner. Total Rule 12b-1 fees from the Funds recorded as an offset against related underwriting and distribution expenses were $20.4 million and $16.5 million for the quarters ended March 31, 2005 and 2004, respectively.

 

We also recognize certain distribution revenues monthly on certain types of investment products, primarily variable annuity products, which are generally calculated based on average daily net assets under management.

 

Stock-Based Compensation

 

The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, in accounting for its stock-based compensation plans.  Accordingly, no compensation expense has been recognized for employee stock-based compensation plans other than for restricted stock and instances where vesting of option awards have been accelerated.  The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation-Transition and Disclosure,” an amendment of Statement of Financial Accounting Standards No. 123 (“SFAS 123”); therefore, no compensation expense was recognized for the Company's employee stock options.  Had compensation expense for the Company's employee stock options been determined based on the fair value at the grant date, consistent with the methodology prescribed under SFAS 148, the Company's net income and earnings per share would have approximated the pro forma amounts indicated below.  

 

9

 

		Three months ended March 31,
		2005			2004
		(in thousands, except per share data)
Net income, as reported		$	22,750		27,881
Deduct: Total stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects		(188		)	(624	)
Pro forma net income		$	22,562		27,257
Basic earnings per share
As reported		$	0.28		0.35
Pro forma		$	0.28		0.34
Diluted earnings per share
As reported		$	0.28		0.34
Pro forma		$	0.27		0.33

 

 

The weighted-average fair value of each stock option included in the preceding pro forma amounts was estimated using a Black-Scholes option-pricing model and is amortized over the vesting period of the underlying options.

 

The Company's Board of Directors approved grants of restricted shares of the Company's Class A common stock in lieu of stock options beginning in 2002.  As of March 31, 2005, a total of 1,745,977 shares of unvested restricted stock were outstanding.  On April 2, 2005, we granted an additional 1,107,533 shares of restricted stock to employees with a fair market value of $19.75 per share under the Company's 1998 Stock Incentive Plan, as amended and restated, (the “SIP”).  Based on the market value of these restricted shares on the grant date, we will record additional deferred compensation totaling $21.9 million during the second quarter of 2005.  Grants of restricted stock are valued on the date of grant and have no purchase price.  The grants are expensed using the straight-line method over a four year vesting period.  Grants of restricted stock vest over four years in one-third increments annually beginning on the second anniversary of the grant date.  Depending on the circumstances of termination, unvested shares of restricted stock may be forfeited upon the termination of employment with the Company.  Except for restrictions placed on the transferability of the restricted stock, holders of restricted stock have full stockholders rights during the term of restriction, including voting rights and the right to receive cash dividends. 

 

2.              Cash and Cash Equivalents

 

Cash and cash equivalents include cash on hand and short-term investments.  We consider all highly liquid investments with original or remaining maturities of 90 days or less at the date of purchase to be cash equivalents.  Cash and cash equivalents at March 31, 2005 and December 31, 2004 include amounts of $20.3 million and $22.6 million, respectively, for the benefit of customers in compliance with applicable securities industry regulations.  Substantially all cash balances are in excess of federal deposit insurance limits. 

 

As collateral for performance of our obligations to a bank under a letter of credit, we have pledged a portion of our commercial paper holdings with a combined market value of $22.1 million and $21.5 million at March 31, 2005 and December 31, 2004, respectively.

 

3.              Fair Value Hedge

 

On March 12, 2002, our $200.0 million 7.5% fixed rate senior notes maturing in January 2006 (the “Notes”) were effectively converted to variable rate debt by entering into an interest rate swap agreement.

 

10

 

The difference in floating rate interest paid and 7.5% fixed rate interest received is recorded as an adjustment to interest expense during the period that the related debt is outstanding.  As short-term interest rates fall, our interest expense declines and vice versa.  As of March 31, 2005, the floating rate being paid was 5.32%.  The change in the fair value of the swap is recorded on the consolidated balance sheet by adjusting the carrying amounts of the Notes by an offsetting amount for the swap. 

 

In the first quarter of 2005, we reclassified the Notes from long-term debt to short-term debt due to their scheduled maturity within the next twelve months.  We are exploring alternatives for the refinancing of our Notes due in January 2006.  While we believe that we should be able to refinance these notes on acceptable terms prior to their maturity, there can be no assurance that we will be able to do so.

 

Under Statement of Financial Accounting Standards No. 133 (“SFAS 133”) “Accounting for Derivative Instruments and Hedging Activities,” we account for the swap as a fair value hedge of the Notes.  This swap is considered 100% effective in hedging the changes in the fair value of the Notes arising from changes in interest rates, and accordingly, there has been no impact on earnings resulting from any ineffectiveness associated with this transaction.  As a result of the hedge, the Company realized interest expense savings of approximately $1.2 million and $2.0 million for the three months ended March 31, 2005 and 2004, respectively.  As of March 31, 2005, we have recorded a cumulative increase in “Other assets” of $1.4 million to reflect the fair value of the swap and a cumulative increase in “Short term notes payable” of $1.4 million to reflect the fair value of the Notes.  As of December 31, 2004, we recorded a cumulative increase in “Other assets” of $3.4 million to reflect the fair value of the swap and a cumulative increase in “Long-term debt” of $3.4 million to reflect the fair value of the Notes.    

 

4.     Investments

 

Investments are as follows (in thousands):

 

		Market Value
		March 31, 2005			December 31, 2004
Available-for-sale securities:
United States government-backed mortgage securities		$	288		315
Municipal bonds		16,856			17,415
Certificates of deposit		57,102			56,753
Corporate bonds		4,835			5,067
Affiliated mutual funds		26,504			35,964
		105,585			115,514
Trading securities:
Affiliated mutual funds		9,595			9,761
Total investments		$	115,180		125,275

 

11

 

        Certain information related to our available-for-sale securities is as follows (in thousands):

 

		March 31,			December 31,
		2005			2004
Cost - available-for-sale securities		$	99,702		108,278
Gross unrealized gains		6,677			8,128
Gross unrealized losses		(794		)	(892	)
Market value - available-for-sale securities		$	105,585		115,514

 

        Effective June 30, 2004, the Company began matching investments to the funding obligations created by our deferred compensation plans.  These plans allow employees to choose investment vehicles, which are primarily Company sponsored mutual funds.  Gross sales and purchases of trading securities for the three months ended March 31, 2005 were $424 thousand and $396 thousand, respectively.

 

The Company’s $57.1 million investment in certificates of deposit is restricted.  In addition, investment securities, which exclude cash and cash equivalents, with a combined market value of $20.6 million at March 31, 2005 and $21.2 million at December 31, 2004 are restricted or pledged as collateral for performance of our obligations to a bank under a letter of credit pending the outcome of legal matters. Refer to Note 8 “Contingencies” for more information on the legal proceedings requiring the restrictions.

 

A summary of debt securities and mutual funds with market values below carrying values at March 31, 2005 is as follows:

		Less than 12 months					12 months or longer				Total
		Fair value			Unrealized (losses)		Fair value		Unrealized (losses)		Fair value		Unrealized (losses)
		(in thousands)
Municipal bonds		$	494		(3	)	5,404		(584	)	5,898		(587	)
Corporate bonds		—			—		1,081		(206	)	1,081		(206	)
Mutual funds		63			(1	)	—		—		63		(1	)
Total temporarily impaired securities		$	557		(4	)	6,485		(790	)	7,042		(794	)

 

We assess the carrying value of investments in debt and equity securities each quarter to determine whether an other than temporary decline in market value exists.  We consider factors affecting the issuer, the industry the issuer operates in, general market trends including interest rates, and our ability and intent to hold an investment until it has recovered. Consideration is given to the length of time an investment's market value has been below carrying value and prospects for recovery to carrying value. At March 31, 2005, we had three municipal securities and one asset-backed security with market values below their carrying values.  Three of the four securities have maturities that exceed ten years, while the fourth security, a municipal bond, has a maturity that exceeds nine years. Based upon our assessment of these bonds and our history of holding bonds until maturity, we determined that a write-down was not appropriate at this time. 

 

5.     Stockholders' Equity

 

Earnings per Share

 

Basic earnings per share is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding, which excludes unvested restricted stock awards.  Diluted earnings per share is computed based upon the weighted average number of common shares and

 

12

 

dilutive common equivalent shares outstanding.  Stock options and restricted stock awards, which are common stock equivalents, have a dilutive effect on earnings per share in all periods presented and are therefore included in the computation of diluted earnings per share.

 

The components of basic and diluted earnings per share were as follows:

 

		Three months ended
		March 31,
		2005			2004
		(in thousands, except per share data)
Net income		$	22,750		27,881
Weighted average shares outstanding - basic		80,920			80,682
Dilutive potential shares from stock options and restricted stock awards		1,186			1,563
Weighted average shares outstanding - diluted		82,106			82,245
Earnings per share:
Basic		$	0.28		0.35
Diluted		$	0.28		0.34

 

 

Anti-dilutive Securities

 

Anti-dilutive potential common shares resulting from options to purchase shares of common stock that were excluded from the diluted earnings per share calculation were 2.83 million and 2.40 million for the quarters ended March 31, 2005 and 2004, respectively. Anti-dilutive shares of unvested restricted stock in the amount of 33,466 shares and 1,229 shares for the quarters ended March 31, 2005 and 2004, respectively, were excluded from the diluted earnings per share calculation.

 

Dividends

 

On March 1, 2005 our Board of Directors approved a dividend in the amount of $0.15 per share to stockholders of record as of April 8, 2005 to be paid on May 2, 2005.  The total dividend to be paid is approximately $12.4 million.

 

Common Stock Repurchases

 

Our Board of Directors has authorized the repurchase of our common stock in the open market and/or private purchases. The acquired shares may be used for corporate purposes, including shares issued to employees in our stock based compensation programs. Common shares repurchased on the open market for the quarters ended March 31, 2005 and 2004 were 292,600 shares and 865,900 shares, respectively.

 

6.     Goodwill and Identifiable Intangible Assets

 

Goodwill

 

Goodwill represents the excess of the purchase price over the tangible assets and identifiable intangible assets of an acquired business.  At March 31, 2005 and December 31, 2004, gross goodwill was $234.0 million and accumulated amortization was $38.6 million.  There were no changes to the carrying amount of goodwill during the first quarter of 2005.  Our goodwill is not deductible for tax purposes. 

 

13

 

Identifiable Intangible Assets

 

Identifiable intangible assets (all considered indefinite lived) are summarized as follows:

 

		March 31,			December 31,
		2005			2004
		(in thousands)
Unamortized intangible assets:
Mutual fund management advisory contracts		$	38,699		38,684
Subadvisory management contracts		16,300			16,300
Total		$	54,999		54,984

 

7.     Pension Plan and Postretirement Benefits Other Than Pension

 

We provide a non-contributory retirement plan that covers substantially all employees of the Company and certain vested former employees of Torchmark Corporation (our former parent company).  Benefits payable under the plan are based on years of service and compensation during the final ten years of employment.  We also sponsor an unfunded defined benefit postretirement medical plan that covers substantially all employees of the Company including our financial advisors and retirement advisors of the Legend group of subsidiaries (“Legend”).  This medical plan is contributory with retiree contributions adjusted annually.  The following table presents the components of net periodic benefit cost related to these plans for the three months ended March 31, 2005 and 2004.

 

							Other
		Pension Benefits					Postretirement Benefits
		Three months ended March 31,					Three months ended March 31,
		2005			2004		2005		2004
		(in thousands)
Components of net periodic benefit cost:
Service cost		$	1,365		1,270		105		118
Interest cost		1,170			1,099		77		85
Expected return on plan assets		(1,385		)	(1,300	)	—		—
Actuarial loss amortization		304			144		22		43
Prior service cost amortization		109			109		6		6
Transition obligation amortization		1			1		—		—
Net periodic benefit cost		$	1,564		1,323		210		252

 

 

        As disclosed in our financial statements for the year ended December 31, 2004, we anticipate that our contribution to the pension plan for 2005 will range from $0 to $10 million.  During the quarter ending March 31, 2005, we did not make a contribution to the pension plan.

 

8.     Contingencies  

 

The Company and/or certain of our subsidiaries are involved from time to time in various legal proceedings and claims incident to the normal conduct of business. On October 28, 2003, the Company announced that it was recording a charge of $32.0 million ($21.5 million net of tax) to recognize liabilities for estimated damages and legal costs for both the third quarter of 2003 and future legal costs in connection with the United Investors Life Insurance Company (“UILIC”) litigation as set forth under the headings “Alabama Proceedings” and “California Proceedings,” the NASD Enforcement Action, and ongoing

 

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disputes with former sales personnel in our Advisors channel, including the Sawtelle Arbitration.  In addition to legal costs incurred in the third quarter of 2003, this charge included estimated damages and future legal costs assuming these matters are resolved in a manner that is unfavorable after exhausting all reasonable legal remedies.  As an estimate, it is possible that the ultimate amount of damages and legal costs could be higher or lower than the Company's recorded liability.  As a result, any changes could have a material effect on the results of operations in a particular quarter or year as the Company evaluates this liability in future periods.

 

NASD Enforcement Action

 

See Note 16 of the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004 for a description and discussion of this litigation and its possible impact on the financial position and results of operations of the Company. There were no material developments in this matter since the filing of the above referenced Form 10-K.

 

Sawtelle Arbitration

 

See Note 16 of the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004 for a description and discussion of this litigation and its possible impact on the financial position and results of operations of the Company. There were no material developments in this matter since the filing of the above referenced Form 10-K.

 

Waddell & Reed Financial, Inc. vs. Torchmark Corporation

 

See Note 16 of the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004 for a description and discussion of this litigation and its possible impact on the financial position and results of operations of the Company. There were no material developments in this matter since the filing of the above referenced Form 10-K.

 

Alabama Proceedings

 

See Note 16 of the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004 for a description and discussion of this litigation and its possible impact on the financial position and results of operations of the Company. There were no material developments in this matter since the filing of the above referenced Form 10-K.

 

California Proceedings

 

See Note 16 of the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004 for a description and discussion of this litigation and its possible impact on the financial position and results of operations of the Company. There were no material developments in this matter since the filing of the above referenced Form 10-K.

 

SEC/New York Attorney General

 

See Note 16 of the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004 for a description and discussion of this litigation and its possible impact on the financial position and results of operations of the Company. There were no material developments in this matter since the filing of the above referenced Form 10-K.

 

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Williams Excessive Fee Litigation

 

See Note 16 of the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004 for a description and discussion of this litigation and its possible impact on the financial position and results of operations of the Company. There were no material developments in this matter since the filing of the above referenced Form 10-K.

 

9.     Subsequent Event

 

On April 25, 2005, the Compensation Committee of the Board of Directors approved the acceleration of vesting of all unvested options to purchase common stock of the Company that were outstanding as of that date.  This action resulted in the accelerated vesting of options to purchase 624,267 shares of common stock of the Company.  Of these options, 447,497 were “in-the-money” options having an exercise price less than the then current market price of the Company's common stock and a weighted average exercise price of $13.90 per share.  While early vesting of in-the-money options triggers remeasurement of compensation cost under current accounting standards, the Company anticipates that all in-the-money option holders will remain employed with the Company throughout the original vesting term of such options, and therefore, in accordance with existing accounting standards, no expense will be recorded for these options, unless option holders are able to exercise an option that would have expired unexercisable pursuant to its original terms.  Pro forma disclosures in the footnotes to the consolidated financial statements will include the impact of early vesting of options in the second quarter of 2005 and will result in an approximate $1.9 million pre-tax charge to pro forma earnings. 

 

In order to limit unintended personal benefits to directors and executive officers receiving accelerated vesting of options, the Compensation Committee required that each such director and executive officer agree not to dispose of any shares of common stock obtained upon exercise of the accelerated options until such time as the options would otherwise have vested, other than dispositions of stock in payment for the exercise price of options and associated taxes, if any.

 

The Company is accelerating these options because it believes it is in the best interest of the stockholders to reduce future compensation expense that the Company would otherwise be required to report in its income statement upon adoption of Statement of Financial Accounting Standards No. 123, “Share-Based Payment, (revised 2004)” (“SFAS No. 123R”) in the first quarter of 2006.  SFAS No. 123R will require that compensation expense associated with stock options be recognized in the Company’s income statement, rather than as pro forma disclosures in the footnotes to the consolidated financial statements. 

 

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Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations

 

        Certain statements contained in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, hopes, beliefs, intentions or strategies regarding the future.  All statements, other than statements of historical fact included in this Form 10-Q regarding our financial position, business strategy and other plans and objectives for future operations are forward-looking statements.  All forward-looking statements included in this Form 10-Q are based on information available to us on the date hereof, and we assume no obligation to update such forward-looking statements, whether as a result of new information, future events or otherwise.  Although we believe that the assumptions and expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct or that we will take any actions that may presently be planned and neither us nor any other person will be responsible for the accuracy or completeness of any such forward-looking statements.  Certain important factors that could cause actual results to differ materially from our expectations are disclosed in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2004, which include, without limitation, a risk that the expected benefits from the expansion of our distribution channels may not be as beneficial as expected, the adverse effect from a decline in securities markets or if our products' performance declines, failure to renew investment management agreements, our ability to retain key personnel and financial advisors, adverse results of litigation and/or arbitration judgments or settlements, acts of terrorism and/or war, competition, changes in government regulation, availability and terms of capital, regulatory enforcement actions or settlements, less favorable economic and market conditions, including our cost to finance the Company, and other risks as set out in the reports filed by us with the Securities and Exchange Commission.   Should one or more of these risks materialize or should the underlying assumptions prove incorrect, actual results could differ materially from those forecasted or expected.  All subsequent written or oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by such factors. 

 

        The information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in this Form 10-Q and the audited financial statements and notes thereto in our 2004 Annual Report on Form 10-K, as well as a more detailed explanation of risk factors at the end of this Item 2 under the heading entitled “Forward Looking Information.”

 

Overview

 

        The Company's earnings and cash flows are heavily dependent on financial market conditions.  Significant increases or decreases in the various securities markets, particularly equity markets, can have a material impact on the Company's results of operations, financial condition and cash flows.  We derive our revenues primarily from providing investment management, investment product underwriting and distribution, and administrative services to the Funds and institutional and separately managed accounts.  Investment management fees, our most substantial source of revenues, are based on the amount of average assets under management and are affected by sales levels, financial market conditions, redemptions, and the composition of assets.  Underwriting and distribution revenues, another substantial source of revenues, consist of sales charges and commissions derived from sales of investment and insurance products, distribution fees on certain variable products and mutual fund share classes, and fees earned on fee-based asset allocation products, as well as advisory services.  The products sold have various commission structures and the revenues received from sales of products vary based on the type and amount sold.  Our products are distributed through either our proprietary sales force of registered financial advisors (the “Advisors channel”) or non-proprietary distribution methods including other broker-dealers, other registered investment advisors (including the Legend retirement advisors), and 401(k) platforms (the “Wholesale channel”).  Rule 12b-1 distribution fees earned for distributing certain mutual fund shares are based upon a

 

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percentage of assets and fluctuate based on sales, redemptions, and financial market conditions.  Shareholder service fees include transfer agency fees, custodian fees for retirement plan accounts, and portfolio accounting fees.

 

Company Developments

 

In the first quarter of 2005, the Company implemented changes to the leadership of the Advisors channel to invigorate sales growth.  A new National Sales Manager and Associate National Sales Manager were appointed, both of whom were former Regional Vice Presidents and have been with us for 10 years and 19 years, respectively.  Throughout their careers, each has established a proven track record in sales management.  In conjunction with these appointments, our Chief Marketing Officer has assumed additional responsibility for all retail mutual fund sales, adding proprietary distribution through the Advisors channel to his existing responsibilities for marketing and sales through the Wholesale channel.

 

Recent Accounting Developments

 

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, “Share-Based Payment, (revised 2004)” (“SFAS No. 123R”). SFAS No. 123R requires entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award, normally the vesting period. This revised statement allows entities to restate previously issued financial statements or adopt the provisions on a prospective basis. The provisions of SFAS No. 123R are effective for our 2006 fiscal year beginning January 1, 2006. We will continue to apply the accounting provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” in accounting for our stock-based compensation plans until the effective date of SFAS No. 123R.

 

On April 25, 2005, the Compensation Committee of the Board of Directors approved the acceleration of vesting of all unvested options to purchase common stock of the Company that were outstanding as of that date.  This action resulted in the accelerated vesting of options to purchase 624,267 shares of common stock of the Company.  Of these options, 447,497 were “in-the-money” options having an exercise price less than the then current market price of the Company's common stock and a weighted average exercise price of $13.90 per share.  While early vesting of in-the-money options triggers remeasurement of compensation cost under current accounting standards, the Company anticipates that all in-the-money option holders will remain employed with the Company throughout the original vesting term of such options, and therefore, in accordance with existing accounting standards, no expense will be recorded for these options, unless option holders are able to exercise an option that would have expired unexercisable pursuant to its original terms.  Pro forma disclosures in the footnotes to the consolidated financial statements will include the impact of early vesting of options in the second quarter of 2005 and will result in an approximate $1.9 million pre-tax charge to pro forma earnings.

 

In order to limit unintended personal benefits to directors and executive officers receiving accelerated vesting of options, the Compensation Committee required that each such director and executive officer agree not to dispose of any shares of common stock obtained upon exercise of the accelerated options until such time as the options would otherwise have vested, other than dispositions of stock in payment for the exercise price of options and associated taxes, if any.

 

The Company is accelerating these options because it believes it is in the best interest of the stockholders to reduce future compensation expense that the Company would otherwise be required to report in its income statement upon adoption of SFAS No. 123R in the first quarter of 2006.  SFAS 123R will require that compensation expense associated with stock options be recognized in the Company’s income statement, rather than as pro forma disclosures in the footnotes to the consolidated financial statements.

 

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Results of Operations – Three Months Ended March 31, 2005 as Compared with Three Months Ended March 31, 2004

 

Net Income

 

The Company reported net income of $22.8 million, or $0.28 per diluted share, in the first quarter of 2005 compared to net income of $27.9 million, or $0.34 per diluted share, in first quarter of 2004.  A discussion of the various components of net income follows.

 

Investment Management Fee Revenues

 

Investment management fee revenues were $63.6 million, an increase of $3.3 million, or 5%, from last year's first quarter.  Total average assets under management for the current quarter were $38.4 billion compared to $37.0 billion for the first quarter of 2004, up 4%.  

 

Revenues from management services provided to our retail mutual funds, which are distributed both through the Advisors channel and through non-proprietary distribution in the Wholesale channel, increased $3.4 million, or 7%, while the related retail average assets increased 5% to $29.9 billion.  Compared to last year’s first quarter, the average assets in the Ivy Funds family grew 58% to $4.6 billion due primarily to significant sales growth in the non-proprietary segment of the Wholesale channel.   The average assets in the Advisors Funds family contracted 3%, due in part to net asset outflows, some of which moved into the Ivy Funds family, and in part to market depreciation of assets.  The Ivy Funds family carries a slightly higher management fee rate; therefore, their significant growth in average assets resulted in a larger management fee increase for combined retail mutual funds than the increase to combined retail average assets.  Institutional and separate account business was flat compared with the first quarter of 2004.

 

The following table provides information regarding the composition of our average assets under management by asset class and distribution channel (in millions).

 

		First Quarter 2005
					Wholesale Channel
		Advisors Channel			Non-proprietary		Institutional		Total
Asset Class:
Equity		$	20,355		4,480		7,837		$	32,672
Fixed Income		3,992			324		638		4,954
Money Market		694			53		—		747
Total		$	25,041		4,857		8,475		$	38,373

 

 

		First Quarter 2004
					Wholesale Channel
		Advisors Channel			Non-proprietary		Institutional		Total
Asset Class:
Equity		$	19,701		3,652		7,762		$	31,115
Fixed Income		4,052			278		717		5,047
Money Market		795			60		—		855
Total		$	24,548		3,990		8,479		$	37,017

 

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