WADDELL & REED FINANCIAL INC - FORM 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2010

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)

Delaware		51-0261715
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification No.)

6300 Lamar Avenue

Overland Park, Kansas 66202

(Address, including zip code, of Registrant’s principal executive offices)

(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 x No ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer x		Accelerated filer o

Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ¨ No x.

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

Class		Outstanding as of October 22, 2010
Class A common stock, $.01 par value		85,388,874

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WADDELL & REED FINANCIAL, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended September 30, 2010

			Page No.

Part I.	Financial Information

Item 1.		Financial Statements (unaudited)

		Consolidated Balance Sheets at September 30, 2010 and December 31, 2009	3

		Consolidated Statements of Income for the three and nine months ended September 30, 2010 and September 30, 2009	4

		Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2010	5

		Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2010 and September 30, 2009	6

		Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and September 30, 2009	7

		Notes to the Unaudited Consolidated Financial Statements	8

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

Item 3.		Quantitative and Qualitative Disclosures About Market Risk	30

Item 4.		Controls and Procedures	30

Part II.	Other Information

Item 1.		Legal Proceedings	31

Item 1A.		Risk Factors	31

Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	31

Item 6.		Exhibits	32

		Signatures	33

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands)

	September 30,
	2010			December 31,
	(unaudited)			2009

Assets:
Cash and cash equivalents	$	246,517		244,359
Cash and cash equivalents - restricted	57,036			72,941
Investment securities	95,539			70,524
Receivables:
Funds and separate accounts	25,863			34,948
Customers and other	95,341			179,100
Deferred income taxes	8,300			8,225
Income taxes receivable	2,320			—
Prepaid expenses and other current assets	10,207			8,619
Total current assets	541,123			618,716

Property and equipment, net	70,030			68,171
Deferred sales commissions, net	63,948			64,123
Goodwill and identifiable intangible assets	221,210			221,210
Other non-current assets	10,368			11,162
Total assets	$	906,679		983,382

Liabilities:
Accounts payable	$	38,004		25,210
Payable to investment companies for securities	100,052			222,168
Accrued compensation	41,333			35,341
Short-term debt	189,996			—
Income taxes payable	—			1,044
Other current liabilities	76,861			76,994
Total current liabilities	446,246			360,757

Long-term debt	—			199,984
Accrued pension and postretirement costs	23,283			28,731
Deferred income taxes	1,263			6,983
Other non-current liabilities	19,952			17,872
Total liabilities	490,744			614,327

Commitments and contingencies

Stockholders’ equity :
Preferred stock-$1.00 par value: 5,000 shares authorized; none issued	—			—
Class A Common stock-$0.01 par value: 250,000 shares authorized; 99,701 shares issued; 85,389 shares outstanding (85,807 shares outstanding at December 31, 2009)	997			997
Additional paid-in capital	198,052			189,900
Retained earnings	589,580			527,876
Cost of 14,312 common shares in treasury (13,894 at December 31, 2009)	(353,680		)	(328,154	)
Accumulated other comprehensive loss	(19,014		)	(21,564	)
Total stockholders’ equity	415,935			369,055
Total liabilities and stockholders’ equity	$	906,679		983,382

See accompanying notes to unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Income

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

	For the three months					For the nine months
	ended September 30,					ended September 30,
	2010			2009		2010		2009

Revenues:
Investment management fees	$	111,159		94,687		333,874		248,234
Underwriting and distribution fees	114,071			96,559		341,752		268,379
Shareholder service fees	29,577			26,730		88,014		77,663

Total	254,807			217,976		763,640		594,276

Operating expenses:
Underwriting and distribution	132,857			115,119		400,229		324,618
Compensation and related costs (including share-based compensation of $10,944, $7,645, $30,049 and $22,541, respectively)	36,164			29,275		103,444		82,373
General and administrative	16,022			15,106		48,417		43,022
Subadvisory fees	6,481			6,129		20,441		16,317
Depreciation	3,526			3,503		10,457		10,259

Total	195,050			169,132		582,988		476,589

Operating income	59,757			48,844		180,652		117,687
Investment and other income	3,933			2,316		3,239		1,385
Interest expense	(3,128		)	(3,153	)	(9,797	)	(9,452	)

Income before provision for income taxes	60,562			48,007		174,094		109,620
Provision for income taxes	20,029			14,594		63,500		37,367

Net income	$	40,533		33,413		110,594		72,253

Net income per share:
Basic	$	0.47		0.39		1.29		0.85
Diluted	$	0.47		0.39		1.29		0.84

Weighted average shares outstanding:
Basic	85,438			85,699		85,683		85,503
Diluted	85,448			85,774		85,715		85,565

See accompanying notes to unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders’ Equity

For the Nine Months Ended September 30, 2010

(Unaudited, in thousands)

										Accumulated
				Additional						Other		Total
	Common Stock			Paid-in		Retained		Treasury		Comprehensive		Stockholders’
	Shares	Amount		Capital		Earnings		Stock		Income (Loss)		Equity

Balance at December 31, 2009	99,701	$	997	189,900		527,876		(328,154	)	(21,564	)	369,055

Net income	—	—		—		110,594		—		—		110,594
Recognition of equity compensation	—	—		30,049		—		—		—		30,049
Issuance of nonvested shares and other	—	—		(28,559	)	—		28,559		—		—
Dividends accrued, $0.57 per share	—	—		—		(48,890	)	—		—		(48,890	)
Exercise of stock options	—	—		2,382		—		7,293		—		9,675
Excess tax benefits from share-based payment arrangements	—	—		4,280		—		—		—		4,280
Repurchase of common stock	—	—		—		—		(61,378	)	—		(61,378	)
Unrealized appreciation on available for sale investment securities	—	—		—		—		—		1,709		1,709
Valuation allowance on investment securities’ deferred tax asset	—	—		—		—		—		590		590
Reclassification for amounts included in net income	—	—		—		—		—		(799	)	(799	)
Pension and postretirement benefits	—	—		—		—		—		1,050		1,050

Balance at September 30, 2010	99,701	$	997	198,052		589,580		(353,680	)	(19,014	)	415,935

See accompanying notes to unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)

	For the three months					For the nine months
	ended September 30,					ended September 30,
	2010			2009		2010		2009

Net income	$	40,533		33,413		110,594		72,253

Other comprehensive income:

Net unrealized appreciation of investment securities during the period, net of income taxes of $1,917, $1,522, $997 and $2,569, respectively	3,286			2,634		1,709		4,471

Valuation allowance on investment securities’ deferred tax asset during the period	1,128			—		590		—

Pension and postretirement benefits, net of income taxes of $206, $201, $617 and $550, respectively	350			347		1,050		1,096

Reclassification adjustments for amounts included in net income, net of income taxes of $(143), $(21), $(464) and $1,271, respectively	(247		)	(35	)	(799	)	2,200

Comprehensive income	$	45,050		36,359		113,144		80,020

See accompanying notes to unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited, in thousands)

	For the nine months
	ended September 30,
	2010			2009
Cash flows from operating activities:
Net income	$	110,594		72,253
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	10,325			10,129
Other than temporary impairment of investments in affiliated mutual funds	—			3,686
Amortization of deferred sales commissions	44,528			30,445
Share-based compensation	30,049			22,941
Excess tax benefits from share-based payment arrangements	(4,280		)	(1,584	)
Gain on sale of available-for-sale investment securities	(1,093		)	(45	)
Net purchases and sales of trading securities	(11,865		)	(119	)
Unrealized gain on trading securities	(2,879		)	(3,919	)
Loss on sale and retirement of property and equipment	88			396
Capital gains and dividends reinvested	(366		)	(470	)
Deferred income taxes	(6,353		)	1,246
Changes in assets and liabilities:
Cash and cash equivalents - restricted	15,905			(32,537	)
Receivables from funds and separate accounts	9,085			(180	)
Other receivables	83,759			(18,752	)
Other assets	(794		)	(3,443	)
Deferred sales commissions	(44,353		)	(37,363	)
Accounts payable and payable to investment companies	(109,322		)	39,048
Other liabilities	5,153			5,037

Net cash provided by operating activities	$	128,181		86,769

Cash flows from investing activities:
Purchases of available-for-sale investment securities	(20,000		)	(7,700	)
Proceeds from sales and maturities of available-for-sale investment securities	12,773			384
Additions to property and equipment	(12,408		)	(11,563	)
Proceeds from sales of property and equipment	5			516

Net cash used in investing activities	$	(19,630	)	(18,363	)

Cash flows from financing activities:
Debt repayment	(10,000		)	—
Dividends paid	(48,970		)	(48,809	)
Repurchase of common stock	(61,378		)	(40,430	)
Exercise of stock options	9,675			10,222
Excess tax benefits from share-based payment arrangements	4,280			1,584

Net cash used in financing activities	$	(106,393	)	(77,433	)
Net increase (decrease) in cash and cash equivalents	2,158			(9,027	)
Cash and cash equivalents at beginning of period	244,359			210,328
Cash and cash equivalents at end of period	$	246,517		201,301

See accompanying notes to unaudited consolidated financial statements.

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WADDELL & REED FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business and Significant Accounting Policies

Waddell & Reed Financial, Inc. and Subsidiaries

Waddell & Reed Financial, Inc. and subsidiaries (hereinafter referred to as the “Company,” “we,” “our” and “us”) 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”), Ivy Funds (the “Ivy Funds”), Ivy Funds Variable Insurance Portfolios (the “Ivy Funds VIP”), and Waddell & Reed InvestEd Portfolios (“InvestEd”), our college savings plan (collectively, the Advisors Funds, Ivy Funds, Ivy Funds VIP and InvestEd are referred to as 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 investment management agreements, underwriting agreements, and shareholder servicing and accounting service agreements that set forth the fees to be charged for these services. The majority of these agreements 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 currently include mainly domestic and international equity securities, but also include debt securities. Accordingly, fluctuations in financial markets and composition of assets under management can significantly 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 Part I, 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, 2009 (the “2009 Form 10-K”). Certain amounts in prior period financial statements 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 2009 Form 10-K, which include the following: use of estimates, cash and cash equivalents, disclosures about fair value of financial instruments, investment securities and investments in affiliated mutual funds, property and equipment, software developed for internal use, deferred sales commissions, revenue recognition, advertising and promotion, share-based compensation, accounting for income taxes, earnings per share and derivatives and hedging activities. The Company modified its accounting policy disclosure related to goodwill and identifiable intangible assets, which is summarized in its Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010.

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 September 30, 2010, the results of operations for the three and nine months ended September 30, 2010 and 2009, and cash flows for the nine months ended September 30, 2010 and 2009 in conformity with accounting principles generally accepted in the United States.

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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 — restricted represents cash held for the benefit of customers segregated in compliance with federal and other regulations. Substantially all cash balances are in excess of federal deposit insurance limits.

3. Investment Securities

Investment securities at September 30, 2010 and December 31, 2009 are as follows:

	Amortized		Unrealized	Unrealized
September 30, 2010	cost		gains	losses		Fair value
	(in thousands)
Available-for-sale securities:
Mortgage-backed securities	$	10	2	—		12
Municipal bonds	4,606		17	(48	)	4,575
Affiliated mutual funds	38,633		4,484	(29	)	43,088
	$	43,249	4,503	(77	)	47,675

Trading securities:
Mortgage-backed securities						74
Municipal bonds						500
Corporate bonds						58
Common stock						29
Affiliated mutual funds						47,203
						47,864

Total investment securities						95,539

	Amortized		Unrealized	Unrealized
December 31, 2009	cost		gains	losses		Fair value
	(in thousands)
Available-for-sale securities:
Mortgage-backed securities	$	10	2	—		12
Municipal bonds	4,959		—	(286	)	4,673
Affiliated mutual funds	29,817		3,241	(143	)	32,915
	$	34,786	3,243	(429	)	37,600

Trading securities:
Mortgage-backed securities						107
Municipal bonds						478
Corporate bonds						94
Common stock						30
Affiliated mutual funds						32,215
						32,924

Total investment securities						70,524

Purchases and sales of trading securities during the nine months ended September 30, 2010 were $15.3 million and $3.4 million, respectively.

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A summary of available-for-sale debt securities and affiliated mutual funds with fair values below carrying values at September 30, 2010 and December 31, 2009 is as follows:

	Less than 12 months				12 months or longer			Total
			Unrealized		Fair	Unrealized		Fair	Unrealized
September 30, 2010	Fair value		losses		value	losses		value	losses
	(in thousands)
Municipal bonds	$	—	—		2,680	(48	)	2,680	(48	)
Affiliated mutual funds	100		(2	)	563	(27	)	663	(29	)
Total temporarily impaired securities	$	100	(2	)	3,243	(75	)	3,343	(77	)

	Less than 12 months				12 months or longer			Total
			Unrealized		Fair	Unrealized		Fair	Unrealized
December 31, 2009	Fair value		losses		value	losses		value	losses
	(in thousands)
Municipal bonds	$	3,843	(125	)	830	(161	)	4,673	(286	)
Affiliated mutual funds	11,064		(64	)	823	(79	)	11,887	(143	)
Total temporarily impaired securities	$	14,907	(189	)	1,653	(240	)	16,560	(429	)

Based upon our assessment of these municipal bonds and affiliated mutual funds, the time frame investments have been in a loss position, our intent to hold affiliated mutual funds until they have recovered and our history of holding bonds until maturity, we determined that a write-down was not necessary at September 30, 2010.

Mortgage-backed securities and municipal bonds accounted for as available-for-sale and held as of September 30, 2010 mature as follows:

	Amortized cost		Fair value
	(in thousands)
After one year but within 10 years	$	3,615	3,633
After 10 years	1,001		954
	$	4,616	4,587

Mortgage-backed securities, municipal bonds and corporate bonds accounted for as trading and held as of September 30, 2010 mature as follows:

	Fair value
	(in thousands)
After one year but within 10 years	$	558
After 10 years	74
	$	632

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We determine the fair value of our investments using broad levels of inputs as defined by related accounting standards as follows:

· Level 1 — Investments are valued using quoted prices in active markets for identical securities at the reporting date. Assets classified as Level 1 include affiliated mutual funds classified as available-for-sale and affiliated mutual funds and common stock classified as trading.

· Level 2 — Investments are valued using other significant observable inputs, including quoted prices in active markets for similar securities. Assets classified as Level 2 include mortgage-backed securities, municipal bonds and corporate bonds.

· Level 3 — Investments are valued using significant unobservable inputs, including the Company’s own assumptions in determining the fair value of investments.

The following table summarizes our investment securities recognized on our balance sheet using fair value measurements based on the differing levels of inputs:

	September 30,		December 31,
	2010		2009
	(in thousands)
Level 1	$	90,320	65,160
Level 2	5,219		5,364
Level 3	—		—
Total	$	95,539	70,524

4. Goodwill and Identifiable Intangible Assets

Goodwill represents the excess of purchase price over the tangible assets and identifiable intangible assets of an acquired business. Our goodwill is not deductible for tax purposes. The carrying values of goodwill and identifiable intangible assets (all considered indefinite-life) are summarized as follows:

	September 30,			December 31,
	2010			2009
	(in thousands)

Goodwill	$	202,518		202,518
Accumulated amortization	(36,307		)	(36,307	)
Total goodwill	166,211			166,211

Mutual fund management advisory contracts	38,699			38,699
Mutual fund subadvisory management contracts	16,300			16,300
Total identifiable intangible assets	54,999			54,999

Total	$	221,210		221,210

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5. Indebtedness

Debt is reported at its carrying amount on the consolidated balance sheet. The fair value of the Company’s debt is approximately $192.9 million as of September 30, 2010, compared to the carrying value of $190.0 million.

During the first quarter of 2010, we repurchased $10.0 million of our $200.0 million aggregate principal amount 5.6% senior notes due January 2011 (the “Notes”). The retirement resulted in a loss of approximately $400 thousand, which is included in interest expense in the statement of income. Additionally, we reclassified the Notes from long-term debt to short-term debt due to their scheduled maturity within the next 12 months.

On August 31, 2010, the Company entered into an agreement to complete a $190.0 million private placement of Senior Notes (the “Senior Notes”). The proceeds of this debt issuance will be used to refinance the existing $190.0 million senior notes expiring in January 2011. The Senior Notes will be unsecured and will be issued in two tranches: $95.0 million bearing interest at 5% and maturing January 13, 2018 and $95.0 million bearing interest of 5.75% and maturing January 13, 2021. Interest will be payable semi-annually in January and July of each year. The most restrictive provisions of the agreement will require the Company to maintain a consolidated leverage ratio not to exceed 3.0 to 1.0 for four consecutive quarters and a consolidated interest coverage ratio of not less than 4.0 to 1.0 for four consecutive quarters. The Senior Notes contain a delayed funding provision which will allow the Company to draw down the proceeds in January 2011 when the existing senior notes mature.

The Company also entered into a three year revolving credit facility (the “Credit Facility”) with various lenders, effective August 31, 2010, which initially provides for borrowings of up to $125.0 million and replaced the Company’s previous revolving credit facility. Lenders could, at their option upon the Company’s request, expand the facility to $200.0 million. At September 30, 2010, there were no borrowings outstanding under the Credit Facility. Borrowings under the Credit Facility bear interest at various rates including adjusted LIBOR or an alternative base rate plus, in each case, an incremental margin based on the Company’s credit rating. The Credit Facility also provides for a facility fee on the aggregate amount of commitments under the revolving facility (whether or not utilized). The facility fee is also based on the Company’s credit rating level. The Credit Facility’s covenants match those outlined above for the Senior Notes. The Company was in compliance with these covenants and similar covenants in prior facilities for all years presented.

6. Income Tax Uncertainties

As of January 1, 2010 and September 30, 2010, the Company had unrecognized tax benefits, including penalties and interest, of $6.8 million ($4.7 million net of federal benefit) and $6.8 million ($4.8 million net of federal benefit), respectively, that if recognized, would impact the Company’s effective tax rate. Unrecognized tax benefits that are not expected to be settled within the next 12 months are included in other non-current liabilities in the consolidated balance sheet; unrecognized tax benefits that are expected to be settled within the next 12 months are included in income taxes payable.

The Company’s accounting policy with respect to interest and penalties related to tax uncertainties is to classify these amounts as income taxes. As of January 1, 2010, the total amount of accrued interest and penalties related to uncertain tax positions recognized in the consolidated balance sheet was $2.0 million ($1.6 million net of federal benefit). The total amount of penalties and interest, net of federal benefit, related to tax uncertainties recognized in the statement of income for the nine month period ended September 30, 2010 was $81 thousand. The total amount of accrued penalties and interest related to uncertain tax positions at September 30, 2010 of $1.9 million ($1.5 million net of federal benefit) is included in the total unrecognized tax benefits described above.

In the ordinary course of business, many transactions occur for which the ultimate tax outcome is uncertain. In addition, respective tax authorities periodically audit our income tax returns. These audits examine our significant tax filing positions, including the timing and amounts of deductions and the allocation of income among tax jurisdictions. The 2007, 2008 and 2009 federal income tax returns are open

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tax years that remain subject to potential future audit. The 2005 and 2006 federal tax years also remain open to a limited extent due to capital loss carryback claims. State income tax returns for all years after 2006, and in certain states, income tax returns for 2005 and 2006, are subject to potential future audit by tax authorities in the Company’s major state tax jurisdictions.

The Company is currently being audited in three state jurisdictions. It is reasonably possible that the Company will settle the audits in these jurisdictions within the next 12 month period. It is estimated that the Company’s liability for unrecognized tax benefits, including penalties and interest, could decrease by approximately $705 thousand to $2.1 million ($474 thousand to $1.4 million net of federal benefit) upon settlement of these audits. Such settlements are not anticipated to have a significant impact on the results of operations.

7. Pension Plan and Postretirement Benefits Other Than Pension

We provide a non-contributory retirement plan that covers substantially all employees (the “Pension Plan”). Benefits payable under the Pension Plan are based on employees’ years of service and compensation during the final 10 years of employment. We also sponsor an unfunded defined benefit postretirement medical plan that covers substantially all employees, including Waddell & Reed and Legend advisors. The medical plan is contributory with retiree contributions adjusted annually. The medical plan does not provide for post age 65 benefits with the exception of a small group of employees that were grandfathered when such plan was established.

The following table presents the components of net periodic pension and other postretirement costs related to these plans:

	Pension Benefits					Other Postretirement Benefits		Pension Benefits				Other Postretirement Benefits
	Three months ended September 30,					Three months ended September 30,		Nine months ended September 30,				Nine months ended September 30,
	2010			2009		2010	2009	2010		2009		2010	2009
	(in thousands)							(in thousands)

Components of net periodic benefit cost:
Service cost	$	1,535		1,319		111	93	4,605		3,957		332	279
Interest cost	1,649			1,597		91	85	4,947		4,790		273	255
Expected return on plan assets	(1,875		)	(1,607	)	—	—	(5,624	)	(4,821	)	—	—
Actuarial loss amortization	404			399		—	—	1,212		1,197		—	—
Prior service cost amortization	139			139		11	10	417		417		34	30
Transition obligation amortization	1			1		—	—	3		3		—	—

Total	$	1,853		1,848		213	188	5,560		5,543		639	564

During the nine months ended September 30, 2010, we made a $10.0 million contribution to the Pension Plan. In October 2010, we made an additional $2.5 million contribution to the Pension Plan. We do not expect to make additional contributions to the Pension Plan for the remainder of 2010.

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8. Stockholders’ Equity

Earnings per Share

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

	Three months ended			Nine months ended
	September 30,			September 30,
	2010		2009	2010	2009
	(in thousands, except per share amounts)

Net income	$	40,533	33,413	110,594	72,253

Weighted average shares outstanding - basic	85,438		85,699	85,683	85,503
Dilutive potential shares from stock options	10		75	32	62
Weighted average shares outstanding - diluted	85,448		85,774	85,715	85,565

Earnings per share:
Basic	$	0.47	0.39	1.29	0.85
Diluted	$	0.47	0.39	1.29	0.84

Anti-dilutive Securities

Options to purchase 401 thousand shares and 327 thousand shares of our common stock were excluded from the diluted earnings per share calculation for the three and nine months ended September 30, 2010, respectively, because they were anti-dilutive. Options to purchase 795 thousand shares and 866 thousand shares of common stock were excluded from the diluted earnings per share calculation for the three and nine months ended September 30, 2009, respectively, because they were anti-dilutive.

Dividends

On July 21, 2010, the Board of Directors (the “Board”) approved a dividend on our common stock in the amount of $0.19 per share to stockholders of record as of October 1, 2010 to be paid on November 1, 2010. The total dividend to be paid is approximately $16.2 million.

On October 14, 2010, the Board approved an increase in the quarterly dividend on our common stock to $0.20 per share. The dividend is payable on February 1, 2011 to stockholders of record as of January 3, 2011.

Common Stock Repurchases

The Board 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. There were 37,087 shares and 1,916,297 shares repurchased in the open market or privately during the three and nine months ended September 30, 2010, respectively, which included 27,087 shares and 299,417 shares repurchased from employees who elected to tender shares to cover their minimum income tax withholdings with respect to the vesting of stock awards during the three and nine months ended September 30, 2010, respectively. There were 678,978 shares and 1,772,843 shares repurchased in the open market or privately during the three and nine months ended September 30, 2009, respectively, which included 6,043 shares and 256,108 shares repurchased from employees who elected to tender shares to cover their minimum income tax withholdings with respect to the vesting of stock awards during the three and nine months ended September 30, 2009, respectively.

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9. Share-Based Compensation

A summary of stock option activity and related information for the nine months ended September 30, 2010 is presented in the table below. All options outstanding expire prior to December 31, 2013.

	Options		Weighted average exercise price
Outstanding, December 31, 2009	897,503		$	30.65
Granted	—		—
Exercised	(303,870	)	31.84
Terminated/Cancelled	(127,026	)	31.65
Outstanding, September 30, 2010	466,607		$	29.61
Exercisable, September 30, 2010	466,607		$	29.61

10. Contingencies

The Company is involved from time to time in various legal proceedings, regulatory investigations and claims incident to the normal conduct of business, which may include proceedings that are specific to us and others generally applicable to business practices within the industries in which we operate. A substantial legal liability or a significant regulatory action against us could have an adverse effect on our business, financial condition and on the results of operations in a particular quarter or year.

Michael E. Taylor, Kenneth B. Young, individuals, on behalf of themselves individually and on behalf of others similarly situated v. Waddell & Reed, Inc., a Delaware Corporation; Waddell & Reed Financial, Inc., a Delaware Corporation; Waddell & Reed Development, Inc., a Delaware Corporation; Waddell & Reed Financial Advisors, a fictitious business name; and DOES 1 through 10 inclusive; Case No. 09-CV-2909 DMS WVG; in the United States District Court for the Southern District of California.

In this action filed December 28, 2009, the Company, along with various of its affiliates, were sued in an individual action, class action and Fair Labor Standards Act (“FLSA”) nationwide collective action by two former advisors asserting misclassification of financial advisors as independent contractors instead of employees. Plaintiffs assert claims under the FLSA for minimum wages and overtime wages, and under California Labor Code Statutes for timely pay wages, minimum wages, overtime compensation, meal periods, reimbursement of losses and business expenses and itemized wage statements and a claim for Unfair Business Practices under §17200 of the California Business & Professions Code. Plaintiffs seek declaratory and injunctive relief and monetary damages. The Company intends to vigorously contest plaintiffs’ claims.

In the opinion of management, the ultimate resolution and outcome of this matter is uncertain. At this stage of the litigation, the Company is unable to estimate the expense or exposure, if any, that it may represent. The ultimate resolution of this matter, or an adverse determination against the Company, could have a material adverse impact on the financial position and results of operations of the Company. However, this possible impact is unknown and not reasonably determinable; therefore, no liability has been recorded in the consolidated financial statements.

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

This Quarterly Report on Form 10-Q contains “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, which reflect the current views and assumptions of management with respect to future events regarding our business and industry in general. These forward-looking statements include all statements, other than statements of historical fact, regarding our financial position, business strategy and other plans and objectives for future operations, including statements with respect to revenues and earnings, the amount and composition of assets under management, distribution sources, expense levels, redemption rates and the financial markets and other conditions. These statements are generally identified by the use of such words as “may,” “could,” “should,” “would,” “believe,” “anticipate,” “forecast,” “estimate,” “expect,” “intend,” “plan,” “project,” “outlook,” “will,” “potential” and similar statements of a future or forward-looking nature. Readers are cautioned that any forward-looking information provided by or on behalf of the Company is not a guarantee of future performance. Actual results may differ materially from those contained in these forward-looking statements as a result of various factors, including but not limited to those discussed below. If one or more events related to these or other risks, contingencies or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from those forecasted or expected. 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, 2009, which include, without limitation:

· A decline in the securities markets or in the relative investment performance of our Funds and other investment portfolios and products as compared to competing funds;

· The introduction of legislative or regulatory proposals or judicial rulings that change the independent contractor classification of our financial advisors at the federal or state level for employment tax or other employee benefit purposes;

· The adverse ruling or resolution of any litigation, regulatory investigations and proceedings, or securities arbitrations by a federal or state court or regulatory body;

· Non-compliance with applicable laws or regulations and changes in current legal, regulatory, accounting, tax or compliance requirements or governmental policies;

· The loss of existing distribution channels or inability to access new distribution channels;

· A reduction in assets under our management on short notice, through increased redemptions in our distribution channels or our Funds, particularly those Funds with a high concentration of assets, or investors terminating their relationship with us or shifting their funds to other types of accounts with different rate structures;

· A decrease in, or the elimination of, any future quarterly dividend paid to stockholders; and

· Our inability to hire and retain senior executive management and other key personnel.

The foregoing factors should not be construed as exhaustive and should be read together with other cautionary statements included in this and other reports and filings we make with the Securities and Exchange Commission, including the information in Item 1 “Business” and Item 1A “Risk Factors” of Part I and Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part II to our Annual Report on Form 10-K for the year ended December 31, 2009 and as updated in our quarterly reports on Form 10-Q during the year ending December 31, 2010. All forward-looking statements speak only as the date on which they are made and we undertake no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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Overview

We are one of the oldest mutual fund and asset management firms in the country, with expertise in a broad range of investment styles and across a variety of market environments. Our 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 our results of operations, financial condition and cash flows.

We derive our revenues primarily from providing investment management, investment product underwriting and distribution, and shareholder services administration to mutual funds and institutional and separately managed accounts. Investment management fees 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. Our underwriting and distribution revenues consist of commissions derived from sales of investment and insurance products, distribution fees on certain variable products, 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 product sales vary based on the type and amount sold. Rule 12b-1 service and distribution fees earned for servicing and/or distributing certain mutual fund shares are based upon assets under management and fluctuate based on sales, redemptions and financial market conditions. Other service fees include transfer agency fees, custodian fees for retirement plan accounts and portfolio accounting.

One of our distinctive qualities is that we are a significant distributor of investment products. Our retail products are distributed through our sales force of registered financial advisors (the “Advisors channel”) or through third-parties such as other broker/dealers, registered investment advisors (including the retirement advisors of Legend) and various retirement platforms, (collectively, the “Wholesale channel”). We also market our investment advisory services to institutional investors, either directly or through consultants (the “Institutional channel”).

Third Quarter Highlights

Our average assets under management during the third quarter of 2010 were 20% higher than our average assets under management during the third quarter of 2009, resulting in a significant increase in revenues for the current year. Ending assets under management of $76.0 billion as of September 30, 2010 are 2% higher than our previous quarter-end high of $74.2 billion at March 31, 2010.

Our balance sheet remains strong, and we ended the quarter with cash and investments of over $342.0 million. We renewed our $125.0 million credit facility during the third quarter and have successfully secured funding for senior notes with a delayed funding provision that will allow us to draw down the proceeds in January 2011 when the existing senior notes mature.

Potential Impact of Health Care Reform Legislation

In March of 2010, President Obama signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act (HR 3590) and the Health Care Education and Affordability Reconciliation Act (HR 4872) (the “Acts”). The Acts contain provisions that could impact the Company’s accounting for its postretirement medical plan in future periods. However, the extent of that impact, if any, cannot be determined until regulations are promulgated under the Acts and additional interpretations of the Acts become available.

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Assets Under Management

Assets under management increased to nearly $76.0 billion on September 30, 2010 compared to $68.3 billion on June 30, 2010 due to market appreciation of $7.0 billion and net flows of $658 million.

Change in Assets Under Management(1)

	Third Quarter 2010
	Advisors			Wholesale		Institutional		Total
	(in millions)

Beginning Assets	$	28,215		32,523		7,541		$	68,279

Sales (net of commissions)	839			2,933		905		4,677
Redemptions	(919		)	(2,566	)	(704	)	(4,189		)
Net Sales	(80		)	367		201		488

Net Exchanges	(138		)	27		115		4
Reinvested Dividends & Capital Gains	81			59		26		166
Net Flows	(137		)	453		342		658

Market Appreciation	2,705			3,504		821		7,030
Ending Assets	$	30,783		36,480		8,704		$	75,967

	Third Quarter 2009
	Advisors			Wholesale		Institutional		Total
	(in millions)

Beginning Assets	$	25,205		23,213		7,193		$	55,611

Disposition of Assets	—			—		(488	)	(488		)

Sales (net of commissions)	804			4,064		277		5,145
Redemptions	(719		)	(1,524	)	(608	)	(2,851		)
Net Sales	85			2,540		(331	)	2,294

Net Exchanges	(25		)	24		—		(1		)
Reinvested Dividends & Capital Gains	78			29		30		137
Net Flows	138			2,593		(301	)	2,430

Market Appreciation	3,008			3,169		759		6,936
Ending Assets	$	28,351		28,975		7,163		$	64,489

(1) Includes all activity of the Funds and institutional accounts, including money market funds.

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Assets under management grew to nearly $76.0 billion on September 30, 2010 compared to $69.8 billion on December 31, 2009 due to net sales of $3.7 billion and market appreciation of $2.0 billion. Net sales were primarily driven by the Wholesale channel during the nine month period.

	Year to Date 2010
	Advisors			Wholesale		Institutional		Total
	(in millions)

Beginning Assets	$	29,474		32,818		7,490		$	69,782

Sales (net of commissions)	2,680			10,893		2,491		16,064
Redemptions	(2,582		)	(7,976	)	(1,771	)	(12,329		)
Net Sales	98			2,917		720		3,735

Net Exchanges	(230		)	115		115		—
Reinvested Dividends & Capital Gains	242			160		75		477
Net Flows	110			3,192		910		4,212

Market Appreciation	1,199			470		304		1,973
Ending Assets	$	30,783		36,480		8,704		$	75,967

	Year to Date 2009
	Advisors			Wholesale		Institutional		Total
	(in millions)

Beginning Assets	$	23,472		17,489		6,523		$	47,484

Disposition of Assets	—			—		(488	)	(488		)

Sales (net of commissions)	2,282			10,557		1,198		14,037
Redemptions	(2,266		)	(4,240	)	(1,397	)	(7,903		)
Net Sales	16			6,317		(199	)	6,134

Net Exchanges	(78		)	49		26		(3		)
Reinvested Dividends & Capital Gains	258			113		82		453
Net Flows	196			6,479		(91	)	6,584

Market Appreciation	4,683			5,007		1,219		10,909
Ending Assets	$	28,351		28,975		7,163		$	64,489

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Average assets under management, which are generally more indicative of trends in revenue for providing investment management services than the quarter over quarter change in ending assets under management, are presented below.

Average Assets Under Management

	Third Quarter 2010
	Advisors		Wholesale	Institutional	Total
	(in millions)

Asset Class:
Equity	$	21,479	31,631	7,359	$	60,469
Fixed Income	6,823		2,546	743	10,112
Money Market	1,267		278	—	1,545
Total

WADDELL & REED FINANCIAL INC - FORM 10-Q - October 28, 2010

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