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Table of Contents

 

 

 

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, 2015

 

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)

 

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 o.

 

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 o.

 

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 o  No x.

 

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

 

Class

 

Outstanding as of November 2, 2015

Class A common stock, $.01 par value

 

82,992,048

 

 

 



Table of Contents

 

WADDELL & REED FINANCIAL, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended September 30, 2015

 

 

 

 

Page No.

 

 

 

 

Part I.

Financial Information

 

 

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

 

 

Consolidated Balance Sheets at September 30, 2015 and December 31, 2014

 

3

 

 

 

 

 

Consolidated Statements of Income for the three and nine months ended September 30, 2015 and September 30, 2014

 

4

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015 and September 30, 2014

 

5

 

 

 

 

 

Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2015

 

6

 

 

 

 

 

Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and September 30, 2014

 

7

 

 

 

 

 

Notes to the Unaudited Consolidated Financial Statements

 

8

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

18

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

35

 

 

 

 

Item 4.

Controls and Procedures

 

35

 

 

 

 

Part II.

Other Information

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

36

 

 

 

 

Item 1A.

Risk Factors

 

36

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

36

 

 

 

 

Item 6.

Exhibits

 

37

 

 

 

 

 

Signatures

 

38

 

2



Table of Contents

 

PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands)

 

 

 

September 30,

 

 

 

 

 

2015

 

December 31,

 

 

 

(unaudited)

 

2014

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

612,660

 

566,621

 

Cash and cash equivalents - restricted

 

39,605

 

76,595

 

Investment securities

 

219,437

 

243,283

 

Receivables:

 

 

 

 

 

Funds and separate accounts

 

33,328

 

39,110

 

Customers and other

 

172,624

 

216,843

 

Deferred income taxes

 

7,635

 

7,454

 

Income taxes receivable

 

4,869

 

7,747

 

Prepaid expenses and other current assets

 

26,461

 

14,980

 

 

 

 

 

 

 

Total current assets

 

1,116,619

 

1,172,633

 

 

 

 

 

 

 

Property and equipment, net

 

100,386

 

92,304

 

Deferred sales commissions, net

 

31,314

 

56,472

 

Goodwill and identifiable intangible assets

 

158,118

 

158,123

 

Deferred income taxes

 

20,764

 

20,036

 

Other non-current assets

 

15,588

 

12,298

 

Total assets

 

$

1,442,789

 

1,511,866

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable

 

$

23,583

 

32,263

 

Payable to investment companies for securities

 

71,990

 

129,633

 

Payable to third party brokers

 

52,012

 

67,954

 

Payable to customers

 

83,227

 

110,399

 

Accrued compensation

 

74,160

 

67,574

 

Other current liabilities

 

52,981

 

55,143

 

 

 

 

 

 

 

Total current liabilities

 

357,953

 

462,966

 

 

 

 

 

 

 

Long-term debt

 

190,000

 

190,000

 

Accrued pension and postretirement costs

 

31,429

 

45,936

 

Other non-current liabilities

 

26,470

 

26,880

 

 

 

 

 

 

 

Total liabilities

 

605,852

 

725,782

 

 

 

 

 

 

 

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; 83,080 shares outstanding (83,654 at December 31, 2014)

 

997

 

997

 

Additional paid-in capital

 

330,834

 

318,636

 

Retained earnings

 

1,116,523

 

1,041,909

 

Cost of 16,621 common shares in treasury
(16,047 at December 31, 2014)

 

(559,253

)

(525,015

)

Accumulated other comprehensive loss

 

(52,164

)

(50,443

)

Total stockholders’ equity

 

836,937

 

786,084

 

Total liabilities and stockholders’ equity

 

$

1,442,789

 

1,511,866

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

3



Table of Contents

 

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,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Investment management fees

 

$

175,218

 

197,783

 

543,237

 

579,444

 

Underwriting and distribution fees

 

165,130

 

173,047

 

503,616

 

507,315

 

Shareholder service fees

 

35,761

 

38,728

 

108,704

 

113,849

 

 

 

 

 

 

 

 

 

 

 

Total

 

376,109

 

409,558

 

1,155,557

 

1,200,608

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Underwriting and distribution

 

189,065

 

197,246

 

580,247

 

587,805

 

Compensation and related costs (including share-based compensation of $12,073, $12,941, $35,880 and $40,620, respectively)

 

46,157

 

48,375

 

152,481

 

146,973

 

General and administrative

 

25,458

 

24,924

 

79,033

 

75,863

 

Subadvisory fees

 

2,305

 

2,203

 

7,086

 

6,149

 

Depreciation

 

4,117

 

3,786

 

12,215

 

10,576

 

Intangible asset impairment

 

 

7,900

 

 

7,900

 

 

 

 

 

 

 

 

 

 

 

Total

 

267,102

 

284,434

 

831,062

 

835,266

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

109,007

 

125,124

 

324,495

 

365,342

 

Investment and other income (loss)

 

(16,872

)

(1,205

)

(12,891

)

8,795

 

Interest expense

 

(2,765

)

(2,769

)

(8,296

)

(8,279

)

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

89,370

 

121,150

 

303,308

 

365,858

 

Provision for income taxes

 

41,312

 

46,564

 

120,692

 

133,420

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

48,058

 

74,586

 

182,616

 

232,438

 

 

 

 

 

 

 

 

 

 

 

Net income per share, basic and diluted:

 

$

0.58

 

0.89

 

2.18

 

2.74

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic and diluted:

 

83,469

 

84,242

 

83,709

 

84,775

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

4



Table of Contents

 

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,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

48,058

 

74,586

 

182,616

 

232,438

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized depreciation of available for sale investment securities during the period, net of income tax benefit of $(5), $(11), $0 and $(9), respectively

 

(1,321

)

(4,962

)

(4,485

)

(3,491

)

 

 

 

 

 

 

 

 

 

 

Pension and postretirement benefits, net of income tax expense of $526, $186, $1,477 and $558, respectively

 

888

 

315

 

2,764

 

947

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

47,625

 

69,939

 

180,895

 

229,894

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

5



Table of Contents

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

 

Consolidated Statement of Stockholders’ Equity

For the Nine Months Ended September 30, 2015

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Paid-in

 

Retained

 

Treasury

 

Comprehensive

 

Stockholders’

 

 

 

Shares

 

Amount

 

Capital

 

Earnings

 

Stock

 

Loss

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2014

 

99,701

 

$

997

 

318,636

 

1,041,909

 

(525,015

)

(50,443

)

786,084

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

182,616

 

 

 

182,616

 

Recognition of equity compensation

 

 

 

35,880

 

 

 

 

35,880

 

Net issuance/forfeiture of nonvested shares

 

 

 

(29,039

)

 

29,039

 

 

 

Dividends accrued, $1.29 per share

 

 

 

 

(108,002

)

 

 

(108,002

)

Excess tax benefits from share-based payment arrangements

 

 

 

5,357

 

 

 

 

5,357

 

Repurchase of common stock

 

 

 

 

 

(63,277

)

 

(63,277

)

Other comprehensive loss

 

 

 

 

 

 

(1,721

)

(1,721

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2015

 

99,701

 

$

997

 

330,834

 

1,116,523

 

(559,253

)

(52,164

)

836,937

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

6



Table of Contents

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited, in thousands)

 

 

 

For the nine months

 

 

 

ended September 30,

 

 

 

2015

 

2014

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

182,616

 

232,438

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Intangible asset impairment

 

 

7,900

 

Depreciation and amortization

 

12,218

 

10,695

 

Amortization of deferred sales commissions

 

34,251

 

49,373

 

Share-based compensation

 

35,880

 

40,620

 

Excess tax benefits from share-based payment arrangements

 

(5,357

)

(16,465

)

Gain on sale of sponsored investment securities

 

(2,799

)

(3,875

)

Net purchases and sales or maturities of trading securities

 

59

 

(14,298

)

(Gain) loss on trading securities

 

2,301

 

(1,985

)

Loss on equity method securities

 

15,326

 

 

Loss on sale and retirement of property and equipment

 

338

 

1,131

 

Capital gains and dividends reinvested

 

 

(14

)

Deferred income taxes

 

(2,384

)

(2,273

)

Changes in assets and liabilities:

 

 

 

 

 

Cash and cash equivalents - restricted

 

36,990

 

60,200

 

Other receivables

 

44,219

 

(24,263

)

Payable to investment companies for securities and payable to customers

 

(84,815

)

(52,849

)

Receivables from funds and separate accounts

 

5,782

 

707

 

Other assets

 

(14,771

)

(7,934

)

Deferred sales commissions

 

(9,093

)

(37,553

)

Accounts payable and payable to third party brokers

 

(24,622

)

2,355

 

Other liabilities

 

4,434

 

16,322

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

230,573

 

260,232

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of sponsored investment securities

 

(25,893

)

(131,844

)

Proceeds from sales and maturities of sponsored investment securities

 

30,363

 

105,826

 

Additions to property and equipment

 

(20,635

)

(25,211

)

Fund adoption transaction

 

(2,200

)

(1,447

)

 

 

 

 

 

 

Net cash used in investing activities

 

$

(18,365

)

(52,676

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Dividends paid

 

(108,249

)

(86,754

)

Repurchase of common stock

 

(63,277

)

(96,145

)

Excess tax benefits from share-based payment arrangements

 

5,357

 

16,465

 

 

 

 

 

 

 

Net cash used in financing activities

 

$

(166,169

)

(166,434

)

Net increase in cash and cash equivalents

 

46,039

 

41,122

 

Cash and cash equivalents at beginning of period

 

566,621

 

487,845

 

Cash and cash equivalents at end of period

 

$

612,660

 

528,967

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

7



Table of Contents

 

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 from investment management and advisory services, investment product underwriting and distribution, and/or 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 InvestEd Portfolios (“InvestEd”) (collectively, the Advisors Funds, Ivy Funds, Ivy Funds VIP and InvestEd are referred to as the “Funds”), the Ivy Global Investors Fund SICAV (the “SICAV”) and its sub-funds (the “IGI 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”).  The IGI Funds are regulated by Luxembourg’s Commission de Surveillance du Secteur Financier as an undertaking for collective investment in transferable securities (“UCITS”). 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.  Services to the IGI Funds are provided under investment management and distribution agreements.  The majority of these agreements are subject to annual review and approval by each Fund’s board of trustees.  Our revenues are largely dependent on the total value and composition of assets under management.  Accordingly, fluctuations in financial markets and composition of assets under management can significantly impact our revenues and results of operations.

 

Basis of Presentation

 

We have prepared the accompanying unaudited consolidated financial statements 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, 2014 (the “2014 Form 10-K”).

 

The accompanying unaudited consolidated financial statements are prepared consistent with the accounting policies described in Note 2 to the consolidated financial statements included in our 2014 Form 10-K except as noted below.  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, 2015, the results of operations for the three and nine months ended September 30, 2015 and 2014, and cash flows for the nine months ended September 30, 2015 and 2014 in conformity with accounting principles generally accepted in the United States.

 

The Company has classified its investments in certain sponsored funds as either equity method investments (when the Company owns between 20% and 50% of the fund) or as available for sale investments (when the Company owns less than 20% of the fund) as described in Note 4 to the unaudited consolidated financial statements. Effective July 1, 2015, $160.2 million of investments previously classified as available for sale investments were reclassified as equity method investments, representing seed investments in which the Company owns between 20% and 50% of the fund. Prior to July 1, 2015, the difference in accounting for these investments as available for sale investments compared to equity method investments was considered immaterial. However, due primarily to market action during the three-month period ended September 30, 2015, the difference in applying the equity method of accounting became more significant. As a result of this classification change, during the three months ended September 30, 2015, $2.1 million of unrealized losses were reclassified from other comprehensive income and recognized in the consolidated statement of income. In future periods, the Company will account for all investments in sponsored funds in which the Company owns between 20% and 50% as equity method securities.

 

Consolidation

 

We provide seed capital to our new investment products at the time we launch the products.  These investment products include certain of the Advisors Funds and the Ivy Funds (“1940 Act Mutual Funds”), the SICAV and IGI Funds, limited liability companies (“LLCs”), and an open-end mutual fund organized in Canada (the “Canadian Mutual Fund”).

 

Seeded investments in 1940 Act Mutual Funds and the Canadian Mutual Fund are organized under a series fund structure, whereby each open-ended mutual fund represents a separate share class of a legal entity organized under a statutory trust.  The Company has determined that the 1940 Act Mutual Funds and the Canadian Mutual Fund are voting interest entities because the structure of the investment product is such that the voting rights held by the equity holders provide for equality among equity investors.  To the extent

 

8



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material, these investment products would be consolidated if Company ownership, directly or indirectly, represents a majority interest.

 

The Company has concluded that seed investments in the privately offered funds, which are structured as investment companies in the legal form of LLCs, are variable interest entities, but qualify for the deferral to certain provisions of Accounting Standards Codification (“ASC”) Subtopic 810-10, “Consolidation — Overall,” afforded by Accounting Standards Update (“ASU”) 2010-10, “Consolidation — Amendments for Certain Investment Funds” (the “Investment Company deferral”).  The Company is not the primary beneficiary of the LLC investments as we do not absorb a majority of the expected variability of the LLC.  The LLCs are investment companies and follow the guidance within ASC Topic 946, “Financial Services — Investment Companies.”  If the Company is determined to be the primary beneficiary of a LLC, the LLC would be consolidated on the Company’s financial statements to the extent material.

 

The Company has determined the SICAV to be a voting interest entity, as its legal structure and the powers of its equity investors prevents the SICAV from meeting the characteristics of being a variable interest entity. To the extent material, the Company would be required to consolidate the SICAV if ownership of the SICAV, directly or indirectly, represents more than 50% of the outstanding voting shares of the SICAV.

 

2.              Cash and Cash Equivalents

 

Cash and cash equivalents include cash on hand and short-term investments.  We consider all highly liquid investments with maturities upon acquisition of 90 days or less 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.

 

3.              Accounting Pronouncements Not Yet Adopted

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, “Revenue from Contracts with Customers.”  ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers.  This standard also specifies the accounting for certain costs to obtain or fulfill a contract with a customer.  This ASU will supersede much of the existing revenue recognition guidance in accounting principles generally accepted in the United States and is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period; early application is permitted for the first interim period within annual reporting periods beginning after December 15, 2016.  ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method.  The Company is evaluating which transition method to apply and the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

In February 2015, the FASB issued ASU 2015-02, “Amendments to the Consolidation Analysis.”  The amendments in this ASU will affect all companies that are required to evaluate whether they should consolidate another entity. Additionally, the amendments in this ASU rescind the indefinite deferral of FASB Statement 167, “Amendments to FASB Interpretation No. 46(r)” included in FASB ASU 2010-10, ASU 2015-02 will be effective for annual reporting periods after December 15, 2015, including interim periods within that reporting period.  This standard permits the use of either a full retrospective or a modified retrospective approach.  The Company believes that the adoption of this ASU on January 1, 2016, will result in an immaterial impact to our consolidated financial statements and related disclosures regarding our seeded investments in the 1940 Act Funds and the Canadian Mutual Fund.  The Company is evaluating which approach to apply and the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures regarding our LLCs and our seeded investments in the SICAV and IGI Funds.

 

In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs.”  The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU.  ASU 2015-03 is effective for annual reporting periods beginning after

 

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December 15, 2015, including interim periods within that reporting period; early adoption is permitted.  The Company believes that the adoption of this ASU in 2016 will result in an immaterial impact to our consolidated financial statements.

 

In April 2015, the FASB issued ASU 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.”  ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license.  If a cloud computing arrangement includes a software license, then the customer would account for the software license element of the arrangement consistent with its accounting for the acquisition of other software licenses.  If a cloud computing arrangement does not include a software license, the customer would account for the arrangement as a service contract.  The proposed guidance would not change GAAP for a customer’s accounting of software license or service contracts.  This standard will be effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015; early adoption is permitted.  The Company believes that the adoption of this ASU in 2016 will result in an immaterial impact to our consolidated financial statements.

 

4.              Investment Securities

 

Investment securities at September 30, 2015 and December 31, 2014 are as follows:

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

September 30, 2015

 

cost

 

gains

 

losses

 

Fair value

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

48,043

 

412

 

(6,376

)

42,079

 

Sponsored privately offered funds

 

500

 

323

 

 

823

 

 

 

$

48,543

 

735

 

(6,376

)

42,902

 

Equity method securities:

 

 

 

 

 

 

 

 

 

Sponsored funds

 

 

 

 

 

 

 

143,438

 

Sponsored privately offered funds

 

 

 

 

 

 

 

2,944

 

 

 

 

 

 

 

 

 

146,382

 

Trading securities:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

 

 

 

 

 

22

 

Corporate bonds

 

 

 

 

 

 

 

6

 

Common stock

 

 

 

 

 

 

 

80

 

Sponsored funds

 

 

 

 

 

 

 

30,045

 

 

 

 

 

 

 

 

 

30,153

 

 

 

 

 

 

 

 

 

 

 

Total investment securities

 

 

 

 

 

 

 

$

219,437

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

December 31, 2014

 

cost

 

gains

 

losses

 

Fair value

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

160,675

 

2,177

 

(5,392

)

157,460

 

Sponsored privately offered funds

 

1,750

 

2,060

 

 

3,810

 

 

 

$

162,425

 

4,237

 

(5,392

)

161,270

 

Trading securities:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

 

 

 

 

 

28

 

Common stock

 

 

 

 

 

 

 

72

 

Sponsored funds

 

 

 

 

 

 

 

81,913

 

 

 

 

 

 

 

 

 

82,013

 

 

 

 

 

 

 

 

 

 

 

Total investment securities

 

 

 

 

 

 

 

$

243,283

 

 

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Sponsored funds

 

The Company has classified its investments in certain sponsored funds as either equity method investments (when the Company owns between 20% and 50% of the fund) or as available for sale investments (when the Company owns less than 20% of the fund).  We do not hold a majority interest in any of our sponsored funds as of September 30, 2015. As a result, there are no sponsored funds consolidated in our financial statements.

 

Sponsored privately offered funds

 

The Company holds variable interests in, but is not the primary beneficiary of, certain sponsored privately offered funds.  The Company held investments in these funds totaling $3.8 million as of September 30, 2015 and December 31, 2014, which is our maximum loss exposure.

 

Purchases of trading securities during the nine months ended September 30, 2015 were $0.3 million.  Sales of trading securities were $0.3 million for the same period.  As described in Note 1 to the unaudited consolidated financial statements, effective July 1, 2015, $160.2 million of investments previously classified as available for sale securities were classified as equity method securities, representing seed investments in which the Company owns between 20% and 50% of the fund.  As a result, during the three months ended September 30, 2015, $2.1 million of unrealized losses were reclassified from other comprehensive income and recognized in the consolidated statement of income.

 

A summary of available for sale sponsored funds with fair values below carrying values at September 30, 2015 and December 31, 2014 is as follows:

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

 

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

September 30, 2015

 

Fair value

 

losses

 

value

 

losses

 

value

 

losses

 

 

 

(in thousands)

 

Sponsored funds

 

$

33,184

 

(5,300

)

4,849

 

(1,076

)

38,033

 

(6,376

)

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

 

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

December 31, 2014

 

Fair value

 

losses

 

value

 

losses

 

value

 

losses

 

 

 

(in thousands)

 

Sponsored funds

 

$

66,858

 

(5,362

)

1,187

 

(30

)

68,045

 

(5,392

)

 

Based upon our assessment of these sponsored funds, the time frame the investments have been in a loss position and our intent to hold sponsored funds until they have recovered, we determined that a write-down was not necessary at September 30, 2015.

 

A corporate bond accounted for as trading and held as of September 30, 2015 matures in 2018 and mortgage-backed securities accounted for as trading and held as of September 30, 2015 mature in 2022.

 

Accounting standards establish a framework for measuring fair value and a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of the asset.  Inputs may be observable or unobservable and refer broadly to the assumptions that market participants would use in pricing the asset.  An individual investment’s fair value measurement is assigned a level based upon the

 

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observability of the inputs that are significant to the overall valuation.  The three-level hierarchy of inputs is summarized as follows:

 

·                  Level 1 — Investments are valued using quoted prices in active markets for identical securities.

 

·                  Level 2 — Investments are valued using other significant observable inputs, including quoted prices in active markets for similar securities.

 

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

 

Assets classified as Level 2 can have a variety of observable inputs.  These observable inputs are collected and utilized, primarily by an independent pricing service, in different evaluated pricing approaches depending upon the specific asset to determine a value.  The fair value of municipal bonds is measured based on pricing models that take into account, among other factors, information received from market makers and broker/dealers, current trades, bid-wants lists, offerings, market movements, the callability of the bond, state of issuance and benchmark yield curves.  The fair value of equity derivatives is measured based on active market broker quotes, evaluated broker quotes and evaluated prices from vendors.

 

Securities’ values classified as Level 3 are primarily determined through the use of a single quote (or multiple quotes) from dealers in the securities using proprietary valuation models.  These quotes involve significant unobservable inputs, and thus, the related securities are classified as Level 3 securities.

 

The following tables summarize our investment securities as of September 30, 2015 and December 31, 2014 that are recognized in our consolidated balance sheets using fair value measurements based on the differing levels of inputs.

 

September 30, 2015

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Mortgage-backed securities

 

$

 

22

 

 

22

 

Corporate bonds

 

 

6

 

 

6

 

Common stock

 

80

 

 

 

80

 

Sponsored funds

 

215,562

 

 

 

215,562

 

Sponsored privately offered funds

 

3,723

 

7

 

37

 

3,767

 

Total

 

$

219,365

 

35

 

37

 

219,437

 

 

December 31, 2014

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Mortgage-backed securities

 

$

 

28

 

 

28

 

Common stock

 

72

 

 

 

72

 

Sponsored funds

 

239,373

 

 

 

239,373

 

Sponsored privately offered funds

 

3,770

 

4

 

36

 

3,810

 

Total

 

$

243,215

 

32

 

36

 

243,283

 

 

5.              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.  Goodwill and identifiable

 

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intangible assets (all considered indefinite lived) at September 30, 2015 and December 31, 2014 are as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2015

 

2014

 

 

 

(in thousands)

 

 

 

 

 

 

 

Goodwill

 

$

106,970

 

106,970

 

 

 

 

 

 

 

Mutual fund management advisory contracts

 

42,748

 

42,753

 

Mutual fund management subadvisory contracts

 

8,400

 

8,400

 

Total identifiable intangible assets

 

51,148

 

51,153

 

 

 

 

 

 

 

Total

 

$

158,118

 

158,123

 

 

6.              Indebtedness

 

Debt is reported at its carrying amount in the consolidated balance sheet.  The fair value of the Company’s outstanding indebtedness is approximately $205.0 million at September 30, 2015 compared to the carrying value of $190.0 million.  Fair value is calculated based on Level 2 inputs.

 

7.              Income Tax Uncertainties

 

As of January 1, 2015 and September 30, 2015, the Company had unrecognized tax benefits, including penalties and interest, of $11.6 million ($8.3 million net of federal benefit) and $12.5 million ($9.1 million net of federal benefit), respectively, that if recognized, would impact the Company’s effective tax rate.  In the accompanying consolidated balance sheet, unrecognized tax benefits that are not expected to be settled within the next 12 months are included in other liabilities; unrecognized tax benefits that are expected to be settled within the next 12 months are included in income taxes payable; unrecognized tax benefits that reduce a net operating loss, similar tax loss, or tax credit carryforward are presented as a reduction to either current or noncurrent deferred income taxes, as applicable.

 

The Company’s accounting policy with respect to interest and penalties related to income tax uncertainties is to classify these amounts as income taxes.  As of January 1, 2015, the total amount of accrued interest and penalties related to uncertain tax positions recognized in the consolidated balance sheet was $3.5 million ($2.9 million net of federal benefit).  The total amount of penalties and interest, net of federal benefit, related to income tax uncertainties recognized in the statement of income for the nine month period ended September 30, 2015 was $0.1 million.  The total amount of accrued penalties and interest related to uncertain tax positions at September 30, 2015 of $3.6 million ($2.9 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 2012, 2013 and 2014 federal income tax returns are open tax years that remain subject to potential future audit.  State income tax returns for all years after 2011 and, in certain states, income tax returns for 2011, are subject to potential future audit by tax authorities in the Company’s major state tax jurisdictions.

 

The Company is currently being audited in various state jurisdictions.  It is reasonably possible that the Company will settle the audits in these jurisdictions within the next 12-month period.  The Company’s liability for unrecognized tax benefits, including penalties and interest, is not expected to decrease significantly upon settlement of these audits.  Additionally, such settlements are not anticipated to have a significant impact on the results of operations.

 

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8.              Pension Plan and Postretirement Benefits Other Than Pension

 

We provide a non-contributory retirement plan that covers substantially all employees and certain vested employees of our former parent company (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, as well as our advisors, who are independent contractors.  The medical plan is contributory with participant 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 components of net periodic pension and other postretirement costs related to these plans were as follows:

 

 

 

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,

 

 

 

2015

 

2014

 

2015

 

2014

 

2015

 

2014

 

2015

 

2014

 

 

 

(in thousands)

 

(in thousands)

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

3,020

 

2,521

 

227

 

180

 

9,061

 

7,563

 

683

 

540

 

Interest cost

 

2,105

 

2,099

 

99

 

99

 

6,315

 

6,297

 

297

 

297

 

Expected return on plan assets

 

(3,628

)

(3,504

)

 

 

(10,884

)

(10,512

)

 

 

Actuarial (gain) loss amortization

 

1,293

 

373

 

 

(4

)

3,879

 

1,121

 

 

(12

)

Prior service cost amortization

 

115

 

117

 

5

 

14

 

345

 

351

 

15

 

42

 

Transition obligation amortization

 

1

 

1

 

 

 

3

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total(1)

 

$

2,906

 

1,607

 

331

 

289

 

8,719

 

4,823

 

995

 

867

 

 


(1)         Approximately 60% of net periodic pension and other postretirement benefit costs are included in compensation and related costs on the consolidated statements of income, while the remainder is included in underwriting and distribution expense.

 

During the first quarter of 2015, we contributed $20.0 million to the Pension Plan.

 

9.              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,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

48,058

 

74,586

 

182,616

 

232,438

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic and diluted

 

83,469

 

84,242

 

83,709

 

84,775

 

 

 

 

 

 

 

 

 

 

 

Earnings per share, basic and diluted

 

$

0.58

 

0.89

 

2.18

 

2.74

 

 

Dividends

 

On July 15, 2015, the Board of Directors approved a dividend on our common stock in the amount of $0.43 per share to stockholders of record on October 12, 2015 to be paid on November 2, 2015.  The total

 

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dividend to be paid is approximately $35.7 million and is included in other current liabilities as of September 30, 2015.

 

Common Stock Repurchases

 

The 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.

 

There were 812,764 shares and 614,062 shares repurchased in the open market or privately during the three months ended September 30, 2015 and 2014, respectively, which includes 108 shares and 1,962 shares, respectively, repurchased from employees who tendered shares to cover their minimum income tax withholdings with respect to vesting of stock awards during these same reporting periods. There were 1,435,355 shares and 1,522,270 shares repurchased in the open market or privately during the nine months ended September 30, 2015 and 2014, respectively, which includes 312,199 shares and 428,081 shares, respectively, repurchased from employees who tendered shares to cover their minimum income tax withholdings with respect to vesting of stock awards during each of these two periods.

 

Accumulated Other Comprehensive Income (Loss)

 

The following tables summarize other comprehensive income (loss) activity for the three and nine months ended September 30, 2015 and September 30, 2014.

 

Three months ended September 30, 2015

 

Unrealized
(gains) losses on
investment
securities

 

Change in
valuation
allowance for
unrealized gains
(losses) on
investment
securities

 

Pension and
postretirement
benefits

 

Total
accumulated
other
comprehensive
income (loss)

 

 

 

(in thousands)

 

Balance at June 30, 2015

 

$

(2,713

)

(2,649

)

(46,369

)

(51,731

)

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss before reclassification

 

(2,165

)

(1,262

)

 

(3,427

)

Amount reclassified from accumulated other comprehensive income

 

1,330

 

776

 

888

 

2,994

 

Net current period other comprehensive income (loss)

 

(835

)

(486

)

888

 

(433

)

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2015

 

$

(3,548

)

(3,135

)

(45,481

)

(52,164

)

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2014

 

Unrealized
(gains) losses on
investment
securities

 

Change in
valuation
allowance for
unrealized gains
(losses) on
investment
securities

 

Pension and
postretirement
benefits

 

Total
accumulated
other
comprehensive
income (loss)

 

 

 

(in thousands)

 

Balance at June 30, 2014

 

$

4,078

 

1,353

 

(19,187

)

(13,756

)

 

 

 

 

 

 

 

 

 

 

Other comprehensive income before reclassification

 

(2,317

)

(1,357

)

 

(3,674

)

Amount reclassified from accumulated other comprehensive income

 

(813

)

(475

)

315

 

(973

)

Net current period other comprehensive income

 

(3,130

)

(1,832

)

315

 

(4,647

)

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2014

 

$

948

 

(479

)

(18,872

)

(18,403

)

 

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Nine months ended September 30, 2015

 

Unrealized
(gains) losses on
investment
securities

 

Change in
valuation
allowance for
unrealized gains
(losses) on
investment
securities

 

Pension and
postretirement
benefits

 

Total
accumulated
other
comprehensive
income (loss)

 

 

 

(in thousands)

 

Balance at December 31, 2014

 

$

(727

)

(1,471

)

(48,245

)

(50,443

)

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss before reclassification

 

(2,387

)

(1,420

)

 

(3,807

)

Amount reclassified from accumulated other comprehensive income

 

(434

)

(244

)

2,764

 

2,086

 

Net current period other comprehensive income (loss)

 

(2,821

)

(1,664

)

2,764

 

(1,721

)

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2015

 

$

(3,548

)

(3,135

)

(45,481

)

(52,164

)

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2014

 

Unrealized
(gains) losses on
investment
securities

 

Change in
valuation
allowance for
unrealized gains
(losses) on
investment
securities

 

Pension and
postretirement
benefits

 

Total
accumulated
other
comprehensive
income (loss)

 

 

 

(in thousands)

 

Balance at December 31, 2013

 

$

3,150

 

810

 

(19,819

)

(15,859

)

 

 

 

 

 

 

 

 

 

 

Other comprehensive income before reclassification

 

239

 

138

 

 

377

 

Amount reclassified from accumulated other comprehensive income

 

(2,441

)

(1,427

)

947

 

(2,921

)

Net current period other comprehensive income

 

(2,202

)

(1,289

)

947

 

(2,544

)

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2014

 

$

948

 

(479

)

(18,872

)

(18,403

)

 

Reclassifications from accumulated other comprehensive income (loss) and included in net income are summarized in the tables that follow.

 

For the three months ended September 30, 2015

 

 

 

Pre-tax

 

Tax
(expense)
benefit

 

Net of tax

 

Statement of income line item

 

 

 

(in thousands)

 

 

 

Reclassifications included in net income:

 

 

 

 

 

 

 

 

 

Sponsored funds investment losses

 

$

(2,119

)

789

 

(1,330

)

Investment and other income (loss)

 

Valuation allowance

 

 

(776

)

(776

)

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

(1,414

)

526

 

(888

)

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

(3,533

)

539

 

(2,994

)

 

 

 

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For the three months ended September 30, 2014

 

 

 

Pre-tax

 

Tax
(expense)
benefit

 

Net of tax

 

Statement of income line item

 

 

 

(in thousands)

 

 

 

Reclassifications included in net income:

 

 

 

 

 

 

 

 

 

Realized gain on sale of sponsored investment securities

 

$

1,290

 

(477

)

813

 

Investment and other income (loss)

 

Valuation allowance

 

 

475

 

475

 

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

(501

)

186

 

(315

)

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

789

 

184

 

973

 

 

 

 

For the nine months ended September 30, 2015

 

 

 

Pre-tax

 

Tax
(expense)
benefit

 

Net of tax

 

Statement of income line item

 

 

 

(in thousands)

 

 

 

Reclassifications included in net income:

 

 

 

 

 

 

 

 

 

Sponsored funds investment gains

 

$

685

 

(251

)

434

 

Investment and other income (loss)

 

Valuation allowance

 

 

244

 

244

 

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

(4,241

)

1,477

 

(2,764

)

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

(3,556

)

1,470

 

(2,086

)

 

 

 

For the nine months ended September 30, 2014

 

 

 

Pre-tax

 

Tax
(expense)
benefit

 

Net of tax

 

Statement of income line item

 

 

 

(in thousands)

 

 

 

Reclassifications included in net income:

 

 

 

 

 

 

 

 

 

Realized gain on sale of sponsored investment securities

 

$

3,875

 

(1,434

)

2,441

 

Investment and other income (loss)

 

Valuation allowance

 

 

1,427

 

1,427

 

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

(1,505

)

558

 

(947

)

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

2,370

 

551

 

2,921

 

 

 

 

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 results of operations in a particular quarter or year.

 

The Company accrues an undiscounted liability for those contingencies where the incurrence of a loss is probable and the amount can be reasonably estimated.  These amounts are not reduced by amounts that may be recovered under insurance or claims against third parties, but undiscounted receivables from insurers or other third parties may be accrued separately. The Company regularly revises such accruals in light of new

 

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information.  For contingencies where an unfavorable outcome is reasonably possible and that are significant, the Company discloses the nature of the contingency and, where feasible, an estimate of the possible loss.  For purposes of our litigation contingency disclosures, “significant” includes material matters as well as other items that management believes should be disclosed.  Management’s judgment is required related to contingent liabilities because the outcomes are difficult to predict.  In our opinion, the likelihood that any pending legal proceeding, regulatory investigation, claim, or other contingency will have a material adverse effect on our business, financial condition or results of operations is remote.

 

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

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the unaudited consolidated financial statements and notes to the unaudited consolidated financial statements included elsewhere in this report.  Unless otherwise indicated or the context otherwise requires all references to the “Company,” “we,” “our” or “is” refer to Waddell & Reed Financial, Inc. and its consolidated subsidiaries.

 

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 us or on our behalf 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, 2014, which include, without limitation:

 

·                                          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;

 

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

 

·                                          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;

 

·                                          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 ability of mutual fund and other investors to redeem their investments without prior notice or on short notice;

 

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

 

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·                                          Our inability to attract and retain senior executive management and other key personnel to conduct our broker/dealer, fund management and investment management advisory business;

 

·                                          A failure in, or breach of, our operational or security systems or our technology infrastructure, or those of third parties on which we rely; and

 

·                                          Our inability to implement new information technology and systems, or our inability to complete such implementation in a timely or cost effective manner.

 

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 (the “SEC”), 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, 2014 and as updated in our quarterly reports on Form 10-Q for the year ending December 31, 2015.  All forward-looking statements speak only as of 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, except to the extent required by law.

 

Overview

 

Founded in 1937, 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 can have a material impact on our results of operations, financial condition and cash flows.

 

We derive our revenues from providing investment management and advisory services, investment product underwriting and distribution, and shareholder services administration 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 InvestEd Portfolios (“InvestEd”) (collectively, the Advisors Funds, Ivy Funds, Ivy Funds VIP and InvestEd are referred to as the “Funds”), the Ivy Global Investors Fund SICAV and its sub-funds (the “IGI Funds”), and institutional and separately managed accounts. Investment management and/or advisory 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 Rule 12b-1 asset-based service and distribution fees, fees earned on fee-based asset allocation products and related advisory services, distribution fees on certain variable products, and commissions derived from sales of investment and insurance products. The products sold have various commission structures and the revenues received from those sales vary based on the type and dollar amount sold.  Shareholder service fee revenue includes transfer agency fees, custodian fees from retirement plan accounts and portfolio accounting and administration fees, and is earned based on assets under management or number of client accounts.  Our major expenses are for commissions, employee compensation, field support, dealer services and information technology.

 

One of our distinctive qualities is that we distribute our investment products through a balanced distribution network. Our retail products are distributed through our Wholesale channel, which includes third parties such as other broker/dealers, registered investment advisors and various retirement platforms, or through our Advisors channel sales force of independent financial advisors.  Through our Institutional channel, we distribute a variety of investment styles for a variety of types of institutions.

 

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Company Developments

 

·                  In October 2015, Ivy Funds launched two income-oriented mutual funds in partnership with Apollo Credit Management.  The Ivy Apollo Strategic Income Fund invests among three investment strategies: Apollo’s total return and Ivy’s global bond and high income.  The Ivy Apollo Multi-Asset Income Fund invests among four investment strategies: Apollo’s total return and Ivy’s high income, global equity income and global real estate, which is subadvised by LaSalle Investment Management Securities.

 

·                  Our assets under management decreased 18% from $128.9 billion at September 30, 2014 to $106.2 billion at September 30, 2015 driven by net outflows of $15.2 billion and market depreciation of $7.5 billion. Our average assets under management decreased 14% from $133.1 billion for the quarter ended September 30, 2014 to $114.8 billion for the quarter ended September 30, 2015.

 

·                  Operating revenues of $376.1 million in the third quarter of 2015 decreased $33.4 million, or 8%, compared to the third quarter of 2014.

 

·                  Operating income of $109.0 million in the third quarter of 2015 decreased $16.1 million, or 13%, compared to the third quarter of 2014.  Our operating margin of 29.0% for the quarter ended September 30, 2015 declined from 30.6% for the quarter ended September 30, 2014. Net income of $48.1 million for the third quarter of 2015 decreased $26.5 million, or 36%, compared to this same period a year ago.

 

·                  The third quarter of 2015 included $15.3 million of mark-to-market investment losses for sponsored funds (Advisor Funds, Ivy Funds and IGI Funds) held as equity method investments in our investment portfolio.  These unrealized losses increased our capital loss carryforward and resulted in a corresponding increase to a valuation allowance. This resulted in the inability to recognize a tax benefit of $6.7 million.

 

·                  Company-wide sales in the third quarter of 2015 decreased 24% compared to sales in the third quarter of 2014. Diversification remains our focus as sales exceeded $100.0 million for eight investment strategies during the third quarter of 2015. Of these investment strategies, sales for three strategies exceeded $500.0 million.

 

·                  Outflows from the Asset Strategy funds comprised 88% of total outflows in our retail distribution channel in the third quarter of 2015.

 

·                  Our balance sheet remains solid, and we ended the third quarter of 2015 with cash and investments of $832.1 million.

 

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Assets Under Management

 

Assets under management at September 30, 2015 decreased 12% to $106.2 billion from $120.7 billion at June 30, 2015 due to market depreciation of $10.4 billion and outflows of $4.2 billion.

 

Change in Assets Under Management(1)

 

 

 

Third Quarter 2015

 

 

 

Wholesale

 

Advisors

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

57,545

 

45,947

 

17,214

 

120,706

 

 

 

 

 

 

 

 

 

 

 

Sales(2)

 

2,768

 

1,238

 

465

 

4,471

 

Redemptions

 

(5,569

)

(1,242

)

(1,817

)

(8,628

)

Net Exchanges

 

265

 

(265

)

 

 

Net Flows

 

(2,536

)

(269

)

(1,352

)

(4,157

)

 

 

 

 

 

 

 

 

 

 

Market Depreciation/Other

 

(5,689

)

(3,463

)

(1,205

)

(10,357

)

Ending Assets

 

$

49,320

 

42,215

 

14,657

 

106,192

 

 

 

 

 

 

 

 

 

 

 

 

 

Third Quarter 2014

 

 

 

Wholesale

 

Advisors

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

71,671

 

45,797

 

18,165

 

135,633

 

 

 

 

 

 

 

 

 

 

 

Sales(2)

 

4,269

 

1,322

 

328

 

5,919

 

Redemptions

 

(7,008

)

(1,146

)

(727

)

(8,881

)

Net Exchanges

 

112

 

(112

)

 

 

Net Flows

 

(2,627

)

64

 

(399

)

(2,962

)

 

 

 

 

 

 

 

 

 

 

Market Depreciation/Other

 

(2,669

)

(953

)

(163

)

(3,785

)

Ending Assets

 

$

66,375

 

44,908

 

17,603

 

128,886

 

 


(1)         Includes all activity of the Funds, the IGI Funds and institutional and separate accounts, including money market funds and transactions at net asset value, for which we receive no commissions.

 

(2)         Primarily gross sales (net of sales commission), but also includes net reinvested dividends and capital gains and investment income.

 

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Assets under management decreased to $106.2 billion at September 30, 2015 compared to $123.7 billion at December 31, 2014 due to outflows of $8.8 billion and market depreciation of $8.7 billion.

 

 

 

Year to Date 2015

 

 

 

Wholesale

 

Advisors

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

60,335

 

45,517

 

17,798

 

123,650

 

 

 

 

 

 

 

 

 

 

 

Sales(2)

 

9,877

 

3,856

 

1,968

 

15,701

 

Redemptions

 

(16,386

)

(3,800

)

(4,280

)

(24,466

)

Net Exchanges

 

633

 

(633

)

 

 

Net Flows

 

(5,876

)

(577

)

(2,312

)

(8,765

)

 

 

 

 

 

 

 

 

 

 

Market Depreciation/Other

 

(5,139

)

(2,725

)

(829

)

(8,693

)

Ending Assets

 

$

49,320

 

42,215

 

14,657

 

106,192

 

 

 

 

 

 

 

 

 

 

 

 

 

Year to Date 2014

 

 

 

Wholesale

 

Advisors

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

67,055

 

43,667

 

15,821

 

126,543

 

 

 

 

 

 

 

 

 

 

 

Sales(2)

 

16,150

 

4,214

 

3,075

 

23,439

 

Redemptions

 

(14,933

)

(3,350

)

(2,257

)

(20,540

)

Net Exchanges

 

(173

)

(312

)

485

 

 

Net Flows

 

1,044

 

552

 

1,303

 

2,899

 

 

 

 

 

 

 

 

 

 

 

Market Appreciation (Depreciation)/Other

 

(1,724

)

689

 

479

 

(556

)

Ending Assets

 

$

66,375

 

44,908

 

17,603

 

128,886

 

 


(2)         Primarily gross sales (net of sales commission), but also includes net reinvested dividends and capital gains and investment income.

 

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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 2015

 

 

 

Wholesale

 

Advisors

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Asset Class:

 

 

 

 

 

 

 

 

 

Equity

 

$

44,286

 

33,271

 

14,730

 

$

92,287