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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 March 31, 2016

 

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 April 15, 2016

Class A common stock, $.01 par value

 

81,489,802

 

 

 


 


Table of Contents

 

WADDELL & REED FINANCIAL, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended March 31, 2016

 

 

 

 

 

 

Page No.

 

 

 

 

 

Part I.

Financial Information

 

 

 

 

 

 

 

Item 1.

 

Financial Statements (unaudited)

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets at March 31, 2016 and December 31, 2015

 

3

 

 

 

 

 

 

 

Consolidated Statements of Income for the three months ended March 31, 2016 and March 31, 2015

 

4

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the three months ended March 31, 2016 and March 31, 2015

 

5

 

 

 

 

 

 

 

Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2016

 

6

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the three months ended March 31, 2016 and March 31, 2015

 

7

 

 

 

 

 

 

 

Notes to the Unaudited Consolidated Financial Statements

 

8

 

 

 

 

 

Item 2.

 

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

 

21

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

34

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

34

 

 

 

 

 

Part II.

Other Information

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

34

 

 

 

 

 

Item 1A.

 

Risk Factors

 

35

 

 

 

 

 

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)

 

 

 

March 31,

 

 

 

 

 

2016

 

December 31,

 

 

 

(unaudited)

 

2015

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

447,112

 

558,495

 

Cash and cash equivalents - restricted

 

39,341

 

66,880

 

Investment securities

 

372,777

 

291,743

 

Receivables:

 

 

 

 

 

Funds and separate accounts

 

28,509

 

34,399

 

Customers and other

 

190,176

 

220,660

 

Income taxes receivable

 

 

10,594

 

Prepaid expenses and other current assets

 

36,912

 

34,800

 

Total current assets

 

1,114,827

 

1,217,571

 

 

 

 

 

 

 

Property and equipment, net

 

106,776

 

105,434

 

Deferred sales commissions, net

 

17,888

 

24,262

 

Goodwill and identifiable intangible assets

 

158,318

 

158,118

 

Deferred income taxes

 

29,723

 

32,692

 

Other non-current assets

 

17,181

 

17,074

 

Total assets

 

$

1,444,713

 

1,555,151

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable

 

$

20,717

 

32,858

 

Payable to investment companies for securities

 

74,958

 

113,648

 

Payable to third party brokers

 

39,506

 

49,848

 

Payable to customers

 

87,497

 

120,420

 

Accrued compensation

 

63,706

 

69,335

 

Other current liabilities

 

61,644

 

57,104

 

Income taxes payable

 

3,873

 

 

Total current liabilities

 

351,901

 

443,213

 

 

 

 

 

 

 

Long-term debt

 

189,475

 

189,432

 

Accrued pension and postretirement costs

 

30,982

 

48,810

 

Other non-current liabilities

 

25,634

 

27,241

 

Total liabilities

 

597,992

 

708,696

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

11,521

 

 

 

 

 

 

 

 

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; 81,758 shares outstanding (82,850 at December 31, 2015)

 

997

 

997

 

Additional paid-in capital

 

344,302

 

331,611

 

Retained earnings

 

1,140,964

 

1,141,608

 

Cost of 17,943 common shares in treasury

 

 

 

 

 

(16,851 at December 31, 2015)

 

(590,711

)

(566,256

)

Accumulated other comprehensive loss

 

(60,352

)

(61,505

)

Total stockholders’ equity

 

835,200

 

846,455

 

 

 

 

 

 

 

Total liabilities, redeemable noncontrolling interests and stockholders’ equity

 

$

1,444,713

 

1,555,151

 

 

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

 

 

 

ended March 31,

 

 

 

2016

 

2015

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

Investment management fees

 

$

144,778

 

182,105

 

Underwriting and distribution fees

 

146,658

 

166,978

 

Shareholder service fees

 

32,380

 

36,375

 

Total

 

323,816

 

385,458

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Underwriting and distribution

 

173,836

 

195,420

 

Compensation and related costs (including share-based compensation of $13,522 and $12,473, respectively)

 

52,940

 

53,495

 

General and administrative

 

19,152

 

25,678

 

Subadvisory fees

 

2,093

 

2,387

 

Depreciation

 

4,362

 

4,034

 

Total

 

252,383

 

281,014

 

 

 

 

 

 

 

Operating income

 

71,433

 

104,444

 

Investment and other income (loss)

 

(10,218

)

3,972

 

Interest expense

 

(2,768

)

(2,766

)

 

 

 

 

 

 

Income before provision for income taxes

 

58,447

 

105,650

 

Provision for income taxes

 

20,978

 

38,537

 

Net income

 

37,469

 

67,113

 

Net income attributable to redeemable noncontrolling interests

 

501

 

 

Net income attributable to Waddell & Reed Financial, Inc.

 

$

36,968

 

67,113

 

 

 

 

 

 

 

Net income per share attributable to Waddell and Reed Financial, Inc. common shareholders, basic and diluted:

 

$

0.45

 

0.80

 

 

 

 

 

 

 

Weighted average shares outstanding, basic and diluted:

 

82,104

 

83,581

 

 

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

 

 

 

ended March 31,

 

 

 

2016

 

2015

 

 

 

 

 

 

 

Net income

 

$

37,469

 

67,113

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

Unrealized appreciation of available for sale investment securities during the period, net of income tax expense of $0 and $13, respectively

 

76

 

1,810

 

 

 

 

 

 

 

Pension and postretirement benefits, net of income tax expense of $619 and $555, respectively

 

1,077

 

943

 

 

 

 

 

 

 

Comprehensive income

 

38,622

 

69,866

 

Comprehensive income attributable to redeemable noncontrolling interests

 

501

 

 

Comprehensive income attributable to Waddell & Reed Financial, Inc.

 

$

38,121

 

69,866

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

5



Table of Contents

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

 

Consolidated Statement of Stockholders’ Equity and redeemable noncontrolling interests

For the Three Months Ended March 31, 2016

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

Redeemable

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Other

 

Total

 

Non

 

 

 

Common Stock

 

Paid-in

 

Retained

 

Treasury

 

Comprehensive

 

Stockholders’

 

Controlling

 

 

 

Shares

 

Amount

 

Capital

 

Earnings

 

Stock

 

Income (Loss)

 

Equity

 

Interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2015

 

99,701

 

$

997

 

331,611

 

1,141,608

 

(566,256

)

(61,505

)

846,455

 

 

Adoption of consolidation guidance on January 1, 2016 - redeemable noncontrolling interests in sponsored funds

 

 

 

 

 

 

 

 

14,330

 

Net income

 

 

 

 

36,968

 

 

 

36,968

 

501

 

Net redemption of redeemable noncontrolling interests in sponsored funds

 

 

 

 

 

 

 

 

(3,310

)

Recognition of equity compensation

 

 

 

13,522

 

 

 

 

13,522

 

 

Net issuance/forfeiture of nonvested shares

 

 

 

(1,143

)

 

1,143

 

 

 

 

Dividends accrued, $0.46 per share

 

 

 

 

(37,612

)

 

 

(37,612

)

 

Excess tax benefits from share-based payment arrangements

 

 

 

312

 

 

 

 

312

 

 

Repurchase of common stock

 

 

 

 

 

(25,598

)

 

(25,598

)

 

Other comprehensive income

 

 

 

 

 

 

1,153

 

1,153

 

 

Balance at March 31, 2016

 

99,701

 

$

997

 

344,302

 

1,140,964

 

(590,711

)

(60,352

)

835,200

 

11,521

 

 

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 three months

 

 

 

ended March 31,

 

 

 

2016

 

2015

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

37,469

 

67,113

 

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

 

 

 

 

 

Depreciation and amortization

 

4,367

 

4,035

 

Amortization of deferred sales commissions

 

7,635

 

13,084

 

Share-based compensation

 

13,522

 

12,473

 

Excess tax benefits from share-based payment arrangements

 

(312

)

(747

)

Investments gain, net

 

(5,144

)

(3,275

)

Net purchases and sales or maturities of trading securities

 

(25,000

)

54

 

Deferred income taxes

 

2,350

 

230

 

Net change in trading securities held by consolidated sponsored funds

 

(43,991

)

 

Other

 

118

 

18

 

Changes in assets and liabilities:

 

 

 

 

 

Cash and cash equivalents - restricted

 

27,539

 

(3,504

)

Customer and other receivables

 

30,484

 

69,464

 

Payable to investment companies for securities and payable to customers

 

(71,613

)

(64,793

)

Receivables from funds and separate accounts

 

5,890

 

5,539

 

Other assets

 

(3,304

)

(3,845

)

Deferred sales commissions

 

(1,261

)

(3,374

)

Accounts payable and payable to third party brokers

 

(22,483

)

(11,319

)

Other liabilities

 

(3,547

)

9,118

 

Net cash provided by (used in) operating activities

 

$

(47,281

)

90,271

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of available for sale and equity method securities

 

(100

)

(25,890

)

Proceeds from sales and maturities of available for sale and equity method securities

 

100

 

28,835

 

Additions to property and equipment

 

(5,741

)

(9,159

)

Net cash of sponsored funds on consolidation

 

6,887

 

 

Other

 

(198

)

 

 

 

$

948

 

(6,214

)

Net cash used in investing activities

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Dividends paid

 

(38,115

)

(35,979

)

Repurchase of common stock

 

(25,598

)

(4,599

)

Net subscriptions from (redemptions and distributions to) redeemable noncontrolling interests in sponsored funds

 

(1,692

)

 

Excess tax benefits from share-based payment arrangements

 

312

 

747

 

Other

 

43

 

 

 

 

 

 

 

 

Net cash used in financing activities

 

$

(65,050

)

(39,831

)

Net increase (decrease) in cash and cash equivalents

 

(111,383

)

44,226

 

Cash and cash equivalents at beginning of period

 

558,495

 

566,621

 

Cash and cash equivalents at end of period

 

$

447,112

 

610,847

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

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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, 2015 (the “2015 Form 10-K”).  Certain amounts in the prior years’ financial statements have been reclassified for consistent presentation.

 

The accompanying unaudited consolidated financial statements are prepared consistent with the accounting policies described in Note 1 to the consolidated financial statements included in our 2015 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 March 31, 2016, the results of operations and cash flows for the three months ended March 31, 2016 and 2015 in conformity with accounting principles generally accepted in the United States.

 

Investments Securities and Investments in Sponsored Funds

 

Sponsored funds, which include the Funds, the IGI Funds and privately offered funds structured in the form of limited liability companies, are investments we have made for general corporate investment purposes and to provide seed capital for new investment products. The Company’s initial investment in a new investment product typically represents 100% ownership in that product.  Sponsored funds are initially consolidated and are accounted for as trading securities.  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.  Investments held by our broker-dealer entities or certain investments that are anticipated to be purchased and sold on a more frequent basis are classified as trading.

 

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Table of Contents

 

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.              New Accounting Guidance

 

Accounting Guidance Adopted During First Quarter of 2016

 

During the first quarter of 2016, the Company adopted Accounting Standards Update (“ASU”) 2015-02, “Amendments to the Consolidation Analysis,” which affects all companies required to evaluate consolidation of another entity. The Company determined that this ASU did not have a material impact on its previous consolidation analysis for its seeded investments in the Advisors and Ivy Funds, an open-end mutual fund organized in Canada, and limited liability companies.  This ASU did impact the consolidation analysis for its seeded investments in the IGI Funds.  Prior to ASU 2015-02, the amount of ownership interest held by the Company was determined at the SICAV legal entity level.  Under ASU 2015-02, the ownership percentage and consolidation analysis of the IGI Funds is evaluated at each individual sub-fund.  To the extent material, the Company is required to consolidate any of its seeded investments if ownership, directly or indirectly, represents more than 50%.

 

During the first quarter of 2016, the Company adopted ASU 2015-03, “Simplifying  the Presentation of Debt Issuance Costs.”  This ASU requires 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.  Prior to the implementation of this ASU, the Company classified its debt issuance costs related to a recognized debt liability as either current or non-current assets.  Previously, the Company reported $0.2 million of debt issuance costs as current assets and $0.4 million of debt issuance costs as non-current assets on the balance sheet for the period ended December 31, 2015.  After implementation of ASU 2015-03, the debt issuance costs have been netted with long-term debt, so that long-term debt is presented as $189.4 million on the balance sheet as of December 31, 2015, to be consistent with the presentation of the March 31, 2016 balance.

 

New Accounting Guidance 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 January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.”  ASU 2016-01 provides updated guidance on the recognition, measurement, presentation and disclosure of certain financial assets and financial liabilities.  This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

In February 2016, the FASB issued ASU 2016-02, “Leases. ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.  This ASU will be presented using a modified retrospective approach, which includes a number of optional practical expedients that entities may elect to apply.  ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim

 

9



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periods within those fiscal years, with early application permitted.  The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

In March 2016, the FASB issued ASU 2016-07, “Simplifying the Transition to the Equity Method of Accounting.”  The amendments in this ASU eliminate the requirement that when an investment qualifies for the use of equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively as if the equity method had been in effect during all previous periods that the investment had been held.  ASU 2016-07 also requires that an entity that has an available for sale equity security that becomes qualified for the equity method recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method.  ASU 2016-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016.  The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting.”  This ASU recognizes all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement, with classifying excess tax benefits along with other income tax cash flows as an operating activity; allows an entity to either estimate the number of awards that are expected to vest or account for forfeitures when they occur; and permits withholding up to the maximum statutory tax rates in the applicable jurisdictions.  ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted.  The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

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4.              Investment Securities

 

Investment securities at March 31, 2016 and December 31, 2015 are as follows:

 

March 31, 2016

 

 

 

(in thousands)

 

 

 

Available for sale securities:

 

 

 

Sponsored funds

 

$

72,572

 

Sponsored privately offered funds

 

826

 

Total available for sale securities

 

73,398

 

Trading securities:

 

 

 

Mortgage-backed securities

 

19

 

Corporate bond

 

4

 

Common stock

 

99

 

Consolidated sponsored funds

 

110,339

 

Sponsored funds

 

29,429

 

Total trading securities

 

139,890

 

Equity method securities:

 

 

 

Sponsored funds

 

156,420

 

Sponsored privately offered funds

 

3,069

 

Total equity method securities

 

159,489

 

Total securities

 

$

372,777

 

 

The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at March 31, 2016:

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

 

 

cost

 

gains

 

losses

 

Fair value

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

78,745

 

1,054

 

(7,227

)

72,572

 

Sponsored privately offered funds

 

500

 

326

 

 

826

 

 

 

$

79,245

 

1,380

 

(7,227

)

73,398

 

 

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December 31, 2015

 

 

 

(in thousands)

 

 

 

Available for sale securities:

 

 

 

Sponsored funds

 

$

40,552

 

Sponsored privately offered funds

 

825

 

Total available for sale securities

 

41,377

 

Trading securities:

 

 

 

Mortgage-backed securities

 

20

 

Corporate bond

 

5

 

Common stock

 

87

 

Sponsored funds

 

29,701

 

Total trading securities

 

29,813

 

Equity method securities:

 

 

 

Sponsored funds

 

217,380

 

Sponsored privately offered funds

 

3,173

 

Total equity method securities

 

220,553

 

Total securities

 

$

291,743

 

 

The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at December 31, 2015:

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

 

 

cost

 

gains

 

losses

 

Fair value

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

46,800

 

434

 

(6,682

)

40,552

 

Sponsored privately offered funds

 

500

 

325

 

 

825

 

 

 

$

47,300

 

759

 

(6,682

)

41,377

 

 

A summary of available for sale sponsored funds with fair values below carrying values at March 31, 2016 and December 31, 2015 is as follows:

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

 

 

Unrealized

 

Fair 

 

Unrealized

 

Fair 

 

Unrealized

 

March 31, 2016

 

Fair value

 

losses

 

value

 

losses

 

value

 

losses

 

 

 

(in thousands)

 

Sponsored funds

 

$

10,193

 

(354

)

33,013

 

(6,873

)

43,206

 

(7,227

)

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

December 31, 2015

 

Fair value

 

Unrealized
losses

 

Fair
value

 

Unrealized
losses

 

Fair
value

 

Unrealized
losses

 

 

 

(in thousands)

 

Sponsored funds

 

$

3,476

 

(166

)

33,619

 

(6,516

)

37,095

 

(6,682

)

 

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 March 31, 2016.

 

The corporate bond accounted for as trading matures in 2018.  Mortgage-backed securities accounted for as trading and held as of March 31, 2016 mature in 2022.

 

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Sponsored funds

 

The Company has classified its investments in the Advisor Funds, Ivy Funds and IGI Funds as either trading, 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).  These entities do not meet the criteria of a variable interest entity and are considered to be voting interest entities.

 

Sponsored privately offered funds

 

The Company holds interests in privately offered funds structured in the form of limited liability companies.  The members of these entities have the substantive ability to remove the Company as managing member or dissolve the entity upon a simple majority vote.  These entities do not meet the criteria of a variable interest entity and are considered to be voting interest entities.

 

Consolidated sponsored funds

 

The following table details the balances related to consolidated sponsored funds at March 31, 2016, as well as the Company’s net interest in these funds:

 

 

 

March 31, 2016

 

 

 

(in thousands)

 

 

 

 

 

Cash

 

$

7,275

 

Investments

 

110,339

 

Other assets

 

3,539

 

Other liabilities

 

(1,270

)

Redeemable noncontrolling interests

 

(11,521

)

Net interest in consolidated sponsored funds

 

$

108,362

 

 

During the three months ended March 31, 2016, we consolidated Advisor Funds, Ivy Funds and IGI Funds in which we provided initial seed capital at the time of its formation. When we no longer have a controlling financial interest in a sponsored fund, it is deconsolidated from our financial statements.  We deconsolidated $44.2 million of these investments from our consolidated balance sheet during the first quarter of 2016.  There was no impact to the consolidated statement of income as a result of this deconsolidation.

 

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 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 corporate bonds is measured using various techniques, which consider recently executed trades in securities of the issuer or comparable issuers, market price quotations (where observable), bond spreads and fundamental data relating to the issuer.

 

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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 March 31, 2016 and December 31, 2015 that are recognized in our consolidated balance sheets using fair value measurements based on the differing levels of inputs.

 

March 31, 2016

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

72,572

 

 

 

72,572

 

Sponsored privately offered funds measured at net asset value (2)

 

 

 

 

826

 

Trading securities:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

19

 

 

19

 

Corporate bonds

 

 

4

 

 

4

 

Common stock

 

99

 

 

 

99

 

Consolidated sponsored funds (2)

 

 

 

 

110,339

 

Sponsored funds

 

29,429

 

 

 

29,429

 

Equity method securities: (1)

 

 

 

 

 

 

 

 

 

Sponsored funds

 

156,420

 

 

 

156,420

 

Sponsored privately offered funds measured at net asset value (2)

 

 

 

 

3,069

 

Total

 

$

258,520

 

23

 

 

372,777

 

 

December 31, 2015

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

40,552

 

 

 

40,552

 

Sponsored privately offered funds measured at net asset value (2)

 

 

 

 

825

 

Trading securities:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

20

 

 

20

 

Corporate bonds

 

 

5

 

 

5

 

Common stock

 

87

 

 

 

87

 

Sponsored funds

 

29,701

 

 

 

29,701

 

Equity method securities: (1)

 

 

 

 

 

 

 

 

 

Sponsored funds

 

217,380

 

 

 

217,380

 

Sponsored privately offered funds measured at net asset value (2)

 

 

 

 

3,173

 

Total

 

$

287,720

 

25

 

 

291,743

 

 


(1)Substantially all of the Company’s equity method investments are investment companies that record their underlying investments at fair value.  Fair value is measured using the Company’s share of the investee’s underlying net income or loss, which is predominantly representative of fair value adjustments in the investments held by the investee.

 

(2)Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy.  The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.

 

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5.              Derivative Financial Instruments

 

In January 2016, the Company implemented an economic hedge program that uses total return swap contracts to hedge market risk with its investments in certain sponsored funds.  As of March 31, 2016, we had 84% of our investments in sponsored funds, excluding our available for sale portfolio, hedged with total return swap contracts.  Certain of the consolidated sponsored funds may utilize derivative financial instruments within their portfolios in pursuit of their stated investment objectives.  We do not hedge for speculative purposes.

 

As of March 31, 2016, excluding derivative financial instruments held in certain consolidated sponsored funds, the Company was party to two total return swap contracts with a combined notional value of $225.6 million. These derivative instruments are not designated as a hedge for accounting purposes.  Changes in fair value of the total return swap contracts are recognized in investment and other income (loss), net on the Company’s consolidated statement of income.

 

The Company posted $11.2 million in cash collateral with the counterparties of the total return swap contracts as of March 31, 2016.  The cash collateral is included in customers and other receivables on the Company’s consolidated balance sheet.  The company does not record its fair value in derivative transactions against the posted collateral.

 

The following table presents the fair value of the derivative financial instruments, excluding derivative financial instruments held in certain consolidated sponsored funds as of March 31, 2016:

 

 

 

March 31, 2016

 

 

 

Balance sheet
location

 

Fair value

 

 

 

 

 

(in thousands)

 

Total return swap contracts

 

Other current liabilities

 

$

3,874

 

 

The following is a summary of net gains (losses) recognized in income for the three months ended March 31, 2016:

 

 

 

Income statement
location

 

Three months ended
March 31, 2016

 

 

 

 

 

(in thousands)

 

Total return swap contracts

 

Investment and other income (loss)

 

$

(15,222

)

 

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6.              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 intangible assets (all considered indefinite lived) at March 31, 2016 and December 31, 2015 are as follows:

 

 

 

March 31,

 

December 31,

 

 

 

2016

 

2015

 

 

 

(in thousands)

 

 

 

 

 

 

 

Goodwill

 

$

106,970

 

106,970

 

 

 

 

 

 

 

Mutual fund management advisory contracts

 

42,748

 

42,748

 

Mutual fund management subadvisory contracts

 

8,400

 

8,400

 

Other

 

200

 

 

Total identifiable intangible assets

 

51,348

 

51,148

 

 

 

 

 

 

 

Total

 

$

158,318

 

158,118

 

 

7.              Indebtedness

 

Debt is reported at its carrying amount in the consolidated balance sheet.  The fair value of the Company’s outstanding indebtedness is approximately $203.3 million at March 31, 2016 compared to the carrying value net of debt issuance costs of $189.5 million.  Fair value is calculated based on Level 2 inputs.

 

8.              Income Tax Uncertainties

 

As of January 1, 2016 and March 31, 2016, the Company had unrecognized tax benefits, including penalties and interest, of $11.9 million ($8.7 million net of federal benefit) and $12.1 million ($8.9 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 noncurrent deferred income taxes.

 

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, 2016, the total amount of accrued interest and penalties related to uncertain tax positions recognized in the consolidated balance sheet was $3.4 million ($2.8 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 three month period ended March 31, 2016 was $0.1 million.  The total amount of accrued penalties and interest related to uncertain tax positions at March 31, 2016 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 through 2015 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.

 

9.              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

 

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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

 

 

 

Three months
ended
March 31,

 

Three months
ended
March 31,

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

(in thousands)

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

2,993

 

3,047

 

185

 

228

 

Interest cost

 

2,439

 

2,154

 

92

 

99

 

Expected return on plan assets

 

(3,536

)

(3,691

)

 

 

Actuarial (gain) loss amortization

 

1,638

 

1,377

 

(39

)

 

Prior service cost amortization

 

94

 

115

 

1

 

5

 

Transition obligation amortization

 

1

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

Total(1)

 

$

3,629

 

3,003

 

239

 

332

 

 


(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 2016, we contributed $20.0 million to the Pension Plan.

 

10.       Stockholders’ Equity

 

Earnings per Share

 

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

 

 

 

Three months ended

 

 

 

March 31,

 

 

 

2016

 

2015

 

 

 

(in thousands, except per share
amounts)

 

 

 

 

 

 

 

Net income attributable to Waddell & Reed Financial, Inc.

 

$

36,968

 

67,113

 

 

 

 

 

 

 

Weighted average shares outstanding, basic and diluted

 

82,104

 

83,581

 

 

 

 

 

 

 

Earnings per share, basic and diluted

 

$

0.45

 

0.80

 

 

Dividends

 

On February 11, 2016, the Board of Directors approved a dividend on our common stock in the amount of $0.46 per share to stockholders of record on April 18, 2016 to be paid on May 2, 2016.  The total dividend to be paid is approximately $38.5 million and is included in other current liabilities as of March 31, 2016.

 

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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 1,125,671 shares and 106,058 shares repurchased in the open market or privately during the three months ended March 31, 2016 and 2015, respectively, which includes 3,671 shares and 5,558 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.

 

In April 2016, the Company repurchased 258,675 shares from employees who tendered shares to cover their minimum income tax withholdings with respect to vesting of stock awards during April 2016.

 

Accumulated Other Comprehensive Income (Loss)

 

The following tables summarize other comprehensive income (loss) activity for the three months ended March 31, 2016 and March 31, 2015.

 

Three months ended March 31, 2016

 

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, 2015

 

$

(3,729

)

(3,240

)

(54,536

)

(61,505

)

Other comprehensive loss before reclassification

 

(4

)

(1

)

 

(5

)

Amount reclassified from accumulated other comprehensive income

 

51

 

30

 

1,077

 

1,158

 

Net current period other comprehensive income

 

47

 

29

 

1,077

 

1,153

 

Balance at March 31, 2016

 

$

(3,682

)

(3,211

)

(53,459

)

(60,352

)

 

Three months ended March 31, 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

 

(327

)

(189

)

 

(516

)

Amount reclassified from accumulated other comprehensive income

 

1,475

 

851

 

943

 

3,269

 

Net current period other comprehensive income

 

1,148

 

662

 

943

 

2,753

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2015

 

$

421

 

(809

)

(47,302

)

(47,690

)

 

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

 

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For the three months ended March 31, 2016

 

 

 

 

 

Pre-tax

 

Tax
(expense)
benefit

 

Net of tax

 

Statement of income line item

 

 

 

(in thousands)

 

 

 

Reclassifications included in net income:

 

 

 

 

 

 

 

 

 

Sponsored funds investment losses

 

$

(81

)

30

 

(51

)

Investment and other income (loss)

 

Valuation allowance

 

 

(30

)

(30

)

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

$

(1,696

)

619

 

(1,077

)

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

(1,777

)

619

 

(1,158

)

 

 

 

 

 

For the three months ended March 31, 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

 

$

(2,345

)

870

 

(1,475

)

Investment and other income (loss)

 

Valuation allowance

 

 

(851

)

(851

)

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

(1,498

)

555

 

(943

)

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

(3,843

)

574

 

(3,269

)

 

 

 

11.       Redeemable noncontrolling Interests

 

Redeemable noncontrolling interests in net income for the three months ended March 31, 2016 was $0.5 million.

 

Noncontrolling interests in consolidated sponsored funds may fluctuate from period to period and are impacted by changes in the Company’s percentage of ownership in sponsored funds, changes in third party investment in sponsored funds and market volatility in the sponsored funds’ underlying investments.

 

The following table details a rollforward of redeemable noncontrolling interests in consolidated sponsored funds for the three months ended March 31, 2016:

 

 

 

Three months ended
March 31, 2016

 

 

 

(in thousands)

 

 

 

 

 

Redeemable noncontrolling interests in sponsored funds upon adoption of new consolidation accounting guidance on January 1, 2016

 

$

14,330

 

Redeemable noncontrolling interests in sponsored funds consolidated during the period

 

18,249

 

Redeemable noncontrolling interests ownership change during the period

 

22,675

 

Redeemable noncontrolling interests deconsolidation

 

(44,234

)

Net income attributable to redeemable noncontrolling interests

 

501

 

Ending balance of redeemable noncontrolling interest in consolidated sponsored funds

 

$

11,521

 

 

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12.       Share-Based Compensation

 

In the first quarter of 2016, we granted 39,065 shares of restricted stock with an average fair value of $27.47 per share under the Company’s 1998 Stock Incentive Plan, as amended and restated (the “SI Plan”). The value of those shares at the grant date, aggregating to $1.1 million, will generally be amortized to expense over a four-year vesting period.

 

At our 2016 annual meeting of stockholders held on April 13, 2016, our stockholders approved amendments to the SI Plan to, among other things, increase the number of shares available for awards by 5,600,000 shares and modify the share counting provisions to allow for the recycling of shares withheld or surrendered for taxes with respect to full value awards.

 

On April 18, 2016, we granted 2,209,135 shares of restricted stock with a fair value of $22.27 per share under the SI Plan.  The value of those shares at the grant date, aggregating to $49.2 million, will generally be amortized to expense over a four-year vesting period.

 

13.       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.

 

The Company establishes reserves for litigation and similar matters when those matters present material loss contingencies that management determines to be both probable and reasonably estimable in accordance with ASC 450, “Contingencies.”    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 information.  The Company discloses the nature of the contingency when management believes it is reasonably possible the outcome may be significant to the Company’s consolidated financial statements 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 an action filed on February 18, 2016 in the United States District Court for the District of Kansas, Saket Kapor (sic), Peter Brockett and Hieu Phan v. Ivy Investment Management Company, et. al. (Case No. 2:16-cv-02106-JWL-TJJ), the Company’s registered investment advisor subsidiaries, the trustees of two of the Company’s affiliated mutual funds, and an officer of a Company subsidiary were sued in a putative derivative action by three mutual fund shareholders alleging breach of fiduciary duty and breach of contract claims relating to investments held in the affiliated mutual funds.  On behalf of the mutual funds, Plaintiffs seek monetary damages and demand a jury trial.  On April 18, 2016, Plaintiff’s dismissed the complaint in the United States District Court for the District of Kansas and filed a similar complaint against the same Plaintiff’s, regarding the same substantive allegations and causes of action, in the District Court of Johnson County, Kansas (Case No. I6CV02338 Div. 4).  To date, no responsive pleading has been filed and no discovery has taken place.

 

In the opinion of management, the ultimate resolution and outcome of this matter is uncertain. Given the preliminary nature of the proceedings and the Company’s dispute over the merits of the claims, the Company is unable to estimate a range of reasonably possible loss, if any, that such matter may represent. While the ultimate resolution of this matter is uncertain, an adverse determination against the Company could have a material adverse impact on our business, financial condition and results of operations.

 

14.       Subsequent Events

 

As a part of the Company’s previously announced cost cutting efforts, on April 4, 2016, the period concluded for employees to elect to voluntarily terminate their employment with the Company pursuant to a voluntary separation offering (the “VSO”).  In addition, on April 22, 2016, the Company began to notify affected employees regarding an involuntary separation program (the “ISP”) to further reduce its workforce.  Affected employees, who represent approximately 10% of the Company’s workforce, will receive a lump sum payment, accelerated vesting of restricted stock and outplacement services.  In connection with the VSO and ISP, the Company expects to record a pre-tax restructuring charge in a range of approximately $16 - $17 million in the second quarter of 2016 related to employee-termination benefits. The Company expects the VSO and ISP to be substantially completed during the second quarter of 2016. These amounts are estimates,

 

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and the actual amounts may vary based on a number of factors, including timing and valuation of certain benefit-related payments.

 

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, 2015, 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;

 

·                                          Our inability to reduce expenses rapidly enough to align with declines in our revenues, the level of our assets under management or our business environment;

 

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

 

·                                          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;

 

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·                                          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, 2015 and as updated in our quarterly reports on Form 10-Q for the year ending December 31, 2016.  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 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 Retail Unaffiliated Distribution channel, which includes third parties such as other broker-dealers, registered investment advisors and various retirement platforms, or through our Retail Broker-Dealer 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 January 2016, we launched the Ivy Targeted Return Bond fund, subadvised by Pictet Asset Management.  This fund seeks to provide a positive total return over the long-term across all market environments by investing in any form of debt security issued in the U.S or internationally.

 

·                  We continue to make progress on modernization of our brokerage and product platform that will include restructuring of our share classes.  We believe that these initiatives, referred to internally as “Project E,” positions the Retail Broker-Dealer channel for long-term competitiveness.  These initiatives move us from a paper-based, labor intensive environment to one utilizing innovative brokerage platform technology, including significant enhancements to our investment advisory programs, financial planning capabilities and client experience.

 

·                  We have completed efforts to identify cost reductions of approximately 10%, or $40.0 million on an annual run-rate basis by 2017, with approximately two-thirds of those savings realized in 2016.  These efforts include a reduction in general and administrative costs and indirect underwriting and distribution costs and an employee headcount reduction of approximately 10%.

 

·                  In April 2016, the U.S. Department of Labor released its final rule that, among other things, expands the scope of a “fiduciary” under the Employee Retirement Income Security Act of 1974, as amended, and Section 4975 of the Internal Revenue Code of 1986, as amended.  The final rule has a phased in implementation from April 10, 2017 through January 1, 2018.  We are in the process of reviewing the final rule to determine its impact on our business.

 

·                  Our assets under management decreased 23% from $122.9 billion at March 31, 2015 to $95.2 billion at March 31, 2016 driven by net outflows of $16.5 billion and market depreciation of $11.2 billion. Our average assets under management decreased 22% from $123.3 billion for the quarter ended March 31, 2015 to $95.7 billion for the quarter ended March 31, 2016.

 

·                  Operating revenues of $323.8 million in the first quarter of 2016 decreased $61.6 million, or 16%, compared to the first quarter of 2015.

 

·                  Operating income of $71.4 million in the first quarter of 2016 decreased $33.0 million, or 32%, compared to the first quarter of 2015.  Our operating margin of 22.1% for the quarter ended March 31, 2016 declined from 27.1% for the quarter ended March 31, 2015. Net income attributable to Waddell & Reed Financial, Inc. of $37.0 million for the first quarter of 2016 decreased $30.1 million, or 45%, compared to this same period a year ago.

 

·                  Company-wide sales in the first quarter of 2016 decreased 33% compared to sales in the first quarter of 2015.

 

·                  During the first quarter of 2016, we returned $63.7 million of capital to stockholders through dividends and share repurchases, compared to $40.6 million in the same period in 2015.

 

·                  Our balance sheet remains solid, and we ended the first quarter of 2016 with cash and investments of $810.6 million, excluding redeemable noncontrolling interests in consolidated sponsored funds.

 

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Assets Under Management

 

During the first quarter of 2016, assets under management decreased 9% to $95.2 billion from $104.4 billion at December 31, 2015 due to outflows of $6.3 billion and market depreciation of $2.9 billion.

 

Change in Assets Under Management(1)

 

 

 

First Quarter 2016

 

 

 

Retail
Unaffiliated
Distribution

 

Retail Broker-Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

45,641

 

43,344

 

15,414

 

104,399

 

 

 

 

 

 

 

 

 

 

 

Sales(2)

 

2,144

 

1,068

 

453

 

3,665

 

Redemptions

 

(7,680

)

(1,197

)

(1,068

)

(9,945

)

Net Exchanges

 

158

 

(172

)

14

 

 

Net Flows

 

(5,378

)

(301

)

(601

)

(6,280

)

 

 

 

 

 

 

 

 

 

 

Market Action

 

(1,640

)

(901

)

(387

)

(2,928

)

Ending Assets

 

$

38,623

 

42,142

 

14,426

 

95,191

 

 

 

 

First Quarter 2015

 

 

 

Retail
Unaffiliated
Distribution

 

Retail Broker-Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

60,335

 

45,517

 

17,798

 

123,650

 

 

 

 

 

 

 

 

 

 

 

Sales(2)

 

3,870

 

1,270

 

300

 

5,440

 

Redemptions

 

(6,259

)

(1,279

)

(1,460

)

(8,998

)

Net Exchanges

 

224

 

(224

)

 

 

Net Flows

 

(2,165

)

(233

)

(1,160

)

(3,558

)

 

 

 

 

 

 

 

 

 

 

Market Action

 

1,242

 

1,101

 

459

 

2,802

 

Ending Assets

 

$

59,412

 

46,385

 

17,097

 

122,894

 

 


(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, accounts 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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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

 

 

 

First Quarter 2016

 

 

 

Retail
Unaffiliated
Distribution

 

Retail Broker-Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Asset Class:

 

 

 

 

 

 

 

 

 

Equity

 

$

32,643

 

29,765

 

13,096

 

$

75,504

 

Fixed Income

 

7,262

 

9,465

 

1,284

 

18,011

 

Money Market

 

188

 

2,030

 

 

2,218

 

Total

 

$

40,093

 

41,260

 

14,380

 

$

95,733

 

 

 

 

First Quarter 2015

 

 

 

Retail
Unaffiliated
Distribution

 

Retail Broker-Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Asset Class:

 

 

 

 

 

 

 

 

 

Equity

 

$

48,628

 

34,188

 

16,551

 

$

99,367

 

Fixed Income

 

10,763

 

10,110

 

1,049

 

21,922

 

Money Market

 

154

 

1,827

 

 

1,981

 

Total

 

$

59,545

 

46,125

 

17,600

 

$

123,270

 

 

Results of Operations — Three Months Ended March 31, 2016 as Compared with Three Months Ended March 31, 2015

 

Net Income

 

 

 

Three months ended

 

 

 

 

 

March 31,

 

 

 

 

 

2016

 

2015

 

Variance

 

 

 

 

 

 

 

 

 

Net income attributable to Waddell & Reed Financial, Inc. (in thousands)

 

$

36,968

 

67,113

 

-45

%

 

 

 

 

 

 

 

 

Earnings per share, basic and diluted

 

$

0.45

 

0.80

 

-44

%

 

 

 

 

 

 

 

 

Operating margin

 

22.1

%

27.1

%

-500 bps

 

 

Total Revenues

 

Total revenues decreased 16% to $323.8 million for the three months ended March 31, 2016 compared to the three months ended March 31, 2015 due primarily to a decrease in average assets under management of 22% driven by net outflows and market depreciation.

 

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Three months ended

 

 

 

 

 

March 31,

 

 

 

 

 

2016

 

2015

 

Variance

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Investment management fees

 

$

144,778

 

182,105

 

-20

%

Underwriting and distribution fees

 

146,658

 

166,978

 

-12

%

Shareholder service fees

 

32,380

 

36,375

 

-11

%

Total revenues

 

$

323,816

 

385,458

 

-16

%

 

Investment Management Fee Revenues

 

Investment management fee revenues are earned by providing investment advisory services to the Funds, the IGI Funds and to institutional and separate accounts.  Investment management fee revenues for the first quarter of 2016 decreased $37.3 million, or 20%, from last year’s first quarter.  The following table summarizes investment management fee revenues, related average assets under management, fee waivers and investment management fee rates for the three months ended March 31, 2016 and 2015.

 

 

 

Three months ended March 31,

 

 

 

 

 

2016

 

2015

 

Variance

 

 

 

(in thousands except for management fee
rate and average assets)

 

 

 

Retail investment management fees

 

$

132,649

 

167,082

 

-21

%

Retail average assets (in millions)

 

81,353

 

105,670