UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2016

 

OR

 

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  No  .

 

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

 

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

 

Large accelerated filer 

 

Accelerated filer 

 

 

 

Non-accelerated filer 

 

Smaller reporting company 

(Do not check if a smaller reporting company)

 

 

 

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

 

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

 

 

 

 

Class

 

Outstanding as of July 15, 2016

Class A common stock, $.01 par value

 

82,840,733

 

 

 

 

 

 


 

WADDELL & REED FINANCIAL, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended June 30, 2016

 

 

 

 

    

Page No.

 

 

 

 

 

Part I.  

Financial Information

 

 

 

 

 

 

 

Item 1.  

 

Financial Statements (unaudited)

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets at June 30, 2016 and December 31, 2015

 

 

 

 

 

 

 

 

Consolidated Statements of Income for the three and six months ended June 30, 2016 and June 30, 2015

 

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and June 30, 2015

 

 

 

 

 

 

 

 

Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2016

 

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and June 30, 2015

 

 

 

 

 

 

 

 

Notes to the Unaudited Consolidated Financial Statements

 

 

 

 

 

 

Item 2.  

 

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

 

21 

 

 

 

 

 

Item 3.  

 

Quantitative and Qualitative Disclosures About Market Risk

 

37 

 

 

 

 

 

Item 4.  

 

Controls and Procedures

 

37 

 

 

 

 

 

Part II.  

Other Information

 

 

 

 

 

 

 

Item 1.  

 

Legal Proceedings

 

38 

 

 

 

 

 

Item 1A.  

 

Risk Factors

 

38 

 

 

 

 

 

Item 2.  

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

39 

 

 

 

 

 

Item 6.  

 

Exhibits

 

40 

 

 

 

 

 

 

 

Signatures

 

41 

 

 

 

 

2


 

PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 

 

 

 

 

 

 

2016

 

 

December 31, 

 

 

 

(Unaudited)

 

 

2015

 

Assets:

    

 

 

    

 

 

    

Cash and cash equivalents

 

$

467,458

 

 

558,495

 

Cash and cash equivalents - restricted

 

 

33,200

 

 

66,880

 

Investment securities

 

 

361,615

 

 

291,743

 

Receivables:

 

 

 

 

 

 

 

Funds and separate accounts

 

 

26,090

 

 

34,399

 

Customers and other

 

 

166,656

 

 

220,660

 

Income taxes receivable

 

 

4,701

 

 

10,594

 

Prepaid expenses and other current assets

 

 

24,042

 

 

34,800

 

Total current assets

 

 

1,083,762

 

 

1,217,571

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

105,871

 

 

105,434

 

Deferred sales commissions, net

 

 

6,783

 

 

24,262

 

Goodwill and identifiable intangible assets

 

 

158,318

 

 

158,118

 

Deferred income taxes

 

 

31,319

 

 

32,692

 

Other non-current assets

 

 

20,185

 

 

17,074

 

Total assets

 

$

1,406,238

 

 

1,555,151

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

25,397

 

 

32,858

 

Payable to investment companies for securities

 

 

48,838

 

 

113,648

 

Payable to third party brokers

 

 

34,458

 

 

49,848

 

Payable to customers

 

 

84,635

 

 

120,420

 

Accrued compensation

 

 

75,861

 

 

69,335

 

Other current liabilities

 

 

63,093

 

 

57,104

 

Total current liabilities

 

 

332,282

 

 

443,213

 

 

 

 

 

 

 

 

 

Long-term debt

 

 

189,519

 

 

189,432

 

Accrued pension and postretirement costs

 

 

29,408

 

 

48,810

 

Other non-current liabilities

 

 

26,605

 

 

27,241

 

Total liabilities

 

 

577,814

 

 

708,696

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

 

10,865

 

 

 —

 

 

 

 

 

 

 

 

 

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; 82,870 shares outstanding (82,850 at December 31, 2015)

 

 

997

 

 

997

 

Additional paid-in capital

 

 

279,206

 

 

331,611

 

Retained earnings

 

 

1,135,646

 

 

1,141,608

 

Cost of 16,831 common shares in treasury (16,851 at December 31, 2015)

 

 

(540,782)

 

 

(566,256)

 

Accumulated other comprehensive loss

 

 

(57,508)

 

 

(61,505)

 

Total stockholders’ equity

 

 

817,559

 

 

846,455

 

 

 

 

 

 

 

 

 

Total liabilities, redeemable noncontrolling interests and stockholders’ equity

 

$

1,406,238

 

 

1,555,151

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

 

3


 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Income

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended June 30, 

 

For the six months ended June 30, 

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues:

    

 

    

    

 

    

    

 

 

    

 

 

    

Investment management fees

 

$

140,880

 

 

185,914

 

 

285,658

 

 

368,019

 

Underwriting and distribution fees

 

 

146,312

 

 

171,508

 

 

292,970

 

 

338,486

 

Shareholder service fees

 

 

32,016

 

 

36,568

 

 

64,396

 

 

72,943

 

Total

 

 

319,208

 

 

393,990

 

 

643,024

 

 

779,448

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting and distribution

 

 

181,245

 

 

195,762

 

 

355,081

 

 

391,182

 

Compensation and related costs (including share-based compensation of $12,625, $11,333, $26,147 and $23,806, respectively)

 

 

58,341

 

 

52,829

 

 

111,281

 

 

106,324

 

General and administrative

 

 

19,276

 

 

27,897

 

 

38,428

 

 

53,575

 

Subadvisory fees

 

 

2,325

 

 

2,394

 

 

4,418

 

 

4,781

 

Depreciation

 

 

4,260

 

 

4,064

 

 

8,622

 

 

8,098

 

Total

 

 

265,447

 

 

282,946

 

 

517,830

 

 

563,960

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

53,761

 

 

111,044

 

 

125,194

 

 

215,488

 

Investment and other income (loss)

 

 

687

 

 

9

 

 

(9,531)

 

 

3,981

 

Interest expense

 

 

(2,776)

 

 

(2,765)

 

 

(5,544)

 

 

(5,531)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

 

51,672

 

 

108,288

 

 

110,119

 

 

213,938

 

Provision for income taxes

 

 

18,101

 

 

40,843

 

 

39,079

 

 

79,380

 

Net income

 

 

33,571

 

 

67,445

 

 

71,040

 

 

134,558

 

Net income (loss) attributable to redeemable noncontrolling interests

 

 

(124)

 

 

 —

 

 

377

 

 

 —

 

Net income attributable to Waddell & Reed Financial, Inc

 

$

33,695

 

 

67,445

 

 

70,663

 

 

134,558

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

0.41

 

 

0.80

 

 

0.86

 

 

1.61

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic and diluted:

 

 

82,947

 

 

84,079

 

 

82,526

 

 

83,831

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

4


 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

For the three months ended June 30, 

 

For the six months ended June 30, 

 

 

 

2016

    

2015

    

2016

    

2015

    

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

33,571

 

 

67,445

 

 

71,040

 

 

134,558

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized appreciation (depreciation) of available for sale investment securities during the period, net of income tax expense (benefit) of $0, $(8), $0, and $5, respectively

 

 

1,884

 

 

(4,974)

 

 

1,960

 

 

(3,164)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pension and postretirement benefits, net of income tax expense of $566, $397, $1,185 and $951, respectively

 

 

960

 

 

933

 

 

2,037

 

 

1,876

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

36,415

 

 

63,404

 

 

75,037

 

 

133,270

 

Comprehensive income (loss) attributable to redeemable noncontrolling interests

 

 

(124)

 

 

 —

 

 

377

 

 

 —

 

Comprehensive income attributable to Waddell & Reed Financial, Inc.

 

$

36,539

 

 

63,404

 

 

74,660

 

 

133,270

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

5


 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders’ Equity and redeemable noncontrolling interests

For the Six Months Ended June 30, 2016

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated Other

 

Total 

 

Non

 

 

 

Common Stock

 

Additional

 

Retained

 

Treasury

 

Comprehensive

 

Stockholders’

 

Controlling

 

 

    

Shares

    

Amount

    

Paid-in Capital

    

Earnings

    

Stock

    

Income (Loss)

    

Equity

    

interest

 

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

 

 —

 

 

 —

 

 —

 

70,663

 

 —

 

 —

 

70,663

 

377

 

Net redemption of redeemable noncontrolling interests in sponsored funds

 

 —

 

 

 —

 

 —

 

 —

 

 —

 

 —

 

 —

 

(3,842)

 

Recognition of equity compensation

 

 —

 

 

 —

 

26,147

 

 —

 

 —

 

 —

 

26,147

 

 —

 

Net issuance/forfeiture of nonvested shares

 

 —

 

 

 —

 

(72,935)

 

 —

 

72,935

 

 —

 

 —

 

 —

 

Dividends accrued, $0.92 per share

 

 —

 

 

 —

 

 —

 

(76,625)

 

 —

 

 —

 

(76,625)

 

 —

 

Tax impact of share-based payment arrangements

 

 —

 

 

 —

 

(5,617)

 

 —

 

 —

 

 —

 

(5,617)

 

 —

 

Repurchase of common stock

 

 —

 

 

 —

 

 —

 

 —

 

(47,461)

 

 —

 

(47,461)

 

 —

 

Other comprehensive income

 

 —

 

 

 —

 

 —

 

 —

 

 —

 

3,997

 

3,997

 

 —

 

Balance at June 30, 2016

 

99,701

 

$

997

 

279,206

 

1,135,646

 

(540,782)

 

(57,508)

 

817,559

 

10,865

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

6


 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

    

For the six months ended June 30, 

 

 

 

2016

    

2015

    

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

71,040

 

 

134,558

 

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

 

 

 

 

 

 

 

Depreciation and amortization

 

 

8,627

 

 

8,100

 

Amortization of deferred sales commissions

 

 

19,661

 

 

24,270

 

Share-based compensation

 

 

26,147

 

 

23,806

 

Excess tax benefits from share-based payment arrangements

 

 

(1,423)

 

 

(4,814)

 

Investments gain, net

 

 

(8,560)

 

 

(2,804)

 

Net purchases and sales or maturities of trading securities

 

 

(24,996)

 

 

56

 

Deferred income taxes

 

 

187

 

 

(2,130)

 

Net change in trading securities held by consolidated sponsored funds

 

 

(45,455)

 

 

 —

 

Other

 

 

328

 

 

81

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Cash and cash equivalents - restricted

 

 

33,680

 

 

16,660

 

Customer and other receivables

 

 

54,004

 

 

65,293

 

Payable to investment companies for securities and payable to customers

 

 

(100,595)

 

 

(83,835)

 

Receivables from funds and separate accounts

 

 

8,309

 

 

5,288

 

Other assets

 

 

6,560

 

 

(7,887)

 

Deferred sales commissions

 

 

(2,182)

 

 

(6,752)

 

Accounts payable and payable to third party brokers

 

 

(22,852)

 

 

(15,814)

 

Other liabilities

 

 

(4,034)

 

 

1,768

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

18,446

 

 

155,844

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of available for sale and equity method securities

 

 

(104)

 

 

(25,891)

 

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

 

 

17,986

 

 

29,778

 

Additions to property and equipment

 

 

(9,265)

 

 

(14,078)

 

Net cash of sponsored funds on consolidation

 

 

6,887

 

 

 —

 

Other

 

 

(196)

 

 

 —

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) investing activities

 

$

15,308

 

 

(10,191)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Dividends paid

 

 

(76,616)

 

 

(72,219)

 

Repurchase of common stock

 

 

(47,461)

 

 

(30,004)

 

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

 

 

(2,224)

 

 

 —

 

Excess tax benefits from share-based payment arrangements

 

 

1,423

 

 

4,814

 

Other

 

 

87

 

 

 —

 

 

 

 

 

 

 

 

 

Net cash used in financing activities

 

$

(124,791)

 

 

(97,409)

 

Net increase (decrease) in cash and cash equivalents

 

 

(91,037)

 

 

48,244

 

Cash and cash equivalents at beginning of period

 

 

558,495

 

 

566,621

 

Cash and cash equivalents at end of period

 

$

467,458

 

 

614,865

 

 

See accompanying notes to the unaudited consolidated financial statements.

7


 

 

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 June 30, 2016, the results of operations and cash flows for the six months ended June 30, 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.

 

8


 

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

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “ Revenue from Contracts with Customers, ” which 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, ” which 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, ” which 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 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, ” which 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.

 

In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments.” The ASU changes the impairment model for most financial assets, and will require the use of an “expected loss” model for instruments measured at amortized cost. Under this model, entities will be required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting

9


 

in a net presentation of the amount expected to be collected on the financial asset. ASU 2016-13 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019. The Company is evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

4. Investment Securities

 

Investment securities at June 30, 2016 and December 31, 2015 are as follows:

 

 

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

 

    

2016

 

2015

 

(in thousands)

 

 

 

 

 

 

Available for sale securities:

 

 

 

 

 

 

Sponsored funds

 

$

84,947

 

40,552

 

Sponsored privately offered funds

 

 

868

 

825

 

Total available for sale securities

 

 

85,815

 

41,377

 

Trading securities:

 

 

 

 

 

 

Mortgage-backed securities

 

 

16

 

20

 

Corporate bond

 

 

3

 

5

 

Common stock

 

 

97

 

87

 

Consolidated sponsored funds

 

 

111,803

 

 —

 

Sponsored funds

 

 

29,924

 

29,701

 

Total trading securities 

 

 

141,843

 

29,813

 

Equity method securities:

 

 

 

 

 

 

Sponsored funds

 

 

130,898

 

217,380

 

Sponsored privately offered funds

 

 

3,059

 

3,173

 

Total equity method securities

 

 

133,957

 

220,553

 

Total securities

 

$

361,615

 

291,743

 

 

The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at June 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Amortized

    

Unrealized

    

Unrealized

    

 

 

 

 

cost

 

gains

 

losses

 

Fair value

 

  

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

89,278

 

1,928

 

(6,259)

 

84,947

 

Sponsored privately offered funds

 

 

500

 

368

 

 —

 

868

 

  

 

$

89,778

 

2,296

 

(6,259)

 

85,815

 

 

 

 

 

 

 

 

 

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

 

 

10


 

A summary of available for sale sponsored funds with fair values below carrying values at June 30, 2016 and December 31, 2015 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

June 30, 2016

    

Fair value  

    

losses

    

Fair value  

    

losses

    

Fair value  

    

losses

 

 

 

(in thousands)

 

Sponsored funds

 

$

2,258

 

(44)

 

33,859

 

(6,037)

 

36,117

 

(6,081)

 

Sponsored privately offered funds

 

 

7,001

 

(178)

 

 —

 

 —

 

7,001

 

(178)

 

 

 

$

9,259

 

(222)

 

33,859

 

(6,037)

 

43,118

 

(6,259)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

December 31, 2015

    

Fair value  

    

losses

    

Fair value  

    

losses

    

Fair value  

    

losses

 

 

 

(in thousands)

 

Sponsored funds

 

$

3,476

 

(166)

 

33,619

 

(6,516)

 

37,095

 

(6,682)

 

 

 

Based upon our assessment of these sponsored funds, we wrote-off $0.1 million at June 30, 2016.

 

The corporate bond accounted for as trading matures in 2018. Mortgage-backed securities accounted for as trading and held as of June 30, 2016 mature in 2022.

 

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 (“VIE”) and are considered to be voting interest entities (“VOE”). The Company has determined the Advisor and Ivy Funds are VOEs because the structure of the investment products is such that the voting rights held by the equity holders provide for equality among equity investors.  The Company has determined that the IGI Funds are VOEs as its legal structure and the powers of its equity investors prevent the IGI Funds from meeting characteristics of being a VIE.

 

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 June 30, 2016, as well as the Company’s net interest in these funds:

 

 

 

 

 

 

 

 

June 30, 2016

 

 

    

(in thousands)

 

 

 

 

 

 

Cash

 

$

7,801

 

Investments

 

 

111,803

 

Other assets

 

 

2,014

 

Other liabilities

 

 

(955)

 

Redeemable noncontrolling interests

 

 

(10,865)

 

Net interest in consolidated sponsored funds

 

$

109,798

 

 

During the six months ended June 30, 2016, we consolidated Ivy Funds and IGI Funds in which we provided initial seed capital at the time of the funds 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.

11


 

 

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. 

 

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 June 30, 2016 and December 31, 2015 that are recognized in our consolidated balance sheets using fair value measurements based on the differing levels of inputs.

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2016

    

Level 1

    

Level 2

    

Level 3

    

Total

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

84,947

 

 —

 

 —

 

84,947

 

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

 

 

 —

 

 —

 

 —

 

868

 

Trading securities:

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

    

 

 —

    

16

    

 —

    

16

 

Corporate bonds

 

 

 —

 

3

 

 —

 

3

 

Common stock

 

 

97

 

 —

 

 —

 

97

 

Consolidated sponsored funds (2)

 

 

 —

 

 —

 

 —

 

111,803

 

Sponsored funds

 

 

29,924

 

 —

 

 —

 

29,924

 

Equity method securities: (1)

 

 

 

 

 

 

 

 

 

 

Sponsored funds

 

 

130,898

 

 —

 

 —

 

130,898

 

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

 

 

 —

 

 —

 

 —

 

3,059

 

Total

 

$

245,866

 

19

 

 —

 

361,615

 

 

 

12


 

 

 

 

 

 

 

 

 

 

 

 

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.

 

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 June 30, 2016, we had 91% of our investments in sponsored funds, excluding our available for sale portfolio, hedged, 82% of which were 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 June 30, 2016, excluding derivative financial instruments held in certain consolidated sponsored funds, the Company was party to three total return swap contracts with a combined notional value of $200.7 million. These derivative instruments are not designated as hedges 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 $8.2 million in cash collateral with the counterparties of the total return swap contracts as of June 30, 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 June 30, 2016:

 

 

 

 

 

 

 

 

 

 

June 30, 2016

 

 

 

Balance sheet

 

 

 

 

 

    

location

    

Fair value

 

 

 

 

 

(in thousands)

 

Total return swap contracts

 

Other current liabilities

 

$

793

 

 

13


 

The following is a summary of net losses recognized in income for the three and six months ended June 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income statement

 

Three months ended

 

Six months ended

 

 

    

location

    

June 30, 2016

    

June 30, 2016

 

 

 

 

 

(in thousands)

 

(in thousands)

 

Total return swap contracts

 

Investment and other income (loss)

 

$

(6,707)

 

$

(21,929)

 

 

 

 

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 June 30, 2016 and December 31, 2015 are as follows:

 

 

 

 

 

 

 

 

 

 

June 30, 

 

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 $20 4.4 million at June 30, 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 June 30, 2016, the Company had unrecognized tax benefits, including penalties and interest, of $11.9 million ($8.7 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 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 six month period ended June 30, 2016 was $0.3 million.  The total amount of accrued penalties and interest related to uncertain tax positions at June 30, 2016 of $3.8 million ($3.1 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.

 

14


 

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 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:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

Other

 

 

 

Pension Benefits

 

Postretirement Benefits

 

Pension Benefits

 

Postretirement Benefits

 

 

 

Three months ended June 30, 

 

Three months ended June 30, 

 

Six months ended June 30, 

 

Six months ended June 30, 

 

 

 

2016

 

2015

 

2016

 

2015

 

2016

 

2015

 

2016

 

2015

 

 

 

(in thousands)

 

(in thousands)

 

Components of net periodic benefit cost:

    

 

    

    

    

    

    

    

    

    

 

 

    

 

    

 

    

 

    

Service cost

 

 

3,106

 

2,994

 

185

 

228

 

 

6,099

 

6,041

 

370

 

456

 

Interest cost

 

 

2,277

 

2,056

 

92

 

99

 

 

4,716

 

4,210

 

184

 

198

 

Expected return on plan assets

 

 

(3,427)

 

(3,565)

 

 —

 

 —

 

 

(6,963)

 

(7,256)

 

 —

 

 —

 

Actuarial (gain) loss amortization

 

 

1,469

 

1,209

 

(38)

 

 —

 

 

3,107

 

2,585

 

(77)

 

 —

 

Prior service cost amortization

 

 

93

 

115

 

1

 

5

 

 

187

 

230

 

2

 

10

 

Transition obligation amortization

 

 

1

 

1

 

 —

 

 —

 

 

2

 

2

 

 —

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total (1)

 

$

3,519

 

2,810

 

240

 

332

 

 

7,148

 

5,812

 

479

 

664

 


(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

 

Six months ended

 

 

 

June 30, 

 

June 30, 

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to Waddell & Reed Financial, Inc.

    

$

33,695

    

67,445

    

 

70,663

    

134,558

    

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic and diluted

 

 

82,947

 

84,079

 

 

82,526

 

83,831

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share, basic and diluted

 

$

0.41

 

0.80

 

 

0.86

 

1.61

 

 

Dividends

 

On April 13, 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 July 11, 2016 to be paid on August 1, 2016. The total dividend to be paid is approximately $38.1 million and is included in other current liabilities as of June 30, 2016.

15


 

 

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 1,075,826 shares and 516,533 shares repurchased in the open market or privately during the three months ended June 30, 2016 and 2015, respectively, which includes 300,826 shares and 306,533 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 2,201,497 shares and 622,591 shares repurchased in the open market or privately during the six months ended June 30, 2016 and 2015, respectively, which includes 304,497 shares and 312,091 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 six months ended June 30, 2016 and June 30, 2015.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in

 

 

 

 

 

 

 

 

 

 

valuation

 

 

 

 

 

 

 

 

 

 

allowance for

 

 

 

 

 

 

 

 

 

 

unrealized

 

Pension and

 

Total

 

 

 

Unrealized

 

gains

 

postretirement

 

accumulated

 

 

 

gains (losses)

 

(losses) on

 

benefits

 

other

 

 

 

on investment

 

investment

 

unrealized

 

comprehensive

 

Three months ended June 30, 2016

 

securities

 

securities

 

gains (losses)

 

income (loss)

 

 

 

(in thousands)

 

Balance at March 31, 2016

    

$

(3,682)

    

 

(3,211)

    

(53,459)

    

(60,352)

 

Other comprehensive income before reclassification

 

 

1,554

 

 

919

 

 —

 

2,473

 

Amount reclassified from accumulated other comprehensive income (loss)

 

 

(370)

 

 

(219)

 

960

 

371

 

Net current period other comprehensive income

 

 

1,184

 

 

700

 

960

 

2,844

 

Balance at June 30, 2016

 

$

(2,498)

 

$

(2,511)

 

(52,499)

 

(57,508)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in

 

 

 

 

 

 

 

 

 

 

valuation

 

 

 

 

 

 

 

 

 

 

allowance for

 

 

 

 

 

 

 

 

 

 

unrealized

 

Pension and

 

Total

 

 

 

Unrealized

 

gains

 

postretirement

 

accumulated

 

 

 

gains (losses)

 

(losses) on

 

benefits

 

other

 

 

 

on investment

 

investment

 

unrealized

 

comprehensive

 

Three months ended June 30, 2015

 

securities

 

securities

 

gains (losses)

 

income (loss)

 

 

 

(in thousands)

 

Balance at March 31, 2015

    

$

421

    

 

(809)

    

(47,302)

    

(47,690)

 

Other comprehensive loss before reclassification

 

 

(2,845)

 

 

(1,671)

 

 —

 

(4,516)

 

Amount reclassified from accumulated other comprehensive income (loss)

 

 

(289)

 

 

(169)

 

933

 

475

 

Net current period other comprehensive income (loss)

 

 

(3,134)

 

 

(1,840)

 

933

 

(4,041)

 

Balance at June 30, 2015

 

$

(2,713)

 

$

(2,649)

 

(46,369)

 

(51,731)

 

 

 

16


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in

 

 

 

 

 

 

 

 

 

 

valuation

 

 

 

 

 

 

 

 

 

 

allowance for

 

 

 

 

 

 

 

 

 

 

unrealized

 

Pension and

 

Total

 

 

 

Unrealized

 

gains

 

postretirement

 

accumulated

 

 

 

gains (losses)

 

(losses) on

 

benefits

 

other

 

 

 

on investment

 

investment

 

unrealized

 

comprehensive

 

Six months ended June 30, 2016

 

securities

 

securities

 

gains (losses)

 

income (loss)

 

 

 

(in thousands)

 

Balance at December 31, 2015

    

$

(3,729)

    

 

(3,240)

    

(54,536)

    

(61,505)

 

Other comprehensive income before reclassification

 

 

1,550

 

 

917

 

 —

 

2,467

 

Amount reclassified from accumulated other comprehensive income (loss)

 

 

(319)

 

 

(188)

 

2,037

 

1,530

 

Net current period other comprehensive income

 

 

1,231

 

 

729

 

2,037

 

3,997

 

Balance at June 30, 2016

 

$

(2,498)

 

$

(2,511)

 

(52,499)

 

(57,508)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in

 

 

 

 

 

 

 

 

 

 

valuation

 

 

 

 

 

 

 

 

 

 

allowance for

 

 

 

 

 

 

 

 

 

 

unrealized

 

Pension and

 

Total

 

 

 

Unrealized

 

gains

 

postretirement

 

accumulated

 

 

 

(gains) losses

 

(losses) on

 

benefits

 

other

 

 

 

on investment

 

investment

 

unrealized

 

comprehensive

 

Six months ended June 30, 2015

 

securities

 

securities

 

gains (losses)

 

income (loss)

 

 

 

(in thousands)

 

Balance at December 31, 2014

    

$

(727)

    

 

(1,471)

    

(48,245)

    

(50,443)

 

Other comprehensive loss before reclassification

 

 

(222)

 

 

(158)

 

 —

 

(380)

 

Amount reclassified from accumulated other comprehensive income (loss)

 

 

(1,764)

 

 

(1,020)

 

1,876

 

(908)

 

Net current period other comprehensive income (loss)

 

 

(1,986)

 

 

(1,178)

 

1,876

 

(1,288)

 

Balance at June 30, 2015

 

$

(2,713)

 

$

(2,649)

 

(46,369)

 

(51,731)

 

 

17


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended June 30, 2016

 

 

 

 

 

 

 

 

Tax

 

 

 

 

 

 

 

 

 

 

(expense)

 

 

 

 

 

 

 

Pre-tax

 

benefit

 

Net of tax

 

Statement of income line item

 

 

 

(in thousands)

 

 

 

Reclassifications included in net income:

    

 

    

    

    

    

    

    

    

 

Sponsored funds investment gains

 

$

589

 

(219)

 

370

 

Investment and other income (loss)

 

Valuation allowance

 

 

 —

 

219

 

219

 

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

 

(1,526)

 

566

 

(960)

 

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

(937)

 

566

 

(371)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended June 30, 2015

 

 

 

 

 

 

 

 

Tax

 

 

 

 

 

 

 

 

 

 

(expense)

 

 

 

 

 

 

 

Pre-tax

 

benefit

 

Net of tax

 

Statement of income line item

 

 

 

(in thousands)

 

 

 

Reclassifications included in net income:

    

 

    

    

    

    

    

    

    

 

Realized gain on sale of sponsored investment securities

 

$

459

 

(170)

 

289

 

Investment and other income (loss)

 

Valuation allowance

 

 

 —

 

169

 

169

 

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

 

(1,330)

 

397

 

(933)

 

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

(871)

 

396

 

(475)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the six months ended June 30, 2016

 

 

 

 

 

 

 

 

Tax

 

 

 

 

 

 

 

 

 

 

(expense)

 

 

 

 

 

 

 

Pre-tax

 

benefit

 

Net of tax

 

Statement of income line item

 

 

 

(in thousands)

 

 

 

Reclassifications included in net income:

    

 

    

    

    

    

    

    

    

 

Sponsored funds investment gains

 

$

508

 

(189)

 

319

 

Investment and other income (loss)

 

Valuation allowance

 

 

 —

 

188

 

188

 

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

 

(3,222)

 

1,185

 

(2,037)

 

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

(2,714)

 

1,184

 

(1,530)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the six months ended June 30, 2015

 

 

 

 

 

 

 

 

Tax

 

 

 

 

 

 

 

 

 

 

(expense)

 

 

 

 

 

 

 

Pre-tax

 

benefit

 

Net of tax

 

Statement of income line item

 

 

 

(in thousands)

 

 

 

Reclassifications included in net income:

    

 

    

    

    

    

    

    

    

 

Realized gain on sale of sponsored investment securities

 

$

2,804

 

(1,040)

 

1,764

 

Investment and other income (loss)

 

Valuation allowance

 

 

 —

 

1,020

 

1,020

 

Provision for income taxes

 

Amortization of pension and postretirement benefits

 

 

(2,827)

 

951

 

(1,876)

 

Underwriting and distribution expense and Compensation and related costs

 

Total

 

$

(23)

 

931

 

908

 

 

 

 

 

 

 

18


 

11. Redeemable Noncontrolling Interests

 

Redeemable noncontrolling interests in net income for the three and six months ended June 30, 2016 was $(0.1) million and $0.4 million, respectively.

 

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 six months ended June 30, 2016:

 

 

 

 

 

 

 

 

Six months ended

 

 

    

June 30, 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

 

 

22,143

 

Redeemable noncontrolling interests deconsolidation

 

 

(44,234)

 

Net income attributable to redeemable noncontrolling interests

 

 

377

 

Ending balance of redeemable noncontrolling interest in consolidated sponsored funds

 

$

10,865

 

 

 

 

12. Share-Based Compensation

 

In the second quarter of 2016, we granted 2,213,850 shares of restricted stock with an average fair value of $22.27 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 $49.3 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, the plaintiffs seek monetary damages and demand a jury trial.  On April 18, 2016, the plaintiffs dismissed the complaint in the United States District Court for the District of Kansas and filed a similar complaint against the same defendants, regarding the same substantive allegations and causes of action, in the District Court of Johnson County, Kansas (Case No. I6CV02338 Div.4).  On April 25, 2016, the plaintiffs voluntarily

19


 

dismissed the officer of a Company subsidiary as a defendant.  On June 30, 2016, the remaining defendants filed a Motion to Dismiss the complaint.  To date, 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.

 

 

 

20


 

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;

 

·

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

 

21


 

·

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 fees earned on fee-based asset allocation products and related advisory services, Rule 12b-1 asset-based service and distribution fees, 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.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

22


 

 

 

Company Developments

 

 

·

We continue to make progress on modernization of our brokerage and product platform and in July 2016 completed the restructuring of our share classes for advisory products.  We believe that these initiatives, referred to internally as “Project E,” position 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.

 

·

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 28% from $120.7 billion at June 30, 2015 to $86.5 billion at June 30, 2016 driven by net outflows of $25.2 billion and market depreciation of $9.0 billion. Our average assets under management decreased 26% from $123.5 billion for the quarter ended June 30, 2015 to $90.8 billion for the quarter ended June 30, 2016.

 

·

Operating revenues of $319.2 million in the second quarter of 2016 decreased $74.8 million, or 19%, compared to the second quarter of 2015.

 

·

Operating income of $53.8 million in the second quarter of 2016 decreased $57.3 million, or 52%, compared to the second quarter of 2015.  Our operating margin of 16.8% for the quarter ended June 30, 2016 declined from 28.2% for the quarter ended June 30, 2015. Net income attributable to Waddell & Reed Financial, Inc. of $33.7  million for the second quarter of 2016 decreased $33.8 million, or 50%, compared to this same period a year ago.

 

·

Our sales in the second quarter of 2016 decreased 51% compared to sales in the second quarter of 2015.

 

·

During the second quarter of 2016, we returned $60.4 million of capital to stockholders through dividends and share repurchases, compared to $61.6 million in the same period in 2015.

 

·

Our balance sheet remains solid, and we ended the second quarter of 2016 with cash and investments of $819.3 million, excluding redeemable noncontrolling interests in consolidated sponsored funds.

 

·

Our income statement for the three months ended June 30, 2016 included expenses of $17.0 million related to a voluntary separation offering (the “VSO”) and involuntary separation program (the “ISP”) , $5.9 million related to accelerated deferred acquisition cost amortization in connection with our share conversion for certain advisory products, and $1.3 million related to Project E implementation costs.

 

23


 

Assets Under Management

 

During the second quarter of 2016, assets under management decreased 9% to $86.5 billion from $95.2 billion at March 31, 2016 due to outflows of $9.8 billion, partially offset by market appreciation of $1.0 billion.

 

Change in Assets Under Management (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter 2016

 

 

    

Retail

    

 

    

 

    

 

 

 

 

Unaffiliated

 

Retail Broker

 

 

 

 

 

 

 

Distribution

 

Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

38,623

 

42,142

 

14,426

 

95,191

 

 

 

 

 

 

 

 

 

 

 

 

Sales (2)

 

 

1,526

 

1,094

 

190

 

2,810

 

Redemptions

 

 

(5,543)

 

(1,329)

 

(5,699)

 

(12,571)

 

Net Exchanges

 

 

127

 

(163)

 

36

 

 —

 

Net Flows

 

 

(3,890)

 

(398)

 

(5,473)

 

(9,761)

 

 

 

 

 

 

 

 

 

 

 

 

Market Action

 

 

464

 

517

 

40

 

1,021

 

Ending Assets

 

$

35,197

 

42,261

 

8,993

 

86,451

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter 2015

 

 

    

Retail

    

 

    

 

    

 

 

 

 

Unaffiliated

 

Retail Broker

 

 

 

 

 

 

 

Distribution

 

Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

59,412

 

46,385

 

17,097

 

122,894

 

 

 

 

 

 

 

 

 

 

 

 

Sales (2)

 

 

3,239

 

1,347

 

1,203

 

5,789

 

Redemptions

 

 

(4,558)

 

(1,279)

 

(1,003)

 

(6,840)

 

Net Exchanges

 

 

144

 

(144)

 

 —

 

 —

 

Net Flows

 

 

(1,175)

 

(76)

 

200

 

(1,051)

 

 

 

 

 

 

 

 

 

 

 

 

Market Action

 

 

(692)

 

(362)

 

(83)

 

(1,137)

 

Ending Assets

 

$

57,545

 

45,947

 

17,214

 

120,706

 

 

Assets under management decreased to $86.5 billion at June 30, 2016 compared to $104.4 billion at December 31, 2015 due to outflows of $16.0 billion and market depreciation of $1.9 billion.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year to Date 2016

 

 

    

Retail

    

 

    

 

    

 

 

 

 

Unaffiliated

 

Retail Broker

 

 

 

 

 

 

 

Distribution

 

Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

45,641

 

43,344

 

15,414

 

104,399

 

 

 

 

 

 

 

 

 

 

 

 

Sales (2)

 

 

3,671

 

2,161

 

643

 

6,475

 

Redemptions

 

 

(13,224)

 

(2,525)

 

(6,767)

 

(22,516)

 

Net Exchanges

 

 

285

 

(335)

 

50

 

 —

 

Net Flows

 

 

(9,268)

 

(699)

 

(6,074)

 

(16,041)

 

 

 

 

 

 

 

 

 

 

 

 

Market Action

 

 

(1,176)

 

(384)

 

(347)

 

(1,907)

 

Ending Assets

 

$

35,197

 

42,261

 

8,993

 

86,451

 

 

 

24


 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year to Date 2015

 

 

    

Retail

    

 

    

 

    

 

 

 

 

Unaffiliated

 

Retail Broker

 

 

 

 

 

 

 

Distribution  

 

Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

60,335

 

45,517

 

17,798

 

123,650

 

 

 

 

 

 

 

 

 

 

 

 

Sales (2)

 

 

7,110

 

2,616

 

1,504

 

11,230

 

Redemptions

 

 

(10,816)

 

(2,558)

 

(2,464)

 

(15,838)

 

Net Exchanges

 

 

367

 

(367)

 

 —

 

 —

 

Net Flows

 

 

(3,339)

 

(309)

 

(960)

 

(4,608)

 

 

 

 

 

 

 

 

 

 

 

 

Market Action

 

 

549

 

739

 

376

 

1,664

 

Ending Assets

 

$

57,545

 

45,947

 

17,214

 

120,706

 

 


(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.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter 2016

 

 

    

Retail

    

 

    

 

    

 

 

 

 

 

Unaffiliated

 

Retail Broker-

 

 

 

 

 

 

 

 

Distribution

 

Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset Class:

 

 

 

 

 

 

 

 

 

 

 

Equity

 

$

29,049

 

30,860

 

10,891

 

$

70,800

 

Fixed Income

 

 

7,397

 

9,791

 

631

 

 

17,819

 

Money Market

 

 

168

 

2,010

 

 

 

2,178

 

Total

 

$

36,614

 

42,661

 

11,522

 

$

90,797

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter 2015

 

 

    

Retail

    

 

    

 

    

 

 

 

 

 

Unaffiliated

 

Retail Broker-

 

 

 

 

 

 

 

 

Distribution

 

Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset Class:

 

 

 

 

 

 

 

 

 

 

 

Equity

 

$

48,580

 

35,106

 

16,216

 

$

99,902

 

Fixed Income

 

 

10,448

 

10,093

 

1,110

 

 

21,651

 

Money Market

 

 

137

 

1,822

 

 

 

1,959

 

Total

 

$

59,165

 

47,021

 

17,326

 

$

123,512

 

 

25


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year to Date 2016

 

 

    

Retail

    

 

    

 

    

 

 

 

 

 

Unaffiliated

 

Retail Broker-

 

 

 

 

 

 

 

 

Distribution

 

Dealer

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset Class:

 

 

 

 

 

 

 

 

 

 

 

Equity

 

$

30,846

 

30,312

 

11,994

 

$

73,152

 

Fixed Income

 

 

7,329

 

9,628

 

958

 

 

17,915

 

Money Market

 

 

178

 

2,020

 

 

 

2,198

 

Total

 

$

38,353

 

41,960

 

12,952

 

$

93,265

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year to Date 2015

 

 

    

Retail

    

 

    

 

    

 

 

 

 

 

Unaffiliated

 

Retail Broker-

 

 

 

 

 

 

 

 

Distribution

 

Dealer

 

Institutional

 

 

Total

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset Class:

 

 

 

 

 

 

 

 

 

 

 

Equity

 

$

48,605

 

34,649

 

16,382

 

$

99,636

 

Fixed Income

 

 

10,604

 

10,101

 

1,080

 

 

21,785

 

Money Market

 

 

146

 

1,825

 

 

 

1,971

 

Total

 

$

59,355

 

46,575

 

17,462

 

$

123,392

 

 

 

Results of Operations — Three and Six Months Ended June 30, 2016 as Compared with Three and Six Months Ended June 30, 2015

 

Net Income

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

 

 

June 30, 

 

 

 

 

    

2016

    

2015

    

Variance

 

 

 

 

 

 

 

 

 

 

Net income attributable to Waddell & Reed

 

 

 

 

 

 

 

 

Financial, Inc. (in thousands)

 

$

33,695

 

67,445

 

(50)

%

Earnings per share, basic and diluted

 

$

0.41

 

0.80

 

(49)

%

Operating Margin

 

 

16.8

%  

28.2

%  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended

 

 

 

 

 

June 30, 

 

Variance

 

 

    

2016

    

2015

    

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to Waddell & Reed

 

 

 

 

 

 

 

 

Financial, Inc. (in thousands)

 

$

70,663

 

134,558

 

(47)

%

Earnings per share, basic and diluted

 

$

0.86

 

1.61

 

(47)

%

Operating Margin

 

 

19.5

%  

27.6

%  

 

 

 

 

 

 

26


 

Total Revenues

 

Total revenues decreased 19% to $319.2 million for the three months ended June 30, 2016 compared to the three months ended June 30, 2015 due primarily to a decrease in average assets under management of 26% driven by net outflows.   For the six months ended June 30, 2016, total revenues decreased $136.4 million, or 18%, compared to the same period in the prior year due to a decrease in average assets under management of 24% driven primarily by net outflows.

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

 

 

June 30, 

 

 

 

 

    

2016

    

2015

    

Variance

 

 

 

(in thousands)

 

 

 

Investment management fees

 

$

140,880

 

185,914

 

(24)

%

Underwriting and distribution fees

 

 

146,312

 

171,508

 

(15)

%

Shareholder service fees

 

 

32,016

 

36,568

 

(12)

%

Total revenues

 

$

319,208

 

393,990

 

(19)

%

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended

 

 

 

 

 

June 30, 

 

 

 

 

    

2016

    

2015

    

Variance

 

 

 

(in thousands)

 

 

 

Investment management fees

 

$

285,658

 

368,019

 

(22)

%

Underwriting and distribution fees

 

 

292,970

 

338,486

 

(13)

%

Shareholder service fees

 

 

64,396

 

72,943

 

(12)

%

Total revenues

 

$

643,024

 

779,448

 

(18)

%

 

 

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 second quarter of 2016 decreased $45.0 million, or 24%, from last year’s second quarter.  For the six month period ended June 30, 2016, investment management fee revenues decreased $82.4 million, or 22%, compared to the same period in 2015.  The following table summarizes investment management fee revenues, related average assets under management, fee waivers and investment management fee rates for the three and six months ended June 30, 2016 and 2015.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

 

 

 

 

    

2016

    

2015

    

 

Variance

 

 

 

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

 

 

 

 

Retail investment management fees

 

$

131,307

 

 

170,822

 

 

(23)

%

Retail average assets (in millions)

 

 

79,275

 

 

106,186

 

 

(25)

%

Retail management fee rate

 

 

0.6662

%  

 

0.6452

%  

 

 

 

Money market fee waivers

 

 

932

 

 

1,757

 

 

(47)

%

Other fee waivers

 

 

983

 

 

945

 

 

4

%

Total fee waivers

 

$

1,915

 

 

2,702

 

 

(29)

%

Institutional investment management fees

 

$

9,573

 

$

15,092

 

 

(37)

%

Institutional average assets (in millions)

 

 

11,523

 

 

17,326

 

 

(34)

%

Institutional management fee rate

 

 

0.3483

%  

 

0.3494

%  

 

 

 

 

27


 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 

 

 

 

 

 

    

2016

    

2015

    

 

Variance

 

 

 

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

 

 

 

 

Retail investment management fees

 

$

264,070

 

 

337,904

 

 

(22)

%

Retail average assets (in millions)

 

 

80,314

 

 

105,929

 

 

(24)

%

Retail management fee rate

 

 

0.6612

%  

 

0.6433

%  

 

 

 

Money market fee waivers

 

 

2,385

 

 

3,566

 

 

(33)

%

Other fee waivers

 

 

2,106

 

 

1,687

 

 

25

%

Total fee waivers

 

$

4,491

 

 

5,253

 

 

(15)

%

Institutional investment management fees

 

$

21,588

 

$

30,115

 

 

(28)

%

Institutional average assets (in millions)

 

 

12,952

 

 

17,462

 

 

(26)

%

Institutional management fee rate

 

 

0.3484

%  

 

0.3478

%  

 

 

 

 

 

Revenues from investment management services provided to our retail mutual funds, which are distributed through the Retail Unaffiliated Distribution and Retail Broker-Dealer channels, decreased $39.5 million in the second quarter of 2016, compared to the second quarter of 2015.  For the six months ended June 30, 2016, revenues from investment management services provided to our retail mutual funds decreased $73.8 million, compared to the first six months of 2015.  For both comparative periods, investment management revenue declined less on a percentage basis than the related average assets under management due to an increase in the average management fee rate.  A lower asset base in the Ivy Asset Strategy Fund has resulted in increased management fee rates in 2016 compared to 2015, due to the fund having a management fee rate less than our average management fee rate.  Fee waivers for the Funds are recorded as an offset to investment management fees up to the amount of fees earned. 

 

Institutional account revenues in the second quarter of 2016 decreased $5.5 million, compared to the second quarter of 2015.  For the six month period ended June 30, 2016, institutional account revenues decreased $8.5 million, compared to the same period in 2015. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Annualized long-term redemption rates

 

 

 

(excludes money market redemptions)

 

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30, 

 

 

June 30, 

 

 

    

2016

    

2015

    

 

2016

    

2015

    

Retail Unaffiliated Distribution channel

 

61.3

%  

31.0

%  

 

69.9

%  

36.9

%  

Retail Broker-Dealer channel

 

10.5

%  

9.0

%  

 

9.9

%  

9.0

%  

Institutional channel

 

198.9

%  

23.2

%  

 

105.1

%  

28.5

%  

Total

 

55.6

%  

21.7

%  

 

48.3

%  

25.3

%  

 

The increased redemption rate in both comparative periods for the Retail Unaffiliated Distribution channel was driven primarily by redemptions in the Asset Strategy funds.  Redemptions in the Asset Strategy funds represent approximately 50% of the Retail Unaffiliated Distribution channel’s redemptions during the second quarter of 2016 and the first six months of 2016.  Prolonged redemptions in the Retail Unaffiliated Distribution channel could negatively affect revenues in future periods.  During the second quarter of 2016 in the Institutional channel, an Asset Strategy account that we subadvise with $2.0 billion in assets under management, a $2.1 billion institutional account in our large cap growth strategy, and an $800.0 million institutional account in our municipal high income strategy were redeemed.

 

Our overall current year-to-date redemption rate of 48.3% is higher than the current year-to-date industry average of approximately 25%, based on data from the Investment Company Institute.

 

28


 

Underwriting and Distribution Fee Revenues and Expenses

 

The following tables summarize our underwriting and distribution fee revenues and expenses segregated by distribution channel:

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter 2016

 

 

 

Retail

 

 

 

 

 

 

 

Unaffiliated

 

Retail Broker-

 

 

 

 

    

Distribution  

    

Dealer

    

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

32,510

 

113,802

 

146,312

 

Expenses - Direct

 

 

(42,452)

 

(87,740)

 

(130,192)

 

Expenses - Indirect

 

 

(14,939)

 

(36,114)

 

(51,053)

 

Net Distribution (Costs)/Excess

 

$

(24,881)

 

(10,052)

 

(34,933)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter 2015

 

 

    

Retail

    

 

    

 

 

 

 

Unaffiliated

 

Retail Broker-

 

 

 

 

 

Distribution  

 

Dealer

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

51,768

 

119,740

 

171,508

 

Expenses - Direct

 

 

(66,947)

 

(85,177)

 

(152,124)

 

Expenses - Indirect

 

 

(13,972)

 

(29,666)

 

(43,638)

 

Net Distribution (Costs)/Excess

 

$

(29,151)

 

4,897

 

(24,254)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year to Date 2016

 

 

    

Retail

    

 

    

 

 

 

 

Unaffiliated

 

Retail Broker-

 

 

 

 

 

Distribution  

 

Dealer

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

68,433

 

224,537

 

292,970

 

Expenses - Direct

 

 

(89,298)

 

(168,017)

 

(257,315)

 

Expenses - Indirect

 

 

(28,288)

 

(69,478)

 

(97,766)

 

Net Distribution (Costs)/Excess

 

$

(49,153)

 

(12,958)

 

(62,111)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year to Date 2015

 

 

    

Retail

    

 

    

 

 

 

 

Unaffiliated

 

Retail Broker-

 

 

 

 

 

Distribution  

 

Dealer

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

103,910

 

234,576

 

338,486

 

Expenses - Direct

 

 

(135,542)

 

(167,199)

 

(302,741)

 

Expenses - Indirect

 

 

(28,001)

 

(60,440)

 

(88,441)

 

Net Distribution (Costs)/Excess

 

$

(59,633)

 

6,937

 

(52,696)

 

 

 

 

29


 

The following tables summarize the significant components of underwriting and distribution fee revenues segregated by distribution channel:

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter 2016

 

 

    

Retail

    

Retail

    

 

 

 

 

Unaffiliated

 

Broker-

 

 

 

 

 

Distribution

 

Dealer

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

Underwriting and distribution fee revenues

 

 

 

 

 

 

 

 

Rule 12b-1 service and distribution fees

 

$

31,590

 

27,739

 

59,329

 

Fee-based asset allocation product revenues

 

 

 

55,486

 

55,486

 

Sales commissions on front-end load mutual fund and variable annuity products

 

 

190

 

17,352

 

17,542

 

Sales commissions on other products

 

 

 

8,029

 

8,029

 

Other revenues

 

 

730

 

5,196

 

5,926

 

Total

 

$

32,510

 

113,802

 

146,312

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second Quarter 2015

 

 

    

Retail

    

Retail

    

 

 

 

 

Unaffiliated

 

Broker-

 

 

 

 

 

Distribution

 

Dealer

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

Underwriting and distribution fee revenues

 

 

 

 

 

 

 

 

Rule 12b-1 service and distribution fees

 

$

49,818

 

31,429

 

81,247

 

Fee-based asset allocation product revenues

 

 

 

57,717

 

57,717

 

Sales commissions on front-end load mutual fund and variable annuity products

 

 

1,015

 

18,266

 

19,281

 

Sales commissions on other products

 

 

 

6,509

 

6,509

 

Other revenues

 

 

935

 

5,819

 

6,754

 

Total

 

$

51,768

 

119,740

 

171,508

 

 

 

 

 

 

 

 

 

 

 

 

 

Year to Date 2016

 

 

    

Retail

    

Retail

    

 

 

 

 

Unaffiliated

 

Broker-

 

 

 

 

 

Distribution

 

Dealer

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

Underwriting and distribution fee revenues

 

 

 

 

 

 

 

 

Rule 12b-1 service and distribution fees

 

$

66,162

 

55,105

 

121,267

 

Fee-based asset allocation product revenues

 

 

 

109,156

 

109,156

 

Sales commissions on front-end load mutual fund and variable annuity products

 

 

511

 

33,853

 

34,364

 

Sales commissions on other products

 

 

 

15,993

 

15,993

 

Other revenues

 

 

1,760

 

10,430

 

12,190

 

Total

 

$

68,433

 

224,537

 

292,970

 

 

 

30


 

 

 

 

 

 

 

 

 

 

 

 

Year to Date 2015

 

 

    

Retail

    

Retail

    

 

 

 

 

Unaffiliated

 

Broker-

 

 

 

 

 

Distribution

 

Dealer

 

Total

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

Underwriting and distribution fee revenues

 

 

 

 

 

 

 

 

Rule 12b-1 service and distribution fees

 

$

99,742

 

61,765

 

161,507

 

Fee-based asset allocation product revenues

 

 

 

113,139

 

113,139

 

Sales commissions on front-end load mutual fund and variable annuity products

 

 

1,935

 

35,192

 

37,127

 

Sales commissions on other products

 

 

 

12,787

 

12,787

 

Other revenues

 

 

2,233

 

11,693

 

13,926

 

Total

 

$

103,910

 

234,576

 

338,486

 

 

 

Underwriting and distribution revenues earned in the second quarter of 2016 decreased by $25.2 million, or 15%, compared to the second quarter of 2015.  Rule 12b-1 asset based service and distribution fees across both channels decreased $21.9 million, or 27%, quarter over quarter, driven by a decrease in average mutual fund assets under management for which we earn Rule 12b-1 revenues.  Approximately 75% of Rule 12b-1 revenues earned are a pass-through to direct underwriting and distribution expenses.  In our Retail Broker-Dealer channel, revenues from fee-based asset allocation products continued to be meaningful, comprising 49% of Retail Broker-Dealer channel underwriting and distribution revenues in the second quarter of 2016. Fee-based asset allocation assets under management slightly decreased from $18.3 billion at June 30, 2015 to $17.8 billion at June 30, 2016, producing a decrease of fee-based asset allocation revenue of $2.2 million, or 4%.

 

For the six months ended June 30, 2016, underwriting and distribution revenues decreased $45.5 million, or 13%, compared with the six months ended June 30, 2015.  Rule 12b-1 asset based service and distribution fees across both channels decreased $40.2 million, or 25%, compared to the first six months of 2015, driven by a decrease in average mutual fund assets under management for which we earn Rule 12b ‑1 revenues.  In our Retail Broker-Dealer channel, revenues from fee-based asset allocation products decreased $4.0 million, or 4%, compared to the prior year.   

 

Underwriting and distribution expenses for the second quarter of 2016 decreased by $14.5 million, or 7%, compared to the second quarter of 2015.  Direct expenses in the Retail Unaffiliated Distribution channel decreased by $24.5 million due to decreased average Retail Unaffiliated Distribution assets under management of 38% and lower sales volume year over year, which resulted in lower dealer compensation, wholesaler commissions and Rule 12b-1 asset-based service and distribution expenses paid to third party distributors.  Direct expenses in the Retail Broker-Dealer channel increased $2.6 million, or 3%, including a $5.9 million write-off of deferred acquisition costs classified as prepaid and other non-current assets related to the share class conversion in our advisory products.  This accelerated amortization will result in lower direct underwriting and distribution expense of $4.5 million for the last half of 2016 and $1.4 million related to 2017.  Excluding this charge, direct expenses in the Retail Broker-Dealer channel decreased $3.3 million due to decreased Rule 12b-1 asset-based service expenses and commissions expense.  Indirect expenses across both channels increased $7.4 million, or 17%, compared to the second quarter of 2015, primarily due to increased employee compensation and benefits of $7.1 million related the VSO and the ISP and $1.3 million related to Project E implementation costs.  These increases were partially offset by lower advertising expenses and sales meeting costs. In July of 2016, we converted load-waived A shares previously offered in our advisory products to institutional share classes, which do not charge a Rule 12b-1 fee or a contingent deferred sales charge.  As a result, we will no longer collect Rule 12b-1 asset-based service and distribution fee revenue on these assets under management, which is expected to reduce our pre-tax operating income by an estimated $7.8 million for the remainder of 2016, net of underwriting and distribution expenses.

 

For the six months ended June 30, 2016, underwriting and distribution expenses decreased by $36.1 million, or 9%, compared to the first six months of 2015.  Direct expenses in the Retail Unaffiliated Distribution channel decreased by $46.2 million due to decreased average wholesale assets under management of 35% and lower sales volume year over year, which resulted in lower dealer compensation, wholesaler commissions and Rule 12b-1 asset-based service and distribution expenses paid to third party distributors.  Direct expenses in the Retail Broker-Dealer channel increased $0.8 million, including a $5.9 million write-off of deferred acquisition costs classified as prepaid and other non-current assets related to our share conversion for certain advisory products.  Excluding this charge, direct expenses in the Retail Broker-Dealer channel decreased $5.1 million due to decreased Rule 12b-1 asset-based service expenses and

31


 

commissions expense.  Indirect expenses, across both channels, during the six months ended June 30, 2016 increased $9.3 million, or 11%, compared with the six months ended June 30, 2015, primarily due to increased employee compensation and benefits of $7.1 million related to the VSO and the ISP, computer services and software expenses and consulting expenses, partially offset by lower advertising expenses and sales meeting costs.  Indirect costs in the Retail Broker-Dealer channel included $2.7 million related to Project E implementation costs.

 

Shareholder Service Fee Revenue

 

Shareholder service fee revenue primarily includes transfer agency fees, custodian fees from retirement plan accounts, and portfolio accounting and administration fees.  Transfer agency fees are asset-based and/or account-based revenues, portfolio accounting and administration fees are asset-based revenues, and custodian fees from retirement plan accounts are based on the number of client accounts.

 

During the second quarter of 2016, shareholder service fee revenue decreased $4.6 million, or 12%, compared to the second quarter of 2015 primarily due to lower average assets under management causing a decrease in asset-based fees.  Of the decrease in asset-based fees, fees for the I, Y, R and R6 share classes of the Funds decreased $4.3 million, or 42%, compared to the second quarter of 2015.  Assets in the I, Y, R and R6 share classes of the Funds declined 40% from a quarterly average of $27.4 billion at June 30, 2015 to an average of $16.5 billion at June 30, 2016.  For the six month period ended June 30, 2016, shareholder service fee revenue decreased $8.5 million, or 12%, compared to the same period in 2015 due to a decrease in asset-based fees.  Asset-based fees during the six months ended June 30, 2016 for the I, Y, R and R6 share classes of the Funds decreased $8.1 million, or 39%.  Assets in the I, Y, R and R6 share classes of the Funds declined 38% from an average of $27.4 billion at June 30, 2015 to an average of $17.1 billion at June 30, 2016. 

 

The share class conversion in July of 2016 from load-waived Class A shares to institutional share classes offered in our advisory programs will result in lower shareholder service fee revenue.  Certain transfer agency fees for institutional share classes are asset-based and maintain lower revenue rates compared to account-based transfer agency fees.  Shareholder service fee revenue will decline following the share class conversion in 2016 and will result in lower revenue rates compared to account-based transfer agency fees.  Based on the composition of accounts and relative balances as of June 30, 2016, shareholder service fee revenue is expected to decline approximately $7.8 million for the remainder of 2016.

 

Total Operating Expenses

 

Operating expenses decreased $17.5 million, or 6%, in the second quarter of 2016 compared to the second quarter of 2015, primarily due to decreased underwriting and distribution expenses and general and administrative expenses.   For the six months ended June 30, 2016, operating expenses decreased $46.1 million, or 8%, compared to the first six months of 2015, primarily due to decreased underwriting and distribution expenses and general and administrative

32


 

expenses, offset by increased compensation and related costs related to the VSO and the ISP severance and related charges.  Underwriting and distribution expenses are discussed above.

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

 

 

June 30, 

 

 

 

 

    

2016

    

2015

    

Variance

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting and distribution

 

$

181,245

 

195,762

 

(7)

%  

Compensation and related costs

 

 

58,341

 

52,829

 

10

%  

General and administrative

 

 

19,276

 

27,897

 

(31)

%  

Subadvisory fees

 

 

2,325

 

2,394

 

(3)

%  

Depreciation

 

 

4,260

 

4,064

 

5

%  

Total operating expenses

 

$

265,447

 

282,946

 

(6)

%  

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended

 

 

 

 

    

June 30, 

 

 

 

 

    

2016

    

2015

    

Variance

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting and distribution

 

$

355,081

 

391,182

 

(9)

%  

Compensation and related costs

 

 

111,281

 

106,324

 

5

%  

General and administrative

 

 

38,428

 

53,575

 

(28)

%  

Subadvisory fees

 

 

4,418

 

4,781

 

(8)

%  

Depreciation

 

 

8,622

 

8,098

 

6

%  

Total operating expenses

 

$

517,830

 

563,960

 

(8)

%  

 

 

 

Cost Reduction Efforts

 

As previously announced, the Company completed significant cost reduction efforts to offset the projected decrease in 2016 operating income related to lower assets under management and the implementation of Project E - the modernization of our brokerage and product platform, including the restructuring of our share classes, which we completed in July 2016.  We have completed the process to identify cost reductions of approximately 10% or $40.0 million on an annual run-rate basis in 2017, with approximately two-thirds of these savings projected to be realized in 2016.  These reductions are expected to impact general and administrative costs, compensation costs and indirect underwriting and distribution costs.  The Company’s workforce was reduced by approximately 10% during the second quarter of 2016 pursuant to the VSO and the ISP.  The company recorded a pre-tax restructuring charge of $17.0 million in the second quarter of 2016 related to employee-termination benefits in connection with the VSO and the ISP, including cash severance costs, the acceleration of stock-based compensation and outplacement services.

 

Compensation and Related Costs

 

Compensation and related costs during the second quarter of 2016 increased $5.5 million, or 10%, compared to the second quarter of 2015.  A $9.6 million increase related to the VSO and the ISP severance and related charges and an increase in share-based compensation of $1.3 million were the primary drivers.  Partially offsetting the increases, incentive compensation, base salaries and other miscellaneous compensation decreased by a total of $5.1 million, compared to the second quarter of 2015.

 

For the six months ended June 30, 2016, c ompensation and related costs increased $5.0 million, or 5%, compared to the first six months of 2015.  Increases of $9.6 million related to the VSO and the ISP severance and related charges, and share-based compensation of $2.3 million were the primary contributors.  Partially offsetting the increases, incentive compensation and other miscellaneous compensation decreased by $6.9 million, compared to the first six months of 2015.

 

33


 

General and Administrative Costs

 

General and administrative expenses decreased $8.6 million to $19.3 million for the second quarter of 2016, compared to the second quarter of 2015.  Lower dealer servicing costs, computer services and software expense, and advertising costs drove the decrease.  A majority of dealer service costs represent pass-through account servicing costs to third party dealers and are based on lower asset levels in certain share classes.

 

For the six months ended June 30, 2016, general and administrative expenses decreased $15.1 million to $38.4 million, compared to the same period in 2015.  The decrease is due to lower dealer service costs, computer services and software expense, and lower money market fund reimbursements.  

 

Subadvisory Fees

 

Subadvisory fees represent fees paid to other asset managers for providing advisory services for certain mutual fund portfolios.  Gross management fee revenues for products subadvised by others were $4.0 million for the three months ended June 30, 2016 compared to $4.4 million for the second quarter of 2015 due to a less than 1% decrease in subadvised average net assets under management.  For the six months ended June 30, 2016, gross management fee revenues for products subadvised by others were $7.6 million compared to $8.9 million for the same period in 2015 due to a 4% decrease in average net assets under management.  For both comparative periods, gross management fee revenues for subadvised products decreased at a greater rate than the related average net assets under management due to a decrease in the average management fee rate.  The decrease in the average management fee rate was driven by a mix-shift of assets into subadvised funds with lower management fee rates.  Subadvisory expenses during the three and six months ended June 30, 2016 decreased in relation to revenue when compared to the same periods in 2015.

 

Subadvised average assets under management at June 30, 2016 were $2.5 billion compared to an average of $2.6 billion at June 30, 2015.

 

Investment and Other Income (Loss) and Taxes

 

Investment and other income was $0.7 million for the three months ended June 30, 2016, compared to investment and other income of $9 thousand for the same period in 2015.  With our hedge program implemented with respect to (91% of) our investments in sponsored funds, we recognized $2.5 million of net losses related to our seed capital investments and associated hedges.  This net loss was more than offset by $2.0 million in dividend and interest income and $0.6 million in realized gains on the sales of sponsored funds held as available for sale. The second quarter of 2016 also included $0.4 million of gains attributable to noncontrolling interests in sponsored funds for the period in which the Company held majority ownership.  During the second quarter of 2015, we recognized $0.9 million of mark-to-market losses related to our portfolio of sponsored funds held as trading securities, and realized $0.5 million of realized gains on the sale of sponsored funds held as available for sale.  Dividend and interest income in the second quarter of 2015 was $0.8 million. 

 

Investment and other losses were $9.5 million for the six months ended June 30, 2016, compared to investment and other income of $4.0 million in the same period in 2015.  The majority of the loss in the first six months of 2016 is related to mark-to-market unrealized losses on our sponsored funds prior to implementing our hedge program.  Prior to executing total return swap contracts in the first part of January 2016, we recognized $9.6 million of unrealized losses related to our portfolio of consolidated sponsored funds, sponsored funds held as trading and equity method sponsored funds.  With our hedge program implemented, we recognized an additional $5.0 million of net losses related to our seed capital investments and associated hedges for the remainder of the first six months of 2016.  The six months ended June 30, 2016 also included $3.0 million in dividend and interest income and $1.2 million of gains attributable to noncontrolling interests in sponsored funds for the period in which the Company held majority ownership.  For the six months ended June 30, 2015, we realized $2.8 million of gains on the sales of sponsored funds held as available for sale and dividend and interest income was $1.2 million.

 

Our effective income tax rate was 35.0% for the second quarter of 2016, as compared to 37.7% for the second quarter of 2015.  The Company has a deferred tax asset related to a capital loss carryforward that is available to offset current and future capital gains.  Further, the Company has deferred tax assets for unrealized losses in investment securities and partnerships.  Due to the character of the losses and the limited carryforward permitted upon realization, the Company has a valuation allowance recorded against these deferred tax assets.  During the second quarter of 2016,

34


 

increases in the fair value of the Company’s investment portfolios, as well as realized capital gains on securities classified as available for sale decreased the valuation allowance, thereby reducing income tax expense by $1.8 million.  During the second quarter of 2015, a decrease in the fair value of the Company’s trading securities portfolio increased the valuation allowance, thereby increasing income tax expense by $0.4 million.

 

Certain subsidiaries of the Company have deferred tax assets for net operating loss carryforwards in states in which these companies file tax returns on a separate company basis.  The Company has a valuation allowance on the portion of the deferred tax assets where it is more likely than not that the asset will not be realized due to an inability to generate sufficient taxable income in future years to utilize the net operating loss carryforwards.  In the second quarter of 2015, the Company released a portion of the valuation allowance on state net operating loss carryforward deferred tax assets, which reduced income tax expense by $0.6 million.

 

The second quarter 2016 and 2015 effective income tax rates, removing the effects of the valuation allowance, would have been 38.4% and 37.9%, respectively.  The adjusted effective tax rate in the second quarter of 2016 was higher primarily due to lower income before taxes in the second quarter of 2016, which increased the impact of non-deductible expenses on the effective income tax rate.

 

Our effective income tax rate was 35.5% for the six months ended June 30, 2016, as compared to 37.1% for the six months ended June 30, 2015.  During 2016, increases in the fair value of the Company’s investment portfolios as well as realized capital gains on securities classified as available for sale allowed for a release of a portion of the valuation allowance, thereby reducing income tax expense by $2.9 million.  During 2015, realized capital gains on the sale of securities classified as available for sale decreased the valuation allowance, thereby reducing income tax expense by $0.8 million.  Additionally, the Company released a portion of the valuation allowance on state net operating loss carryforward deferred tax assets, which reduced income tax expense by $0.6 million.

 

Removing the effects of the valuation allowance for the six months ended June 30, 2016 and 2015, the effective income tax rate would have been 38.1% and 37.8%, respectively.  The adjusted effective tax rate in 2016 was higher primarily due to lower income before taxes, which increased the impact of non-deductible expenses on the effective income tax rate.

 

The Company expects its future effective tax rate, exclusive of any increases or reductions to the valuation allowance, state tax incentives, unanticipated state tax legislative changes, and unanticipated fluctuations in earnings to range from 37% to 39%.

 

Liquidity and Capital Resources

 

Our operations provide much of the cash necessary to fund our priorities, as follows:

 

·

Finance internal growth

 

·

Pay dividends

 

·

Repurchase our stock

 

Finance Internal Growth

 

We use cash to fund growth in our distribution channels.  Our Retail Unaffiliated Distribution channel requires cash outlays for wholesaler commissions and commissions to third parties on deferred load product sales.  We continue to invest in our Retail Broker-Dealer channel by providing additional support to our advisors through home office resources, wholesaling efforts and enhanced technology tools, including the modernization of our brokerage and product platform associated with Project E.  Across both channels, we provide seed money for new products.

 

Pay Dividends

 

We paid quarterly dividends on our Class A common stock that resulted in financing cash outflows of $76.6 million and $72.2 million for the first six months of 2016 and 2015, respectively.  The Company’s Board of Directors approved

35


 

a quarterly dividend on our Class A common stock of $0.46 per share payable on August 1, 2016 to stockholders of record as of July 11, 2016.

 

Repurchase Our Stock

 

We repurchased 2,201,497 shares and 622,591 shares of our Class A common stock in the open market or privately during the six months ended June 30, 2016 and 2015, respectively, resulting in cash outflows of $47.5 million and $30.0 million, respectively.

 

Operating Cash Flows

 

Cash from operations, our primary source of funds, decreased $137.4 million for the six months ended June 30, 2016 compared to the six months ended June 30, 2015.  The decrease is primarily due to $69.0 million related to seeding new investment products and lower net income of $63.5 million.

 

The payable to investment companies for securities, payable to customers and other receivables accounts can fluctuate significantly based on trading activity at the end of a reporting period.  Changes in these accounts result in variances within cash from operations on the statement of cash flows; however, there is no impact to the Company’s liquidity and operations for the variances in these accounts.

 

During the first quarter of 2016, we contributed $20.0 million to our pension plan.  We do not expect to make additional contributions for the remainder of the year.

 

Investing Cash Flows

 

Investing activities consist primarily of the c onsolidation of sponsored investment securities, as well as capital expenditures.  We expect our 2016 capital expenditures to be in the range of $15.0 to $25.0 million.

 

Financing Cash Flows

 

As noted previously, dividends and stock repurchases accounted for a majority of our financing cash outflows in the first six months of 2016 and 2015.

 

Future Capital Requirements

 

Management believes its available cash, marketable securities and expected cash flow from operations will be sufficient to fund its short-term operating and capital requirements during 2016. Expected short-term uses of cash include dividend payments, interest payments on outstanding debt, income tax payments, seed money for new products, capital expenditures including those related to the Project E initiatives, share repurchases, transition loans to financial advisors, pension funding, restructuring costs and home office leasehold and building improvements, and could include strategic acquisitions.

 

In 2016, the Company plans to offer terminated, vested pension plan participants a one-time voluntary lump sum window distribution equal to the present value of the participant’s pension benefit, in an effort to reduce pension obligations and ongoing annual pension expense.  This offer may result in a noncash charge in the fourth quarter of 2016, in accordance with the relevant accounting standards, dependent on the number of plan participants who elect to take the lump sum distribution and the total amount of such distributions.

 

Expected long-term capital requirements include indebtedness, operating leases and purchase obligations, and potential settlement of tax liabilities.  Other possible long-term discretionary uses of cash could include capital expenditures for enhancement of technology infrastructure and home office expansion, strategic acquisitions, payment of dividends, income tax payments, seed money for new products, pension funding, share repurchases and payment of upfront fund commissions for Class C shares and certain fee-based asset allocation products.  We expect payment of upfront fund commissions for certain fee-based asset allocation products will decline in future years due to a change in our advisor compensation plan whereby a smaller population of advisors are eligible for upfront commissions on the sale of these products.

 

36


 

Critical Accounting Policies and Estimates

 

Management believes certain critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.  The Company’s critical accounting policies and estimates are disclosed in the “Critical Accounting Policies and Estimates” section of our Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K”).

 

Supplemental Information

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second

 

Second

 

 

 

 

Year to

 

Year to

 

 

 

 

 

Quarter

 

Quarter

 

 

 

 

Date

 

Date

 

 

 

 

    

2016

    

2015

    

Variance

 

 

2016

 

2015

 

Variance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset Manager (in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail Unaffiliated Distribution

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AUM

 

$

35,197

 

57,545

 

(38.8)

%

 

$

35,197

 

57,545

 

(38.8)

%

Net flows

 

$

(3,890)

 

(1,175)

 

(231.1)

%

 

$

(9,268)

 

(3,339)

 

(177.6)

%

Organic decay annualized

 

 

(40.3)

%  

(7.9)

%  

 

 

 

 

(40.6)

%

(11.1)

%

 

 

Redemption rate

 

 

61.3

%  

31.0

%  

 

 

 

 

69.9

%

36.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail Broker-Dealer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AUM

 

$

42,261

 

45,947

 

(8.0)

%

 

$

42,261

 

45,947

 

(8.0)

%

Net flows

 

$

(398)

 

(76)

 

(423.7)

%

 

$

(699)

 

(309)

 

(126.2)

%

Organic decay annualized

 

 

(3.8)

%  

(0.7)

%  

 

 

 

 

(3.2)

%

(1.4)

%

 

 

Redemption rate

 

 

10.5

%  

9.0

%  

 

 

 

 

9.9

%

9.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AUM

 

$

8,993

 

17,214

 

(47.8)

%

 

$

8,993

 

17,214

 

(47.8)

%

Net flows

 

$

(5,473)

 

200

 

(2836.5)

%

 

$

(6,074)

 

(960)

 

(532.7)

%

Organic growth (decay) annualized

 

 

(151.8)

%  

4.7

%  

 

 

 

 

(78.8)

%

(10.8)

%

 

 

Redemption rate

 

 

198.9

%  

23.2

%  

 

 

 

 

105.1

%

28.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broker-Dealer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AUA (1) (in billions)

 

$

50.5

 

53.6

 

(5.8)

%

 

$

50.5

 

53.6

 

(5.8)

%

AUA fee based accounts (in billions)

 

$

17.8

 

18.3

 

(2.7)

%

 

$

17.8

 

18.3

 

(2.7)

%

Number of advisors

 

 

1,799

 

1,780

 

1.1

%

 

 

1,799

 

1,780

 

1.1

%

Advisor productivity (2) (in thousands)

 

$

63.1

 

67.9

 

(7.1)

%

 

$

124.4

 

133.8

 

(7.0)

%

U&D revenues (in thousands)

 

$

113,802

 

119,740

 

(5.0)

%

 

$

224,537

 

234,576

 

(4.3)

%


(1)

Assets under administration

 

(2)

Advisors’ productivity is calculated by dividing underwriting and distribution revenues for the Retail Broker-Dealer channel by the average number of advisors during the period.

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

We are primarily exposed to market risk associated with unfavorable movements in interest rates and securities prices.  Except as described below, the Company has had no material changes in its market risk policies or its market risk sensitive instruments and positions since December 31, 2015.  As further described in Note 5 to the unaudited consolidated financial statements, in January 2016, the Company implemented an economic hedge program that uses total return swap contracts to hedge market risk with its investments in sponsored funds.

 

Item 4. Controls and Procedures

 

The Company maintains a system of disclosure controls and procedures that is designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of

37


 

1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  The Company’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act) as of June 30, 2016, have concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2016.

 

The Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  There were no changes in the Company’s internal control over financial reporting that occurred during the fiscal quarter ended June 30, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.  However, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

 

Part II. Other Information

 

Item 1. Legal Proceedings

 

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 the 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.

 

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, the plaintiffs seek monetary damages and demand a jury trial.  On April 18, 2016, the plaintiffs dismissed the complaint in the United States District Court for the District of Kansas and filed a similar complaint against the same defendants, regarding the same substantive allegations and causes of action, in the District Court of Johnson County, Kansas (Case No. I6CV02338 Div.4).  On April 25, 2016, the plaintiffs voluntarily dismissed the officer of a Company subsidiary as a defendant.  On June 30, 2016, the remaining defendants filed a Motion to Dismiss the complaint.  To date, 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.

 

 

Item 1A. Risk Factors

 

The Company has had no material changes during the quarter to its Risk Factors from those previously reported in the Company’s 2015 Form 10-K.

 

38


 

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

 

The following table sets forth certain information about the shares of Class A common stock we repurchased during the second quarter of 2016.

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

Total Number of

    

Maximum Number (or

 

 

 

 

 

 

 

 

Shares

 

Approximate Dollar

 

 

 

 

 

 

 

 

Purchased as

 

Value) of Shares That

 

 

 

Total Number

 

Average

 

Part of Publicly

 

May Yet Be

 

 

 

of Shares

 

Price Paid

 

Announced

 

Purchased Under The

 

Period

 

Purchased (1)

 

per Share

 

Program

 

Program

 

April 1   April 30

 

583,675

 

$

21.92

 

325,000

 

n/a

(1)

May 1   May 31

 

100,000

 

 

19.58

 

100,000

 

n/a

(1)

June 1   June 30

 

392,151

 

 

18.14

 

350,000

 

n/a

(1)

Total

 

1,075,826

 

$

20.32

 

775,000

 

 

 


(1)

On August 31, 1998, we announced that our Board of Directors approved a program to repurchase shares of our common stock on the open market.  Under the repurchase program, we are authorized to repurchase, in any seven-day period, the greater of (i) 3% of our outstanding common stock or (ii) $50 million of our common stock.  We may repurchase our common stock in privately negotiated transactions or through the New York Stock Exchange, other national or regional market systems, electronic communication networks or alternative trading systems.  Our stock repurchase program does not have an expiration date or an aggregate maximum number or dollar value of shares that may be repurchased.  Our Board of Directors reviewed and ratified the stock repurchase program in October 2012.  During the second quarter of 2016, 775,000 shares of our common stock were repurchased pursuant to the repurchase program and 300,826 shares, reflected in the table above, were purchased in connection with funding employee income tax withholding obligations arising from the vesting of restricted shares.

39


 

Item 6. Exhibits

 

 

 

 

10.1 

    

Waddell & Reed Financial, Inc. 1998 Stock Incentive Plan, as amended and restated. Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K, File No. 001-13913, on April 14, 2016 and incorporated herein by reference.

 

 

 

31.1*

 

Section 302 Certification of Chief Executive Officer

 

 

 

31.2*

 

Section 302 Certification of Chief Financial Officer

 

 

 

32.1**

 

Section 906 Certification of Chief Executive Officer

 

 

 

32.2**

 

Section 906 Certification of Chief Financial Officer

 

 

 

101*

 

Materials from the Waddell & Reed Financial, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, formatted in Extensible Business Reporting Language (XBRL):  (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) related Notes to the Unaudited Consolidated Financial Statements, tagged in detail.


*     Filed herewith

**   Furnished herewith

 

40


 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, this 29th day of July 2016.

 

 

WADDELL & REED FINANCIAL, INC.

 

 

 

 

By:

/s/ Henry J. Herrmann

 

 

Chief Executive Officer, Chairman of the Board and Director

 

 

(Principal Executive Officer)

 

 

 

 

By:

/s/ Brent K. Bloss

 

 

Senior Vice President, Chief Financial Officer and Treasurer

 

 

(Principal Financial Officer)

 

 

 

 

By:

/s/ Benjamin R. Clouse

 

 

Vice President

 

 

(Principal Accounting Officer)

 

41


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