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WDR Waddell & Reed Financial

Filed: 1 Nov 19, 12:23pm


​​

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 September 30, 2019

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)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Class A Common Stock, $.01 par value

WDR

New York Stock Exchange

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  No .

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer 

Accelerated filer 

Non-accelerated filer 

Smaller reporting company 

Emerging growth company 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   

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 October 25, 2019

Class A common stock, $.01 par value

70,323,231

WADDELL & REED FINANCIAL, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended September 30, 2019

    

Page No.

Part I.

Financial Information

Item 1.

Financial Statements (unaudited)

Consolidated Balance Sheets at September 30, 2019 and December 31, 2018

3

Consolidated Statements of Income for the three and nine months ended September 30, 2019 and September 30, 2018

4

Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and September 30, 2018

5

Consolidated Statements of Stockholders’ Equity and Redeemable Noncontrolling Interests for the three and nine months ended September 30, 2019 and September 30, 2018

6

Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and September 30, 2018

7

Notes to the Unaudited Consolidated Financial Statements

8

Item 2.

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

23

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

37

Item 4.

Controls and Procedures

37

Part II.

Other Information

Item 1A.

Risk Factors

37

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

38

Item 6.

Exhibits

39

Signatures

40

2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands)

September 30,

2019

December 31, 

(Unaudited)

2018

Assets:

    

    

    

Cash and cash equivalents

$

162,567

 

231,997

Cash and cash equivalents - restricted

 

23,350

 

 

59,558

Investment securities

 

691,616

 

 

617,135

Receivables:

Funds and separate accounts

 

14,752

 

 

18,112

Customers and other

 

98,667

 

 

151,515

Prepaid expenses and other current assets

 

20,464

 

 

27,164

Total current assets

 

1,011,416

 

 

1,105,481

Property and equipment, net

 

49,785

 

 

63,429

Goodwill and identifiable intangible assets

 

145,869

 

 

145,869

Deferred income taxes

 

6,775

 

 

12,321

Other non-current assets

 

41,261

 

 

16,979

Total assets

$

1,255,106

 

1,344,079

Liabilities:

Accounts payable

$

17,095

 

26,253

Payable to investment companies for securities

 

31,022

 

 

100,085

Payable to third party brokers

 

18,036

 

 

19,891

Payable to customers

 

49,294

 

 

86,184

Accrued compensation

 

67,432

 

 

54,129

Other current liabilities

 

87,946

 

 

51,580

Total current liabilities

 

270,825

 

 

338,122

Long-term debt

 

94,908

 

 

94,854

Accrued pension and postretirement costs

 

822

 

 

798

Other non-current liabilities

 

32,108

 

 

15,392

Total liabilities

 

398,663

 

 

449,166

Redeemable noncontrolling interests

16,913

11,463

Stockholders’ equity:

Preferred stock—$1.00 par value: 5,000 shares authorized; NaN issued

 

 

 

Class A Common stock—$0.01 par value: 250,000 shares authorized; 99,701 shares issued; 71,211 shares outstanding (76,790 at December 31, 2018)

 

997

 

 

997

Additional paid-in capital

 

303,138

 

 

311,264

Retained earnings

 

1,242,677

 

 

1,198,445

Cost of 28,490 common shares in treasury (22,911 at December 31, 2018)

 

(710,565)

 

 

(627,587)

Accumulated other comprehensive income

 

3,283

 

 

331

Total stockholders’ equity

 

839,530

 

 

883,450

Total liabilities, redeemable noncontrolling interests and stockholders’ equity

$

1,255,106

 

1,344,079

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 September 30, 

For the nine months ended September 30, 

2019

2018

2019

2018

Revenues:

    

    

    

    

    

    

    

Investment management fees

$

111,806

 

129,302

$

334,438

 

393,385

Underwriting and distribution fees

 

135,787

 

140,308

395,527

 

416,222

Shareholder service fees

 

23,087

 

25,508

70,279

 

78,464

Total

 

270,680

 

295,118

800,244

 

888,071

Operating expenses:

Distribution

 

117,425

 

116,591

343,696

 

345,376

Compensation and benefits (including share-based compensation of $11,580, $12,856, $35,471, and $42,526, respectively)

 

64,999

 

64,561

191,718

 

199,174

General and administrative

 

16,680

 

17,559

47,421

 

56,240

Technology

15,019

15,414

47,769

49,293

Occupancy

5,684

7,148

19,100

21,081

Marketing and advertising

2,134

2,461

6,497

7,638

Depreciation

 

4,833

 

8,141

16,062

 

19,262

Subadvisory fees

 

3,882

 

3,767

11,154

 

11,158

Intangible asset impairment

1,200

Total

 

230,656

 

235,642

683,417

 

710,422

Operating income

 

40,024

 

59,476

116,827

 

177,649

Investment and other income

 

5,212

 

1,697

23,690

 

5,354

Interest expense

 

(1,562)

 

(1,555)

(4,662)

 

(4,908)

Income before provision for income taxes

 

43,674

 

59,618

135,855

 

178,095

Provision for income taxes

 

10,175

 

13,105

35,036

 

41,355

Net income

33,499

 

46,513

100,819

 

136,740

Net income (loss) attributable to redeemable noncontrolling interests

445

208

1,763

(380)

Net income attributable to Waddell & Reed Financial, Inc.

$

33,054

46,305

$

99,056

137,120

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

$

0.46

0.58

$

1.33

1.69

Weighted average shares outstanding, basic and diluted:

 

72,387

79,595

74,446

81,372

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 September 30, 

For the nine months ended September 30, 

2019

    

2018

    

2019

    

2018

    

Net income

$

33,499

 

46,513

$

100,819

 

136,740

Other comprehensive income:

Unrealized gain (loss) on available for sale investment securities during the period, net of income tax expense (benefit) of $92, $80, $1,011 and $(218), respectively

 

296

 

 

262

 

3,235

 

 

(700)

Postretirement benefit, net of income tax benefit of $(30), $(7), $(88) and $(22), respectively

 

(94)

 

 

(24)

 

(283)

 

 

(70)

Comprehensive income

33,701

 

46,751

103,771

 

135,970

Comprehensive income (loss) attributable to redeemable noncontrolling interests

445

208

1,763

(380)

Comprehensive income attributable to Waddell & Reed Financial, Inc.

$

33,256

46,543

$

102,008

136,350

See accompanying notes to the unaudited consolidated financial statements.

5

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity and Redeemable Noncontrolling Interests

(Unaudited, in thousands)

For the three months ended September 30,

Accumulated

Redeemable

Additional

Other

Total 

Non

Common Stock

Paid-In

Retained

Treasury

Comprehensive

Stockholders’

Controlling

    

Shares

    

Amount

    

Capital

    

Earnings

    

Stock

    

Income (Loss)

    

Equity

    

interest

Balance at June 30, 2018

 

99,701

$

997

 

302,144

 

1,144,090

 

(560,181)

 

(1,332)

 

885,718

 

17,052

Net income

 

 

 

 

46,305

 

 

 

46,305

 

208

Net redemption of redeemable noncontrolling interests in sponsored funds

(1,127)

Recognition of equity compensation

 

 

 

9,228

 

78

 

 

 

9,306

 

Net issuance/forfeiture of nonvested shares

 

 

 

841

 

 

(841)

 

 

 

Dividends accrued, $0.25 per share

 

 

 

 

(19,688)

 

 

(19,688)

Repurchase of common stock

 

(28,369)

 

(28,369)

 

Other comprehensive income

 

 

 

 

 

 

238

 

238

 

Balance at September 30, 2018

99,701

$

997

 

312,213

 

1,170,785

 

(589,391)

 

(1,094)

 

893,510

 

16,133

    

Balance at June 30, 2019

 

99,701

$

997

 

294,487

 

1,227,314

 

(669,223)

 

3,081

 

856,656

 

15,115

Net income

 

 

 

 

33,054

 

 

 

33,054

 

445

Net subscription of redeemable noncontrolling interests in sponsored funds

1,353

Recognition of equity compensation

 

 

 

8,024

 

57

 

 

 

8,081

 

Net issuance/forfeiture of nonvested shares

 

 

 

627

 

 

(627)

 

 

 

Dividends accrued, $0.25 per share

 

 

 

 

(17,748)

 

 

(17,748)

Repurchase of common stock

 

(40,715)

 

(40,715)

 

Other comprehensive income

 

 

 

 

 

 

202

 

202

 

Balance at September 30, 2019

99,701

$

997

 

303,138

 

1,242,677

 

(710,565)

 

3,283

 

839,530

 

16,913

For the nine months ended September 30,

Accumulated

Redeemable

Additional

Other

Total 

Non

Common Stock

Paid-In

Retained

Treasury

Comprehensive

Stockholders’

Controlling

    

Shares

    

Amount

    

Capital

    

Earnings

    

Stock

    

Income (Loss)

    

Equity

    

interest

Balance at December 31, 2017

 

99,701

$

997

 

301,410

 

1,092,394

 

(522,441)

 

524

 

872,884

 

14,509

Adoption of recognition and measurement of financial assets and liabilities guidance (ASU 2016-01) on
January 1, 2018

812

(812)

Adoption of reclassification of tax effects from accumulated other comprehensive income (loss) guidance (ASU 2018-02) on January 1, 2018

 

 

 

 

36

 

 

(36)

 

 

Net income (loss)

 

 

 

 

137,120

 

 

 

137,120

 

(380)

Net subscription of redeemable noncontrolling interests in sponsored funds

2,004

Recognition of equity compensation

 

 

 

32,871

 

991

 

 

 

33,862

 

Net issuance/forfeiture of nonvested shares

 

 

 

(22,068)

 

 

22,068

 

 

 

Dividends accrued, $0.75 per share

 

 

 

 

(60,568)

 

 

(60,568)

Repurchase of common stock

 

(89,018)

 

(89,018)

 

Other comprehensive loss

 

 

 

 

 

 

(770)

 

(770)

 

Balance at September 30, 2018

99,701

$

997

 

312,213

 

1,170,785

 

(589,391)

 

(1,094)

 

893,510

 

16,133

    

Balance at December 31, 2018

 

99,701

$

997

 

311,264

 

1,198,445

 

(627,587)

 

331

 

883,450

 

11,463

Net income

 

 

 

99,056

 

 

 

99,056

 

1,763

Net subscription of redeemable noncontrolling interests in sponsored funds

3,687

Recognition of equity compensation

 

 

25,573

 

297

 

 

 

25,870

 

Net issuance/forfeiture of nonvested shares

(33,699)

33,699

Dividends accrued, $0.75 per share

 

 

 

(55,121)

 

 

 

(55,121)

 

Repurchase of common stock

 

 

 

 

(116,677)

 

 

(116,677)

 

Other comprehensive income

 

 

 

 

 

2,952

 

2,952

 

Balance at September 30, 2019

99,701

$

997

 

303,138

 

1,242,677

 

(710,565)

 

3,283

 

839,530

 

16,913

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 nine months ended September 30, 

2019

    

2018

    

Cash flows from operating activities:

Net income

$

100,819

 

136,740

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

Depreciation and amortization

 

16,057

 

 

19,262

Write-down of impaired assets

 

 

 

1,200

Amortization of deferred sales commissions

 

1,492

 

 

2,682

Share-based compensation

 

35,471

 

 

42,526

Investments (gain) loss, net

 

(25,916)

 

 

2,521

Net purchases, maturities, and sales of trading and equity securities

 

(47,641)

 

 

(4,387)

Deferred income taxes

 

4,622

 

 

5,307

Net change in equity securities and trading debt securities held by consolidated sponsored funds

16,697

71,452

Other

1,273

2,973

Changes in assets and liabilities:

Customer and other receivables

 

74,807

 

 

9,286

Payable to investment companies for securities and payable to customers

 

(105,953)

 

 

(14,394)

Receivables from funds and separate accounts

 

3,360

 

 

3,345

Other assets

 

19,599

 

 

7,650

Accounts payable and payable to third party brokers

 

(11,013)

 

 

(1,388)

Other liabilities

 

557

 

 

(21,042)

Net cash provided by operating activities

$

84,231

 

 

263,733

Cash flows from investing activities:

Purchases of available for sale and equity method securities

(149,835)

(56,840)

Proceeds from sales of available for sale and equity method securities

 

19,667

 

 

1,157

Proceeds from maturities of available for sale securities

116,197

100,085

Additions to property and equipment

 

(4,189)

 

 

(1,831)

Net cash (used in) provided by investing activities

$

(18,160)

 

 

42,571

Cash flows from financing activities:

Dividends paid

 

(56,560)

 

 

(61,531)

Repurchase of common stock

 

(118,668)

 

 

(88,166)

Repayment of short-term debt, net of debt issuance costs

(94,943)

Net subscriptions (redemptions, distributions and deconsolidations) of redeemable noncontrolling interests in sponsored funds

3,687

2,004

Other

(168)

Net cash used in financing activities

$

(171,709)

 

 

(242,636)

Net (decrease) increase in cash, cash equivalents and restricted cash

 

(105,638)

 

 

63,668

Cash, cash equivalents, and restricted cash at beginning of period

 

291,555

 

 

235,985

Cash, cash equivalents, and restricted cash at end of period

$

185,917

 

299,653

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. (hereinafter referred to as the “Company,” “we,” “our” or “us”) is a holding company, incorporated in the state of Delaware in 1981, that conducts business through its subsidiaries. Founded in 1937, we are one of the oldest mutual fund complexes in the United States, having introduced the former Waddell & Reed Advisors group of mutual funds (the “Advisors Funds”) in 1940. Over time, we added additional mutual funds: Ivy Funds (the “Ivy Funds”); Ivy Variable Insurance Portfolios, our variable product offering (“Ivy VIP”); InvestEd Portfolios, our 529 college savings plan (“InvestEd”); and the Ivy High Income Opportunities Fund, a closed-end mutual fund (“IVH”). In 2016, we introduced the Ivy NextShares® exchange-traded managed funds (“Ivy NextShares”), which were liquidated in the third quarter of 2019 (collectively, Ivy Funds, Ivy VIP, InvestEd, IVH, and Ivy NextShares are referred to as the “Funds”).  In addition to the Funds, our assets under management (“AUM”) include institutional managed accounts.  As of September 30, 2019, we had $68.8 billion in AUM.

We derive our revenues from providing investment management and advisory services, investment product underwriting and distribution, and shareholder services administration to the Funds and institutional accounts. We also provide wealth management services, primarily to retail clients through Waddell & Reed, Inc. (“W&R”), and independent financial advisors associated with W&R (“Advisors”), who provide financial planning and advice to their clients. Investment management and advisory fees and certain underwriting and distribution revenues are based on the level of AUM and assets under administration (“AUA”) 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 programs and related advisory services, asset-based service and distribution fees promulgated under Rule 12b-1 of the Investment Company Act of 1940 (“Rule 12b-1”), 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, portfolio accounting and administration fees, and is earned based on client AUM or number of client accounts.  Our major expenses are for distribution of our products, compensation related costs, occupancy, general and administrative, and information technology.

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, 2018 (our “2018 Form 10-K”).  Certain amounts in the prior year’s 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 2018 Form 10-K with the exception of the adoption of Accounting Standards Update (“ASU”) 2016-02, “Leases” and ASU 2018-07, “Compensation – Stock Compensation: Improvements to Nonemployee Share-Based Payment Accounting,” both of which became effective January 1, 2019, and ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” which was early adopted during the second quarter of 2019. 

In our opinion, the accompanying unaudited consolidated financial statements reflect all adjustments (consisting of only a normal and recurring nature) necessary to present fairly our financial position at September 30, 2019 and the results of operations and cash flows for the three and nine months ended September 30, 2019 and 2018 in conformity with accounting principles generally accepted in the United States.

8

2.

New Accounting Guidance

In August 2018, FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). This ASU is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. The Company will adopt the provisions of this guidance on January 1, 2020 and expects to elect the prospective adoption approach, which does not require the restatement of prior years. While we continue to assess all of the effects of adoption, we currently believe the adoption of this ASU will not have a material impact on our operating income or net income as requirements under the standard are generally consistent with our current accounting for cloud computing arrangements, with the primary difference being the classification of certain information in our consolidated financial statements and related disclosures.

3.

Revenue Recognition

All revenue recognized in the consolidated statements of income is considered to be revenue from contracts with customers. The vast majority of revenue is determined based on average assets and is earned daily or monthly or is transactional and is earned on the trade date. As such, revenue from remaining performance obligations is not significant.  The following table depicts the disaggregation of revenue by product and distribution channel:

Three months ended
September 30, 2019

Three months ended
September 30, 2018

Nine months ended
September 30, 2019

Nine months ended
September 30, 2018

(in thousands)

(in thousands)

Investment management fees:

    

    

    

    

    

    

    

Funds

$

107,926

 

123,764

 

322,678

 

376,193

Institutional

 

3,880

 

5,538

 

11,760

 

17,192

Total investment management fees

$

111,806

 

129,302

 

334,438

 

393,385

Underwriting and distribution fees:

Unaffiliated

Rule 12b-1 service and distribution fees

$

16,003

19,707

48,514

60,734

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

361

441

1,287

1,418

Other revenues

67

126

242

459

Total unaffiliated distribution fees

$

16,431

20,274

50,043

62,611

Wealth Management

Fee-based asset allocation product revenues

$

73,356

69,468

208,806

201,565

Rule 12b-1 service and distribution fees

16,426

18,106

48,441

54,591

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

12,523

13,651

36,845

41,900

Sales commissions on other products

8,024

9,111

24,127

26,632

Other revenues

9,027

9,698

27,265

28,923

Total wealth management distribution fees

119,356

120,034

345,484

353,611

Total distribution fees

$

135,787

140,308

395,527

416,222

Shareholder service fees:

Total shareholder service fees

$

23,087

 

25,508

 

70,279

 

78,464

 

 

 

 

Total revenues

$

270,680

 

295,118

 

800,244

 

888,071

9

4.

Investment Securities

Investment securities at September 30, 2019 and December 31, 2018 were as follows:

September 30, 

December 31, 

    

2019

 

2018

(in thousands)

Available for sale securities:

Certificates of deposit

$

5,001

Commercial paper

1,975

7,970

Corporate bonds

267,064

218,121

U.S. Treasury bills

19,672

Total available for sale securities

 

269,039

250,764

Trading debt securities:

Commercial paper

1,975

1,993

Corporate bonds

 

89,057

77,250

U.S. Treasury bills

5,968

5,884

Mortgage-backed securities

 

5

7

Term loans

42,272

Consolidated sponsored funds

 

41,269

33,088

Total trading securities 

 

180,546

118,222

Equity securities:

Common stock

 

31,744

21,204

Sponsored funds

174,219

153,548

Sponsored privately offered funds

 

781

678

Consolidated sponsored funds

24,879

Total equity securities

206,744

200,309

Equity method securities:

Sponsored funds

 

35,287

47,840

Total securities

$

691,616

617,135

Commercial paper and corporate bonds accounted for as available for sale and held as of September 30, 2019 mature as follows:

Amortized

cost

 

Fair value

  

(in thousands)

Within one year

$

83,965

84,173

After one year but within five years

181,873

184,866

$

265,838

269,039

Commercial paper, corporate bonds, U.S. Treasury bills, mortgage-backed securities and term loans accounted for as trading and held as of September 30, 2019 mature as follows:

Fair value

  

(in thousands)

Within one year

$

32,977

After one year but within five years

76,645

After five years but within 10 years

29,655

$

139,277

10

The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at September 30, 2019:

    

Amortized

    

Unrealized

    

Unrealized

    

 

cost

gains

losses

Fair value

 

  

 

(in thousands)

Available for sale securities:

Commercial paper

$

1,975

1,975

Corporate bonds

263,863

 

3,240

(39)

 

267,064

$

265,838

 

3,240

 

(39)

 

269,039

The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at December 31, 2018:

    

Amortized

    

Unrealized

    

Unrealized

    

 

cost

gains

losses

Fair value

 

(in thousands)

Available for sale securities:

Certificates of deposit

$

5,000

1

5,001

Commercial paper

 

7,902

68

7,970

Corporate bonds

219,236

 

254

(1,369)

 

218,121

U.S. Treasury bills

19,672

19,672

$

251,810

 

323

 

(1,369)

 

250,764

A summary of available for sale investment securities with fair values below carrying values at September 30, 2019 is as follows:

Less than 12 months

12 months or longer

Total

Unrealized

Unrealized

Unrealized

September 30, 2019

    

Fair value 

    

losses

    

Fair value 

    

losses

    

Fair value 

    

losses

(in thousands)

Corporate bonds

$

19,987

(19)

27,105

(20)

47,092

(39)

A summary of available for sale investment securities with fair values below carrying values at December 31, 2018 is as follows:

Less than 12 months

12 months or longer

Total

Unrealized

Unrealized

Unrealized

December 31, 2018

    

Fair value 

    

losses

    

Fair value 

    

losses

    

Fair value 

    

losses

(in thousands)

Corporate bonds

$

36,302

(160)

119,480

(1,209)

155,782

(1,369)

The Company’s investment portfolio included 12 available for sale securities in an unrealized loss position at September 30, 2019.

The Company evaluated available for sale securities in an unrealized loss position at September 30, 2019 and concluded no other-than-temporary impairment existed.  The unrealized losses in the Company’s investment portfolio were primarily caused by changes in interest rates. At this time, the Company does not intend to sell, and does not believe it will be required to sell these securities before recovery of their amortized cost.

Sponsored Funds

The Company has classified its equity investments in the Ivy Funds as equity method investments (when the Company owns between 20% and 50% of the fund) or equity securities measured at fair value through net income (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 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.  

11

Sponsored Privately Offered Funds

The Company holds an interest in a privately offered fund structured in the form of a limited liability company.  The members of this entity have the substantive ability to remove the Company as managing member or dissolve the entity upon a simple majority vote.  This entity does not meet the criteria of a VIE and is considered to be a VOE.

Consolidated Sponsored Funds

The following table details the balances related to consolidated sponsored funds at September 30, 2019 and December 31, 2018, as well as the Company’s net interest in these funds:

September 30, 

December 31, 

2019

    

2018

    

(in thousands)

Cash

 

$

5,161

4,285

Investments

 

41,269

 

57,967

Other assets

 

486

 

872

Other liabilities

 

 

(79)

Redeemable noncontrolling interests

 

(16,913)

 

(11,463)

Net interest in consolidated sponsored funds

 

$

30,003

51,582

At September 30, 2019, we consolidated an Ivy Fund and Ivy Global Investors Funds in which we provided initial seed capital at the time of the funds’ formation. During 2018, we liquidated the Ivy Global Investors Société d’Investissement à Capital Variable and its Ivy Global Investors sub-funds, including converting the investments held by the sub-funds to cash, and redeemed the majority of our investment.  During the third quarter of 2019, the formerly consolidated Ivy Nextshares were liquidated and distributed to shareholders. When we no longer have a controlling financial interest in a sponsored fund, it is deconsolidated from our consolidated financial statements.  

Fair Value

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.

12

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 carrying amounts of certificates of deposit and commercial paper are measured at amortized cost, which approximates fair value due to the short-time between purchase and expected maturity of the investments. Depending on the nature of the inputs, these investments are generally classified as Level 1 or 2 within the fair value hierarchy. U.S. Treasury bills are valued upon quoted market prices for similar assets in active markets, quoted prices for identical or similar assets that are not active and inputs other than quoted prices that are observable or corroborated by observable market data. The fair value of corporate bonds is measured using various techniques, which consider recently executed transactions in securities of the issuer or comparable issuers, market price quotations (where observable), bond spreads and fundamental data relating to the issuer. Term loans are valued using a price or composite price from one or more brokers or dealers as obtained from an independent pricing service. The fair value of loans is estimated using recently executed transactions, market price quotations, credit/market events, and cross-asset pricing. Inputs are generally observable market inputs obtained from independent sources. Term loans are generally categorized in Level 2 of the fair value hierarchy, unless key inputs are unobservable in which case they would be categorized as Level 3. The fair value of equity derivatives is measured based on active market broker quotes, evaluated broker quotes and evaluated prices from vendors.

The following tables summarize our investment securities as of September 30, 2019 and December 31, 2018 that are recognized in our consolidated balance sheets using fair value measurements based on the differing levels of inputs.

September 30, 2019

    

Level 1

    

Level 2

    

Level 3

    

Other Assets Held at Net Asset Value

Total

 

(in thousands)

 

Cash equivalents: (1)

Money market funds

$

3,090

3,090

U.S. government sponsored enterprise note

896

896

Commercial paper

37,104

37,104

Total cash equivalents

$

3,090

38,000

41,090

Available for sale securities:

Commercial paper

$

1,975

1,975

Corporate bonds

267,064

267,064

Trading debt securities:

Commercial paper

1,975

1,975

Corporate bonds

89,057

89,057

U.S. Treasury bills

5,968

5,968

Mortgage-backed securities

    

    

5

    

    

5

Term loans

 

 

40,879

 

1,393

 

42,272

Consolidated sponsored funds

 

 

41,269

 

 

41,269

Equity securities:

Common stock

31,742

2

31,744

Sponsored funds

174,219

174,219

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

781

781

Equity method securities: (3)

Sponsored funds

35,287

35,287

Total investment securities

$

241,248

448,192

1,395

781

691,616

13

December 31, 2018

    

Level 1

    

Level 2

    

Level 3

    

Other Assets Held at Net Asset Value

Total

 

(in thousands)

 

Cash equivalents: (1)

Money market funds

$

121,759

121,759

U.S. government sponsored enterprise note

895

895

Commercial paper

74,277

74,277

Total cash equivalents

$

121,759

75,172

196,931

Available for sale securities:

Certificates of deposit

$

5,001

5,001

Commercial paper

7,970

7,970

Corporate bonds

218,121

218,121

U.S. Treasury bills

19,672

19,672

Trading debt securities:

Commercial paper

1,993

1,993

Corporate bonds

77,250

77,250

U.S. Treasury bills

5,884

5,884

Mortgage-backed securities

    

    

7

    

    

7

Consolidated sponsored funds

33,088

33,088

Equity securities:

Common stock

 

21,192

 

 

12

 

21,204

Sponsored funds

 

153,548

 

 

 

153,548

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

678

678

Consolidated sponsored funds

 

24,879

 

 

 

24,879

Equity method securities: (3)

Sponsored funds

47,840

47,840

Total investment securities

$

247,459

368,986

12

678

617,135

(1)Cash equivalents include highly liquid investments with original maturities of 90 days or less. Cash investments in actively traded money market funds are measured at net asset value and are classified as Level 1. Cash investments in commercial paper are measured at cost, which approximates fair value because of the short time between purchase of the instrument and its expected realization, and are classified as Level 2.

(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.

(3)Substantially all of the Company’s equity method investments are investment companies that record their underlying investments at fair value.

14

The following table summarizes the activity of investments categorized as Level 3 for the nine months ended September 30, 2019:

    

For the nine months ended

September 30, 2019

(in thousands)

Level 3 assets at December 31, 2018

$

12

Additions

 

2,357

Transfers out of level 3

(196)

Losses in Investment and other income

 

(23)

Redemptions/Paydowns

(755)

Level 3 assets at September 30, 2019

$

1,395

Change in unrealized losses for Level 3 assets held at
September 30, 2019

$

(21)

5.

Derivative Financial Instruments

The Company has in place an economic hedge program that uses total return swap contracts to hedge market risk related to its investments in certain sponsored funds.  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.

Excluding derivative financial instruments held in certain consolidated sponsored funds, the Company was party to 14 total return swap contracts with a combined notional value of $222.1 million and 5 total return swap contracts with a combined notional value of $194.4 million as of September 30, 2019 and December 31, 2018, respectively. These derivative financial 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 in the Company’s consolidated statements of income.  

The Company posted $0.6 million and $5.2 million in cash collateral with the counterparties of the total return swap contracts as of September 30, 2019 and December 31, 2018, respectively.  The cash collateral is included in Customers and other receivables in 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 September 30, 2019 and December 31, 2018 and is calculated based on Level 2 inputs:

September 30, 

December 31, 

Balance sheet

2019

2018

    

location

    

Fair value

    

Fair value

 

(in thousands)

Total return swap contracts

 

Prepaid expenses and other current assets

$

153

4,968

Total return swap contracts

Other current liabilities

467

Net total return swap (liability) asset

 

$

(314)

4,968

The following is a summary of net gains (losses) recognized in income for the three and nine months ended September 30, 2019 and September 30, 2018:

Three months ended

Nine months ended

Income statement

September 30, 

September 30, 

    

location

    

2019

2018

    

2019

2018

 

(in thousands)

(in thousands)

Total return swap contracts

 

Investment and other income

 

$

135

(6,769)

$

(25,728)

(7,313)

15

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 September 30, 2019 and December 31, 2018 are as follows:

September 30, 

December 31, 

 

2019

2018

(in thousands)

Goodwill

    

$

106,970

    

106,970

 

Mutual fund management advisory contracts

 

38,699

 

38,699

Other

 

200

 

200

Total identifiable intangible assets

 

38,899

 

38,899

Total

$

145,869

 

145,869

7.

Indebtedness

Debt is reported at its carrying amount in the consolidated balance sheet.  The fair value, calculated based on Level 2 inputs, of the Company’s senior unsecured notes maturing January 13, 2021 was $98.6 million at September 30, 2019 compared to the carrying value net of debt issuance costs of $94.9 million, which is listed under long-term debt in the consolidated balance sheet.

8.

Income Tax Uncertainties

In the accompanying consolidated balance sheets, 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 non-current deferred income taxes. As of September 30, 2019 and December 31, 2018, the Company’s consolidated balance sheet included unrecognized tax benefits, including penalties and interest, of $2.7 million ($2.3 million net of federal benefit) and $2.7 million ($2.4 million net of federal benefit), respectively, that if recognized, would impact the Company’s effective tax rate.

The Company’s accounting policy with respect to interest and penalties related to income tax uncertainties is to classify these amounts as income taxes.  The total amount of penalties and interest, net of federal benefit, related to income tax uncertainties recognized in the statements of income for the three and nine month periods ended September 30, 2019 was $38 thousand and $79 thousand, respectively.  The total amount of accrued penalties and interest related to uncertain tax positions recognized in the consolidated balance sheet at September 30, 2019 and December 31, 2018 is $0.7 million ($0.6 million net of federal benefit) and $0.7 million ($0.6 million net of federal benefit), respectively.

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 Company does not expect the resolution or settlement of any open audits, Federal or State, to materially impact the consolidated financial statements.

The 2016, 2017, and 2018 federal income tax returns are open tax years that remain subject to potential future audit.  State income tax returns for all years after 2014 and, in certain states, income tax returns for 2014, are subject to potential future audit by tax authorities in the Company’s major state tax jurisdictions.

16

9.

Pension Plan and Postretirement Benefits Other Than Pension

Benefits payable under our noncontributory retirement plan that covers substantially all employees and certain vested employees of our former parent company (the “Pension Plan”) were based on employees’ years of service and compensation during the final 10 years of employment. On July 26, 2017, the Compensation Committee of the Company’s Board of Directors approved an amendment to freeze the Pension Plan, effective September 30, 2017.  After September 30, 2017, participants in the Pension Plan ceased accruing additional benefits for future service or compensation. Participants retain benefits accumulated as of September 30, 2017 in accordance with the terms of the Pension Plan. The Company intends to terminate the Pension Plan in a standard termination, as defined by the Pension Benefit Guaranty Corporation, with an expected completion date in 2020.

We also sponsor an unfunded defined benefit postretirement medical plan that previously covered substantially all employees, as well as Advisors.  The medical plan is contributory with participant contributions adjusted annually. The medical plan does not provide for benefits after age 65 with the exception of a small group of employees that were grandfathered when this plan was established. During the third quarter of 2016, the Company amended this plan to discontinue the availability of coverage for any individuals who retire after December 31, 2016.

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 September 30, 

Three months ended September 30, 

Nine months ended September 30, 

Nine months ended September 30, 

2019

2018

2019

2018

2019

2018

2019

2018

(in thousands)

(in thousands)

Components of net periodic benefit cost:

    

    

    

    

    

    

    

    

    

    

    

    

    

Interest cost

$

1,537

 

1,497

$

9

 

14

$

4,610

 

4,490

 

$

25

 

41

Expected return on plan assets

 

(1,579)

 

(2,065)

 

 

 

(4,736)

 

(6,196)

 

 

 

Actuarial gain amortization

 

 

 

(124)

 

(30)

 

 

 

 

(371)

 

(90)

Prior service credit amortization

 

 

 

 

(1)

 

 

 

 

 

(2)

Total

$

(42)

(568)

$

(115)

(17)

$

(126)

(1,706)

$

(346)

(51)

10.

Stockholders’ Equity

Earnings per Share

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

Three months ended

Nine months ended

September 30, 

September 30, 

2019

2018

2019

2018

(in thousands, except per share amounts)

Net income attributable to Waddell & Reed Financial, Inc.

    

$

33,054

    

46,305

    

$

99,056

    

137,120

Weighted average shares outstanding, basic and diluted

 

72,387

79,595

 

74,446

81,372

Earnings per share, basic and diluted

$

0.46

0.58

$

1.33

1.69

Dividends

During the quarter, the Board of Directors declared a quarterly dividend on our Class A common stock in the amount of $0.25 per share with a November 1, 2019 payment date and an October 11, 2019 record date. The total dividend paid on November 1, 2019 was $17.7 million.

17

Common Stock Repurchases

The Board of Directors has authorized the repurchase of our Class A common stock in the open market and/or private purchases. The acquired shares may be used for corporate purposes, including issuing shares to employees in our stock-based compensation programs.

There were 2,480,019 shares and 1,424,612 shares repurchased in the open market or privately during the three months ended September 30, 2019 and 2018, respectively, which includes 19 shares and 225 shares, respectively, repurchased from employees who tendered shares to cover income tax withholdings with respect to vesting of stock awards during these two reporting periods. There were 6,849,238 shares and 4,519,546 shares repurchased in the open market or privately during the nine months ended September 30, 2019 and 2018, respectively, which includes 440,002 shares and 630,159 shares, respectively, repurchased from employees who tendered shares to cover income tax withholdings with respect to vesting of stock awards during these two reporting periods.

Accumulated Other Comprehensive Income (Loss)

The following tables summarize accumulated other comprehensive income (loss) activity for the three and nine months ended September 30, 2019 and September 30, 2018.

For the three months ended September 30,

Total

Unrealized

Postretirement

accumulated

gains (losses) on

benefits

other

AFS investment

unrealized

comprehensive

securities

gains (losses)

income (loss)

(in thousands)

Balance at June 30, 2019

    

$

2,142

  

939

  

3,081

Other comprehensive income before reclassification

 

 

379

 

379

Amount reclassified from accumulated other comprehensive (loss)

 

 

(83)

(94)

 

(177)

Net current period other comprehensive income (loss)

 

 

296

(94)

 

202

Balance at September 30, 2019

$

2,438

 

845

 

3,283

Balance at June 30, 2018

    

$

(1,772)

  

440

  

(1,332)

Other comprehensive income before reclassification

 

 

218

 

 

218

Amount reclassified from accumulated other comprehensive income (loss)

 

 

44

 

(24)

 

20

Net current period other comprehensive income (loss)

 

 

262

(24)

 

238

Balance at September 30, 2018

$

(1,510)

 

416

 

(1,094)

18

For the nine months ended September 30,

Total

Unrealized

Postretirement

accumulated

gains (losses)

benefits

other

on investment

unrealized

comprehensive

securities

gains (losses)

income (loss)

(in thousands)

Balance at December 31, 2018

    

$

(797)

    

1,128

    

331

Other comprehensive income before reclassification

 

3,413

 

 

3,413

Amount reclassified from accumulated other comprehensive (loss)

 

(178)

 

(283)

 

(461)

Net current period other comprehensive income (loss)

 

3,235

(283)

 

2,952

Balance at September 30, 2019

$

2,438

 

845

 

3,283

Balance at December 31, 2017

    

$

145

    

379

    

524

Amount reclassified to retained earnings for ASUs adopted in 2018

 

(955)

 

107

 

(848)

Other comprehensive loss before reclassification

(744)

(744)

Amount reclassified from accumulated other comprehensive income (loss)

 

44

(70)

 

(26)

Net current period other comprehensive (loss) income

 

(1,655)

37

 

(1,618)

Balance at September 30, 2018

$

(1,510)

 

416

 

(1,094)

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

Tax

For the three months ended September 30, 2019

Pre-tax

expense

Net of tax

Statement of income line item

(in thousands)

Reclassifications included in net income:

    

    

    

    

    

    

    

    

Gains on available for sale debt securities

$

109

(26)

83

 

Investment and other income

Amortization of postretirement benefits

124

 

(30)

 

94

 

Compensation and benefits

Total

$

233

 

(56)

 

177

Tax

benefit

For the three months ended September 30, 2018

Pre-tax

(expense)

Net of tax

Statement of income line item

(in thousands)

Reclassifications included in net income:

    

    

    

    

    

    

    

    

Losses on available for sale debt securities

$

(58)

 

14

(44)

 

Investment and other income

Amortization of postretirement benefits

31

 

(7)

 

24

 

Compensation and benefits

Total

$

(27)

 

7

 

(20)

Tax

For the nine months ended September 30, 2019

Pre-tax

expense

Net of tax

Statement of income line item

(in thousands)

Reclassifications included in net income:

    

    

    

    

    

    

    

    

Gains on available for sale debt securities

$

234

 

(56)

 

178

 

Investment and other income

Amortization of postretirement benefits

371

 

(88)

 

283

 

Compensation and benefits

Total

$

605

 

(144)

 

461

19

Tax

(expense)

Statement of income

For the nine months ended September 30, 2018

Pre-tax

benefit

Net of tax

 line item or retained earnings

(in thousands)

Reclassifications included in net income or retained earnings for ASUs adopted in 2018:

    

    

    

    

    

    

    

    

Sponsored funds investment gains

$

1,295

 

(340)

 

955

 

Retained earnings

Losses on available for sale debt securities

 

(58)

 

14

 

(44)

 

Investment and other income

Amortization of postretirement benefits

 

92

 

(129)

 

(37)

 

Compensation and benefits and retained earnings

Total

$

1,329

 

(455)

 

874

11.

Leases

On January 1, 2019, the Company adopted ASU 2016-02, Leases, and related ASUs (“ASU 2016-02”), which increases transparency and comparability among organizations by establishing a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet with additional disclosures of key information about leasing arrangements.  The Company applied the required modified retrospective transition approach, applying the new standard to all leases existing at the date of initial application, and elected the effective date of the ASU as its initial date of application. The implementation of the new standard included recognition of new ROU assets and lease liabilities on our balance sheet as of January 1, 2019.

The Company has operating and finance leases for corporate office space and equipment.  Our leases have remaining lease terms of less than one year to seven years, some of which include options to extend leases for up to 20 years, and some of which include options to terminate the leases within one year.  Certain leases include variable lease payments in future periods based on a market index or rate.  We determine if an arrangement is a lease at inception (or the effective date of ASU 2016-02). Operating lease assets and liabilities are included in other non-current assets, other current liabilities, and other non-current liabilities in our consolidated balance sheet at September 30, 2019.  Finance leases are included in property and equipment, net, other current liabilities, and other non-current liabilities in our consolidated balance sheets.  

ROU assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease.  ROU assets and liabilities are recognized at the commencement date (or the effective date of ASU 2016-02) based on the present value of lease payments over the lease term. The Company uses an incremental borrowing rate based on the information available at the commencement date (or the effective date of ASU 2016-02) in determining the present value of lease payments. The ROU assets also include any lease payments made and exclude lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for separately.  

The components of lease expense were as follows:

For the three

For the nine

months ended

months ended

September 30, 2019

September 30, 2019

(in thousands)

Operating Lease Cost

$

4,189

 

$

14,472

Finance Lease Cost:

Amortization of ROU assets

$

80

 

$

224

Interest on lease liabilities

8

 

23

Total

$

88

$

247

20

Supplemental cash flow information related to leases was as follows:

For the nine

months ended

September 30, 2019

(in thousands)

Cash paid for amounts included in the measurement of lease liabilities:

    

    

Operating cash flows from operating leases

$

13,661

Operating cash flows from finance leases

 

23

Financing cash flows from finance leases

222

ROU assets obtained in exchange for lease obligations:

Operating leases

2,410

Finance leases

40

Supplemental balance sheet information related to leases was as follows:

September 30, 2019

(in thousands,

except lease term

and discount rate)

Operating Leases:

    

    

Operating lease ROU assets (Other non-current assets)

$

25,795

Other current liabilities

$

10,873

Other non-current liabilities

16,445

Total operating lease liabilities

$

27,318

Finance Leases:

Property and equipment, gross

$

1,054

Accumulated depreciation

(734)

Property and equipment, net

$

320

Other current liabilities

$

241

Other non-current liabilities

90

Total finance lease liabilities

$

331

Weighted average remaining lease term:

Operating leases

4 years

Finance leases

1 year

Weighted average discount rate:

Operating leases

4.32%

Finance leases

6.00%

21

Maturities of lease liabilities are as follows:

Operating

Finance

Leases

Leases

(in thousands)

Year ended December 31,

2019 (excluding the nine months ended September 30, 2019)

    

$

3,361

    

68

2020

10,580

218

2021

 

6,468

 

45

2022

 

2,178

 

6

2023

2,090

Thereafter

 

4,703

 

Total lease payments

 

29,380

 

337

Less imputed interest

(2,062)

(6)

Total

$

27,318

 

331

The adoption of the lease standard using the effective date as the date of initial application requires the inclusion of the disclosures for periods prior to adoption, which are included below.

Minimum future rental commitments as of December 31, 2018 for all non-cancelable operating leases were as follows:

Year

    

Commitments

 

(in thousands)

 

2019

$

16,488

2020

 

9,797

2021

 

5,757

2022

 

2,913

2023

2,320

Thereafter

 

5,161

$

42,436

Rent expense was $5.8 million and $17.6 million for the three and nine months ended September 30, 2018, respectively.

As of December 31, 2018, we had property and equipment under capital leases with a cost of $1.6 million and accumulated depreciation of $1.1 million.

12.

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.

22

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 AUM, distribution sources, expense levels, redemption rates, stock repurchases 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, 2018, which include, without limitation:

The loss of existing distribution relationships or inability to access new distribution relationships;

A reduction in our AUM 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;

Changes in our business model, operations and procedures, including our methods of distributing our proprietary products, as a result of evolving fiduciary standards;

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;

Our inability to reduce expenses rapidly enough to align with declines in our revenues due to various factors, including fee pressure, the level of our AUM 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 business;

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

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

23

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, 2018 and as updated in our quarterly reports on Form 10-Q for the year ending December 31, 2019.  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

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 and client activity. Significant increases or decreases in the various securities markets can have a material impact on our results of operations, financial condition and cash flows.

Our products are distributed through our unaffiliated channel, or through our wealth management channel by Advisors. Through our institutional channel, we distribute an array of investment styles to a variety of clients.

Through our unaffiliated channel, we distribute mutual funds through broker-dealers, retirement platforms and registered investment advisers through a team of external and internal wholesalers.

In our wealth management channel, we had 948 Advisors and 396 licensed advisor associates as of September 30, 2019, for a total of 1,344 licensed individuals associated with W&R who operate out of offices located throughout the United States and provide financial advice for retirement, education funding, estate planning and other financial needs for clients.

We manage assets in a variety of investment styles in our institutional channel. Most of the clients in this channel are other asset managers that hire us to act as a subadviser for their branded products; they are typically domestic and foreign distributors of investment products who lack scale or the track record to manage internally, or choose to market multi-manager styles. Our diverse client list also includes pension funds, Taft Hartley plans and endowments.

Operating Results

Net income attributable to Waddell & Reed Financial, Inc. for the third quarter of 2019 was $33.1 million, or $0.46 per diluted share, compared to $46.3 million, or $0.58 per diluted share, during the third quarter of 2018.

Revenues of $270.7 million during the third quarter of 2019 decreased 8% compared to the third quarter of 2018.  Operating expenses of $230.7 million during the third quarter of 2019 decreased 2% compared to the same quarter in 2018. The operating margin was 14.8% during the third quarter of 2019, compared to 20.2% during the third quarter of 2018.

AUM ended the quarter at $68.8 billion, a decrease of 14% compared to the third quarter of 2018.  Equity markets during the quarter continued to experience volatility leading to lower sales in key products as investors preferred lower-risk fixed income and money market funds.  Redemptions improved 3% compared to the third quarter of 2018.

Wealth management AUA ended the quarter at $57.1 billion, a 2% decrease compared to the same quarter in 2018 primarily due to outflows in non-advisory assets.

During the third quarter of 2019, we returned $59.1 million of capital to stockholders through dividends and share repurchases, compared to $48.4 million in the same period in 2018.  We repurchased 2,480,019 shares during the third quarter of 2019 at a weighted average share price of $16.42.

Our balance sheet remains solid and we ended the third quarter of 2019 with cash and investments of $837.5 million, excluding restricted cash and cash and investments of redeemable noncontrolling interests in consolidated sponsored funds.

24

Within our wealth management channel, we are boosting our recruiting efforts nationally, targeting experienced financial advisors and hiring two veteran regional recruiting executives.  During the third quarter of 2019, we also announced the addition of a platform of client engagement tools and analytics technology, which is designed to help Advisors enhance their service and align risk metrics with specific client needs and risk tolerances.

Assets Under Management

During the third quarter of 2019, AUM decreased 4% to $68.8 billion from $71.9 billion at June 30, 2019 due to net outflows of $2.7 billion and market depreciation of $0.4 billion. Sales of $1.8 billion during the current quarter declined 30% compared to the third quarter of 2018.  Redemptions improved 3% compared to the third quarter of 2018.

Change in Assets Under Management (1)

Three months ended September 30, 2019

 

Wealth

 

 

Unaffiliated(2)

Institutional

Management

Total

 

(in millions)

Beginning Assets

 

$

27,545

 

3,887

 

40,444

 

71,876

Sales (3)

 

999

 

49

 

744

 

1,792

Redemptions

 

(2,684)

 

(230)

 

(1,542)

 

(4,456)

Net Exchanges

 

334

 

 

(334)

 

Net Flows

 

(1,351)

 

(181)

 

(1,132)

 

(2,664)

Market Action

 

(337)

 

(29)

 

(64)

 

(430)

Ending Assets

 

$

25,857

 

3,677

 

39,248

 

68,782

Three months ended September 30, 2018

 

Wealth

 

 

Unaffiliated(2)

Institutional

Management

Total

 

(in millions)

Beginning Assets

 

$

30,782

 

5,250

 

42,619

 

78,651

Sales (3)

 

1,589

83

 

874

 

2,546

Redemptions

 

(2,425)

 

(535)

 

(1,612)

 

(4,572)

Net Exchanges

 

360

 

 

(360)

 

Net Flows

 

(476)

 

(452)

 

(1,098)

 

(2,026)

Market Action

 

866

 

389

 

1,662

 

2,917

Ending Assets

 

$

31,172

 

5,187

 

43,183

 

79,542

25

Change in Assets Under Management (continued) (1)

During the first nine months of 2019, AUM increased 5% to $68.8 billion from $65.8 billion at December 31, 2018 due to market appreciation of $9.8 billion, offset by net outflows of $6.8 billion.  Sales of $6.4 billion during the first nine months of 2019 declined 31% compared to same period in 2018.  Redemptions improved 17% compared to the first nine months of 2018.

Nine months ended September 30, 2019

 

Wealth

 

 

Unaffiliated(2)

Institutional

Management

Total

 

(in millions)

Beginning Assets

 

$

24,977

 

3,655

 

37,177

 

65,809

Sales (3)

 

3,883

 

244

 

2,286

 

6,413

Redemptions

 

(7,431)

 

(1,027)

 

(4,776)

 

(13,234)

Net Exchanges

 

914

 

25

 

(939)

 

Net Flows

 

(2,634)

 

(758)

 

(3,429)

 

(6,821)

Market Action

 

3,514

 

780

 

5,500

 

9,794

Ending Assets

 

$

25,857

 

3,677

 

39,248

 

68,782

Nine months ended September 30, 2018

 

Wealth

 

 

Unaffiliated(2)

Institutional

Management

Total

 

(in millions)

Beginning Assets

 

$

31,133

 

6,289

 

43,660

 

81,082

Sales (3)

 

5,613

 

788

 

2,877

 

9,278

Redemptions

 

(7,762)

 

(2,792)

 

(5,341)

 

(15,895)

Net Exchanges

 

890

 

 

(890)

 

Net Flows

 

(1,259)

 

(2,004)

 

(3,354)

 

(6,617)

Market Action

 

1,298

 

902

 

2,877

 

5,077

Ending Assets

 

$

31,172

 

5,187

 

43,183

 

79,542

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

(2)Unaffiliated includes National channel (home office and wholesale), Defined Contribution Investment Only, Registered Investment Advisor and Variable Annuity.

(3)Sales consists of gross sales (net of sales commissions) and includes net reinvested dividends, capital gains and investment income.

26

Average Assets Under Management

Average AUM, which are generally more indicative of trends in revenue from investment management services than the change in ending AUM, are presented below.

Three months ended September 30, 2019

 

Wealth

 

 

Unaffiliated

Institutional

Management

Total

 

(in millions)

Asset Class:

Equity

 

$

20,988

 

3,808

 

29,642

 

$

54,438

Fixed Income

 

5,210

 

3

 

9,256

 

14,469

Money Market

 

97

 

 

1,523

 

1,620

Total

 

$

26,295

 

3,811

 

40,421

 

$

70,527

Three months ended September 30, 2018

Wealth

Unaffiliated

Institutional

Management

Total

(in millions)

Asset Class:

Equity

 

$

24,946

 

5,176

 

32,121

 

$

62,243

Fixed Income

 

5,595

 

27

 

9,856

 

15,478

Money Market

 

89

 

 

1,652

 

1,741

Total

 

$

30,630

 

5,203

 

43,629

 

$

79,462

Nine months ended September 30, 2019

 

Wealth

 

 

Unaffiliated

Institutional

Management

Total

 

(in millions)

Asset Class:

Equity

 

$

21,237

 

3,851

 

29,396

 

$

54,484

Fixed Income

 

5,217

 

14

 

9,281

 

14,512

Money Market

 

100

 

 

1,571

 

1,671

Total

 

$

26,554

 

3,865

 

40,248

 

$

70,667

Nine months ended September 30, 2018

Wealth

Unaffiliated

Institutional

Management

Total

(in millions)

Asset Class:

Equity

 

$

24,970

 

5,740

 

32,319

 

$

63,029

Fixed Income

 

5,701

 

66

 

9,996

 

15,763

Money Market

 

92

 

 

1,728

 

1,820

Total

 

$

30,763

 

5,806

 

44,043

 

$

80,612

27

Performance

We have seen improvements in trailing one-, three- and five-year performance as measured by the percentage of assets ranked in the top half of their respective Morningstar universes. As measured by percentage of funds, three- and five-year performance improved modestly, however one-year performance slightly declined.

The following table is a summary of Morningstar rankings and ratings as of September 30, 2019:

MorningStar Fund Rankings 1

    

1 Year

    

3 Years

    

5 Years

 

Funds ranked in top half

 

54

%  

42

%  

29

%

Assets ranked in top half

 

63

%  

63

%  

40

%

MorningStar Ratings 1

    

Overall

    

3 Years

    

5 Years

 

Funds with 4/5 stars

 

29

%  

29

%  

23

%

Assets with 4/5 stars

 

45

%  

42

%  

36

%

(1) Based on class I share, which reflects the largest concentration of sales and assets.

28

Assets Under Administration

AUA includes both client assets invested in the Funds and in other companies’ products that are distributed through W&R and held in brokerage accounts or within our fee-based asset allocation programs. AUA are presented below.

September 30, 2019

September 30, 2018

(in millions)

AUA

Advisory assets

$

25,107

23,653

Non-advisory assets

 

32,006

34,468

Total assets under administration

$

57,113

58,121

Three months ended

Three months ended

September 30, 2019

September 30, 2018

(in millions, except percentage data)

Net new advisory assets (1)

$

236

(87)

Net new non-advisory assets (1), (2)

 

(769)

(931)

Total net new assets (1), (2)

$

(533)

(1,018)

Annualized advisory AUA growth (3)

3.8

%

(1.5)

%

Annualized AUA growth (3)

(3.7)

%

(7.1)

%

Nine months ended

Nine months ended

September 30, 2019

September 30, 2018

(in millions, except percentage data)

Net new advisory assets (1)

$

709

620

Net new non-advisory assets (1), (2)

 

(2,474)

(2,831)

Total net new assets (1), (2)

$

(1,765)

(2,211)

Annualized advisory AUA growth (3)

4.5

%

3.8

%

Annualized AUA growth (3)

(4.6)

%

(5.2)

%

September 30, 2019

September 30, 2018

Advisors and advisor associates

 

1,344

1,425

Average trailing 12-month production per Advisor (4) (in thousands)

$

422

350

(1)Net new assets are calculated as total client deposits and net transfers less client withdrawals.

(2)Excludes activity related to products held outside of our wealth management platform. These assets represent less than 10% of total AUA.

(3)Annualized growth is calculated as annualized total net new assets divided by beginning AUA.

(4)Production per Advisor is calculated as trailing 12-month Total Underwriting and distribution fees less “other” underwriting and distribution fees divided by the average number of Advisors.  “Other” underwriting and distribution fees predominantly include fees paid by Advisors for programs and services. 

29

Results of Operations — Three and Nine Months Ended September 30, 2019 as Compared with Three and Nine Months Ended September 30, 2018

Total Revenues

Total revenues decreased 8% to $270.7 million for the three months ended September 30, 2019 compared to the three months ended September 30, 2018.  For the nine months ended September 30, 2019, total revenues decreased $87.8 million, or 10%, compared to the same period in the prior year.

Three months ended

September 30, 

    

2019

    

2018

    

Variance

 

(in thousands, except percentage data)

Investment management fees

$

111,806

 

129,302

 

(14)

%

Underwriting and distribution fees

 

135,787

 

140,308

 

(3)

%

Shareholder service fees

 

23,087

 

25,508

 

(9)

%

Total revenues

$

270,680

 

295,118

 

(8)

%

Nine months ended

September 30, 

    

2019

    

2018

    

Variance

 

(in thousands, except percentage data)

Investment management fees

$

334,438

 

393,385

 

(15)

%

Underwriting and distribution fees

 

395,527

 

416,222

 

(5)

%

Shareholder service fees

 

70,279

 

78,464

 

(10)

%

Total revenues

$

800,244

 

888,071

 

(10)

%

Investment Management Fee Revenues

Investment management fee revenues for the third quarter of 2019 decreased $17.5 million, or 14%, from the third quarter of 2018.  For the nine month period ending September 30, 2019, investment management fee revenues decreased $58.9 million, or 15%, compared to the same period in 2018.  For both comparative periods, the decrease was due to lower average AUM and a lower effective management fee rate.  The effective management fee rate decrease is due to fee waivers related to fee reductions in selected mutual funds implemented as of July 31, 2018.  Fee waivers are recorded as an offset to investment management fees up to the amount of fees earned.

The following table summarizes investment management fee revenues, related average AUM, fee waivers and investment management fee rates for the three and nine months ended September 30, 2019 and 2018.

Three months ended September 30, 

    

2019

    

2018

    

Variance

 

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

Investment management fees (net)

$

107,926

123,764

(13)

%

Average assets (in millions)

$

66,716

74,259

(10)

%

Management fee rate (net)

 

0.6418

%  

0.6612

%  

Total fee waivers

$

8,154

5,641

45

%

Institutional investment management fees (net)

$

3,880

5,538

(30)

%

Institutional average assets (in millions)

$

3,811

 

5,203

 

(27)

%

Institutional management fee rate (net)

 

0.4040

%  

 

0.4071

%  

 

30

Nine months ended September 30, 

    

2019

    

2018

    

Variance

 

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

Investment management fees (net)

$

322,678

376,193

(14)

%

Average assets (in millions)

 

66,802

74,806

(11)

%

Management fee rate (net)

 

0.6458

%  

0.6724

%  

Total fee waivers

$

22,127

11,087

100

%

Institutional investment management fees (net)

$

11,760

17,192

(32)

%

Institutional average assets (in millions)

 

3,865

 

5,806

 

(33)

%

Institutional management fee rate (net)

 

0.4068

%  

 

0.4055

%  

 

Revenues from investment management services provided to our retail mutual funds, which are distributed through the unaffiliated and wealth management channels, decreased 13% in the third quarter of 2019 and 14% for the nine months ended September 30, 2019, compared to the same periods in 2018.  These decreases were due to a decrease in average AUM and a lower effective management fee rate due to fee waivers related to fee reductions in selected mutual funds that were implemented as of July 31, 2018.  

Institutional account revenues in the third quarter of 2019 decreased $1.7 million compared to the third quarter of 2018.  For the nine months ended September 30, 2019, institutional account revenues decreased $5.4 million compared to the same period in 2018.  The decreases for both comparative periods were due to decreases in average AUM due to elevated event-driven redemptions.

Annualized long-term redemption rates

(excludes money market redemptions)

Three months ended

Nine months ended

September 30, 

September 30, 

    

2019

    

2018

    

2019

    

2018

    

Unaffiliated channel

 

40.9

%  

31.8

%  

37.8

%  

34.1

%  

Institutional channel

 

23.9

%  

40.8

%  

35.5

%  

64.3

%  

Wealth Management channel

 

13.4

%  

12.9

%  

13.9

%  

14.1

%  

Total

 

24.3

%  

22.1

%  

24.2

%  

25.5

%  

The long-term redemption rate for the three and nine months ended September 30, 2019 increased in the unaffiliated channel as compared to the three and nine months ended September 30, 2018.  For both comparative periods, increased volatility in the equity markets in recent quarters led to continued redemptions, particularly in our International Core Equity fund. The long-term redemption rate has decreased in the institutional channel, primarily due to client redemptions of $1.3 billion from our Core Equity and Large Cap Growth strategies during the second quarter of 2018.  We had been previously notified of $0.5 billion of redemptions in the institutional channel of which $0.3 billion was redeemed during the second quarter of 2019 and the remainder was redeemed in October 2019. Prolonged redemptions in any of our distribution channels could negatively affect revenues in future periods.  

The current year-to-date industry average redemption rate, based on data provided by the Investment Company Institute, was 22.1%, versus our rate of 24.2%.

31

Underwriting and Distribution Fee Revenues

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

For the three months ended September 30, 2019

 

 

Wealth

 

Unaffiliated

 

Management

Total

 

(in thousands)

Underwriting and distribution fee revenues

Fee-based asset allocation product revenues

$

 

73,356

 

73,356

Rule 12b-1 service and distribution fees

 

16,003

 

16,426

 

32,429

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

 

361

12,523

 

12,884

Sales commissions on other products

 

 

8,024

 

8,024

Other revenues

 

67

 

9,027

 

9,094

Total

 

$

16,431

 

119,356

 

135,787

For the three months ended September 30, 2018

 

Wealth

Unaffiliated

 

Management

Total

(in thousands)

Underwriting and distribution fee revenues

Fee-based asset allocation product revenues

 

$

 

69,468

 

69,468

Rule 12b-1 service and distribution fees

 

19,707

 

18,106

 

37,813

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

 

441

 

13,651

 

14,092

Sales commissions on other products

 

 

9,111

 

9,111

Other revenues

 

126

 

9,698

 

9,824

Total

 

$

20,274

 

120,034

 

140,308

For the nine months ended September 30, 2019

 

 

Wealth

 

Unaffiliated

 

Management

Total

 

(in thousands)

Underwriting and distribution fee revenues

Fee-based asset allocation product revenues

 

$

 

208,806

 

208,806

Rule 12b-1 service and distribution fees

 

48,514

 

48,441

 

96,955

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

 

1,287

 

36,845

 

38,132

Sales commissions on other products

 

 

24,127

 

24,127

Other revenues

 

242

 

27,265

 

27,507

Total

 

$

50,043

 

345,484

 

395,527

For the nine months ended September 30, 2018

 

Wealth

Unaffiliated

 

Management

Total

(in thousands)

Underwriting and distribution fee revenues

Fee-based asset allocation product revenues

 

$

 

201,565

 

201,565

Rule 12b-1 service and distribution fees

 

60,734

 

54,591

 

115,325

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

 

1,418

 

41,900

 

43,318

Sales commissions on other products

 

 

26,632

 

26,632

Other revenues

 

459

 

28,923

 

29,382

Total

 

$

62,611

 

353,611

 

416,222

32

Underwriting and distribution revenues earned in the third quarter of 2019 decreased by $4.5 million, or 3%, compared to the third quarter of 2018.  For the nine months ended September 30, 2019, underwriting and distribution revenues decreased by $20.7 million, or 5%, compared to the nine months ended September 30, 2018.  For both comparative periods, the decreases were primarily driven by a decrease in Rule 12b-1 asset-based service and distribution fees and commissionable sales across both channels, partially offset by increases in fee-based asset allocation revenues.  Rule 12b-1 asset-based service and distribution fees decreased due to a decrease in average mutual fund AUM for which we earn Rule 12b-1 revenues. Additionally, sales commissions decreased primarily due to a decrease in mutual fund and variable annuity product commissionable sales.  Fee-based asset allocation product revenues increased due to an increase in fee-based asset allocation assets.

Shareholder Service Fee Revenue

During the third quarter of 2019, shareholder service fee revenue decreased $2.4 million, or 9%, compared to the third quarter of 2018.  For the nine months ended September 30, 2019, shareholder service fee revenue decreased $8.2 million, or 10%, as compared to the same period for 2018.  Decreases for both comparative periods were primarily due to a decrease in the number of accounts and assets on which these fees are based, in part due to fund mergers in 2018.

Total Operating Expenses

Operating expenses for the third quarter of 2019 decreased $5.0 million, or 2%, compared to the third quarter of 2018, primarily due to decreased occupancy and depreciation expenses.  For the nine months ended September 30, 2019, operating expenses decreased $27.0 million, or 4%, compared to the nine months ended September 30, 2018, primarily due to decreased compensation and benefits, general and administrative costs and depreciation expenses.  We have been able to successfully reduce expenses during the year as we execute our corporate strategy while investing in targeted growth areas.

Three months ended

September 30, 

    

2019

    

2018

    

Variance

 

(in thousands)

Distribution

$

117,425

 

116,591

 

1

%  

Compensation and benefits

 

64,999

 

64,561

 

1

%  

General and administrative

 

16,680

 

17,559

 

(5)

%  

Technology

 

15,019

 

15,414

 

(3)

%  

Occupancy

 

5,684

 

7,148

 

(20)

%  

Marketing and advertising

 

2,134

 

2,461

 

(13)

%  

Depreciation

4,833

8,141

(41)

%  

Subadvisory fees

3,882

3,767

3

%  

Total operating expenses

$

230,656

 

235,642

 

(2)

%  

Nine months ended

    

September 30, 

    

2019

    

2018

    

Variance

 

(in thousands)

Distribution

$

343,696

 

345,376

 

(0)

%  

Compensation and benefits

 

191,718

 

199,174

 

(4)

%  

General and administrative

 

47,421

 

56,240

 

(16)

%  

Technology

 

47,769

 

49,293

 

(3)

%  

Occupancy

 

19,100

 

21,081

 

(9)

%  

Marketing and advertising

6,497

7,638

(15)

%  

Depreciation

16,062

19,262

(17)

%  

Subadvisory fees

11,154

11,158

(0)

%  

Intangible asset impairment

1,200

(100)

%  

Total operating expenses

$

683,417

 

710,422

 

(4)

%  

33

Distribution expenses for the third quarter of 2019 increased by $0.8 million, or 1%, compared to the third quarter of 2018.  For the nine months ended September 30, 2019, distribution expenses decreased slightly compared to the same period for 2018.  For both comparative periods, Rule 12b-1 commissions paid to third parties decreased due to lower average mutual fund AUM in our unaffiliated channel. This decrease in expense was more than offset by enhancements to the Advisor compensation grid in our wealth management channel starting in 2019.

Compensation and benefits during the third quarter of 2019 increased $0.4 million, or 1%, compared to the same period of 2018, due to severance expense, primarily related to the outsourcing of our transfer agency transactional processing operations.  The increase was partially offset by lower costs from reduced headcount as well as a $1.3 million decrease in share-based compensation due to previously issued awards vesting fully as well as forfeitures.  For the nine months ended September 30, 2019, compensation and benefits expenses decreased $7.5 million, or 4%, compared to the same period in 2018, primarily due to a decrease in share-based compensation from previously issued awards vesting fully, forfeitures and prior year accelerated vestings as well as lower costs from reduced headcount. These decreases were partially offset by increased severance expense, primarily related to the aforementioned outsourcing.  The Company expects to record the remaining amount of the previously disclosed $4.0 million - $6.0 million pre-tax restructuring charge for severance benefits due to the outsourcing of the transactional processing operations of its internal transfer agency during the fourth quarter of 2019.

General and administrative expenses for the third quarter of 2019 decreased $0.9 million, or 5%, compared to the third quarter of 2018. The decrease was primarily due to decreases in contractor, legal and consulting costs due to the completion of significant projects in 2018.  For the nine months ended September 30, 2019, general and administrative expenses decreased $8.8 million, or 16%, compared to the nine months ended September 30, 2018.  The decrease was primarily due to decreases in contractor, legal and consulting costs due to the completion of significant projects in 2018. Fund expenses also decreased for the comparative period primarily due to decreased fee waivers in excess of revenue on certain products.

Technology, occupancy and marketing and advertising expenses for the third quarter of 2019 decreased a combined $2.2 million, or 9%, and for the nine months ended September 30, 2019, decreased $4.6 million, or 6%, compared to the same periods in 2018. Technology costs decreased due to lower shareholder servicing expense resulting from fewer accounts and a non-recurring benefit from the outsourcing of our transfer agency transactional processing.  These decreases were partially offset by costs from the centralized advisor desktop platform which was rolled out during the second quarter of 2019.  Occupancy costs decreased as we realized cost savings from the closure of our field offices.  Marketing and advertising expenses decreased as prior period fund mergers have reduced fund-related marketing expenses.

Depreciation expense for third quarter of 2019 decreased $3.3 million, or 41%, compared to the third quarter of 2018.  For the nine months ended September 30, 2019, depreciation expense decreased $3.2 million, or 17%, compared to the same period in 2018.  For both comparative periods, the decrease was primarily due to certain fixed assets reaching the end of their useful lives.

The nine months ended September 30, 2018 included an intangible impairment charge of $1.2 million related to a terminated subadvisory agreement.

Investment and Other Income  

Investment and other income for the three and nine months ended September 30, 2019 increased $3.5 million and $18.3 million, respectively, compared to the same periods in 2018 primarily due to market appreciation, net of hedging activity, and an increase in interest income in our corporate investment portfolio.

34

Taxes

The following table reconciles the statutory federal income tax rate with our effective income tax rate from continuing operations for the three and nine months ended September 30, 2019 and 2018:

    

Three months ended

Nine months ended

September 30,

September 30,

2019

    

2018

2019

    

2018

Statutory federal income tax rate

 

21.0

%  

21.0

%  

21.0

%  

21.0

%  

State income taxes, net of federal tax benefit

 

2.7

2.7

2.8

2.8

Effects of U.S. tax rate decrease

(1.7)

(0.6)

Share-based compensation

(0.5)

(0.4)

1.6

2.3

Uncertain tax positions

 

0.1

0.4

0.2

(2.9)

Other items

 

0.2

0.6

Effective income tax rate

 

23.3

%  

22.0

%  

25.8

%  

23.2

%  

Our effective income tax rate was 23.3% and 25.8% for the three and nine months ended September 30, 2019, as compared to 22.0% and 23.2% for the same periods in 2018.  During the third quarter of 2018, we adjusted our net deferred tax asset for provision-to-return adjustments related to the 2017 tax year.  Accordingly, we recognized a discrete tax benefit of $1.0 million as a result of this provision-to-return revaluation and the related impact of the statutory federal tax rate decrease from 35% to 21%, which increased the three and nine month effective tax rates by 1.7% and 0.6%, respectively.  The nine months ended September 30, 2018 included the reversal of previously recorded uncertain tax expense upon the completion of a voluntary disclosure agreement with a state tax jurisdiction, which decreased the rate for that period.

The Company expects continued future volatility in its effective tax rate as the tax effects of share-based compensation will be impacted by market fluctuations in our stock price. The future effective tax rate could also experience volatility from federal and state tax incentives, unanticipated federal and state tax legislative changes, and unanticipated fluctuations in earnings.

Liquidity and Capital Resources

Management believes its available cash, marketable securities and expected cash flow from operations will be sufficient to fund the Company’s short-term operating and capital requirements. Expected short-term uses of cash include dividend payments, repurchases of our Class A common stock, interest on indebtedness, income tax payments, seed money for new products, ongoing technology enhancements, capital expenditures, and collateral funding for margin accounts established to support derivative positions, and could include strategic acquisitions.

Expected long-term capital requirements include interest on indebtedness and maturities of outstanding debt, operating leases and purchase obligations. Other possible long-term discretionary uses of cash could include capital expenditures for enhancement of technology infrastructure, strategic acquisitions, payment of dividends, seed money for new products, and repurchases of our Class A common stock.

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

Repurchase our stock
Pay dividends
Finance growth objectives

Our existing capital return policy is designed to provide financial flexibility to invest in our business, support ongoing operations and maintain a strong balance sheet, while continuing to provide a very competitive return to stockholders.  The components of the capital return policy are described below.

35

Repurchase Our Stock

We repurchased 6,849,238 shares and 4,519,546 shares of our Class A common stock in the open market or privately during the nine months ended September 30, 2019 and 2018, respectively, resulting in share repurchases of $116.7 million and $89.0 million, respectively.

In connection with our existing capital return policy, during the third quarter of 2019, we completed the two-year initiative to repurchase $250 million of our Class A common stock by late 2019, which was inclusive of buybacks to offset dilution of our equity awards.  We continue to engage in an active share repurchase plan as part of our ongoing capital management plan.

Pay Dividends

We paid quarterly dividends on our Class A common stock that resulted in financing cash outflows of $56.6 million and $61.5 million for the first nine months of 2019 and 2018, respectively.  

The Board of Directors approved a dividend on our Class A common stock of $0.25 per share with a November 1, 2019 payment date and an October 11, 2019 record date.

Finance Growth Objectives

We use cash to fund growth in our distribution channels. We continue to invest in our wealth management channel by offering home office resources, wholesaling efforts and enhanced technology tools, including the modernization of our wealth management platforms. Our unaffiliated channel requires cash outlays for wholesaler commissions and commissions to third parties on deferred-load product sales. We also provide seed money for new products to further enhance our product offerings and distribution efforts.  As we continue to advance our investment in improved technology, we expect increased costs in this area in the near term.

Cash Flows

Cash from operations is our primary source of funds. Cash from operations decreased $179.5 million for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018.  The decrease is primarily due to a decrease in net income, net purchases, maturities and sales of trading and equity securities, net change in equity and trading debt securities held by consolidated sponsored funds and fluctuations in assets and liabilities, as described below.

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 resulted in variances within cash from operations on the statement of cash flows; however, there is no impact to the Company’s liquidity and operations due to the variances in these accounts. During the year, cash provided by operations was $84.2 million and was reduced due to a decrease in restricted cash balances of $36.2 million related to customer trading activity.

Investing activities consist primarily of the seeding and sale of sponsored investment securities, purchases and maturities of investments held in our corporate investment portfolio and capital expenditures.

Financing activities include payment of dividends and repurchases of our Class A common stock.  Additionally, in the first quarter of 2018, financing activities included repayment of our $95.0 million Series A senior unsecured notes at maturity.   Future financing cash outflows will be affected by the existing capital return policy.

Critical Accounting Policies and Estimates

There have been no material changes in the critical accounting policies and estimates disclosed in the “Critical Accounting Policies and Estimates” section of our 2018 Form 10-K.

36

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.  The Company has had no material changes in its market risk policies or its market risk sensitive instruments and positions since December 31, 2018 other than the changes to the investment and derivative portfolios disclosed in Note 4 and Note 5 to the unaudited consolidated financial statements.  As further described in Note 5, the Company has an economic hedge program that uses total return swap contracts to hedge market risk related to 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 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 September 30, 2019, have concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2019.

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 September 30, 2019 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 1A.

Risk Factors

Except as noted below, there have been no material changes to the Company’s Risk Factors from those previously reported in the Company’s 2018 Form 10-K.

Regulatory Risk Is Substantial In Our Business And Regulatory Reforms Could Have A Material Adverse Effect On Our Business, Reputation And Prospects.    

In June 2019, the SEC adopted a package of rulemakings and interpretations, including Regulation Best Interest and the new Form CRS Relationship Summary (“Form CRS”), which are intended to enhance the quality and transparency of retail investors’ relationships with broker-dealers and investment advisers.  Regulation Best Interest enhances the broker-dealer standard of conduct beyond existing suitability obligations and requires compliance with disclosure, care, conflict of interest and compliance obligations.  Form CRS requires broker-dealers and registered investment advisers to provide a brief relationship summary to retail investors, including (i) the types of client and customer relationships and services the firm offers, (ii) the fees, costs, conflicts of interest and required standard of conduct associated with those relationships and services, (iii) whether the firm and its financial professionals currently have reportable legal or disciplinary history; and (iv) how to obtain additional information about the firm.  The compliance date for Regulation Best Interest and Form CRS is June 30, 2020.  These regulations may have a material impact on the provision of investment services to retail investors, including imposing additional compliance, reporting and operational requirements, which could negatively affect our business.

Specific references in the Risk Factors reported in the Company’s 2018 Form 10-K regarding the impact that new fiduciary standards may have on the Company should be read to include best interest standards, including the SEC’s Regulation Best Interest.

37

We remain subject to various state and federal laws and regulations related to data privacy and protection of data we maintain concerning certain individuals, including Fund shareholders, our clients, Advisors’ clients and our employees.  For example, the State of California recently enacted the California Consumer Privacy Act of 2018, which will be effective January 1, 2020 and, among other things, creates detailed notice, opt-out/opt-in, access and erasure rights for consumers vis-à-vis business that collect their personal information, and provides a new private cause of action for data breaches.  Other states have enacted or proposed, or in the future may enact, similar data privacy and protection legislation.  Privacy and data protection laws and regulations could impose significant limitations, require changes to our business, restrict our use or storage of personal information and subject us to legal liability or regulatory action, which may result in increased compliance expenses, fines or penalties, the termination of client contracts, costly mitigation activities and harm to our reputation.

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 third quarter of 2019.

    

    

    

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

per Share

Program (1)

Program (1)

July 1 - July 31

 

715,000

$

16.94

 

715,000

 

n/a

August 1 - August 31

 

1,270,019

 

15.91

 

1,270,000

 

n/a

September 1 - September 30

 

495,000

 

16.97

 

495,000

 

n/a

Total

 

2,480,019

$

16.42

 

2,480,000

(1)In October 2012, our Board of Directors approved a program to repurchase shares of our Class A 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 Class A common stock or (ii) $50 million of our Class A common stock.  We may repurchase our Class A 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.  

During the third quarter of 2019, 19 shares were purchased in connection with funding employee income tax withholding obligations arising from the vesting of restricted shares.

In connection with our existing capital return policy, in the third quarter of 2019 we completed the two-year initiative to repurchase $250 million of our Class A common stock by late 2019, which was inclusive of buybacks to offset dilution of our equity awards.  We continue to engage in an active share repurchase plan.

38

Item 6.

Exhibits

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 September 30, 2019, formatted in Inline Extensible Business Reporting Language (iXBRL):  (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) related Notes to the Unaudited Consolidated Financial Statements, tagged in detail.

104*

Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

*     Filed herewith

**   Furnished herewith

39

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 1st day of November 2019.

WADDELL & REED FINANCIAL, INC.

By:

/s/ Philip J. Sanders

Chief Executive Officer and Director

(Principal Executive Officer)

By:

/s/ Benjamin R. Clouse

Senior Vice President and Chief Financial Officer

(Principal Financial Officer)

40