UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
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
WADDELL & REED FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction | (I.R.S. Employer | |
of incorporation or organization) | Identification No.) |
(Address, including zip code, of Registrant’s principal executive offices)
(
(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 |
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.
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).
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.
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
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 |
WADDELL & REED FINANCIAL, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Quarter Ended September 30, 2019
| Page No. | |||
Consolidated Balance Sheets at September 30, 2019 and December 31, 2018 | 3 | |||
4 | ||||
5 | ||||
6 | ||||
7 | ||||
8 | ||||
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 23 | |||
37 | ||||
37 | ||||
37 | ||||
38 | ||||
39 | ||||
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: |
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Cash and cash equivalents | $ | |
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Cash and cash equivalents - restricted |
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Investment securities |
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Receivables: | |||||||
Funds and separate accounts |
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Customers and other |
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Prepaid expenses and other current assets |
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Total current assets |
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Property and equipment, net |
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Goodwill and identifiable intangible assets |
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Deferred income taxes |
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Other non-current assets |
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Total assets | $ | |
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Liabilities: | |||||||
Accounts payable | $ | |
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Payable to investment companies for securities |
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Payable to third party brokers |
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Payable to customers |
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Accrued compensation |
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Other current liabilities |
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Total current liabilities |
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Long-term debt |
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Accrued pension and postretirement costs |
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Other non-current liabilities |
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Total liabilities |
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Redeemable noncontrolling interests | | | |||||
Stockholders’ equity: | |||||||
Preferred stock—$ |
| — |
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| — | ||
Class A Common stock—$ |
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Additional paid-in capital |
| |
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Retained earnings |
| |
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Cost of |
| ( |
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| ( | ||
Accumulated other comprehensive income |
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Total stockholders’ equity |
| |
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Total liabilities, redeemable noncontrolling interests and stockholders’ equity | $ | |
| |
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: |
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Investment management fees | $ | |
| | $ | |
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Underwriting and distribution fees |
| |
| | |
| | ||||||
Shareholder service fees |
| |
| | |
| | ||||||
Total |
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Operating expenses: | |||||||||||||
Distribution |
| |
| | |
| | ||||||
Compensation and benefits (including share-based compensation of $ |
| |
| | |
| | ||||||
General and administrative |
| |
| | |
| | ||||||
Technology | | | | | |||||||||
Occupancy | | | | | |||||||||
Marketing and advertising | | | | | |||||||||
Depreciation |
| |
| | |
| | ||||||
Subadvisory fees |
| |
| | |
| | ||||||
Intangible asset impairment | — | — | — | | |||||||||
Total |
| |
| | |
| | ||||||
Operating income |
| |
| | |
| | ||||||
Investment and other income |
| |
| | |
| | ||||||
Interest expense |
| ( |
| ( | ( |
| ( | ||||||
Income before provision for income taxes |
| |
| | |
| | ||||||
Provision for income taxes |
| |
| | |
| | ||||||
Net income | |
| | |
| | |||||||
Net income (loss) attributable to redeemable noncontrolling interests | | | | ( | |||||||||
Net income attributable to Waddell & Reed Financial, Inc. | $ | | | $ | | | |||||||
Net income per share attributable to Waddell and Reed Financial, Inc. common shareholders, basic and diluted: | $ | | | $ | | | |||||||
Weighted average shares outstanding, basic and diluted: |
| | | | |
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 | $ | |
| | $ | |
| | |||||
Other comprehensive income: | |||||||||||||
Unrealized gain (loss) on available for sale investment securities during the period, net of income tax expense (benefit) of $ |
| |
|
| |
| |
|
| ( | |||
Postretirement benefit, net of income tax benefit of $( |
| ( |
|
| ( |
| ( |
|
| ( | |||
Comprehensive income | |
| | |
| | |||||||
Comprehensive income (loss) attributable to redeemable noncontrolling interests | | | | ( | |||||||||
Comprehensive income attributable to Waddell & Reed Financial, Inc. | $ | | | $ | | |
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 |
| | $ | |
| |
| |
| ( |
| ( |
| |
| | |
Net income |
| — |
| — |
| — |
| |
| — |
| — |
| |
| | |
Net redemption of redeemable noncontrolling interests in sponsored funds | — | — | — | — | — | — | — | ( | |||||||||
Recognition of equity compensation |
| — |
| — |
| |
| |
| — |
| — |
| |
| — | |
Net issuance/forfeiture of nonvested shares |
| — |
| — |
| |
| — |
| ( |
| — |
| — |
| — | |
Dividends accrued, $ |
| — |
| — |
| — |
| ( |
| — |
| — | ( | — | |||
Repurchase of common stock |
| — | — | — | — | ( | — |
| ( |
| — | ||||||
Other comprehensive income |
| — |
| — |
| — |
| — |
| — |
| |
| |
| — | |
Balance at September 30, 2018 | | $ | |
| |
| |
| ( |
| ( |
| |
| | ||
| |||||||||||||||||
Balance at June 30, 2019 |
| | $ | |
| |
| |
| ( |
| |
| |
| | |
Net income |
| — |
| — |
| — |
| |
| — |
| — |
| |
| | |
Net subscription of redeemable noncontrolling interests in sponsored funds | — | — | — | — | — | — | — | | |||||||||
Recognition of equity compensation |
| — |
| — |
| |
| |
| — |
| — |
| |
| — | |
Net issuance/forfeiture of nonvested shares |
| — |
| — |
| |
| — |
| ( |
| — |
| — |
| — | |
Dividends accrued, $ |
| — |
| — |
| — |
| ( |
| — |
| — | ( | — | |||
Repurchase of common stock |
| — | — | — | — | ( | — |
| ( |
| — | ||||||
Other comprehensive income |
| — |
| — |
| — |
| — |
| — |
| |
| |
| — | |
Balance at September 30, 2019 | | $ | |
| |
| |
| ( |
| |
| |
| |
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 |
| | $ | |
| |
| |
| ( |
| |
| |
| | |
Adoption of recognition and measurement of financial assets and liabilities guidance (ASU 2016-01) on | — | — | — | | — | ( | — | — | |||||||||
Adoption of reclassification of tax effects from accumulated other comprehensive income (loss) guidance (ASU 2018-02) on January 1, 2018 |
| — |
| — |
| — |
| |
| — |
| ( |
| — |
| — | |
Net income (loss) |
| — |
| — |
| — |
| |
| — |
| — |
| |
| ( | |
Net subscription of redeemable noncontrolling interests in sponsored funds | — | — | — | — | — | — | — | | |||||||||
Recognition of equity compensation |
| — |
| — |
| |
| |
| — |
| — |
| |
| — | |
Net issuance/forfeiture of nonvested shares |
| — |
| — |
| ( |
| — |
| |
| — |
| — |
| — | |
Dividends accrued, $ |
| — |
| — |
| — |
| ( |
| — |
| — | ( | — | |||
Repurchase of common stock |
| — | — | — | — | ( | — |
| ( |
| — | ||||||
Other comprehensive loss |
| — |
| — |
| — |
| — |
| — |
| ( |
| ( |
| — | |
Balance at September 30, 2018 | | $ | |
| |
| |
| ( |
| ( |
| |
| | ||
| |||||||||||||||||
Balance at December 31, 2018 |
| | $ | |
| |
| |
| ( |
| |
| |
| | |
Net income | — |
| — |
| — |
| |
| — |
| — |
| |
| | ||
Net subscription of redeemable noncontrolling interests in sponsored funds | — | — | — | — | — | — | — | | |||||||||
Recognition of equity compensation | — |
| — |
| |
| |
| — |
| — |
| |
| — | ||
Net issuance/forfeiture of nonvested shares | — | — | ( | | — | — | — | ||||||||||
Dividends accrued, $ | — |
| — |
| — |
| ( |
| — |
| — |
| ( |
| — | ||
Repurchase of common stock | — |
| — |
| — |
| — |
| ( |
| — |
| ( |
| — | ||
Other comprehensive income | — |
| — |
| — |
| — |
| — |
| |
| |
| — | ||
Balance at September 30, 2019 | | $ | |
| |
| |
| ( |
| |
| |
| |
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 | $ | |
| | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Depreciation and amortization |
| |
|
| | ||
Write-down of impaired assets |
| — |
|
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Amortization of deferred sales commissions |
| |
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Share-based compensation |
| |
|
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Investments (gain) loss, net |
| ( |
|
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Net purchases, maturities, and sales of trading and equity securities |
| ( |
|
| ( | ||
Deferred income taxes |
| |
|
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Net change in equity securities and trading debt securities held by consolidated sponsored funds | | | |||||
Other | | | |||||
Changes in assets and liabilities: | |||||||
Customer and other receivables |
| |
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| | ||
Payable to investment companies for securities and payable to customers |
| ( |
|
| ( | ||
Receivables from funds and separate accounts |
| |
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Other assets |
| |
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Accounts payable and payable to third party brokers |
| ( |
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| ( | ||
Other liabilities |
| |
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| ( | ||
Net cash provided by operating activities | $ | |
|
| | ||
Cash flows from investing activities: | |||||||
Purchases of available for sale and equity method securities | ( | ( | |||||
Proceeds from sales of available for sale and equity method securities |
| |
|
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Proceeds from maturities of available for sale securities | | | |||||
Additions to property and equipment |
| ( |
|
| ( | ||
Net cash (used in) provided by investing activities | $ | ( |
|
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Cash flows from financing activities: | |||||||
Dividends paid |
| ( |
|
| ( | ||
Repurchase of common stock |
| ( |
|
| ( | ||
Repayment of short-term debt, net of debt issuance costs | — | ( | |||||
Net subscriptions (redemptions, distributions and deconsolidations) of redeemable noncontrolling interests in sponsored funds | | | |||||
Other | ( | — | |||||
Net cash used in financing activities | $ | ( |
|
| ( | ||
Net (decrease) increase in cash, cash equivalents and restricted cash |
| ( |
|
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Cash, cash equivalents, and restricted cash at beginning of period |
| |
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Cash, cash equivalents, and restricted cash at end of period | $ | |
| |
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 $
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
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 | Three months ended | Nine months ended | Nine months ended | ||||||
(in thousands) | (in thousands) | ||||||||
Investment management fees: |
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Funds | $ | |
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| | |
Institutional |
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| |
| |
| | |
Total investment management fees | $ | |
| |
| |
| | |
Underwriting and distribution fees: | |||||||||
Unaffiliated | |||||||||
Rule 12b-1 service and distribution fees | $ | | | | | ||||
Sales commissions on front-end load mutual fund and variable annuity sales | | | | | |||||
Other revenues | | | | | |||||
Total unaffiliated distribution fees | $ | | | | | ||||
Wealth Management | |||||||||
Fee-based asset allocation product revenues | $ | | | | | ||||
Rule 12b-1 service and distribution fees | | | | | |||||
Sales commissions on front-end load mutual fund and variable annuity sales | | | | | |||||
Sales commissions on other products | | | | | |||||
Other revenues | | | | | |||||
Total wealth management distribution fees | | | | | |||||
Total distribution fees | $ | | | | | ||||
Shareholder service fees: | |||||||||
Total shareholder service fees | $ | |
| |
| |
| | |
|
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| ||||||
Total revenues | $ | |
| |
| |
| |
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 | $ | — | | |||
Commercial paper | | | ||||
Corporate bonds | | | ||||
U.S. Treasury bills | — | | ||||
Total available for sale securities |
| | | |||
Trading debt securities: | ||||||
Commercial paper | | | ||||
Corporate bonds |
| | | |||
U.S. Treasury bills | | | ||||
Mortgage-backed securities |
| | | |||
Term loans | | — | ||||
Consolidated sponsored funds |
| | | |||
Total trading securities |
| | | |||
Equity securities: | ||||||
Common stock |
| | | |||
Sponsored funds | | | ||||
Sponsored privately offered funds |
| | | |||
Consolidated sponsored funds | — | | ||||
Total equity securities | | | ||||
Equity method securities: | ||||||
Sponsored funds |
| | | |||
Total securities | $ | | |
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 | $ | | | |
After one year but within five years | | | ||
$ | | |
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 | $ | | ||
After one year but within five years | | |||
After five years but within 10 years | | |||
$ | |
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 | $ | | — | — | | |||||
Corporate bonds | |
| | ( |
| | ||||
$ | |
| |
| ( |
| |
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 | $ | | | — | | |||||
Commercial paper |
| | | — | | |||||
Corporate bonds | |
| | ( |
| | ||||
U.S. Treasury bills | | — | — | | ||||||
$ | |
| |
| ( |
| |
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 | $ | | ( | | ( | | ( |
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 | $ | | ( | | ( | | ( |
The Company’s investment portfolio included
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 |
| $ | | | ||
Investments |
| |
| | ||
Other assets |
| |
| | ||
Other liabilities |
| — |
| ( | ||
Redeemable noncontrolling interests |
| ( |
| ( | ||
Net interest in consolidated sponsored funds |
| $ | | |
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 | $ | | — | — | — | | ||||||
U.S. government sponsored enterprise note | — | | — | — | | |||||||
Commercial paper | — | | — | — | | |||||||
Total cash equivalents | $ | | | — | — | | ||||||
Available for sale securities: | ||||||||||||
Commercial paper | $ | — | | — | — | | ||||||
Corporate bonds | — | | — | — | | |||||||
Trading debt securities: | ||||||||||||
Commercial paper | — | | — | — | | |||||||
Corporate bonds | — | | — | | ||||||||
U.S. Treasury bills | — | | — | — | | |||||||
Mortgage-backed securities |
| — |
| |
| — |
| — | | |||
Term loans |
| — |
| |
| |
| — | | |||
Consolidated sponsored funds |
| — |
| |
| — |
| — | | |||
Equity securities: | ||||||||||||
Common stock | | — | | — | | |||||||
Sponsored funds | | — | — | — | | |||||||
Sponsored privately offered funds measured at net asset value (2) | — | — | — | | | |||||||
Equity method securities: (3) | ||||||||||||
Sponsored funds | | — | — | — | | |||||||
Total investment securities | $ | | | | | |
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 | $ | | — | — | — | | ||||||
U.S. government sponsored enterprise note | — | | — | — | | |||||||
Commercial paper | — | | — | — | | |||||||
Total cash equivalents | $ | | | — | — | | ||||||
Available for sale securities: | ||||||||||||
Certificates of deposit | $ | — | | — | — | | ||||||
Commercial paper | — | | — | — | | |||||||
Corporate bonds | — | | — | — | | |||||||
U.S. Treasury bills | — | | — | — | | |||||||
Trading debt securities: | ||||||||||||
Commercial paper | — | | — | — | | |||||||
Corporate bonds | — | | — | | ||||||||
U.S. Treasury bills | — | | — | — | | |||||||
Mortgage-backed securities |
| — |
| |
| — |
| — | | |||
Consolidated sponsored funds | — | | — | — | | |||||||
Equity securities: | ||||||||||||
Common stock |
| |
| — |
| |
| — | | |||
Sponsored funds |
| |
| — |
| — |
| — | | |||
Sponsored privately offered funds measured at net asset value (2) | — | — | — | | | |||||||
Consolidated sponsored funds |
| |
| — |
| — |
| — | | |||
Equity method securities: (3) | ||||||||||||
Sponsored funds | | — | — | — | | |||||||
Total investment securities | $ | | | | | |
(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 | $ | | |
Additions |
| | |
Transfers out of level 3 | ( | ||
Losses in Investment and other income |
| ( | |
Redemptions/Paydowns | ( | ||
Level 3 assets at September 30, 2019 | $ | | |
Change in unrealized losses for Level 3 assets held at | $ | ( |
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
The Company posted $
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 | $ | | | |||
Total return swap contracts | Other current liabilities | | — | |||||
Net total return swap (liability) asset |
| $ | ( | |
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 |
| $ | | ( | $ | ( | ( |
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 |
| $ | |
| |
|
Mutual fund management advisory contracts |
| |
| | ||
Other |
| |
| | ||
Total identifiable intangible assets |
| |
| | ||
Total | $ | |
| |
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 $
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 $
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 $
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
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
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 | $ | |
| | $ | |
| | $ | |
| |
| $ | |
| | |||
Expected return on plan assets |
| ( |
| ( |
| — |
| — |
| ( |
| ( |
|
| — |
| — | |||
Actuarial gain amortization |
| — |
| — |
| ( |
| ( |
| — |
| — |
|
| ( |
| ( | |||
Prior service credit amortization |
| — |
| — |
| — |
| ( |
| — |
| — |
|
| — |
| ( | |||
Total | $ | ( | ( | $ | ( | ( | $ | ( | ( | $ | ( | ( |
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. |
| $ | |
| |
| $ | |
| |
Weighted average shares outstanding, basic and diluted |
| | |
| | | ||||
Earnings per share, basic and diluted | $ | | | $ | | |
Dividends
During the quarter, the Board of Directors declared a quarterly dividend on our Class A common stock in the amount of $
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
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 |
| $ | |
| |
| |
Other comprehensive income before reclassification |
|
| | — |
| | |
Amount reclassified from accumulated other comprehensive (loss) |
|
| ( | ( |
| ( | |
Net current period other comprehensive income (loss) |
|
| | ( |
| | |
Balance at September 30, 2019 | $ | |
| |
| | |
Balance at June 30, 2018 |
| $ | ( |
| |
| ( |
Other comprehensive income before reclassification |
|
| |
| — |
| |
Amount reclassified from accumulated other comprehensive income (loss) |
|
| |
| ( |
| |
Net current period other comprehensive income (loss) |
|
| | ( |
| | |
Balance at September 30, 2018 | $ | ( |
| |
| ( |
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 |
| $ | ( |
| |
| |
Other comprehensive income before reclassification |
| |
| — |
| | |
Amount reclassified from accumulated other comprehensive (loss) |
| ( |
| ( |
| ( | |
Net current period other comprehensive income (loss) |
| | ( |
| | ||
Balance at September 30, 2019 | $ | |
| |
| | |
Balance at December 31, 2017 |
| $ | |
| |
| |
Amount reclassified to retained earnings for ASUs adopted in 2018 |
| ( |
| |
| ( | |
Other comprehensive loss before reclassification | ( | — | ( | ||||
Amount reclassified from accumulated other comprehensive income (loss) |
| | ( |
| ( | ||
Net current period other comprehensive (loss) income |
| ( | |
| ( | ||
Balance at September 30, 2018 | $ | ( |
| |
| ( |
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 | $ | | ( | |
| Investment and other income | |||
Amortization of postretirement benefits | |
| ( |
| |
| Compensation and benefits | ||
Total | $ | |
| ( |
| |
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 | $ | ( |
| | ( |
| Investment and other income | ||
Amortization of postretirement benefits | |
| ( |
| |
| Compensation and benefits | ||
Total | $ | ( |
| |
| ( |
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 | $ | |
| ( |
| |
| Investment and other income | |
Amortization of postretirement benefits | |
| ( |
| |
| Compensation and benefits | ||
Total | $ | |
| ( |
| |
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 | $ | |
| ( |
| |
| Retained earnings | |
Losses on available for sale debt securities |
| ( |
| |
| ( |
| Investment and other income | |
Amortization of postretirement benefits |
| |
| ( |
| ( |
| Compensation and benefits and retained earnings | |
Total | $ | |
| ( |
| |
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
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 | $ | |
| $ | | |
Finance Lease Cost: | ||||||
Amortization of ROU assets | $ | |
| $ | | |
Interest on lease liabilities | |
| | |||
Total | $ | | $ | | ||
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 | $ | | |
Operating cash flows from finance leases |
| | |
Financing cash flows from finance leases | | ||
ROU assets obtained in exchange for lease obligations: | |||
Operating leases | | ||
Finance leases | |
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) | $ | | |
Other current liabilities | $ | | |
Other non-current liabilities | | ||
Total operating lease liabilities | $ | | |
Finance Leases: | |||
Property and equipment, gross | $ | | |
Accumulated depreciation | ( | ||
Property and equipment, net | $ | | |
Other current liabilities | $ | | |
Other non-current liabilities | | ||
Total finance lease liabilities | $ | | |
Weighted average remaining lease term: | |||
Operating leases | |||
Finance leases | |||
Weighted average discount rate: | |||
Operating leases | |||
Finance leases |
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) |
| $ | |
| | |
2020 | | | ||||
2021 |
| |
| | ||
2022 |
| |
| | ||
2023 | | — | ||||
Thereafter |
| |
| — | ||
Total lease payments |
| |
| | ||
Less imputed interest | ( | ( | ||||
Total | $ | |
| |
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 | $ | | ||
2020 |
| | ||
2021 |
| | ||
2022 |
| | ||
2023 | | |||
Thereafter |
| | ||
$ | |
Rent expense was $
As of December 31, 2018, we had property and equipment under capital leases with a cost of $
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) | % |
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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.
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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.
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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.
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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.
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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.
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Item 6. | Exhibits |
31.1* | Section 302 Certification of Chief Executive Officer | |
31.2* | ||
32.1** | ||
32.2** | ||
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
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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) | ||
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