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WDR > SEC Filings for WDR > Form 10-Q on 25-Apr-2013All Recent SEC Filings

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Form 10-Q for WADDELL & REED FINANCIAL INC


25-Apr-2013

Quarterly Report


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

This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which reflect the current views and assumptions of management with respect to future events regarding our business and industry in general. These forward-looking statements include all statements, other than statements of historical fact, regarding our financial position, business strategy and other plans and objectives for future operations, including statements with respect to revenues and earnings, the amount and composition of assets under management, distribution sources, expense levels, redemption rates and the financial markets and other conditions. These statements are generally identified by the use of such words as "may," "could," "should," "would," "believe," "anticipate," "forecast," "estimate," "expect," "intend," "plan," "project," "outlook," "will," "potential" and similar statements of a future or forward-looking nature. Readers are cautioned that any forward-looking information provided by or on behalf of the Company 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, 2012, which include, without limitation:

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;

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

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

A reduction in assets under our management on short notice, through increased redemptions in our distribution channels or our Funds, particularly those Funds with a high concentration of assets, or investors terminating their relationship with us or shifting their funds to other types of accounts with different rate structures;


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

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

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; and

Our inability to hire and retain senior executive management and other key personnel.

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, 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, 2012 and as updated in our quarterly reports on Form 10-Q for the year ending December 31, 2013. All forward-looking statements speak only as 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.

Overview

Founded in 1937, we are one of the oldest mutual fund complexes in the United States, with expertise in a broad range of investment styles and across a variety of market environments. Our earnings and cash flows are heavily dependent on financial market conditions. Significant increases or decreases in the various securities markets can have a material impact on our results of operations, financial condition and cash flows.

We derive our revenues from providing investment management, investment product underwriting and distribution, and shareholder services administration to mutual funds and institutional and separately managed accounts. Investment management fees are based on the amount of average assets under management and are affected by sales levels, financial market conditions, redemptions and the composition of assets. Our underwriting and distribution revenues consist of commissions derived from sales of investment and insurance products, Rule 12b-1 asset-based service and distribution fees, distribution fees on certain variable products, fees earned on fee-based asset allocation products, and related advisory services. The products sold have various commission structures and the revenues received from those sales vary based on the type and 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 assets under management or number of client accounts. Our major expenses are underwriting and distribution-related commissions, employee compensation, amortization of deferred sales commissions, subadvisory fee expenses and information technology expense.

One of our distinctive qualities is that we are a significant distributor of investment products. Our retail products are distributed through our Wholesale channel, which includes third-parties such as other broker/dealers, registered investment advisors and various retirement platforms, or through our Advisors channel sales force of independent financial advisors. We also market our investment advisory services to institutional investors, either directly or through consultants, in our Institutional channel.


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Company Highlights

The Company sold its Legend group of subsidiaries ("Legend") effective January 1, 2013. The operational results of Legend have been reclassified as discontinued operations in the unaudited consolidated financial statements for the three months ended March 31, 2012. Unless stated otherwise, any reference to income statement items refers to results from continuing operations.

In April, we launched the Ivy Global Real Estate Fund and Ivy Global Risk-Managed Real Estate Fund, both subadvised by LaSalle Investment Management Securities, to help investors and financial advisors pursue the potential opportunities of investment in real estate securities.

Our assets under management increased 8% during the quarter, from $96.4 billion to $103.8 billion, driven by market appreciation and net flows.

Income from continuing operations increased 15% compared to the first quarter of 2012, and our operating margin was 26.2%, an improvement from 25.0% for the same period a year ago.

During the quarter, we recorded investment income of $4.4 million. Certain components of this investment income allowed us to release a portion of our existing tax valuation allowance, which reduced income tax expense by $1.4 million.

Our balance sheet remains solid, and we ended the quarter with cash and investments of $566.1 million.


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Assets Under Management

During the first quarter, assets under management increased to $103.8 billion compared to $96.4 billion on December 31, 2012 due to market appreciation of $5.3 billion and net flows of $2.1 billion.

Change in Assets Under Management(1)



                                                First Quarter 2013
                                  Wholesale    Advisors   Institutional    Total
                                                  (in millions)

Beginning Assets                 $    48,930     35,660          11,775    96,365

Sales and Other Net Inflows(2)         5,042      1,303             430     6,775
Redemptions                           (3,157 )   (1,047 )          (469 )  (4,673 )
Net Exchanges                             66        (66 )             0         0
Net Flows                              1,951        190             (39 )   2,102

Market Appreciation                    2,373      2,065             890     5,328
Ending Assets                    $    53,254     37,915          12,626   103,795




                                               First Quarter 2012
                                  Wholesale    Advisors   Institutional   Total
                                                  (in millions)

Beginning Assets                 $    40,954     31,709          10,494   83,157

Sales and Other Net Inflows(2)         4,520      1,097             682    6,299
Redemptions                           (3,446 )   (1,042 )          (507 ) (4,995 )
Net Exchanges                           (104 )      103               0       (1 )
Net Flows                                970        158             175    1,303

Market Appreciation                    4,814      3,206           1,312    9,332
Ending Assets                    $    46,738     35,073          11,981   93,792



(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) Sales and Other Net Inflows is primarily gross sales (net of sales commission). This amount also includes net reinvested dividends and capital gains and investment income.


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Average assets under management, which are generally more indicative of trends in revenue for providing investment management services than the quarter over quarter change in ending assets under management, are presented below.

Average Assets Under Management



                               First Quarter 2013
                Wholesale    Advisors   Institutional     Total
                                 (in millions)

Asset Class:
Equity         $    41,056     26,257          11,477   $  78,790
Fixed Income        10,478      9,597             798      20,873
Money Market           167      1,369               -       1,536
Total          $    51,701     37,223          12,275   $ 101,199




                              First Quarter 2012
                Wholesale    Advisors   Institutional    Total
                                 (in millions)

Asset Class:
Equity         $    38,902     24,285          10,398   $ 73,585
Fixed Income         5,769      8,410             785     14,964
Money Market           226      1,315               -      1,541
Total          $    44,897     34,010          11,183   $ 90,090

Results of Operations - Three Months Ended March 31, 2013 as Compared with Three
Months Ended March 31, 2012



Income from continuing operations



                                              Three months ended
                                                  March 31,
                                             2013            2012         Variance

Net income from continuing operations    $      53,863         46,837             15 %

Net income per share from continuing
operations, basic and diluted            $        0.63           0.55             15 %

Operating Margin                                  26.2 %         25.0 %            5 %

We reported income from continuing operations of $53.9 million, or $0.63 per diluted share, for the first quarter of 2013 compared to $46.8 million, or $0.55 per diluted share, for the first quarter of 2012.


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Total Revenues

Total revenues increased 10% to $316.6 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 due to an increase in average assets under management of 12% and an increase in gross sales of 8%.

                                           Three months ended
                                               March 31,
                                           2013             2012         Variance
                                         (in thousands, except percentage data)

Investment management fees           $        148,445       134,900              10 %
Underwriting and distribution fees            135,419       121,153              12 %
Shareholder service fees                       32,691        31,818               3 %
Total revenues                       $        316,555       287,871              10 %

Investment Management Fee Revenues

Investment management fee revenues are earned for providing investment advisory services to the Funds and to institutional and separate accounts. Investment management fee revenues increased $13.5 million, or 10%, from last year's first quarter.

Revenues from investment management services provided to our retail mutual funds, which are distributed through the Wholesale, Advisors and Institutional channels, were $136.9 million for the quarter ended March 31, 2013. Revenues increased $12.6 million, or 10%, compared to the first quarter of 2012, while the related retail average assets increased 13% to $88.9 billion. Investment management fee revenues increased less than the related retail average assets due to a shift in assets to products with lower management fee rates, as well as one less day in the first quarter of 2013.

Institutional account revenues were $11.5 million for the first quarter of 2013, representing an increase of $0.9 million, or 9%, from the first quarter of 2012, while average assets increased 10%. Account revenues increased less than the related average assets due to a decline in the average management fee rate.

Long-term redemption rates (which exclude money market fund redemptions) in the Wholesale channel were 24.6% in the first quarter of 2013, compared to 30.7% in the first quarter of 2012. In the Advisors channel, long-term redemption rates were 9.4% for the quarter ended March 31, 2013, compared to 10.1% in the first quarter of 2012. We expect the Advisors channel long-term redemption rate to remain lower than that of the Wholesale channel due to the personal and customized nature in which our financial advisors provide service to our clients. Long-term redemption rates for our Institutional channel were 15.5% and 18.2% for the first quarter of 2013 and 2012, respectively.

Our overall redemption rate of 18.0% for the first quarter of 2013 compares positively to the current year to date industry average of approximately 24%, based on data from the Investment Company Institute.


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Underwriting and Distribution Fee Revenues and Expenses



The following tables summarize our underwriting and distribution fee revenues
and expenses segregated by distribution method within the respective Wholesale
or Advisors channel:



                                        First Quarter 2013
                                  Wholesale    Advisors    Total
                                          (in thousands)

Revenue                           $   48,175     87,244   135,419
Expenses - Direct                     63,548     59,657   123,205
Expenses - Indirect                   11,000     27,366    38,366
Net Distribution (Costs)/Excess   $  (26,373 )      221   (26,152 )




                                 First Quarter 2012
                           Wholesale    Advisors    Total
                                   (in thousands)

Revenue                    $   44,473     76,680   121,153
Expenses - Direct              55,104     53,676   108,780
Expenses - Indirect             9,339     26,367    35,706
Net Distribution (Costs)   $  (19,970 )   (3,363 ) (23,333 )

Underwriting and distribution revenues earned in the first quarter of 2013 increased $14.3 million, or 12%, compared with the first quarter of 2012 due to increased revenues in our Advisors channel of $10.6 million, and increased revenues in our Wholesale channel of $3.7 million. Revenues from fee-based asset allocation products increased $8.7 million compared to the prior year, as assets grew from $8.6 billion at March 31, 2012 to $11.3 billion at March 31, 2013. Rule 12b-1 asset-based service and distribution fee revenues increased $5.6 million, or 9%, primarily due to an increase in average mutual fund assets under management. Partially offsetting these increases, variable annuity revenues decreased $1.6 million.

Underwriting and distribution expenses increased by $17.1 million, or 12%, compared to the first quarter of 2012. Direct expenses in the Wholesale channel increased by $8.4 million, as a result of an increase in average wholesale assets under management and higher sales volume year over year. We incurred higher dealer compensation paid to third party distributors, increased Rule 12b-1 asset-based service and distribution expenses and higher wholesaler commissions. Direct expenses in the Advisors channel increased $6.0 million, or 11%, compared to the first quarter of 2012 due to increased commissions related to the sale of fee-based asset allocation products of $6.5 million and increased Rule 12b-1 asset-based service and distribution expenses of $0.4 million, partially offset by decreased commissions on variable annuity product sales of $1.0 million. Indirect expenses increased $2.7 million compared to the quarter ended March 31, 2012 due primarily to increased group health expenses, IT and marketing expenses.


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Shareholder Service Fee Revenue

Shareholder service fee revenue primarily includes transfer agency fees, custodian fees from retirement plan accounts, and portfolio accounting and administration fees. Transfer agency fees and portfolio accounting and administration fees are asset-based revenues or account-based revenues, while custodian fees from retirement plan accounts are based on the number of client accounts. During the first quarter of 2013, shareholder service fee revenue increased $0.9 million, or 3%, over the first quarter of 2012. Of the total increase, $1.6 million was due to higher asset-based fees quarter over quarter in certain share classes. This increase was partially offset by a decrease of $0.7 million attributable to account-based revenues, primarily due to an amended contract effective the beginning of the year. The number of accounts increased 1% compared to the first quarter of 2012.

Total Operating Expenses

Operating expenses increased $17.6 million, or 8%, in the first quarter of 2013 compared to the first quarter of 2012, primarily due to increased underwriting and distribution expenses. Underwriting and distribution expenses are discussed above.

                                       Three Months Ended
                                           March 31,
                                       2013             2012         Variance
                                     (in thousands, except percentage data)
Underwriting and distribution    $        161,571       144,486              12 %
Compensation and related costs             48,155        44,158               9 %
General and administrative                 16,208        17,764              -9 %
Subadvisory fees                            4,484         6,271             -28 %
Depreciation                                3,227         3,359              -4 %
Total operating expenses         $        233,645       216,038               8 %

Compensation and Related Costs

Compensation and related costs increased $4.0 million, or 9%, compared to the first quarter of 2012. Of the total increase period over period, $1.7 million was due to higher base salaries associated with increased headcount and annual salary increases. Incentive compensation increased $1.4 million, $0.6 million of which related to higher earnings on portfolio manager deferred compensation plans. Share-based compensation decreased $0.2 million due a credit in the amount of $1.6 million taken in the first quarter 2013 related to the cancellation of unvested shares granted to Legend employees. This decrease was partially offset by higher amortization expense associated with our April 2012 and December 2012 grants of nonvested stock compared to grants that became fully vested in 2012 and an increase in non-employee advisor (independent contractor) stock award amortization expense.

General and Administrative Costs

General and administrative expenses decreased $1.6 million to $16.2 million for the first quarter of 2013 compared to the first quarter of 2012, primarily due to lower legal and consulting costs.

Subadvisory Fees

Subadvisory fees represent fees paid to other asset managers for providing advisory services for certain mutual fund portfolios. These expenses reduce our operating margin since we pay out approximately half of our management fee revenue received from subadvised products. Gross management fee revenues for products subadvised by others were $8.9 million for the three months ended March 31, 2013 compared to $12.5 million for the first quarter of 2012 due to a 28% decrease in average net assets. Subadvisory expenses followed the same pattern of decrease compared to 2012.


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Other Income and Expenses

Investment and Other Income, Interest Expense and Taxes

Investment and other income was $4.4 million for the quarter ended March 31, 2013, compared to $3.9 million in the same period a year ago. We recorded realized gains of $2.4 million on the sale of available for sale mutual fund holdings during the current quarter compared to $1.5 million in the first quarter of 2012. In our mutual fund trading portfolio, we recorded mark-to-market gains of $2.2 million during the quarter compared to gains of $2.0 million for the three months ended March 31, 2012.

Interest expense was $2.9 million and $2.8 million for the quarter ended March 31, 2013 and 2012, respectively.

Our effective income tax rate from continuing operations was 36.2% for the first quarter of 2013, as compared to 35.8% for the first quarter of 2012. Due to the sale of subsidiaries in 2009 and 2013, the Company has deferred tax assets related to capital loss carryforwards, which are available to offset current and future capital gains. A valuation allowance was recorded on a portion of these capital losses when realized due to the limited carryforward period permitted by law on losses of this character. Realized capital gains on securities classified as available for sale and increases in the fair value of the Company's trading securities portfolio in the first quarters of 2013 and 2012 allowed for a release of the valuation allowance and a reduction of income tax expense by $1.4 million and $1.3 million, respectively. The reduction in the valuation allowance decreased our effective tax rate in both quarters.

The first quarter 2013 and 2012 effective income tax rates for continuing operations, removing the effects of the valuation allowance, would have been 37.9% and 37.6%, respectively. The higher effective tax rate in 2013 compared to 2012 was largely attributable to changes in state legislation in a jurisdiction in which the Company operates.

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

Liquidity and Capital Resources

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

Finance internal growth

Pay dividends

Repurchase our stock

Finance Internal Growth

We use cash to fund growth in our distribution channels. Our Wholesale channel, which has a higher cost to gather assets, requires cash outlays for wholesaler commissions and commissions to third parties on deferred load product sales. We continue to invest in our Advisors channel by providing additional support to our advisors through wholesaling efforts and enhanced technology tools.

Pay Dividends

We paid quarterly dividends on our common stock that resulted in financing cash outflows of $24.0 million and $21.4 million for the first quarter of 2013 and 2012, respectively. The Board approved an increase in the quarterly dividend on our common stock from $0.25 per share to $0.28 per share beginning with our fourth quarter 2012 dividend, paid on February 1, 2013.

Repurchase Our Stock

We repurchased 81,701 shares and 366 shares of our common stock in the open market or privately during the three months ended March 31, 2013 and 2012, respectively, resulting in cash outflows of $3.4 million and $12 thousand, respectively.


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Operating Cash Flows

Cash from operations, our primary source of funds, decreased $23.0 million for the three months ended March 31, 2013 compared to the previous year. The first quarter of 2013 benefited from increased net income compared to 2012, offset by a decrease in net sales or maturities of trading securities.

During the first quarter of 2013, we contributed $10.0 million to the Pension Plan and contributed an additional $7.0 million to the Pension Plan in April 2013. We do not expect to make additional contributions for the remainder of 2013.

Investing Cash Flows

Investing activities consist primarily of the purchase, sale and maturities of available for sale investment securities, as well as capital expenditures. We expect our 2013 capital expenditures to be in the range of $15.0 to $20.0 million. Related to the sale of Legend, we received cash proceeds of $22.0 . . .

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