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Waddell & Reed Financial 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2010

 

OR

 

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

 

For the transition period from                                to

 

Commission file number 001-13913

 

WADDELL & REED FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

51-0261715

(State or other jurisdiction

 

(I.R.S. Employer

of incorporation or organization)

 

Identification No.)

 

6300 Lamar Avenue

Overland Park, Kansas  66202

(Address, including zip code, of Registrant’s principal executive offices)

 

(913) 236-2000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No ¨.

 

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

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

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

 

Class

 

Outstanding as of October 22, 2010

Class A common stock, $.01 par value

 

85,388,874

 

 

 



Table of Contents

 

WADDELL & REED FINANCIAL, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended September 30, 2010

 

 

 

Page No.

 

 

 

Part I.

Financial Information

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

Consolidated Balance Sheets at September 30, 2010 and December 31, 2009

3

 

 

 

 

Consolidated Statements of Income for the three and nine months ended September 30, 2010 and September 30, 2009

4

 

 

 

 

Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2010

5

 

 

 

 

Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2010 and September 30, 2009

6

 

 

 

 

Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and September 30, 2009

7

 

 

 

 

Notes to the Unaudited Consolidated Financial Statements

8

 

 

 

Item 2.

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

16

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

30

 

 

 

Item 4.

Controls and Procedures

30

 

 

 

Part II.

Other Information

 

 

 

 

Item 1.

Legal Proceedings

31

 

 

 

Item 1A.

Risk Factors

31

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

31

 

 

 

Item 6.

Exhibits

32

 

 

 

 

Signatures

33

 

2



Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands)

 

 

 

September 30,

 

 

 

 

 

2010

 

December 31,

 

 

 

(unaudited)

 

2009

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

246,517

 

244,359

 

Cash and cash equivalents - restricted

 

57,036

 

72,941

 

Investment securities

 

95,539

 

70,524

 

Receivables:

 

 

 

 

 

Funds and separate accounts

 

25,863

 

34,948

 

Customers and other

 

95,341

 

179,100

 

Deferred income taxes

 

8,300

 

8,225

 

Income taxes receivable

 

2,320

 

 

Prepaid expenses and other current assets

 

10,207

 

8,619

 

Total current assets

 

541,123

 

618,716

 

 

 

 

 

 

 

Property and equipment, net

 

70,030

 

68,171

 

Deferred sales commissions, net

 

63,948

 

64,123

 

Goodwill and identifiable intangible assets

 

221,210

 

221,210

 

Other non-current assets

 

10,368

 

11,162

 

Total assets

 

$

906,679

 

983,382

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable

 

$

38,004

 

25,210

 

Payable to investment companies for securities

 

100,052

 

222,168

 

Accrued compensation

 

41,333

 

35,341

 

Short-term debt

 

189,996

 

 

Income taxes payable

 

 

1,044

 

Other current liabilities

 

76,861

 

76,994

 

Total current liabilities

 

446,246

 

360,757

 

 

 

 

 

 

 

Long-term debt

 

 

199,984

 

Accrued pension and postretirement costs

 

23,283

 

28,731

 

Deferred income taxes

 

1,263

 

6,983

 

Other non-current liabilities

 

19,952

 

17,872

 

Total liabilities

 

490,744

 

614,327

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity :

 

 

 

 

 

Preferred stock-$1.00 par value: 5,000 shares authorized; none issued

 

 

 

Class A Common stock-$0.01 par value: 250,000 shares authorized; 99,701 shares issued; 85,389 shares outstanding (85,807 shares outstanding at December 31, 2009)

 

997

 

997

 

Additional paid-in capital

 

198,052

 

189,900

 

Retained earnings

 

589,580

 

527,876

 

Cost of 14,312 common shares in treasury (13,894 at December 31, 2009)

 

(353,680

)

(328,154

)

Accumulated other comprehensive loss

 

(19,014

)

(21,564

)

Total stockholders’ equity

 

415,935

 

369,055

 

Total liabilities and stockholders’ equity

 

$

906,679

 

983,382

 

 

See accompanying notes to unaudited consolidated financial statements.

 

3



Table of Contents

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Income

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

 

 

 

For the three months

 

For the nine months

 

 

 

ended September 30,

 

ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Investment management fees

 

$

111,159

 

94,687

 

333,874

 

248,234

 

Underwriting and distribution fees

 

114,071

 

96,559

 

341,752

 

268,379

 

Shareholder service fees

 

29,577

 

26,730

 

88,014

 

77,663

 

 

 

 

 

 

 

 

 

 

 

Total

 

254,807

 

217,976

 

763,640

 

594,276

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Underwriting and distribution

 

132,857

 

115,119

 

400,229

 

324,618

 

Compensation and related costs (including share-based compensation of $10,944, $7,645, $30,049 and $22,541, respectively)

 

36,164

 

29,275

 

103,444

 

82,373

 

General and administrative

 

16,022

 

15,106

 

48,417

 

43,022

 

Subadvisory fees

 

6,481

 

6,129

 

20,441

 

16,317

 

Depreciation

 

3,526

 

3,503

 

10,457

 

10,259

 

 

 

 

 

 

 

 

 

 

 

Total

 

195,050

 

169,132

 

582,988

 

476,589

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

59,757

 

48,844

 

180,652

 

117,687

 

Investment and other income

 

3,933

 

2,316

 

3,239

 

1,385

 

Interest expense

 

(3,128

)

(3,153

)

(9,797

)

(9,452

)

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

60,562

 

48,007

 

174,094

 

109,620

 

Provision for income taxes

 

20,029

 

14,594

 

63,500

 

37,367

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

40,533

 

33,413

 

110,594

 

72,253

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.47

 

0.39

 

1.29

 

0.85

 

Diluted

 

$

0.47

 

0.39

 

1.29

 

0.84

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

85,438

 

85,699

 

85,683

 

85,503

 

Diluted

 

85,448

 

85,774

 

85,715

 

85,565

 

 

See accompanying notes to unaudited consolidated financial statements.

 

4



Table of Contents

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

 

Consolidated Statement of Stockholders’ Equity

For the Nine Months Ended September 30, 2010

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Paid-in

 

Retained

 

Treasury

 

Comprehensive

 

Stockholders’

 

 

 

Shares

 

Amount

 

Capital

 

Earnings

 

Stock

 

Income (Loss)

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2009

 

99,701

 

$

997

 

189,900

 

527,876

 

(328,154

)

(21,564

)

369,055

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

110,594

 

 

 

110,594

 

Recognition of equity compensation

 

 

 

30,049

 

 

 

 

30,049

 

Issuance of nonvested shares and other

 

 

 

(28,559

)

 

28,559

 

 

 

Dividends accrued, $0.57 per share

 

 

 

 

(48,890

)

 

 

(48,890

)

Exercise of stock options

 

 

 

2,382

 

 

7,293

 

 

9,675

 

Excess tax benefits from share-based payment arrangements

 

 

 

4,280

 

 

 

 

4,280

 

Repurchase of common stock

 

 

 

 

 

(61,378

)

 

(61,378

)

Unrealized appreciation on available for sale investment securities

 

 

 

 

 

 

1,709

 

1,709

 

Valuation allowance on investment securities’ deferred tax asset

 

 

 

 

 

 

590

 

590

 

Reclassification for amounts included in net income

 

 

 

 

 

 

(799

)

(799

)

Pension and postretirement benefits

 

 

 

 

 

 

1,050

 

1,050

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2010

 

99,701

 

$

997

 

198,052

 

589,580

 

(353,680

)

(19,014

)

415,935

 

 

See accompanying notes to unaudited consolidated financial statements.

 

5


 


Table of Contents

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)

 

 

 

For the three months

 

For the nine months

 

 

 

ended September 30,

 

ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

40,533

 

33,413

 

110,594

 

72,253

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized appreciation of investment securities during the period, net of income taxes of $1,917, $1,522, $997 and $2,569, respectively

 

3,286

 

2,634

 

1,709

 

4,471

 

 

 

 

 

 

 

 

 

 

 

Valuation allowance on investment securities’ deferred tax asset during the period

 

1,128

 

 

590

 

 

 

 

 

 

 

 

 

 

 

 

Pension and postretirement benefits, net of income taxes of $206, $201, $617 and $550, respectively

 

350

 

347

 

1,050

 

1,096

 

 

 

 

 

 

 

 

 

 

 

Reclassification adjustments for amounts included in net income, net of income taxes of $(143), $(21), $(464) and $1,271, respectively

 

(247

)

(35

)

(799

)

2,200

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

45,050

 

36,359

 

113,144

 

80,020

 

 

See accompanying notes to unaudited consolidated financial statements.

 

6



Table of Contents

 

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited, in thousands)

 

 

 

For the nine months

 

 

 

ended September 30,

 

 

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

110,594

 

72,253

 

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

 

 

 

 

 

Depreciation and amortization

 

10,325

 

10,129

 

Other than temporary impairment of investments in affiliated mutual funds

 

 

3,686

 

Amortization of deferred sales commissions

 

44,528

 

30,445

 

Share-based compensation

 

30,049

 

22,941

 

Excess tax benefits from share-based payment arrangements

 

(4,280

)

(1,584

)

Gain on sale of available-for-sale investment securities

 

(1,093

)

(45

)

Net purchases and sales of trading securities

 

(11,865

)

(119

)

Unrealized gain on trading securities

 

(2,879

)

(3,919

)

Loss on sale and retirement of property and equipment

 

88

 

396

 

Capital gains and dividends reinvested

 

(366

)

(470

)

Deferred income taxes

 

(6,353

)

1,246

 

Changes in assets and liabilities:

 

 

 

 

 

Cash and cash equivalents - restricted

 

15,905

 

(32,537

)

Receivables from funds and separate accounts

 

9,085

 

(180

)

Other receivables

 

83,759

 

(18,752

)

Other assets

 

(794

)

(3,443

)

Deferred sales commissions

 

(44,353

)

(37,363

)

Accounts payable and payable to investment companies

 

(109,322

)

39,048

 

Other liabilities

 

5,153

 

5,037

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

128,181

 

86,769

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of available-for-sale investment securities

 

(20,000

)

(7,700

)

Proceeds from sales and maturities of available-for-sale investment securities

 

12,773

 

384

 

Additions to property and equipment

 

(12,408

)

(11,563

)

Proceeds from sales of property and equipment

 

5

 

516

 

 

 

 

 

 

 

Net cash used in investing activities

 

$

(19,630

)

(18,363

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Debt repayment

 

(10,000

)

 

Dividends paid

 

(48,970

)

(48,809

)

Repurchase of common stock

 

(61,378

)

(40,430

)

Exercise of stock options

 

9,675

 

10,222

 

Excess tax benefits from share-based payment arrangements

 

4,280

 

1,584

 

 

 

 

 

 

 

Net cash used in financing activities

 

$

(106,393

)

(77,433

)

Net increase (decrease) in cash and cash equivalents

 

2,158

 

(9,027

)

Cash and cash equivalents at beginning of period

 

244,359

 

210,328

 

Cash and cash equivalents at end of period

 

$

246,517

 

201,301

 

 

See accompanying notes to unaudited consolidated financial statements.

 

7



Table of Contents

 

WADDELL & REED FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1.              Description of Business and Significant Accounting Policies

 

Waddell & Reed Financial, Inc. and Subsidiaries

 

Waddell & Reed Financial, Inc. and subsidiaries (hereinafter referred to as the “Company,” “we,” “our” and “us”) derive revenues primarily from investment management, investment product underwriting and distribution, and shareholder services administration provided to the Waddell & Reed Advisors Group of Mutual Funds (the “Advisors Funds”), Ivy Funds (the “Ivy Funds”), Ivy Funds Variable Insurance Portfolios (the “Ivy Funds VIP”), and Waddell & Reed InvestEd Portfolios (“InvestEd”), our college savings plan (collectively, the Advisors Funds, Ivy Funds, Ivy Funds VIP and InvestEd are referred to as the “Funds”), and institutional and separately managed accounts.  The Funds and the institutional and separately managed accounts operate under various rules and regulations set forth by the United States Securities and Exchange Commission (the “SEC”). Services to the Funds are provided under investment management agreements, underwriting agreements, and shareholder servicing and accounting service agreements that set forth the fees to be charged for these services. The majority of these agreements are subject to annual review and approval by each Fund’s board of directors/trustees and shareholders. Our revenues are largely dependent on the total value and composition of assets under management, which currently include mainly domestic and international equity securities, but also include debt securities.  Accordingly, fluctuations in financial markets and composition of assets under management can significantly impact revenues and results of operations.

 

Basis of Presentation

 

We have prepared the accompanying unaudited consolidated financial statements included herein 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, 2009 (the “2009 Form 10-K”).  Certain amounts in prior period financial statements have been reclassified for consistent presentation.

 

The accompanying unaudited consolidated financial statements have been prepared consistently with the accounting policies described in Note 2 to the consolidated financial statements included in our 2009 Form 10-K, which include the following: use of estimates, cash and cash equivalents, disclosures about fair value of financial instruments, investment securities and investments in affiliated mutual funds, property and equipment, software developed for internal use, deferred sales commissions, revenue recognition, advertising and promotion, share-based compensation, accounting for income taxes, earnings per share and derivatives and hedging activities.  The Company modified its accounting policy disclosure related to goodwill and identifiable intangible assets, which is summarized in its Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2010.

 

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, 2010, the results of operations for the three and nine months ended September 30, 2010 and 2009, and cash flows for the nine months ended September 30, 2010 and 2009 in conformity with accounting principles generally accepted in the United States.

 

8



Table of Contents

 

2.              Cash and Cash Equivalents

 

Cash and cash equivalents include cash on hand and short-term investments.  We consider all highly liquid investments with original or remaining maturities of 90 days or less at the date of purchase to be cash equivalents. Cash and cash equivalents — restricted represents cash held for the benefit of customers segregated in compliance with federal and other regulations.  Substantially all cash balances are in excess of federal deposit insurance limits.

 

3.     Investment Securities

 

Investment securities at September 30, 2010 and December 31, 2009 are as follows:

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

September 30, 2010

 

cost

 

gains

 

losses

 

Fair value

 

 

 

(in thousands)

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

$

10

 

2

 

 

12

 

Municipal bonds

 

4,606

 

17

 

(48

)

4,575

 

Affiliated mutual funds

 

38,633

 

4,484

 

(29

)

43,088

 

 

 

$

43,249

 

4,503

 

(77

)

47,675

 

 

 

 

 

 

 

 

 

 

 

Trading securities:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

 

 

 

 

 

74

 

Municipal bonds

 

 

 

 

 

 

 

500

 

Corporate bonds

 

 

 

 

 

 

 

58

 

Common stock

 

 

 

 

 

 

 

29

 

Affiliated mutual funds

 

 

 

 

 

 

 

47,203

 

 

 

 

 

 

 

 

 

47,864

 

 

 

 

 

 

 

 

 

 

 

Total investment securities

 

 

 

 

 

 

 

95,539

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

December 31, 2009

 

cost

 

gains

 

losses

 

Fair value

 

 

 

(in thousands)

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

$

10

 

2

 

 

12

 

Municipal bonds

 

4,959

 

 

(286

)

4,673

 

Affiliated mutual funds

 

29,817

 

3,241

 

(143

)

32,915

 

 

 

$

34,786

 

3,243

 

(429

)

37,600

 

 

 

 

 

 

 

 

 

 

 

Trading securities:

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

 

 

 

 

 

107

 

Municipal bonds

 

 

 

 

 

 

 

478

 

Corporate bonds

 

 

 

 

 

 

 

94

 

Common stock

 

 

 

 

 

 

 

30

 

Affiliated mutual funds

 

 

 

 

 

 

 

32,215

 

 

 

 

 

 

 

 

 

32,924

 

 

 

 

 

 

 

 

 

 

 

Total investment securities

 

 

 

 

 

 

 

70,524

 

 

Purchases and sales of trading securities during the nine months ended September 30, 2010 were $15.3 million and $3.4 million, respectively.

 

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A summary of available-for-sale debt securities and affiliated mutual funds with fair values below carrying values at September 30, 2010 and December 31, 2009 is as follows:

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

 

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

September 30, 2010

 

Fair value

 

losses

 

value

 

losses

 

value

 

losses

 

 

 

(in thousands)

 

Municipal bonds

 

$

 

 

2,680

 

(48

)

2,680

 

(48

)

Affiliated mutual funds

 

100

 

(2

)

563

 

(27

)

663

 

(29

)

Total temporarily impaired securities

 

$

100

 

(2

)

3,243

 

(75

)

3,343

 

(77

)

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

 

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

December 31, 2009

 

Fair value

 

losses

 

value

 

losses

 

value

 

losses

 

 

 

(in thousands)

 

Municipal bonds

 

$

3,843

 

(125

)

830

 

(161

)

4,673

 

(286

)

Affiliated mutual funds

 

11,064

 

(64

)

823

 

(79

)

11,887

 

(143

)

Total temporarily impaired securities

 

$

14,907

 

(189

)

1,653

 

(240

)

16,560

 

(429

)

 

Based upon our assessment of these municipal bonds and affiliated mutual funds, the time frame investments have been in a loss position, our intent to hold affiliated mutual funds until they have recovered and our history of holding bonds until maturity, we determined that a write-down was not necessary at September 30, 2010.

 

Mortgage-backed securities and municipal bonds accounted for as available-for-sale and held as of September 30, 2010 mature as follows:

 

 

 

Amortized
cost

 

Fair value

 

 

 

(in thousands)

 

After one year but within 10 years

 

$

3,615

 

3,633

 

After 10 years

 

1,001

 

954

 

 

 

$

4,616

 

4,587

 

 

Mortgage-backed securities, municipal bonds and corporate bonds accounted for as trading and held as of September 30, 2010 mature as follows:

 

 

 

Fair value

 

 

 

(in thousands)

 

After one year but within 10 years

 

$

558

 

After 10 years

 

74

 

 

 

$

632

 

 

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We determine the fair value of our investments using broad levels of inputs as defined by related accounting standards as follows:

 

·    Level 1 — Investments are valued using quoted prices in active markets for identical securities at the reporting date.  Assets classified as Level 1 include affiliated mutual funds classified as available-for-sale and affiliated mutual funds and common stock classified as trading.

 

·    Level 2 — Investments are valued using other significant observable inputs, including quoted prices in active markets for similar securities.  Assets classified as Level 2 include mortgage-backed securities, municipal bonds and corporate bonds.

 

·    Level 3 — Investments are valued using significant unobservable inputs, including the Company’s own assumptions in determining the fair value of investments.

 

The following table summarizes our investment securities recognized on our balance sheet using fair value measurements based on the differing levels of inputs:

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(in thousands)

 

Level 1

 

$

90,320

 

65,160

 

Level 2

 

5,219

 

5,364

 

Level 3

 

 

 

Total

 

$

95,539

 

70,524

 

 

4.     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.  The carrying values of goodwill and identifiable intangible assets (all considered indefinite-life) are summarized as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(in thousands)

 

 

 

 

 

 

 

Goodwill

 

$

202,518

 

202,518

 

Accumulated amortization

 

(36,307

)

(36,307

)

Total goodwill

 

166,211

 

166,211

 

 

 

 

 

 

 

Mutual fund management advisory contracts

 

38,699

 

38,699

 

Mutual fund subadvisory management contracts

 

16,300

 

16,300

 

Total identifiable intangible assets

 

54,999

 

54,999

 

 

 

 

 

 

 

Total

 

$

221,210

 

221,210

 

 

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5.     Indebtedness

 

Debt is reported at its carrying amount on the consolidated balance sheet. The fair value of the Company’s debt is approximately $192.9 million as of September 30, 2010, compared to the carrying value of $190.0 million.

 

During the first quarter of 2010, we repurchased $10.0 million of our $200.0 million aggregate principal amount 5.6% senior notes due January 2011 (the “Notes”).  The retirement resulted in a loss of approximately $400 thousand, which is included in interest expense in the statement of income.  Additionally, we reclassified the Notes from long-term debt to short-term debt due to their scheduled maturity within the next 12 months.

 

On August 31, 2010, the Company entered into an agreement to complete a $190.0 million private placement of Senior Notes (the “Senior Notes”).  The proceeds of this debt issuance will be used to refinance the existing $190.0 million senior notes expiring in January 2011.  The Senior Notes will be unsecured and will be issued in two tranches:  $95.0 million bearing interest at 5% and maturing January 13, 2018 and $95.0 million bearing interest of 5.75% and maturing January 13, 2021.  Interest will be payable semi-annually in January and July of each year.  The most restrictive provisions of the agreement will require the Company to maintain a consolidated leverage ratio not to exceed 3.0 to 1.0 for four consecutive quarters and a consolidated interest coverage ratio of not less than 4.0 to 1.0 for four consecutive quarters. The Senior Notes contain a delayed funding provision which will allow the Company to draw down the proceeds in January 2011 when the existing senior notes mature.

 

The Company also entered into a three year revolving credit facility (the “Credit Facility”) with various lenders, effective August 31, 2010, which initially provides for borrowings of up to $125.0 million and replaced the Company’s previous revolving credit facility.  Lenders could, at their option upon the Company’s request, expand the facility to $200.0 million.  At September 30, 2010, there were no borrowings outstanding under the Credit Facility.  Borrowings under the Credit Facility bear interest at various rates including adjusted LIBOR or an alternative base rate plus, in each case, an incremental margin based on the Company’s credit rating. The Credit Facility also provides for a facility fee on the aggregate amount of commitments under the revolving facility (whether or not utilized). The facility fee is also based on the Company’s credit rating level.  The Credit Facility’s covenants match those outlined above for the Senior Notes.  The Company was in compliance with these covenants and similar covenants in prior facilities for all years presented.

 

6.     Income Tax Uncertainties

 

As of January 1, 2010 and September 30, 2010, the Company had unrecognized tax benefits, including penalties and interest, of $6.8 million ($4.7 million net of federal benefit) and $6.8 million ($4.8 million net of federal benefit), respectively, that if recognized, would impact the Company’s effective tax rate.  Unrecognized tax benefits that are not expected to be settled within the next 12 months are included in other non-current liabilities in the consolidated balance sheet; unrecognized tax benefits that are expected to be settled within the next 12 months are included in income taxes payable.

 

The Company’s accounting policy with respect to interest and penalties related to tax uncertainties is to classify these amounts as income taxes.  As of January 1, 2010, the total amount of accrued interest and penalties related to uncertain tax positions recognized in the consolidated balance sheet was $2.0 million ($1.6 million net of federal benefit).  The total amount of penalties and interest, net of federal benefit, related to tax uncertainties recognized in the statement of income for the nine month period ended September 30, 2010 was $81 thousand.  The total amount of accrued penalties and interest related to uncertain tax positions at September 30, 2010 of $1.9 million ($1.5 million net of federal benefit) is included in the total unrecognized tax benefits described above.

 

In the ordinary course of business, many transactions occur for which the ultimate tax outcome is uncertain.  In addition, respective tax authorities periodically audit our income tax returns. These audits examine our significant tax filing positions, including the timing and amounts of deductions and the allocation of income among tax jurisdictions.  The 2007, 2008 and 2009 federal income tax returns are open

 

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tax years that remain subject to potential future audit. The 2005 and 2006 federal tax years also remain open to a limited extent due to capital loss carryback claims.  State income tax returns for all years after 2006, and in certain states, income tax returns for 2005 and 2006, are subject to potential future audit by tax authorities in the Company’s major state tax jurisdictions.

 

The Company is currently being audited in three state jurisdictions.  It is reasonably possible that the Company will settle the audits in these jurisdictions within the next 12 month period.  It is estimated that the Company’s liability for unrecognized tax benefits, including penalties and interest, could decrease by approximately $705 thousand to $2.1 million ($474 thousand to $1.4 million net of federal benefit) upon settlement of these audits.  Such settlements are not anticipated to have a significant impact on the results of operations.

 

7.     Pension Plan and Postretirement Benefits Other Than Pension

 

We provide a non-contributory retirement plan that covers substantially all employees (the “Pension Plan”).  Benefits payable under the Pension Plan are based on employees’ years of service and compensation during the final 10 years of employment.  We also sponsor an unfunded defined benefit postretirement medical plan that covers substantially all employees, including Waddell & Reed and Legend advisors.  The medical plan is contributory with retiree contributions adjusted annually.  The medical plan does not provide for post age 65 benefits with the exception of a small group of employees that were grandfathered when such plan was established.

 

The following table presents the components of net periodic pension and other postretirement costs related to these plans:

 

 

 

Pension Benefits

 

Other
Postretirement
Benefits

 

Pension Benefits

 

Other
Postretirement
Benefits

 

 

 

Three months
ended
September 30,

 

Three months
ended
September 30,

 

Nine months
ended
September 30,

 

Nine months
ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

2010

 

2009

 

2010

 

2009

 

 

 

(in thousands)

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

1,535

 

1,319

 

111

 

93

 

4,605

 

3,957

 

332

 

279

 

Interest cost

 

1,649

 

1,597

 

91

 

85

 

4,947

 

4,790

 

273

 

255

 

Expected return on plan assets

 

(1,875

)

(1,607

)

 

 

(5,624

)

(4,821

)

 

 

Actuarial loss amortization

 

404

 

399

 

 

 

1,212

 

1,197

 

 

 

Prior service cost amortization

 

139

 

139

 

11

 

10

 

417

 

417

 

34

 

30

 

Transition obligation amortization

 

1

 

1

 

 

 

3

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,853

 

1,848

 

213

 

188

 

5,560

 

5,543

 

639

 

564

 

 

During the nine months ended September 30, 2010, we made a $10.0 million contribution to the Pension Plan.  In October 2010, we made an additional $2.5 million contribution to the Pension Plan.  We do not expect to make additional contributions to the Pension Plan for the remainder of 2010.

 

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8.   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,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

40,533

 

33,413

 

110,594

 

72,253

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

85,438

 

85,699

 

85,683

 

85,503

 

Dilutive potential shares from stock options

 

10

 

75

 

32

 

62

 

Weighted average shares outstanding - diluted

 

85,448

 

85,774

 

85,715

 

85,565

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.47

 

0.39

 

1.29

 

0.85

 

Diluted

 

$

0.47

 

0.39

 

1.29

 

0.84

 

 

Anti-dilutive Securities

 

Options to purchase 401 thousand shares and 327 thousand shares of our common stock were excluded from the diluted earnings per share calculation for the three and nine months ended September 30, 2010, respectively, because they were anti-dilutive.  Options to purchase 795 thousand shares and 866 thousand shares of common stock were excluded from the diluted earnings per share calculation for the three and nine months ended September 30, 2009, respectively, because they were anti-dilutive.

 

Dividends

 

On July 21, 2010, the Board of Directors (the “Board”) approved a dividend on our common stock in the amount of $0.19 per share to stockholders of record as of October 1, 2010 to be paid on November 1, 2010.  The total dividend to be paid is approximately $16.2 million.

 

On October 14, 2010, the Board approved an increase in the quarterly dividend on our common stock to $0.20 per share.  The dividend is payable on February 1, 2011 to stockholders of record as of January 3, 2011.

 

Common Stock Repurchases

 

The Board has authorized the repurchase of our common stock in the open market and/or private purchases. The acquired shares may be used for corporate purposes, including shares issued to employees in our stock-based compensation programs.  There were 37,087 shares and 1,916,297 shares repurchased in the open market or privately during the three and nine months ended September 30, 2010, respectively, which included 27,087 shares and 299,417 shares repurchased from employees who elected to tender shares to cover their minimum income tax withholdings with respect to the vesting of stock awards during the three and nine months ended September 30, 2010, respectively.  There were 678,978 shares and 1,772,843 shares repurchased in the open market or privately during the three and nine months ended September 30, 2009, respectively, which included 6,043 shares and 256,108 shares repurchased from employees who elected to tender shares to cover their minimum income tax withholdings with respect to the vesting of stock awards during the three and nine months ended September 30, 2009, respectively.

 

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9.     Share-Based Compensation

 

A summary of stock option activity and related information for the nine months ended September 30, 2010 is presented in the table below. All options outstanding expire prior to December 31, 2013.

 

 

 

Options

 

Weighted
average
exercise price

 

Outstanding, December 31, 2009

 

897,503

 

$

30.65

 

Granted

 

 

 

Exercised

 

(303,870

)

31.84

 

Terminated/Cancelled

 

(127,026

)

31.65

 

Outstanding, September 30, 2010

 

466,607

 

$

29.61

 

Exercisable, September 30, 2010

 

466,607

 

$

29.61

 

 

10.  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.

 

Michael E. Taylor, Kenneth B. Young, individuals, on behalf of themselves individually and on behalf of others similarly situated v. Waddell & Reed, Inc., a Delaware Corporation; Waddell & Reed Financial, Inc., a Delaware Corporation; Waddell & Reed Development, Inc., a Delaware Corporation; Waddell & Reed Financial Advisors, a fictitious business name; and DOES 1 through 10 inclusive; Case No. 09-CV-2909 DMS WVG; in the United States District Court for the Southern District of California.

 

In this action filed December 28, 2009, the Company, along with various of its affiliates, were sued in an individual action, class action and Fair Labor Standards Act (“FLSA”) nationwide collective action by two former advisors asserting misclassification of financial advisors as independent contractors instead of employees.  Plaintiffs assert claims under the FLSA for minimum wages and overtime wages, and under California Labor Code Statutes for timely pay wages, minimum wages, overtime compensation, meal periods, reimbursement of losses and business expenses and itemized wage statements and a claim for Unfair Business Practices under §17200 of the California Business & Professions Code.  Plaintiffs seek declaratory and injunctive relief and monetary damages.  The Company intends to vigorously contest plaintiffs’ claims.

 

In the opinion of management, the ultimate resolution and outcome of this matter is uncertain.  At this stage of the litigation, the Company is unable to estimate the expense or exposure, if any, that it may represent.   The ultimate resolution of this matter, or an adverse determination against the Company, could have a material adverse impact on the financial position and results of operations of the Company.  However, this possible impact is unknown and not reasonably determinable; therefore, no liability has been recorded in the consolidated financial statements.

 

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Table of Contents

 

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, 2009, which include, without limitation:

 

·                                          A decline in the securities markets or in the relative investment performance of our Funds and other investment portfolios and products as compared to competing funds;

 

·                                          The 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;

 

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

 

·                                          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;

 

·                                          A decrease in, or the elimination of, any future quarterly dividend paid to stockholders; 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, 2009 and as updated in our quarterly reports on Form 10-Q during the year ending December 31, 2010.  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.

 

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Table of Contents

 

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

 

We derive our revenues primarily 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, distribution fees on certain variable products, and fees earned on fee-based asset allocation products, as well as advisory services.  The products sold have various commission structures and the revenues received from product sales vary based on the type and amount sold.  Rule 12b-1 service and distribution fees earned for servicing and/or distributing certain mutual fund shares are based upon assets under management and fluctuate based on sales, redemptions and financial market conditions.  Other service fees include transfer agency fees, custodian fees for retirement plan accounts and portfolio accounting.

 

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

 

Third Quarter Highlights

 

Our average assets under management during the third quarter of 2010 were 20% higher than our average assets under management during the third quarter of 2009, resulting in a significant increase in revenues for the current year.  Ending assets under management of $76.0 billion as of September 30, 2010 are 2% higher than our previous quarter-end high of $74.2 billion at March 31, 2010.

 

Our balance sheet remains strong, and we ended the quarter with cash and investments of over $342.0 million.  We renewed our $125.0 million credit facility during the third quarter and have successfully secured funding for senior notes with a delayed funding provision that will allow us to draw down the proceeds in January 2011 when the existing senior notes mature.

 

Potential Impact of Health Care Reform Legislation

 

In March of 2010, President Obama signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act (HR 3590) and the Health Care Education and Affordability Reconciliation Act (HR 4872) (the “Acts”). The Acts contain provisions that could impact the Company’s accounting for its postretirement medical plan in future periods. However, the extent of that impact, if any, cannot be determined until regulations are promulgated under the Acts and additional interpretations of the Acts become available.

 

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Assets Under Management

 

Assets under management increased to nearly $76.0 billion on September 30, 2010 compared to $68.3 billion on June 30, 2010 due to market appreciation of $7.0 billion and net flows of $658 million.

 

Change in Assets Under Management(1)

 

 

 

Third Quarter 2010

 

 

 

Advisors

 

Wholesale

 

Institutional

 

Total

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

Beginning Assets

 

$

28,215

 

32,523

 

7,541

 

$

68,279

 

 

 

 

 

 

 

 

 

 

 

Sales (net of commissions)

 

839

 

2,933

 

905

 

4,677

 

Redemptions

 

(919

)

(2,566

)

(704

)

(4,189

)

Net Sales

 

(80

)

367

 

201

 

488

 

 

 

 

 

 

 

 

 

 

 

Net Exchanges

 

(138

)

27

 

115

 

4

 

Reinvested Dividends & Capital Gains

 

81

 

59

 

26

 

166

 

Net Flows

 

(137

)

453

 

342

 

658

 

 

 

 

 

 

 

 

 

 

 

Market Appreciation

 

2,705

 

3,504

 

821

 

7,030

 

Ending Assets

 

$

30,783

 

36,480

 

8,704

 

$

75,967

 

 

 

 

Third Quarter 2009

 

 

 

Advisors

 

Wholesale

 

Institutional

 

Total

 

 

 

(in millions)