Waddell & Reed Financial, Inc. Reports Third Quarter Results

Waddell & Reed Financial, Inc. Reports Third Quarter Results

OVERLAND PARK, Kan.--(BUSINESS WIRE)-- Waddell & Reed Financial, Inc. (NYS: WDR) today reported third quarter income from continuing operations of $52.1 million, or $0.61 per diluted share, compared to $41.2 million, or $0.48 per diluted share, during the second quarter of 2012 and $39.4 million, or $0.46 per diluted share, during the same period last year.

On October 29 of this year, the Company entered into a definitive agreement to sell its Legend group of subsidiaries to First Allied Holdings Inc. As a result of this transaction, Legend's operations are now classified as discontinued operations in current and prior periods presented. Results from discontinued operations in the current quarter include a non-cash charge of $42.4 million related to the write-down of Legend as a result of the sale. We expect the transaction to close in January 2013, subject to regulatory approval customary for transactions of this type.


"The sale of Legend reflects our desire to emphasize our core business," said Hank Herrmann, Chairman and Chief Executive Officer of Waddell & Reed Financial, Inc. "We appreciate the efforts of the Legend team over the past 12 years and wish them continued success in their new alliance with First Allied."

Net income, including the loss from discontinued operations, was $8.5 million, or $0.10 per diluted share, during the quarter compared to net income of $41.7 million, or $0.48 per diluted share, during the previous quarter and $39.8 million, or $0.46 per diluted share, during the third quarter of 2011. Unless stated otherwise, any reference to income statement items in this release refers to results from continuing operations.

Operating income was $79.7 million during the quarter, an 18% increase compared to the previous quarter and 8% increase compared to the same period last year. Our operating margin reached 27.2%, compared to 23.3% during the previous quarter and 26.4% during the same period last year.

Assets under management rose 6% during the quarter and ended the month of September at $95 billion driven by a combination of positive market action and organic growth.

Business Discussion

Advisors channel

Sales of $906 million rose 4% compared to the same period in 2011, but fell 13% compared to the second quarter of 2012 due principally to weaker sales of variable annuity products. After a good start to 2012, third quarter flows were slightly negative at $75 million. For the first nine months of this year, the Advisors channel generated positive flows of $266 million.

Our Advisors business remains our most stable channel. The stickiness of our clients' investments yields one of the longest asset retention periods in the industry, and certainly the highest among the retail clientele of our publicly traded peers. Clients' growing preference for fee-based solutions also provides us with an increasingly predictable stream of recurring revenues. Fee-based assets currently comprise 25% of total assets under management in this channel, up from 20% during the same period last year.

Wholesale channel

Sales from our Wholesale channel were $3.6 billion during the quarter, or 10% lower than the same period last year and 8% lower than the previous quarter. Net flows improved 22% and 7% compared to the third quarter of 2011 and second quarter of 2012, respectively. The improvement in net flows was due to lower redemptions.

Despite a 16% increase year-to-date in the S&P 500 index, investors continue to withdraw from actively managed equity products. While this continues to pose a challenge, the strength of our investment process, breadth of our product line and our embedded relationships with key distributors and their financial advisors continue to facilitate our organic growth in this channel. On a year-to-date basis, 59% of our equity funds and 74% of our equity assets beat their Lipper peers. Our longer-term record is similarly solid.

Institutional channel

Sales of $721 million rose 27% compared to the previous quarter and inflows of $231 million compare favorably to outflows of $433 during the second quarter. Last year's third quarter included the funding of a material mandate for approximately $800 million that boosted both sales and inflows.

Our Core Equity strategy continues to generate meaningful interest and led to two significant new relationships being funded in the current quarter. This has been the fastest growing strategy over the past year and now ranks second, as measured by assets, behind Large Cap Growth in this channel.

Management Fee Revenue Analysis

The sequential increase in revenues was due to higher levels of assets under management and one additional day in the current period. Compared to the same period last year, the increase in revenues was due to higher levels of assets under management and partly offset by a mix-shift toward fixed income products.

The effective fee rate during the current quarter was 59.8 basis points, compared to 59.9 basis points during the second quarter and 60.6 basis points during the third quarter of 2011.

Underwriting and Distribution Revenue and Expense Analysis

Advisors channel

Revenues declined sequentially due to lower sales from front-load funds, variable annuity products and insurance products. These were partly offset by higher revenue from asset allocation fees and Rule 12b-1 fees. Direct expenses declined with revenues while indirect expenses declined due to a combination of lower convention costs, payroll taxes and group insurance costs.

Compared to the third quarter of 2011, revenues increased with higher asset allocation fees and were partly offset by lower sales commissions from variable annuity products. Direct expenses rose with associated revenues. Indirect expenses were largely unchanged.

Wholesale channel

Compared to the previous quarter, revenues rose with higher Rule 12b-1 fees, partly offset by lower sales commissions. Direct expenses rose with associated revenues and higher third party payouts. Indirect expenses remained unchanged.

Compared to the same period last year, revenues declined on a combination of lower asset-based fees and sales commissions. Direct expenses rose on higher third party payouts. Business travel and related expenses were the main contributors to the increase in indirect costs.

Compensation and Related Expense Analysis

Last year's third quarter included an adjustment of $3.2 million to lower estimates for annual incentive bonuses. The remainder of the increase compared to the same period last year is attributable to higher base salary, equity compensation and pension costs.

Sequentially, compensation and related costs remained unchanged as higher earnings on deferred compensation was offset by lower payroll taxes.

General and Administrative Expense Analysis

The current quarter included an adjustment to reflect a revision in the estimated costs of distributing the 2006 SEC market timing settlement and a reduction in the estimated legal costs related to an ongoing class action suit, partly offset by higher consultant fees. In sum, these items totaled a $2.5 million benefit.

The second quarter of 2012 included a $5 million charge to write off software capitalization costs. It, along with adjustments to estimates described above, were responsible for the sequential decline in costs.

Subadvisory Fees

The decline in subadvisory fees is attributable to lower levels of subadvised assets under management compared to the previous quarter, as well as the same quarter last year. During the current quarter, subadvised average assets under management were $4.7 billion.

Investment and Other Income/Loss

Compared with the second quarter, investment and other income include higher gains recognized on the sale of available-for-sale securities and gains in our investment trading portfolio. These gains were partly offset by the write-down of a partnership interest.

Compared with the same period last year, gains recognized on the sale of available-for-sale securities were much more sizable while losses in our mutual fund trading portfolios were lower.

Tax Rate

Our effective tax for continuing operations during the current quarter was 34.5%. The lower tax rate resulted from statute limitations running out on previously open tax years, which resulted in the release of tax reserves for those years; investment gains that reduced the valuation allowance against capital loss carryforwards; and adjustment to prior year tax estimates based upon actual filing positions.

We estimate our annual effective tax rate to range between 37% and 39%, excluding any changes related to the valuation allowance.

Balance Sheet Information

As of September 30, 2012, cash and cash equivalents and investment securities were $545 million. Long-term debt was $190 million and there was no short-term debt outstanding.

Stockholders' equity was $568 million and there were 85.6 million shares outstanding. During the quarter, we repurchased 213 thousand shares on the open market or privately, bringing our annual total to 1.2 million shares at an aggregate cost of $36 million.

Unaudited Consolidated Statement of Income

(Amounts in thousands, except for per share data)

2011

2012

1st Qtr.

2nd Qtr.

3rd Qtr.

4th Qtr.

1st Qtr.

2nd Qtr.

3rd Qtr.

4th Qtr.

Operating Revenues:

Investment management fees

$

131,644

$

138,985

$

133,495

$

126,476

$

134,900

$

134,213

$

138,364

Underwriting and distribution fees

117,041

121,101

115,786

115,556

121,153

123,687

122,819

Shareholder service fees

29,750

31,109

31,060

30,530

31,818

31,786

32,182

Total operating revenues

278,435

291,195

280,341

272,562

287,871

289,686

293,365

Operating Expenses:

Underwriting and distribution

138,607

142,910

138,111

140,590

144,486

148,067

147,408

Compensation and related costs

39,542

40,971

36,105

40,714

44,158

41,931

42,343

General and administrative

16,087

17,854

20,979

19,190

17,764

23,634

15,774

Subadvisory fees

8,080

8,313

7,291

6,201

6,271

5,208

4,921

Depreciation

3,483

3,725

3,866

3,690

3,359

3,329

3,188

Total operating expenses

205,799

213,773

206,352

210,385

216,038

222,169

213,634

Operating Income

72,636

77,422

73,989

62,177

71,833

67,517

79,731

Investment and other income/(loss)

948

2,459

(4,178

)

2,876

3,949

1,325

2,632

Interest expense

(2,900

)

(2,832

)

(2,837

)

(2,839

)

(2,826

)

(2,825

)

(2,826

)

Income from continuing operations before taxes

70,684

77,049

66,974

62,214

72,956

66,017

79,537

Provision for taxes

26,314

27,954

27,603

22,843

26,119

24,792

27,421

Income from continuing operations

44,370

49,095

39,371

39,371

46,837

41,225

52,116

Income/(loss) from discontinued operations, net of income taxes

1,263

875

463

651

550

493

(43,590

)

Net Income

$

45,633

$

49,970

$

39,834

$

40,022

$

47,387

$

41,718

$

8,526

Net Income per share from continuing operations

0.52

0.57

0.46

0.46

0.55

0.48

0.61

Income/(loss) per share from discontinued operations

0.01

0.01

0.00

0.01

0.00

0.00

(0.51

)

Net income per share

0.53

0.58

0.46

0.47

0.55

0.48

0.10

Weighted average shares outstanding - diluted

85,836

86,275

85,782

85,286

85,606

86,095

85,755

Operating margin

26.1

%

26.6

%

26.4

%

22.8

%

25.0

%

23.3

%

27.2

%

Underwriting and Distribution

(Amounts in thousands)

2011

2012

Advisors Channel

1st Qtr.

2nd Qtr.

3rd Qtr.

4th Qtr.

1st Qtr.

2nd Qtr.

3rd Qtr.

4th Qtr.

Revenues

$

72,555

$

74,018

$

70,088

$

73,416

$

76,680

$

79,779

$

78,160

Expenses

Direct

50,872

52,422

49,748

51,316

53,676

55,813

54,246

Indirect

22,791

23,724

24,761

26,138

26,367

26,755

25,727

Total expenses

$

73,663

$

76,146

$

74,509

$

77,454

$

80,043

$

82,568

$

79,973

Wholesale Channel

Revenues

$

44,486

$

47,083

$

45,698

$

42,140

$

44,473

$

43,908

$

44,659

Expenses

Direct

56,498

58,425

55,502

53,664

55,104