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 fees117,041121,101115,786115,556121,153123,687122,819
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 distribution138,607142,910138,111140,590144,486148,067147,408
Compensation and related costs39,54240,97136,10540,71444,15841,93142,343
General and administrative16,08717,85420,97919,19017,76423,63415,774
Subadvisory fees8,0808,3137,2916,2016,2715,2084,921
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 Income72,63677,42273,98962,17771,83367,51779,731
Investment and other income/(loss)9482,459(4,178)2,8763,9491,3252,632
Interest expense  (2,900)  (2,832)  (2,837)  (2,839) (2,826)  (2,825)  (2,826)  
Income from continuing operations before taxes70,68477,04966,97462,21472,95666,01779,537
Provision for taxes  26,314   27,954   27,603   22,843  26,119   24,792   27,421   
Income from continuing operations44,37049,09539,37139,37146,83741,22552,116
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 operations0.520.570.460.460.550.480.61
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)20112012
Advisors Channel1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
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
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