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Section 1: 10-Q (10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2016

 

OR

 

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

 

For the transition period from                                 to                                

 

Commission file number 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 ☒ 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 ☒ 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 ☒

 

Accelerated filer ☐

 

 

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

(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 ☒.

 

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

 

 

 

 

Class

 

Outstanding as of October 14, 2016

Class A common stock, $.01 par value

 

82,806,327

 

 

 

 

 

 


 

Table of Contents

WADDELL & REED FINANCIAL, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended September 30, 2016

 

 

 

 

    

Page No.

 

 

 

 

 

Part I. 

Financial Information

 

 

 

 

 

 

 

Item 1. 

 

Financial Statements (unaudited)

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets at September 30, 2016 and December 31, 2015

 

 

 

 

 

 

 

 

Consolidated Statements of Income for the three and nine months ended September 30, 2016 and September 30, 2015

 

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2016 and September 30, 2015

 

 

 

 

 

 

 

 

Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2016

 

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and September 30, 2015

 

 

 

 

 

 

 

 

Notes to the Unaudited Consolidated Financial Statements

 

 

 

 

 

 

Item 2. 

 

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

 

21 

 

 

 

 

 

Item 3. 

 

Quantitative and Qualitative Disclosures About Market Risk

 

37 

 

 

 

 

 

Item 4. 

 

Controls and Procedures

 

37 

 

 

 

 

 

Part II. 

Other Information

 

 

 

 

 

 

 

Item 1. 

 

Legal Proceedings

 

38 

 

 

 

 

 

Item 1A. 

 

Risk Factors

 

39 

 

 

 

 

 

Item 2. 

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

40 

 

 

 

 

 

Item 6. 

 

Exhibits

 

41 

 

 

 

 

 

 

 

Signatures

 

42 

 

 

 

 

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, 

 

 

 

 

 

 

2016

 

 

December 31, 

 

 

 

(Unaudited)

 

 

2015

 

Assets:

    

 

 

    

 

 

    

Cash and cash equivalents

 

$

529,784

 

 

558,495

 

Cash and cash equivalents - restricted

 

 

22,064

 

 

66,880

 

Investment securities

 

 

319,247

 

 

291,743

 

Receivables:

 

 

 

 

 

 

 

Funds and separate accounts

 

 

25,670

 

 

34,399

 

Customers and other

 

 

153,322

 

 

220,660

 

Income taxes receivable

 

 

4,377

 

 

10,594

 

Prepaid expenses and other current assets

 

 

23,213

 

 

34,800

 

Total current assets

 

 

1,077,677

 

 

1,217,571

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

105,812

 

 

105,434

 

Deferred sales commissions, net

 

 

5,279

 

 

24,262

 

Goodwill and identifiable intangible assets

 

 

152,618

 

 

158,118

 

Deferred income taxes

 

 

26,833

 

 

32,692

 

Other non-current assets

 

 

30,398

 

 

17,074

 

Total assets

 

$

1,398,617

 

 

1,555,151

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

27,260

 

 

32,858

 

Payable to investment companies for securities

 

 

41,213

 

 

113,648

 

Payable to third party brokers

 

 

33,708

 

 

49,848

 

Payable to customers

 

 

61,735

 

 

120,420

 

Accrued compensation

 

 

75,606

 

 

69,335

 

Other current liabilities

 

 

62,386

 

 

57,104

 

Total current liabilities

 

 

301,908

 

 

443,213

 

 

 

 

 

 

 

 

 

Long-term debt

 

 

189,562

 

 

189,432

 

Accrued pension and postretirement costs

 

 

24,726

 

 

48,810

 

Other non-current liabilities

 

 

26,572

 

 

27,241

 

Total liabilities

 

 

542,768

 

 

708,696

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

 

10,372

 

 

 —

 

 

 

 

 

 

 

 

 

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; 82,819 shares outstanding (82,850 at December 31, 2015)

 

 

997

 

 

997

 

Additional paid-in capital

 

 

293,134

 

 

331,611

 

Retained earnings

 

 

1,151,376

 

 

1,141,608

 

Cost of 16,882 common shares in treasury (16,851 at December 31, 2015)

 

 

(542,011)

 

 

(566,256)

 

Accumulated other comprehensive loss

 

 

(58,019)

 

 

(61,505)

 

Total stockholders’ equity

 

 

845,477

 

 

846,455

 

 

 

 

 

 

 

 

 

Total liabilities, redeemable noncontrolling interests and stockholders’ equity

 

$

1,398,617

 

 

1,555,151

 

 

See accompanying notes to the 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 ended September 30, 

 

For the nine months ended September 30, 

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues:

    

 

    

    

 

    

    

 

 

    

 

 

    

Investment management fees

 

$

138,745

 

 

175,218

 

 

424,403

 

 

543,237

 

Underwriting and distribution fees

 

 

135,778

 

 

165,130

 

 

428,748

 

 

503,616

 

Shareholder service fees

 

 

28,563

 

 

35,761

 

 

92,959

 

 

108,704

 

Total

 

 

303,086

 

 

376,109

 

 

946,110

 

 

1,155,557

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting and distribution

 

 

152,999

 

 

189,065

 

 

508,080

 

 

580,247

 

Compensation and related costs (including share-based compensation of $12,425, $12,073, $38,573 and $35,880 respectively)

 

 

40,214

 

 

46,157

 

 

151,495

 

 

152,481

 

General and administrative

 

 

23,280

 

 

25,458

 

 

61,708

 

 

79,033

 

Subadvisory fees

 

 

2,566

 

 

2,305

 

 

6,984

 

 

7,086

 

Depreciation

 

 

4,541

 

 

4,117

 

 

13,163

 

 

12,215

 

Intangible asset impairment

 

 

5,700

 

 

 —

 

 

5,700

 

 

 —

 

Total

 

 

229,300

 

 

267,102

 

 

747,130

 

 

831,062

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

73,786

 

 

109,007

 

 

198,980

 

 

324,495

 

Investment and other income (loss)

 

 

7,878

 

 

(16,872)

 

 

(1,653)

 

 

(12,891)

 

Interest expense

 

 

(2,792)

 

 

(2,765)

 

 

(8,336)

 

 

(8,296)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

 

78,872

 

 

89,370

 

 

188,991

 

 

303,308

 

Provision for income taxes

 

 

24,067

 

 

41,312

 

 

63,146

 

 

120,692

 

Net income

 

 

54,805

 

 

48,058

 

 

125,845

 

 

182,616

 

Net income attributable to redeemable noncontrolling interests

 

 

978

 

 

 —

 

 

1,355

 

 

 —

 

Net income attributable to Waddell & Reed Financial, Inc

 

$

53,827

 

 

48,058

 

 

124,490

 

 

182,616

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share attributable to Waddell and Reed Financial, Inc. common shareholders, basic and diluted:

 

$

0.65

 

 

0.58

 

 

1.51

 

 

2.18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic and diluted:

 

 

82,834

 

 

83,469

 

 

82,629

 

 

83,709

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

4


 

Table of Contents

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

For the three months ended September 30, 

 

For the nine months ended September 30, 

 

 

 

2016

    

2015

    

2016

    

2015

    

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

54,805

 

 

48,058

 

 

125,845

 

 

182,616

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized appreciation (depreciation) of available for sale investment securities during the period, net of income tax expense (benefit) of $1, $(5), $2, and $(0), respectively

 

 

(344)

 

 

(1,321)

 

 

1,616

 

 

(4,485)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pension and postretirement benefits, net of income tax expense (benefit) of $(167), $526, $1,018 and $1,477, respectively

 

 

(167)

 

 

888

 

 

1,870

 

 

2,764

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

54,294

 

 

47,625

 

 

129,331

 

 

180,895

 

Comprehensive income attributable to redeemable noncontrolling interests

 

 

978

 

 

 —

 

 

1,355

 

 

 —

 

Comprehensive income attributable to Waddell & Reed Financial, Inc.

 

$

53,316

 

 

47,625

 

 

127,976

 

 

180,895

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

5


 

Table of Contents

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders’ Equity and redeemable noncontrolling interests

For the Nine Months Ended September 30, 2016

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated Other

 

Total 

 

Non

 

 

 

Common Stock

 

Additional

 

Retained

 

Treasury

 

Comprehensive

 

Stockholders’

 

Controlling

 

 

    

Shares

    

Amount

    

Paid-in Capital

    

Earnings

    

Stock

    

Income (Loss)

    

Equity

    

interest

 

Balance at December 31, 2015

 

99,701

 

 

997

 

331,611

 

1,141,608

 

(566,256)

 

(61,505)

 

846,455

 

 —

 

Adoption of consolidation guidance on January 1, 2016 - redeemable noncontrolling interests in sponsored funds

 

 —

 

 

 —

 

 —

 

 —

 

 —

 

 —

 

 —

 

14,330

 

Net income

 

 —

 

 

 —

 

 —

 

124,490

 

 —

 

 —

 

124,490

 

1,355

 

Net redemption of redeemable noncontrolling interests in sponsored funds

 

 —

 

 

 —

 

 —

 

 —

 

 —

 

 —

 

 —

 

(5,313)

 

Recognition of equity compensation

 

 —

 

 

 —

 

38,573

 

 —

 

 —

 

 —

 

38,573

 

 —

 

Net issuance/forfeiture of nonvested shares

 

 —

 

 

 —

 

(72,229)

 

 —

 

72,229

 

 —

 

 —

 

 —

 

Dividends accrued, $1.38 per share

 

 —

 

 

 —

 

 —

 

(114,722)

 

 —

 

 —

 

(114,722)

 

 —

 

Tax impact of share-based payment arrangements

 

 —

 

 

 —

 

(4,821)

 

 —

 

 —

 

 —

 

(4,821)

 

 —

 

Repurchase of common stock

 

 —

 

 

 —

 

 —

 

 —

 

(47,984)

 

 —

 

(47,984)

 

 —

 

Other comprehensive income

 

 —

 

 

 —

 

 —

 

 —

 

 —

 

3,486

 

3,486

 

 —

 

Balance at September 30, 2016

 

99,701

 

$

997

 

293,134

 

1,151,376

 

(542,011)

 

(58,019)

 

845,477

 

10,372

 

 

See accompanying notes to the 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, 

 

 

 

2016

    

2015

    

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

125,845

 

 

182,616

 

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

 

 

 

 

 

 

 

Depreciation

 

 

13,163

 

 

12,218

 

Write down of impaired assets

 

 

5,700

 

 

 —

 

Amortization of deferred sales commissions

 

 

21,842

 

 

34,251

 

Share-based compensation

 

 

38,573

 

 

35,880

 

Excess tax benefits from share-based payment arrangements

 

 

(2,234)

 

 

(5,357)

 

Investments gain, net

 

 

(13,834)

 

 

(2,799)

 

Net purchases and sales or maturities of trading securities

 

 

(24,353)

 

 

59

 

Deferred income taxes

 

 

4,840

 

 

(2,384)

 

Net change in trading securities held by consolidated sponsored funds

 

 

(57,444)

 

 

 —

 

Other

 

 

525

 

 

17,965

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Cash and cash equivalents - restricted

 

 

44,816

 

 

36,990

 

Customer and other receivables

 

 

67,338

 

 

44,219

 

Payable to investment companies for securities and payable to customers

 

 

(131,120)

 

 

(84,815)

 

Receivables from funds and separate accounts

 

 

8,729

 

 

5,782

 

Other assets

 

 

(2,826)

 

 

(14,771)

 

Deferred sales commissions

 

 

(2,859)

 

 

(9,093)

 

Accounts payable and payable to third party brokers

 

 

(21,738)

 

 

(24,622)

 

Other liabilities

 

 

(8,904)

 

 

4,434

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

66,059

 

 

230,573

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of available for sale and equity method securities

 

 

(71,852)

 

 

(25,893)

 

Proceeds from sales of available for sale and equity method securities

 

 

148,373

 

 

30,363

 

Additions to property and equipment

 

 

(13,933)

 

 

(20,635)

 

Net cash of sponsored funds on consolidation

 

 

6,887

 

 

 —

 

Other

 

 

(194)

 

 

(2,200)

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) investing activities

 

$

69,281

 

 

(18,365)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Dividends paid

 

 

(114,736)

 

 

(108,249)

 

Repurchase of common stock

 

 

(47,984)

 

 

(63,277)

 

Net subscriptions from (redemptions and distributions to) redeemable noncontrolling interests in sponsored funds

 

 

(3,695)

 

 

 —

 

Excess tax benefits from share-based payment arrangements

 

 

2,234

 

 

5,357

 

Other

 

 

130

 

 

 —

 

 

 

 

 

 

 

 

 

Net cash used in financing activities

 

$

(164,051)

 

 

(166,169)

 

Net increase (decrease) in cash and cash equivalents

 

 

(28,711)

 

 

46,039

 

Cash and cash equivalents at beginning of period

 

 

558,495

 

 

566,621

 

Cash and cash equivalents at end of period

 

$

529,784

 

 

612,660

 

 

See accompanying notes to the 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 from investment management and advisory services, investment product underwriting and distribution, and/or shareholder services administration provided to the Waddell & Reed Advisors group of mutual funds (the “Advisors Funds”), Ivy Funds (the “Ivy Funds”), Ivy Variable Insurance Portfolios (the “Ivy VIP”) and InvestEd Portfolios (“InvestEd”) (collectively, the Advisors Funds, Ivy Funds, Ivy VIP and InvestEd are referred to as the “Funds”), the Ivy Global Investors Fund SICAV (the “SICAV”) and its sub-funds (the “IGI 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”).  The IGI Funds are regulated by Luxembourg’s Commission de Surveillance du Secteur Financier as an undertaking for collective investment in transferable securities (“UCITS”). 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.  Services to the IGI Funds are provided under investment management and distribution agreements.  The majority of these agreements are subject to annual review and approval by each Fund’s board of trustees.  Our revenues are largely dependent on the total value and composition of assets under management.  Accordingly, fluctuations in financial markets and composition of assets under management can significantly impact our revenues and results of operations.

 

Basis of Presentation

 

We have prepared the accompanying unaudited consolidated financial statements pursuant to the rules and regulations of the SEC.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures are adequate to enable a reasonable understanding of the information presented.  The information in this Quarterly Report on Form 10-Q should be read in conjunction with Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K”).  Certain amounts in the prior years’ financial statements have been reclassified for consistent presentation.

 

The accompanying unaudited consolidated financial statements are prepared consistent with the accounting policies described in Note 1 to the consolidated financial statements included in our 2015 Form 10-K except as noted below.  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, 2016, the results of operations and cash flows for the nine months ended September 30, 2016 and 2015 in conformity with accounting principles generally accepted in the United States.

 

Investments Securities and Investments in Sponsored Funds

 

Sponsored funds, which include the Funds, the IGI Funds and privately offered funds structured in the form of limited liability companies, are investments we have made for general corporate investment purposes and to provide seed capital for new investment products. The Company’s initial investment in a new investment product typically represents 100% ownership in that product.  Sponsored funds are initially consolidated and are accounted for as trading securities.  The Company has classified its investments in certain sponsored funds as either equity method investments (when the Company owns between 20% and 50% of the fund) or as available for sale investments (when the Company owns less than 20% of the fund) as described in Note 4.  Investments held by our broker-dealer entities or certain investments that are anticipated to be purchased and sold on a more frequent basis are classified as trading.

 

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2.Cash and Cash Equivalents

 

Cash and cash equivalents include cash on hand and short-term investments.  We consider all highly liquid investments with maturities upon acquisition of 90 days or less 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.

 

3.New Accounting Guidance

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers.  This standard also specifies the accounting for certain costs to obtain or fulfill a contract with a customer.  This ASU will supersede much of the existing revenue recognition guidance in accounting principles generally accepted in the United States and is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period; early application is permitted for the first interim period within annual reporting periods beginning after December 15, 2016.  ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method.  We have evaluated our population of contracts and concluded that the adoption of this ASU will have an immaterial impact on our consolidated financial statements and related disclosures.

 

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,” which provides updated guidance on the recognition, measurement, presentation and disclosure of certain financial assets and financial liabilities.  This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  We are evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

In February 2016, the FASB issued ASU 2016-02, “Leases,” which increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.  This ASU will be presented using a modified retrospective approach, which includes a number of optional practical expedients that entities may elect to apply.  ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early application permitted.  We are evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

In March 2016, the FASB issued ASU 2016-07,“Simplifying the Transition to the Equity Method of Accounting.”  The amendments in this ASU eliminate the requirement that when an investment qualifies for the use of equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively as if the equity method had been in effect during all previous periods that the investment had been held.  ASU 2016-07 also requires that an entity that has an available for sale equity security that becomes qualified for the equity method recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method.  ASU 2016-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016.  We have concluded that the adoption of this ASU will have an immaterial impact on our consolidated financial statements and related disclosures.

 

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which requires recognition of all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement and classification of excess tax benefits along with other income tax cash flows as an operating activity; allows an entity to either estimate the number of awards that are expected to vest or account for forfeitures when they occur; and permits withholding up to the maximum statutory tax rates in the applicable jurisdictions.  ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted.  Upon adoption of this standard on January 1, 2017, the Company will account for forfeitures when they occur.  We do not expect a material impact on our consolidated financial statements and related disclosures upon adoption of this ASU.  However, after the adoption date, recognition of excess tax benefits as income tax benefit and tax deficiencies as income tax expense in the income statement may result in increased volatility in our provision for income taxes and effective tax rate.

 

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In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments.” The ASU changes the impairment model for most financial assets, and will require the use of an “expected loss” model for instruments measured at amortized cost. Under this model, entities will be required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. ASU 2016-13 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019. We are evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments.”  This ASU eliminates the diversity in practice related to the classification of certain cash receipts and payments for debt prepayment or extinguishment costs, the maturing of a zero coupon bond, the settlement of contingent liabilities arising from a business combination, proceeds from insurance settlements, distributions from certain equity method investees and beneficial interests obtained in a financial asset securitization. ASU 2016-15 designates the appropriate cash flow classification, including requirements to allocate certain components of these cash receipts and payments among operating, investing and financing activities.  This ASU is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2017, with early adoption permitted. We are evaluating the estimated impact the adoption of ASU 2016-15 will have on our consolidated financial statements and related disclosures. 

 

4.Investment Securities

 

Investment securities at September 30, 2016 and December 31, 2015 are as follows:

 

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

 

    

2016

 

2015

 

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

Sponsored funds

 

$

124,812

 

40,552

 

Sponsored privately offered funds

 

 

552

 

825

 

Total available for sale securities

 

 

125,364

 

41,377

 

Trading securities:

 

 

 

 

 

 

Mortgage-backed securities

 

 

15

 

20

 

Corporate bond

 

 

3

 

5

 

Common stock

 

 

101

 

87

 

Consolidated sponsored funds

 

 

123,792

 

 —

 

Sponsored funds

 

 

29,597

 

29,701

 

Total trading securities 

 

 

153,508

 

29,813

 

Equity method securities:

 

 

 

 

 

 

Sponsored funds

 

 

37,100

 

217,380

 

Sponsored privately offered funds

 

 

3,275

 

3,173

 

Total equity method securities

 

 

40,375

 

220,553

 

Total securities

 

$

319,247

 

291,743

 

 

The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Amortized

    

Unrealized

    

Unrealized

    

 

 

 

 

cost

 

gains

 

losses

 

Fair value

 

  

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

129,406

 

723

 

(5,317)

 

124,812

 

Sponsored privately offered funds

 

 

264

 

288

 

 —

 

552

 

  

 

$

129,670

 

1,011

 

(5,317)

 

125,364

 

 

 

 

 

 

 

 

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The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at December 31, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Amortized

    

Unrealized

    

Unrealized

    

 

 

 

 

cost

 

gains

 

losses

 

Fair value

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

46,800

 

434

 

(6,682)

 

40,552

 

Sponsored privately offered funds

 

 

500

 

325

 

 —

 

825

 

 

 

$

47,300

 

759

 

(6,682)

 

41,377

 

 

A summary of available for sale sponsored funds with fair values below carrying values at September 30, 2016 and December 31, 2015 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

September 30, 2016

    

Fair value 

    

losses

    

Fair value 

    

losses

    

Fair value 

    

losses

 

 

 

(in thousands)

 

Sponsored funds

 

$

40,736

 

(528)

 

34,863

 

(4,789)

 

75,599

 

(5,317)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 12 months

 

12 months or longer

 

Total

 

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

December 31, 2015

    

Fair value 

    

losses

    

Fair value 

    

losses

    

Fair value 

    

losses

 

 

 

(in thousands)

 

Sponsored funds

 

$

3,476

 

(166)

 

33,619

 

(6,516)

 

37,095

 

(6,682)

 

 

 

Based upon our assessment of these sponsored funds, the time frame the investments have been in a loss position and our intent to hold sponsored funds until they have recovered, we determined that a write-down was not necessary at September 30, 2016.

 

The corporate bond accounted for as trading matures in 2018. Mortgage-backed securities accounted for as trading and held as of September 30, 2016 mature in 2022.

 

Sponsored funds

 

The Company has classified its investments in the Advisor Funds, Ivy Funds and IGI Funds as either trading, equity method investments (when the Company owns between 20% and 50% of the fund) or as available for sale investments (when the Company owns less than 20% of the fund).  These entities do not meet the criteria of a variable interest entity (“VIE”) and are considered to be voting interest entities (“VOE”). The Company has determined the Advisor and Ivy Funds are VOEs because the structure of the investment products is such that the voting rights held by the equity holders provide for equality among equity investors.  The Company has determined that the IGI Funds are VOEs as their legal structure and the powers of their equity investors prevent the IGI Funds from meeting characteristics of being a VIE.

 

Sponsored privately offered funds

 

The Company holds interests in privately offered funds structured in the form of limited liability companies.  The members of these entities have the substantive ability to remove the Company as managing member or dissolve the entity upon a simple majority vote.  These entities do not meet the criteria of a variable interest entity and are considered to be voting interest entities.

 

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Consolidated sponsored funds

 

The following table details the balances related to consolidated sponsored funds at September 30, 2016, as well as the Company’s net interest in these funds:

 

 

 

 

 

 

 

 

September 30, 2016

 

 

    

(in thousands)

 

 

 

 

 

 

Cash

 

$

4,524

 

Investments

 

 

123,792

 

Other assets

 

 

1,017

 

Other liabilities

 

 

(1,093)

 

Redeemable noncontrolling interests

 

 

(10,372)

 

Net interest in consolidated sponsored funds

 

$

117,868

 

 

During the nine months ended September 30, 2016, we consolidated the Ivy Funds and IGI Funds in which we provided initial seed capital at the time of the fund’s formation. When we no longer have a controlling financial interest in a sponsored fund, it is deconsolidated from our financial statements.  We deconsolidated $44.2 million of these investments from our consolidated balance sheet during the first quarter of 2016.  There was no impact to the consolidated statement of income as a result of this deconsolidation.

 

Accounting standards establish a framework for measuring fair value and a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of the asset.  Inputs may be observable or unobservable and refer broadly to the assumptions that market participants would use in pricing the asset.  An individual investment’s fair value measurement is assigned a level based upon the observability of the inputs that are significant to the overall valuation.  The three-level hierarchy of inputs is summarized as follows:

 

·

Level 1 – Investments are valued using quoted prices in active markets for identical securities.

 

·

Level 2 – Investments are valued using other significant observable inputs, including quoted prices in active markets for similar securities. 

 

·

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

 

Assets classified as Level 2 can have a variety of observable inputs.  These observable inputs are collected and utilized, primarily by an independent pricing service, in pricing approaches evaluated differently depending upon the specific asset to determine a value.  The fair value of municipal bonds is measured based on pricing models that take into account, among other factors, information received from market makers and broker-dealers, current trades, bid-wants lists, offerings, market movements, the callability of the bond, state of issuance and benchmark yield curves.  The fair value of corporate bonds is measured using various techniques, which consider recently executed trades in securities of the issuer or comparable issuers, market price quotations (where observable), bond spreads and fundamental data relating to the issuer. 

 

Securities’ values classified as Level 3 are primarily determined through the use of a single quote (or multiple quotes) from dealers in the securities using proprietary valuation models.  These quotes involve significant unobservable inputs, and thus, the related securities are classified as Level 3 securities.

 

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The following tables summarize our investment securities as of September 30, 2016 and December 31, 2015 that are recognized in our consolidated balance sheets using fair value measurements based on the differing levels of inputs.

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2016

    

Level 1

    

Level 2

    

Level 3

    

Total

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

124,812

 

 —

 

 —

 

124,812

 

Sponsored privately offered funds measured at net asset value (1)

 

 

 —

 

 —

 

 —

 

552

 

Trading securities:

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

    

 

 —

    

15

    

 —

    

15

 

Corporate bonds

 

 

 —

 

3

 

 —

 

3

 

Common stock

 

 

101

 

 —

 

 —

 

101

 

Consolidated sponsored funds

 

 

87,393

 

36,399

 

 —

 

123,792

 

Sponsored funds

 

 

29,597

 

 —

 

 —

 

29,597

 

Equity method securities: (2)

 

 

 

 

 

 

 

 

 

 

Sponsored funds

 

 

37,100

 

 —

 

 —

 

37,100

 

Sponsored privately offered funds measured at net asset value (1)

 

 

 —

 

 —

 

 —

 

3,275

 

Total

 

$

279,003

 

36,417

 

 —

 

319,247

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

    

Level 1

    

Level 2

    

Level 3

    

Total

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

 

Sponsored funds

 

$

40,552

 

 —

 

 —

 

40,552

 

Sponsored privately offered funds measured at net asset value (1)

 

 

 —

 

 —

 

 —

 

825

 

Trading securities:

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

    

 

 —

    

20

    

 —