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Section 1: 10-Q (10-Q)

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Table of contents


 

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 June 30, 2018

 

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” 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)

 

 

 

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐ 

 

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 July 27, 2018

Class A common stock, $.01 par value

 

79,759,291

 

 

 

 

 

 


 

 

 

Table of contents

WADDELL & REED FINANCIAL, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

Quarter Ended June 30, 2018

 

 

 

 

    

Page No.

 

 

 

 

 

Part I. 

Financial Information

 

 

 

 

 

 

 

Item 1. 

 

Financial Statements (unaudited)

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets at June 30, 2018 and December 31, 2017

 

3

 

 

 

 

 

 

 

Consolidated Statements of Income for the three and six months ended June 30, 2018 and June 30, 2017

 

4

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2018 and June 30, 2017

 

5

 

 

 

 

 

 

 

Consolidated Statement of Stockholders’ Equity and Redeemable Noncontrolling Interests for the six months ended June 30, 2018

 

6

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the six months ended June 30, 2018 and June 30, 2017

 

7

 

 

 

 

 

 

 

Notes to the Unaudited Consolidated Financial Statements

 

8

 

 

 

 

 

Item 2. 

 

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

 

25

 

 

 

 

 

Item 3. 

 

Quantitative and Qualitative Disclosures About Market Risk

 

39

 

 

 

 

 

Item 4. 

 

Controls and Procedures

 

39

 

 

 

 

 

Part II. 

Other Information

 

 

 

 

 

 

 

Item 1. 

 

Legal Proceedings

 

39

 

 

 

 

 

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)

 

 

 

 

 

 

 

 

 

 

 

June 30, 

 

 

 

 

 

 

2018

 

 

December 31, 

 

 

 

(Unaudited)

 

 

2017

 

Assets:

    

 

 

    

 

 

    

Cash and cash equivalents

 

$

240,420

 

 

207,829

 

Cash and cash equivalents - restricted

 

 

25,872

 

 

28,156

 

Investment securities

 

 

584,769

 

 

700,492

 

Receivables:

 

 

 

 

 

 

 

Funds and separate accounts

 

 

23,176

 

 

25,664

 

Customers and other

 

 

133,915

 

 

131,108

 

Prepaid expenses and other current assets

 

 

34,768

 

 

25,593

 

Total current assets

 

 

1,042,920

 

 

1,118,842

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

77,154

 

 

87,667

 

Goodwill and identifiable intangible assets

 

 

145,869

 

 

147,069

 

Deferred income taxes

 

 

10,531

 

 

13,308

 

Other non-current assets

 

 

11,308

 

 

17,476

 

Total assets

 

$

1,287,782

 

 

1,384,362

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

36,208

 

 

38,998

 

Payable to investment companies for securities

 

 

61,695

 

 

43,422

 

Payable to third party brokers

 

 

24,237

 

 

25,153

 

Payable to customers

 

 

51,236

 

 

66,830

 

Short-term notes payable

 

 

 —

 

 

94,996

 

Accrued compensation

 

 

46,192

 

 

47,643

 

Other current liabilities

 

 

41,925

 

 

44,797

 

Total current liabilities

 

 

261,493

 

 

361,839

 

 

 

 

 

 

 

 

 

Long-term debt

 

 

94,819

 

 

94,783

 

Accrued pension and postretirement costs

 

 

14,027

 

 

15,137

 

Other non-current liabilities

 

 

14,673

 

 

25,210

 

Total liabilities

 

 

385,012

 

 

496,969

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

 

17,052

 

 

14,509

 

 

 

 

 

 

 

 

 

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; 80,355 shares outstanding (82,687 at December 31, 2017)

 

 

997

 

 

997

 

Additional paid-in capital

 

 

302,144

 

 

301,410

 

Retained earnings

 

 

1,144,090

 

 

1,092,394

 

Cost of 19,346 common shares in treasury (17,014 at December 31, 2017)

 

 

(560,181)

 

 

(522,441)

 

Accumulated other comprehensive (loss) income

 

 

(1,332)

 

 

524

 

Total stockholders’ equity

 

 

885,718

 

 

872,884

 

 

 

 

 

 

 

 

 

Total liabilities, redeemable noncontrolling interests and stockholders’ equity

 

$

1,287,782

 

 

1,384,362

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

 

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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 June 30, 

 

For the six months ended June 30, 

 

 

 

2018

 

2017

 

2018

 

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues:

    

 

    

    

 

    

    

 

 

    

 

 

    

Investment management fees

 

$

130,391

 

 

130,878

 

$

264,083

 

 

261,314

 

Underwriting and distribution fees

 

 

137,873

 

 

128,776

 

 

275,914

 

 

257,607

 

Shareholder service fees

 

 

27,074

 

 

27,003

 

 

52,956

 

 

54,300

 

Total

 

 

295,338

 

 

286,657

 

 

592,953

 

 

573,221

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Distribution

 

 

114,315

 

 

109,060

 

 

228,785

 

 

217,497

 

Compensation and benefits (including share-based compensation of $14,902, $14,054, $29,670 and $28,239, respectively)

 

 

65,828

 

 

65,332

 

 

134,613

 

 

132,367

 

General and administrative

 

 

19,143

 

 

23,287

 

 

38,681

 

 

45,482

 

Technology

 

 

17,235

 

 

17,780

 

 

33,879

 

 

34,757

 

Occupancy

 

 

6,969

 

 

7,548

 

 

13,933

 

 

15,333

 

Marketing and advertising

 

 

2,896

 

 

3,264

 

 

5,177

 

 

5,875

 

Depreciation

 

 

5,819

 

 

5,175

 

 

11,121

 

 

10,396

 

Subadvisory fees

 

 

3,683

 

 

3,194

 

 

7,391

 

 

5,891

 

Intangible asset impairment

 

 

1,200

 

 

900

 

 

1,200

 

 

1,500

 

Total

 

 

237,088

 

 

235,540

 

 

474,780

 

 

469,098

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

58,250

 

 

51,117

 

 

118,173

 

 

104,123

 

Investment and other income

 

 

841

 

 

2,997

 

 

3,657

 

 

6,009

 

Interest expense

 

 

(1,551)

 

 

(2,788)

 

 

(3,353)

 

 

(5,574)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

 

57,540

 

 

51,326

 

 

118,477

 

 

104,558

 

Provision for income taxes

 

 

13,284

 

 

26,608

 

 

28,250

 

 

45,489

 

Net income

 

 

44,256

 

 

24,718

 

 

90,227

 

 

59,069

 

Net (loss) income attributable to redeemable noncontrolling interests

 

 

(222)

 

 

656

 

 

(588)

 

 

1,136

 

Net income attributable to Waddell & Reed Financial, Inc.

 

$

44,478

 

 

24,062

 

$

90,815

 

 

57,933

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

0.55

 

 

0.29

 

$

1.10

 

 

0.69

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic and diluted:

 

 

81,449

 

 

83,611

 

 

82,275

 

 

83,843

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

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Table of contents

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

For the three months ended June 30, 

 

For the six months ended June 30, 

 

 

 

2018

    

2017

    

2018

    

2017

    

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

44,256

 

 

24,718

 

$

90,227

 

 

59,069

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized appreciation (depreciation) of available for sale investment securities during the period, net of income tax expense (benefit) of $53, $(192), $(298) and $(1,673), respectively

 

 

169

 

 

1,235

 

 

(962)

 

 

4,834

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Postretirement benefit, net of income tax benefit of $(7) , $(17), $(15) and $(34), respectively

 

 

(23)

 

 

(28)

 

 

(46)

 

 

(57)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

44,402

 

 

25,925

 

 

89,219

 

 

63,846

 

Comprehensive (loss) income attributable to redeemable noncontrolling interests

 

 

(222)

 

 

656

 

 

(588)

 

 

1,136

 

Comprehensive income attributable to Waddell & Reed Financial, Inc.

 

$

44,624

 

 

25,269

 

$

89,807

 

 

62,710

 

 

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 Six Months Ended June 30, 2018

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

Redeemable

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Other

 

Total 

 

Non

 

 

 

Common Stock

 

Paid-In

 

Retained

 

Treasury

 

Comprehensive

 

Stockholders’

 

Controlling

 

 

    

Shares

    

Amount

    

Capital

    

Earnings

    

Stock

    

Income (Loss)

    

Equity

    

interest

 

Balance at December 31, 2017

 

99,701

 

 

997

 

301,410

 

1,092,394

 

(522,441)

 

524

 

872,884

 

14,509

 

Adoption of recognition and measurement of financial assets and liabilities guidance (ASU 2016-01) on January 1, 2018

 

 —

 

 

 —

 

 —

 

812

 

 —

 

(812)

 

 —

 

 —

 

Adoption of reclassification of tax effects from accumulated other comprehensive income (loss) guidance (ASU 2018-02) on January 1, 2018

 

 

 

 

 

 

 

 

36

 

 

 

(36)

 

 —

 

 

 

Net income

 

 —

 

 

 —

 

 —

 

90,815

 

 —

 

 —

 

90,815

 

(588)

 

Net subscription of redeemable noncontrolling interests in sponsored funds

 

 —

 

 

 —

 

 —

 

 —

 

 —

 

 —

 

 —

 

3,131

 

Recognition of equity compensation

 

 —

 

 

 —

 

23,643

 

913

 

 —

 

 —

 

24,556

 

 —

 

Net issuance/forfeiture of nonvested shares

 

 —

 

 

 —

 

(22,909)

 

 

 

22,909

 

 

 

 —

 

 —

 

Dividends accrued, $0.50 per share

 

 —

 

 

 —

 

 —

 

(40,880)

 

 —

 

 —

 

(40,880)

 

 —

 

Repurchase of common stock

 

 —

 

 

 —

 

 —

 

 —

 

(60,649)

 

 —

 

(60,649)

 

 —

 

Other comprehensive loss

 

 —

 

 

 —

 

 —

 

 —

 

 —

 

(1,008)

 

(1,008)

 

 —

 

Balance at June 30, 2018

 

99,701

 

$

997

 

302,144

 

1,144,090

 

(560,181)

 

(1,332)

 

885,718

 

17,052

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

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Table of contents

WADDELL & REED FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

    

For the six months ended June 30, 

 

 

 

2018

    

2017

    

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

90,227

 

 

59,069

 

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

 

 

 

 

 

 

 

Depreciation and amortization

 

 

11,121

 

 

10,396

 

Write-down of impaired assets

 

 

1,200

 

 

1,500

 

Amortization of deferred sales commissions

 

 

1,890

 

 

2,675

 

Share-based compensation

 

 

29,670

 

 

28,239

 

Investments loss (gain), net

 

 

4,536

 

 

(4,662)

 

Net purchases of trading securities

 

 

(8,338)

 

 

(15,613)

 

Deferred income taxes

 

 

3,090

 

 

1,515

 

Net change in equity securities and trading debt securities held by consolidated sponsored funds

 

 

70,759

 

 

(114,407)

 

Other

 

 

2,092

 

 

209

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Customer and other receivables

 

 

(2,807)

 

 

28,823

 

Payable to investment companies for securities and payable to customers

 

 

2,679

 

 

(33,943)

 

Receivables from funds and separate accounts

 

 

2,488

 

 

5,994

 

Other assets

 

 

(1,932)

 

 

3,052

 

Accounts payable and payable to third party brokers

 

 

(3,706)

 

 

(6,805)

 

Other liabilities

 

 

(29,888)

 

 

3,857

 

Net cash provided by (used in) operating activities

 

$

173,081

 

 

(30,101)

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of available for sale and equity method securities

 

 

(27,093)

 

 

(28,881)

 

Proceeds from sales of equity and equity method securities

 

 

 —

 

 

14,917

 

Proceeds from maturities of available for sale securities

 

 

77,966

 

 

 —

 

Additions to property and equipment

 

 

(1,142)

 

 

(3,704)

 

Net cash provided by (used in) investing activities

 

$

49,731

 

 

(17,668)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Dividends paid

 

 

(41,481)

 

 

(77,236)

 

Repurchase of common stock

 

 

(59,195)

 

 

(12,013)

 

Repayment of short-term debt, net of debt issuance costs

 

 

(94,960)

 

 

 —

 

Net subscriptions, (redemptions, distributions and deconsolidations) of redeemable noncontrolling interests in sponsored funds

 

 

3,131

 

 

16,929

 

Other

 

 

 —

 

 

87

 

Net cash used in financing activities

 

$

(192,505)

 

 

(72,233)

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

 

30,307

 

 

(120,002)

 

Cash, cash equivalents, and restricted cash at beginning of period

 

 

235,985

 

 

586,239

 

Cash, cash equivalents, and restricted cash at end of period

 

$

266,292

 

 

466,237

 

 

See accompanying notes to the unaudited consolidated financial statements.

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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. (hereinafter referred to as the “Company,” “we,” “our” or “us”) is a holding company, incorporated in the state of Delaware in 1981, that conducts business through its subsidiaries. Founded in 1937, we are one of the oldest mutual fund complexes in the United States, having introduced the Waddell & Reed Advisors group of mutual funds (the “Advisors Funds”) in 1940. Over time, we added additional mutual funds: Ivy Funds (the “Ivy Funds”); Ivy Variable Insurance Portfolios, our variable product offering (“Ivy VIP”); InvestEd Portfolios, our 529 college savings plan (“InvestEd”); and the Ivy High Income Opportunities Fund, a closed-end mutual fund (“IVH”). In 2016, we introduced the Ivy NextShares® exchange-traded managed funds (“Ivy NextShares”) (collectively, Ivy Funds, Ivy VIP, InvestEd, IVH, and Ivy NextShares are referred to as the “Funds”). On February 26, 2018, we completed the merger of Advisor Funds into Ivy Funds with substantially similar objectives and strategies. As of June 30, 2018, we had $78.7 billion in assets under management.

We derive our revenues from providing investment management and advisory services, investment product underwriting and distribution, and shareholder services administration to the Funds and institutional and separately managed accounts. Investment management and/or advisory 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 fees earned on fee‑based asset allocation programs and related advisory services, asset‑based service and distribution fees promulgated under the 1940 Act (“Rule 12b-1”), distribution fees on certain variable products, and commissions derived from sales of investment and insurance products. The products sold have various commission structures and the revenues received from those sales vary based on the type and dollar amount sold. Shareholder service fee revenue includes transfer agency fees, custodian fees from retirement plan accounts, portfolio accounting and administration fees, and is earned based on assets under management or number of client accounts.  Our major expenses are for commissions, employee compensation, field services, dealer services, information technology, occupancy and marketing and advertising.

 

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, 2017 (the “2017 Form 10-K”).  Certain amounts in the prior year’s 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 2017 Form 10-K with the exception of the adoption of Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts from Customers,”  ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,” ASU 2016-18, “Statement of Cash Flows: Restricted Cash,” ASU 2017-07, “Compensation-Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,” and ASU 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” with all ASUs effective January 1, 2018. 

 

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The implementation of ASU 2014-09 did not have a material impact on the measurement or recognition of revenue from prior periods. See Note 3 – Revenue Recognition, for additional accounting policy information and the additional disclosures required by this ASU. Upon adoption of ASU 2016-01, we reclassified net unrealized holding gains, net of taxes, related to our available for sale investment portfolio from accumulated other comprehensive income to retained earnings. See consolidated statement of stockholders’ equity and redeemable noncontrolling interests for the financial statement reclassification impact of adopting this ASU. Upon adoption of ASU 2016-18, the Cash and cash equivalents – restricted financial statement line item is included as a component of cash and cash equivalents on the Company’s consolidated statements of cash flows for all periods presented. The adoption of ASU 2017-07 changed the income statement presentation of our noncontributory retirement plan that covers substantially all employees and certain vested employees of our former parent company (the “Pension Plan”) by requiring separation between operating expense (service cost component) and non-operating expense (all other components, including interest cost, amortization of prior service cost, mark-to-market gains and losses, curtailments and settlements, etc.). In addition, only the service cost component is eligible for capitalization as part of an asset. The adoption of this ASU had no effect on our net income because it only impacts the classification of certain information on the consolidated statements of income. An amendment to freeze the Pension Plan was approved effective September 30, 2017; therefore, after September 30, 2017, we no longer incur service costs. The service cost component of net periodic benefit cost was recognized in compensation and related costs through September 30, 2017. The other components of net periodic cost were reclassified to investment and other income (loss) on a retrospective basis. Upon early adoption of ASU 2018-02 tax effects that were stranded in other comprehensive income due to the Tax Reform Act were reclassified from accumulated other comprehensive income to retained earnings. The adoption of this ASU did not have a material impact on our consolidated financial statements and related disclosures. See consolidated statement of stockholders’ equity and redeemable noncontrolling interests for the financial statement reclassification impact of adopting this ASU.

 

Additionally, during the first quarter of 2018, we changed the presentation of certain line items in the consolidated statements of income that are intended to improve the transparency of the Company’s financial statements through clearer alignment of operating expenses with financial statement captions. Specifically, the Company revised its accounting policy related to the reporting of indirect underwriting and distribution expenses in the former underwriting and distribution caption and certain expenses historically reported as general and administrative. Expenses previously recorded as Underwriting and distribution expenses were retrospectively reclassified into (a) the following existing operating expense captions: Compensation and benefits and General and administrative, and (b) the following newly created operating expense captions: Distribution, Technology, Occupancy, and Marketing and advertising. Certain expenses historically reported as general and administrative were retrospectively reclassified into the following newly created operating expense captions: Technology, Occupancy, and Marketing and advertising. The Company considers the change in policy to be preferable and does not consider the change to be material to its consolidated financial statements. These changes were applied retrospectively to all periods presented and do not affect net income attributable to the Company.

 

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 June 30, 2018 and the results of operations and cash flows for the six months ended June 30, 2018 and 2017 in conformity with accounting principles generally accepted in the United States.

 

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2.New Accounting Guidance

 

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02, “Leases,” which increases transparency and comparability among organizations by establishing a right-of-use model that requires a lessee to record a right-of-use asset and a lease liability on the balance sheet with additional disclosures of key information about leasing arrangements.  This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted and certain practical expedients are available. The Company expects to adopt the provisions of this guidance on January 1, 2019.  The Company is in the process of identifying its impacted leases and continues to evaluate the impact that the ASU will have on its consolidated financial statements and related disclosures.

 

In June 2018, FASB issued ASU 2018-07, Compensation – Stock Compensation: Improvements to Nonemployee Share-Based Payment Accounting, which simplifies the accounting for share–based payments granted to nonemployees by aligning the accounting with the requirements for employee share–based compensation. This ASU is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. We are evaluating the estimated impact the adoption of this ASU will have on our consolidated financial statements and related disclosures.

 

3.Revenue Recognition

 

As of January 1, 2018, the Company adopted ASU 2014-09, “Revenue from Contracts with Customers” and all subsequent ASUs that modified ASC 606, “Revenue from Contracts with Customers.”  The Company elected to apply the standard utilizing the cumulative effect approach. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue.

 

Investment Management and Advisory Fees

 

We recognize investment management fees as earned over the period in which investment management services are provided. While our investment management contracts are long-term in nature, the performance obligations are generally satisfied daily or monthly based on assets under management. We calculate investment management fees from the Funds daily based upon average daily net assets under management in accordance with investment management agreements between the Funds and the Company. The majority of investment and/or advisory fees earned from institutional and separate accounts are calculated either monthly or quarterly based upon an average of net assets under management in accordance with such investment management agreements. The Company may waive certain fees for investment management services at its discretion, or in accordance with contractual expense limitations, and these waivers are reflected as a reduction to investment management fees on the consolidated statements of income.

 

Our investment advisory business receives research products and services from broker-dealers through soft dollar arrangements. Consistent with the soft dollar safe harbor established by Section 28(e) of the Securities Exchange Act of 1934, as amended, the investment advisory business does not have any contractual obligation requiring it to pay for research products and services obtained through soft dollar arrangements with brokers. As a result, we present soft dollar arrangements on a net basis.

 

The Company has contractual arrangements with third parties to provide subadvisory services.  Investment advisory fees are recorded gross of any subadvisory payments and are included in investment management fees based on management’s determination that the Company is acting in the capacity of principal service provider with respect to its relationship with the Funds.  Any corresponding fees paid to subadvisors are included in operating expenses.

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Underwriting, Distribution and Shareholder Service Fees

 

Fee‑based asset allocation revenues are calculated monthly based upon average daily net assets under management. For certain types of investment products, primarily variable annuities, distribution revenues are generally calculated based upon average daily net assets under management. Fees collected from independent financial advisors associated with Waddell & Reed, Inc. for various services are recorded in underwriting and distribution fees on a gross basis, as the Company is the principal in these arrangements.

 

Under a Rule 12b-1 service plan, the Funds may charge a maximum fee of 0.25% of the average daily net assets under management for Ivy Funds Class B, C, E and Y shares for expenses paid to broker-dealers and other sales professionals in connection with providing ongoing services to the Funds’ shareholders and/or maintaining the Funds’ shareholder accounts, with the exception of the Funds’ Class R shares, for which the maximum fee is 0.50%. The Funds’ Class B and Class C shares may charge a maximum of 0.75% of the average daily net assets under management under a Rule 12b-1 distribution plan to broker-dealers and other sales professionals for their services in connection with distributing shares of that class.  The Funds’ Class A shares may charge a maximum fee of 0.25% of the average daily net assets under management under a Rule 12b-1 service and distribution plan for expenses detailed previously.  The Rule 12b-1 plans are subject to annual approval by the Funds’ board of trustees, including a majority of the disinterested members, by votes cast in person at a meeting called for the purpose of voting on such approval.  All Funds may terminate the service and distribution plans at any time with approval of fund trustees or portfolio shareholders (a majority of either) without penalty.

 

Underwriting and distribution commission revenues resulting from the sale of investment products are recorded upon satisfaction of performance obligations, which occurs on the trade date. When a client purchases Class A or Class E shares (front-end load), the client pays an initial sales charge of up to 5.75% of the amount invested. The sales charge for Class A or Class E shares typically declines as the investment amount increases.  In addition, investors may combine their purchases of all fund shares to qualify for a reduced sales charge. When a client invests in a fee-based asset allocation product, Class I or Y shares are purchased at net asset value, and we do not charge an initial sales charge.

 

Underwriting and distribution revenues resulting from payments from independent financial advisors for office space, compliance oversight and affiliation fees are earned over the period in which the service is provided, which is generally monthly and is based on a fee schedule.

 

Shareholder service fee revenue primarily includes transfer agency fees, custodian fees from retirement plan accounts, and portfolio accounting and administration fees. Transfer agency fees and portfolio accounting and administration fees are asset‑based revenues or account‑based revenues, while custodian fees from retirement plan accounts are based on the number of client accounts. Custodian fees, transfer agency fees and portfolio accounting and administration fees are earned upon completion of the service when all performance obligations have been satisfied. 

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All revenue recognized in the consolidated statements of income is considered to be revenue from contracts with customers. The vast majority of revenue is determined based on average assets and is earned daily or monthly or is transactional and is earned on the trade date. As such, revenue from remaining performance obligations is not significant.  The following table depicts the disaggregation of revenue by product and distribution channel:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended
June 30, 2018

 

Three months ended
June 30, 2017

 

Six months ended
June 30, 2018

 

Six months ended
June 30, 2017

 

 

 

 

(in thousands)

 

(in thousands)

 

Investment management fees:

 

 

    

    

    

    

    

    

    

 

Unaffiliated and Broker-Dealer

 

$

124,766

 

124,686

 

252,429

 

248,486

 

Institutional

 

 

5,625

 

6,192

 

11,654

 

12,828

 

Total investment management fees

 

$

130,391

 

130,878

 

264,083

 

261,314

 

Underwriting and distribution fees:

 

 

 

 

 

 

 

 

 

 

Unaffiliated

 

 

 

 

 

 

 

 

 

 

Rule 12b-1 service and distribution fees

 

$

20,051

 

22,852

 

41,027

 

46,869

 

Sales commissions on front-end load mutual fund and variable annuity sales

 

 

507

 

319

 

977

 

765

 

Other revenues

 

 

148

 

353

 

333

 

779

 

Total unaffiliated distribution fees

 

$

20,706

 

23,524

 

42,337

 

48,413

 

Broker-Dealer

 

 

 

 

 

 

 

 

 

 

Fee-based asset allocation product revenues

 

$

66,580

 

58,313

 

132,097

 

115,069

 

Rule 12b-1 service and distribution fees

 

 

18,109

 

18,863

 

36,486

 

37,518

 

Sales commissions on front-end load mutual fund and variable annuity sales

 

 

13,823

 

14,529

 

28,249

 

28,855

 

Sales commissions on other products

 

 

9,065

 

8,460

 

17,487

 

15,697

 

Other revenues

 

 

9,590

 

5,087

 

19,258

 

12,055

 

Total broker-dealer distribution fees

 

 

117,167

 

105,252

 

233,577

 

209,194

 

Total distribution fees

 

$

137,873

 

128,776

 

275,914

 

257,607

 

Shareholder service fees:

 

 

 

 

 

 

 

 

 

 

Total shareholder service fees

 

$

27,074

 

27,003

 

52,956

 

54,300

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

295,338

 

286,657

 

592,953

 

573,221

 

 

 

 

 

 

 

 

 

 

 

 

 

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4.Investment Securities

 

Investment securities at June 30, 2018 and December 31, 2017 are as follows:

 

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

 

    

2018

 

2017

 

 

 

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

Certificates of deposit

 

$

8,000

 

12,999

 

Commercial paper

 

 

 —

 

34,978

 

Corporate bonds

 

 

186,136

 

197,442

 

U.S. Treasury bills

 

 

22,538

 

19,779

 

Total available for sale securities

 

 

216,674

 

265,198

 

Trading debt securities:

 

 

 

 

 

 

Certificates of deposit

 

 

2,000

 

1,999

 

Corporate bonds

 

 

59,671

 

55,414

 

U.S. Treasury bills

 

 

6,855

 

4,929

 

Mortgage-backed securities

 

 

 9

 

10

 

Consolidated sponsored funds

 

 

37,342

 

62,038

 

Total trading securities 

 

 

105,877

 

124,390

 

Equity securities:

 

 

 

 

 

 

Common stock

 

 

202

 

116

 

Sponsored funds(1) 

 

 

167,777

 

137,857

 

Sponsored privately offered funds

 

 

782

 

695

 

Consolidated sponsored funds

 

 

30,985

 

77,048

 

Total equity securities

 

 

199,746

 

215,716

 

Equity method securities:

 

 

 

 

 

 

Sponsored funds

 

 

62,472

 

95,188

 

Total securities

 

$

584,769

 

700,492

 


(1)Includes $124.0 million of investments at December 31, 2017, that were previously reported as available for sale securities prior to the adoption of ASU 2016-01 on January 1, 2018. Refer to Note 1 – Description of Business and Significant Accounting Policies – Basis of Presentation.

 

Certificates of deposit, corporate bonds and U.S. Treasury bills accounted for as available for sale and held as of June 30, 2018 mature as follows:

 

 

 

 

 

 

 

Amortized

 

 

 

 

cost

 

Fair value

  

 

(in thousands)

Within one year

$

82,240

 

81,761

After one year but within five years

 

136,756

 

134,913

 

$

218,996

 

216,674

Certificates of deposit, corporate bonds, U.S. Treasury bills and mortgage-backed securities accounted for as trading and held as of June 30, 2018 mature as follows:

 

 

 

 

 

 

 

 

 

Fair value

  

 

 

 

(in thousands)

Within one year

 

 

$

19,143

After one year but within five years

 

 

 

44,619

After 10 years

 

 

 

4,773

 

 

 

$

68,535

 

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The following is a summary of the gross unrealized gains (losses) related to securities classified as available for sale at June 30, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Amortized

    

Unrealized

    

Unrealized

    

 

 

 

 

cost

 

gains

 

losses

 

Fair value

 

  

 

(in thousands)

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

 

Certificates of deposit