WADDELL & REED FINANCIAL, INC. The following should be read in conjunction with the "Selected Financial Data" and our Consolidated Financial Statements and Notes thereto appearing elsewhere in this Annual Report. Overview We are one of the oldest mutual fund and asset management firms in the country, with expertise in a broad range of investment styles and across a variety of market environments. Our earnings and cash flows are heavily dependent on financial market conditions and client activity. Significant increases or decreases in the various securities markets can have a material impact on our results of operations, financial condition and cash flows. Our products are distributed through our unaffiliated channel, or through our wealth management channel by Advisors. Through our institutional channel, we distribute an array of investment styles to a variety of clients.
Through our unaffiliated channel, we distribute mutual funds through broker-dealers, retirement platforms and registered investment advisers through a team of external and internal wholesalers.
In our wealth management channel, we had 936 Advisors and 397 licensed advisor associates as ofDecember 31, 2020 , for a total of 1,333 licensed individuals associated with W&R who operate out of offices located throughoutthe United States and provide financial advice for retirement, education funding, estate planning and other financial needs for clients. We manage assets in a variety of investment styles in our institutional channel. Most of the clients in this channel are other asset managers that hire us to act as a subadviser for their branded products; they are typically domestic and foreign distributors of investment products who lack scale or the track record to manage internally, or choose to market multi-manager styles. Our diverse client list also includes pension funds,Taft Hartley plans and endowments.
Proposed Acquisition of
On
Subject to the terms and conditions of the Merger Agreement, Merger Sub will be merged with and into the Company, with the Company surviving the merger as a wholly owned subsidiary of Macquarie. Pursuant to the Merger Agreement, at the effective time of the merger, each share of the Company's Class A common stock issued and outstanding immediately prior to the effective time will be converted into the right to receive$25.00 per share in cash, without interest and subject to any withholding of taxes required by applicable law in accordance with the Merger Agreement. On completion of the merger, Macquarie intends to sell our wealth management business toLPL Holdings, Inc. The proposed merger is expected to close by the end ofApril 2021 , subject to regulatory approvals,Waddell & Reed Financial, Inc. stockholder approval and other customary closing conditions. Please see the Risks Related to the Proposed Merger included in Item 1A-"Risk Factors" in this Annual Report for a discussion of certain risks related to our proposed merger with Macquarie. Please see the Company's definitive proxy statement filed with theSEC onFebruary 17, 2021 , for additional information on the merger. Impact of COVID-19
The market volatility that began inMarch 2020 , as a result of the reaction to COVID-19 and its impact on the global economy, resulted in significant depreciation in the stock markets. In the second through fourth quarters of 2020, the markets rebounded, benefiting our measures of AUM and AUA and the revenues that are based on these assets for these periods. Some of our expenses, particularly certain distribution expenses, are directly correlated with revenue, and we saw increases in these expenses in line with the revenue increases during the second through fourth quarters of 2020. At the same time, controllable expenses, defined as Compensation and benefits, General and administrative, Technology, Occupancy and Marketing and advertising, increased approximately 5% year-over-year. While the Company took several incremental actions to reduce these expenses throughout 2020, we took a long-term view and invested in the areas we 31
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thought would allow us to come out of the pandemic in a stronger position to drive growth.
We transitioned most of our workforce and Advisors to a work from home environment early inMarch 2020 . By late March, 98% of our employees were working remotely, with negligible downtime. The remote work environment has largely continued through the end of 2020 and into the new year. Our steady and proactive response has allowed our asset management and wealth management businesses to maintain full continuity of service and the access that our clients need and expect. With a successful transition to a remote working environment, we plan to closely monitor developments and reintroduce employees to the workplace only when it is safe to do so. The transition of employees to a work from home environment did not result in any material incremental expenses during 2020, and we do not expect to incur any material incremental expenses in future periods. For additional discussion regarding steps we have taken to facilitate safety, security and full continuity of service, please see Part I - Item 1 -Business, of this Annual Report on Form 10-K.
For additional discussion regarding the risks that can impact our business, results of operations and financial condition due to COVID-19 and the related economic conditions, please see Part I - Item 1A - "Risk Factors".
Highlights
Announced execution of a Merger Agreement under which Macquarie would acquire
all the outstanding shares of the Company for
? representing total consideration of approximately
is expected to close by the end of
conditions.
? Continued execution of strategic initiatives in Asset Management
o AUM as of
increase was due to market appreciation, partially offset by net outflows.
o Both gross sales and the overall redemption rate improved compared to the prior
year, with unaffiliated sales notably improving.
Investment performance improved across the complex as measured by the
o percentage of funds ranked in the top half of their respective Morningstar
universes, where we saw an increase from the prior year in trailing one-,
three- and five-year performance.
o Continued progress in strategic pricing evaluation, with 79% of AUM at or
better than competitor median fees.
o Ivy Investments introduced two additional strategies in a model-delivery
format, bringing the total offering to nine strategies.
Significant progress in wealth management transformation continued, with
? enhanced focus on recruiting, improving operating metrics and additional growth
opportunities
AUA increased 16% compared to 2019, primarily due to strong market appreciation
o and growth in net new Advisory AUA, partially offset by ongoing migration away
from Non-advisory brokerage accounts.
o Continued growth in Advisory AUA on the strength of positive net new Advisory
AUA for the 8th consecutive quarter.
Number of Advisors and advisor associates increased slightly to 1,333 on strong
o recruiting results during the year. Since
affiliated with W&R with combined prior firm AUA totaling over
In 2020, W&R expanded its WaddellONE centralized digital platform with the
launch of ONESource, a consolidated digital repository, which seamlessly
o connects data across platforms for advisors, and ONEService, a web-based
repository of processes, procedures and other information available to all
Advisors.
During 2020, we returned
? dividends and share repurchases, including repurchasing 8.0 million shares
during the year.
Balance sheet remains strong with
? investments at
unsecured notes in
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Operating Results (1)
We earned
Average AUM were$66.7 billion in 2020 compared to$70.3 billion in 2019. AUA increased 16% in 2020 to$69.7 billion , compared to$60.1 billion in 2019. The increase in AUA was related to increases in Advisory AUA, due to market appreciation and positive net new Advisory AUA. The fourth quarter of 2020 was the 8th consecutive quarter for positive net new Advisory AUA. Net income attributable toWaddell & Reed Financial, Inc. of$70.5 million decreased 39% compared to$115.0 million in 2019. Net income per diluted share was$1.08 for 2020 compared to$1.57 for 2019. The year endedDecember 31, 2020 included$39.6 million in costs related to our proposed merger with Macquarie. Excluding the merger-related costs, adjusted net income for 2020 was$102.8 million and adjusted net income per diluted share was$1.58 . The year endedDecember 31, 2019 included non-cash asset impairment charges of$12.8 million in connection with certain assets held for sale, including real property related to our corporate headquarters move planned for 2022 and the elimination of our internal aviation operations, an$11.2 million non-cash charge related to the annual revaluation of the pension plan liability and$5.4 million in severance expense related to the outsourcing of our transfer agency transactional processing operations. Excluding these non-cash and severance expense charges, adjusted net income for 2019 was$137.4 million and adjusted net income per diluted share was$1.87 . Operating expenses of$954.7 million in 2020 increased$30.1 million compared to the prior year. Excluding merger-related costs, non-cash asset impairment charges and severance described above, adjusted operating expenses increased$8.7 million , or 1%, compared to adjusted 2019 operating expenses. The operating margin for 2020 was 9.0% and the adjusted operating margin was 12.8%, compared to the reported and adjusted operating margin of 13.6% and 15.3% for 2019,
respectively.
(1) Adjusted net income, adjusted net income per diluted share, adjusted
operating expenses and adjusted operating margin are non-GAAP financial
measures. See Non-GAAP Financial Measures and Reconciliation of GAAP to
non-GAAP Financial Measures on pages 48 and 49.
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Assets Under Management
AUM of $74.8 billion at December 31, 2020 increased $4.8 billion , or 7%,
compared to $70.0 billion at December 31, 2019 . The increase in AUM is due to
market appreciation of $12.2 billion , partially offset by net outflows of $7.3
billion .
Change in Assets Under Management (1)
Wealth
Unaffiliated (2) Institutional Management Total
(in millions)
2020
Beginning Assets $ 26,264 3,096 40,598 69,958
Sales(3) 5,450 200 2,869 8,519
Redemptions (9,096) (735) (5,981) (15,812)
Net Exchanges 976 22 (998) -
Net Flows (2,670) (513) (4,110) (7,293)
Market Action 4,383 987 6,787 12,157Ending Assets at December 31, 2020 $ 27,977
3,570 43,275 74,822 2019 Beginning Assets $ 24,977 3,655 37,177 65,809 Sales(3) 4,737 276 2,948 7,961 Redemptions (9,933) (1,901) (6,311) (18,145) Net Exchanges 1,192 25 (1,217) - Net Flows (4,004) (1,600) (4,580) (10,184) Market Action 5,291 1,041 8,001 14,333
Ending Assets at December 31, 2019 $ 26,264
3,096 40,598 69,958 2018 Beginning Assets $ 31,133 6,289 43,660 81,082 Sales(3) 7,287 873 3,835 11,995 Redemptions (11,399) (4,108) (6,889) (22,396) Net Exchanges 759 511 (1,270) - Net Flows (3,353) (2,724) (4,324) (10,401) Market Action (2,803) 90 (2,159) (4,872)
Ending Assets at December 31, 2018 $ 24,977
3,655 37,177 65,809
Includes all activity of the Funds, the IGI Funds (prior to their liquidation (1) in 2018) and institutional accounts, including money market funds and
transactions at net asset value, accounts for which we receive no
commissions.
(2) Unaffiliated includes National channel (home office and wholesale), DCIO, RIA
and Variable Annuity.
(3) Sales consists of gross sales and includes net reinvested dividends, capital
gains and investment income.
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Average AUM, which are generally more indicative of trends in revenue from investment management services than the change in ending AUM, decreased by 5% compared to 2019.
Average Assets Under Management
2020 2019 2018
Percentage Percentage Percentage
Average of Total Average of Total Average of Total
(in millions, except percentage data)
Distribution Channel:
Unaffiliated
Equity $ 19,465 80 % 21,026 80 % 24,164 81 %
Fixed income 4,534 19 % 5,177 20 % 5,607 19 %
Money market 138 1 % 99 - 92 -
Total $ 24,137 100 % 26,302 100 % 29,863 100 %
Institutional
Equity $ 3,052 100 % 3,719 100 % 5,410 99 %
Fixed income - - 11 - % 54 1 %
Money market - - - - - -
Total $ 3,052 100 % 3,730 100 % 5,464 100 %
Wealth Management
Equity $ 29,149 74 % 29,453 73 % 31,446 73 %
Fixed income 8,673 22 % 9,231 23 % 9,870 23 %
Money market 1,724 4 % 1,556 4 % 1,696 4 %
Total $ 39,546 100 % 40,240 100 % 43,012 100 %
Total by Asset Class:
Equity $ 51,666 77 % 54,198 77 % 61,020 78 %
Fixed income 13,207 20 % 14,419 21 % 15,531 20 %
Money market 1,862 3 % 1,655 2 % 1,788 2 %
Total $ 66,735 100 % 70,272 100 % 78,339 100 %
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The following table summarizes our five largest mutual funds as ofDecember 31, 2020 by ending AUM and investment management fees, with the comparative positions in 2019 and 2018. The AUM and management fees of these mutual funds are presented as a percentage of our total AUM and total management fees. Five Largest Mutual Funds by Ending Assets Under Management and Investment Management Fees 2020 2019 2018 Percentage Percentage Percentage Ending of Total Ending of Total Ending of Total (in millions, except percentage data) By AUM: Ivy Science & Technology$ 9,846 13 % 8,143 12 % 6,345 10 % Ivy Mid Cap Growth 7,273 10 % 5,063 7 % 3,983 6 % Ivy Large Cap Growth 5,666 8 % 4,762 7 % 3,873 6 % Ivy Core Equity 4,546 6 % 4,268 6 % 3,862 6 % Ivy High Income 4,108 5 % 4,722 7 % 4,857 7 % Total$ 31,439 42 % 26,958 39 % 22,920 35 % (in thousands, except percentage data) By Management Fees: Ivy Science & Technology$ 64,960 15 % 59,182 13 % 56,997 11 % Ivy Mid Cap Growth 38,292 9 % 32,577 7 % 30,885 6 % Ivy Large Cap Growth 27,347 7 % 25,248 6 % 21,465 4 % Ivy Core Equity 25,520 6 % 25,751 6 % 28,264 6 % Ivy High Income 21,580 5 % 25,914 6 % 27,971 5 % Total$ 177,699 42 % 168,672 38 % 165,582 32 % Performance We have seen an increase from the prior year in trailing one-, three- and five-year performance as measured by the percentage of funds ranked in the top half of their respective Morningstar universes. As measured by percentage of assets, five-year performance improved while one- and three-year performance declined. Our commitment to institutional caliber processes means that while we are mindful of short-term market dynamics, we remain focused on the long term and on maintaining discipline and consistency in volatile times such as we
have seen throughout 2020. The following table is a summary of Morningstar rankings and ratings as ofDecember 31, 2020 : MorningStar Fund Rankings 1 1 Year 3 Years 5 Years Funds ranked in top half 52 % 48 % 43 % Assets ranked in top half 51 % 52 % 55 % MorningStar Ratings 1 Overall 3 Years 5 Years Funds with 4/5 stars 28 % 30 % 21 % Assets with 4/5 stars 48 % 44 % 43 % (1) Based on class I share, which reflects the largest concentration of sales and assets. 36 Table of ContentsAssets Under Administration AUA includes both client assets invested in the Funds and in other companies' products that are distributed through W&R and held in direct to fund accounts, brokerage accounts or within our fee-based advisory programs. AUA increased 16% compared to 2019, primarily due to strong market appreciation and growth in net new advisory assets, partially offset by ongoing migration away from Non-advisory brokerage accounts. Average AUA increased 6% compared to 2019. Average productivity per Advisor for the year endedDecember 31, 2020 was$487 thousand , an increase of 11% as compared to 2019. During 2020, we updated our definition of net new AUA to include dividends and interest to be more consistent with peers and have reflected this new definition for all periods presented in the table below. The slight increase in Advisors, along with an increase in productivity is due to our efforts to transform W&R into a fully competitive and profitable aspect of our business model, with a focus on higher producing Advisors. For the Year ended December 31, 2020 2019 2018 (in millions, except advisor data and percentages) Ending AUA Advisory AUA$ 33,100 26,947 21,207 Non-advisory AUA 36,605 33,148 30,059 Total ending AUA$ 69,705 60,095 51,266 Average AUA (1) Advisory AUA (1)$ 27,562 24,217 22,629 Non-advisory AUA (1) 32,373 32,110 34,224 Total average AUA (1)$ 59,935 56,327 56,853 Net new Advisory AUA (2)$ 1,695 1,447 1,130
Net new Non-advisory AUA (2), (3) (1,878) (2,987)
(3,335)
Total net new AUA (2), (3) $ (183) (1,540) (2,205)
Annualized Advisory AUA growth (4) 6.3 % 6.8
% 5.2 % Annualized AUA growth (4) (0.3) % (3.0) % (3.9) %
Advisors and advisor associates 1,333 1,327
1,403
Average trailing 12-month production per Advisor (5) (in thousands) $ 487 438 378
(1) Average AUA are calculated as the average of the beginning of month AUA
during each reporting period.
(2) Net new AUA are calculated as total client deposits and net transfers less
client withdrawals. Client deposits include dividends and interest.
(3) Excludes activity related to products held outside of our wealth management
platform. These assets represent less than 10% of total AUA.
(4) Annualized growth is calculated as annualized total net new AUA divided by
beginning AUA.
Production per Advisor is calculated as trailing 12-month Total Underwriting
and distribution fees less "other" underwriting and distribution fees divided
(5) by the average number of Advisors. "Other" underwriting and distribution
fees predominantly include fees paid by Advisors for programs and services.
Detail of "other" amounts is on page 41.
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Results of Operations
Net Income
For the Year ended
December 31, Variance
2020 vs. 2019 vs.
2020 2019 2018 2019 2018
(in thousands, except per share and percentage data)
Net income attributable toWaddell & Reed Financial, Inc.$ 70,457 114,992 183,588 (39) % (37) % Earnings per share, basic and diluted$ 1.08 1.57 2.28 (31) % (31) % Operating Margin 9 % 14 % 19 % (5) % (5) % Total Revenues Total revenues decreased 2% in 2020 and 8% in 2019 compared to 2019 and 2018, respectively, primarily due to lower average AUM, partially offset by an increase in advisory fees due to higher AUA. The decrease in investment management fees from 2019 to 2020 was primarily due to a decrease in average AUM and new fee reductions made on our large cap growth and core bond products effectiveApril 1, 2020 as well as increased money market fee waivers due to the low interest rate environment. The increase in underwriting and distribution fees was primarily due to an increase in advisory fees due to higher AUA. Shareholder services fees were also lower due to the decrease in average AUM. For the Year ended December 31, Variance 2020 vs. 2019 vs. 2020 2019 2018 2019 2018 (in thousands, except percentage data) Investment management fees$ 419,728 445,144 507,906 (6) % (12) %
Underwriting and distribution fees 544,440 531,836 550,010
2 % (3) %
Shareholder service fees 85,329 93,335 102,385 (9) % (9) %
Total revenues $ 1,049,497 1,070,315 1,160,301 (2) % (8) %
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Investment Management Fee Revenues
Investment management fee revenues decreased$25.4 million , or 6%, in 2020 and decreased$62.8 million , or 12%, in 2019. Investment management fee revenues are based on the level of average client AUM and are affected by sales, financial market conditions, redemptions and the composition of assets. The following graph illustrates the direct relationship between average client AUM and investment management fee revenues for the years endingDecember 31, 2020 ,
2019
and 2018.
[[Image Removed: Graphic]]
The following table summarizes investment management fee revenues, related average AUM, fee waivers and investment management fee rates for the years endingDecember 31, 2020 , 2019 and 2018. Fee waivers for the Funds are recorded as an offset to investment management fees up to the amount of fees earned, with excess fee waivers recorded in general and administrative expense. For the Year ended December 31, Variance 2020 vs. 2019 vs. 2020 2019 2018 2019 2018 (in thousands, except for
management fee rate, average assets and
percentage data)
Funds investment management fees
(net) $ 407,396 430,028 486,181 (5) % (12) %
Funds average assets (in millions) 63,683 66,542 72,875 (4) % (9) %
Funds management fee rate (net) 0.6397 % 0.6462 %
0.6671 %
Total fee waivers $ 33,278 29,284 17,696 14 % 65 %
Institutional investment management
fees (net) $ 12,332 15,116 21,725 (18) % (30) %
Institutional average assets
(in millions) 3,052 3,730 5,464 (18) % (32) %
Institutional management fee rate
(net) 0.4037 % 0.4053 % 0.4057 %
Revenues from investment management services provided to our retail mutual funds, which are distributed through the unaffiliated and wealth management channels, decreased$22.6 million in 2020, or 5%, compared to 2019, primarily due to a decrease in average assets and a decrease in the effective management fee rate, which was primarily due to fee reductions on selected mutual funds. The increased fee waivers were due to new fee reductions made on our large cap growth and core bond products effectiveApril 1, 2020 as well as increased money market fee waivers due to the low interest rate environment. Revenues from investment management services provided to our mutual funds decreased 39
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$56.2 million in 2019, or 12%, compared to 2018, primarily due to a decrease in average assets and fee reductions on selected mutual funds that were implemented as ofJuly 31, 2018 . Institutional account revenues in 2020 decreased$2.8 million , or 18%, compared to 2019 due to a decrease in average AUM. Institutional account revenues in 2019 decreased$6.6 million , or 30%, compared to 2018. Outflows in assets for 2019 in this channel were primarily due to carryover effects of prior year personnel changes at the portfolio manager level. Long-term redemption rates (excludes money market redemptions) for the year ended December 31, 2020 2019 2018 Unaffiliated channel 37.9 % 38.1 % 38.7 % Institutional channel 24.1 % 51.0 % 75.2 % Wealth Management channel 13.4 % 13.8 % 13.9 % Total 22.9 % 25.0 % 27.8 %
The long-term redemption rates continued a multi-year improvement in 2020, improving across all channels. The unaffiliated redemption rate improved modestly; prolonged redemptions in the unaffiliated channel could negatively affect revenues in future periods. The institutional redemption rate returned closer to historical levels as the effects of portfolio manager turnover in 2018 and 2019 subsided. In the wealth management channel, we continued to benefit from a long-term redemption rate that is significantly lower than that of the industry average. In aggregate, the industry average redemption rate in 2020, based on data provided by the ICI, was 28.8% versus our rate of 22.9%.
Underwriting and Distribution Fee Revenues
We offer a wide range of fee-based advisory products. These products offer
clients a selection of traditional asset allocation models, as well as features
such as systematic rebalancing and client and Advisor participation in
determining asset allocation across asset classes. These products utilize a
variety of underlying investment options, including mutual funds, stocks, bonds
and ETFs. We earn asset-based fees on our advisory products.
We earn underwriting and distribution fee revenues primarily by distributing the
Funds pursuant to an underwriting agreement with each Fund (except Ivy VIP as
explained below) and by distributing mutual funds offered by other unaffiliated
companies. Pursuant to each agreement, we offer and sell the Funds' shares on a
continuous basis (open-end funds) and pay certain costs associated with
underwriting and distributing the Funds, including the costs of developing and
producing sales literature and printing of prospectuses, which may be either
partially or fully reimbursed by the Funds. The Funds are sold in various
classes that are structured in ways that conform to industry standards
(e.g., "front-end load," "back-end load," "level-load" and institutional).
We distribute variable products offering Ivy VIP as investment vehicles pursuant
to general agency arrangements with our business partners and receive
commissions, marketing allowances and other compensation as stipulated by such
agreements. In connection with these arrangements, Ivy VIP is offered and sold
on a continuous basis.
In addition to distributing variable products, we distribute a number of other
insurance products through our insurance agency subsidiaries, including
individual term life, group term life, whole life, accident and health,
long-term care, Medicare supplement and disability insurance. We receive
commissions and compensation from various underwriters for distributing these
products. We are not an underwriter for any insurance policies.
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The following tables summarize the significant components of underwriting and
distribution fee revenues segregated by distribution channel for the years ended
December 31, 2020 , 2019 and 2018:
Total
2020 2019 2018
(in thousands)
Underwriting and distribution fee revenues:
Advisory fees $ 318,964 284,188 269,069
Service and distribution fees 118,054 128,424 148,979 Sales commissions 72,398 82,515 92,912 Other revenues 35,024 36,709 39,050 Total$ 544,440 531,836 550,010 Unaffiliated Channel 2020 2019 2018 (in thousands) Underwriting and distribution fee revenues: Service and distribution fees$ 58,507 65,227 78,041
Sales commissions 1,065 1,730 1,886 Other revenues 362 290 568 Total$ 59,934 67,247 80,495 Wealth Management Channel 2020 2019 2018 (in thousands) Underwriting and distribution fee revenues: Advisory fees$ 318,964 284,188
269,069
Service and distribution fees 59,547 63,197 70,938 Sales commissions 71,333 80,785 91,026 Other revenues 34,662 36,419 38,482 Total$ 484,506 464,589 469,515 A significant portion of underwriting and distribution fee revenues are received from asset-based fees earned on our advisory products and commissions. Underwriting and distribution fee revenues also include Rule 12b-1 asset-based service and distribution fees earned on load, load-waived and deferred-load products sold by Advisors and third party intermediaries, sales commissions charged on front-end load products sold by Advisors, including mutual fund Class A shares (those sponsored by the Company and those underwritten by other non-proprietary mutual fund companies), variable annuities, sales of other insurance products, and financial planning fees. A significant amount of unaffiliated channel mutual fund sales are load-waived. We recover certain of our underwriting and distribution costs through Rule 12b-1 service and distribution fees, which are paid by the Funds. All Rule 12b-1 service and distribution fee revenue received from the Funds is recorded on a gross basis. Underwriting and distribution fee revenues earned in 2020 increased by$12.6 million , or 2%, compared to 2019. Revenues from fee-based advisory products earned in 2020 in our wealth management channel increased 12% compared to 2019 due to an increase in average Advisory AUA of 14%, slightly offset by a decrease in the average fee rate due to product mix. This increase was partially offset by a decrease of$10.4 million , or 8%, in Rule 12b-1 asset-based service and distribution fees across both channels, as compared to 2019, which was driven by a decrease in average mutual fund AUM for which we earn Rule 12b-1 revenue. Sales commission revenues decreased$10.1 million , or 12%, due to lower commissionable sales, in part due to the impact of COVID-19 on sales activity. Other revenue also decreased$1.7 million primarily due to lower office space revenue from Advisors as we continued the transition to Advisor personal branch offices. Due to current industry trends toward institutional share classes in fee-based programs, we anticipate a continued decrease in 12b-1 service and distribution fees and sales commissions. Underwriting and distribution fee revenues earned in 2019 decreased by$18.2 million , or 3%, compared to 2018. A decrease of$20.6 million , or 14%, in Rule 12b-1 asset-based service and distribution fees across both channels, as compared to 2018, was driven by a decrease in average mutual fund AUM for which we earn Rule 12b-1 revenue. Sales commissions decreased$11.8 million , or 13%, due to lower commissionable sales. These decreases were partially offset 41
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by a 6% increase in revenues from fee-based advisory products due to an increase in average advisory AUA of 7%, slightly offset by a decrease in the average fee rate due to product mix.
Shareholder Service Fees Revenue
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. During 2020, shareholder service fees revenue decreased$8.0 million , or 9%, compared to 2019. Account-based fees decreased$5.3 million compared to 2019 primarily due to a decrease in the number of accounts and decreases related to the outsourcing of our transfer agency transactional processing operations, which was offset by lower reimbursable costs. Service fees based on assets decreased$2.7 million , or 5%, compared to 2019, primarily due to a decrease in assets. During 2019, shareholder service fees revenue decreased$9.1 million , or 9%, compared to 2018. Account-based fees decreased$4.6 million compared to 2018 primarily due to a decrease in the number of accounts. Service fees based on assets decreased$4.4 million , or 8%, compared to 2018, due to a decrease in assets as well as a decrease in fund administrative and accounting services
fees due to the 2018 fund mergers. Total Operating Expenses Operating expenses for 2020, including$39.6 million of merger-related costs, were up 3% compared to 2019. Operating expenses for 2019, including$12.8 million of non-cash asset impairment charges and$5.4 million of severance expense related to the outsourcing of our transactional processing operations of our transfer agency, were down 1% compared to 2018. During 2021, we expect additional merger-related costs in general and administrative, including legal costs and certain expenses related to the Funds, and in compensation and benefits, including retention and incentive awards. Operating expenses for the years endedDecember 31, 2020 , 2019 and 2018 are set forth in the following table: For the Year ended December 31, Variance 2020 vs. 2019 vs. 2020 2019 2018 2019 2018 (in thousands, except percentage data) Distribution$ 478,578 460,921 456,832 4 % 1 % Compensation and benefits 278,711 254,534 263,329 9 % (3) % General and administrative 90,813 77,482 73,643 17 % 5 % Technology 57,066 63,719 65,275 (10) % (2) % Occupancy 16,559 24,243 27,197 (32) % (11) % Marketing and advertising 6,253 8,964 10,323 (30) % (13) % Depreciation 12,833 19,829 25,649 (35) % (23) % Subadvisory fees 13,914 14,931 14,805 (7) % 1 % Intangible asset impairment - - 1,200 - (100) % Total operating expenses$ 954,727 924,623 938,253 3 % (1) % Distribution Expenses
Distribution costs fluctuate with sales volume, such as Advisor commissions and
commissions paid to field management, Advisor incentive compensation,
commissions paid to third parties and to our own wholesalers, and related
management commissions in our unaffiliated channel. Direct selling costs also
fluctuate with AUM, such as Rule 12b-1 service and distribution fees paid to
third parties.
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Distribution expenses for the years ended
For the Year ended
December 31, Variance
2020 vs. 2019 vs.
2020 2019 2018 2019 2018
(in thousands, except percentage data)
Distribution - unaffiliated channel $ 91,157 96,718 112,562 (6) % (14) %
Distribution - wealth management channel 387,421 364,203 344,270 6 % 6 %
Total distribution expenses $ 478,578 460,921 456,832 4 % 1 %
Distribution expenses in 2020 increased by $17.7 million , or 4%, compared to
2019. Expenses in the wealth management channel increased $23.2 million compared
to 2019, primarily due to an increase in Advisory fee revenue resulting in a
higher payout to Advisors. Expenses in the unaffiliated channel decreased $5.6
million compared to 2019 primarily due to lower Rule 12b-1 asset-based service
and distribution expenses paid to third party distributors.
Distribution expenses in 2019 increased by $4.1 million , or 1%, compared to
2018. Expenses in the wealth management channel increased $19.9 million compared
to 2018, primarily due to an increase in Advisor payouts following the
additional enhancements to the Advisor compensation grid effective January 1,
2019 . Expenses in the unaffiliated channel decreased $15.8 million compared to
2018 primarily due to lower Rule 12b-1 asset-based service and distribution
expenses paid to third party distributors.
Compensation and Benefits
Compensation and benefits in 2020 increased$24.2 million , or 9%, compared to 2019. The primary driver of the increase was merger-related compensation expense of$29.1 million , including mark-to-market adjustments on outstanding restricted share units as a result of the increase in share price of our common stock, retention award accruals and higher cash incentive payments. In addition, compensation and benefits expense increased due to deferred compensation plan valuation adjustments and higher incentive accruals. Partially offsetting these increases were decreases in salaries and wages due to a decrease in headcount and a decrease in severance expenses due to charges related to the outsourcing of our transactional processing operations of our transfer agency in the prior period. Compensation and benefits in 2019 decreased$8.8 million , or 3%, compared to 2018. The primary drivers of the decrease were a decrease in share-based compensation of$5.0 million and a decrease in headcount, which were partially offset by an increase in employer contributions to our 401(k) plan. The decrease in share-based compensation is primarily due to higher forfeitures in 2018 which resulted in lower expense in 2019. The decrease in headcount resulted in a decrease in salaries and wages and related taxes and benefits of$6.2 million .
Partially offsetting these decreases was an increase of
General and Administrative Expenses
General and administrative expenses are operating costs, including, but not limited to, dealer services, professional services, including legal, audit and consulting, travel and meetings and temporary office staff.
General and administrative expenses increased$13.3 million for the year endedDecember 31, 2020 , compared to 2019. The increase was due to$10.5 million of merger-related expenses, including legal expense, consulting expense and project-related asset impairments, a shift of our transfer agency transactional processing operations costs from technology expenses to general and administrative expenses as a result of outsourcing and increased strategic project spending. Partially offsetting these increases were lower travel and meetings costs and lower non-cash impairment charges. General and administrative expenses increased$3.8 million for the year endedDecember 31, 2019 , compared to 2018. A non-cash impairment charge of$12.8 million in connection with certain assets held for sale, including real property related to our corporate headquarters move planned for 2022 and the elimination of our internal aviation operations, was recorded in 2019, which was partially offset by decreases in temporary office staff expense of$4.2 million , primarily due to reduced consulting services for projects completed in 2018, and lower dealer services costs of$1.5 million 43
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due to decreases in accounts and assets used to calculate the fees. There were also decreases in legal, audit and consulting costs and fund expenses in 2019 compared to 2018. Technology
Technology expenses decreased$6.7 million for the year endedDecember 31, 2020 , compared to 2019 due to a shift of our transfer agency transactional processing operations costs from technology expenses to general and administrative expenses, partially offset by increased software and technology costs for strategic projects. Technology expenses decreased$1.6 million for the year endedDecember 31, 2019 , compared to 2018 as lower shareholder servicing expense resulting from fewer accounts was partially offset by increased software costs for new technologies. Occupancy
Occupancy expenses include facilities costs for our home office, as well as rent expense for our leased home office and field office space. Occupancy expenses decreased$7.7 million in 2020 compared to 2019 and decreased$3.0 million in 2019 compared to 2018 primarily as a result of the planned transition from Advisors leasing space from the Company to Advisors utilizing personal branch offices. Marketing and advertising Marketing and advertising expense decreased$2.7 million in 2020 compared to 2019, primarily due to lower fees in connection with the shift to virtual industry conferences. Marketing and advertising expense decreased$1.4 million in 2019 compared to 2018 due to reduced fund-related marketing expenses from 2018 fund mergers and focusing our marketing efforts on the highest impact markets and activities.
Depreciation
Depreciation expense decreased in 2020 compared to 2019 primarily due to certain fixed assets becoming fully depreciated and no depreciation on assets held for sale. Depreciation expense decreased in 2019 compared to 2018 primarily due to certain fixed assets reaching the end of their useful lives.
Subadvisory Fees
Subadvisory fees represent fees paid to other asset managers for providing advisory services for certain mutual fund portfolios. These expenses reduce our operating margin, as we pay out approximately half of our management fee revenues received from subadvised products.
Subadvisory expenses decreased
Subadvisory expenses were relatively flat for the year endedDecember 31, 2019 compared to 2018 due to relatively no change in subadvised average assets or average subadvisory fee rate. Intangible Asset Impairment During 2018, we recorded an intangible asset impairment charge of$1.2 million related to our subadvisory agreement to manage certain mutual fund products, as a result of the termination of the subadvisory agreement. AtDecember 31, 2018 , there was no remaining balance of our subadvisory intangible asset. Other Income and Expenses Investment and Other Income
Investment and other income decreased
Lower unrealized and realized gains in 2020 as compared to 2019 on our corporate fixed income investments and seed investments, net of losses generated by our economic hedging program that uses total return swap contracts to hedge market risk, caused a decrease of$9.0 million . Interest and dividend income also decreased$4.8 million compared to 2019 primarily due to lower interest rates and redemptions in our corporate fixed income portfolio. Offsetting these decreases, lower expenses related to Pension 44
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Plan settlement expense in 2020 compared to unrealized losses related to the revaluation of the Pension Plan liability in 2019 resulted in an increase of$9.2 million .
Investment and other income decreased
Losses related to the revaluation of the Pension Plan liability in 2019 compared to gains in 2018 resulted in a decrease of$28.9 million . Offsetting this decrease, unrealized and realized gains in 2019 on our corporate fixed income investments and seed investments, net of losses generated by our economic hedging program that uses total return swap contracts to hedge market risk, caused an increase of$19.0 million compared to net unrealized and realized losses in 2018. In addition, investment income attributable to noncontrolling interests in sponsored funds where the Company held majority ownership increased$2.1 million compared to 2018. Interest and dividend income also increased$4.0 million compared to 2018 primarily due to higher interest rates in our corporate fixed income portfolio. Interest Expense Interest expense was$6.2 million ,$6.2 million and$6.5 million in 2020, 2019 and 2018, respectively. The majority of our interest expense was related to our$95.0 million Series B senior unsecured notes. We expect interest expense to decrease in 2021 as the$95.0 million Series B senior unsecured notes matured and were repaid inJanuary 2021 .
Income Taxes
Our effective income tax rate was 29.3%, 26.2% and 23.3% in 2020, 2019, and 2018, respectively. The higher effective tax rate in 2020 compared to 2019 was primarily the result of an increase in non-deductible compensation. Also, state tax rates increased compared to the prior year. The impact of share-based payments was relatively flat in 2020 compared to 2019. The tax effects of share-based payments and non-deductible compensation could create continued volatility in the effective tax rate in future periods. The higher effective tax rate in 2019 compared to 2018 was primarily the result of$6.4 million uncertain tax expense that was reversed in 2018 upon completion of a voluntary disclosure agreement with a state tax jurisdiction. State tax rates increased compared to the prior year. Offsetting these increases was the impact of share-based payments, which created a tax shortfall in both 2019 and 2018 due to the reduction in value of restricted stock from issuance to vesting, but the impact was greater in 2018.
Liquidity and Capital Resources
The Merger Agreement limits our ability to take certain actions while the merger is pending, including, among other things, actions related to acquiring businesses or investment securities, making seed capital investments, repurchasing our common stock, entering into or amending material contracts, incurring capital expenditures and incurring additional debt. Management believes its available cash, marketable securities and expected cash flow from operations will be sufficient to fund the Company's operating and capital requirements. Subject to the terms and conditions of the Merger Agreement, expected uses of cash include dividend payments, maturities of outstanding debt inJanuary 2021 , costs related to our proposed merger with Macquarie, income tax payments, seed capital investments, ongoing technology enhancements, capital expenditures, collateral funding for margin accounts established to support derivative positions and operating expenses of our business. 45 Table of Contents For the Year Ended Variance December 31, 2020 vs. 2019 vs. 2020 2019 2018 2019 2018 (in thousands, except percentage data) Balance Sheet Data: Cash and cash equivalents$ 273,756 151,815
231,997 80 % (35) % Investment securities 486,765 688,346 617,135 (29) % 12 % Short-term debt 94,997 - - - - Long-term debt - 94,926 94,854 (100) % - Cash Flow Data: Cash flows from operating activities 188,044 165,983 357,015 13 % (54) % Cash flows from investing activities 98,660 (6,851)
10,343 NM NM Cash flows from financing activities (175,494) (224,547) (311,788) 22 % 28 %
Our operations provide much of the cash necessary to fund our priorities, which historically have been as follows:
? Pay dividends
? Repurchase our common stock
? Finance growth objectives Pay Dividends
We paid quarterly dividends on our common stock that resulted in financing cash outflows of$65.6 million ,$74.3 million and$81.2 million in 2020, 2019 and 2018, respectively. The Merger Agreement limits our ability to increase the dividend on our common stock while the merger is pending; however, we may continue to pay regular quarterly cash dividends not exceeding$0.25 per share, with declaration, record and payment dates substantially consistent with those paid during 2020. OnFebruary 1, 2021 , we paid a quarterly dividend on our common stock of$0.25 per share to stockholders of record as ofJanuary 11, 2021 . The Board of Directors has declared a quarterly dividend on our common stock of$0.25 per share, payable onApril 30, 2021 , to stockholders of record as ofApril 9 ,
2021. Repurchase Our Common Stock We repurchased 8.0 million shares of our common stock in 2020 compared to 9.2 million and 7.0 million shares in 2019 and 2018, respectively, resulting in share repurchases of$114.7 million ,$154.2 million and$135.9 million , respectively. These share repurchases included 554,062 shares, 548,132 shares and 729,882 shares tendered by employees to cover their tax withholdings with respect to vesting of share-based awards during the years endedDecember 31, 2020 , 2019 and 2018, respectively.
The terms of the Merger Agreement restrict our ability to repurchase shares of our common stock while the merger is pending; however, we may continue to repurchase shares of our common stock from employees to cover their tax withholdings in connection with the vesting of restricted shares.
Finance Growth Objectives
We use cash to fund growth in our distribution channels. We continue to invest in our wealth management channel by offering home office resources, wholesaling efforts and enhanced technology tools, including the modernization of our wealth management platforms. Our unaffiliated channel requires cash outlays for wholesaler commissions and commissions to third parties on deferred load product sales and technology enhancements for asset management and distribution. We also provide seed money for new products to further enhance our product offerings and distribution efforts. The Merger Agreement limits our ability to take certain actions while the merger is pending, including making seed capital investments, entering into or amending material contracts and incurring capital expenditures.
On
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replaced the prior credit facility, which was set to terminate inOctober 2020 . The covenants in the Credit Facility are materially consistent with the covenants in the prior credit facility, including the requirement that the Company maintain a consolidated leverage ratio not to exceed 3.0 for four consecutive quarters and a consolidated interest coverage ratio of not less than 4.0 for four consecutive quarters. The Company was in compliance with these covenants for all periods presented. As ofDecember 31, 2020 , the Company's consolidated leverage ratio was 0.7, and consolidated interest coverage ratio was 22.4. There were no borrowings under the Credit Facility or prior credit facility atDecember 31, 2020 or at any point during the year.
On
The
Cash Flows
Cash from operations is our primary source of funds.In 2020, cash from operations increased compared to 2019 primarily due to increased maturities and sales of trading securities, partially offset by a decrease in net income. In 2019, cash from operations decreased primarily due to decreased sales of trading securities held by consolidated sponsored funds, due to the liquidation of the IGI Funds in 2018, and a decrease in net income as compared to 2018. In 2018, cash from operations increased primarily due to increased sales of trading securities held by consolidated sponsored funds, due to the liquidation of the IGI Funds, and an increase in net income as compared to 2017. In addition to the items noted above, the payable to investment companies for securities, payable to customers and other receivables accounts can fluctuate significantly based on trading activity at the end of a reporting period. Changes in these accounts result in variances within cash from operations on the statement of cash flows; however, there is no impact to the Company's liquidity and operations for the variances in these accounts. Investing activities consist primarily of the seeding and sale of sponsored investment securities classified as available for sale, purchases and maturities of investments held in our fixed income laddering program classified as available for sale and capital expenditures. Future investing cash flows will be impacted by limitations on our ability to acquire investment securities and make seed capital investments pursuant to the terms of the Merger Agreement. Financing activities include payment of dividends and repurchase of our common stock. Additionally, in 2018, financing activities included repayment of our Series A senior unsecured notes at maturity. Financing cash flows in 2021 will be affected by repayment of our Series B senior unsecured notes at maturity inJanuary 2021 and our existing capital return policy, subject to the terms of the Merger Agreement.
Contractual Obligations and Contingencies
Expected short- and long-term capital requirements include interest on indebtedness and maturities of outstanding debt inJanuary 2021 , operating leases and purchase obligations, and potential recognition of tax liabilities, which are summarized in the following table as ofDecember 31, 2020 . Purchase obligations include amounts that will be due for the purchase of goods and services to be used in our operations under long-term commitments or contracts. 2022- 2024- Thereafter/ Total 2021 2023 2025 Indeterminate (in thousands) Short-term and long-term debt
obligations, including interest$ 97,731 97,731 - - - Non-cancelable operating lease commitments 195,260 6,814 25,162 26,644 136,640 Purchase obligations 118,133 58,050 52,460 7,623 - Unrecognized tax benefits 1,945 - - - 1,945$ 413,069 162,595 77,622 34,267 138,585
We signed a lease inJanuary 2020 for our new corporate headquarters, which we anticipate will be complete in 2022 and will create future lease commitments included in the table above for 2022 and beyond. The impact that our proposed merger with Macquarie will have on our new corporate headquarters lease, including eligibility for state and local tax savings, has not been determined; however, the Merger Agreement limits our ability to take certain actions while 47 Table of Contents the merger is pending, including authorizing material expenditures in connection with the relocation of operations, employees or assets of the Company to the new headquarters.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet financing. The Company has not created, and is not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating its business.
Critical Accounting Policies and Estimates
Management believes the following critical accounting policies affect its significant estimates and judgments used in the preparation of its consolidated financial statements.
Accounting for
Two significant considerations arise with respect to goodwill and intangible assets that require management estimates and judgment: (i) the valuation in connection with the initial purchase price allocation, and (ii) the ongoing evaluation of impairment.
In connection with all of our acquisitions, an evaluation is completed to determine reasonable purchase price allocations. The purchase price allocation process requires management estimates and judgments as to expectations for the various products, distribution channels and business strategies. For example, certain growth rates and operating margins were assumed for different products and distribution channels. If actual growth rates or operating margins, among other assumptions, differ from the estimates and judgments used in the purchase price allocation, the amounts recorded in the financial statements for identifiable intangible assets and goodwill could be subject to charges for impairment in the future. We complete an ongoing review of the recoverability of goodwill and intangible assets on an annual basis, or more frequently whenever events occur, or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Annually, the Company first assesses qualitative factors to determine whether it is necessary to perform a quantitative impairment test. If the Company determines, based on qualitative factors, that the fair value of the reporting unit is more likely than not greater than the carrying amount, a quantitative impairment test would not be required. We consider mutual fund advisory contracts indefinite lived intangible assets as they are expected to be renewed without significant cost or modification of terms. Factors that are considered important in determining whether an impairment of goodwill or intangible assets might exist include significant continued underperformance compared to peers, the likelihood of termination or non-renewal of a mutual fund advisory contract or substantial changes in revenues earned from such contracts, significant changes in our business and products, material and ongoing negative industry or economic trends, or other factors specific to each asset or subsidiary relationship being evaluated. Because of the significance of goodwill and other intangibles to our consolidated balance sheets, the annual impairment analysis is critical. Any changes in key assumptions about our business and our prospects, or changes in market conditions or other externalities, could result in an impairment charge.
Seasonality and Inflation
We do not believe our operations are subject to significant seasonal fluctuation. We have historically experienced increased sales activity in the first and fourth quarters of the year due to funding of retirement accounts by our clients. The Company has not suffered material adverse effects from inflation in the past. However, a substantial increase in the inflation rate in the future may adversely affect clients' purchasing decisions, may increase the costs of borrowing, or may have an impact on the Company's margins and overall cost structure. Non-GAAP Financial Measures "Adjusted net income attributable toWaddell & Reed Financial, Inc. ," "adjusted net income per share, basic and diluted," "adjusted operating expenses," "adjusted operating income" and "adjusted operating margin" are non-GAAP financial measures that are not presented in accordance withU.S. generally accepted accounting principles ("GAAP"). We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our performance by excluding charges and gains that are not indicative of our core operating results, and allow management and investors to better evaluate our performance between periods and compared to other companies in our industry. 48 Table of Contents
These non-GAAP financial measures should not be considered a substitute for financial measures presented in accordance with GAAP and you should not rely on non-GAAP financial measures alone as measures of our performance.
A reconciliation of these non-GAAP financial measures to the comparable GAAP financial measures is included in the table below.
Reconciliation of GAAP to non-GAAP Financial Measures
(in thousands, except for per share and percentage data)
Year Ended December 31,
2020 2019 2018
Net income attributable to Waddell & Reed
Financial, Inc. (GAAP) $ 70,457 $ 114,992 $ 183,588
Adjustments
Merger-related costs (1) 39,606 - -
Severance - 5,401 9,066
Non-cash asset impairments - 12,841 -
Intangible impairment - - 1,200
Pension revaluation - 11,217 (16,129)
Tax effect of adjustments (7,226) (7,070) 1,407
Adjusted net income attributable to Waddell
& Reed Financial, Inc. (non-GAAP) $ 102,837 $ 137,381 Weighted average shares outstanding-basic and diluted 64,974 73,299
80,468
Adjusted net income per share, basic and diluted (non-GAAP)$ 1.58 $ 1.87 $ 2.23 Operating expenses (GAAP)$ 954,727 $ 924,623 $ 938,253 Adjustments Merger-related costs (1) 39,606 - - Severance - 5,401 9,066 Non-cash asset impairments - 12,841 - Intangible impairment - - 1,200 Adjusted operating expenses (non-GAAP)$ 915,121 $ 906,381 $ 927,987 Operating income (GAAP)$ 94,770 $ 145,692 $ 222,048 Adjustments Merger-related costs (1) 39,606 - - Severance - 5,401 9,066 Non-cash asset impairments - 12,841 - Intangible impairment - - 1,200
Adjusted operating income (non-GAAP)
Operating revenue$ 1,049,497 $ 1,070,315 $ 1,160,301 Adjusted operating margin (non-GAAP) 12.8 % 15.3 %
20.0 %
Primarily represents increased compensation from mark-to-market adjustments
on outstanding restricted share units as a result of the increase in share
(1) price of our common stock, retention award accruals, higher cash incentive
payments, legal and consulting costs and project-related asset impairments
all related to our proposed merger with Macquarie.
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