Waddell & Reed Financial Inc
Q1 2018 Earnings Call Transcript

Published: 1 May 2018

[Operator:]

Good morning, everyone, and welcome to the Waddell & Reed's First Quarter 2018 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I would like to turn the conference call over to Ms. Nicole Russell, Head of Investor Relations. Ma'am, please go ahead.

[Nicole McIntosh-Russell:]

Thank you, Jamie. On behalf of our management team, I would like to welcome you to our quarterly earnings call. Joining me on our call today will be Phil Sanders, our CEO; Ben Clouse, our CFO; Brent Bloss, our COO; Shawn Mihal, President of our broker-dealer, Waddell & Reed, Inc.; and Amy Scupham, who leads distribution and is President of Ivy Distributors, Inc. Before we begin, I would like to remind you that some of our comments and responses will include forward-looking statements. While we believe these statements to be reasonable based on information that is currently available to us, actual results could materially differ from those expressed or implied due to a number of factors that we reference in our public filing with the SEC. We assume no duty to update any forward-looking statements. Materials that are relevant to today's call, including a copy of our press release and supplemental schedule have been posted on the Investor Relations section of our website at ir.waddell.com. I would now like to turn the call over to Phil.

[Philip James Sanders:]

Good morning, everyone. Today, we reported quarterly net income of $46 million or $0.56 per share, compared to net income of $30 million or $0.36 per share last quarter. You will recall that the prior quarter included several items that, in aggregate, reduce net income by $11 million and earnings per share by $0.13. Ben will expand on our financial results later in the call. Assets under management ended the quarter at $80 billion, down approximately 1% from year-end. During the first quarter of 2018, we made steady progress in executing against the strategic initiatives we had previously outlined. We're well underway toward our goals of improving operational efficiencies, evolving the broker-dealer to a more competitive model, reducing net outflows and improving overall investment performance. Although we can see progress, we also know much more work needs to be done. That said, our objectives are clear and our organization is focused on the task at hand. While reducing costs and creating a more streamlined organization are key tenets of our strategy, we are also committed to making the investments necessary to enhance our long-term success. Importantly, our balance sheet strength and capital return policy provides us with a great deal of financial flexibility even during times of market stress. We understand that solid investment performance is essential to our long-term success and first quarter results were strong across much of our product line. Notably, 9 out of our 10 largest strategies exceeded their respective benchmarks for the quarter. We continue to see improvement across the one, three, and five-year Lipper and MorningStar rankings in most of our key strategies. In the first quarter, equity markets exhibited a stepped up level of volatility. We are optimistic that this higher level of volatility, combined with a gradual trend toward the normalization of monetary policy on the part of global central banks, will continue to improve the investment backdrop for active managers. Improving investment performance is an ongoing focus and recent trends are encouraging. From a sales and redemption perspective, the quarter showed marked sequential improvement as did comparisons from a year ago. Our emerging markets' equity and international core strategies continue to lead the way in terms of net inflows. We also continue to see some traction in our small cap strategies, but broadening our sales growth remains a key priority. Under Amy's leadership, we will continue to refine our sales and distribution strategies through effectively deploying data analytics, sharpening our product focus, properly aligning sales and marketing incentives, and identifying the right go-to-market approaches across our various distribution channels. Amy's experience and background is well-suited for today's evolving distribution landscape. She played a key role in developing our sales and distribution strategy and is supported by a strong team. Thus, our strategic priorities remain unchanged and we will move forward with clear intentions and focus. We do anticipate some near-term headwinds in our Institutional channel, however, given the departure of one of our long-tenured large cap growth portfolio managers. That said, we will continue to emphasize our collaborative investment culture and team-managed approach to portfolio management in an effort to alleviate concerns as best we can. As previewed on our last call, we did complete the merger of all remaining Waddell & Reed Advisors Funds into the Ivy Funds, providing greater brand leverage and cost efficiency for our fund shareholders. We also completed the merger of the Ivy Dividend Opportunities Fund into the Global Equity Income Fund. As we continue to review our product offerings, we expect to have additional opportunities to refine and better position our product lineup over time. Additionally, we are actively reviewing the fee structures of our funds and are intending to implement some adjustments in order to enhance their long-term competitiveness. Our cost reduction initiatives and savings from recent tax reform legislation provide us incremental opportunities to invest in our company and improve our firm's long-term growth and profitability prospects. Let me now turn it over to Shawn for an update on the evolution of our broker-dealer investments. Shawn?

[Shawn M. Mihal:]

Thanks, Phil, and good morning. The broker-dealer ended March with $56 billion in assets under administration, slightly down compared to the year-end and up 5% to March of 2017. Advisory assets increased to $22 billion and accounted for 56% of the $116 million of broker-dealer revenue during the first quarter. Advisor's annual – average annual productivity continues to rise and at $285,000 per advisor, productivity is up 24% compared to the average productivity in March 2017, while underwriting and distribution fees are up 12% in the year-over-year quarterly comparisons. As expected, we continue to see attrition in the total number of advisors as we shift to a more industry standard model. The number of advisors was 1,170 at the end of March with an additional 327 advisor associates, who are licensed assistants supporting advisors. It's worth noting that the average annual production for advisors who left during the quarter was $69,000, which excludes advisors who have left as part of a succession plan or as part of a transition to an advisor associate roll, resulting in the retention of their book of business by another Waddell & Reed advisor. As we continue our path toward a stand-alone profitable broker-dealer, we are focused on retaining high performing advisors and seek to further – seek to further rightsize the advisor model. Our strategic goals for the broker-dealer will continue to drive our focus in 2018. This includes transitioning to a fully competitive brokerage-centric model, improvements in technology that enable more efficient processes and greater ease of doing business, enhancements to our advisory suite of programs and a comprehensive support program for our highest performing advisors initially. We are actively engaged in data management project to consolidate our broker-dealer's core data into one environment. Our business administration platform project is designed to increase efficiencies by allowing the seamless connection of business processes to an aggregated data platform. The efficient use of data will allow us to enhance our operations through straight-through and intuitive business processes. Our goal is to provide advisors with a user interface, designed to connect directly to our back office business processes with end connections to underlying custodians where client accounts are held. Whilst our intent to launch our business administration platform in 2019, in the interim, we intend to expand or advise – use of our advisory processing platform. This expansion will allow for additional advisor functionality, provide investment advisory account servicing in a straight-through processing environment. We believe this functionality will allow advisors to more efficiently maintain its service investment advisory account held on our brokerage platform. Lastly, we are actively building a comprehensive service model to provide a speedy and dedicated service to advisors. This service model is being designed to provide advisors with a single point of contact for service and issue resolution. We're targeting a rollout in the third quarter of this year to our highest performing advisors with expansion of the program to additional advisors through subsequent quarters. With regard to regulatory developments, we're continuing to monitor the Fifth Circuit Court of Appeals' decision to vacate the DOL's fiduciary rule. While the DOL has elected not to pursue an appeal in this case, the AARP and a handful of states have petitioned the Court to defend the case on behalf of the DOL. We will continue to monitor these developments while we evaluate many of the fiduciary rule's most burdensome requirements for consideration of changes should the Court's decision be upheld. In addition, the SEC recently voted on its Best Interest rule proposal, which would revamp the standards of conduct for broker-dealers. The SEC rule is intended to create the Best Interest standard of care for broker-dealers, which is focused on conflict mitigation and disclosure. We're continuing to monitor these developments. But based on early understandings of this proposed rule, much of our conflict mitigation and disclosure preparation for the DOL's fiduciary rule will likely remain applicable, allowing for a reasonable compliance transition. As our business evolves, so must our disclosures in order to help investors evaluate the progress we're making and to promote comparability to other brokerage business models. Our earnings press release includes additional transparency around asset movement, advisory programs and productivity advisors. Now, let me turn it over to Ben.

[Benjamin R. Clouse:]

Thanks, Shawn, and good morning, everyone. As Phil stated, earnings for the first quarter were $46.3 million or $0.56 per share. Revenues were up 1% sequentially in total. Management fee revenues were down slightly due to fewer days in the quarter, despite an increase in average assets. The asset increase was driven by higher sales and slightly better redemptions, offset partly by lower market action. U&D revenues were higher due in part to an increase in advisory fee revenue. We also earned additional revenue from the programs and services being offered to advisors. The additional revenues generated from these programs and services were generally offset by increases in our commission payout grid reflected in distribution expense. Distribution expenses were otherwise in line with the change in revenue. Compensation and benefits were down slightly with the absence of our fourth quarter discretionary 401(k) contribution, more than offsetting normal beginning-of-the-year merit increases and the resetting of payroll taxes. Other operating expenses were neutral in total. As expected, interest expense declined due to our debt repayment, and corporate tax reform provided us a sizable reduction in income tax expense. We continue to expect our tax rate to be between 23% and 25%, excluding an additional charge expected in the second quarter for the shortfall associated with price changes for share-based compensation of approximately $4.5 million. These shortfalls going forward will decrease significantly for our outstanding grants. I'll stop here to point out the income statement reclassifications we made this quarter, as disclosed in the 8-K filed April 19th, which detail the historical changes by quarter. We believe this revised presentation, as well as incremental disclosures about our broker-dealer business that Shawn mentioned, will improve the transparency of our financial results and align the various elements of our operating expenses and other metrics with the categories prevalent in our industry. Following the 2017 changes in our field management to move away from a commission-type compensation structure, this quarter was an opportune time to make these reclassifications which had no impact on expenses in total or earnings. We continued to make progress on our cost containment initiatives. One initiative in our broker-dealer is that we began to rationalize our real estate footprint in locations with low occupancy or low profitability. As we continue to focus on our most productive advisors, we have less demand for office space due to a lower influx of new advisors. We continue to target an additional $10 million to $20 million in net savings toward our overall $30 million to $40 million goal across the company to be realized in our 2019 run rate. The income statement changes will bring additional clarity to our expense run rate. The first quarter, of course, was slightly higher due to the resetting of payroll tax and 401(k) limits, but we see that number leveling off as the year progresses. While we are focused on prudent expense management, we continue to invest in initiatives meant to drive revenue growth. We continue to add investment research staff and are working on a more comprehensive data strategy, including enhancements in the ease of doing business for advisors that Sean mentioned, as well as enhanced data availability for our distribution and investment management teams. In support of our sales and distribution efforts, we are also evaluating our fund fee rates to enhance competitiveness of our products and considering further fund merger opportunities. We intend to make adjustments to increase the attractiveness of certain funds. As we noted in January, the recent tax reform will provide additional flexibility and help offset any potential impact of revenue losses and other investments we are making. In support of our new capital strategy, we completed share buybacks during the quarter of $20 million. Including the $20 million of repurchases in the fourth quarter, this puts us approximately 700,000 shares beyond the annual grants we made in December and January. We intend to continue making progress on the return of capital to shareholders in the coming quarters. Lastly, our balance sheet continues to remain strong with ample flexibility and liquidity to meet our strategic goals. We completed the pay down of our first tranche of $95 million of private placement notes in January, leaving us with $820 million in cash and investments at the end of the quarter. I will now turn it back to Phil for closing remarks.

[Philip James Sanders:]

Thanks, Ben. Over the past year-and-a-half, we are focused on establishing an enduring framework for success across all aspects of our company. And to this end, I believe we have made solid progress. Our team orientation and culture of collaboration is designed to allow us to provide continuity to our strategic initiatives through a dynamic changing environment. We understand that the path is not always easy and there will be challenges along the way. However, we remain steadfast in our mission of helping investors realize their long-term financial goals through superior investment performance, sound advice, and exceptional client service. Operator, we would now like to open the call for questions.

[Operator:]

Ladies and gentlemen, at this time, we'll begin the question-and-answer session. And our first question today comes from Craig Siegenthaler from Credit Suisse. Please go ahead with your question. Craig Siegenthaler - Credit Suisse Securities (USA) LLC Good morning. So, when you take a step back, Waddell & Reed really operates two distinct businesses, an asset manager and a broker-dealer. Can you help us think about the level of profits generated between these two businesses either this quarter or last year? And any color on the margin would be helpful, too.

[Benjamin R. Clouse:]

This is Ben. Maybe I'll start and Phil may want to add. As you know, we currently operate under one segment for purposes of external disclosure. As our business evolves, we'll continue to evaluate that, of course. I think we've previously stated that our asset manager margins are generally in line with the industry, and we're working on improving the margins in our broker-dealer in support of the third pillar of our strategy to move that business to more of a standalone basis. I don't know, Phil or Shawn want to add to that.

[Philip James Sanders:]

Yeah. I don't know that I've a lot to add, I don't know if Shawn. Most of our, I guess, restructuring efforts or reorganizational efforts have evolved in our broker-dealer, where we're basically responding to the evolution of the industry and separating these two businesses in the sense that, as you know, historically our broker-dealer was essentially an asset gatherer where we were just basically taking in assets and the asset management fees supported kind of that business. But as the industry has evolved, and clients and advisors want more choices and options, then we've gradually adjusted and transitioned our business model, and that's kind of where we're stated. Obviously, I think we'll have more to say on this as the next – as the quarters evolve and the future transpires, but that's kind of where we are right now. Craig Siegenthaler - Credit Suisse Securities (USA) LLC And just as a quick follow-up, I saw that commissions on front-end load share classes like As and also variable annuities were moving higher, and 12b-1 fees were going lower. Can you talk about how the mix of your sales activity in the broker-dealer is evolving?

[Shawn M. Mihal:]

Yeah. Craig, I can take that. This is Shawn. We're certainly seeing the transition away from more of the commission-type products into the advisory space, and that's obviously represented in the overall revenues being accounted for coming out of the advisory space. So, when you look at the $116 million in revenue, a large portion of that is coming off of the advisory assets under management which is consistent, we believe, with industry trends as that dynamics around that business continues to shift more towards an advisory model. The overall – we would have to pull some data around the commissionable sales data associated with that. But 12b-1 fees certainly have gone through some compression over the course of several years as the 12b-1 fees that were once accounted for in advisory programs have been removed and are no longer applicable in the advisory program. So, we've seen an overall reduction from prior years with regard to 12b-1 fees that were inclusive inside of advisory programs.

[Brent K. Bloss:]

And Craig, this is Brent. On the loaded revenue, it's still a little over 80% is proprietary on the load products that we're selling today. Craig Siegenthaler - Credit Suisse Securities (USA) LLC Thank you.

[Operator:]

Our next question comes from Glenn Schorr from Evercore. Please go ahead with your question.

[Glenn Schorr:]

Hi. Thanks very much. Just want to dig a little into your comment about the PM departure and potential impact on the institutional side. I just want to be clear you're talking about the more of the large cap growth product and fixed income, because I see that as less than 5% of AUM. I just want to make sure we're talking about the same stuff.

[Philip James Sanders:]

Yes, Glenn. This is Phil. That's correct. I was referencing really the large cap growth portfolios.

[Glenn Schorr:]

Okay. And could you – do you mind talking about what you can do? The team that's taking over has been there for six years or so. So, how do you manage that process? And I don't think it was performance related or anything else, so I am just trying to read into your remarks (22

[Philip James Sanders:]

Well, maybe I'll give you a little bit of perspective. I think we indicated that the large cap growth institutional business was about $2.7 billion at the end of the first quarter. The PM that departed has been long-time PM, 20-plus years running that strategy. I was involved in that strategy for a long time. So, we've now – so, that is just something that happens in this business when you have a key PM departing, clients will stop and consult will stop and reassess. It is true we've got a team managed approach and we've had two to three PMs on this product for many, many years. The co-PM on that product has been affiliated with the large cap growth team for seven years. There is also an Assistant PM there. So, we've got continuity in terms of familiarity with the portfolios, and the style and the process. And importantly, the large cap growth style and philosophies really I think embedded within our firm and many of our clients. Nevertheless, when you have a key departure like this, we understand how that works in this business and we do the best we can to alleviate that through this team managed structures. But when you have long-time PMs, who are – based on our conversations with clients, we know we're going to have some challenges here in certain relationships over the next few quarters, but we'll have to see how that plays out.

[Glenn Schorr:]

Okay. Maybe I could slip the question on the performance side. I think five of the seven largest funds have some tougher patches of performance rolling off over the next two quarters into the three-year record. So, all else equal, those relative performance records should all improve. In the past that would equate to reasonable either reduction in redemptions or a pick-up in gross sales or both. Has the market changed so much lately that that shouldn't be the case or can we expect that to keep improving? It looks like it might even be working already in the unaffiliated channel, but just curious on your thoughts there.

[Philip James Sanders:]

Right. Well, maybe I'll start and I'll let Amy jump in if she has any perspective. I think that your observation is a good one. I think the way I think about it, we have kind of some short-term challenges in the next couple quarters with some of that headwinds we've outlined, especially within our large cap growth institutional area. But longer term, we have a broader suite of products with a steadily improving performance that we have some more opportunity, probably more shots on goal, so to speak, than we've had in the last few years, and that's a good thing. So, hopefully, we can – we just need to execute upon that and deliver in terms of better sales. I do think the industry has changed a little bit and we're kind of fighting the industry headwinds of shelf space rationalization, and you can't just rely on the power of distribution, I think performance and the whole marketplace has become more institutionalized. So, it's become a little bit tougher landscape for sure, but I think that's how I would characterize as a balance of some short-term headwinds with some longer-term opportunities. And I don't know, Amy, if you have anything to add to that.

[Amy Scupham:]

No. I think that's right.

[Philip James Sanders:]

Okay.

[Glenn Schorr:]

Okay. Thank you, both.

[Philip James Sanders:]

Yeah.

[Operator:]

Our next question comes from Dan Fannon from Jefferies & Company. Please go ahead with your question.

[Daniel Thomas Fannon:]

Thanks. I guess could you talk a bit more about the pricing strategy that you're looking at in terms of how broad this might be in terms of potential pricing changes? Is it kind of oneoff in nature? Just give us some of the – a little more detail potentially.

[Philip James Sanders:]

Yeah. I think we'll have a little more to say about this probably next quarter, but we're in the process of evaluating it. I think we're taking a holistic approach to it, but probably the key areas of focus will be in our focus funds and we'll be strategic in how we do this. I think that the point is that we've got an opportunity here with some tax savings and the tax rate. We also know that fees remain an important focal point of the industry. So, we have to make sure we're competitive. And so, we're going to definitely take this opportunity to invest some of those savings back into our product suite. The exact amounts, I think we probably would be able to offer a little more guidance maybe next quarter. Keep in mind that we're talking about any adjustments we make. The total financial impact will be relatively muted in 2018, because you're talking about maybe second half adjustments that type of thing. The full impact would be more of a 2019 effect. And like I said, I think we'll likely have more to share in the future when we get a better handle on it.

[Daniel Thomas Fannon:]

Okay. And then just to follow-up on kind of gross sales, in the unaffiliated channel improved. I'm just curious maybe how April has trended just given – thinking about seasonality versus maybe some underlying factors and the sustainability of some of these improvements.

[Amy Scupham:]

Hi. This is Amy. I can address that. In April, I think what we've seen is a modest softening on the sales side and a slight pick-up in redemptions in the unaffiliated channel. Some of this, I believe, is due to some seasonality. First quarter is always generally one of your better sales quarters. However, I think we're also – I'm just experiencing some softer sales. So, the trends that you see in April are lower than what you saw for the first quarter. I would also add that in the Institutional channel, we have had few clients redeem in April totaling approximately $500 million.

[Daniel Thomas Fannon:]

Great. Thank you.

[Operator:]

Our next question comes from Bill Katz from Citi. Please go ahead with your question.

[William Katz:]

Okay. Thank you very much for taking the questions. So a couple things, just on expenses, given the sort of restatements or reclassifications I should say, could you walk us through how that compares in terms of the savings, both the dollar amount and the timing, as you think about your prior guidance? I'm just trying to level set where we are versus where we were.

[Benjamin R. Clouse:]

Good morning, Bill. I'd be happy to do that. As I stated in my remarks, there were some timing impacts that elevated compensation in particular in the first quarter due to tax and 401(k) resets. We also have a little bit of incremental stock comp in Q1 as a result of moving our grant date last year up to January. So, there's a little bit of overlap here in the first quarter before the 2014 grant will roll off in Q2. More pertinent to your question, if we add compensation, G&A, technology, occupancy and marketing, we'd come up to about $114 million for the quarter. I think there is $3 million to $4 million of timing impacts in there. So, if I remove that, we're at about $110 million or $440 million run rate, which Brent would have talked about in the prior quarter. We'll definitely have some one-time items in the balance of the year. As we exit real estate, there will be some cost associated with that. I also expect some severance, in particular in Q2, in a range of $4 million to $5 million. But we still intend to take another $10 million to $20 million out of our 2019 run rate, as we previously stated, I don't expect to see significant reductions until late in 2018.

[William Katz:]

Okay. And then just sort of coming back to the sort of the ins and outs on the financial advisor side, so I appreciate the extra disclosure about the low productivity advisors leaving. Can you give me a sense of sort of the gross inflows, if you will, in terms of financial advisor, like how many new financial advisors you brought onto the platform versus what you lost? And then just sort of stepping back with all the sort of the flux of the platform in terms of both senior executives or line officer changes plus some of these PM changes, what's sort of residual value proposition to bring others on in a period where many of your peers are spending heavily on their own systems and opportunities?

[Shawn M. Mihal:]

Yeah, Bill, it's Shawn. It'll take me just a minute to get the overall ins and outs on the advisors that joined here during the course of the third quarter and to get you the overall net. So give me a second to look up those numbers and then we'll be able to report those back. The other question was relevant to the...

[Unknown Speaker:]

(32

[Shawn M. Mihal:]

Thanks. Yeah. The other question was relevant to the technology platform and where we stand. Is that correct?

[William Katz:]

Well, just to understand just sort of value proposition, how the dialogue is going in terms of attracting those financial advisors just given that a lot of it changed, but it's all sort of related to each other. Maybe I'll sort of toss one also out there while waiting for that and you can sort of come back to me later. You mentioned that you're still reviewing some more funds for potential mergers? Just sort of wondering if you could quantify the amount of AUM that you're looking at? And then, relatedly, I think you've historically given out your AUM sort of as of where we stand today. I was wondering if you could give that to us as well.

[Philip James Sanders:]

This is Phil. As far as potential fund mergers, we're not really in a position to quantify that exactly right now, because we haven't finalized any decision making. But generally speaking, they will be not the largest funds obviously, that kind of thing. It will be more of an opportunity to reallocate resources, be the most effective in terms of consolidating our resources and driving longer term performance and competitiveness. So I expect it'd be relatively modest, and I think we'll have more to say on that next quarter in terms of how many. But it would be a handful, I would say, potentially, that we're reviewing. As far as the AUM spend, I don't know if you want to comment...

[Benjamin R. Clouse:]

Sure. Yeah. Bill, in regard to AUM, as you know, last year, we began disclosing our level monthly, I think, last summer. And then this past month, for March, we've added flows to that to give a little bit more data. Going forward, we really need to let our process execute to make sure we're disclosing an accurate number. In particular, since today's call is on the 1st, we'll disclose yesterday's AUM here in about a week.

[William Katz:]

Okay. Thanks for taking my questions today.

[Shawn M. Mihal:]

And, Bill, this is Shawn, just to round back on the overall nets on the advisors. We were down 197 advisors. I'd have to get the actual inflows to get what the actual net of those numbers are with regard to advisors. But one thing to note is we did also see an increase in licensed associates, so advisors that are transitioning out of the advisor roles will move more to the industry standard model and increasing levels of production associated with advisors. We've seen 62 advisors move into that licensed advisor roles as well as we are seeing some of that shift occur as we anticipated as we increase the minimum production requirements associated for advisors. Overall, we are still functioning at a capacity of which we've offered from a value proposition and to be able to recruit advisors. And as we have in the past, we have a dedicated support model associated with those advisors that are in our field along with our field support from an overall field leadership perspective. What we've done over the course of the last two years with regard to Project E and some of the technology packages that we've installed through those projects, we've also, through those projects, enhanced the suite of programs and services that we've offered to our advisors from an overall advisory shelf space and we're going to continue to enhance that advisory suite of products that we're offering to our advisors and then continuing to focus on data-driven initiatives. And that's where we're really headed for the future, is continuous enhancements to the data platforms that we have to drive to greater efficiencies in doing business. So we think we're able to continue and compete in that space, particularly as we shift the service model to provide that dedicated support model, more concentrated support to our highest performing advisors.

[William Katz:]

Okay. Thanks.

[Operator:]

And our next question comes from Michael Carrier from Bank of America. Please go ahead with your question.

[Michael Carrier:]

Hi. Thanks, guys. Maybe just one question on the flows, I know you have the seasonality in the first quarter, but was there anything you and the unaffiliated or the institutional that kind of drove the sequential improvement? Like anything that was more significant in terms of a lumpy win or add on a platform that may have driven some of that?

[Amy Scupham:]

Hi. This is Amy. In the unaffiliated space, I would say it was just continued strength with our emerging market equity products and our international core strategy. As far as the institutional, net positive was a big inflow from one of our sub-advisor clients in our mid-cap growth strategy.

[Michael Carrier:]

Okay. Got it. And then just a follow up, so when I look at, I think, like the $30 million, $40 million that you guys have already outlined, I think, you're at sort of that $20 million, so you have the $10 million to $20 million left in terms of efficiencies. And then when we're thinking about some of maybe the investments that you're making in a review of like the fee rates and taking that into context of some of the tax savings. I'm just trying to understand like when you look kind of going forward, we still have that kind of $10 million and $20 million from an efficiency standpoint, but when we think about some of the new investments, like the fee changes, how should we think about that relative to maybe the tax benefit that you're going to get this year? Meaning, how much are you thinking about kind of reinvesting in the business versus coming to the bottom line? And I know it's probably a little early, because you mentioned we're going to get more color on the next call (38

[Philip James Sanders:]

Right.

[Michael Carrier:]

...So, just more a big picture if you have it.

[Philip James Sanders:]

Right. Well, I'll just give how I'm thinking about them, if Ben wants to elaborate any. I think from the tax savings perspective, the way we're thinking about it is, we're taking this opportunity and some portion of that will be reinvested in terms of our product line through fee reductions and that type of thing. I think we're going to be strategic and thoughtful about it. But obviously, we have to remain competitive from a fee perspective. We have some broad-based improvement in some performance across several products here that I think appropriate fee adjustments will help drive and be a longer term investment to drive future sales. So, that's how we're thinking about them. That's probably unsatisfying in terms of sizing it. But again, I think we're in the early stages as I indicated and we'll probably have more guidance on that going forward. I don't know, Ben, if there's anything else to add from your perspective.

[Benjamin R. Clouse:]

No. I think that's right.

[Michael Carrier:]

Okay. Thanks a lot.

[Operator:]

Our next question comes from Chris Shutler from William Blair. Please go ahead with your question.

[Chris Charles Shutler:]

Hey, guys. Good morning. Just a few on the broker-dealer channel. So, there are some pretty aggressive offers out there in terms of firm recruiting packages. Does it feel to you like the recruiting environment has gotten more competitive and I guess how are you responding to those pressures?

[Shawn M. Mihal:]

Hey, Chris. This is Shawn. And certainly, I think the environment has been – for the last several years, has been pretty competitive with regard to the recruiting that takes place. And we are certainly being responsive with regard to our initiatives and what we're doing inside the evolution of our broker-dealer to retain our advisors, particularly as we go through a number of transitional shifts to different data strategies and how we've implemented things associated with Project E, and how we're moving forward in our goals and strategies with respect to enhancements to data platforms and how we will continue to conduct business in the future to remain competitive. We think we offer a competitive platform to our advisors, so we have a longstanding relationships with our advisors and are continuing to focus on providing that dedicated support to our high-performing advisors. Certainly, we've shifted the model. And as we moved, as Phil had discussed, with regard to being more of an asset gatherer from the past and enhancing the product offerings that we have expanded out and inside, particularly our classic channel as we moved here forward, and we will continue to look for opportunities to expand out how we engage with our advisors. We're certainly focused on the recruiting side and aspects of recruiting as well in an effort to compete with the environment that's taking place with other firms from a recruiting aspect. Certainly, our focus has changed with regard to those recruits that we're bringing in. In the past, we were focused on bringing a lot of inexperienced advisors into this space, which resulted in a significant amount of recruiting, but the overall retention of those advisors was somewhat challenged at times, whereas now, we're focused on more of the higher-performing advisors and recruiting to that model and, as Ben mentioned, has caused us to do some rightsizing with regard to our real estate footprint. So we'll continue to make some adjustments around that as we shifted this model. So we think we offer a competitive package to our advisors. We have a very broad scope of programs and services and an à la carte model that our advisors can purchase from us associated with their association as advisors. So we feel that there's a significant amount of opportunity associated with bringing advisors into the firm. But the model has been shifted more away from the large mass of recruiting of the lower or newer inexperienced advisors to focusing on those higher-performing advisors.

[Chris Charles Shutler:]

Okay. Makes sense. And then just a follow up on the same sort of area. The proprietary assets, Waddell & Reed Funds versus third party, can you just give us an update on the percentage currently at the broker-dealer, and how is that compared to the, if you look at NNA and the percentage of proprietary within the NNA? Thanks.

[Benjamin R. Clouse:]

Well, I might start. This is Ben, and Shawn or Brent could add in. We really don't track frontload sales for non-proprietary. If we look at revenue, it continues to be consistently nonprofit, about 20%, and proprietary, about 80% including this quarter.

[Chris Charles Shutler:]

All right. Thank you.

[Operator:]

Our next question comes from Robert Lee from KBW. Please go ahead with your question.

[Robert Lee:]

Great. Thanks for taking my question, guys. I just have a question. So, I mean, some of the prior calls, I think, kind of suggested or maybe hinted at the fact that strategically going forward, you may be more open to thinking about inorganic possibilities. So can you maybe update us on that? And I guess I'm particularly interested in the broker-dealer RIA space. You've clearly seen a lot of activity it seems recently. So as you think about inorganic and the interest in scaling your B-D infrastructure over time, you see that as being a potential avenue too that you may kind of look to do something inorganic in the broker-dealer space?

[Philip James Sanders:]

Well, maybe just – I'll start. If Shawn wants to add anything, he can. But I think from a high-level perspective, we still are open to inorganic growth opportunities. We are doing this – we've got a lot going on internally and we're transitioning our business model as we've talked about. But fortunately, we have a lot of financial flexibility, a strong balance sheet, so we have potential opportunities here. It takes two parties and it takes the right opportunity at the right time and that kind of thing. I think initially, our primary focus would be on the investment side where we have – potentially would look for opportunities to increase our capabilities or enhance some of our core strengths and capabilities. We've got some work to do in fixing our broker-dealer and that type of thing longer term. Hard to say how it evolves over time, but I think initially, our first area of focus is probably on the asset management side. Shawn, I don't know if there's anything to add there.

[Shawn M. Mihal:]

I agree with you. I think a lot of the projects that we're focused on inside the broker-dealer really will make it that – have the ability to be more nimble in the future and so certainly providing for opportunities around that, but we're certainly more focused on what – the inorganic growth on the asset management side of the business.

[Robert Lee:]

Okay. Great. And then maybe to follow up going back to kind of an expense question. So and I just there's always so many numbers being thrown around and obviously the recasting of your disclosure, which I appreciate, and is helpful. Can you maybe help us think about as we look ahead to 2019? I mean, if I think about the core kind of expense run rate kind of $110-ish million, obviously it's going to be severance and other kind of one-time things that come in and out. But as you think about your longer term goals getting your core run rate down, say, another – over time another $30 million plus, could you – how are you thinking that evolves? I mean, there's only so much you're going to get out of real estate, I assume and maybe kind of that 10%, half of it or 20% of it. Is the rest just – and particularly against the backdrop of having to spend on technology just to remain competitive. So if you maybe help outline to assume that $110 million run rate, where you think the opportunities are to get that down over time, your ultimate goal of $30 million annually, I guess.

[Benjamin R. Clouse:]

Well, to level set, Robert, our original goal of $30 million to $40 million toward our run rate, starting in 2019, we achieved about half of that last year through pension freeze and some field market structure changes in Shawn's organization. And so we're seeking the other half of that this year. So if you think about the $110 million for the quarter or $440 million for the year, we'd be seeking an additional 10% to 20% on that. I don't anticipate in the long-term that we have significant reduction targets, and Brent or others might want to add to this. As we think about technology investments that we are making and some of the data strategy that I and Shawn alluded to in our comments, there's clearly investments that will need to be made there. I think we have some possible savings as we sunset older systems or legacy systems that are going away, but I don't anticipate major reductions to the run rate. Of course we're always up against continued inflation and wage increases annually. I don't know, Brent, if you or Shawn want to add to that, but that'd be my perspective, Robert.

[Robert Lee:]

Okay. I appreciate that clarification. And if I, maybe just one last quick question which is really just again from the kind of recasting. They talked in the quarter – I mean, there were – I guess you talked about distribution revenues benefiting from commissions that flow there, on the other hand, distribution expenses. There was an offset in commissions there. None of that was in the recast numbers going back. So that just started this quarter. So if I look at your recast 4Q, that's kind of an additional change that was effective January 1st, correct?

[Philip James Sanders:]

That is correct. And so, to be – to be clear, we had approximately $5 million of incremental revenue from offered programs and services in the quarter, generally offset by incremental distribution expense by modifying our grid, as well as a couple of other savings items, but all of those are within the distribution line.

[Robert Lee:]

Great. That's very helpful. I appreciate you taking my questions.

[Philip James Sanders:]

Sure.

[Operator:]

Our next question comes from Kenneth Lee from RBC Capital Markets. Please go ahead with your question.

[Kenneth S. Lee:]

Thanks for taking my question. Just in terms of the broker-dealer unit, looks like the revenue per advisor is picking up nicely. What levels should we think about as being reasonable for you guys to aim for as you work on the profitability improvement at the unit? And as well, as you mentioned, in terms of the potential regulatory changes down the line, what key levers are available to further boost this metric over time? Thanks.

[Shawn M. Mihal:]

Hey, Kenneth, this is Shawn. And certainly, we're going to continue to track that profitability by advisor, and that's certainly something that we're focused on as we shift the model. And as Ben noted the overall reduction in advisors and really concentrating on the retention of high-performing advisors. We did end the quarter at $285,000 on average annual productivity of advisors, and we're certainly targeting to the north of $300,000 with regard to annual average productivity of advisors. So, we'll continue to target in that direction as we evolve the broker-dealer. On the regulatory front, certainly we're going to continue to monitor what's happening in that space, in a couple of different areas. As I mentioned in the prepared comments, the Department of Labor fiduciary rule, while there's still some uncertainty as to what may happen with the finalization of the court's decision to vacate the rule, it's something that we're going to continue to evaluate as there were a number of items that were enacted as part of coming into compliance with that rule that increased or caused some expense to the firm, which may no longer be required as we move forward. I'm certainly easing the process of our advisors from a business perspective. So, we're looking at those most burdensome requirements that were structured out of that rule and how those may be applicable as we move forward. Separately, the SEC proposal, obviously we're at the very early beginning of that proposal, which will have a longer road ahead of it before it likely moves forward into any type of finalization of becoming a rule. But the early indications are based on it being more of a disclosure based rule. It does provide for the additional flexibility with regard to the broker-dealer not causing significant cost increase associated with the broker-dealer and the financial advisors that we support. So we're going to continue to monitor that. I don't expect at least in the initial stages that to hamper our ability to increase our advisors' overall annual productivity ranges. But we're going to continue to monitor what happens in the space with regard to the SEC rule proposal.

[Kenneth S. Lee:]

Great. And just one follow-up on the strength in the retail, and affiliated sales. Wondering if you can give us some detail as to which particular set of clients or distribution platforms have been driving the sales strength? Thanks.

[Amy Scupham:]

Hi. This is Amy, Kenneth. It's primarily our national channel wholesalers are a strong driver of the sales that we see so far. As we look forward, the goal would be to broaden the distribution diversification by channel. But what you're looking at primarily right now would be about 80% from national channel, which would include DCIO. It includes at this point some RIA numbers in it and then also variable annuities.

[Kenneth S. Lee:]

Great. Thank you very much.

[Operator:]

Our next question comes from Patrick Davitt from Autonomous Research. Please go ahead with your question.

[Patrick Davitt:]

Hey, guys. Good morning. Amy, on the $500 million of redemption, is that related to the large-cap PM departure or will any redemption from that pool be incremental? And then more broadly, could you speak to any relationships that could get worse from Nikki's departure given your discussions thus far?

[Amy Scupham:]

Sure. As far as the $500 million, no, those were not due to the departure of the large cap growth manager, though one of the account was a large cap growth account that came out right at the beginning of the month. The other was from a different strategy and we had been notified of the departure of that account months ago due to performance. So any departures you see from here would be incremental after the announcement of the departure.

[Patrick Davitt:]

Then on Nikki.

[Philip James Sanders:]

As far as relationships, I'll add – I don't know, Amy, you can add on this. But I mean obviously when there's disruptions in personnel, there's conversations that take place, people want to be reassured. The way I think about it, these things are always – there's never great timing on these things, but our strategy is in place where we've got a great team. We're committed to it. Our philosophy, our mission, our strategy is obviously always bigger than one or two individuals and we're moving forward. But it takes some conversations and reassurance, but well that's something we'll have to manage through.

[Patrick Davitt:]

Thank you.

[Operator:]

Our next question comes from Mac Sykes from Gabelli & Company. Please go ahead with your question.

[Macrae Sykes:]

Hi. Good morning, everyone.

[Philip James Sanders:]

Good morning.

[Macrae Sykes:]

As the sales process – as the platforms for the big intermediary channels become more competitive and you begin to focus more on RIAs, can you talk about the sales process there in terms of what may be different from the traditional practices? And then what products you're targeting for that particular space?

[Amy Scupham:]

Hi. This is Amy. So the sales practices and the way that they're different in the RIA channel, as I see it is they're much more consistent with that of an institutional investment consultant. In fact, institutional investment consultants are RIAs, just at a larger level. And so I think the due diligence process is a little bit longer in its cycle, and they're much more fee-sensitive. And then also, I think that from their client base, they're looking for products that can be differentiated from their peers. And so it's something that we continue to look at. We have a list of seven focus funds across all of our distribution channels or seven focus strategies across all of our distribution channels with a couple of on-deck strategies in the queue. And so it's just kind of a continued evolving conversation with us with the RIA channel.

[Macrae Sykes:]

Great. And could you just remind us about the velocity or the trajectory of the repurchase plan?

[Amy Scupham:]

I'm sorry. Can you repeat that?

[Macrae Sykes:]

For the repurchase plan, could you just remind us...

[Philip James Sanders:]

Oh, okay.

[Macrae Sykes:]

...yeah, the trajectory of that? Thank you.

[Philip James Sanders:]

Yeah. I think we had indicated $250 million over a two-year plan. So we'll be opportunistic in length along the way here. As I indicated, I think the way to think about it is we'll be persistent in that effort and you ought to expect to see us be active every quarter. I think it will ebb and flow in terms of its intensity based on market conditions, and the stock price and other things obviously. But I don't have any concerns about our ability to hit that goal over that stated time period.

[Macrae Sykes:]

Thank you.

[Operator:]

And ladies and gentlemen, we have a final question from Michael Cyprys from Morgan Stanley. Please go ahead with your question.

[Michael J. Cyprys:]

Hi. Good morning. Thanks for letting me in. Just a question for Phil. You mentioned earlier that a key focus is on increasing, enhancing the strengths on the investment side. Just curious if you could help flush that out a little bit just in terms of what specifically you have in mind there. And then also if you could talk to more broadly, how you're thinking about technology has a role within the investment process at Waddell Reed.

[Philip James Sanders:]

Sure. As far as adding to the investment capabilities, I think that could come in a couple of different ways. It could be an acquisition of a small boutique or something like that if the right opportunity presented itself. But it also could just be coming in terms of acquiring some new investment talent or lift-outs or teams or just additional capabilities. We'll see how that transpires and where we're open if the right opportunity presents itself. In the meantime though, we're also investing in our own people and growing our staff internally. We did I think hire about seven analysts last year and we're hiring a comparable number. Our intention is to hire a comparable number this year. So we're looking at commitments and investing in our own internal research capabilities. Our idea really here is we're investing in our people while we're also looking at becoming more focused as an organization. And really the idea is really to create this framework where all of our products are properly resourced and really play to our core strengths. And the second part of your question was? It slipped my mind. I'm sorry.

[Michael J. Cyprys:]

That's okay. Just on technology. How you see...

[Philip James Sanders:]

That's right, the role of technology. Yeah. To this point, most of it has been in terms of just helping us get data analytics and detailed attribution and more efficiencies and Barra and factor analysis and helping us understand just the ongoing process of investment management, making sure we're complying within our risk management goals, those types of things. As far as AI, if that's what you're alluding to in terms of the investment process, that's something we've kind of looked at a broad level, but nothing in a great detailed level at this point.

[Michael J. Cyprys:]

Great. Thank you.

[Philip James Sanders:]

Yeah.

[Operator:]

And ladies and gentlemen, at this time, we've reached the end of today's question-and-answer session. I'd like to turn the conference call back over to management for any closing remarks.

[Philip James Sanders:]

Well, I think we're all set. Appreciate everybody's attention and tuning in. We look forward to catching up with you next quarter. Thank you very much.

[Operator:]

And ladies and gentlemen that will conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.