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Waddell & Reed Financial, Inc. (NYSE:WDR)

Q4 2007 Earnings Call

January 29, 2008, 10:00 a.m., ET

Executives

Henry J. Herrmann – Chief Executive Officer

Michael L. Avery – Senior Vice President, Chief Investment Officer

Thomas W. Butch – Senior Vice President, Chief Marketing Officer

Daniel P. Connealy – Senior Vice President, Chief Financial Officer

Analysts

William Katz – Buckingham Research

Craig Siegenthaler – Credit Suisse

Marc Irizarry – Goldman Sachs

Robert Lee – Keefe, Bruyette & Woods

Bob Glasspiegel – Langen McAlleney

Cynthia Mayer – Merrill Lynch

Jeffrey Hopson – Stifel, Nicolaus & Co.

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Waddell & Reed fourth quarter earnings conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions). The conference call is being recorded today, Tuesday, January 29th of 2008. I would now like to turn the conference over to Mr. Hank Herrmann, Chief Executive Officer of Waddell & Reed. Please go ahead, Sir.

Henry J. Herrmann

Thank you, Mary. Good morning. With me today are Tom Butch, our chief marketing officer, Dan Connealy, our chief financial officer, Mike Avery, our chief investment officer, and Nicole McIntosh, our director of Investor Relations. Nicole, would you read the forward-looking statements, please?

Nicole McIntosh

During this call 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, including but not limited to those referenced in our public filing with the SEC. We assume no duty to update any forward-looking statements.

Materials relevant to today’s call, including a copy of today’s press release as well as supplemental schedules, have been posted on a website at waddell.com under the corporate tab.

Henry J. Herrmann

Thank you, Nicole. This morning we reported our results for the final quarter of 2007. Earnings per diluted share of $0.42 were the highest on record and 17% above the same period a year ago.

The income statement was not the only area where we broke records. Throughout 2007 we delivered consistent and persistent sales improvement. Those sales increased every quarter through 2007 and finished the year at a record $14.9 billion in annual sales volume improvement, in excess of 70%.

Net sales were even more impressive coming in at $6.2 billion representing a 254% increase compared to 2006. Perhaps most impressive, momentum accelerated throughout backdrop of market turmoil in the second half of the year.

What’s most encouraging is that our sales growth was evident across all of our distribution channels. We saw record highs in each channel. Wholesale saw the fastest growth causing assets under management to double in 12 months as organic growth reached 63%.

While growth continues to be driven primarily by asset strategy and global natural resources, we’re experiencing good growth in a number of other funds. Ivy large cap growth, Ivy capital appreciation, and Ivy science and tech are pretty consistently seeing daily sales of around $1 million apiece. These flows demonstrate we are gaining real traction for a number of funds; a trend we are focused on sustaining. It is also important to note that in this channel flows are primarily into Waddell & Reed managed products, which accounted for 82% of fourth quarter gross sales.

Our success here has outpaced most optimistic expectations. This is not an accident, but rather the result of a highly focused strategy that we have followed since re-introducing the Ivy funds in 2003.

The progress we are making towards improving our advisors channel is also very noteworthy. Quarterly sales volume is at record highs, breaking the billion-dollar mark for only the second time since our IPO in March of 1998. Net sales improved consistently as the year progressed and turned positive in the fourth quarter.

Advisory productivity improved materially, recording significant gains over 2006. Specifically, sales per advisor during the quarter increased 43% compared to the same quarter last year. Annual advisor productivity increased 20% compared to 2006. Increasing advisor productivity is at the heart of our efforts to revitalize this channel. Our results over the last three years show consistent improvement and a validation of our strategy.

Finally, turning our attention to the institutional channel, sales also were at a record high. Our agreement with Pictet & Cie is bearing fruit, justifying our original optimism regarding this relationship. We concluded the year with about $1 billion under management with Pictet. Net sales during the quarter were meaningfully positive in the institutional channel.

Of course, none of our sales success would be possible without the support of our strong investment management team and the outstanding performance results they deliver year in and year out. Our lipper rankings are nothing short of remarkable, with 60% of our equity funds and 66% of our equity assets ranking in the top quartile of the respective lipper universes for the 12-month period ending December 31st, and 74% of our equity funds and 80% of our equity assets ranking in the top half for the same period.

Our long-term record is similarly impressive. Currently 51% of our equity funds are ranked four or five star by Morningstar on a one- and three-year basis, and 79% and 62% of our assets are similarly ranked for the same period.

Our operating margin was 22% during the fourth quarter, down 1.2% when compared to the third quarter due to the impact of sales in our wholesale channel have on our U&D margin.

During the fourth quarter we sold nearly $4 billion of mutual funds in our wholesale channel or $1.5 billion more than the previous quarter and $2.8 billion more than in the fourth quarter ’06.

A meaningful catch up in our accrual rate for the incentive bonus also impacted margins. During our earnings call last quarter we mentioned that our investment performance had significantly improved during the second half of the year and if this persists that it would likely result in having to revisit our accrual assumptions.

As indicated in our release, performance remained well above average into the end of the year. In total, company-wide incentive bonuses and related payroll taxes contributed nearly $3 million of the $3.1 million sequential increase in compensation and related costs.

I would also like to bring to your attention the increase in share count. In the fourth quarter we saw heavier than usual stock option exercises. Mostly due to the nearby expiration of our 1998 IPO option grants. In total we issued approximately 3 million new shares, half of which occurred in December. A fully diluted impact won’t be felt until the first quarter.

Operator, at this time I would like to open the call up for questions.

Question-and-Answer Session

Operator

Thank you. At this time we will begin the question and answer session. (Operator Instructions). Our first question comes from Jeff Hopson with Stifel, Nicolaus. Please go ahead.

Jeffrey Hopson – Stifel, Nicolaus & Co.

Good morning. Two questions. With the Pictet situation do you expect ongoing flows or was there some lumpiness this quarter? And then in terms of the indirect expenses from the wholesale channel, can you give us a sense in a normal environment what type of increase percentagewise you would expect in those for 2008? Or give us a sense of direction of that number.

Henry J. Herrmann

Okay. I’ll answer this first and then I’ll let Mr. Connealy comment on the second. Now, there was a certain amount of lumpiness in Pictet flows in the third and the fourth quarter, but their total contribution probably not particularly outsized. There has been a steady flow on a daily basis which really began in August. In the current time, looking into what is probably 85% of the month of January, the flows have continued to run at a very significant level. As you know, the vast majority of the flows are coming into our large cap growth product and I think that Pictet continues to support the idea that that is a relatively undervalued segment of the world market, so I expect that we will continue to enjoy at least decent flows. We’ll have to see how it goes. I’ll turn it over to Dan.

Daniel P. Connealy

Jeff, as far as the indirect cost in the wholesale channel, those are expected to grow this year because as we finish the year we had about 32 wholesalers. Our goal is to be up to about 40 external wholesalers by the end of the year. We’ll also be supporting the external wholesalers with indirect wholesalers. So that will be the cost that goes into the indirect. That and the travel expenses and other expenses associated with them. But of course we’re expecting these people are going to be revenue generators. So those are the kind increases that salaries and fringes go into the indirect line. We are modelling those expenses to grow at a slower rate than production, obviously.

Jeffrey Hopson – Stifel, Nicolaus & Co.

Okay. And then can Mr. Avery give us an update on investment strategy for 2008? Any changes there, I guess.

Michael L. Avery

Well, thanks for the question. I don’t anticipate any major changes. I think the way to look at it is to anticipate that we’ll continue in the same process that we’ve employed for a long period of time and that is a consistent focus on fundamental analysis that has resulted in good stock selection and a focus on where growth in the world is occurring, which helped us a lot in ’07 but is again part of a process that we have employed for many number of years.

Jeffrey Hopson – Stifel, Nicolaus & Co.

Okay, great. Thank you.

Operator

Thank you. Next question comes from William Katz with Buckingham Research. Please go ahead.

William Katz – Buckingham Research

Okay. Thank you. Good morning. Just a couple questions. Just starting with the margin discussion for a moment. It looks to me as if the booming flows are sort of coming at the expense of margins, which fell about 120 basis points sequentially and just continued to trend lower. I think if I recall correctly, and maybe you’re tempering your comments based on what you said on conversation, but it sounded like you thought that margins were probably bottoming in the third quarter and would sort of gradually move higher. I was just sort of wondering if you could maybe give us an update on your thinking on margins and, within that, just sort of how you expect the professional conversation to relate to investment advisory fees. Thank you.

Henry J. Herrmann

Well, I don’t think we anticipated that we were going to have so much sales success in the fourth quarter, Bill. So I think that we’re very proud of the sales level we accomplished in the third quarter only to be well outdone in the fourth quarter. So that’s put the additional pressure on the margin and the comments we made about we should be sort of bottoming out depends very much on the volume of these sales because we have to pay for those $4 billion of assets we acquired in the fourth quarter in the wholesale channel are paid at the time of acquisition. So it’s like buying a small money manager and expensing it.

William Katz – Buckingham Research

Just to follow up on that point, are you now at a point given the actual AUM though that if sales were to moderate you could actually see margins go higher or does the ongoing investment spend to the wholesale as in support, etcetera, continue to eat into some of that potential market recapture.

Henry J. Herrmann

So what’s your market action forecast, Bill, and I’ll answer your question.

William Katz – Buckingham Research

Well, let’s assume 7% from here.

Henry J. Herrmann

If sales stop and we get 7% market action margins will rise. But you understand, I’ve explained numerous times on various calls and with meetings with yourself and others, that there are three moving parts in the equation and if sales do this and market action does that this will happen and that will happen. We continue to work very hard to do whatever we can to control expenses and distribution. I think that’s been demonstrated in our quarterly reports for quite a long time. The one part that puts pressure on us is sharp sales growth and, as the TV commercial says, that’s a good thing, not a bad thing.

William Katz – Buckingham Research

Okay. Second question I have just in terms of capital management, given what appears to be about a 3.5% dilution impact, if I’ve done the math correct, in terms of the new option grants and having a full-year impact, any thoughts or changes in sort of capital management as a move to potentially offset that dilution?

Henry J. Herrmann

First of all, it was not new option grants. The exercising of existing grants and recognize, please, that those related to catch up option grants that were made at the time of our IPO from separation from our previous parent. So the size of the expirations were significant and are likely to be repeated.

Two, to get to the thrust of your question, we continue to expect to use our excess cash flow to manage dilution and also to focus on things like the dividend. There will be no change in that. We did point out that the majority of the increase as a result of the option conversions that happened late in the quarter and we’ll be working on the management of dilution as the year unfolds.

William Katz – Buckingham Research

Okay. And then just sort of a final question. Just given the tremendous success you’re having, maybe more so on the global natural resources relative asset location to the thrust of my question, are there any scale issues that you’re worried about in those two products at this point in time?

Henry J. Herrmann

Let me address the first half of your question. At the present time asset strategies gross of net sales are higher than on a daily basis the gross of net sales of natural resources fund. Asset strategy fund is driving top line sales number more so than the global natural resources. About 60% to 70% of flows are coming out of asset strategy.

I would also note, this is a little bit of a step aside, but I would also note in this quarter was the first time that asset management fees grew more rapidly than sub-advice fees, which I think is an important thing to take note of.

Then there was a second part to your question. I’m sorry.

William Katz – Buckingham Research

Just overall if there’s any scale. It was really more a scale question than volume. Are there any sort of capacity constraints in either one of these flagship funds at this point in time?

Michael L. Avery

Well, I don’t think so. I have the responsibility of being one of the managers of the asset strategy fund in addition to being the CIO. The question comes up all the time. We’ve had the benefit of managing that product from a very small base. And I think the way that’s helped us is that all along we’ve looked for opportunities that would allow the fund to accommodate increasing forward. When we started managing the asset strategy fund it was $50 million 11 years ago and now it’s over $13 billion. So we seem to keep finding opportunities to match the money that we’ve been trusted with.

I guess what you wouldn’t know is that by having the full weight of the investment management staff behind us we’re able to call upon a lot of talented people who are managing other funds, the entire research department in equities and fixed income – and that’s 65 people – and as long as we keep finding opportunities we’ll be fine. I think there’s more opportunities out there, quite frankly, than we have knowledge to put to work at this point. I don’t think we’ve reached it yet.

William Katz – Buckingham Research

Okay. Thank you very much.

Operator

Thank you. Our next question comes from Craig Siegenthaler with Credit Suisse. Please go ahead.

Craig Siegenthaler – Credit Suisse

Thanks and good morning. First I’d just like to hit on the revenue yield decline. Can you give us a little more detail on the equity product mix shift about the wholesale and institutional channel and how the shift is impacting fees? And also, if you can disclose what the ROA is or the revenue (inaudible) yield on the asset strategy fund on the Pictet large cap growth mandate and have these fees actually changed over the last year?

Henry J. Herrmann

Well, the management fee on asset strategy is 58 basis points roughly. The management fee on global natural resource is just shy of 80, so 78 or 79. So that we see the mix shift as more and more of the sales are going into asset strategy you’re going to have that mix selling into it.

Craig Siegenthaler – Credit Suisse

And then on the natural resource, what percentage of that or what part of that would you actually pay back to Mackenzie?

Henry J. Herrmann

Roughly half.

Craig Siegenthaler – Credit Suisse

And then on the Pictet large cap growth mandate?

Henry J. Herrmann

I don’t think we’ve disclosed just what that would be. That wouldn’t be appropriate.

Craig Siegenthaler – Credit Suisse

Okay. And then second question. On the high level of net flows this quarter, on the wholesale front do you view net flows could become even stronger? Because the asset strategy is really taking off here. Almost $1 billion net close per month. Just wondering, have we kind of reached a plateau here or could this even start exceeding? How has January market weakness really impacted Waddell & Reed’s flows to the wholesale channel?

Thomas W. Butch

It’s Tom. There’s been no indication of a plateau at this point. The sales and asset strategy remain very strong and have accelerated a touch since the fourth quarter.

Henry J. Herrmann

The asset strategy fund has benefited, I think, as a result of volatility we’ve seen which began in the summer. And that’s been reflected in the steady sequential increase on a monthly basis, weekly basis, through this entire period. I think it’s rather remarkable that the numbers we’re experiencing occurred in a backdrop of significant outflow in the industry as a whole in equity product.

Craig Siegenthaler – Credit Suisse

Just one more question on the investment portfolio. I’m just trying to figure out what the asset mix is here. I guess my worry is in the first quarter could you get negative income from non-core investment income just because of what the opening markets have done? If you (inaudible) cap on some of your funds.

Henry J. Herrmann

Craig, as me again. I didn’t quite get that.

Craig Siegenthaler – Credit Suisse

Oh, sure. I’m wondering what your non-core investment income is. The one, you know, you actually had a very strong level in the fourth quarter due to cap industries and I’m wondering if that could go negative just because, I imagine a lot of that seed sample on some of the Waddell & Reed funds.

Henry J. Herrmann

Non-core is not an expression I understand yet. What do you mean when you say non-core?

Craig Siegenthaler – Credit Suisse

I just mean your investment portfolio. So your proprietary money that’s invested in Waddell & Reed funds.

Daniel P. Connealy

This is Dan. Most of those funds are in available for sale, so they don’t affect our income statement until we sell them or unless we get dividends on them, like we did in the fourth quarter. But they will go up and down on the balance sheet and be registered in equity. We did have strong dividends as is typical in the fourth quarter in those funds. So we do have a trading portfolio, though it’s smaller, having to do with the portfolio manager’s bonuses. That does go up and down, but it’s also matched by the equal counterweight in the compensation line.

Craig Siegenthaler – Credit Suisse

Got it. And the line I was referring to is investment and other income. And it sounds like, this line actually from my conclusion from what you just said is it probably should not go negative. It should probably turn somewhere in the $2 million to $3.5 million range where it’s kind of been previously.

Henry J. Herrmann

Yes. We have larger cash balances, so we’re earning more, but of course rates are coming down a little bit. So I hesitate to predict just what that would be for a quarter.

Craig Siegenthaler – Credit Suisse

Got it. All right. Great. Thanks a lot.

Operator

And our next question comes from Bob Glasspiegel with Langen McAlenney. Please go ahead.

Bob Glasspiegel – Langen McAlleney

Hank, this is a little bit of a tricky one to sort of communicate, but as an investment guy running an asset management company how do you balance at a point in time where you think a group has been particularly hot and has done its thing and there is strong retail demand for the product when you don’t think the asset class is particularly attractive, when do you step in to sort of tell your marketing people to slow down and not go over the cliff as some of your competitors have done that have sold some sector funds that have done well?

Henry J. Herrmann

You know, Bob, that is a tough question for you to ask me. Now, this is a culture at this shop that’s built on never forgetting it’s other people’s money ever. And we obviously, therefore, don’t have a caveat emptor attitude. Particularly in the retail channel. We are real sensitive to the point you raised and we try to communicate to people what our views are. And we do it softly because, as you understand, sometimes our views are wrong. I’ve been humbled enough that I don’t like to speak up too loudly. And that is the best way I can say it.

In the wholesale channel we’re not going to have a lot of impact no matter what we say. It’s more just a matter of thinking about the portfolios in terms of their size and whether or not the size precludes effectively managing that mandate. And we think about that in its present time we’re not particularly hung up with that question. I think we can manage our successful funds and (inaudible) them to the point where we can’t deal with their size.

Bob Glasspiegel – Langen McAlleney

There’s sort of three elements to the question: can you manage, do you have capacity? The answer is yes. The second is, do you think the group is particularly unattractive that you’re selling, and I trust you that the answer is no. I mean, I trust the answer is that you’re comfortable selling the products that you’re selling given your character. But the third question is business risk can sort of mean from over leverage to a sector. That’s one nice thing about your asset strategy fund is that you assume it’s mobile and you’re not tied to whatever (inaudible) as what’s meant as the underlying assets are. That’s a nice feature of that product.

Henry J. Herrmann

Well, we certainly think a lot about the business risk associated with having a very large percentage of total close and the wholesale channel being basically two products. We’ve been talking about that on conference calls and with people for a long time and letting everyone know how hard we’re working to try to expand the number of funds that are appreciated in the channel. Remember that a year ago almost everything that you’d talk about was global natural resources and we thought we had some products coming along that would help improve the ratio and in fact that’s occurred.

We’re just hopeful that if we keep working on it that we will see an improvement in the breadth of products that are going through our wholesalers. It is obviously a business risk. If for some reason the two styles that are working fall completely out of favour. I would make it clear, however, that asset strategy fund has the flexibility to do just about anything and go anywhere. Because of the nature of the whole organization we’re confident in a lot of different places. We manage every plain, vanilla product and lipper. As a result of that we’re pretty darn aware of whether or not it’s no longer going to be the natural resources and it’s going to be stable growth, or whether or not it’s going to be international or domestic, or whether or not it’s going to be big or small cap, etcetera. And because of that the asset strategy fund has the opportunity and the knowledge to move around. Whether or not we’re blessed with good timing on top of that is not always as assured as the first two points.

Bob Glasspiegel – Langen McAlleney

Thank you for the very thoughtful answer, Hank.

Henry J. Herrmann

I think Tom’s got a point.

Bob Glasspiegel – Langen McAlleney

Okay.

Thomas W. Butch

Bob, the only thing I would add is that there’s a pretty profound linkage between the investment organization and the wholesale organization and the direction of the investment organization is very firmly taken into account in every sales activity. That is to say, were there a strategy that the investment people did not feel good about it would not be gathering much attention on the sales side because obviously the relationship that the wholesalers create are dependent on what they sell. So that direction and that linkage really is a daily phenomenon.

The second point I would make is we do have the capacity to direct behaviour as well through compensation and have from time to time done that too.

Bob Glasspiegel – Langen McAlleney

Okay. Thank you. The memory of technology meltdowns through various funds, most funds, a lot of funds then was still in my mind. So I appreciate the thoughtful answer.

Henry J. Herrmann

As you recall, I had something to do with technology in my youth and it’s never left my mind either. I used to have hair.

Bob Glasspiegel – Langen McAlleney

Me too. Take care, Hank.

Henry J. Herrmann

Take care, Bob.

Operator

Thank you. Next question comes from Robert Lee with KBW. Please go ahead.

Robert Lee – Keefe, Bruyette & Woods

Thanks. Good morning, everyone. Hank, my first question is, can you talk a little bit about, outside of Pictet, what you’re seeing in the institutional business? Are you starting to see, I think last quarter you talked about noticing more RFP activity pick up and maybe bring us up to speed on that business?

Henry J. Herrmann

Okay. The traditional institutional channel is still slow. I don’t believe we had any material net wins. But I do think that it was slightly in positive territory in the quarter. ACF was in positive territory and has had no outflow experience now since May or June. The institutional pipeline is looking better, as I implied last time I talked to you, and it’s largely because of the large capital growth strategy which has come back into favour. I’m expecting that we will get some wins over the next three to six months. I do know that we are in two final set of material in terms of size. Other than that, there really isn’t much I can say. It’s clear that in the quarter Pictet kind of drove what happened in institutional. Again, it’s also large cap growth and so you can look at Pictet and think that other good things might follow.

Robert Lee – Keefe, Bruyette & Woods

Okay.

Henry J. Herrmann

But I have no proof.

Robert Lee – Keefe, Bruyette & Woods

Maybe in focus on Pictet a little bit. The extremely strong flow, obviously it’s got a lot of momentum there. One of the things that I always think about when it comes to kind of non-US retail, somehow it always tend to seem, if you listen to a lot of your competitors talk about their non-US retail businesses it seems to be a little bit more skittish at times. Money can move around faster. Is there anything structurally about the products that Pictet is selling that may, you know, if Pictet decides a year and a half from now that large cap growth has had its run and it’s time to do something else and you can see this big shift out, is there anything structurally that would mitigate some of that risk about the products or how they’re marketing them?

Henry J. Herrmann

Well, I think that the client base is somewhat more sophisticated than average. But the feedback I’ve gotten when our people were over on marketing trips is that they see the same sort of personality profile in Pictet’s retail business as we experience here. So I think if something were to occur to turn people off on large cap growth that we would expect to see the outflows.

Robert Lee – Keefe, Bruyette & Woods

I think last quarter you also talked about that they were maybe looking at some other products. Given the success of asset strategy is there any thoughts of borrowing that distribution? Are they interested in that product as well or anything else?

Henry J. Herrmann

I really have nothing to say specifically beyond the point I made already. There is a possibility for other products, but that’s all I can say at the moment.

Robert Lee – Keefe, Bruyette & Woods

Okay. And I guess lastly, aside from the expected increase in wholesalers, in the wholesale channel support staff there, given the strong volumes through the organization is there any need or plans to maybe step up infrastructure growth, whether it’s just to support higher volumes in the advisor channel? Do you feel you’re pretty much right sized elsewhere to handle the strong volumes?

Thomas W. Butch

This is Tom. I think as Dan mentioned previously on the wholesale side of the organization it’s principally a matter of adding internal wholesalers who on pretty much a one-to-one basis will support the external wholesalers. So infrastructurally that’s the item of significance on that side. On the advisors channel we talked in the past about the fact that we’re adding a new brokerage capability and there will be some staffing around that, but not at a level which I would judge to be material to the advisors channel.

Daniel P. Connealy

On our operating departments we do have some pressure from the side flows and have added some positions and plan on it, but not a significant number.

Robert Lee – Keefe, Bruyette & Woods

All right. Great. Congratulations on the strong close.

Henry J. Herrmann

Rob, this is Hank back. I still think that we’ll be able to keep the growth rate and expenses in retail and wholesale distribution in segment that we control below the growth rate of production. We’ve modelled for that and I expect that it will work out that way. You reminded me that, I should note that the U&D margin in the advisors channel, which I think we reported to you, continued to improve. Part of that was because of higher levels of production but also in part because of, again, expense management. And I think that’s something that we’ve been talking about trying to get that back to a break-even and possibly even a surplus position. We’re headed in the right direction on that side of it.

On the wholesale side it’s just one of those things that went around so fast that even though we can control part of it we’re going to continue to have some margin experience that’s not helpful. If you give me good market action we’re going to see the benefits of the larger assets and we will see some improved margin.

Robert Lee – Keefe, Bruyette & Woods

Great. Thanks a lot and congratulations on the strong flows.

Operator

Thank you. Our next question comes from Cynthia Mayer with Merrill Lynch. Please go ahead.

Cynthia Mayer – Merrill Lynch

Hi. Good morning. Let’s see. Just a couple of questions. It seems like in the past you’ve had a seasonal bump up in sales in the advisors channel in 1Q, but I’m just wondering, given the environment, whether you’d still expect that.

Daniel P. Connealy

Much as was the case with my comment relative to the wholesale channel where I indicated we had seen an acceleration of momentum from the fourth quarter, the same holds true in the advisors channel.

Cynthia Mayer – Merrill Lynch

Okay. Great. And on the variable annuities, it looks like sales are improving there. Can you tell me, what are the primary funds underlying those? Do you have an asset strategy version of variable annuity?

Daniel P. Connealy

We have what amounts to a parallel or cloned family of funds that attach solely to the variable products that make available in those products all the strategies that are available on a retail level. Those are the W&R target funds.

Cynthia Mayer – Merrill Lynch

So basically all of your funds are available in that format.

Daniel P. Connealy

Yeah. Give or take a couple.

Henry J. Herrmann

I know it’s probably a concentration of two or three right now that are particularly popular.

Cynthia Mayer – Merrill Lynch

Which are the popular ones?

Henry J. Herrmann

It’s not in my head. I’m not sure, Cynthia. I’ll get back to you.

Cynthia Mayer – Merrill Lynch

Okay. And just to clarify on the comp, how much of that –

Henry J. Herrmann

Cynthia, I’m being contradicted. Somebody thinks they do have the answer. Hold on a second. We’ll get back to you.

Cynthia Mayer – Merrill Lynch

It’s okay.

Michael L. Avery

They’d be similar generally to the funds that are selling on retail. Though because often you’re doing an asset allocation within a variable product you might see, for example, a higher concentration in international than would be as a percentage of, a higher concentration as a percentage of these funds than perhaps you would see of the retail funds. Because you’re doing an intra-product asset allocation.

Cynthia Mayer – Merrill Lynch

Okay. And any thoughts on head count in the advisors channel or are you still expecting sort of the seasonal decline in 1Q?

Michael L. Avery

Actually, the way I would say it is yeah, we would expect that decline in the amount of the magnitude of say a couple years ago. I think we’ve seen smoothing of that in the last couple years and as we look at it the year we’re hopeful to sustain the growth and in kind of a mid-single-digit level.

Cynthia Mayer – Merrill Lynch

Okay. And just to clarify on the comp, how much of that increase was non-recurring or catch up? Given investment performance continues to be good, particularly in asset strategy, do you feel you have to keep comp at sort of an elevated level as you look ahead?

Henry J. Herrmann

I guess we hope to continue to have those problems. The answer’s yes.

Cynthia Mayer – Merrill Lynch

Okay. And on the build out of wholesalers, is that sort of an even build out throughout the year?

Henry J. Herrmann

Yes.

Cynthia Mayer – Merrill Lynch

Great. I think that’s it. Thanks.

Operator

Thank you. (Operator Instructions). And our next question comes from Marc Irizarry with Goldman Sachs. Please go ahead.

Marc Irizarry – Goldman Sachs

Oh, great, thanks. Hank, this is a question for you. If you just assume the market is down double digits this year how is the advisory organization equipped to sort of hang on to more assets this time around than perhaps in the dot-com days? Thanks.

Henry J. Herrmann

I’m not quite sure how you meant the advisory organization. Define that for me? What do you mean?

Marc Irizarry – Goldman Sachs

Just the advisor channel business. Are you more comfortable with the product composition? Are you more comfortable with the level of technology that’s available? Is there anything inherent about the business now versus sort of in the early 2000s?

Henry J. Herrmann

Marc, I don’t have any reason to expect our redemption experience in a down market will be different than the redemption experiences we’ve had in down markets my entire career. I just think it’s the nature of the way we sell the product and the nature of our client base that our redemption rates will be very low relative to industry norms. If it drifted a little bit above 10% that would suggest to me that the market was really not too good. The worst redemption rate that I can remember annualized was in ’87 and the redemption rate didn’t get to 15%. The industry got to 30 something. So in the advisors channel I expect the same as we’ve experienced over a long period of time. The bigger question is what will we see in the wholesale channel and frankly the performance of the asset strategy fund particularly has been very, very resilient in a period of highly volatile markets. At the top of my head, let me ask Mr. Avery. Mr. Avery, are we down at this point or are we flat?

Michael L. Avery

Year to date (inaudible) year to date is about at 2%, 10%.

Henry J. Herrmann

What we’re seeing is in the volatile market we’re experiencing right now there’s a trend for that to be beneficial. The asset strategy fund as people are moving money toward what they perceive is a fund that’s structured in such a way that it can withstand a pretty good down draft.

Marc Irizarry – Goldman Sachs

Great. So the product field sounds like it’s better positioned in general than in the past. And then, this question for Tom, on the wholesale side of the equation. Think about the productivity levels. I guess you’ve got some targets in terms of where you want the wholesale organization to be. Where are sort of the productivity levels now versus where you think they’ll go. Also, can you talk a little bit about the breadth of the channels of distribution, particularly wirehouses and the independent channels, where you stand there in terms of maybe an update. Thanks.

Thomas W. Butch

You can look at productivity a number of ways. The first thing is that our wholesaler productivity relative to the industry is quite high, as you would expect with a sales force that’s still coming up the plain size wise and an asset base that’s growing quite rapidly. In terms of the expectations for growth, we expect growth to be significant this year. And your last question had to do with product mix?

Marc Irizarry – Goldman Sachs

Channel mix in terms of –

Thomas W. Butch

Channel mix. Pardon me. Channel mix last year we were particularly wirehouse-centric. Our top five distributors were wirehouses, but at the same time we had material relationships with a couple of the independents and a couple of what I guess you would still call regional.

Our emphasis, as we’ve said in the past, this year is to focus on finding out the span of distributions such that it’s a little less weighted to the wirehouse side of the world. That has been very productive for us.

Interestingly, even absent that channel specific focus on the independent side, about 20% of our flows last year came from that due in large part to success in certainly the territories, but a lot of work by our internal sales staff. So we’re not starting from zero there and ultimately we would like the mix to be better balanced between the wirehouses and the independents.

We also had about 14% of our sales last year on the RAA side, the Schwabbs, Fidelities, TDs that are our service agents in that part of the market. So while at the top of the sales charts we’re pretty wirehouse-centric we had some reasonable penetration elsewhere and we expect that to grow. And that is our goal.

Marc Irizarry – Goldman Sachs

Great. And I guess this is a question for both Dan and Tom in terms of technology on the advisor side of the equation. Publicly your indirect for advisor obviously it’s picking up. But where do you think we are in terms of spending on technology in the advisors channel and is this sort of the per advisor run rate on the indirect side to think about going forward?

Daniel P. Connealy

Well, we did wrap up this year in technology for our advisors with broad ridge platforms, so we already absorbed that. The new purging (sic) broker-dealer platform will add a layer of cost and will really depend on how many of our advisors utilize that. We don’t think it’s going to be a significant change to our overall budget though.

Thomas W. Butch

I think the purging capability, which is the brokerage platform, is directed principally at enhancing our ability to attract industry experienced advisors and maybe a little less to our existing advisors, though we’ve made it available to certain of them. I would say from the perspective of the field and field management, having made a lot of investments in financial planning technology, in asset allocation technology, and now in this brokerage platform we’ve pretty much done what we need to do.

Marc Irizarry – Goldman Sachs

Great. Thank you.

Operator

Thank you. Next question is a follow up from the line of Robert Lee with KBW. Please go ahead.

Robert Lee – Keefe, Bruyette & Woods

Thanks. Hank, I have a couple of strategy questions for you. I mean, in the past I think you had mentioned, if I look at the fixed income business, that there may be some things there that you need to think about, whether it’s fee structures or something with that, just to maybe make it a bit more competitive. I guess coupled with that, if you look down the road, in the advisor channel clearly it’s retirement savings oriented. Particularly IRA and what not. Do you feel that you have the right product mix or capabilities? If you’re looking a few years down the road as maybe more of the assets have to be converted to income producing that if you feel like there’s a longer-term risk that you can lose some assets there, is there any kind of internal initiative to try to develop new or additional fixed income or other kind of income-producing capabilities and products?

Thomas W. Butch

I just want to give a couple answers to that. If you look at a lot of the research that’s been done on where mutual fund flows are going to go in the future there’s kind of a counter-intuitive notion that fixed income products may actually be a lesser part of sales. Maybe that’s partly a function of the investment management part of the world being lesser a factor over time than perhaps the annuity people. At least now that’s the case. So when you’re looking at the retirement side we don’t feel at all vulnerable on the advisors side because of a lot of the innovations come in the form of living benefits and guarantees within the annuity world, which is one of the reasons that you’re seeing our annuity sales pick up. As people move into that retirement phase they’re looking for preservation and guarantees of it and the annuity part of the world has done a very good job of that.

In terms of the fixed income side, speaking from the marketing and not the investment perspective, I think our product complement is more than sufficient and such as in all the major categories one of the things we are doing here in the first quarter is undertaking an effort to clone into the Ivy side of the world, the wholesale side of the world a very successful global bond fund that has been in our advisors side of the world for some time managed by one of Mike’s colleagues on the asset strategy fund and another portfolio manager who’s been on that fund since its inception. So we’ll come to market, we hope, with that in the second quarter and we think that will be a good and well accepted compliment on the wholesale side of the business to the equity things that are already working.

But on the advisors side I don’t feel any vulnerability at this point to the transition from accumulation to distribution because we think we’re well situated, (a) with our fixed income products and (b) especially with our annuity products.

Robert Lee – Keefe, Bruyette & Woods

Okay. Thank you.

Henry J. Herrmann

Hold on a second, Rob. Mr. Avery has a comment, too.

Robert Lee – Keefe, Bruyette & Woods

Okay.

Michael L. Avery

I just wanted to add on to that that if you look at the performance of the fixed income funds for the last year in ’07 and on a three-year basis the performance has improved dramatically and is pretty good, even though we focused at the beginning on the equity performance. You could say the same thing last year about the fixed income performance where 58% of the assets under management and fixed income were in the top 25% of the lipper peer growth and 85% of the assets and fixed income were in the top half. On a three-year basis 23% of the top quartile 52% are in the top half.

In a year, when for the last three years when most of the fixed income world was focused on lesser quality reaching for yields we stayed with the philosophy that we’ve maintained for years and focused on quality and as a result we avoided a lot of big mistakes that the fixed income shop stepped into. I think we’ve given Tom and his group something to sell in fixed income as well. As Tom mentioned, we’re going to roll out a product in Ivy that I’m very optimistic about, as well as Tom.

Robert Lee – Keefe, Bruyette & Woods

Great. Thanks, guys.

Operator

Thank you. Our next question is a follow up from the line of William Katz of Buckingham Research. Please go ahead.

William Katz – Buckingham Research

Okay. Thanks again. Just a couple of sort of quick questions here. Hank, you mentioned, someone mentioned, I apologize, that you saw the momentum in the advisor channel continue into January. When looking across the asset classes it looks like equity is a little bit less negative and so despite fixed income in money markets. Where are you seeing the change, if you will, or the improvement on the advisory channel?

Henry J. Herrmann

Try us again because we’re not quite sure the question. Sorry.

William Katz – Buckingham Research

That’s okay. I apologize. I thought I heard someone say, I think it was Tom or Hank, yourself, say that the momentum in the advisors channel on gross sales continued to improve into the new year. And just sort of curious where you’re seeing that because is it just less negative on the equity outflows or have you shifted actually to inflows? I’m just trying to get a sense of where you’re seeing the improvement.

Thomas W. Butch

We are experiencing solid inflows across the span of products and to date the redemption experience has maybe picked up a touch year over year. But the flow experience is very strong and in a map product particularly that continues to gather a lot of momentum.

Nicole McIntosh

Bill, this is Nicole. Don’t forget that when we report on our data tables the mass sales, although all of them are reallocated to equity and fixed income, actually do come in as a sale in our money market product. So the number you’re seeing in equity as an (inaudible) experience or a lack of sales experience has more to do with the fact that the map and the spa are not put into that product from the get go.

William Katz – Buckingham Research

Okay.

Henry J. Herrmann

It’s Hank. Put it in a big picture point of view. If you look at our January year-over-year rate of change in the advisor channel it’s significantly higher this year.

William Katz – Buckingham Research

That’s helpful. And then, Hank, I’m just curious, I should have asked earlier. I apologize. On the institutional channel you talked about the sort of increase in large cap growth, maybe by inference you’re suggesting slowdowns elsewhere, but what are you seeing from the institutional consultant community as it relates to both alternative product and quant demand?

Henry J. Herrmann

The alternative product that we’re trying to get people to be interested in is, yes, a strategic one. And we’re not seeing anything in terms of quant kind of approach. One-thirty-thirty is a product that we’re still working on in terms of establishing a credible paper portfolio and we’re about a year into that.

William Katz – Buckingham Research

Well, I was actually meaning more broader. In prior calls you’ve suggested you’ve lost market share because of the interest away from large cap growth.

Henry J. Herrmann

Whoa. What I’ve suggested is we’ve lost market share in the institutional business because large cap growth has been dis-intermediated as fiduciaries transfer out what I would call plain middle product (sic) into alternative strategy, private equity and hedge funds. I think that some rethinking on the part of institutions as to how much more aggressive they want to be in those areas given events over the last nine months. But as yet that has not translated into any improvement in our business in the traditional institutional channel, although as I said earlier, the pipeline is getting better and we’ll just see if we can break that into new cap development.

William Katz – Buckingham Research

Okay. And the last one – I appreciate all the patience here. I missed what you said earlier about in the wholesale channel what your sales were in the fourth quarter excluding asset strategy and global natural resources. I think you sort of quantified or qualified some of the data.

Henry J. Herrmann

I don’t believe we mentioned that.

William Katz – Buckingham Research

All right. I thought I heard you had a certain level of flows relative ex global natural resources. Okay. Thank you.

Operator

Thank you. Next question is a follow up from the line of Cynthia Mayer with Merrill Lynch. Please go ahead.

Cynthia Mayer – Merrill Lynch

Hi. Thanks. Just very quickly. Maybe you mentioned this, but was there anything responsible for the tick up in G&A in particular and is that a good run rate?

Henry J. Herrmann

I think it was just a little higher in the quarter. We had some legal things that hit that quarter. Nothing huge and a little higher technology. So that run rate, we hope that maybe we’ll be just below that.

Cynthia Mayer – Merrill Lynch

Okay. Thank you.

Operator

Thank you. And, management, as there are no further questions, we’ll turn it back to you for closing comments.

Henry J. Herrmann

Well, we thank you all for your interest and appreciation. We look forward to talking to you again at the end of the first quarter. Thank you.

Operator

Thank you. Ladies and gentlemen, that will conclude today’s teleconference. If you would like to listen to a replay of today’s conference please dial in to 303-590-3000 or 1-800-405-2236 and enter the access code of 1110482.

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Source: Waddell & Reed Financial, Inc. Q4 2007 Earnings Call Transcript
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