Waddell & Reed Financial Inc. ( WDR - Analyst Report ) reported adjusted second-quarter earnings of 52 cents per share, missing the Zacks Consensus Estimate by a penny. However, this compares unfavorably with earnings of 55 cents in the prior quarter and 58 cents in the prior-year quarter.

After considering an impairment of certain capitalized software development costs, net income for the reported quarter came in at $41.7 million, down 12.0% sequentially and 16.5% year over year.

Results, on a year-over-year basis, were adversely impacted by lower operating revenues and higher expenses. Further, gross sales across all the revenue channels, except Advisory channel decreased. Nevertheless, stable assets under management (AUM) and solid balance sheet were among the positives.

Performance in Detail

Waddell & Reed’s operating revenues for the reported quarter were $308.2 million, up 0.5% from $306.6 million in the prior quarter but down 0.6% from $309.9 million in the year-ago quarter. Further, operating revenues lagged the Zacks Consensus Estimate of $314.0 million.

Overall, gross sales fell 10.4% sequentially and 5.2% year over year to $5.5 billion. Redemptions were $5.6 billion, up from $5.0 billion in the prior quarter and $4.3 billion in the year-ago quarter. Inflows deteriorated significantly from $1.3 billion in the prior quarter and $1.7 billion in the prior-year quarter to $376 million.

At the Advisors channel, revenues grew 4.0% sequentially and 7.9% year over year to $79.8 million. Gross sales for the quarter were $1,046 million, up 1.6% from $1,030 million in the prior quarter and 3.5% from $1,011 million in the year-ago quarter. Net inflows were $183 million compared with $158 million in the first quarter of 2012 and $25 million in the second quarter of 2011.

At the Wholesale channel, revenues dipped 1.1% from the prior quarter and 5.0% from the prior-year quarter to $60.2 million. Similarly, gross sales decreased 12.8% from the prior quarter and 8.2% from the year-ago quarter to $3.9 billion. Net inflows also drastically plummeted from $970 million in the prior quarter and $1.8 billion in the prior-year quarter to $626 million.

Gross sales at the Institutional channel were $567 million, down 13.0% from $652 million in the prior quarter and 2.0% from $556 million in the year-ago quarter. Net outflows during the quarter were $433 million compared with net inflow of $175 million in the prior quarter and net outflows of $125 million in the year-ago quarter.

Waddell & Reed’s operating expenses (excluding the abovementioned charge) increased 0.3% sequentially and 1.6% year over year to $234.7 million. Both sequential and year-over-year increases were primarily due to higher underwriting and distribution expenses.

Operating margin (adjusted) was 23.9% in the reported quarter compared with 23.7% in the prior quarter and 25.5% in the prior-year quarter.

As of June 30, 2012, AUM totaled $89.1 billion compared with $93.8 billion as of March 31, 2012 and $91.7 billion as of June 30, 2011.

Balance Sheet

As of June 30, 2012, cash and cash equivalents and investment securities were $505 million. Moreover, long-term debt totaled $190 million.

Our Viewpoint

Waddell & Reed’s sustained growth and history of boosting shareholders’ value through dividend hike and share repurchase activities are impressive. However, persistently volatile equity markets and significant intangibles on its balance sheet are expected to mar profitability in the upcoming quarters.

Though we remain optimistic considering the competitive ranking of Waddell & Reed’s funds and its efforts to control cost in the upcoming quarters, irregular investment performance and rising competition obscure our outlook.

Waddell & Reed currently retains a Zacks #4 Rank, which translates into a short-term Sell rating. However, considering the fundamentals, we also maintain a ‘Neutral’ recommendation on the stock.

One of the peers of Waddle & Reed, Eaton Vance Corp. ( EV - Snapshot Report ) is expected to announce its fiscal third quarter 2012 (ended June 30) results on August 13.