Federated Hermes, Inc. — Q2 2020 Form 10-Q
Business context and reporting period. Federated Hermes provides investment management, administrative, distribution, stewardship and real estate development services. This unaudited filing covers the quarter and six months ended June 30, 2020; comparisons are with the corresponding 2019 periods. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $360.7 | $321.5 | $719.9 | $628.5 |
| Operating income | $97.3 | $84.9 | $190.0 | $155.8 |
| Operating margin | 27.0% | 26.4% | 26.4% | 24.8% |
| Net income attributable to Federated Hermes | $81.2 | $62.7 | $145.4 | $117.3 |
| Diluted EPS | $0.80 | $0.62 | $1.44 | $1.16 |
| Cash dividends per share | $0.27 | $0.27 | $0.54 | $0.54 |
- Revenue drivers: Money market revenue rose with higher average assets; Q2 revenue also benefited from $6.7 million more performance fees and consolidation of the acquired HGPE business. Lower average equity assets partly offset gains. Revenue-to-average-assets ratio for the first half declined to 0.24% from 0.26%, reflecting the greater money-market asset mix.
- Costs and earnings: Operating expenses increased to $263.5 million in Q2 from $236.5 million, including higher compensation and distribution costs. Q2 nonoperating income included a $13.8 million net securities gain, compared with $0.6 million a year earlier. First-half net securities results were a $2.0 million loss versus a $2.3 million gain in 2019; the first half also included a $7.5 million gain from remeasuring the prior HGPE investment.
- Assets under management: Period-end managed assets were $628.8 billion, up 25% year over year. Money market assets increased 37% to $457.6 billion; long-term assets rose 1% to $171.2 billion. Q2 average managed assets increased 29%, led by a 45% increase in average money market assets.
- Cash flow and liquidity: Six-month operating cash flow was $153.4 million, versus $112.4 million. Investing activities used $13.9 million and financing activities used $97.4 million. Cash and cash equivalents were $277.8 million at June 30. Management reported $412.3 million of liquid assets, net of noncontrolling interests.
- Debt and capital: Long-term debt was $90 million, down from $100 million at December 31, 2019; $285 million remained available under the revolving facility. The company reported compliance with debt covenants. It paid $54.6 million of dividends and repurchased approximately 1.6 million shares for $34.1 million during the first half; about 3.0 million shares remained authorized for repurchase at June 30.
Material changes, outlook and risks
- Federated Hermes acquired HGPE, an infrastructure and private equity investment manager, effective March 1, 2020, and MEPC, a UK real estate development business, effective January 1, 2020. Purchase accounting was preliminary. HGPE contributed $11.3 million of revenue for its four months included in the first half; acquisition activity affects period comparability.
- Near-zero short-term rates prompted money-market fee waivers to support positive or zero fund yields. For Q2, waivers were $20.0 million, largely offset by $18.0 million in lower distribution expense, for a net pretax impact of $2.0 million. Management estimated a negative pretax impact of approximately $4 million in Q3 if asset levels and mix remained constant and based on then-current expected conditions; actual results could vary materially.
- Management said COVID-19 had not materially affected the company’s financial condition or cash flows as of June 30, while warning that continued market volatility, asset declines, outflows, low or negative rates, additional waivers and business disruption could adversely affect revenue and earnings. More than 95% of employees were working remotely; the company reported remaining operational.
- Approximately $10 million of carried interest was subject to potential clawback in 2021 based on year-end fund valuations. The recorded estimated liability was immaterial, but management said the estimate could change materially. Certain indefinite-lived intangible assets had fair value only about 11% above carrying value in impairment analyses; further deterioration could lead to impairment.
- Revenue concentration is a risk: money market assets represented 43% of first-half revenue, and one intermediary accounted for approximately 10% of first-half revenue. The filing also describes regulatory, Brexit, LIBOR-transition and other market uncertainties whose effects could not yet be fully assessed. Management stated it expected available liquidity and financing capacity to cover foreseeable cash needs.
- The board declared a $0.27-per-share dividend on July 30, payable August 14, 2020. No broader earnings or revenue guidance is provided in the filing.
Investor verification priorities
- Track money market asset levels, short-term yields, fee waivers and their offset by distribution-cost reductions, including actual Q3 impact versus the approximate $4 million estimate.
- Separate organic asset flows and performance from market movements, product mix and the HGPE/MEPC acquisitions when assessing revenue and AUM growth.
- Review subsequent fund valuations and any carried-interest clawback, plus impairment testing of the indefinite-lived intangible assets.
- Monitor concentration in money market products and key intermediaries, as well as debt-facility availability, buybacks and dividend payments.
- Assess whether COVID-19, regulatory changes, Brexit and the LIBOR transition materially alter asset flows, costs, operations or liquidity after the reporting date.