Federated Investors, Inc. (now Federated Hermes, Inc.) — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. The filing was submitted under the name Federated Investors, Inc.
Business context
Federated is an investment manager whose revenue depends mainly on assets under management (AUM), asset mix, market performance, fee rates and fee waivers. Period-end managed assets were $369.7 billion, up 4% year over year. Average managed assets rose 1% to $363.9 billion. Money market assets were 72% of average AUM and generated 47% of revenue; equity and fixed-income assets generated 36% and 17%, respectively.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $272.1 million | $220.5 million | Up 23.4% |
| Operating income | $74.6 million | $59.0 million | Up 26.3% |
| Operating margin | 27.4% | 26.8% | Up 0.6 percentage points |
| Net income attributable to Federated | $45.3 million | $36.3 million | Up 24.7% |
| Diluted earnings per share | $0.44 | $0.35 | Up $0.09 |
| Cash dividends per share | $0.25 | $0.25 | No change |
Revenue growth primarily reflected a $56.6 million reduction in voluntary yield-related money-market fee waivers, partly offset by lower average fixed-income assets and a less favorable equity asset mix. Distribution expense rose $34.9 million, largely because lower waivers also reduced related distribution-cost offsets. Total operating expenses increased $36.1 million. Effective tax rate was 36.0%, compared with 37.8%.
Voluntary yield-related waivers reduced revenue by $37.5 million in Q1 2016 versus $94.1 million a year earlier. After related distribution-expense and noncontrolling-interest offsets, the negative pretax impact was $9.4 million, compared with $27.0 million.
Cash flow, liquidity and debt
- Operating cash flow was $25.6 million, versus $14.7 million. Investing activities used $4.0 million; financing activities used $46.5 million, including $26.0 million of dividends, $13.7 million of share repurchases and $6.4 million of debt repayments.
- Cash and cash equivalents ended the quarter at $147.8 million, down from $172.6 million at December 31, 2015. Management reported liquid assets, net of noncontrolling interests, of $354.7 million, versus $367.4 million at year-end.
- Total debt was $210.4 million: $25.5 million short-term and $184.9 million long-term. The $200 million revolving facility was undrawn and fully available. Federated reported compliance with its debt covenants; leverage ratio was 0.6-to-1 against a maximum of 3-to-1.
- Management believed available liquidity, operating cash flow and borrowing capacity would meet present and reasonably foreseeable needs. It did not project drawing on the revolver in the next 12 months.
Changes, outlook and significant matters
- Money market reforms require floating NAVs for institutional prime and municipal funds, and liquidity-fee/gate provisions for covered funds, by October 14, 2016. Federated planned four institutional prime funds and one institutional national municipal fund with floating NAVs, while Treasury and government funds would continue seeking a $1.00 NAV. The company said implementation and customer approvals remained subject to contingencies and regulatory developments.
- Based on then-current assumptions, management estimated a negative pretax fee-waiver impact of about $6 million in Q2 2016. Excluding a prospective customer-relationship change, a 25-basis-point increase in gross money-market yields could reduce the quarterly impact to about $2 million; a 50-basis-point increase could nearly eliminate waivers. Management also estimated the anticipated customer change could reduce pretax income by about $6 million per quarter beginning in late 2016.
- Key risks include money-market reform and low short-term rates, AUM outflows or changes in asset mix, rising regulatory and compliance costs, and customer concentration. Bank of New York Mellon and its Pershing subsidiary accounted for 16% of Q1 revenue.
- A CCM Rochester lawsuit seeks about $37 million plus attorneys’ fees. Federated said it considered a material loss remote; no loss was estimable. The filing also disclosed up to $29 million of potential employment- and incentive-related payments through 2019, subject to conditions, and $2.1 million of recorded estimated acquisition-related future consideration.
- Federated adopted new consolidation guidance in Q1, consolidating one fund and deconsolidating another; management reported no income-statement impact from adoption. A newly consolidated VIE increased reported fund investments and redeemable noncontrolling interests.
- On April 27, 2016, Federated entered an agreement to transfer its general partnership interest in Passport Research, with closing expected in Q4 2016 subject to approvals and other conditions. The arrangement includes anticipated changes to the advisory and administrative roles for the Edward Jones Money Market Fund; completion and final terms remain contingent.
- After quarter-end, the board declared a $0.25-per-share dividend payable May 13, 2016. The board also appointed J. Christopher Donahue Chairman, President and CEO.
Most important facts for investors to verify
- Subsequent AUM flows and asset mix, especially money-market assets and fixed-income redemptions.
- Actual fee-waiver levels, interest-rate changes and the timing and financial impact of the anticipated customer-relationship change.
- Execution, costs and customer effects of money-market product conversions ahead of the October 2016 compliance deadline.
- Status and economics of the Passport transaction, including required approvals and any resulting revenue or servicing changes.
- Progress of the CCM litigation, potential contingent payments, and continued liquidity and covenant compliance.