Federated Investors, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2016; unaudited interim results. The filing identifies the registrant as Federated Investors, Inc. (the company is labeled Federated Hermes, Inc. in the request metadata).
Business context
Federated was an investment manager with $367.2 billion in managed assets at June 30, 2016, up 5% year over year. Revenue is principally tied to assets under management, asset mix, fee rates, and fee waivers. Money market assets accounted for 47% of first-half revenue, compared with 31% a year earlier.
Key financial metrics
Amounts below are in millions, except per-share data and ratios.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $286.7 | $228.1 | $558.8 | $448.6 |
| Operating income | $87.7 | $69.3 | $162.2 | $128.3 |
| Operating margin | 30.6% | 30.4% | 29.0% | 28.6% |
| Net income attributable to Federated | $52.7 | $41.8 | $98.2 | $78.1 |
| Diluted EPS | $0.51 | $0.40 | $0.94 | $0.74 |
| Dividends per share | $0.25 | $0.25 | $0.50 | $0.50 |
- Cash flow: First-half operating cash flow was $89.2 million, versus $72.6 million a year earlier. Investing activities used $8.5 million, principally for property, equipment and technology; financing activities used $99.5 million. Cash and cash equivalents ended the period at $153.9 million, down from $172.6 million at year-end 2015.
- Liquidity: Liquid assets, net of noncontrolling interests, were $358.3 million at June 30, compared with $367.4 million at December 31, 2015. Management said available liquidity and expected operating cash flows were sufficient for foreseeable needs.
- Debt: Term-loan borrowings were $204.0 million, including $25.5 million classified as short-term; $12.8 million was repaid during the first half. The $200 million revolving facility was fully available. The company reported compliance with covenants; its leverage ratio was 0.6:1 against a maximum of 3:1.
- Asset mix: Period-end money market assets were $255.0 billion, equity assets $61.9 billion and fixed-income assets $50.3 billion. Equity assets rose 13% year over year, money market assets rose 5%, and fixed-income assets declined 5%.
Material changes versus prior periods
- Revenue increased 26% in Q2 and 25% for the first half; attributable net income increased 26% and 26%, respectively. Diluted EPS rose from $0.40 to $0.51 in Q2 and from $0.74 to $0.94 for the first half.
- The principal revenue driver was lower voluntary money-market yield-related fee waivers: their revenue impact declined by $62.9 million in Q2 and $119.5 million for the first half versus 2015. Higher average money market assets also contributed.
- Distribution expense rose $40.7 million in Q2 and $75.6 million in the first half, largely because lower fee waivers reduced the related distribution-expense offsets. Compensation expense also increased, mainly with sales-related incentive compensation.
- Average managed assets increased 4% in Q2 and 3% for the first half. Equity and money market assets grew, while fixed-income assets declined.
Outlook, risks and unusual items
- Fee-waiver outlook: Based on then-current market conditions and assuming asset levels and mix stayed constant, management estimated a negative pretax impact from yield-related waivers of about $4 million in Q3 2016. A 25-basis-point increase in gross yields on money-market portfolio purchases was estimated to reduce that impact to about $1 million per quarter; a 50-basis-point increase could nearly eliminate waivers. These estimates were subject to market, asset-mix and customer factors.
- Management expected a customer-relationship change to reduce pretax income by approximately $6 million per quarter beginning in late 2016. The filing also cautions that waivers could continue if short-term rates remained low.
- Money-market reforms required institutional prime and municipal funds to move to floating NAVs, and introduced liquidity-fee and redemption-gate provisions, by October 14, 2016. Federated planned four institutional prime funds and one institutional national municipal fund with floating NAVs, while continuing stable-NAV Treasury, government and designated retail offerings. Management said regulatory response, product changes and compliance work could materially affect expenses, flows and results.
- Other material uncertainties included the Department of Labor fiduciary rule, proposed SEC liquidity and derivatives rules, European money-market reform, Brexit-related uncertainty, and potential changes in investor preferences or intermediary relationships. One intermediary generated approximately 15% of revenue in both Q2 and the first half.
- Unusual items: Q2 included $3.5 million of insurance proceeds, primarily recorded as a reduction in professional service fees, and a $1.6 million impairment charge on two available-for-sale investments. The SEC settled a proceeding with a subsidiary for a $1.5 million penalty; the order found inadequate policies concerning an outside consultant, but no misuse of material nonpublic information. The company said the matter was not material.
- Contingencies: In the CCM Rochester litigation, the plaintiff sought approximately $37 million plus attorneys’ fees. The court excluded the plaintiff’s expert evidence; Federated filed for summary judgment and said a material loss was remote, with no loss estimable. Potential compensation-related payments under employment and incentive arrangements could total up to $31 million through 2019, subject to asset levels and performance goals.
- The board declared a $0.25-per-share dividend on July 28, payable August 15, 2016. Management reported no goodwill impairment indicators at June 30 and no material change in market-risk exposure during the first half.
Important facts for investors to verify
- Whether money-market yields, asset levels and product mix develop as assumed in management’s fee-waiver estimates, and whether the projected customer-relationship impact occurs.
- Actual customer and asset-flow effects of the October 2016 money-market reforms, including floating-NAV adoption, liquidity fees and redemption gates.
- The sustainability of revenue and earnings growth after accounting for lower waiver-related offsets to distribution expense and the one-time insurance proceeds.
- Developments in the CCM Rochester case, the auditor-independence risk disclosure, and any further regulatory or compliance costs.
- Debt repayment requirements, continued covenant compliance, and the use of cash for dividends and share repurchases; the company repurchased $41.0 million of stock in the first half.