Federated Investors, Inc. (now Federated Hermes) — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019; comparisons are to the corresponding 2018 periods unless noted. Financial statement amounts below are in millions of dollars, except per-share data and AUM. The company provides investment management, administration, distribution and related services.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $340.3 | $308.6 | $968.9 | $828.5 |
| Operating income | $89.3 | $81.9 | $245.1 | $242.3 |
| Net income attributable to Federated | $73.0 | $59.6 | $190.2 | $158.8 |
| Diluted EPS | $0.72 | $0.59 | $1.88 | $1.57 |
| Operating margin | 26.2% | 26.5% | 25.3% | 29.3% |
| Net margin attributable to Federated | 21.4% | 19.3% | 19.6% | 19.2% |
- Revenue drivers: Q3 revenue rose 10%, led by a $37.0 million increase in money-market revenue as average money-market assets grew. Nine-month revenue increased 17%; the increase reflected $96.4 million of additional Hermes activity in the first half compared with the prior-year consolidation period, and $74.0 million of higher money-market revenue.
- Expenses and earnings: Q3 operating expenses rose $24.3 million, principally from distribution costs on money-market assets (+$15.9 million) and compensation (+$9.2 million). Nine-month expenses increased $137.6 million, including $93.2 million from Hermes activity in the first half and higher distribution costs. Q3 net income rose 22%; nine-month net income rose 20%.
- Cash flow: Nine-month operating cash flow was $212.3 million, versus $88.7 million. Investing activities used $66.3 million and financing activities used $101.4 million. Cash and cash equivalents were $196.5 million at September 30, 2019, up from $156.8 million at year-end 2018. Management’s liquid-assets measure, net of noncontrolling interests, was $335.4 million, versus $222.1 million at year-end.
- Debt and liquidity: Long-term debt was $120.0 million, down from $135.0 million at December 31, 2018. The revolving facility had $255 million available; the company reported covenant compliance, a 79-to-1 interest coverage ratio against a 4-to-1 minimum, and a 0.3-to-1 leverage ratio against a 3-to-1 maximum. Management believes existing liquid assets, operating cash flow and borrowing capacity are sufficient for foreseeable needs.
- Dividends and capital: Dividends paid during the first nine months totaled $81.9 million ($0.81 per share). The board declared a further $0.27-per-share dividend on October 24, payable November 15, 2019. The company repurchased approximately 0.2 million shares for $4.1 million in the first nine months.
Material changes and operating context
- Period-end managed assets were $527.2 billion, up 21% year over year. Money-market assets grew 36% to $359.3 billion; long-term assets declined 3% to $167.9 billion. Average managed assets increased 19% in Q3 and 22% year to date.
- Growth was concentrated in money markets; equity and alternative/private-market assets fell 4% and 8%, respectively, at period end. Long-term assets recorded $4.5 billion of net redemptions in the first nine months, partly offset by market gains.
- The Hermes acquisition, consolidated from July 1, 2018, materially affects year-over-year comparisons, particularly for the first half of 2019. Hermes contributed $145.9 million in revenue and $5.5 million in net income for the nine months of 2019, before acquisition-related intangible amortization and noncontrolling interests.
- The company adopted lease accounting on January 1, 2019, recognizing $102.5 million of right-of-use assets and $122.6 million of lease liabilities at September 30. Management said adoption did not materially affect results or cash flows.
Outlook, commentary and risks
- The filing gives no specific revenue, earnings or AUM guidance. Management expects cash needs to include compensation, distributions, dividends, debt repayment, acquisitions, technology and compliance spending, and product development. It expects regulatory-related costs may continue to rise.
- Revenue depends on market levels, asset flows and mix, fee rates and investor demand; managed assets can generally be withdrawn without advance notice. Money-market fund yields, fee waivers and product mix can affect revenue and profitability. Fee waivers were $110.2 million in Q3 2019 and $310.7 million for the first nine months, compared with $89.3 million and $264.9 million in 2018, respectively.
- Regulatory change may raise costs or affect products, intermediary platforms, flows and asset mix. Management cited uncertainty around U.S. money-market and fiduciary rules, European regulation and Brexit. It said Brexit had not significantly affected the business as of September 30, but its potential impact remained uncertain.
- Revenue concentration is a risk: one intermediary generated approximately 11% of revenue in both Q3 and the first nine months of 2019. Three named strategies/funds each accounted for 9%–11% of nine-month revenue. Management cautioned that a significant, prolonged decline in those assets or a negative change in the intermediary relationship could adversely affect revenue.
- Nonoperating results included private-equity carried-interest income. Nine-month 2018 results included a $29.0 million loss on currency forwards related to the Hermes acquisition, making the year-over-year nonoperating comparison favorable in 2019. In Q3 2019, currency and investment hedges also generated reported losses.
- Management did not believe material losses from ordinary-course legal claims or indemnifications were reasonably possible. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether continued money-market asset growth offsets weaker flows or declines in long-term asset classes, and how changing rates affect money-market yields, fee waivers and margins.
- How much reported growth reflects underlying performance and flows versus Hermes consolidation and other comparison effects; track Hermes profitability and the redeemable noncontrolling interest.
- Whether elevated expense growth—especially distribution, compensation, technology and regulatory-compliance costs—limits operating leverage.
- Liquidity and capital allocation: cash generation, debt repayment, facility availability, dividends and repurchases, alongside acquisition and lease commitments.
- Developments in regulation and Brexit, as well as dependence on the significant intermediary and revenue-concentrated strategies/funds.