Federated Hermes, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. Comparisons are to Q1 2019 unless otherwise noted. Dollar amounts below are in millions, except per-share data.
Business context and reporting period
Federated Hermes provides investment management, administrative, distribution, shareholder servicing, stewardship and related services. Period-end managed assets were $605.8 billion, up 25% year over year. The increase was led by money market assets; long-term assets were lower. The quarter included the effects of sharp market declines and volatility associated with COVID-19.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 / comparison |
|---|---|---|
| Revenue | $359.2 | $307.1; up 17% |
| Operating income | $92.7 | $70.9; up 31% |
| Operating margin | 25.8% | 23.1% |
| Net income attributable to Federated Hermes | $64.2 | $54.5; up 18% |
| Diluted earnings per share | $0.63 | $0.54 |
| Cash dividends per share | $0.27 | $0.27 |
| Cash provided by operating activities | $29.3 | $16.8 |
| Cash and cash equivalents at March 31 | $308.3 | $249.2 at December 31, 2019 |
| Long-term debt at March 31 | $195.0 | $100.0 at December 31, 2019 |
Revenue growth primarily reflected higher average money market assets and higher average equity assets. Total operating expenses rose to $266.4 million from $236.2 million, driven mainly by a $18.5 million increase in distribution expense. Nonoperating results were a net expense of $7.0 million, versus net income of $1.6 million a year earlier, largely due to $15.8 million of net securities losses. Net income also included a $7.5 million gain from remeasuring the previously held HGPE investment.
Average managed assets rose 22% to $580.2 billion. Period-end money market assets increased 42% year over year to $451.3 billion; equity assets declined 15% to $68.2 billion, primarily from market depreciation and net redemptions. Long-term assets ended at $154.5 billion, down 7%.
Material changes and capital position
- Operating cash flow improved year over year. Investing activities used $8.2 million, including $4.7 million paid for acquisitions; financing activities provided $50.4 million, principally reflecting $100 million of new borrowings, offset in part by dividends, repurchases and debt payments.
- Liquid assets, net of noncontrolling interests, were $414.0 million at March 31, compared with $359.1 million at year-end 2019. The company had $180 million available under its revolving facility and reported compliance with its covenants. Its leverage ratio was 0.4-to-1 against a maximum of 3-to-1.
- Federated Hermes acquired MEPC effective January 1 and acquired HGPE Capital Limited, gaining control of Hermes GPE, effective March 1. The HCL purchase accounting remained preliminary. HCL contributed $2.6 million of revenue and $0.3 million of net income for March, before specified adjustments and noncontrolling interests.
- Q1 share repurchases totaled approximately 714,000 shares for $16.0 million. On April 30, the board authorized an additional program for up to 3.5 million shares and declared a $0.27-per-share dividend, payable May 15, 2020.
Outlook, commentary and risks
- Management said COVID-19 had not materially affected the company’s business, operations, financial condition or cash flows as of March 31, while warning that the pandemic and market disruption could materially harm future results. More than 95% of employees were working remotely, and management reported that operations remained functional.
- Near-zero short-term rates led to voluntary money market fund fee waivers beginning in Q1; these were not material to Q1 results. Assuming asset levels and mix remain constant, management estimated a negative pretax impact of approximately $3 million in Q2. The actual impact is uncertain and depends on rates, assets, yields, expenses and arrangements with intermediaries.
- Approximately $9 million of carried interest was subject to potential clawback. Management could not estimate the amount, if any, that may need to be repaid in 2021 because it depends on fund values at year-end 2020.
- COVID-related market declines triggered an impairment indicator for certain indefinite-lived intangible assets totaling $187 million. No impairment was recorded at March 31; estimated fair value exceeded carrying value by approximately 11%. Further market declines could lead to a future impairment.
- Other key exposures include investment-market and AUM declines, currency and international risks, regulatory changes, Brexit, low money market yields and fee waivers, and reliance on intermediaries. One intermediary accounted for approximately 11% of Q1 revenue. Management stated it expects available liquid assets, operating cash flow and borrowing capacity to cover present and reasonably foreseeable cash needs. No formal earnings or revenue guidance was provided.
Important facts for investors to verify
- Whether subsequent market movements, flows and fund yields changed AUM, revenue, distribution costs or money market fee-waiver exposure after March 31.
- Final HCL acquisition accounting, including goodwill, intangible asset values and contingent consideration.
- The realization and potential repayment of the $9 million carried-interest amount subject to clawback.
- Whether further market deterioration leads to impairment of the identified intangible assets.
- Debt balances, covenant headroom, cash availability and the execution of the announced dividend and repurchase program.