Federated Investors, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. The filing identifies the registrant as Federated Investors, Inc. (the company associated with the Federated Hermes name in the request). Unaudited results are compared with Q1 2013 unless noted.
Business context
Federated managed $366.2 billion at quarter-end, primarily through investment advisory, administrative, distribution and shareholder services. Its revenue depends on assets under management (AUM), asset and product mix, fee rates, market performance and fee waivers. Equity assets generally earn higher advisory fees than money market and fixed-income assets.
Financial results and liquidity
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $211.5 million | $228.0 million | Down 7% |
| Operating income | $56.6 million | $68.2 million | Down 17% |
| Operating margin | 26.8% | 29.9% | Down 3.1 percentage points |
| Net income attributable to Federated | $35.2 million | $43.0 million | Down 18% |
| Diluted EPS | $0.34 | $0.41 | Down $0.07 |
| Cash dividends per share | $0.25 | $0.24 | Up $0.01 |
| Operating cash flow | $17.8 million | $19.8 million | Down $2.0 million |
Net cash used in investing activities was $7.1 million; net cash used in financing activities was $43.5 million. Cash and cash equivalents ended the quarter at $71.6 million, down from $104.4 million at year-end 2013. Liquid assets, net of noncontrolling interests, were $266.0 million, versus $303.2 million at year-end.
Total debt was $265.6 million ($95.6 million short-term and $170.0 million long-term), down from $276.3 million at December 31, 2013. The $200 million revolving credit facility was fully available. Debt was hedged at a 3.646% fixed rate through an interest-rate swap expiring April 1, 2015. Federated reported compliance with covenants; its leverage ratio was 0.9:1 against a maximum of 2.5:1, and interest coverage was 28:1 against a minimum of 4:1. Current assets were $300.4 million and current liabilities $186.2 million.
Changes versus the prior comparable period
- Total revenue fell $16.5 million, chiefly as higher money-market fee waivers reduced revenue by $19.4 million year over year; lower average money-market and fixed-income assets also weighed on results. Higher average equity assets partly offset the declines.
- Average managed assets declined 2% to $374.4 billion. Period-end managed assets fell 3% to $366.2 billion: money-market assets declined 6%, fixed-income assets 3%, while equity assets grew 21%.
- Operating expenses decreased 3% to $154.9 million. Distribution expense fell $9.6 million, largely reflecting offsets to fee waivers; compensation expense rose $4.9 million, including higher incentive compensation and payroll costs.
- The effective tax rate increased to 37.9% from 35.5%, partly because the prior-year rate benefited from a reduction in the capital-loss deferred-tax-asset valuation allowance.
Outlook, risks and notable items
- Money-market fee waivers: Q1 waivers reduced revenue by $106.7 million, offset by $74.3 million of lower distribution expense and $2.7 million of lower noncontrolling-interest income; the resulting negative pretax impact was $29.7 million, versus $21.7 million in Q1 2013. Management estimated an approximately $29 million negative pretax impact for Q2 2014, assuming asset levels and mix remained constant. Waivers could continue for the foreseeable future; higher short-term yields would reduce their impact.
- Regulatory exposure: Proposed U.S. money-market reforms included floating NAVs and liquidity fees/redemption gates. Management warned that floating NAV requirements or limits on amortized-cost valuation could harm the money-market business, but said the final impact could not yet be assessed. European money-market reforms and a proposed financial transactions tax were additional uncertainties.
- Asset and revenue concentration: Money-market assets generated 34% of Q1 revenue, down from 43% a year earlier. The Federated Kaufmann Fund and Federated Prime Obligations Fund accounted for 12% and 10% of revenue, respectively.
- Contingencies: Estimated remaining SunTrust acquisition contingent payments were about $5 million over two years, with actual amounts variable and not capped. Certain employment arrangements could require up to $33 million through 2018, dependent on performance goals. The company reported no material pending legal proceedings and did not consider a material loss reasonably possible.
- Capital allocation: Federated paid $26.2 million in dividends and repurchased $7.5 million of shares during Q1. The board declared a further $0.25-per-share dividend payable May 15, 2014.
- Management said existing liquid assets, expected operating cash flow and available borrowing capacity should cover present and reasonably foreseeable cash needs. It did not project drawing on the revolver in the following 12 months.
Important facts for investors to verify
- Subsequent money-market fee-waiver levels, the effect on earnings, and the timing and extent of any short-term interest-rate increases.
- Final U.S. and European money-market regulations and any systemic-risk designation or related requirements.
- Changes in AUM, net flows and revenue mix, particularly money-market outflows and whether equity-asset growth continues.
- Debt repayment, cash generation, covenant headroom and the company’s ongoing dividend and share-repurchase commitments.
- Amounts and timing of acquisition-related contingent payments and performance-based employee compensation.