Federated Investors, Inc. — FY 2017 Form 10-K
The filing is for the fiscal year ended December 31, 2017, with unaudited fourth-quarter results also presented. The registrant’s name in this filing is Federated Investors, Inc.; it is not identified as Federated Hermes in the filing. Federated is an investment manager whose revenue is primarily based on assets under management (AUM) and fees for advisory, administrative, distribution and related services.
Financial and operating performance
| Metric | FY 2017 | FY 2016 | Change |
|---|---|---|---|
| Total revenue | $1,102.9 million | $1,143.4 million | Down 4% |
| Operating income | $341.5 million | $335.7 million | Up 2% |
| Operating margin | 31.0% | 29.4% | Up 1.6 percentage points |
| Net income attributable to Federated | $291.3 million | $208.9 million | Up 39% |
| Diluted EPS | $2.87 | $2.03 | Up $0.84 |
| Net cash from operating activities | $270.4 million | $252.8 million | Up $17.6 million |
- Period-end AUM grew 9% to $397.6 billion. Average AUM rose 1% to $366.4 billion.
- Year-end AUM by asset class: money market $265.2 billion, equity $68.1 billion and fixed income $64.2 billion. Average money-market AUM declined 3%; average equity and fixed-income AUM increased 11% and 8%, respectively.
- Equity and fixed-income funds had net redemptions of $3.7 billion; equity and fixed-income Separate Accounts had net sales of $10.2 billion. Asset growth also reflected market gains.
- Revenue was pressured by money-market asset mix and a customer-relationship change, partly offset by reduced fee waivers and higher average equity and fixed-income assets. Total operating expenses declined 6%, including lower distribution and compensation expenses.
- Cash and cash equivalents were $316.3 million at year-end; management reported liquid assets, net of noncontrolling interests, of $392.6 million. Federated had $170.0 million of long-term debt and $205 million available under its revolving facility. It reported compliance with debt covenants and a leverage ratio of 0.4 to 1.
- Cash used in financing was $176.9 million, including $101.5 million in dividends, $48.6 million in share repurchases and $21.3 million in debt payments. The regular dividend was $1.00 per share for 2017; the 2016 total of $2.00 included a $1.00 special dividend.
Fourth quarter and material changes
Fourth-quarter 2017 revenue was $278.3 million and operating income was $90.8 million. Net income attributable to Federated was $131.8 million, or $1.31 per diluted share. Fourth-quarter and full-year earnings included a $70.4 million tax benefit, adding approximately $0.70 to fourth-quarter EPS and $0.69 to full-year EPS. Excluding this one-time deferred-tax remeasurement, reported net income and EPS growth would have been materially lower.
Revenue fell 4% for the year despite higher period-end AUM. AUM composition shifted: money-market assets contributed 41% of revenue, down from 45% in 2016, while equity assets contributed 42%, up from 38%. Voluntary yield-related money-market fee waivers had a net pretax impact of only $0.8 million in 2017, compared with $22.0 million in 2016; the December 2017 rate increase eliminated the need for these waivers, according to management.
Outlook, risks and contingencies
- The Tax Cuts and Jobs Act reduced the federal corporate tax rate to 21%. Management estimated a combined federal, state and local tax rate of approximately 24% to 25% for 2018 and expected the tax-rate reduction to materially affect results and cash flows. The $70.4 million 2017 tax benefit was provisional and could be adjusted as guidance emerged.
- Management stated it expected sufficient liquidity for foreseeable needs, considering operating cash flows, cash and investments, and borrowing capacity. The credit facility expires in June 2022; borrowings bear variable-rate interest.
- Management noted that the Federal Reserve had signaled further rate increases for 2018. Higher rates could reduce fee waivers and support money-market yields, but may also prompt investors to move from funds into direct investments, lower fixed-income asset values or increase market volatility. Future fee waivers and their effects remain uncertain.
- Regulatory requirements and uncertainty—including U.S. money-market and fiduciary rules, liquidity-risk requirements, and European money-market reforms—could raise compliance costs, change product structures and distribution, and affect AUM, revenue and operating income. Brexit and a possible financial transaction tax were also identified as uncertainties.
- Key risks include reliance on AUM and fee rates, revenue concentration in certain strategies and intermediaries, investment performance, fund redemptions, competition, cybersecurity and third-party operational risks. One intermediary accounted for approximately 16% of 2017 revenue; the Strategic Value Dividend strategy accounted for approximately 18%.
- Federated disclosed ordinary-course claims but did not believe a material loss was reasonably possible as of year-end. It reported no material off-balance-sheet arrangements and no goodwill impairment indicators. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Assess earnings and EPS excluding the $70.4 million tax benefit, and monitor the final accounting and tax treatment.
- Track AUM flows and mix, especially continued money-market fund trends, equity-fund redemptions and Separate Account sales.
- Monitor the large intermediary and strategy revenue concentrations, including changes in customer relationships or investment performance.
- Review the effects of rising rates on fee waivers, money-market asset retention, yields and distribution costs.
- Follow regulatory implementation, compliance spending, product changes and potential effects of European reforms and Brexit.
- Confirm debt balances, variable interest costs, facility availability, capital returns and the company’s ability to sustain liquidity under adverse market or redemption conditions.