Federated Investors, Inc. — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010; compared with the corresponding 2009 periods. The filing’s registrant is Federated Investors, Inc. (the company named in the request is Federated Hermes, Inc.). Federated was an investment manager with $336.8 billion in managed assets at quarter-end.
Financial performance
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Revenue | $231.5 million | $306.9 million | $464.5 million | $617.5 million |
| Operating income | $83.9 million | $88.1 million | $155.7 million | $148.1 million |
| Net income attributable to Federated | $47.7 million | $53.3 million | $89.7 million | $88.4 million |
| Diluted EPS | $0.46 | $0.52 | $0.85 | $0.86 |
| Operating margin, calculated | 36.2% | 28.7% | 33.5% | 24.0% |
- Q2 revenue fell 25%; six-month revenue also fell 25%. Lower money-market assets and substantially higher fee waivers were the main pressures, partly offset by growth in equity and fixed-income assets.
- Q2 operating income declined about 5% and net income about 11%. Six-month operating income rose about 5% and net income about 1%, despite the revenue decline, reflecting lower expenses and a $25 million insurance recovery recognized in Q2.
- Operating margins above are calculated from reported revenue and operating income. The insurance recovery reduced reported expenses, including professional-service fees; Q2 professional-service expense was a credit of $9.9 million.
- Cash provided by operations was $99.7 million for the first half, versus $112.7 million in 2009. Investing used $91.5 million and financing provided $107.3 million. Cash and cash equivalents ended June at $205.9 million, versus $90.5 million at year-end 2009.
- At June 30, total assets were $1.067 billion and total liabilities $617.5 million. Recourse debt was $425.0 million and nonrecourse debt $8.9 million. The $200 million revolving facility was fully available; the company reported covenant compliance.
- Liquid assets, as defined by management, were $301.3 million at June 30, compared with $141.6 million at December 31, 2009.
Material changes and business developments
- Period-end managed assets declined 16% year over year to $336.8 billion. Average managed assets fell 19% in Q2 and 15% for the first half. Period-end money-market assets decreased 25%, while fixed-income assets rose 33% and equity assets 2%.
- Money-market assets accounted for about 50% of first-half revenue, down from 70% a year earlier. Equity assets generated 32% of first-half revenue and fixed-income assets 17%.
- Fee waivers to maintain positive or zero money-market fund yields totaled $127.8 million in the first half, partly offset by $97.0 million of lower distribution expenses, for a net operating-income impact of $30.8 million. The comparable 2009 net impact was $10.7 million.
- Federated amended and restated its term loan as a five-year, $425 million facility maturing April 1, 2015. A forward-starting swap fixes the loan rate at 4.396%; its June 30 fair-value liability was $11.8 million. A $25 million insurance recovery for legal-related costs was recognized in Q2. A $7.0 million impairment charge was recorded for certain acquired intangible and fixed assets.
- First-half dividends paid totaled $179.2 million, or $1.74 per share, including a $1.26 special dividend and regular quarterly dividends. The board subsequently declared a further $0.24 per-share dividend, payable in August.
Outlook, risks and contingencies
- Management expected money-market fee waivers and related distribution-expense reductions to continue through the remainder of 2010 and likely be material. Assuming market conditions and asset levels remained constant, it estimated a net operating-income impact of approximately $11–$12 million in Q3. Higher short-term rates could reduce the impact; the amount remained uncertain.
- On July 16, 2010, after quarter-end, Federated agreed to acquire SunTrust’s money-market management business, involving $17 billion in assets as of May 31. Upfront payments could reach $8.75 million, and contingent payments were estimated at about $30 million over five years at those asset levels. The transaction was subject to customary approvals and fund-consent processes.
- Key exposures include prolonged low short-term rates, money-market asset outflows or regulatory changes, market declines, investment performance, client and intermediary concentration, and the ability of money-market funds to maintain a stable $1.00 NAV. One intermediary generated 12% of first-half revenue; one sponsored fund generated about 12%.
- Market-timing and late-trading litigation had a preliminary settlement awaiting final court approval, scheduled for Q4 2010. Excessive-fee litigation remained pending; plaintiffs sought return of advisory fees and other damages. An unfavorable outcome could materially affect financial results or liquidity. First-half legal, regulatory and compliance costs were $6.5 million.
- Potential acquisition-related contingent payments included up to $99.5 million for the Prudent Bear acquisition and up to $56 million for Clover Capital, subject to targets. The expected final Alliance acquisition payment was approximately $3.3 million. Management said it expected sufficient liquidity for foreseeable needs.
- The filing discussed the Dodd-Frank Act, enacted July 21, 2010, and possible future regulatory changes; their effects were not yet clear. Management also noted potential further impairment if assets under management tied to certain impaired intangibles declined by more than 30% over the following 12 months.
Important facts for investors to verify
- How reported earnings compare with results excluding the $25 million insurance recovery and considering the $7 million impairment.
- Whether money-market yields, asset levels and fee waivers track management’s Q3 estimate and full-year expectations.
- Progress, approvals, asset-transition terms and final economics of the SunTrust acquisition.
- Debt repayment, swap costs, covenant headroom, and the status and potential financial impact of the pending litigation.
- Whether asset mix and concentration trends—especially money-market assets, the identified fund and the intermediary—continue to affect revenue and margins.