Federated Hermes, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Federated Hermes provides investment management, administrative, distribution, stewardship and real estate development services. Unless stated otherwise, dollar amounts below are in millions.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $364.5 | $340.3 | $1,084.4 | $968.9 |
| Operating income | $113.4 | $89.3 | $303.4 | $245.1 |
| Operating margin | 31.1% | 26.2% | 28.0% | 25.3% |
| Net income attributable to Federated Hermes | $85.8 | $73.0 | $231.2 | $190.2 |
| Diluted EPS | $0.85 | $0.72 | $2.29 | $1.88 |
| Dividends per share | $0.27 | $0.27 | $0.81 | $0.81 |
Revenue rose 7.1% in Q3 and 11.9% for the first nine months year over year. Operating income increased 27.0% and 23.8%, respectively; net income increased 17.6% and 21.5%. Revenue growth reflected higher average money market and fixed-income assets and inclusion of HCL’s results following its acquisition. Q3 operating expenses were essentially flat year over year; lower distribution expense, including offsets to money-market fee waivers, helped margins expand.
- Cash flow: Nine-month operating cash flow was $243.5 versus $212.3 in 2019. Investing activities used $18.5; financing activities used $141.8. Cash and cash equivalents were $322.8 at September 30, 2020.
- Debt and liquidity: Long-term debt was $90.0, down from $100.0 at year-end 2019. The $375 million revolving facility had $285 million available; the company reported compliance with covenants and leverage of 0.2:1. Management reported net liquid assets of $457.5, after noncontrolling interests, and expects sufficient liquidity for foreseeable needs.
- Assets under management: Period-end managed assets were $614.8 billion, up 17% year over year. Money market assets rose 21% to $433.0 billion and fixed-income assets rose 21% to $79.5 billion; equity assets were essentially unchanged at $80.4 billion. Nine-month average managed assets increased 24% to $615.0 billion.
Material changes and notable items
- Very low short-term rates prompted voluntary money-market yield fee waivers. For Q3, waivers were $36.8 million, partly offset by $33.0 million of lower distribution expense, for a $3.8 million net pretax impact. Nine-month amounts were $56.9 million, $51.0 million and $5.9 million, respectively.
- Management estimated that, assuming asset levels and mix remained constant, Q4 2020 yield waivers could have an approximately $9 million negative pretax impact. Actual results may vary with rates, assets, expenses, and intermediary arrangements.
- HCL, a UK infrastructure and private-equity manager, was acquired effective March 1, 2020; MEPC, a UK real estate development business, was acquired effective January 1. Purchase accounting remained preliminary. HCL contributed $23.2 million of revenue and $7.0 million of net income for its seven months included in the nine-month period, before acquisition-related intangible amortization and noncontrolling interests.
- The board declared a subsequent $1.27-per-share dividend: the regular $0.27 quarterly dividend plus a $1.00 special dividend, payable November 13, 2020. Management estimated the special dividend would reduce Q4 diluted EPS by approximately $0.01–$0.02 under the two-class EPS method.
Outlook, risks and contingencies
- Management said COVID-19 had not materially affected the company’s financial condition or cash flows through September 30, while noting continuing economic and market uncertainty. More than 95% of employees were working remotely; a significant return to U.S. offices was delayed until mid-February 2021.
- Results remain sensitive to market values, asset flows and mix, fee rates, customer relationships, and near-zero or potentially negative rates. Higher money-market assets supported revenue, but their lower fee economics and fee waivers can pressure revenue yield and earnings.
- Approximately $11 million of previously recorded carried interest was subject to clawback. Management estimated no clawback based on September valuations, but said a repayment in 2021 could occur and could be material depending on year-end asset values.
- The estimated fair value of certain indefinite-lived Hermes acquisition intangibles exceeded carrying value by less than 5% at September 30. Management planned the annual impairment test for Q4; lower projected cash flows or growth, or a higher discount rate, could increase impairment risk.
- Regulatory changes and scrutiny, including possible money-market-fund reforms, Brexit-related changes, ESG and fiduciary requirements, and the LIBOR transition, could increase costs or affect products, flows and revenues. The company also cited operational, cybersecurity and remote-work risks. It reported no material loss reasonably possible from ordinary-course legal claims or indemnifications at the reporting date.
- For one fixed-income separate account, reported nine-month sales and redemption flows were corrected; redemptions increased by $390 million, sales decreased by $1.1 billion, and market gains increased by $1.5 billion. Total account assets were not affected.
Investor verification priorities
- Track money-market yields, future fee-waiver levels, intermediary expense offsets and the resulting net earnings impact.
- Verify whether AUM growth persists and whether asset mix, flows and fee rates support revenue growth.
- Review the final HCL and MEPC purchase-price allocations, contingent consideration and acquisition contribution to results.
- Monitor year-end asset valuations for possible carried-interest clawback and the Q4 impairment test for Hermes intangibles.
- Assess liquidity and capital returns after the $1.00 special dividend, alongside buybacks, debt repayment and the company’s stated borrowing capacity.
- Follow regulatory developments, Brexit and LIBOR transition costs, and any material changes to operational or cybersecurity risk.