Federated Investors, Inc. (Federated Hermes) — Q1 2019 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2019; compared with Q1 2018. Federated provides investment management and related services. Results include Hermes, acquired effective July 1, 2018, for the full quarter; Hermes was not included in the comparable 2018 results. Unless noted, financial amounts below are in U.S. dollars.
Period-end managed assets were $484.9 billion, up 24% year over year; average managed assets were $475.4 billion, up 19%. Growth reflected money market assets and the Hermes acquisition, alongside stronger equity markets. Long-term assets had $2.4 billion of net redemptions during the quarter.
Financial and operating metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $307.1 million | $263.9 million | +16.4% |
| Operating income | $70.9 million | $79.7 million | -11.0% |
| Operating margin | 23.1% | 30.2% | -7.1 percentage points |
| Net income attributable to Federated | $54.5 million | $60.3 million | -9.6% |
| Diluted earnings per share | $0.54 | $0.60 | -10.0% |
| Cash provided by operating activities | $16.8 million | $48.1 million | -$31.3 million |
Net margin was 17.8%, compared with 22.9% a year earlier. The revenue-to-average-managed-assets ratio was 0.26%, versus 0.27%. Revenue increases included $48.3 million from Hermes and $16.0 million from higher average money market assets, partly offset by lower average equity and fixed-income assets excluding Hermes. Operating expenses rose $52.0 million, principally reflecting Hermes and higher distribution expense. Hermes reported $48.3 million of revenue and $0.4 million of net income before acquisition-related intangible amortization and noncontrolling-interest attribution.
Cash and cash equivalents were $134.5 million at March 31, down from $156.8 million at year-end. Liquid assets, net of noncontrolling interests, were $204.4 million versus $222.1 million. Net cash used in investing activities was $5.4 million and net cash used in financing was $35.9 million, including $27.2 million of dividends paid. The company declared a further $0.27-per-share dividend payable May 15, 2019.
Long-term debt was $130.0 million, with a 3.614% interest rate at quarter-end; $245 million remained available under the revolving credit facility. The company reported compliance with debt covenants and ratios of 64-to-1 interest coverage and 0.4-to-1 leverage, against minimum 4-to-1 and maximum 3-to-1 requirements, respectively. Adoption of the new lease standard added $109.2 million of right-of-use assets and $130.3 million of lease liabilities; management said adoption did not materially affect earnings or cash flows.
Material changes, outlook, and risks
- Despite higher revenue, profitability declined as operating expenses grew faster. The company attributed the drop in operating cash flow primarily to higher incentive-compensation payments, including payments to Hermes employees.
- Management expects cash uses to include compensation, distributions, dividends, debt repayment, acquisitions, technology and compliance spending, and product development. It believes existing liquid assets, operating cash flow, borrowing capacity, and potential financing options will be sufficient for present and reasonably foreseeable needs. No quantitative earnings or revenue guidance was provided.
- Management said money market funds may benefit from higher yields relative to deposit alternatives, and noted a 2018 and Q1 2019 shift back toward institutional prime and municipal funds. It cautioned that this asset-mix recovery may not continue or return to pre-2016 levels.
- Key uncertainties include asset flows and market performance; fee waivers and money-market yields; regulatory changes affecting fund structures, distribution and fiduciary standards; and Brexit, which could affect Hermes and cross-border product distribution. Management could not fully assess the financial impact of regulatory developments or Brexit.
- One intermediary, BNY Mellon and its Pershing subsidiary, accounted for approximately 12% of Q1 revenue, compared with 14% in Q1 2018. A significant deterioration in that relationship could adversely affect results. A prolonged decline in certain large investment strategies could also hurt revenue.
- Management said material losses from ordinary-course legal claims and indemnifications were not reasonably possible as of March 31, 2019. Hermes’s acquisition purchase-price allocation remained preliminary and could be adjusted materially. The filing reported no material change to previously disclosed risk factors or market-risk exposures.
Important facts for investors to verify
- How much future revenue and earnings growth is attributable to acquired Hermes versus organic asset flows, and whether the acquisition’s preliminary purchase-price allocation changes.
- Whether asset growth—particularly in money market funds—continues, and how net redemptions in long-term assets affect fee revenue and asset mix.
- Whether expense growth moderates and operating margins recover after the increase in compensation, distribution and acquisition-related costs.
- Cash generation and liquidity after dividends, debt service and incentive payments; confirm debt availability and covenant headroom as conditions change.
- Developments in money-market regulation, fiduciary and distribution rules, Brexit, and the BNY Mellon/Pershing relationship, including any material effects on assets, fees or costs.