Federated Investors, Inc. (now Federated Hermes) — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing includes fourth-quarter results; Hermes was consolidated beginning July 1, 2018. The company operated as one investment-management segment.
Business context and key metrics
Federated provides investment management, fund administration and distribution, and stewardship services. Revenue is largely tied to assets under management (AUM) and fee rates. At year-end, AUM was $459.9 billion, up 16% from 2017; average AUM rose 13% to $415.4 billion.
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Revenue | $1,135.7 million | $1,102.9 million |
| Operating income | $330.3 million | $341.5 million |
| Operating margin | 29.1% | 31.0% |
| Net income attributable to Federated | $220.3 million | $291.3 million |
| Diluted EPS | $2.18 | $2.87 |
| Net cash from operating activities | $206.3 million | $387.4 million |
| Cash and cash equivalents at year-end | $156.8 million | $316.3 million |
| Long-term debt at year-end | $135.0 million | $170.0 million |
Fourth-quarter 2018 revenue was $307.2 million, operating income $88.0 million, net income attributable to Federated $61.5 million and diluted EPS $0.61. Fourth-quarter 2017 net income of $131.8 million and EPS of $1.31 included a $70.4 million tax benefit from revaluation of deferred taxes under the Tax Act.
Material changes versus prior year
- Revenue rose 3%, reflecting $100.8 million of Hermes revenue in the second half, partly offset by competitive money-market waivers, lower equity assets excluding Hermes, a customer relationship change, and accounting presentation changes.
- Operating income fell 3%; operating expenses increased $44.0 million. Higher compensation and professional fees, including Hermes-related costs, more than offset lower distribution expense.
- Net income declined 24%, affected by the prior-year tax benefit and a $29.0 million loss on acquisition-related foreign-exchange derivatives in 2018.
- Equity AUM increased 15% and money-market AUM 14%; fixed-income AUM decreased 2%. Long-term assets had $12.3 billion of net redemptions, while acquisition-related assets substantially lifted reported balances. 2018 market losses also reduced long-term AUM.
- Voluntary yield-related money-market fee waivers were zero in 2018, compared with a $0.8 million negative pretax impact in 2017. Separate competitive waivers were reported as increasing by $10.5 million in 2018.
Liquidity, capital and unusual items
Operating cash flow was $206.3 million. Investing activities used $174.4 million, including acquisition payments; financing activities used $186.1 million, including $106.9 million of dividends, $29.2 million of share repurchases and net debt repayment. The company had $240 million available under its $375 million revolving facility and reported compliance with covenants; leverage was 0.4:1 against a 3:1 maximum. Management said existing liquid assets, operating cash flow and borrowing capacity should cover reasonably foreseeable needs. The board declared a $0.27-per-share dividend in January 2019.
Hermes was acquired for $344.3 million. Federated acquired a controlling interest, while BT Pension Scheme retained 29.5% and has put/call rights at fair value after specified anniversaries. The preliminary purchase-price allocation included $154.9 million goodwill and $276.2 million intangible assets; final allocation could change materially. The acquisition added $170.9 million of redeemable noncontrolling interest at year-end. Goodwill and intangible assets totaled $1.15 billion; no impairment indicators were identified at year-end.
Outlook, commentary and principal risks
- No quantified earnings or AUM guidance is provided. Management estimated voluntary yield-related waivers would remain zero assuming asset levels, mix and recent market conditions remained constant; actual waivers could differ.
- Management said the investment business remains sensitive to market levels, investment performance, redemptions, asset mix and fee pressure. Money-market products represented 37% of 2018 revenue; equity strategies 41%.
- Regulatory changes, including money-market rules, fiduciary standards and evolving U.S. and European requirements, may alter products, distribution, asset flows, expenses and profitability. Effects were not fully quantifiable.
- Brexit created uncertainty for product distribution, cross-border operations and compliance costs. The filing reported no significant business impact as of year-end but could not assess potential future effects.
- Other key risks include concentrated revenue (one intermediary contributed about 13% of 2018 revenue; two strategies contributed 15% and 10%), poor investment performance, loss of key personnel, cyber and operational incidents, advisory-contract termination, and acquisition integration or impairment risk.
- The filing reports no material off-balance-sheet arrangements and states that material losses on ordinary-course legal claims were not considered reasonably possible. Management and the auditor gave unqualified opinions on the financial statements and internal controls; Hermes’s controls were excluded from the 2018 internal-control assessment.
Investor verification priorities
- Separate organic AUM and revenue trends from assets and results added by Hermes, including subsequent integration and retention.
- Track net flows and market performance by product, particularly money-market mix and higher-fee equity strategies.
- Reconcile reported revenue and distribution expense to Topic 606 presentation changes and ongoing competitive waivers.
- Assess the recurring earnings impact of the $29.0 million derivative loss, acquisition costs, Hermes noncontrolling interest and future put/call obligations.
- Monitor cash conversion, the debt balance and facility availability, dividends and repurchases, and the new lease balance-sheet recognition expected in 2019.
- Review Brexit and regulatory developments, the preliminary Hermes purchase-price allocation, goodwill/intangible valuations, and the scope of internal-control testing.