Federated Investors, Inc. (now Federated Hermes, Inc.) — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet amounts are as of March 31, 2017. The filing was submitted under the name Federated Investors, Inc.
Business context
Federated is an investment manager whose revenue primarily depends on assets under management (AUM), asset mix, fee rates, and fee waivers. Managed assets were $361.7 billion at quarter-end, down 2% from March 31, 2016. Money market assets represented 68% of average managed assets; equity assets represented 18%.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $273.5 million | $272.1 million | Up 0.5% |
| Operating income | $77.8 million | $74.6 million | Up 4.3% |
| Operating margin | 28.4% | 27.4% | Up 1.0 percentage point |
| Net income attributable to Federated | $49.6 million | $45.4 million | Up 9.2% |
| Diluted earnings per share | $0.49 | $0.44 | Up $0.05 |
| Cash dividends per share | $0.25 | $0.25 | No change |
| Net cash from operating activities | $33.0 million | $26.2 million | Up $6.8 million |
Q1 2017 revenue benefited from a $33.2 million year-over-year reduction in voluntary money-market yield-related fee waivers and $14.8 million from higher average equity assets. These benefits were largely offset by lower average money market fund assets and a customer-relationship change. Waivers reduced revenue by $4.3 million in Q1 2017 versus $37.5 million in Q1 2016; their net pre-tax impact fell to $0.8 million from $9.4 million.
Operating expenses declined 0.9% to $195.7 million. Compensation expense fell $3.4 million, partly offset by higher distribution expense. The effective tax rate was 36.9%, compared with 35.7%.
Assets, cash flow, debt, and liquidity
- Period-end AUM was $361.7 billion versus $369.7 billion a year earlier. Money market assets fell 6% to $245.2 billion, equity assets rose 15% to $64.8 billion, and fixed-income assets rose 1% to $51.8 billion. Average AUM was essentially unchanged year over year.
- Equity and fixed-income funds and separate accounts had net redemptions of $1.8 billion in aggregate during the quarter; market gains and acquisition-related assets partly offset outflows.
- Cash and cash equivalents were $94.6 million. Management reported liquid assets, net of noncontrolling interests, of $291.2 million, down from $310.3 million at December 31, 2016.
- Total debt was $184.9 million, including $25.5 million current and $159.4 million long-term. The $200 million revolving facility was fully available. Federated repaid $6.4 million of term-loan principal during the quarter.
- Federated reported compliance with all debt covenants; its interest coverage ratio was 103:1 against a 4:1 minimum, and leverage was 0.5:1 against a 3:1 maximum.
- Financing activities used $48.5 million, including $25.5 million of dividends, $14.9 million of treasury-stock purchases, and $6.4 million of debt repayment. Cash declined by $10.2 million during the quarter.
Changes, outlook, and risks
- Revenue and earnings improved modestly, substantially aided by the sharp reduction in money-market fee waivers as fund yields rose. The Federal Reserve raised its target rate twice between December 2016 and March 2017; management said the increases had nearly eliminated the waivers’ pre-tax impact.
- A change in a customer relationship was expected to reduce pre-tax income by approximately $2 million per quarter in future quarters compared with Q4 2016, including the related fee-waiver impact.
- Management gave no specific earnings or revenue guidance. It said existing liquid assets, operating cash flow, and borrowing capacity should be sufficient for foreseeable needs and was not projecting a revolver draw in the next 12 months.
- Regulatory changes remain a significant uncertainty. U.S. money-market reforms had contributed to migration from institutional prime and municipal funds to stable-NAV government funds. The DOL fiduciary rule’s applicability was delayed to June 9, 2017, with further changes possible; management continued preparing for implementation. Management warned that regulation, compliance spending, product changes, and customer responses could adversely affect AUM, revenue, expenses, and operating income.
- Revenue concentration is notable: one investment strategy generated approximately 18% of Q1 2017 revenue, up from 12% a year earlier; one intermediary customer generated approximately 16% in both periods.
- Federated’s CCM Rochester litigation concluded in its favor after the plaintiff did not timely appeal the summary judgment ruling. Management said other asserted or threatened claims were not reasonably expected to result in a material loss.
- Future minimum compensation payments under certain arrangements were approximately $7 million; performance-based payments could add up to $8 million. The board declared a further $0.25-per-share dividend on April 27, payable May 15, 2017.
Important facts for investors to verify
- Whether improving money-market yields continue to reduce fee waivers, and whether the benefit is offset by asset migration or higher expenses.
- Subsequent AUM flows and the durability of equity-market gains, especially given the quarter’s $1.8 billion net redemptions in equity and fixed-income assets.
- Developments in the major intermediary relationship and the concentrated Strategic Value Dividend strategy.
- Implementation and business effects of U.S. and European regulatory changes, including money-market rules and the fiduciary rule.
- Debt repayment schedule, covenant headroom, and cash uses for dividends, repurchases, acquisitions, and compliance investment.