Federated Investors, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2011. The filing identifies the registrant as Federated Investors, Inc.; “Federated Hermes, Inc.” appears in the request metadata. Unless otherwise noted, dollar amounts below are in millions.
Business context
Federated is an investment manager whose revenue principally comes from advising and administering mutual funds and separate accounts, plus distribution, shareholder servicing and related services. Managed assets were $351.7 billion at quarter-end, up 3% from September 30, 2010. Money market assets represented about 46% of nine-month revenue.
Financial results
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $214.0 | $242.2 | $678.7 | $706.6 |
| Operating income | $67.0 | $75.1 | $195.6 | $230.8 |
| Net income attributable to Federated | $38.3 | $43.1 | $114.0 | $132.7 |
| Basic and diluted EPS | $0.37 | $0.42 | $1.09 | $1.27 |
| Operating margin | 31.3% | 31.0% | 28.8% | 32.7% |
- Revenue and earnings: Q3 revenue declined 12% year over year; nine-month revenue declined 4%. Net income attributable to Federated fell 11% in Q3 and 14% for the nine months.
- Cash flow: Nine-month operating cash flow was $145.0, versus $171.0 in 2010. Investing activities used $100.1 and financing activities used $110.8. Cash and cash equivalents ended at $132.8, down from $198.8 at December 31, 2010.
- Liquidity: Management reported liquid assets of $341.3 at September 30, compared with $354.9 at year-end 2010. The entire $200.0 revolving credit facility was undrawn and available. Management believed available liquidity and operating cash flows would cover foreseeable needs.
- Debt: Recourse debt totaled $371.9, including $42.5 current and $329.4 long-term, compared with $403.8 at year-end 2010. The term loan’s weighted-average rate was 3.646%, with an interest-rate swap fixing the rate through April 2015. Federated reported compliance with loan covenants; leverage was 1.16x against a maximum 2.5x.
- Dividends and repurchases: Federated paid $0.72 per share in dividends during the first nine months, and repurchased approximately 1.0 million shares for $19.1. After quarter-end, the board declared a $0.24-per-share dividend payable November 15, 2011.
Material changes and drivers
- Money market fee waivers were the primary revenue headwind. Nine-month waived fees were $231.7, partly offset by $170.5 of lower distribution expense and $5.5 of lower noncontrolling-interest income, for a net negative pretax impact of $55.7. The comparable 2010 impact was $41.8.
- Management expected fee waivers and related offsets to continue at least into 2013. Assuming stable asset levels and recent market conditions, it estimated a roughly $26 million net pretax impact in Q4 2011. Management estimated that 10-basis-point and 25-basis-point increases in gross money market yields could reduce the impact by about 40% and 70%, respectively; actual results could vary substantially.
- Average managed assets rose 3% in Q3 and 2% for the nine months, but revenue from managed assets fell 12% and 4%, respectively, largely because of increased waivers and lower-fee asset mix. Period-end equity assets fell 4% year over year, while fixed-income assets rose 7%.
- Nine-month professional service fees rose to $44.2 from $9.6, reflecting $17.4 of 2011 legal and related costs associated with the Kaufmann Fund litigation and the absence of $21.6 of insurance proceeds recorded as a professional-fee reduction in 2010. Intangible-asset-related expense declined, partly because 2010 included impairment charges.
- The June 2011 amended credit agreement extended the term loan and replaced the prior revolving facility with a new $200 million facility. A Pittsburgh headquarters lease amendment extended the lease through 2021, with renewal options through 2032.
Outlook, risks and contingencies
- Key risks: dependence on money market revenue and prolonged low rates; possible changes to money market fund regulation, including stable-NAV rules; market declines, redemptions and investment underperformance; concentration in particular funds and distribution partners; rising distribution and compliance costs; and loss of key personnel.
- Two sponsored funds, Federated Kaufmann Fund and Federated Prime Obligations Fund, each generated approximately 12% and 11% of revenue, respectively, in the periods disclosed. One intermediary, Bank of New York Mellon and its Pershing subsidiary, accounted for about 9% of Q3 revenue and 10% of nine-month revenue.
- SunTrust acquisition contingent payments were estimated at $25 million over five years, with no contractual maximum; the recorded fair-value liability was $18.4 million. Additional contingent payments potentially remain under other acquisitions, including up to $49 million for the Prudent Bear acquisition and up to $56 million for Clover Capital, subject to targets and conditions.
- Maximum incentive bonuses under certain employment arrangements were estimated at approximately $68 million over their remaining terms. The filing states that ordinary-course legal claims were not reasonably estimable as to material loss; an unfavorable outcome could affect results, liquidity or reputation. Federated also recorded a $10.0 million liability for insurance advances subject to disputes with insurers.
- No material change in market-risk exposures was reported. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Subsequent money market fee-waiver costs, the pace of any short-term rate changes, and whether the projected Q4 2011 impact and continuation through at least 2013 remain applicable.
- Trends in managed assets, net flows, market performance and revenue mix—especially money market concentration and equity asset movements.
- Progress and final outcomes in the Kaufmann Fund litigation and insurance-reimbursement disputes, including the possibility of repayment of the $10.0 million insurance advance.
- Debt repayment, covenant headroom, use of the available revolving facility, and contingent acquisition and employment-related payments.
- The effects of potential money market regulatory changes and the assumptions supporting the $18.4 million SunTrust contingent-consideration liability and remaining intangible-asset values.