Federated Investors, Inc. (now Federated Hermes) — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unless otherwise noted, financial amounts below are in millions of dollars. The company provides investment management, advisory, administrative, distribution and stewardship services. Results include Hermes from July 1, 2018, following Federated’s acquisition of a controlling interest.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $321.5 | $256.0 | $628.5 | $519.8 |
| Operating income | $84.9 | $80.8 | $155.8 | $160.4 |
| Operating margin | 26.4% | 31.5% | 24.8% | 30.9% |
| Net income attributable to Federated | $62.7 | $38.8 | $117.3 | $99.2 |
| Diluted EPS | $0.62 | $0.38 | $1.16 | $0.98 |
| Dividends per share | $0.27 | $0.27 | $0.54 | $0.52 |
- Revenue increased 25.6% in Q2 and 20.9% for the first half. Management attributed the increases primarily to Hermes, contributing $48.1 million in Q2 and $96.4 million for the first half, and higher average money market assets.
- Operating expenses grew faster than revenue: 35.0% in Q2 and 31.5% for the first half. The increase mainly reflected Hermes and higher money market fund distribution costs. Consequently, operating margin declined year over year in both periods.
- Net income rose year over year, but comparisons are affected by a $29.0 million loss on acquisition-related foreign-exchange derivatives recorded in Q2 2018. Q2 2019 also included a $2.8 million loss on Hermes currency forwards.
- Average managed assets were $493.3 billion in Q2, up 28%; first-half average assets were $484.3 billion, up 24%. Period-end managed assets were $502.2 billion, up 32% from June 2018. Money market and equity assets were major contributors; Hermes substantially expanded equity and alternative/private markets assets.
Cash flow, balance sheet and liquidity
- First-half operating cash flow was $112.4 million, versus $136.4 million a year earlier. Management cited higher cash incentive compensation, including payments to Hermes employees.
- Investing activities used $21.5 million, principally for investments and property and equipment. Financing activities used $67.5 million, including $54.5 million of dividends and net debt repayments.
- Cash and cash equivalents were $180.0 million at June 30, 2019, compared with $156.8 million at December 31, 2018. Liquid assets, net of noncontrolling interests, were $255.7 million.
- Long-term debt was $125.0 million, down from $135.0 million at year-end. The revolving facility had $250 million available; the company reported compliance with covenants, with a 70-to-1 interest coverage ratio and 0.3-to-1 leverage ratio against respective limits of 4-to-1 and 3-to-1.
- Adoption of lease accounting in January 2019 added $105.9 million of right-of-use assets and $126.5 million of operating lease liabilities at June 30. Management said adoption did not materially affect results or cash flows.
Outlook, risks and unusual items
- Management said existing liquid assets, operating cash flow and borrowing capacity should be sufficient for present and reasonably foreseeable cash needs. Expected uses include compensation, dividends, debt repayment, acquisitions, technology and product investment, and regulatory compliance.
- No quantified earnings or revenue guidance was provided in the filing. Revenue and profitability remain sensitive to managed-asset levels, market performance, investor flows, asset and product mix, fee waivers and distribution costs.
- Regulatory changes, including U.S. fiduciary and money-market-fund rules and European requirements, could affect product offerings, intermediary relationships, flows, costs and revenue. Management said the ultimate effects were uncertain.
- Brexit remained a material area of uncertainty for Hermes and the wider business, including potential currency, market, legal and regulatory effects. Federated said Brexit had not significantly affected its business as of June 30, 2019, but it could not assess the eventual impact.
- Revenue concentration is a risk: one intermediary accounted for approximately 11% of revenue in 2019, down from 14% in 2018. Three strategies/funds each represented 9%–11% of first-half 2019 revenue.
- Hermes-related redeemable noncontrolling interests were remeasured upward by $16.6 million in Q2, with a corresponding reduction to retained earnings. The June 30 carrying value for the Hermes interest was $190.3 million.
- Management did not consider material losses from ordinary-course legal claims or indemnifications reasonably possible. A $0.27-per-share dividend was declared July 25, payable August 15, 2019.
Most important facts for investors to verify
- How much of revenue and asset growth reflects ongoing organic flows and market performance versus the Hermes acquisition.
- Whether expense growth moderates and operating margins stabilize as Hermes is integrated.
- Asset flows and mix, especially money market assets, equity assets, and the profitability of each category after fee waivers and distribution costs.
- Hermes performance, acquisition-related costs, the valuation of redeemable noncontrolling interests, and potential future put/call transactions.
- Effects of regulatory developments and Brexit on products, intermediary distribution, compliance spending and international operations.
- Liquidity, debt repayment and covenant headroom, along with the company’s ability to sustain dividends and fund acquisitions and other investments.