Business context and reporting period
Federated Investors, Inc. (the registrant named in this 2012 filing) is an investment manager. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods. Managed assets were $364.1 billion at quarter-end, up 4% year over year. Money market assets were 74% of period-end AUM and generated 47% of nine-month revenue.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $238.5 million | $214.0 million | $700.9 million | $678.7 million |
| Operating income | $90.0 million | $67.0 million | $229.4 million | $195.6 million |
| Operating margin | 37.8% | 31.3% | 32.7% | 28.8% |
| Net income attributable to Federated | $55.8 million | $38.3 million | $138.5 million | $114.0 million |
| Diluted earnings per share | $0.54 | $0.37 | $1.33 | $1.09 |
For the nine months, operating cash flow was $239.9 million, versus $145.0 million in 2011; investing activities provided $11.2 million and financing activities used $116.9 million. Cash and cash equivalents were $183.5 million at September 30, up from $49.3 million at December 31, 2011. Management reported total liquid assets of $400.2 million, including investments and receivables.
Debt totaled $329.4 million ($42.5 million short-term and $286.9 million long-term), down from $361.3 million at year-end 2011. The $200 million revolving facility was fully available. Federated reported compliance with its debt covenants, with leverage of 1.01-to-1 against a 2.5-to-1 maximum and interest coverage of 24.61-to-1 against a 4-to-1 minimum. Nine-month dividends paid were $0.72 per share.
Material changes versus prior periods
- Q3 revenue rose 11% and nine-month revenue rose 3%. Growth reflected higher average fixed-income and equity assets and reduced money-market fee waivers.
- Q3 operating income increased 34%; nine-month operating income increased 17%. Net income attributable to Federated rose 46% for Q3 and 22% for the nine months.
- Period-end fixed-income and equity AUM rose 20% and 26%, respectively, year over year; money-market AUM declined 1%. Average AUM increased 3% for both the quarter and nine-month period.
- Lower professional-service expense materially benefited results: Q3 included $17.3 million of approved insurance recoveries recorded as a reduction to that expense. The nine-month comparison also reflected lower legal-related costs than in 2011.
- Operating cash flow improved substantially, but the filing attributes much of the year-over-year increase to an $84.1 million increase in net sales of trading securities, as well as higher customer cash receipts.
Outlook, risks, contingencies and unusual items
- Money-market fee waivers reduced Q3 pretax income by $16.3 million and nine-month pretax income by $55.7 million, net of associated distribution-expense and noncontrolling-interest offsets. Management expected Q4 2012’s pretax impact to be approximately similar to Q3, assuming asset levels remained constant. The Federal Reserve expected exceptionally low rates through at least mid-2015, so waivers could continue; the amount remains uncertain.
- Management estimated a 10-basis-point increase in gross money-market yields could reduce the fee-waiver impact by about 40% from current levels, and a 25-basis-point increase by about 70%. Rising rates could also prompt investors to move assets out of funds or reduce fixed-income asset values.
- Money-market products were the principal concentration risk: 47% of nine-month revenue came from money-market assets. Two funds each contributed 10–11% of revenue, and Bank of New York Mellon contributed 10% of Q3 revenue and 11% of nine-month revenue. Proposed money-market reforms under consideration by FSOC could materially affect the business; the ultimate impact was not yet assessable.
- Federated acquired London-based Prime Rate Capital Management in Q2 and expanded European distribution and opened an Australia office in Q3. The Asia-Pacific expansion could add approximately $6 million of operating costs over the next 12 months.
- On October 25, the board declared a $1.75-per-share dividend, comprising the regular $0.24 quarterly dividend and a $1.51 special dividend, payable November 15. The special dividend was expected to reduce diluted EPS by about $0.04 for Q4 and $0.02 for full-year 2012. Management expected liquidity to remain sufficient after payment.
- Other commitments include an estimated $15 million of remaining SunTrust acquisition payments over four years (not capped), up to $49 million for the Prudent Bear acquisition and up to $56 million for Clover Capital, subject to performance targets; no amounts were accrued for the latter two at quarter-end. Maximum remaining incentive payments under significant employment arrangements were approximately $56 million. Management said ordinary-course legal claims were not reasonably expected to result in a material loss.
- A tentative $3.0 million insurance settlement reached after quarter-end would be recognized as an expense reduction when finalized. Management reported no goodwill impairment indicators and concluded its $6.9 million equity-method investment was not other-than-temporarily impaired, while noting uncertainty related to the investee’s AUM and performance.
Important facts for investors to verify
- Whether money-market regulatory proposals advance and how any resulting rules affect AUM, fee waivers and revenue.
- Actual fee-waiver levels, short-term yields and the sustainability of management’s Q4 estimate.
- Asset flows and performance in fixed-income, equity and money-market products, particularly the two revenue-concentrated funds and the Bank of New York Mellon distribution relationship.
- The persistence of cash generation excluding trading-security sales, and liquidity following the special dividend and ongoing debt repayments.
- Final insurance recovery amounts and timing, acquisition-related contingent payments, and the costs and returns of international expansion.