Federated Hermes, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; comparative period is Q1 2022. Federated Hermes provides investment management, fund administration, distribution and related services. It reported $701.0 billion of managed assets at quarter-end, up 11% year over year.
Key financial results
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Revenue | $382.2 million | $324.8 million | +17.7% |
| Operating income | $85.2 million | $83.9 million | +1.4% |
| Operating margin | 22.3% | 25.8% | Down 3.5 percentage points |
| Net income attributable to Federated Hermes | $69.6 million | $55.9 million | +24.6% |
| Diluted earnings per share | $0.78 | $0.61 | +$0.17 |
| Net cash from operating activities | $5.4 million | $(19.2) million | Improved $24.7 million |
Net margin was approximately 18.2%, compared with 17.2% a year earlier. Revenue growth reflected the elimination of voluntary yield-related money-market fee waivers and higher average money-market assets. Operating expenses rose $56.2 million, including a $44.8 million increase in distribution expense, largely because related distribution-cost offsets also ended with the waivers. No voluntary yield-related waivers were recorded in Q1 2023; Q1 2022 waivers were $75.8 million, with $57.5 million of related distribution-expense reductions and an $18.3 million net negative pretax impact.
Assets under management and business mix
- Average managed assets were $679.4 billion, up 5%; period-end assets were $701.0 billion, up 11% year over year.
- Period-end money-market assets rose 20% to $505.8 billion; long-term assets fell 7% to $195.2 billion. Average money-market assets increased 12%, while average long-term assets declined 8%.
- Q1 revenue mix shifted toward money markets: 47% of revenue versus 27% in Q1 2022. Equity and fixed-income assets contributed 33% and 13%, respectively, versus 45% and 18% a year earlier.
- Long-term assets had net sales of $191 million, compared with net redemptions of $2.0 billion in Q1 2022. Fixed-income assets had net redemptions of $1.1 billion; equity assets had net sales of $895 million.
Cash, debt and liquidity
- Cash and cash equivalents were $324.0 million at March 31, versus $336.8 million at December 31, 2022. Management reported liquid assets, net of noncontrolling interests, of $563.6 million, versus $559.5 million at year-end.
- Long-term debt was $347.6 million, net of issuance costs, consisting principally of $350 million of unsecured notes bearing fixed interest at 3.29% and maturing in 2032. No revolving-credit borrowings were outstanding.
- The company had $350 million available under its revolver, plus a $200 million optional accordion. It reported compliance with debt covenants, a 35-to-1 interest coverage ratio and a 0.79-to-1 leverage ratio.
- Cash used in financing was $22.0 million, including $24.1 million of dividends and $6.6 million of treasury-stock purchases, partly offset by $12.8 million of noncontrolling-interest contributions.
Management said existing liquid assets, expected operating cash flow and borrowing capacity should be sufficient for short- and reasonably foreseeable long-term cash needs. The board declared a subsequent $0.28-per-share dividend, payable May 15, 2023.
Material changes, commentary and risks
- Nonoperating results improved to $7.3 million of net income from a $11.7 million net expense, mainly reflecting a $17.2 million year-over-year improvement in securities gains and losses. Net investment income also increased.
- An administrative error involving registration of shares issued by a tender fund led to an estimated $19.6 million cost accrual. The company recorded a probable $17.1 million insurance receivable and a $2.5 million net expense; amounts may change following regulatory, insurer and shareholder review.
- Revenue remains sensitive to market levels, asset flows and asset mix, fee rates, intermediary relationships and potential fee waivers. A single intermediary accounted for approximately 13% of Q1 2023 revenue, versus 5% a year earlier.
- Management highlighted ongoing regulatory uncertainty, including proposed U.S. money-market and open-end-fund reforms, ESG and climate disclosure requirements, cybersecurity rules and evolving UK/EU requirements. Compliance and related professional-service costs could rise; the company said the ultimate effects are uncertain.
- The company recorded a $31.5 million noncash impairment of an FHL intangible asset in Q4 2022. At March 31, 2023, estimated fair value exceeded carrying value by less than 5%, leaving sensitivity to projected revenue growth, margins and discount rates.
- Management reported no material change in risk factors from its 2022 Form 10-K, no material change in market-risk exposure, and effective disclosure controls as of quarter-end. It provided no specific financial guidance in this filing.
Investor verification priorities
- Assess whether the higher money-market revenue and absence of voluntary yield-related waivers persist, and how future rate changes could affect waivers and distribution expense.
- Track long-term asset flows, average AUM and product mix, particularly fixed-income redemptions and the concentration of revenue with the key intermediary.
- Verify the final cost, insurance recovery and resolution of the tender-fund share-registration error.
- Monitor the FHL intangible asset’s valuation and impairment assumptions, as well as any further regulatory or legal developments.
- Confirm liquidity, debt covenant headroom, capital returns and the effect of share repurchases and dividends on cash.