Federated Investors, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2016; unaudited. The filing identifies the issuer as Federated Investors, Inc.
Business context
Federated is an investment manager whose revenue depends primarily on assets under management (AUM), asset mix, fee rates and fee waivers. Period-end managed assets were $364.3 billion, up 4% year over year. Money-market assets were $248.4 billion, equity assets $64.1 billion and fixed-income assets $51.8 billion.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $294.6 million | $234.3 million | $853.5 million | $683.0 million |
| Operating income | $88.6 million | $74.2 million | $250.9 million | $202.6 million |
| Net income attributable to Federated | $54.9 million | $44.1 million | $153.1 million | $122.2 million |
| Diluted EPS | $0.54 | $0.42 | $1.48 | $1.17 |
| Operating margin | 30.1% | 31.7% | 29.4% | 29.7% |
- Revenue rose 26% in Q3 and 25% for the nine months. Management attributed the increase mainly to lower voluntary money-market yield-related fee waivers; equity AUM growth also helped Q3.
- Operating expenses increased to $206.0 million in Q3 and $602.6 million for the nine months, principally as distribution expenses rose when fee waivers declined. This offset part of the revenue benefit.
- Cash provided by operating activities was $175.5 million for the nine months, versus $152.2 million in 2015. Investing activities used $4.7 million and financing activities used $158.4 million. Cash and cash equivalents ended at $185.1 million.
- Total debt was $197.6 million, including $25.5 million current and $172.1 million long-term, down from $216.8 million at year-end 2015. The $200 million revolving facility was undrawn and available; Federated reported compliance with covenants.
- Liquid assets, net of noncontrolling interests, were $384.7 million, compared with $367.4 million at December 31, 2015. Management said projected liquidity and operating cash flow should cover foreseeable needs.
- Cash dividends were $0.25 per share in Q3 and $0.75 per share for the nine months. Federated repurchased $64.1 million of stock during the first nine months.
Material changes and management commentary
- Voluntary yield-related fee-waiver revenue reductions were $18.0 million in Q3 2016 versus $83.3 million in Q3 2015, and $76.8 million for the first nine months versus $261.6 million in 2015. After related distribution-expense offsets, their pretax impact was negative $4.2 million for Q3 and $18.6 million for the nine months, improved from negative $20.3 million and $69.5 million, respectively.
- Average AUM increased 4% in Q3 and 3% for the nine months year over year. Equity assets grew notably; fixed-income average assets declined. Money-market funds generated 46% of nine-month revenue, up from 32% in 2015, largely reflecting reduced fee waivers.
- Management estimated that, assuming asset levels and mix remained constant, Q4 2016 fee waivers could have a negative pretax impact of about $4 million. A customer-relationship change was expected to reduce pretax income by about $3 million per quarter beginning in late 2016. These estimates are sensitive to rates, yields, AUM and other factors.
- On October 27, 2016, the board declared a $1.25-per-share dividend, comprising the regular $0.25 quarterly dividend and a $1.00 special dividend, payable November 15. The special dividend was expected to reduce Q4 diluted EPS by approximately $0.01–$0.02. The board also authorized a new repurchase program for up to 4 million shares.
Risks, contingencies and unusual items
- Money-market reform compliance, including floating NAV for institutional prime and municipal funds and liquidity-fee/gate provisions where applicable, reached its final U.S. compliance date on October 14, 2016. Federated warned that regulation, product changes and implementation costs could affect assets, revenue and expenses.
- Persistently low short-term rates may sustain fee waivers. Money-market funds represented a material share of revenue, and yields, asset mix, investor preferences and intermediary relationships could change results.
- Approximately 15% of revenue came from Bank of New York Mellon and its Pershing subsidiary. The Federated Strategic Value Dividend Fund generated approximately 11% of Q3 revenue and 9% of nine-month revenue.
- CCM Rochester seeks approximately $37 million plus attorneys’ fees in litigation. Federated said it believes the claims are meritless, considers a material loss remote and cannot estimate any loss; summary-judgment briefing had concluded.
- Potential compensation-related payments under employment and incentive arrangements could total up to approximately $30 million through 2019, based on period-end asset levels and performance goals. The Pittsburgh headquarters lease was extended through 2030, with options through 2040.
- The filing added an auditor-independence risk concerning EY’s lending relationships with certain lenders connected to Federated Funds. The company relied on SEC staff no-action relief, effective for 18 months from June 20, 2016, subject to conditions.
- Management reported no goodwill impairment indicators and no material change in market-risk exposures. Disclosure controls were deemed effective at September 30, 2016.
Important facts for investors to verify
- Whether money-market yields, assets and customer mix support the company’s fee-waiver and Q4 pretax-impact estimates.
- The actual revenue and earnings effect of the expected customer-relationship change and any further intermediary changes.
- Compliance costs and asset-flow consequences from money-market reforms and other regulatory requirements.
- Final cash, debt and liquidity effects of the special dividend, debt repayments and new share-repurchase authorization.
- Developments in the CCM litigation and the conditions and duration of the SEC auditor-independence relief.