Federated Investors, Inc. — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. The filing is for Federated Investors, Inc. (now identified in the request as Federated Hermes); it reports annual results, with quarterly data also provided. The company is an investment manager whose revenue is primarily based on assets under management (AUM).
Financial performance and position
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Total revenue | $926.6 million | $859.3 million | +8% |
| Operating income | $279.4 million | $237.9 million | +17% |
| Operating margin | 30.2% | 27.7% | +2.5 percentage points |
| Net income attributable to Federated | $169.8 million | $149.2 million | +14% |
| Diluted EPS | $1.62 | $1.42 | +14% |
| Net cash from operating activities | $233.2 million | $192.5 million | +$40.7 million |
| Period-end AUM | $361.1 billion | $362.9 billion | Approximately flat |
Revenue growth reflected a $77.0 million reduction in voluntary money-market fee waivers and higher average equity assets, partly offset by lower average money-market assets. Average AUM declined 1% to $353.5 billion. Average equity AUM rose 12%, while average money-market AUM fell 3% and fixed-income AUM increased 3%. Equity assets accounted for 46% of revenue, money-market assets 33%, and fixed-income assets 21%.
Operating expenses increased 4% to $647.2 million, led by a 10% increase in distribution expense. The company reported a $4.5 million net nonoperating expense, versus $1.4 million of nonoperating income in 2014; 2015 included a $5.3 million net securities loss and a $1.3 million impairment of an available-for-sale investment. The effective tax rate was 37.4%, unchanged from 2014.
At year-end, cash and cash equivalents were $172.6 million, and reported liquid assets, net of noncontrolling interests, were $367.4 million. Total debt was $216.8 million, including $25.5 million classified as short-term. The full $200 million revolving credit facility was available; Federated was in compliance with its debt covenants. Management said existing liquidity, operating cash flow, and borrowing capacity should cover reasonably foreseeable needs. Total assets were $1.19 billion and shareholders’ equity was $647.8 million.
Cash used in financing activities was $170.1 million, including $104.6 million of dividends, $53.9 million of treasury-stock purchases, and $25.5 million of debt repayments. The annual dividend was $1.00 per share. The board declared a further $0.25-per-share dividend in January 2016.
Material changes and business developments
- Period-end AUM was broadly unchanged year over year, but the mix shifted: equity AUM increased 4%, money-market AUM decreased 1%, and fixed-income AUM decreased 3%.
- Equity net sales were $2.9 billion, down from $4.3 billion in 2014; fixed-income assets recorded $1.2 billion of net redemptions, versus $1.1 billion of net sales in 2014. Combined equity and fixed-income net sales were $1.7 billion, down from $5.4 billion.
- Money-market fee waivers reduced 2015 pretax income by $85.9 million, compared with $119.0 million in 2014. Waivers reduced reported revenue by $333.6 million, partly offset by $240.6 million in lower distribution expense and $7.1 million in lower noncontrolling-interest expense.
- Federated continued to invest in product and operational changes in response to U.S. money-market reforms and other regulatory developments. Its liquidation portfolio, which contributed AUM in 2014, had been fully liquidated in late 2014.
Outlook, risks, contingencies and unusual items
- Fee-waiver outlook: Based on then-current market conditions and assuming stable asset levels and mix, management estimated a negative pretax waiver impact of about $11 million in the first quarter of 2016. It estimated that, excluding a potential customer-relationship change, 25- and 50-basis-point increases in gross yields on money-market portfolio purchases could reduce the quarterly impact to about $4 million and $1 million, respectively; a 75-basis-point increase could nearly eliminate waivers. These estimates are sensitive to yields, assets, product mix, expenses, and distribution arrangements.
- Regulatory transition: U.S. money-market reforms required further compliance and product changes, with key floating-NAV and liquidity-fee/gate provisions due by October 14, 2016. Federated planned institutional prime and municipal funds with floating NAVs and identified certain retail funds to continue seeking a stable $1.00 NAV. Management warned reform could reduce product appeal, AUM, revenue, or increase costs; the ultimate financial impact was not yet clear.
- Interest rates and asset flows: The Federal Reserve raised its target range by 25 basis points to 0.25%–0.50% in December 2015. Low yields had necessitated waivers since 2008. While higher rates may lessen waivers, they could also prompt investors to leave money-market products, reduce fixed-income valuations, and increase market volatility.
- Passport transaction: In February 2016, the board approved a proposed transfer of Federated’s general partnership interest in Passport Research to a Jones Financial subsidiary, expected in the fourth quarter of 2016 subject to definitive agreements, fund and regulatory approvals, shareholder consents, and other conditions. The transaction could reduce pretax income by up to $6 million per quarter after closing. The filing stated there was no assurance it would close as described.
- Litigation: CCM Rochester sought approximately $37 million plus attorneys’ fees in a dispute related to an acquisition earn-out. Federated said it intended to defend the case, assessed a material loss as remote, and recorded no estimable loss. Other claims were described as ordinary-course matters; management did not believe a material loss was reasonably possible.
- Other risks: The business is exposed to investment performance, market-driven AUM declines, distribution and intermediary costs, regulatory change, cyber and operational incidents, and the risk of impairment of substantial goodwill and intangible assets. Goodwill and other intangible assets totaled $734.5 million; management reported no impairment indicators at year-end.
- Audit and controls: Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management concluded disclosure controls and internal controls were effective as of year-end.
Most important facts for investors to verify
- Whether AUM and revenue growth persist, particularly given net redemptions in fixed-income products and the continuing decline in average money-market assets.
- Actual 2016 fee-waiver costs and whether improving money-market yields translate into income recovery after changes in customer and distribution arrangements.
- Implementation costs and customer flows as Federated completes the 2016 money-market reform transition, including floating-NAV products, fees, and redemption gates.
- Closing status and final economics of the Passport transfer, including the potential pretax income reduction of up to $6 million per quarter.
- Debt repayment, dividend, and repurchase levels relative to operating cash flow and liquidity needs; also monitor goodwill and intangible-asset impairment indicators.
- Developments in the CCM litigation and any new material regulatory, legal, or cybersecurity matters.