Federated Investors, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2010. The filing identifies the registrant as Federated Investors, Inc. (not Federated Hermes, Inc.). Unless noted otherwise, dollar amounts below are in millions.
Business context and key metrics
Federated is an investment manager whose revenue is primarily based on assets under management (AUM). Period-end managed assets were $341.3 billion, down 13% year over year. Money market assets were $260.9 billion, down 18%; fixed-income assets were $40.2 billion, up 25%; and equity assets were $29.1 billion, essentially unchanged.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $242.2 | $293.6 | $706.6 | $911.1 |
| Operating income | $75.1 | $94.7 | $230.8 | $242.8 |
| Operating margin | 31.0% | 32.3% | 32.7% | 26.6% |
| Net income attributable to Federated | $43.1 | $57.0 | $132.7 | $145.4 |
| Diluted earnings per share | $0.42 | $0.56 | $1.27 | $1.42 |
| Net cash from operating activities | Not separately reported | Not separately reported | $171.0 | $200.7 |
Operating margin is calculated from reported revenue and operating income. Nine-month revenue from managed assets fell 23%; average managed assets fell 16%. Money market fee waivers totaled $181.6 million for the nine months, partly offset by $139.8 million of lower distribution expenses, for a net $41.8 million reduction in operating income.
Liquidity, debt and cash flow
- Cash and cash equivalents were $222.7 million at September 30, 2010, versus $90.5 million at December 31, 2009. Liquid assets, as defined by management, totaled $336.5 million, up from $141.6 million.
- Nine-month cash flows were $171.0 million from operations, $(105.1) million from investing activities and $66.3 million from financing activities; cash increased $132.2 million.
- Recourse debt was $414.4 million, including $42.5 million classified as short-term; nonrecourse debt was $6.6 million. The $200 million revolving credit facility was fully available. The term loan is hedged at a fixed 4.396% rate through April 2015.
- Federated reported compliance with debt covenants. Management stated that available cash, operating cash flow and borrowing capacity should meet present and reasonably foreseeable needs.
Material changes versus the prior comparable period
- Q3 revenue declined 18% and attributable net income declined 24%. For the first nine months, revenue fell 22% and attributable net income fell 9%.
- The largest revenue pressure was lower average money market assets and higher voluntary fee waivers. Growth in fixed-income and equity assets partially offset the declines.
- Operating expenses fell 16% in Q3 and 29% year to date, led by lower distribution costs. Nine-month professional service expense also benefited from $21.6 million of insurance recoveries.
- Debt expense rose with higher borrowings. Recourse debt increased substantially following the $425 million amended term loan; the company also paid $204.0 million in dividends during the nine months, including a $1.26-per-share special dividend.
Outlook, unusual items and risks
- Management expected money market fee waivers and related distribution-expense reductions to continue through the remainder of 2010 and into 2011, likely at material levels. Assuming current market conditions and AUM, the estimated net operating-income impact for Q4 2010 was $11–$12 million.
- Federated acquired SunTrust’s money market management business. Approximately $11.0 billion of assets had transitioned by quarter-end; two additional closings were expected in November. Upfront payments could total $7 million, with $4.9 million paid by September 30. A $21.8 million fair-value liability was recorded for contingent future consideration; the final purchase-price allocation remained preliminary.
- A $7.0 million impairment charge was recorded in Q2 2010 for certain acquired intangible and fixed assets. The filing said there were no impairment indicators for those assets at September 30, but further declines in their AUM could prompt additional impairment review.
- Federated recognized $25 million of insurance proceeds in Q2 as reductions to previously charged operating expenses. The filing also reports ongoing excessive-fee litigation seeking, among other relief, return of advisory fees earned on the Federated Kaufmann Fund; the potential impact is uncertain. A settlement in the market-timing/late-trading cases received final court approval on October 25, 2010.
- Key risks include dependence on money market AUM and historically low short-term rates, fee waivers, redemptions and market performance, regulatory changes affecting money market funds, reliance on distribution intermediaries and the Kaufmann Fund, litigation, and possible impairment of acquisition-related assets. Approximately 14% of Q3 revenue came from one intermediary customer; about 11% came from the Kaufmann Fund.
Important facts for investors to verify
- Whether asset flows, interest rates and fee-waiver levels produce the projected Q4 2010 impact and how long waivers continue.
- Completion and economics of the SunTrust transition, including final valuation and contingent-payment assumptions.
- Progress and potential financial exposure from the remaining excessive-fee litigation and other legal matters.
- Debt repayment, covenant headroom and cash needs alongside dividends, acquisitions and other capital uses.
- Whether AUM declines in acquired strategies or changes in market conditions trigger further impairment charges.