FEDERATED HERMES, INC. quarterly report, Q2 FY2015

Federated Investors, Inc. — Q2 2015 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2015. The filing is for Federated Investors, Inc. (the company identified in the request as Federated Hermes). Federated manages investment funds and separate accounts; period-end managed assets were $349.7 billion.

Financial performance

• Q2 revenue rose 7%; six-month revenue rose 6%. Management attributed the increase primarily to lower money-market fee waivers and higher average equity assets, partly offset by lower average money-market assets.
• Six-month operating expenses increased 4% to $320.3 million, chiefly from compensation and distribution costs. Six-month nonoperating results were a net expense of $1.1 million, versus net income of $2.3 million a year earlier, reflecting lower securities gains.
• Six-month cash from operations was $72.6 million, versus $65.2 million. Investing activities used $5.1 million and financing activities used $73.6 million. Cash ended the period at $109.1 million, down from $115.3 million at year-end 2014.
• At June 30, total debt was $229.5 million ($25.5 million current and $204.0 million long-term), down from $242.3 million at December 31. The $200 million revolving facility was undrawn and available. The company reported covenant compliance, with leverage of 0.8:1 against a 3:1 maximum and interest coverage of 54:1 against a 4:1 minimum.
• Liquid assets, net of noncontrolling interests, were $312.6 million. The company paid $52.4 million in dividends and spent $19.5 million on treasury-stock purchases during the half year. A quarterly dividend of $0.25 per share was declared after quarter-end.

Changes, outlook and material risks

• Period-end assets under management were down 1% year over year to $349.7 billion; average managed assets declined 3% in both the quarter and half year. Average equity assets increased 17%, while average money-market assets fell 6% in Q2 and 7% over six months.
• Money-market fee waivers had a negative pretax impact of $22.2 million in Q2 and $49.2 million for the half year, improving from $29.6 million and $59.3 million, respectively, in 2014. Assuming asset levels and mix remain constant, management expected the Q3 pretax impact to be approximately the same as Q2. Higher short-term rates could reduce waivers, but timing and magnitude were uncertain.
• SEC money-market reforms, including future floating-NAV requirements for certain institutional funds and liquidity-fee/redemption-gate provisions, could adversely affect Federated’s business. The company was planning fund reorganizations and product changes; management could not yet quantify the reforms’ overall impact. European money-market reforms and potential financial-transaction taxes also pose uncertainty.
• Revenue concentration is notable: equity assets generated 47% of six-month revenue and money-market assets 31%. The Federated Kaufmann Fund contributed 12% of Q2 revenue; a significant, prolonged decline in its assets could materially affect revenue and earnings.
• In the CCM Rochester litigation, the plaintiff sought approximately $37 million plus attorneys’ fees. The court dismissed breach-of-contract and best-efforts claims but allowed a fraud claim to proceed. Federated said it considered the claims meritless, assessed a material loss as remote, and stated that no loss was estimable.
• Management said liquidity should be sufficient for present and reasonably foreseeable needs and did not then expect to draw on the revolver over the next 12 months. It also noted potential future spending on compliance, product restructuring, acquisitions, dividends, debt repayment and other needs.
• No material changes to the previously disclosed risk factors or market-risk exposures were reported. Management concluded disclosure controls were effective, with no material change in internal control over financial reporting during the quarter.

Investor verification priorities

1. Track money-market asset flows, fee-waiver levels, short-term yields and the net earnings impact as rates and product structures change.
2. Assess implementation and customer response to U.S. and European money-market regulation and related restructuring plans.
3. Monitor equity-market performance and the concentration of revenue in equity products and the Kaufmann Fund.
4. Follow developments in the CCM case and acquisition-related or employee contingent-payment obligations.
5. Verify continued debt covenant compliance, cash generation and capital allocation, including dividends and share repurchases.