Federated Hermes, Inc. — Q1 2021 Form 10-Q
Business context and reporting period: Unaudited results for the three months ended March 31, 2021, compared with Q1 2020. Federated Hermes provides investment management and related services; it reported $625.0 billion in managed assets at quarter-end, up 3% year over year.
Key financial results
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Revenue | $341.2 million | $359.2 million | Down 5% |
| Operating income | $97.5 million | $92.7 million | Up 5% |
| Operating margin | 28.6% | 25.8% | Up 2.8 percentage points |
| Net income attributable to Federated Hermes | $74.5 million | $64.2 million | Up 16% |
| Diluted EPS | $0.75 | $0.63 | Up $0.12 |
| Cash dividends per share | $0.27 | $0.27 | Unchanged |
| Net cash from (used in) operating activities | $(30.0) million | $29.3 million | Declined $59.3 million |
Unless stated otherwise, dollar amounts are U.S. dollars. Revenue as a percentage of average managed assets was 0.22%, versus 0.25% in Q1 2020. The reported margin figures above are calculated from reported revenue and operating income.
Material changes and financial position
- Revenue mix and assets: Long-term assets under management ended the quarter at $205.9 billion, up 33% year over year, while money market assets were $419.1 billion, down 7%. Average managed assets rose 7% to $618.1 billion. Equity and fixed-income revenue benefited from higher average assets, but money market revenue fell sharply.
- Low-rate fee waivers: Voluntary yield-related waivers were $83.1 million, partly offset by $61.4 million of lower distribution expense; the net negative pretax impact was $21.7 million. Total fee waivers were $201.1 million, compared with $130.5 million a year earlier.
- Expenses and earnings: Operating expenses fell $22.7 million, largely from lower distribution expense related to fee waivers. Compensation and related expense increased $28.3 million. Nonoperating results improved, including a $1.4 million net securities gain versus a $15.8 million loss in Q1 2020.
- Cash, liquidity and debt: Cash and cash equivalents were $222.6 million at March 31, down from $301.8 million at year-end. Management reported $373.6 million of liquid assets, net of noncontrolling interests, versus $432.5 million at year-end. Debt was $70.0 million, down from $75.0 million; $305 million remained available under the $375 million revolving facility, with a further $200 million accordion option. The facility matures June 5, 2022. The company reported compliance with debt covenants.
- Capital returns: The company paid $26.8 million in dividends and repurchased 1.505 million shares for approximately $45.0 million during the quarter. On April 29, the board declared another $0.27 per-share dividend and authorized a new repurchase program for up to 4 million shares.
Outlook, risks and unusual items
- Near-term outlook: Assuming asset levels and mix remain constant and based on recent and projected conditions, management estimated that voluntary yield-related waivers could have a negative pretax impact of approximately $35 million to $45 million in Q2 2021. Actual results may vary materially with rates, assets, yields, expenses, customer relationships and the extent of distributor cost-sharing. The filing provides no broader earnings or revenue guidance.
- Key business risks: Near-zero short-term rates and potential money market fund reforms could affect waivers, revenue and fund assets. The filing also discusses pandemic and market uncertainty, regulatory change, Brexit, possible financial transaction taxes, LIBOR transition, cybersecurity and operational resilience, and foreign-exchange and investment risks.
- Acquisition and accounting matters: Q1 included final purchase accounting adjustments related to the 2020 HCL acquisition and consolidation of certain entities. The consolidation added $6.9 million of revenue and an equal amount of compensation expense, with no net income or EPS effect from the adjustments. Management reported that the acquired indefinite-lived intangible assets’ estimated fair value exceeded carrying value by about 7% at March 31; further deterioration in assumptions could result in impairment.
- Contingencies: Approximately $11 million of previously recognized carried interest remained subject to clawback. Management did not estimate a clawback was likely based on current valuations, but further asset-value declines could trigger repayment. Management did not believe a material loss from ordinary-course legal claims or indemnifications was reasonably possible.
- Management commentary: Management said the pandemic had not materially affected the company’s financial condition or cash flows as of March 31 and believed projected liquidity, operating cash flow and borrowing capacity would meet present and reasonably foreseeable needs. It also noted that continuing regulatory and compliance work could increase expenses.
Important facts for investors to verify
- Whether short-term rates, money market fund yields and distributor cost-sharing cause Q2 fee-waiver impacts to differ from the $35 million–$45 million estimate.
- Subsequent trends in average and period-end AUM, particularly money market assets and higher-fee equity, fixed-income and alternatives assets.
- Cash generation and liquidity after incentive compensation payments, dividends and share repurchases; and the refinancing or repayment plan for the credit facility due in June 2022.
- Whether acquired intangible-asset valuations retain adequate headroom and whether carried-interest clawback exposure changes.
- The effect of proposed U.S. and international money market regulation, Brexit-related requirements and the LIBOR transition on products, costs and distribution.