FEDERATED HERMES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with Item 1- Business, Item 1A - Risk Factors, Item 6 - Selected Financial Data and Item 8 - Financial Statements and Supplementary Data. General Federated is one of the largest investment managers in theU.S. with$575.9 billion in managed assets as ofDecember 31, 2019 . The majority of Federated's revenue is derived from advising Federated Funds and Separate Accounts in both domestic and international markets. Federated also derives revenue from providing administrative and other fund-related services (including distribution and shareholder servicing) and stewardship services. For additional information on Federated's markets, see Item 1 - Business under the caption Distribution Channels and Product Markets. Investment advisory fees, administrative service fees and certain fees for other services, such as distribution and shareholder service fees, are contract-based fees that are generally calculated as a percentage of the average net assets of managed investment portfolios. Federated's revenue is primarily dependent upon factors that affect the value of managed assets including market conditions and the ability to attract and retain assets. Generally, managed assets in Federated's investment products and strategies can be redeemed or withdrawn at any time with no advance notice requirement. Fee rates for Federated's services generally vary by asset and service type and may vary based on changes in asset levels. Generally, management-fee rates charged for advisory services provided to equity and multi-asset products and strategies are higher than management-fee rates charged to fixed-income and alternative/private markets products and strategies, which in turn are higher than management-fee rates charged to money market products and strategies. Likewise, Federated Funds typically have a higher management-fee rate than Separate Accounts. Similarly, revenue is also dependent upon the relative composition of average AUM across both asset and product types. Federated may implement Fee Waivers for competitive reasons such as to maintain certain fund expense ratios, to meet regulatory requirements or to meet contractual requirements. Since Federated's products are largely distributed and serviced through financial intermediaries, Federated pays a portion of fees earned from sponsored products to the financial intermediaries that sell these products and strategies. These payments are generally calculated as a percentage of net assets attributable to the applicable financial intermediary and represent the vast majority of Distribution expense on the Consolidated Statements of Income. Certain components of Distribution expense can vary depending upon the asset type, distribution channel and/or the size of the customer relationship. Federated generally pays out a larger portion of the revenue earned from managed assets in money market and multi-asset funds than the revenue earned from managed assets in equity, fixed-income and alternative/private markets funds. Federated's most significant operating expenses are Compensation and Related expense and Distribution expense. Compensation and Related expense includes base salary and wages, incentive compensation and other employee expenses including payroll taxes and benefits. Incentive compensation, which includes stock-based compensation, can vary depending on various factors including, but not limited to, the overall results of operations of Federated, investment management performance and sales performance. The discussion and analysis of Federated's financial condition and results of operations are based on Federated's Consolidated Financial Statements. Management evaluates Federated's performance at the consolidated level. Therefore, Federated operates in one operating segment, the investment management business. Management analyzes all expected revenue and expenses and considers market demands in determining an overall fee structure for services provided and in evaluating the addition of new business. Federated's growth and profitability are dependent upon its ability to attract and retain AUM and upon the profitability of those assets, which is impacted, in part, by Fee Waivers. Fees for mutual fund-related services are ultimately subject to the approval of the independent directors or trustees of the mutual funds. Management believes that meaningful indicators of Federated's financial performance include AUM, gross and net product sales, total revenue and net income, both in total and per diluted share. 36 -------------------------------------------------------------------------------- Business Developments Current Regulatory Environment Federated and its investment management business are subject to extensive regulation both in and outside theU.S. Federated and its products, such as the Federated Funds, and strategies are subject to: federal securities laws, principally the 1933 Act, the 1934 Act, the 1940 Act and the Advisers Act; state laws regarding securities fraud and registration; regulations or other rules promulgated by various regulatory authorities, self-regulatory organizations or exchanges; and foreign laws, regulations or other rules promulgated by foreign regulatory or other authorities. See Item 1 - Business under the caption Regulatory Matters and Item 1A - Risk Factors under the caption Potential Adverse Effects of Changes in Laws, Regulations and Other Rules on Federated's Investment Management Business for additional information. Asset Highlights Managed Assets at Period End 2019
in millions as of
$ 89,011 $ 72,497 23 % Fixed-Income 69,023 63,158 9 Alternative / Private Markets1 18,102 18,318 (1 ) Multi-Asset 4,199 4,093 3 Total Long-Term Assets 180,335 158,066 14 Money Market 395,539 301,794 31 Total Managed Assets$ 575,874 $ 459,860 25 % By Product Type Funds: Equity$ 48,112 $ 36,584 32 % Fixed-Income 44,223 40,490 9 Alternative / Private Markets1 11,389 11,365 0 Multi-Asset 4,000 3,920 2 Total Long-Term Assets 107,724 92,359 17 Money Market 286,612 208,480 37 Total Fund Assets 394,336 300,839 31 Separate Accounts: Equity 40,899 35,913 14 Fixed-Income 24,800 22,668 9
Alternative / Private Markets 6,713 6,953 (3 ) Multi-Asset
199 173 15
Total Long-Term Assets 72,611 65,707 11
Money Market 108,927 93,314 17
Total Separate Account Assets 181,538 159,021 14 Total Managed Assets
$ 575,874 $ 459,860 25 %
1 The balance at
billion, respectively, of fund assets managed by a non-consolidated entity,
Hermes GPE LLP , in which Hermes holds an equity method investment. 37
-------------------------------------------------------------------------------- Average Managed Assets in millions for the years ended 2019 2018 December 31, 2019 2018 2017 vs. 2018 vs. 2017 By Asset Class Equity$ 81,212 $ 70,680 $ 60,255 15 % 17 % Fixed-Income 65,375 63,454 55,204 3 15 Alternative / Private Markets1 17,896 9,397 441 90 NM Multi-Asset 4,192 4,764 5,062 (12 ) (6 ) Total Long-Term Assets 168,675 148,295 120,962 14 23 Money Market 340,505 267,093 245,459 27 9 Total Average Managed Assets$ 509,180 $ 415,388 $ 366,421 23 % 13 % By Product Type Funds: Equity$ 42,712 $ 36,984 $ 32,160 15 % 15 % Fixed-Income 41,938 40,952 40,676 2 1 Alternative / Private Markets1 11,317 5,784 441 96 NM Multi-Asset 4,003 4,554 4,841 (12 ) (6 ) Total Long-Term Assets 99,970 88,274 78,118 13 13 Money Market 238,876 182,828 176,580 31 4 Total Average Fund Assets 338,846 271,102 254,698 25 6 Separate Accounts: Equity 38,500 33,696 28,095 14 20 Fixed-Income 23,437 22,502 14,528 4 55 Alternative / Private Markets 6,579 3,613 0 82 0 Multi-Asset 189 210 221 (10 ) (5 ) Total Long-Term Assets 68,705 60,021 42,844 14 40 Money Market 101,629 84,265 68,879 21 22 Total Average Separate Account Assets 170,334 144,286 111,723 18 29
Total Average Managed Assets
23 % 13 %
1 The average for the years ended
billion and
non-consolidated entity,
method investment.
38-------------------------------------------------------------------------------- Changes inEquity Fund and Separate Account Assets in millions for the years ended December 31, 2019 2018 Equity Funds Beginning Assets$ 36,584 $ 33,008 Sales 12,380 8,408 Redemptions (11,757 ) (12,192 ) Net Sales (Redemptions) 623 (3,784 ) Net Exchanges 181 (115 ) Acquisition-Related 2,191 11,131 Impact of Foreign Exchange1 54 0 Market Gains and (Losses)2 8,479 (3,656 ) Ending Assets$ 48,112 $ 36,584 Equity Separate Accounts Beginning Assets$ 35,913 $ 29,808 Sales3 7,842 5,547 Redemptions3 (10,037 ) (10,209 ) Net Sales (Redemptions)3 (2,195 ) (4,662 ) Net Exchanges 0 (1 ) Acquisition-Related 53 13,569 Impact of Foreign Exchange1 (82 ) 0 Market Gains and (Losses)2 7,210 (2,801 ) Ending Assets$ 40,899 $ 35,913 Total Equity Beginning Assets$ 72,497 $ 62,816 Sales3 20,222 13,955 Redemptions3 (21,794 ) (22,401 ) Net Sales (Redemptions)3 (1,572 ) (8,446 ) Net Exchanges 181 (116 ) Acquisition-Related 2,244 24,700 Impact of Foreign Exchange1 (28 ) 0 Market Gains and (Losses)2 15,689 (6,457 ) Ending Assets$ 89,011 $ 72,497
1 Reflects the impact of translating non-
dollars for reporting purposes. Reporting only contains foreign exchange
separately beginning in 2019, previously included in Market Gains and
(Losses).
2 Reflects the approximate changes in the fair value of the securities held by
the portfolios and, to a lesser extent, reinvested dividends, distributions,
net investment income and the impact of changes in foreign exchange rates for
2018.
3 For certain accounts, Sales and Redemptions are calculated as the remaining
difference between beginning and ending assets after the calculation of total
investment return.
39-------------------------------------------------------------------------------- Changes inFixed-Income Fund and Separate Account Assets in millions for the years ended December 31, 2019 2018 Fixed-Income Funds Beginning Assets$ 40,490 $ 41,144 Sales 16,730 16,594 Redemptions (16,311 ) (18,366 ) Net Sales (Redemptions) 419 (1,772 ) Net Exchanges (98 ) 138 Acquisition-Related 450 1,565 Impact of Foreign Exchange1 72 0 Market Gains and (Losses)2 2,890 (585 ) Ending Assets$ 44,223 $ 40,490 Fixed-Income Separate Accounts Beginning Assets$ 22,668 $ 23,016 Sales3 4,694 3,562 Redemptions3 (5,232 ) (5,004 ) Net Sales (Redemptions)3 (538 ) (1,442 ) Net Exchanges (110 ) (2 ) Acquisition-Related 0 1,167 Impact of Foreign Exchange1 (12 ) 0 Market Gains and (Losses)2 2,792 (71 ) Ending Assets$ 24,800 $ 22,668 Total Fixed-Income Beginning Assets$ 63,158 $ 64,160 Sales3 21,424 20,156 Redemptions3 (21,543 ) (23,370 ) Net Sales (Redemptions)3 (119 ) (3,214 ) Net Exchanges (208 ) 136 Acquisition-Related 450 2,732 Impact of Foreign Exchange1 60 0 Market Gains and (Losses)2 5,682 (656 ) Ending Assets$ 69,023 $ 63,158
1 Reflects the impact of translating non-
dollars for reporting purposes. Reporting only contains foreign exchange
separately beginning in 2019, previously included in Market Gains and
(Losses).
2 Reflects the approximate changes in the fair value of the securities held by
the portfolios and, to a lesser extent, reinvested dividends, distributions,
net investment income and the impact of changes in foreign exchange rates for
2018.
3 For certain accounts, Sales and Redemptions are calculated as the remaining
difference between beginning and ending assets after the calculation of total
investment return.
40-------------------------------------------------------------------------------- Changes in Alternative /Private Markets Fund and Separate Account Assets in millions for the years ended December 31, 2019 2018 Alternative / Private Markets Funds1 Beginning Assets$ 11,365 $ 366 Sales 1,062 1,127 Redemptions (1,721 ) (790 ) Net Sales (Redemptions) (659 ) 337 Net Exchanges (65 ) (2 ) Acquisition-Related 0 10,823 Impact of Foreign Exchange2 430 0 Market Gains and (Losses)3 318 (159 ) Ending Assets$ 11,389 $ 11,365 Alternative / Private Markets Separate Accounts Beginning Assets$ 6,953 $ 0 Sales4 381 123 Redemptions4 (738 ) (525 ) Net Sales (Redemptions)4 (357 ) (402 ) Acquisition-Related 0 7,686 Impact of Foreign Exchange2 264 0 Market Gains and (Losses)3 (147 ) (331 ) Ending Assets$ 6,713 $ 6,953 Total Alternative / Private Markets1 Beginning Assets$ 18,318 $ 366 Sales4 1,443 1,250 Redemptions4 (2,459 ) (1,315 ) Net Sales (Redemptions)4 (1,016 ) (65 ) Net Exchanges (65 ) (2 ) Acquisition-Related 0 18,509 Impact of Foreign Exchange2 694 0 Market Gains and (Losses)3 171 (490 ) Ending Assets$ 18,102 $ 18,318
1 The balance at
billion, respectively, of fund assets managed by a non-consolidated entity,
2 Reflects the impact of translating non-
dollars for reporting purposes. Reporting only contains foreign exchange
separately beginning in 2019, previously included in Market Gains and
(Losses).
3 Reflects the approximate changes in the fair value of the securities held by
the portfolios and, to a lesser extent, reinvested dividends, distributions,
net investment income and the impact of changes in foreign exchange rates for
2018.
4 For certain accounts, Sales and Redemptions are calculated as the remaining
difference between beginning and ending assets after the calculation of total
investment return.
41-------------------------------------------------------------------------------- Changes inMulti-Asset Fund and Separate Account Assets in millions for the years ended December 31, 2019 2018 Multi-Asset Funds Beginning Assets$ 3,920 $ 4,783 Sales 317 472 Redemptions (864 ) (1,013 ) Net Sales (Redemptions) (547 ) (541 ) Net Exchanges 55 (21 ) Acquisition-Related 11 45 Market Gains and (Losses)1 561 (346 ) Ending Assets$ 4,000 $ 3,920 Multi-Asset Separate Accounts Beginning Assets$ 173 $ 231 Sales2 15 21 Redemptions2 (29 ) (31 ) Net Sales (Redemptions)2 (14 ) (10 ) Market Gains and (Losses)1 40 (48 ) Ending Assets$ 199 $ 173 Total Multi-Asset Beginning Assets$ 4,093 $ 5,014 Sales2 332 493 Redemptions2 (893 ) (1,044 ) Net Sales (Redemptions)2 (561 ) (551 ) Net Exchanges 55 (21 ) Acquisition-Related 11 45 Market Gains and (Losses)1 601 (394 ) Ending Assets$ 4,199 $ 4,093
1 Reflects the approximate changes in the fair value of the securities held by
the portfolios and, to a lesser extent, reinvested dividends, distributions
and net investment income.
2 For certain accounts, Sales and Redemptions are calculated as the remaining
difference between beginning and ending assets after the calculation of total
investment return.
42-------------------------------------------------------------------------------- Changes in Total Long-Term Assets in millions for the years ended December 31, 2019 2018Total Long-Term Fund Assets1 Beginning Assets$ 92,359 $ 79,301 Sales 30,489 26,601 Redemptions (30,653 ) (32,361 ) Net Sales (Redemptions) (164 ) (5,760 ) Net Exchanges 73 0 Acquisition-Related 2,652 23,564 Impact of Foreign Exchange2 556 0 Market Gains and (Losses)3 12,248 (4,746 ) Ending Assets$ 107,724 $ 92,359 Total Long-Term Separate Accounts Assets Beginning Assets$ 65,707 $ 53,055 Sales4 12,932 9,253 Redemptions4 (16,036 ) (15,769 ) Net Sales (Redemptions)4 (3,104 ) (6,516 ) Net Exchanges (110 ) (3 ) Acquisition-Related 53 22,422 Impact of Foreign Exchange2 170 0 Market Gains and (Losses)3 9,895 (3,251 ) Ending Assets$ 72,611 $ 65,707 Total Long-Term Assets1 Beginning Assets$ 158,066 $ 132,356 Sales4 43,421 35,854 Redemptions4 (46,689 ) (48,130 ) Net Sales (Redemptions)4 (3,268 ) (12,276 ) Net Exchanges (37 ) (3 ) Acquisition-Related 2,705 45,986 Impact of Foreign Exchange2 726 0 Market Gains and (Losses)3 22,143 (7,997 ) Ending Assets$ 180,335 $ 158,066
1 The balance at
billion, respectively, of fund assets managed by a non-consolidated entity,
2 Reflects the impact of translating non-
dollars for reporting purposes. Reporting only contains foreign exchange
separately beginning in 2019, previously included in Market Gains and
(Losses).
3 Reflects the approximate changes in the fair value of the securities held by
the portfolios and, to a lesser extent, reinvested dividends, distributions,
net investment income and the impact of changes in foreign exchange rates for
2018.
4 For certain accounts, Sales and Redemptions are calculated as the remaining
difference between beginning and ending assets after the calculation of total
investment return.
43
--------------------------------------------------------------------------------
Changes in Federated's average asset mix year-over-year across both asset
classes and product types have a direct impact on Federated's operating income.
Asset mix impacts Federated's total revenue due to the difference in the fee
rates earned on each asset class and product type per invested dollar and
certain components of distribution expense can vary depending upon the asset
class, distribution channel and/or the size of the customer relationship. The
following table presents the relative composition of average managed assets and
the percent of total revenue derived from each asset class and product type over
the last three years:
Percent of Total Average Managed Assets Percent of Total Revenue
2019 2018 2017 2019 2018 2017
By Asset Class
Money Market 67 % 64 % 67 % 40 % 37 % 41 %
Equity 16 % 17 % 17 % 40 % 41 % 38 %
Fixed-Income 13 % 16 % 15 % 14 % 16 % 17 %
Alternative / Private Markets 3 % 2 % 0 % 3 % 2 % 0 %
Multi-Asset 1 % 1 % 1 % 2 % 3 % 4 %
Other 0 % 0 % 0 % 1 % 1 % 0 %
By Product Type
Funds:
Money Market 47 % 44 % 48 % 37 % 34 % 38 %
Equity 8 % 9 % 9 % 30 % 31 % 30 %
Fixed-Income 8 % 10 % 11 % 12 % 14 % 15 %
Alternative / Private Markets 2 % 1 % 0 % 1 % 1 % 0 %
Multi-Asset 1 % 1 % 1 % 2 % 3 % 4 %
Other 0 % 0 % 0 % 0 % 0 % 0 %
Separate Accounts:
Money Market 20 % 20 % 19 % 3 % 3 % 3 %
Equity 8 % 8 % 8 % 10 % 10 % 8 %
Fixed-Income 5 % 6 % 4 % 2 % 2 % 2 %
Alternative / Private Markets 1 % 1 % 0 % 2 % 1 % 0 %
Multi-Asset 0 % 0 % 0 % 0 % 0 % 0 %
Other 0 % 0 % 0 % 1 % 1 % 0 %
Total managed assets represent the balance of AUM at a point in time. By
contrast, total average managed assets represent the average balance of AUM
during a period of time. Because substantially all revenue and certain
components of distribution expense are generally calculated daily based on AUM,
changes in average managed assets are typically a key indicator of changes in
revenue earned and asset-based expenses incurred during the same period.
Average managed assets increased 23% for 2019 as compared to 2018. Period-end
managed assets increased 25% at December 31, 2019 as compared to December 31,
2018 primarily due to an increase in money market and equity assets. Average
money market assets increased 27% for 2019 compared to 2018. Period-end money
market assets increased 31% at December 31, 2019 as compared to December 31,
2018 . Average equity assets increased 15% for 2019 as compared to 2018.
Period-end equity assets increased 23% at December 31, 2019 as compared to
December 31, 2018 primarily due to market appreciation. Average fixed income
assets increased 3% for 2019 as compared to 2018. Period-end fixed-income assets
increased 9% at December 31, 2019 as compared to December 31, 2018 , primarily
due to market appreciation. During 2019, the combination of fading recession
fears, easing trade tensions and Federal Reserve easing helped push equity
markets to new highs, with the S&P 500 increasing 31.5% on a total return basis
for its best year since 2013. Muted inflation pressures and three 0.25%
reductions in the Federal Reserve's target funds rate in the second half of the
year also helped drive bond yields down over the course of the year, with the
10-year Treasury yield declining from 2.69% at the end of 2018 to 1.92% at the
end of 2019. For all of 2019, the Bloomberg Barclays U.S. Aggregate Bond Index
returned 8.7%, its best year since 2002.
For an explanation of the changes in managed assets at December 31, 2018
compared to December 31, 2017 and changes in average managed assets for 2018 as
compared to 2017, see Federated's Annual Report on Form 10-K for the year ended
December 31, 2018 , Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations under the caption Asset Highlights.
44
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Results of Operations
For an explanation of changes for 2018 as compared to 2017, see Federated's
Annual Report on Form 10-K for the year ended December 31, 2018 , Item 7
Management's Discussion and Analysis of Financial Condition and Results of
Operations under the caption Results of Operations.
Revenue. Revenue increased $191.2 million in 2019 as compared to 2018 primarily
due to (1) an increase in money market revenue of $114.6 million primarily due
to higher average money market assets and (2) $96.4 million of Hermes activity
being included in the Consolidated Financial Statements for two additional
quarters in 2019 as compared to 2018 (Hermes Full Year Impact). These increases
in revenue were partially offset by decreases of $6.5 million and $5.1 million
from lower average equity and multi-asset assets (excluding the Hermes Full Year
Impact), respectively.
Federated's ratio of revenue to average managed assets for 2019 was 0.26% as
compared to 0.27% for 2018.
Operating Expenses. Total operating expenses for 2019 increased $173.6 million
compared to 2018. Compensation and Related expense increased $87.4 million in
2019 as compared to 2018 primarily related to the Hermes Full Year Impact of
$61.4 million and an increase in incentive compensation of $15.5 million driven
primarily by international efforts and investment management performance.
Distribution expense increased $53.1 million in 2019 as compared to 2018
primarily due to higher average money market fund assets. Systems and
Communications expense increased $13.1 million in 2019 compared to 2018
primarily related to $8.3 million resulting from the Hermes Full Year Impact and
$4.2 million due to increased market data services. The remaining operating
expenses for 2019 increased $20.0 million compared to 2018 primarily due to the
Hermes Full Year Impact.
Nonoperating Income (Expenses). Nonoperating Income (Expenses), net, increased
$51.5 million in 2019 as compared to 2018. The increase is primarily due to
(1) a $29.0 million loss, recorded in Other, net in 2018, related to two
derivative financial instruments associated with the Hermes Acquisition and
(2) an increase of $9.1 million of private equity carried interest income on
assets managed by a nonconsolidated entity, recorded in Other, net on the
Consolidated Statements of Income. In addition, Gain (Loss) on Securities, net
increased $9.3 million due primarily to an increase in the market value of
investments primarily held by consolidated investment companies.
Income Taxes. The income tax provision for 2019 and 2018 was $88.1 million and
$73.9 million , respectively. The provision for 2019 increased $14.2 million as
compared to 2018 primarily due to higher income before income taxes as a result
of the changes in revenues, operating expenses and nonoperating income
(expenses) noted above. The effective tax rate was 24.1% for 2019 and 24.9% for
2018. See Note (16) to the Consolidated Financial Statements for additional
information on the effective tax rate, as well as other tax disclosures.
Net Income Attributable to Federated Hermes, Inc. Net income increased $52.0
million in 2019 as compared to 2018 primarily as a result of the changes in
revenues, operating expenses, nonoperating income (expenses) and income taxes
noted above. Diluted earnings per share for 2019 increased $0.51 as compared to
2018 primarily due to increased net income.
Liquidity and Capital Resources
Liquid Assets. At December 31, 2019 , liquid assets, net of noncontrolling
interests, consisting of cash and cash equivalents, investments and receivables,
totaled $359.1 million as compared to $222.1 million at December 31, 2018 . The
change in liquid assets is discussed below.
At December 31, 2019 , Federated's liquid assets included investments in certain
money market and fluctuating-value Federated Funds that may have direct and/or
indirect exposures to international sovereign debt and currency risks. Federated
continues to actively monitor its investment portfolios to manage sovereign debt
and currency risks with respect to certain European countries (such as the UK in
light of Brexit), China and certain other countries subject to economic
sanctions. Federated's experienced portfolio managers and analysts work to
evaluate credit risk through quantitative and fundamental analysis. Further,
regarding international exposure, certain money market funds (approximately $212
million ), that meet the requirement of Rule 2a-7 or operate in accordance with
requirements similar to those in Rule 2a-7, include holdings with indirect
short-term exposures invested primarily in high-quality international bank names
that are subject to Federated's credit analysis process.
Cash Provided by Operating Activities. Net cash provided by operating activities
totaled $334.9 million for 2019 as compared to $206.3 million for 2018. The
increase of $128.6 million was primarily due to (1) an increase in cash received
related to the $191.2 million increase in revenue previously discussed, (2) a
decrease of $65.0 million in cash paid for incentive compensation (primarily
related to Hermes employees in the third quarter of 2018) and (3) a decrease of
$29.0 million in cash paid due to the settlement of two derivative financial
instruments associated with the Hermes Acquisition in 2018. These were partially
offset by (1) a decrease due to additional cash paid related to the $53.1
million increase in distribution related expenses previously discussed, (2) an
increase of $43.1 million in cash paid for net purchases of investments by
consolidated Federated
45
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Funds, (3) an increase of $25.9 million in cash paid for compensation (excluding
incentive compensation) primarily related to the Hermes Full Year Impact and
(4) an increase of $11.0 million in cash paid for taxes primarily due to an
increase in pretax book income.
Cash Used by Investing Activities. In 2019, net cash used by investing
activities was $94.7 million which primarily represented (1) $103.4 million in
cash paid for purchases of investments, (2) $58.0 million in cash paid for
indefinite-lived rights to manage fund assets acquired in connection with the
acquisition of certain components of the PNC Capital Advisors LLC investment
management business and (3) $15.0 million in cash paid for property and
equipment, partially offset by $81.1 million in proceeds from the redemption of
investments.
Cash Used by Financing Activities. In 2019, net cash used by financing
activities was $152.7 million . Of this amount, Federated paid $109.1 million or
$1.08 per share in dividends to holders of its common shares, paid $43.8 million
in connection with its debt obligations and paid $15.7 million to repurchase
shares of Class B common stock primarily in connection with its stock repurchase
program (see Note (15) to the Consolidated Financial Statements for additional
information). This activity was partially offset by $8.8 million borrowed from
Federated's revolving credit facility.
Borrowings. In 2017, Federated entered into an unsecured Third Amended and
Restated Credit Agreement by and among Federated, certain of its subsidiaries as
guarantors party thereto, a syndicate of ten banks as Lenders party thereto, PNC
Bank, National Association as administrative agent, PNC Capital Markets LLC , as
sole bookrunner and joint lead arranger, Citigroup Global Markets, Inc. , as
joint lead arranger, Citibank, N.A . as syndication agent, and TD Bank, N.A . as
documentation agent (Credit Agreement). The Credit Agreement consists of a $375
million revolving credit facility with an additional $200 million available via
an optional increase (or accordion) feature. The original proceeds were used for
general corporate purposes including cash payments related to acquisitions,
dividends, investments and share repurchases. As of December 31, 2019 , Federated
has $275 million available to borrow under the Credit Agreement. See Note (12)
to the Consolidated Financial Statements for additional information.
The Credit Agreement includes an interest coverage ratio covenant (consolidated
earnings before interest, taxes, depreciation and amortization (EBITDA) to
consolidated interest expense) and a leverage ratio covenant (consolidated debt
to consolidated EBITDA) as well as other customary terms and conditions.
Federated was in compliance with all of its covenants, including its interest
coverage and leverage ratios at and during the year ended December 31, 2019 . An
interest coverage ratio of at least 4 to 1 is required and, as of December 31,
2019 , Federated's interest coverage ratio was 94 to 1. A leverage ratio of no
more than 3 to 1 is required and, as of December 31, 2019 , Federated's leverage
ratio was 0.2 to 1. The Credit Agreement also has certain stated events of
default and cross default provisions which would permit the
lenders/counterparties to accelerate the repayment of debt outstanding if not
cured within the applicable grace periods. The events of default generally
include breaches of contract, failure to make required loan payments,
insolvency, cessation of business, notice of lien or assessment, and other
proceedings, whether voluntary or involuntary, that would require the repayment
of amounts borrowed.
Dividends. Cash dividends of $109.1 million , $106.9 million and $101.5 million
were paid in 2019, 2018 and 2017 respectively, to holders of Federated common
stock. All dividends were considered ordinary dividends for tax purposes.
Future Cash Needs. In addition to the contractual obligations described below,
management expects that principal uses of cash will include funding business
acquisitions and global expansion, funding distribution expenditures, paying
incentive and base compensation, paying shareholder dividends, repaying debt
obligations, paying taxes, repurchasing company stock, developing and seeding
new products and strategies, modifying existing products, strategies and
relationships, and funding property and equipment (including technology). Any
number of factors may cause Federated's future cash needs to increase. As a
result of the highly regulated nature of the investment management business,
management anticipates that aggregate expenditures for compliance and investment
management personnel, compliance systems and technology and related professional
and consulting fees may continue to increase.
On January 30, 2020 , the board of directors declared a $0.27 per share dividend.
The dividend was payable to shareholders of record as of February 7, 2020 ,
resulting in $27.3 million being paid on February 14, 2020 .
After evaluating Federated's existing liquid assets, expected continuing cash
flow from operations, its borrowing capacity under the Credit Agreement and its
ability to obtain additional financing arrangements and issue debt or stock,
management believes it will have sufficient liquidity to meet its present and
reasonably foreseeable cash needs.
46
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Financial Position
The following discussion summarizes significant changes in assets and
liabilities that are not discussed elsewhere in Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Goodwill at December 31, 2019 decreased $35.1 million from December 31, 2018
primarily due to the final purchase price adjustment related to the Hermes
Acquisition (see Note (3) to the Consolidated Financial Statements).
Intangible Assets, net at December 31, 2019 increased $106.6 million from
December 31, 2018 primarily due to $58.0 million of indefinite-lived rights to
manage fund assets acquired in connection with the acquisition of certain
components of the PNC Capital Advisors LLC investment management business. The
remaining difference primarily related to the final purchase price adjustment
related to the Hermes Acquisition (see Note (3) to the Consolidated Financial
Statements).
The following line items increased as a result of the adoption of the new lease
guidance effective January 1, 2019 : (1) Right-of-Use Assets, net ($100.5
million ), (2) Lease Liabilities ($13.6 million ) and (3) Long-Term Lease
Liabilities ($107.5 million ). In addition, Other Long-Term Liabilities at
December 31, 2019 decreased $16.6 million from December 31, 2018 primarily due
to the reclassification of certain lease-related liabilities into the
right-of-use (ROU) asset in accordance with this adoption. See Note (2) and
Note (18) to the Consolidated Financial Statements for additional information.
Accrued Compensation and Benefits at December 31, 2019 increased $23.6 million
from December 31, 2018 primarily due to 2019 incentive compensation accruals
recorded at December 31, 2019 ($117.3 million ), partially offset by the 2018
accrued annual incentive compensation being paid in the first quarter of 2019
($99.0 million ).
Off-Balance Sheet Arrangements
As of December 31, 2019 and 2018, Federated did not have any material
off-balance sheet arrangements.
Contractual Obligations
The following table presents, as of December 31, 2019 , Federated's significant
minimum noncancelable contractual obligations by payment date. The payments
represent amounts contractually due to the recipient and do not include any
carrying value adjustments. Further discussion of the nature of each obligation
is included below the table.
Payments Due in
in millions 2020 2021-2022 2023-2024 After 2024 Total
Long-Term Debt Obligations $ 0.0 $ 100.0 $ 0.0 $ 0.0 $ 100.0
Operating Lease Obligations 17.9 35.8 36.3 53.1 143.1
Purchase Obligations 31.9 15.4 9.1 8.6 65.0
Other Obligations 2.7 0.5 0.0 0.0 3.2
Total $ 52.5 $ 151.7 $ 45.4 $ 61.7 $ 311.3
Long-Term Debt Obligations. Outstanding principal is to be paid no later than
the expiration date of the Credit Agreement. Amount includes principal only. The
interest is variable, based on LIBOR plus a 112.5 basis point spread, in
accordance with the Credit Agreement. Assuming management's current plan for
repayment of the Credit Agreement and LIBOR as of December 31, 2019 , Federated's
interest payments are estimated to be $2.6 million and $2.3 million for 2020 and
2021-2022, respectively. Any changes in future cash needs can impact the
projected repayment schedule. As such, management's repayment plan is subject to
change at management's discretion, which may impact the estimated interest
payments. See Note (12) to the Consolidated Financial Statements for additional
information.
Operating Lease Obligations. See Note (18) to the Consolidated Financial
Statements for additional information.
Purchase Obligations. Federated is a party to various contracts pursuant to
which it receives certain services, including services for marketing and
information technology, access to various fund-related information systems and
research databases, trade order transmission and recovery services as well as
other services. These contracts contain certain minimum noncancelable payments,
cancellation provisions and renewal terms. The contracts require payments
through the year 2027. Costs for such services are expensed as incurred.
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Variable Interest Entities
Federated is involved with various entities in the normal course of business
that may be deemed to be variable interest entities (VIEs). Federated determined
that it was the primary beneficiary of certain Federated Fund VIEs and, as a
result, consolidated the assets, liabilities and operations of these VIEs in its
Consolidated Financial Statements. See Note (6) to the Consolidated Financial
Statements for more information.
Recent Accounting Pronouncements
For a complete list of new accounting standards applicable to Federated, see
Note (2) to the Consolidated Financial Statements.
Critical Accounting Policies
Federated's Consolidated Financial Statements have been prepared in accordance
with U.S. generally accepted accounting principles (GAAP). In preparing the
financial statements, management is required to make estimates and assumptions
that affect the amounts reported in the Consolidated Financial Statements and
accompanying notes. Management continually evaluates the accounting policies and
estimates it uses to prepare the Consolidated Financial Statements. In general,
management's estimates are based on historical experience, information from
third-party professionals and various other assumptions that are believed to be
reasonable under the facts and circumstances. Actual results may differ from
those estimates made by management and those differences may be material.
Of the significant accounting policies described in Note (1) to the Consolidated
Financial Statements, management believes that its policies regarding accounting
for asset acquisitions and business combinations, goodwill and intangible assets
and Hermes redeemable noncontrolling interest involves a higher degree of
judgment and complexity.
Asset Acquisitions and Business Combinations. Federated performs an analysis to
determine whether a transaction meets the definition of a business under U.S.
GAAP. When determining whether a set of assets and activities constitute a
business, management considers whether substantially all of the fair value of
the gross assets acquired is concentrated in a single identifiable asset or a
group of similar identifiable assets. If this threshold is met, these assets and
activities do not meet the definition of a business and the transaction is
accounted for as an asset acquisition. If it is not met, management then
evaluates whether these assets and activities meet the requirement of a business
including, at a minimum, an input and a substantive process that together
significantly contribute to the ability to create outputs. If these assets and
activities do not meet these requirements, the transaction is accounted for as
an asset acquisition.
A transaction that does not meet this definition of a business is accounted for
as an asset acquisition. Asset acquisitions are accounted for using a cost
accumulation and allocation method where the cost of the transaction is
allocated on a relative fair value basis to the qualifying assets acquired and
liabilities assumed on the acquisition date. The cost of the transaction
includes both the consideration transferred to the seller and any direct
transaction costs incurred. The primary asset acquired in previous asset
acquisitions has been the rights to manage fund assets. The rights to manage
fund assets is an intangible asset valued using the excess earnings method,
under the income approach, which estimates fair value by quantifying the amount
of discounted cash flows generated by the asset. No goodwill is recognized in an
asset acquisition.
A transaction that meets this definition of a business is accounted for as a
business combination under the acquisition method of accounting. The
consideration transferred to the seller in a business combination is measured at
fair value and calculated as the sum of the acquisition date fair values of the
assets transferred by Federated, the liabilities incurred by Federated to the
acquirer and any equity interests issued by Federated. Direct transaction costs
are expensed as incurred in a business combination. Results of operations of an
acquired business are included in Federated's results from the date of
acquisition.
Rights to manage fund assets and trade names acquired in a business combination
are recorded at fair value. The fair value of the rights to manage fund assets
is determined using the excess earnings method, under the income approach. The
fair value of the trade name is determined using the relief from royalty method,
under the income approach. Each method considers various factors to project
future cash flows expected to be generated from the asset. After the fair values
of all separately identifiable assets and liabilities have been estimated,
goodwill is recorded to the extent that the consideration paid exceeds the sum
of the fair values of the separately identifiable acquired assets, net of
assumed liabilities.
For both asset acquisitions and business combinations, the significant
assumptions used in the valuation of the intangible assets acquired typically
include: (1) the asset's estimated useful life; (2) projected AUM; (3) projected
revenue growth rates; (4) projected pre-tax profit margins; (5) tax rates;
(6) discount rates and (7) in the case of a trade name valuation, a royalty
rate. Federated has determined that certain acquired assets, primarily certain
rights to manage fund assets and trade names, have indefinite useful lives. In
reaching this conclusion, management considered the acquired assets' legal,
regulatory and agreed-upon provisions, the highest and best use of the asset,
the level of cost and effort required in agreed-upon renewals, and the
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effects of obsolescence, demand, competition and other economic factors that
could impact the assets' fair value. Management estimates a rate of change for
underlying managed assets based on a combination of an estimated rate of market
appreciation or depreciation and an estimated net redemption or sales rate.
Expected revenue per managed asset and incremental operating expenses of the
acquired asset are generally based on agreed-upon terms, average market
participant data and historical experience. The assumptions for tax rates are
based on current and projected rates. The discount rates are estimated at the
current market rate of return. The royalty rate is estimated after consideration
of comparable third-party royalty rate licensing agreements, pre-tax profit
margins and the age and importance of the trade name. Given the complexity and
judgment involved in accounting for asset acquisitions and business
combinations, management may utilize the services of an independent valuation
expert to assist in this process.
Goodwill and Intangible Assets. The process of determining the amount of
goodwill and the fair value of identifiable intangible assets at the date of
acquisition requires significant management estimates and judgment. If
subsequent changes in these assumptions differ significantly from those used in
the initial valuation, the goodwill and/or intangible asset amounts recorded in
the financial statements could be subject to possible impairment. In addition,
finite-lived intangible assets could require an acceleration in amortization
expense. These adjustments could have a material adverse effect on Federated's
business, results of operations and financial condition.
Goodwill is reviewed for impairment annually as of June 30 , or when indicators
of a potential impairment exist. Federated has a single reporting unit,
consistent with Federated's single operating segment, to which all goodwill has
been assigned. Federated first performs a qualitative analysis and considers
various factors including macroeconomic and entity-specific considerations,
industry and market conditions, and overall financial performance. A
quantitative impairment test is performed if there are indications that it is
more likely than not that the fair value of the reporting unit is less than its
carrying value. At December 31, 2019 , Federated had $774.5 million in goodwill
recorded on its Consolidated Balance Sheets. No impairments were recorded during
the years ended December 31, 2019 , 2018 or 2017.
Indefinite-lived intangible assets are reviewed for impairment at the accounting
unit level annually as of October 1 , or when indicators of a potential
impairment exist. Management may use a qualitative or quantitative approach
which requires the weighting of positive and negative evidence collected through
the consideration of various factors to determine whether it is more likely than
not that an indefinite-lived intangible asset or asset group is impaired. In
2019, management used a quantitative approach. Management considers
macroeconomic and entity-specific factors, including projected AUM, projected
revenue growth rates, projected pre-tax profit margins, tax rates, discount
rates and, in the case of a trade name valuation, a royalty rate. In addition,
management reconsiders on a quarterly basis whether events or circumstances
indicate that a change in the useful life may have occurred. Indicators of a
possible change in useful life monitored by management generally include changes
in the expected use of the asset, a significant decline in the level of managed
assets, changes to legal, regulatory or contractual provisions of the rights to
manage fund assets, the effects of obsolescence, demand, competition and other
economic factors that could impact the funds' projected performance and
existence, and significant reductions in underlying operating cash flows.
Finite-lived intangible assets are amortized on a straight-line basis over their
estimated useful lives. Finite-lived intangible assets are reviewed for
impairment at least annually, or when indicators of a potential impairment
exist.
If actual changes in the underlying managed assets or other conditions indicate
that it is more likely than not that the asset is impaired, or if the estimated
useful life is reduced, management estimates the fair value of the intangible
asset using an income approach where future cash flows are discounted.
Impairment is indicated when the carrying value of the intangible asset exceeds
its fair value.
At December 31, 2019 , Federated had $446.2 million in intangible assets recorded
on its Consolidated Balance Sheets. No impairments were recorded during the
years ended December 31, 2019 , 2018 or 2017.
Hermes Redeemable Noncontrolling Interest. The Hermes noncontrolling interest
represents equity which is subject to the terms of a Put and Call Option Deed,
redeemable at the option of either the noncontrolling party or Federated at
future predetermined dates and, therefore, not entirely within Federated's
control. The subsidiary's net income or loss and related dividends are allocated
to Federated and the noncontrolling interest holder based on their relative
ownership percentages.
The Hermes noncontrolling interest carrying value is adjusted on a quarterly
basis to the higher of the carrying value or current redemption value (fair
value), as of the balance sheet date, through a corresponding adjustment to
retained earnings. Management may use an independent valuation expert to assist
in estimating the current redemption value (fair value) using three
methodologies: (1) the discounted cash flow methodology under the income
approach, (2) the guideline public company methodology under the market approach
and (3) the guideline public transaction methodology under the market approach.
The estimated current redemption value is derived from equally weighting the
result of each of the three methodologies. The estimation of the current
redemption value includes significant assumptions concerning: (1) projected AUM;
(2) projected
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revenue growth rates; (3) projected pre-tax profit margins; (4) tax rates and (5) discount rates. Management estimates a rate of change for underlying managed assets based on a combination of an estimated rate of market appreciation or depreciation and an estimated net redemption or sales rate. Expected revenue per managed asset and incremental operating expenses of the acquired asset are generally based on agreed-upon terms, average market participant data and historical experience. The assumptions for tax rates are based on current and projected rates. The discount rate is estimated at the current market rate of return. AtDecember 31, 2019 , Federated had$192.2 million in Redeemable Noncontrolling Interest in Subsidiaries related to Hermes recorded on its Consolidated Balance Sheets.
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