UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ------------EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
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OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
- ------------ SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 001-14818
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Federated Investors, Inc.
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(Exact name of registrant as specified in its charter)
Pennsylvania 25-1111467
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(State or other jurisdiction of (IRS Employer
incorporation or organization)
Identification No.)
Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779
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(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code) 412-288-1900
------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X . No ______.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date: As of August 12, 2002, the
Registrant had outstanding 9,000 shares of Class A Common Stock and
114,193,971 shares of Class B Common Stock.
Table of Contents
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Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets at June 30, 2002 and December 3
31, 2001
Consolidated Statements of Income for the Three and Six
Months Ended June 30, 4
2002 and 2001
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 5
2002 and 2001
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market 16
Risk
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits required by Item 601 of Regulation S-K 18
(b) Reports on Form 8-K 18
Signatures 19
Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 19
Special Note Regarding Forward-Looking Information
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Certain statements under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included in Future Cash Requirements and
elsewhere in this report, constitute forward-looking statements, which involve
known and unknown risks, uncertainties, and other factors that may cause the
actual results, levels of activity, performance, achievements, or industry
results, to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by such
forward-looking statements. For a discussion of such risk factors, see the
section titled Risk Factors and Cautionary Statements in Federated's Annual
Report on Form 10-K for the year ended December 31, 2001, and other reports on
file with the Securities and Exchange Commission. Many of these factors may be
more likely to occur as a result of the ongoing threat of terrorism. As a
result of the foregoing and other factors, no assurance can be given as to
future results, levels of activity, performance or achievements, and neither
we nor any other person assumes responsibility for the accuracy and
completeness of such statements.
3
Part I, Item 1. Financial Statements
Consolidated Balance Sheets
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(dollars in thousands)
(unaudited) June 30, December
31,
2002 2001
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Current Assets:
Cash and cash equivalents $ 76,274$ 73,511
Securities available for sale 205 4,602
Receivables, net of reserve of $226 and $315, 29,114 32,581
respectively
Accrued revenues 6,547 6,596
Prepaid expenses 6,634 2,633
Current deferred tax asset, net 370 2,025
Other current assets 720 361
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Total current assets 119,864 122,309
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Long-Term Assets:
Goodwill, net of accumulated amortization of $24,862 164,931 131,867
Other intangible assets, net 75,532 80,026
Deferred sales commissions, net of accumulated
amortization of $54,130 and 58,498 56,875
$47,222, respectively
Property and equipment, net of accumulated
depreciation of $50,934 and 33,397 34,521
$47,264, respectively
Other long-term assets 5,679 5,955
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Total long-term assets 338,037 309,244
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Total assets $ 457,901$ 431,553
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Current Liabilities:
Cash overdraft $ 4,405$ 5,085
Current portion of long-term debt - recourse 267 157
Accrued expenses 51,179 58,275
Accounts payable 26,451 29,102
Income taxes payable 598 26,543
Other current liabilities 3,527 5,946
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Total current liabilities 86,427 125,108
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Long-Term Liabilities:
Long-term debt - recourse 472 0
Long-term debt - nonrecourse 56,476 54,954
Long-term deferred tax liability, net 10,924 7,036
Other long-term liabilities 7,053 6,995
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Total long-term liabilities 74,925 68,985
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Total liabilities 161,352 194,093
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Minority interest 307 363
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Shareholders' Equity:
Common stock:
Class A, no par value, 20,000 shares authorized, 189 189
9,000 shares issued and outstanding
Class B, no par value, 900,000,000 shares 82,436 82,299
authorized, 129,505,456 shares issued
Additional paid-in capital from treasury stock 3,610 3,543
transactions
Retained earnings 504,583 411,447
Treasury stock, at cost, 15,235,885 and 14,144,515
shares Class B common stock, respectively (294,182) (259,626)
Employee restricted stock plan (349) (469)
Accumulated other comprehensive loss (45) (286)
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Total shareholders' equity 296,242 237,097
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Total liabilities, minority $ 457,901$ 431,553
interest, and shareholders' equity
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(The accompanying notes are an integral part of these consolidated
financial statements.)
Consolidated Statements of Income
(in thousands, except per share data)
(unaudited) Three Months Ended Six Months Ended
June 30, June 30,
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2002 2001 2002 2001
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Revenue:
Investment-advisory fees, $ 112,548 $ 102,593 $ 226,130 $ 197,052
net-affiliates
Investment-advisory fees, net-other 3,351 2,633 6,209 5,176
Administrative-service fees, 30,584 26,560 61,695 51,160
net-affiliates
Administrative-service fees, 4,749 5,250 9,881 10,471
net-other
Other service fees, net-affiliates 23,145 33,353 44,934 65,797
Other service fees, net-other 6,470 7,040 12,695 13,751
Commission income 1,012 759 1,773 1,826
Other, net 522 543 684 928
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Total revenue 182,381 178,731 364,001 346,161
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Operating Expenses:
Compensation and related 47,429 43,890 95,965 83,536
Advertising and promotional 18,492 17,335 36,395 33,496
Systems and communications 7,692 7,238 14,010 14,728
Office and occupancy 6,430 7,148 12,718 13,610
Professional service fees 5,610 7,170 11,270 14,150
Travel and related 3,551 3,545 5,985 6,764
Amortization of deferred sales 3,791 11,557 7,542 24,204
commissions
Amortization of intangible assets 2,942 4,069 6,003 6,080
Other 2,356 1,699 4,354 2,797
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Total operating expenses 98,293 103,651 194,242 199,365
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Operating income 84,088 75,080 169,759 146,796
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Nonoperating Income (Expense):
Interest and dividends 509 2,419 1,084 6,917
Loss on sale of securities available (34) (1) (153) (496)
for sale, net
Debt expense - recourse (108) (1,810) (208) (3,607)
Debt expense - nonrecourse (1,063) (5,880) (2,117) (12,027)
Other, net (69) (285) (68) (304)
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Total nonoperating expenses, net (765) (5,557) (1,462) (9,517)
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Income before minority interest and 83,323 69,523 168,297 137,279
income taxes
Minority interest 2,638 2,710 5,302 5,358
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Income before income taxes 80,685 66,813 162,995 131,921
Income tax provision 28,074 23,939 58,061 47,403
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Net income $ 52,611 $ 42,874 $ 104,934 $ 84,518
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Earnings per share:
Basic $ 0.47 $ 0.37 $ 0.93 $ 0.73
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Diluted $ 0.45 $ 0.36 $ 0.89 $ 0.70
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Cash dividends per share $ 0.057 $ 0.046 $ 0.103 $ 0.083
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(The accompanying notes are an integral part of these consolidated
financial statements.)
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Six Months Ended June 30, 2002 2001
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Operating Activities:
Net income $ 104,934 $ 84,518
Adjustments to reconcile net income to net cash
provided by
operating activities:
Amortization of intangible assets 6,003 6,080
Depreciation and other amortization 3,667 4,440
Amortization of deferred sales commissions 7,542 24,204
Minority interest 5,302 5,358
Gain on disposal of assets (2,223) (1,763)
Provision (benefit) for deferred income taxes 4,535 (197)
Tax benefit from exercise of stock options 80 6,703
Deferred sales commissions paid (42,963) (38,632)
Contingent deferred sales charges received 381 17,911
Proceeds from sale of certain future revenues 35,792 32,991
Other changes in assets and liabilities:
Decrease (increase) in receivables, net 3,467 (3,034)
Increase in other assets (2,446) (5,190)
Decrease in accounts payable and accrued expenses (9,747) (13,050)
Decrease in income taxes payable (25,945) (7,815)
(Decrease) increase in other current liabilities (3,475) 3,978
Decrease in other long-term liabilities (817) (908)
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Net cash provided by operating activities 84,087 115,594
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Investing Activities:
Additions to property and equipment (1,896) (3,296)
Proceeds from disposal of property and equipment 18 25
Business acquisitions (33,494) (171,814)
Purchases of securities available for sale (111) (504)
Proceeds from redemptions of securities available for 4,529 52,846
sale
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Net cash used by investing activities (30,954) (122,743)
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Financing Activities:
Distributions to minority interest (5,358) (5,782)
Dividends paid (11,798) (9,711)
Proceeds from exercise of options 218 1,087
Purchase of treasury stock (34,707) (21,771)
Proceeds from new borrowings - nonrecourse 7,331 6,747
Payments on debt - nonrecourse (5,809) (39,805)
Payments on debt - recourse (247) (14,153)
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Net cash used by financing activities (50,370) (83,388)
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Net increase (decrease) in cash and cash equivalents 2,763 (90,537)
Cash and cash equivalents, beginning of period 73,511 149,920
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Cash and cash equivalents, end of period $ 76,274 $ 59,383
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(The accompanying notes are an integral part of these consolidated
financial statements.)
Notes to Consolidated Financial Statements
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(unaudited)
(1) Summary of Significant Accounting Policies
(a) Basis of Presentation
The unaudited interim consolidated financial statements of Federated
Investors, Inc. (Federated) included herein have been prepared in accordance
with accounting principles generally accepted in the United States. In the
opinion of management, the financial statements reflect all adjustments which
are of a normal recurring nature and necessary for a fair statement of the
results for the interim periods presented.
In preparing the unaudited interim consolidated financial statements,
management is required to make estimates and assumptions that affect the amounts
reported in the financial statements. Actual results may differ from such
estimates and such differences may be material to the financial statements.
These financial statements should be read in conjunction with Federated's
Annual Report on Form 10-K for the year ended December 31, 2001. Certain items
previously reported have been reclassified to conform with the current year's
presentation.
(b) Recent Accounting Pronouncements
In April 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 145, "Rescission of FASB
Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical
Corrections." Among other things, Statement 145 eliminates the requirement under
FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt"
to report gains and losses from extinguishment of debt as extraordinary items in
the income statement. Similarly, FASB Statement No. 64, "Extinguishments of Debt
Made to Satisfy Sinking-Fund Requirements" has been rescinded. Accordingly,
gains or losses from extinguishments of debt for fiscal years beginning after
May 15, 2002 shall not be reported as extraordinary items unless the
extinguishment qualifies as an extraordinary item under the provisions of
Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations
- - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions."
Statement 145 also amends FASB Statement No. 13 to require certain modifications
to capital leases be treated as a sale-leaseback and modifies the accounting for
sub-leases when the original lessee remains a secondary obligor (or guarantor).
The adoption of Statement 145 is not expected to have a material impact on
Federated's results of operations or financial condition.
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities".
Statement 146 nullifies Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The principal
difference between Statement 146 and Issue No. 94-3 relates to its requirements
for recognition of a liability for a cost associated with an exit or disposal
activity. Statement 146 requires that such a liability be recognized when the
liability is incurred as opposed to the date of an entity's commitment to an
exit plan, as defined in Issue No. 94-3. The provisions of Statement 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. The adoption of Statement 146 is not
expected to have a material impact on Federated's results of operations or
financial position.
(2) Intangible Assets and Goodwill
On January 1, 2002, Federated adopted the provisions of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
(SFAS 142). SFAS 142 states that goodwill and other intangible assets with
indefinite useful lives should no longer be amortized but rather tested at least
annually for impairment. This Statement requires that goodwill be tested for
impairment using a two-step process that begins with an estimation of the fair
value of a reporting unit. This first step is a screen for potential impairment,
and if impairment has occurred, the second step measures the amount of
impairment. Management has identified and determined the fair value of its
reporting unit for purposes of completing this first step of the transitional
impairment test and has concluded that no impairment has occurred.
Federated continues to amortize identifiable intangible assets, including
investment advisory contracts and noncompete agreements, over their useful
lives, which range from one to 14 years. The following table shows the balances
of identifiable intangible assets as of June 30, 2002 and December 31, 2001, and
the related cost and accumulated amortization:
June 30, 2002 December 31, 2001
----------------------------------- --------------------------------
----------------------------------- --------------------------------
Accumulated Carrying Accumulated Carrying
in thousands Cost Amortization Value Cost Amortization Value
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Investment advisory $ 71,282 $ (8,788) $ 62,494 $ 78,920 $ (13,511) $ 65,409
contracts
Noncompete agreements 15,400 (3,679) 11,721 15,400 (2,139) 13,261
Other 1,806 (489) 1,317 1,780 (424) 1,356
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Total identifiable $ 88,488 $ (12,956) $ 75,532 $ 96,100 $ (16,074) $ 80,026
intangible assets
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The balance representing goodwill at June 30, 2002, was $164.9 million as
compared to $131.9 million at December 31, 2001. The $33.0 million increase in
goodwill reflects the first contingent purchase price payment for the
acquisition of substantially all of the business of Edgemont Asset Management
Corporation completed in the second quarter 2001. The first contingent purchase
price payment was made on May 8, 2002, and represented approximately 20% of the
total amount of contingent purchase price available to be paid over the first
six years following the closing date of the acquisition, provided certain
revenue targets are met.
Amortization expense for identifiable intangible assets for the three- and
six-month periods ended June 30, 2002, was $2.9 million and $6.0 million,
respectively as compared to $3.3 million and $4.6 million, respectively for the
same periods last year. The following table presents adjusted net income for the
three- and six-month periods ended June 30, 2002 and 2001, reflecting prior year
net income and basic and diluted earnings per share as though Federated had
adopted the provisions of SFAS 142 on January 1, 2001:
Three Months Ended Six Months Ended
June 30, June 30,
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in thousands, except per share data 2002 2001 2002 2001
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Net income $52,611 $42,874 $ 104,934 $84,518
Add back: Goodwill amortization, net 0 1,085 0 1,761
of tax
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Adjusted net income $52,611 $43,959 $ 104,934 $86,279
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Basic earnings per share $0.47 $0.37 $0.93 $0.73
Add back: Goodwill amortization, net 0.00 0.01 0.00 0.02
of tax
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Adjusted basic earnings per share $0.47 $0.38 $0.93 $0.75
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Diluted earnings per share $0.45 $0.36 $0.89 $0.70
Add back: Goodwill amortization, net 0.00 0.00 0.00 0.02
of tax
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Adjusted diluted earnings per share $0.45 $0.36 $0.89 $0.72
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(3) Long-Term Debt - Recourse
During the first quarter 2002, Federated repaid all outstanding liabilities
on the capital leases held as of December 31, 2001. Federated entered into a new
capital lease for computer hardware during the first quarter 2002 and recorded
recourse debt which has a balance of $0.7 million as of June 30, 2002. This
lease has an interest rate of 4.55% and a term of three years.
(4) B-Share Programs and Long-Term Debt - Nonrecourse
Federated sells its rights to future cash flow streams associated with
B-share deferred sales commissions [distribution and servicing fees as well as
contingent deferred sales charges (CDSCs)] to an independent third party. For
accounting purposes, sales of these distribution fees and CDSCs from inception
of the first program in 1997 through September 2000 were accounted for as
financings as a result of Federated's retained interest in any residual cash
flows in this program. Sales of servicing fees under the first program were also
accounted for as financings due to the same retained interest as well as
Federated's ongoing involvement in performing shareholder-servicing activities.
Accordingly, nonrecourse debt was recorded. As a result, "Other service fees,
net - affiliates" in the Consolidated Statements of Income reflected
distribution and servicing fees earned on B shares sold through September 2000.
In addition, debt expense associated with the nonrecourse debt, amortization of
deferred sales commissions and other program-related expenses were recorded for
sales through September 2000.
Beginning in October 2000, pursuant to the terms of a second sales program
with an independent third party, Federated accounted for the sales of its rights
to future distribution fees and CDSCs as sales. Sales of Federated's rights to
future servicing fees continued to be accounted for as financings due to
Federated's ongoing involvement in performing shareholder-servicing activities.
Accordingly, nonrecourse debt has been recorded. Total nonrecourse debt at June
30, 2002, and December 31, 2001, was $56.5 million and $55.0 million,
respectively. The nonrecourse debt carries interest rates ranging from 5.80% to
8.60% with weighted average interest rates of 7.57% and 7.79% at June 30, 2002
and December 31, 2001, respectively. The current B-share program allows
Federated to sell its rights to future cash flow streams associated with B-share
deferred sales commissions through December 2003.
On December 31, 2001, Federated sold its retained interest in the residual
cash flows under its first B-share program to an independent third party. As a
result, Federated recognized sale treatment accounting for B-share 12b-1 fees
and CDSCs sold under this program. The recognition of sale treatment resulted in
the reversal of certain asset and liability balances associated with this
program as of December 31, 2001. Beginning January 1, 2002, Federated no longer
recognizes revenue and expense items in its Consolidated Statements of Income
for these sold 12b-1 fees and CDSCs or the related asset and liability balances.
Federated continues to account for the prior sale of rights to future servicing
fees as financings. "Other service fees, net-affiliates," "Amortization of
deferred sales commissions" and "Debt expense - nonrecourse" for the three and
six months ended June 30, 2001, included $12.5 million and $26.0 million, $6.9
million and $14.4 million and $4.9 million and $10.1 million, respectively,
recorded in connection with the financing accounting treatment of future 12b-1
fees and CDSCs sold under this B-share program.
(5) Common Stock
(a) Cash Dividends and Stock Repurchases
Federated's Second Amended and Restated Credit Agreement (Credit Facility)
contains restrictions on cash payments of dividends and purchases of treasury
stock. The Credit Facility limits cash payments for dividends to 50% of net
income earned during the period from January 1, 2000, to and including the
payment date, less certain payments for dividends and stock repurchases. As of
June 30, 2002, approximately $167.9 million was available to pay dividends under
this restriction. The Credit Facility limits cash payments for purchases of
treasury stock to $125.0 million plus the amount allowable for dividend payments
less certain additional stock repurchases. As of June 30, 2002, approximately
$179.6 million was available to repurchase stock under this restriction.
Cash dividends of $0.046 and $0.057 per share or approximately $5.3 million
and $6.5 million were paid in the first and second quarters of 2002,
respectively, to holders of common shares. Additionally, on July 23, 2002, the
board of directors of Federated declared a dividend of $0.057 per share to be
paid on August 15, 2002 to shareholders of record as of August 7, 2002.
As of June 30, 2002, under Federated's current share buyback programs,
Federated can repurchase approximately 5.9 million additional shares subject
to the cash payment limit imposed by its Credit Facility.
(b) Employee Stock Purchase Plan
Federated offers an Employee Stock Purchase Plan which allows employees to
purchase a maximum of 750,000 shares of Class B common stock. Employees may
contribute up to 10% of their salary to purchase shares of Federated's Class B
common stock on a quarterly basis at the market price. The shares under the plan
may be newly issued shares, treasury shares or shares purchased on the open
market. As of June 30, 2002, a total of 51,998 shares had been purchased by
employees in this plan.
(6) Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share:
Three Six
Months Ended Months Ended
June 30, June 30,
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in thousands, except per share data 2002 2001 2002 2001
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Numerator
Net income $ 52,611 $42,874 $104,934 $84,518
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Denominator
Basic weighted-average shares 112,624 115,389 112,895 115,272
outstanding
Dilutive potential shares from 5,087 5,063 5,055 5,112
stock-based compensation
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Diluted weighted-average shares 117,711 120,452 117,950 120,384
outstanding
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Basic earnings per share $ 0.47 $0.37 $ 0.93 $ 0.73
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Diluted earnings per share $ 0.45 $0.36 $ 0.89 $ 0.70
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(7) Comprehensive Income
Comprehensive income was $52.8 million and $42.7 million for the
three-month periods ended June 30, 2002 and 2001, respectively, and $105.2
million and $83.1 million for the six-month periods ended June 30, 2002 and
2001, respectively.
Part I, Item 2. Management's Discussion and Analysis
- --------------------------------------------------------------------------------
of Financial Condition and Results of Operations
(unaudited)
The discussion and analysis below should be read in conjunction with the
consolidated financial statements appearing elsewhere in this report. We have
presumed that the readers of this interim financial information have read or
have access to management's discussion and analysis of financial condition and
results of operations appearing in Federated's Annual Report on Form 10-K for
the year ended December 31, 2001.
General
Federated is a leading provider of investment management products and
related financial services. The majority of our revenue is derived from
advising, distributing and servicing Federated mutual funds, separately managed
accounts and other related products, in both domestic and international markets.
We also derive revenue through servicing third-party mutual funds.
Investment advisory, distribution and the majority of our servicing fees
are based on the net asset value of investment portfolios that we manage or
administer. As such, these revenues are dependent upon factors including market
conditions and the ability to attract and maintain assets. Accordingly, revenues
will fluctuate with changes in the total value and composition of the assets
under management or administration.
Asset Highlights
Managed Assets at Period End
Percent
in millions as of June 30, 2002 2001 Change
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By Asset Class
Money market $ 140,860 $ 117,810 20%
Equity 20,886 24,269 (14%)
Fixed-income 23,260 18,695 24%
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Total managed assets $ 185,006 $ 160,774 15%
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By Product
Type
Funds:
Money market $ 127,972 $ 117,035 9%
Equity 19,034 22,461 (15%)
Fixed-income 19,472 15,179 28%
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- ----------------------------------------------------------------------------------
Total fund assets $ 166,478 $ 154,675 8%
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- ----------------------------------------------------------------------------------
Separate Accounts:
Money market $ 12,888 $ 775 1,563%
Equity 1,852 1,808 2%
Fixed-income 3,788 3,516 8%
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- ----------------------------------------------------------------------------------
Total separate $ 18,528 $ 6,099 204%
account assets
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Total managed assets $ 185,006 $ 160,774 15%
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Average Managed Assets
Three Months Ended Six Months Ended
June 30, Percent June 30, Percent
in millions Change Change
2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
Money market $ 145,632 $114,227 27% $142,524 $110,242 29%
Equity 22,191 23,812 (7%) 22,283 22,741 (2%)
Fixed-income 22,949 18,727 23% 22,346 18,681 20%
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Total average $ 190,772 156,766 22% 187,153 $151,664 23%
managed assets
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Period-End and Average Administered Assets
Three Months Ended Six Months Ended
June 30, June 30,
Percent Percent
in millions Change Change
2002 2001 2002 2001
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
Period-end assets $ 32,830 41,841 (22%) $32,830 $41,841 (22%)
Average assets $ 39,367 42,200 (7%) $41,458 $42,139 (2%)
Components of Changes in Equity and Fixed-Income Fund Managed Assets
Three Months Six Months Ended
Ended
June 30, June 30,
----------------------------------------------
----------------------------------------------
in millions 2002 2001 2002 2001
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Equity Funds
Beginning assets $21,125 $18,249 $20,760 $20,641
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Sales 1,527 1,337 3,090 3,005
Redemptions (1,388) (1,446) (2,694) (3,184)
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Net sales 139 (109) 396 (179)
(redemptions)
Net exchanges (66) 28 (30) (37)
Acquisition related - 3,235 - 3,235
Other* (2,164) 1,058 (2,092) (1,199)
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Ending assets $19,034 $22,461 $19,034 $22,461
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Fixed-Income Funds
Beginning assets $18,533 $15,112 $17,378 $14,268
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Sales 3,121 1,631 6,303 3,590
Redemptions (2,353) (1,390) (4,522) (2,788)
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Net sales 768 241 1,781 802
Net exchanges 100 (29) 134 (42)
Other* 71 (145) 179 151
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Ending assets $19,472 $15,179 $19,472 $15,179
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* Includes changes in the market value of securities held by the funds,
reinvested dividends and distributions and net investment income.
The June 30, 2002, period-end managed assets increased 15% over period-end
managed assets at June 30, 2001. Average managed assets for the three months
ended June 30, 2002, grew 22% over average managed assets for the three months
ended June 30, 2001. These increases in total and average assets primarily
reflect strong money market and fixed-income fund sales in 2001 and the first
half of 2002 as well as the additions of the Federated Kaufmann Fund in the
second quarter 2001 and TexPool, a Texas local government investment pool in the
second quarter 2002. Money market products led in average asset growth with a
27% increase for the three months ended June 30, 2002 as compared to the same
period in 2001. Market conditions were favorable for growth in money market
products as declining short-term interest rates in 2001 gave money market mutual
funds a persistent yield advantage as compared to the direct market. Rapid and
sustained fluctuations in the equity markets in 2001 and the first half of 2002
also caused investors to increase their allocations to money market investments.
Additionally, Federated benefited from the quality and performance of its
products, the strength of its relationships and an increase in cash-management
relationships with corporations, universities, government entities and
broker/dealer organizations. Changes in Federated's average asset mix period
over period, which reflect shifts in investor demands, have a direct impact on
Federated's total revenue per dollar of assets managed as money market and
fixed-income products generally carry lower management fees per invested dollar
than equity products. The following table shows the percent of total revenue
derived from each asset type for the three and six months ended June 30:
Relative Contribution to Three Six
Total Revenue Months Ended Months Ended
June 30, June 30,
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2002 2001 2002 2001
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- --------------------------------------------------------------------------
Money market assets 45% 39% 46% 39%
% % % %
Equity assets 31% 37% 30% 36%
Fixed-income assets 17% 18% 17% 18%
Other activities 7% 6% 7% 7%
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The increase in revenue derived from money market assets and decreases in
revenue from equity and fixed-income assets reflects not only strong growth in
money market assets experienced during 2001 and the first half of 2002 but also
a change to sale-treatment accounting beginning January 1, 2002 for the 12b-1
cash flows associated with Class B shares of Federated mutual funds (see
"B-Share Programs" for a detailed explanation).
Results of Operations
Net Income. The table below presents the highlights of our operations for
the three- and six-month periods ended June 30, 2002 and 2001:
Three Months Ended Six Months Ended
June 30, Percent June 30, Percent
2002 2001 Change Change 2002 2001 Change Change
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Net income (in millions) 52.6 $42.9 $ 9.7 23% 104.9 84.5 20.4 24%
Earnings per share
Basic 0.47 $ 0.37 $ 0.10 27% 0.93 0.73 0.20 27%
Diluted 0.45 $ 0.36 $ 0.09 25% 0.89 0.70 0.19 27%
Revenue (in millions)
Revenue from managed 170.6 $165.9 $ 4.7 3% 340.7 321.0 19.7 6%
assets
Service-related
revenue from 11.8 12.8 (1.0) (8%) 23.3 25.2 (1.9) (8%)
Sources other than
managed assets
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- ----------------------------------------------------------------------------------------------------------
Total Revenue 182.4 $178.7 $ 3.7 2% 364.0 346.2 17.8 5%
- ----------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------
Operating margin 46.1% 42.0% 4.1% 10% 46.6% 42.4% 4.2% 10%
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Net income for the three- and six-month periods ended June 30, 2002
increased 23% and 24%, respectively, compared to the same periods last year. The
increases reflect increased revenue from managed assets as a result of
significant growth in assets, improved operating margins and reduced
nonoperating expenses. Diluted earnings per share for the three- and six-month
periods ended June 30, 2002 increased 25% and 27%, respectively, compared to the
same periods of 2001 due to increased net income and reduced weighted-average
diluted shares outstanding resulting from stock repurchases during 2001 and the
first half of 2002.
Revenue. Total revenue for the three- and six-month periods ended June 30,
2002 increased $3.7 million and $17.8 million, respectively, as compared to the
same periods of 2001. Revenue from managed assets for the three- and six-month
periods ended June 30, 2001 included $12.5 million and $26.0 million,
respectively, in 12b-1 fees associated with Class B shares of Federated's mutual
funds. Due to the fourth quarter 2001 sale of Federated's retained interest in
residual cash flows associated with the B shares, 2002 revenues do not include
these fees (see "B-Share Programs" for a detailed explanation). Excluding the
B-share-related 12b-1 fees for 2001, total revenue for the three- and six-month
periods ended June 30, 2002, increased $16.2 million or 10% and $43.8 million or
14%, respectively, over the same periods of 2001. These increases are the result
of increased revenue from managed assets. Revenue from average assets grew
period over period, but to a lesser degree than the growth in assets due to a
higher composition of money market and fixed-income products, which earn, on
average, lower fees per invested dollar than equity products.
Service-related revenue from sources other than managed assets decreased
$1.0 million and $1.9 million for the three- and six-month periods ended June
30, 2002, respectively, as compared to the same periods last year. The decreases
were due largely to the internalization of administrative services and other
changes in services provided to certain bank customers. These revenues
represented 1.5% of Federated's total revenue in 2001.
Operating Expenses. Operating expenses for the three- and six-month periods
ended June 30, are set forth in the following table:
Three Months Ended Six Months Ended
June 30, Percent June 30, Percent
(in millions) 2002 2001 Change Change 2002 2001 Change Change
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- ----------------------------------------------------------------------------------------------
Compensation and related 47.4 43.9 3.5 8% 96.0 83.5 12.5 15%
Advertising and 18.5 17.3 1.2 7% 36.4 33.5 2.9 9%
promotional
Amortization of deferred
sales commissions 3.8 (7.8) (67%) 7.5 24.2 (16.7) (69%)
11.6
Amortization of 2.9 4.1 (1.2) (29%) 6.0 6.1 (0.1) (2%)
intangible assets
All other 25.7 26.8 (1.1) (4%) 48.3 52.1 (3.8) (7%)
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Total Operating Expenses 98.3 103.7 (5.4) (5%) 194.2 199.4 (5.2) (3%)
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Total operating expenses for the three- and six-month periods ended June
30, 2002 decreased $5.5 million and $5.2 million, respectively, as compared to
the same periods last year. Compensation and related expense for the three- and
six-month periods ended June 30, 2002, increased as compared to the same periods
last year as a result of increased variable-based compensation due in part to
the acquisition of substantially all of the business of Edgemont Asset
Management Corporation in the second quarter 2001 (the Kaufmann Acquisition).
The increases in advertising and promotional expense reflects increases in
marketing allowances due primarily to significant asset and sales growth.
Amortization of deferred sales commissions decreased for both the three- and
six-month periods ended June 30, 2002 as compared to the same periods last year
primarily as a result of the fourth quarter 2001 sale of Federated's retained
interest in residual cash flows associated with the B shares (see "B-Share
Programs" for a detailed explanation). Amortization of intangible assets
decreased for both periods in 2002 as compared to 2001 as a result of both the
discontinuation of goodwill amortization (see Note (2) to the Consolidated
Financial Statements) and the full amortization of certain assets during 2001
and the first half of 2002, partially offset by the addition of identifiable
intangible assets related to the Kaufmann Acquisition. All other expenses
decreased for both periods in 2002 as compared to 2001 primarily as a result of
reductions to professional service fees due to the change in services provided
to certain bank customers and the full depreciation of various leasehold
improvements.
Nonoperating Income (Expense). Net nonoperating expenses for the three- and
six-months ended June 30, 2002, decreased $4.8 million and $8.1 million,
respectively, compared to the same periods last year. Interest and dividend
income decreased in 2002 due to lower investment balances as a result of cash
used for the Kaufmann Acquisition in the second quarter 2001 and lower
investment yields in 2002. Debt expense decreased in 2002 as a result of lower
levels of outstanding debt. Recourse debt levels were lower due to the early
retirement of Federated's 7.96% Senior Secured Notes in the fourth quarter of
2001. Nonrecourse debt levels were lower due to the fourth quarter 2001 sale of
Federated's retained interest in residual cash flows associated with the B
shares of Federated's mutual funds (see "B-Share Programs" for a detailed
explanation).
Income Taxes. The income tax provision for the three- and six-month periods
ended June 30, 2002 were $28.1 million and $58.1 million as compared to $23.9
million and $47.4 million, respectively, for the same periods in 2001. The
effective tax rate was 34.8% and 35.8% for the second quarter 2002 and 2001,
respectively, and 35.6% and 35.9% for the first half of 2002 and 2001,
respectively.
B-Share Programs. Federated funds upfront commissions paid to
broker/dealers on the sale of Class B shares of Federated mutual funds (B
shares) through the sale of the rights to future cash flow streams associated
with B-share commissions to an independent third party. Rights to future 12b-1
fees and contingent deferred sales charges (CDSCs) sold through September 2000
were accounted for as financings for reporting purposes as a result of
Federated's retained interest in the residual cash flows under this program.
Rights to future shareholder service fees were also accounted for as financings
due to the same retained interest as well as Federated's ongoing involvement in
performing shareholder-servicing activities. Accordingly, sales commissions paid
were capitalized and nonrecourse debt was recorded.
On December 31, 2001, Federated sold its retained interest in the residual
cash flows under this B-share program to an independent third party. As a
result, Federated recognized sale treatment accounting for B-share 12b-1 fees
and CDSCs sold under this program. The recognition of sale treatment resulted in
the reversal of certain asset and liability balances associated with this
program as of December 31, 2001. Beginning January 1, 2002, Federated no longer
recognizes revenue and expense items in its Consolidated Statements of Income
for these sold 12b-1 fees and CDSCs or the related asset and liability balances.
"Other service fees, net-affiliates," "Amortization of deferred sales
commissions" and "Debt expense - nonrecourse" for the three and six months ended
June 30, 2001, included $12.5 million and $26.0 million, $6.9 million and $14.4
million and $4.9 million and $10.1 million, respectively, recorded in connection
with the financing accounting treatment of future 12b-1 fees and CDSCs sold
under this B-share program.
Federated continues to account for the prior sale of rights to future
shareholder service fees as financings as a result of Federated's ongoing
involvement in performing shareholder-servicing activities.
Rights to future B-share-related 12b-1 fees and CDSCs sold subsequent to
September 2000 have been and continue to be accounted for as sales and gains on
these sales are recorded in "Other service fees, net-affiliates" in the
Consolidated Statements of Income. The sale of rights to future shareholder
service fees continues to be accounted for as financings.
Liquidity and Capital Resources
At June 30, 2002, liquid assets, consisting of cash and cash equivalents,
the current portion of securities available for sale and receivables, totaled
$105.6 million as compared to $110.7 million at December 31, 2001.
Operating Activities. Net cash provided by operating activities totaled
$84.1 million for the six-month period ended June 30, 2002, as compared to
$115.6 million for the same period of 2001. This decrease is largely
attributable to the effects of certain cash payments made in the first half of
2002 and the elimination of 12b-1 fees and CDSCs received on Class B shares of
Federated's mutual funds as a result of the fourth quarter 2001 sale of
Federated's retained interest in residual cash flows associated with the B
shares (see "B-Share Programs" for a detailed explanation), partially offset by
increased profitability in 2002. Cash payments made in the first half of 2002
included taxes paid on the sale of Federated's retained interest in the residual
cash flows and the payment of normal operating expenses accrued as of the end of
2001.
Investing Activities. During the first half of 2002, Federated made a $33.1
million contingent payment related to the Kaufmann Acquisition, paid $1.9
million to acquire property and equipment and received $4.5 million from
redemptions of available-for-sale securities.
Financing Activities. During the six months ended June 30, 2002, Federated
used $50.4 million for financing activities. Of this amount, $34.7 million was
used to repurchase 1,105,370 shares of Class B common stock. As of June 30,
2002, Federated can repurchase an additional 5.9 million shares through its
authorized programs. Repurchases under these programs are subject to
restrictions under Federated's Second Amended and Restated Credit Agreement,
which limit cash payments for additional stock repurchases to $170.0 million
after considering earnings through June 30, 2002, certain stock repurchases
through July 31, 2002, and the dividend payment on August 15, 2002 (see Note (5)
to the Consolidated Financial Statements).
During the first and second quarters of 2002, Federated paid dividends of
$5.3 million and $6.5 million or $0.046 and $0.057 per share, respectively. In
July 2002, Federated's board of directors declared a dividend of $0.057 per
share that will be paid on August 15, 2002, to shareholders of record as of
August 7, 2002. After considering earnings through June 30, 2002, certain stock
repurchases through July 31, 2002, and the dividend payment on August 15, 2002,
Federated, given current debt covenants, has the ability to pay dividends of
approximately $159.8 million.
Payments on debt-nonrecourse were significantly lower during the first half
of 2002 than in the first half of 2001 as a result of the fourth quarter 2001
sale of Federated's retained interest in residual cash flows associated with the
B shares (see "B-Share Programs" for a detailed explanation). Payments on
debt-recourse were lower during the first half of 2002 than amounts for the same
period in 2001 due to the early retirement of Federated's 7.96% Senior Secured
Notes in the fourth quarter 2001.
Future Cash Requirements. Management expects that the principal uses of
cash will be to advance sales commissions, repurchase company stock, fund
strategic business acquisitions, pay shareholder dividends, pay incentive
compensation, fund property and equipment acquisitions, fund minimum lease
payments and seed new products. Management believes that Federated's existing
liquid assets, together with the expected continuing cash flow from operations,
its borrowing capacity under the current credit facility, the B-share program
and its ability to issue stock will be sufficient to meet its present and
reasonably foreseeable cash needs.
Alternative Products
Federated acts as the investment manager for two high-yield collateralized
bond obligation (CBO) products and a mortgage-backed CBO product pursuant to the
terms of an investment management agreement between Federated and each CBO. The
CBO products are structured using special-purpose entities. The financial
condition and results of operations of these CBOs are not included in
Federated's Consolidated Financial Statements as of and for the three- and
six-month periods ended June 30, 2002, or for any prior period. In each case,
there exists a majority owner(s) that is an independent third party from
Federated owning at least three percent equity in the CBO. Federated has not
guaranteed nor has any recourse related to any of the notes issued by the CBOs.
As of June 30, 2002, assets managed by Federated in the CBOs totaled $1.1
billion.
Critical Accounting Policies
Federated's Consolidated Financial Statements have been prepared in
accordance with accounting principles generally accepted in the United States.
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. Of the significant accounting policies
described in Federated's Annual Report on Form 10-K for the year ended December
31, 2001, management believes that its policy regarding the identification,
valuation and impairment of intangible assets involves a high degree of judgment
and complexity due to the significant use of assumptions. Significant
differences between actual results and the assumptions used in the valuation and
impairment analyses could have a significant impact on the carrying value of the
assets. (See Note (1) to the Consolidated Financial Statements included in
Federated's Annual Report on Form 10-K for the year ended December 31, 2001, and
Note (2) to the Consolidated Financial Statements included herein).
Quantitative and Qualitative Disclosures About Market Risk (Continued)
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Part I, Item 3. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------------------
(unaudited)
In the normal course of our business, Federated is exposed to the risk of
loss due to fluctuations in the securities market and general economy.
Management is responsible for identifying, assessing and managing market and
other risks. Federated's investments are primarily money market funds and mutual
funds with investments which have a duration of two years or less. Federated
also invests in mutual funds sponsored by Federated (performance seeds) in order
to provide investable cash to the fund allowing the fund to establish a
performance history. Federated may use derivative financial instruments to hedge
these investments. At June 30, 2002, Federated was exposed to price risk with
regard to its $0.1 million of performance seed investments in fluctuating-value
mutual funds. Price risk is the risk that the fair value of the investments will
decline and ultimately result in the recognition of a loss for Federated.
Federated did not hold any derivative investments to hedge its performance seeds
at June 30, 2002.
As of June 30, 2002, Federated is also exposed to interest rate and credit
risk relating to its investment in asset-backed securities with a $2.5
million investment in the mortgage-backed CBO product. Due to factors
including credit risk/ defaults and rising interest rates, the carrying value
of the investment may be adversely affected by unfavorable changes in cash
flow estimates, declines in the value of the underlying fixed-rate securities,
and related expected returns.
It is also important to note that a significant portion of Federated's revenue
is based on the market value of managed and administered assets. Declines in
the market values of assets as a result of changes in market or other
conditions will therefore negatively impact revenue and net income.
Part II, Item 4. Submission of Matters to a Vote of Security Holders
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(unaudited)
(a) Federated's annual shareholders' meeting was held on April 24, 2002.
(b) The board of directors of Federated Investors, Inc. as previously
reported to the Securities and Exchange Commission was re-elected in its
entirety.
(c) The matters voted upon were the Federated Investors, Inc. Stock Incentive
Plan and the Federated Investors, Inc. Annual Incentive Plan, as
amended. All 9,000 Class A Shares eligible to vote did so affirmatively.
Part II, Item 6. Exhibits and Reports on Form 8-K
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(a) The following exhibits required to be filed by Item 601 of Regulation
S-K are filed herewith and incorporated by reference herein:
Exhibit 10.1 Material contracts - Annual Stock Option Agreement dated
April 24, 2002 between Federated Investors, Inc. and the independent
directors (filed herewith)
Exhibit 10.2 Material contracts -Federated Investors, Inc. Stock
Incentive Plan as approved by shareholders April 24, 2002 (filed
herewith)
Exhibit 10.3 Material Contracts - Federated Investors, Inc. Annual
Incentive Plan as approved by shareholders April 24, 2002, as amended
(filed herewith)
(b) Reports on Form 8-K: No reports on Form 8-K were filed during the
period subject to this Quarterly Report on Form 10-Q.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Federated Investors, Inc.
- ------------------------ --------------------------
(Registrant)
Date August 14, 2002 By: /s/ J. Christopher Donahue
J. Christopher Donahue
President and
Chief Executive Officer
Date August 14, 2002 By: /s/ Thomas R. Donahue
Thomas R. Donahue
Chief Financial Officer
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Federated Investors, Inc. (the
"Company") on Form 10-Q for the quarterly period ended June 30, 2002 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
each of the undersigned, in the capacities and on the dates indicated below,
hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operation of the Company.
Date August 14, 2002 By: /s/ J. Christopher Donahue
J. Christopher Donahue
President and
Chief Executive Officer
Date August 14, 2002 By: /s/ Thomas R. Donahue
Thomas R. Donahue
Chief Financial Officer