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, 1998 OR
------------------------------------
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-14818
FEDERATED INVESTORS, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 25-1111467
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
FEDERATED INVESTORS TOWER
PITTSBURGH, PENNSYLVANIA 15222-3779
(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 ______.
(APPLICABLE ONLY TO CORPORATE ISSUERS)
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date: As of May 31, 1998, the
Registrant had outstanding 6,000 shares of Class A Common Stock and 86,337,000
shares of Class B Common Stock.
Federated Investors, Inc.
Form 10-Q
For the Three Months and Six Months
Ended June 30, 1998
Index
PAGE NO.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets at
June 30, 1998 and December 31, 1997 3
Consolidated Statements of Income
for the Three Months and Six Months Ended
June 30, 1998 and 1997 4
Consolidated Statements of Cash
Flows for the Six Months Ended
June 30, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 16
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds 17
Item 6. Exhibits and Reports on Form 8-K 18
(a) Exhibits required by Item 601 of Regulation S-K
(b) Reports on Form 8-K
Signatures 19
FEDERATED INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands Except Share Data)
JUNE 30, DECEMBER 31,
1998 1997
--------- -------
Current Assets:
Cash and cash $ $
equivalents...................................................132,910...22,912
Marketable
securities....................................................2,443.....8,945
Receivables, net of reserve of $3,621 and $3,266,
respectively..................................................33,766....32,078
Prepaid
expenses......................................................2,301.....2,853
Income taxes
receivable....................................................128.......7,519
Other current
assets........................................................1,867.....1,805
--------- -------
Total Current
Assets........................................................173,415...76,112
--------- -------
Long-Term Assets:
Customer relationships, net of accumulated amortization
of $33,325 and $26,907, 23,979 30,398
respectively
Goodwill, net of accumulated amortization of $12,636 and
$11,512, 36,232 37,356
respectively
Other intangible assets, net
.................................................................116.......126
Deferred sales commissions,
net........................................................ 219,784 164,623
Property and equipment,
net...........................................................20,606....22,163
Other long-term
assets........................................................5,307.....6,378
--------- -------
Total Long-Term
Assets........................................................306,024...261,044
--------- -------
Total $ $
Assets........................................................479,439...337,156
========= ========
Current Liabilities:
Cash $ $
overdraft.....................................................308.......7,680
Current portion of long-term debt -
Recourse......................................................260.......280
Accrued
expenses......................................................43,454....34,939
Accounts
payable.......................................................25,164....18,634
Other current
liabilities...................................................3,922.....2,520
--------- -------
Total Current
Liabilities...................................................73,108....64,053
--------- -------
Long-Term Liabilities:
Long-term debt -
Recourse......................................................98,833....98,950
Long-term debt -
Nonrecourse...................................................234,073...185,388
Deferred tax liability,
net...........................................................26,346....26,546
Other long-term
liabilities...................................................2,784.....2,863
--------- -------
Total Long-Term
Liabilities...................................................362,036...313,747
--------- -------
Total
Liabilities...................................................435,144...377,800
--------- -------
Minority
Interest......................................................360.......466
--------- -------
Shareholders' Equity :
Common Stock :
Class A, no par value, 20,000 shares
authorized, 6,000 and 0 shares issued and
outstanding, respectively.....................................189 -
Class B, no par value, 900,000,000 shares
authorized, 86,337,000 and 0 shares issued and
outstanding, respectively.....................................74,993 -
Class A, $1.00 stated value, 99,000 shares
authorized, - a6d 6,000 shares issued and outstanding,
respectively ............................................
Class B, $.01 stated value, 149,700,000 shares
authorized,
0 and 90,094,000 shares issued and outstanding,
respectively .................................................- 901
Additional paid-in
capital.......................................................-.........28,574
(Accumulated deficit) retained
earnings......................................................(29,287)..55,139
Treasury stock, at cost, 0 and 6,667,000 shares Class B
Common Stock, respectively....................................- (123,373)
Employee restricted stock
plan..........................................................(1,822)...(2,266)
Accumulated other comprehensive
income........................................................(138).....(91)
--------- -------
Total Shareholders'
Equity........................................................43,935....(41,110)
--------- -------
Total Liabilities, Minority Interest, $ $
and Shareholders' 479,439 337,156
Equity ========= ==========
December 31, 1997 share amounts have been restated to reflect the one for
one stock dividend paid on April 15, 1998 and the one for two stock
dividend paid on April 30, 1998.
(THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.)
FEDERATED INVESTORS, INC.
CONSOLIDATED STATEMENTS OF INCOME THREE MONTHS SIX MONTHS ENDED
ENDED
(Dollars In Thousands Except Per Share JUNE 30, JUNE 30,
Data)
--------------- ----------------
1998 1997 1998 1997
------ ------ -------- ------
Revenue:
Investment advisory fees, $ 64,862 $48,993 $ 126,767 $ 98,401
net-Federated Funds
Investment advisory fees, 1,880 850 3,652 2,326
net-Other
Administrative service fees, 17,697 14,331 34,959 28,576
net-Federated Funds
Administrative service fees, 4,906 5,878 10,332 11,642
net-Other
Other service fees, net-Federated 24,991 15,326 47,547 28,944
Funds
Other service fees, 7,185 5,102 14,640 9,930
net-Other
Commission income-Federated 1,201 616 2,142 1,073
Funds
Interest and 2,163 619 3,558 1,303
dividends
Marketable securities (losses) (148) (31) 41 (8)
gains
Other 1,479 1,773 5,171 2,897
income
------ ------- ----- ---------
Total
Revenue......................................126,216..93,457...248,809...185,084
------ ------ -------- -------
Operating Expenses:
Compensation and 37,283...33,293 74,801 66,801
related
Amortization of deferred sales 9,531... 5,381 14,706 9,905
commissions..................................
Office and 7,289 6,315 13,923 12,603
occupancy
Systems and 6,732 6,968 13,093 13,442
communications
Advertising and 9,731 8,499 20,939 17,022
promotional
Travel and 3,563 4,001 6,686 7,280
related
5,124 4,025 14,038 8,632
Other
Amortization of intangible 3,778 3,245 7,554 6,178
assets
------ ------ -------- ---------
Total Operating
Expenses.....................................83,040...71,727...165,740...141,863
------ ------ -------- ---------
Operating
income.......................................43,176...21,730...83,069....43,221..
------ ------ -------- ---------
Nonoperating Expenses:
Interest 6,244 4,826 11,961 9,671
expense
Other debt 517 253 952 510
expense
-------- ---------
Total Nonoperating
Expenses.....................................6,761....5,079....12,913.. 10,181
------ ------ -------- ---------
Income before minority interest and
income taxes............................. 36,415 16,651 70,156 33,040
Minority 2,213 1,801 4,208 3,682
interest
------ ------ -------- ---------
Income before income
taxes........................................34,202 14,850 65,948 29,358
Income tax 13,131 5,760 24,039 11,424
provision
------ ------ -------- ---------
Net $ $ $ $
income.......................................21,071...9,090....41,909....17,934
====== ====== ======== =========
Earnings per common share:
Basic...................................$ 0.25 $ 0.11 $ 0.50 $ 0.22
====== ====== ======== =========
Diluted.................................$ 0.24 $ 0.11 $ 0.49 $ 0.22
====== ====== ======== =========
Cash dividends declared and paid per $ 0.038 $ - $ 0.059 $ -
common share
====== ====== ======== =========
Per share amounts for 1997 have been restated to reflect the one for one
stock dividend paid on April 15, 1998 and the one for two stock dividend paid on
April 30, 1998.
(THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.)
FEDERATED INVESTORS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS SIX MONTHS ENDED
(Dollars in Thousands) JUNE 30,
------------------
1998 1997
- ------------------------------------------------------- -------- --------
Net Cash Provided by Operating $ 18,528 $ 7,289
Activities...........................................................
-------- --------
Investing Activities:
Proceeds from sale of property and - 5
equipment.......................................................
Additions to property and (1,603) (1,095)
equipment.......................................................................
Cash paid for (308) (13,888)
acquisitions
Purchases of marketable (1,063) (19,926)
securities
Proceeds from redemptions of marketable 7,598 22,607
securities............................................
-------- --------
Net Cash Provided (Used) by Investing 4,624 (12,297)
Activities.....................................................................
-------- --------
Financing Activities:
Distributions to minority (4,314) (4,278)
interest
Dividends (4,920) -
paid
Issuance of common 47,532 25
stock
Purchase of treasury
stock.........................................................-.........(50)
Proceeds from new borrowings -
Recourse......................................................-.........15,707
Proceeds from new borrowings - 73,609
Nonrecourse.............................................................-.
Payments on debt - (137) (7,827)
Recourse
Payments on debt - (24,924) -
Nonrecourse
-------- --------
Net Cash Provided by Financing 86,846 3,577
Activities....................................................................
-------- --------
Net Increase (Decrease) In Cash and Cash 109,998 (1,431)
Equivalents.................................................................
Cash and Cash Equivalents, Beginning of 22,912 6,561
Period......................................................
-------- --------
Cash and Cash Equivalents, End of $ 132,910 $ 5,130
Period..................................................................
======== ========
(THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.)
FEDERATED INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
(a) BASIS OF PRESENTATION
The interim financial statements of Federated Investors, Inc. (the
"Company") included herein have been prepared in accordance with generally
accepted accounting principles. In the opinion of management, the
financial statements reflect all adjustments, which are of a normal
recurring nature, necessary for a fair statement of the results for the
interim periods presented.
In preparing the unaudited consolidated interim financial statements,
management is required to make estimates and assumptions that affect the
amounts reported in the financial statements. Actual results will differ
from such estimates and such differences may be material to the financial
statements.
These financial statements should be read in conjunction with the
Company's audited financial statements for the year ended December 31,
1997.
(b) COMPREHENSIVE INCOME
In 1998, the Company adopted Statement of Financial Standards No. 130,
"Reporting Comprehensive Income" ("SFAS 130"), which requires companies to
report all changes in equity during a period, except those resulting from
investment by owners and distribution to owners, in a financial statement
for the period in which they are recognized. Comprehensive income was
$21.1 million and $9.3 million for the three month periods ended June 30,
1998 and 1997, respectively and $41.9 million and $18.0 million for the
six month periods ended June 30, 1998 and 1997, respectively.
(c) RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Standards No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("SFAS 131") is effective for
financial statements for periods beginning after December 15, 1997. SFAS
131 is not required to be applied to interim financial statements in the
initial year of its application.
Statement of Position No. 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1") was adopted
effective January 1, 1998. SOP 98-1 requires the capitalization of certain
costs incurred in connection with developing or obtaining software for
internal use. Qualifying software costs are capitalized and amortized over
the estimated useful life of the software. Prior to the adoption of SOP
98-1, software costs were expensed as incurred. Restatement of prior year
financial statements was not required.
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities",
which is required to be adopted in years beginning after June 15, 1999. As
a result of the Company's minimal use of derivatives, management does not
anticipate that the adoption of the new Statement will have a significant
effect on earnings or the financial position of the Company.
(2) Deferred Sales Commissions and Nonrecourse Debt
The Company entered into an agreement in the fourth quarter of 1997 with
a third party to sell the rights to the future revenue streams associated
with the 12b-1, shareholder service and CDSC fees of the Class B shares of
various mutual funds it manages. This agreement includes both an initial
sale of existent rights to future revenue streams as well as establishing
a program to sell on a continuous basis the future rights associated with
future
FEDERATED INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(2) Deferred Sales Commissions and Nonrecourse Debt, Continued
revenue streams relating to the ongoing sale of B shares. For accounting
purposes, transactions executed under the agreement are reflected as
financings and nonrecourse debt has been recorded.
The following tables summarize the changes in both the deferred sales
commissions and nonrecourse debt related to this agreement:
Six Months Ended
JUNE 30, 1998
(In Thousands)
Deferred Sales Commissions:
Deferred B share sales commissions at
December 31, 1997 $162,398
Payments to brokers/dealers 77,566
CDSC fees collected (9,743)
Amortization (13,306)
------------------
Deferred B share sales commissions at
June 30, 1998 $216,915
================
Nonrecourse Debt:
Nonrecourse debt at December 31, 1997 $185,388
Additional financings 73,609
Payments of nonrecourse debt (24,924)
--------
Nonrecourse debt at June 30, 1998 $234,073
===============
The nonrecourse debt had a weighted average interest rate of 7.63% at
June 30, 1998.
(3) Long-Term Debt
The Company's long-term debt consisted of the following:
June December
30, 31,
1998 1997
----------- ----------
(In Thousands)
Recourse Debt:
Senior Secured Note Purchase Agreement $ 98,000 $98,000
Capitalized Leases................ 1,093 1,230
-------------------------
Total Recourse Debt......... 99,093 99,230
Less Current Portion............... 260 280
--------------------------
Total Long-Term Debt - Recourse....$ 98,833 $ 98,950
============ ===========
Nonrecourse Debt...................... $ 234,073 $ 185,388
=========== ==========
(4) Common Stock
On May 19, 1998, Federated Investors was merged with and into the
Company, a wholly owned subsidiary, with the Company continuing as the
surviving corporation. All outstanding Class A and Class B common shares
of Federated Investors were exchanged for an equal number of shares of no
par Class A and Class B common stock of the Company, respectively, with
the same proportionate ownership and substantially similar rights, and all
treasury stock of Federated Investors was retired.
As a condition precedent to the merger described above, the Company
issued an additional 2,610,000 shares of Class B common stock in an
initial public offering for net proceeds of approximately $46 million in
cash. At June 30, 1998, 6,000 and 86,337,000 shares of Class A and Class B
Common Stock were issued and outstanding, respectively.
FEDERATED INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(4) Common Stock, Continued
A one for one stock dividend was paid on April 15, 1998 to stockholders
of record on March 17, 1998. Also, a one for two stock dividend was paid
on April 30, 1998 to stockholders of record on April 21, 1998. The 1997
per share amounts have been restated to reflect the affect of the stock
dividends.
In July 1998, the Company's Senior Secured Credit Agreement was amended
to allow dividends to an amount not to exceed $20 million plus 50% of any
net income, (less 100% of any net loss), during the period from January 1,
1998 to and including the date of payment. The Senior Secured Note
Purchase Agreement allows dividends to an amount of $5 million plus 50% of
any net income, (less 100% of any net loss), during the period from
January 1, 1996 to and including the date of payment. Cash dividends of
$0.0208 and $0.038 per share or approximately $1.7 million and $3.2
million were paid in the first and second quarters of 1998, respectively,
to holders of common shares. Additionally, on July 21, 1998, the Board of
Directors of the Company declared a dividend of $0.038 per share to be
paid on August 10, 1998 to shareholders of record on July 31, 1998. After
the payment of the August 10th dividend, the Company will have dividend
paying capacity of approximately $32.8 million.
(5) Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ----------------------
1998 1997 1998 1997
---------- --------- ---------- ----------
(In Thousands, Except Per Share Data)
Numerator:
Net income $
21,071 $ 9,090 $ 41,909 $ 17,934
========== ========= ========== ==========
Denominator:
Basic weighted-average common
shares outstanding 83,964 82,302 83,090 82,264
Effect of dilutive securities:
Restricted stock
659 237 686 315
Employee stock options/SARs
2,014 566 1,799 588
---------- --------- ---------- ----------
Dilutive potential common
shares 2,673 803 2,485 903
---------- --------- ---------- ----------
Diluted weighted-average common
shares outstanding 86,637 83,105 85,575 83,167
========== ========= ========== ==========
Basic earnings per share $ 0.25 $ 0.11 $ 0.50 $ 0.22
========== ========= ========== ==========
Diluted earnings per share $ 0.24 $ 0.11 $ 0.49 $ 0.22
========== ========= ========== ==========
(6) Subsequent Event
In July 1998, the Company established an Employee Stock Purchase Plan
which allows for the issuance of a maximum of 500,000 shares of Class B
Common Stock.
Part I, Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
HIGHLIGHTS
Three Months Six Months Ended
Ended
SELECTED OPERATING DATA (IN THOUSANDS, June 30, June 30,
EXCEPT PER SHARE DATA)
------------------- -------------------
1998 1997 1998 1997
--------- -------- --------- --------
Total Revenue $ 126,216 $ 93,457 $ 248,809 $185,084
Operating Expenses........................... 83,040 71,727 165,740 141,863
--------- -------- --------- --------
Operating Income............................. 43,176 21,730 83,069 43,221
Nonoperating Expenses and Minority
Interest.......................... 8,974 6,880 17,121 13,863
--------- -------- --------- --------
Income Before Income Taxes 34,202 14,850 65,948 29,358
Income Tax Provision........ 13,131 5,760 24,039 11,424
--------- -------- --------- --------
Net Income................... 21,071 9,090 41,909 17,934
========= ======== ========= ========
Earnings per Basic Common $ 0.25 $ 0.11 $ 0.50 $ 0.22
Share......................................
Earnings per Diluted Common $ 0.24 $ 0.11 $ 0.49 $ 0.22
Share...................................
MANAGED AND ADMINISTERED
ASSETS
(IN June 30,
MILLIONS)
-------------------
1998 1997
--------- --------
Money Market Funds.........................$ 67,842 54,011
Fixed Income Funds.........................$ 15,816 14,286
Equity Funds...............................$ 14,561 9,795
Separate Accounts..........................$ 2,350 1,705
--------- --------
Total Managed $ 100,569 $79,797
Assets........................... ========= ========
Total Administered
Assets............................$55,528 $41,942
========= ========
AVERAGE MANAGED AND ADMINISTERED ASSETS Three Months Six Months Ended
Ended
(IN June 30, June 30,
MILLIONS)
------------------- -------------------
1998 1997 1998 1997
--------- -------- --------- --------
Money Market Funds..........................$65,439 $52,247 $65,135 $52,556
Fixed Income Funds 15,787 13,998 15,597 14,052
Equity Funds.................................14,195 8,811 13,381 8,429
Separate Accounts............................ 2,330 1,618 2,313 1,844
--------- -------- --------- --------
Total Average Managed $
Assets.......................... 97,751 $ 76,674 $ 96,426 $ 76,881
========= ======== ========= ========
Total Average Administered $
Assets..................... 54,411 $ 41,344 $ 52,179 $ 40,946
========= ======== ========= ========
COMPONENTS OF CHANGES IN EQUITY AND FIXED INCOME FUND
MANAGED ASSETS (IN MILLIONS)
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
EQUITY FUNDS 1998 1997 1998 1997
- ------------
--------- -------- --------- --------
Beginning Assets..................$13,843 $ 8,000 $ 11,710 $ 7,594
--------- -------- --------- --------
Sales..........................1,403 959 2,793 1,805
Redemptions....................(711) (645) (1,342) (1,098)
--------- -------- --------- --------
Net Sales............692 314 1,451 707
Net Exchanges..................(69) 64 (18) 64
Acquisition
Related........................- 353 - 353
Other*.........................95 1,064 1,418 1,077
--------- -------- --------- --------
Ending Assets.....................$ 14,561 $ 9,795 $ 14,561 $ 9,795
========= ======== ========= ========
FIXED INCOME FUNDS
Beginning Assets..................$ 15,601 $ 13,788 $ 15,067 $ 14,109
--------- -------- --------- --------
Sales............................ 1,404 1,053 2,981 2,195
Redemptions......................(1,138) (1,090) (2,201) (2,291)
--------- -------- --------- --------
Net Sales(Redemptions).. 266 (37) 780 (96)
Net Exchanges.....................(127) 50 (257) (53)
Acquisition
Related............................- 175 - 175
Other*............................. 76 310 226 151
--------- -------- --------- --------
Ending Assets.....................$ 15,816 $ 14,286 $ 15,816 $ 14,286
========= ======== ========= ========
* Primarily reinvested dividends and distributions, net investment income and
changes in the value of securities held by the funds.
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THE
THREE MONTHS ENDED JUNE 30, 1997
NET INCOME. Revenue growth of 35.1% was the principal reason Federated
Investors, Inc.'s (the "Company") consolidated net income for the second
quarter of 1998 increased to $21.1 million, or $0.24 per diluted common
share. The 1998 results compare with net income of $9.1 million, or $0.11
per diluted common share in the second quarter of 1997. The improved
performance was principally the result of increased revenues generated
from higher levels of average managed and administered assets.
REVENUE. The Company's consolidated revenue increased $32.7 million, or
35.1% to $126.2 million for the quarter ended June 30, 1998 from $93.5
million for the same period in 1997. Approximately $30.5 million, or 93.1%
of the increase in revenues is due to increased average managed assets.
Average managed assets increased 27.5% from $76.7 billion for the second
quarter of 1997 to $97.8 billion for the second quarter of 1998, including
increases of 61.1%, 25.2%, 12.8%, and 44.0% in equity funds, money market
funds, fixed income funds, and separate accounts, respectively. Service
related revenues from other sources increased by approximately $1.1
million due primarily to increased revenues within the Company's clearing
and retirement plan recordkeeping services. Interest and dividends
increased by $1.5 million as a result of higher levels of invested cash
resulting from the B share advanced commission financing programs, net
proceeds from the Company's initial public offering, and higher levels of
cash generated from operations.
OPERATING EXPENSES. Total operating expenses increased from $71.7
million for the second quarter of 1997 to $83.0 million for the second
quarter of 1998, an increase of $11.3 million or 15.8%.
Compensation and related expenses increased $4.0 million or 12.0% from
$33.3 million for the quarter ended June 30, 1997 to $37.3 million for the
quarter ended June 30, 1998. The increase was mainly attributed to an
increase in variable based compensation and staff growth experienced
within investment research and certain service areas and was partially
offset by reductions resulting from the outsourcing of the portfolio
accounting function.
Amortization of deferred sales commissions increased from $5.4 million
for the second quarter of 1997 to $9.5 million for the same period of
1998, an increase of $4.1 million or 77.1%. This increase was due to
higher levels of deferred sales commissions as a result of the continued
sale of shares of funds which require the Company to advance a commission
to the broker/dealers.
Office and occupancy expenses increased from $6.3 million in the second
quarter of 1997 to $7.3 million for the same period in 1998, an increase
of $1.0 million or 15.6%. The increase is primarily attributable to
increased rent expense for leased space.
Advertising and promotional expenses increased from $8.5 million for the
quarter ended June 30, 1997 to $9.7 million for the quarter ended June 30,
1998, an increase of $1.2 million or 14.5%, primarily as a result of
higher levels of marketing allowances being paid to brokers and bank
clients for retailing efforts of marketing funds, as well as increased
spending in advertising and promotional expense to build company name
awareness.
Travel and related expenses declined $0.4 million, or 10.9%, from $4.0
million in the second quarter of 1997 to $3.6 million for the same period
of 1998 as a result of continued expense management.
Other expenses increased $1.1 million or 27.3% from $4.0 million for the
quarter ended June 30, 1997 to $5.1 million for the quarter ended June 30,
1998. This increase is primarily attributable to fees paid for portfolio
accounting services which were previously performed internally throughout
most of 1997. This increase was partially offset by reductions in
consulting expenses as well as reduced bad debt expense as a result of
improved collections of various receivables.
Amortization of intangible assets increased by $0.6 million, or 16.4%
from $3.2 million for the three months ended June 30, 1997 to $3.8 million
for the three months ended June 30, 1998. The increase in the amortization
of intangible assets occurred as a result of an acquisition in the second
quarter of 1997.
NONOPERATING EXPENSES. Nonoperating expenses increased by $1.7 million,
or 33.1%, to $6.8 million for the three months ended June 30, 1998 as
compared to $5.1 million for the three months ended June 30, 1997. This
increase is attributable to the interest expense recognized relative to
nonrecourse debt incurred for the securitization of certain B share fund
assets.
MINORITY INTEREST. The minority interest increased from $1.8 million for
the second quarter of 1997 to $2.2 million for the second quarter of 1998
as a result of higher net income for the subsidiary for which the Company
acts as the general partner with a majority interest of 50.5%. The
increase in income is attributable to higher average managed assets of
which the subsidiary advises.
INCOME TAXES. The income tax provision for the quarter ended June 30,
1998 was $13.1 million as compared to $5.8 million for the second quarter
of 1997, an increase of $7.3 million or 128.0%. This increase was due
primarily to the increase in the level of income before income taxes from
$14.9 million for the three months ended June 30, 1997 to $34.2 million
for the three months ended June 30, 1998, an increase of 130.3%.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO THE SIX
MONTHS ENDED JUNE 30, 1997
NET INCOME. Revenue growth of 34.4%, when comparing the six month period
ending June 30, 1998 to the same period in 1997, was the principal factor
for the increase in consolidated net income for the first half of 1998 to
$41.9 million, or $0.49 per diluted common share. The 1998 results compare
favorably to the net income of $17.9 million, or $0.22 per diluted common
share for the same period in 1997. The improved performance was
principally the result of increased revenues generated from higher levels
of average managed and administered assets.
REVENUE. The Company's consolidated revenue increased $63.7 million, or
34.4% to $248.8 million for the six month period ended June 30, 1998 from
$185.1 million for the same period in 1997. Approximately $55.7 million,
or 87.5% of the increase in revenues is due to increased average managed
assets. Average managed assets increased 25.4% from $76.9 billion for the
first six months of 1997 to $96.4 billion for the same period in 1998,
including increases of 58.7%, 23.9%, 11.0%, and 25.4% in equity funds,
money market funds, fixed income funds, and separate accounts,
respectively. Service related revenues from other sources increased by
approximately $3.4 million due primarily to an increase in average
administered assets and increased revenues within the Company's clearing
and retirement plan recordkeeping services. Average administered assets
increased $11.2 billion or 27.4% from $41.0 billion for the first half of
1997 to $52.2 billion for the same period in 1998. Interest and dividends
increased by $2.3 million as a result of higher levels of invested cash
from the B share advanced commission financing programs, net proceeds from
the initial public offering, and higher levels of cash generated from
operations. Other income improved $2.3 million due to a servicing contract
buyout of a bank-sponsored mutual fund complex of $2.5 million in the
first quarter of 1998. This servicing contract accounted for approximately
$0.5 million of administrative and other service fee revenue in the first
quarter of 1998.
OPERATING EXPENSES. Total operating expenses increased from $141.9
million for the six month period ended June 30, 1997 to $165.7 million for
the same period in 1998, an increase of $23.8 million or 16.8%.
Compensation and related expenses increased $8.0 million or 12.0% from
$66.8 million for the first half of 1997 to $74.8 million for the first
half of 1998. The increase was mainly attributed to an increase in
variable based compensation, staff growth experienced within the areas of
investment research and certain service areas, and increases in resulting
payroll taxes and retirement plan expenses. The increase was partially
offset by reductions resulting from the outsourcing of the portfolio
accounting function.
Amortization of deferred sales commissions increased from $9.9 million
for the six month period ended June 30, 1997 to $14.7 million for the same
period of 1998, an increase of $4.8 million or 48.5%. This increase was
due to higher levels of deferred sales commissions as a result of the
continued sale of shares of funds which require the Company to advance a
commission to the broker/dealers.
Office and occupancy expenses increased from $12.6 million for the first
six months of 1997 to $13.9 million for the same period in 1998, an
increase of $1.3 million or 10.5%. The increase is primarily attributable
to increased rent expense for leased space.
Advertising and promotional expenses increased from $17.0 million for the
six month period ended June 30, 1997 to $20.9 million for the six month period
ended June 30, 1998, an increase of $3.9 million or 23.0%, primarily as a result
of higher levels of marketing allowances being paid to brokers and bank clients
for retailing efforts of marketing funds, as well as increased spending in
advertising and promotional expense to build company name awareness.
Travel and related expenses declined $0.6 million, or 8.2%, from $7.3
million in the first half of 1997 to $6.7 million for the same period of
1998 as a result of continued expense management.
Other expenses increased $5.4 million or 62.6% from $8.6 million for the
six month period ended
June 30, 1997 to $14.0 million for the six month period ended June 30,
1998. This increase is primarily attributable to fees paid for portfolio
accounting services which were previously performed internally throughout
most of 1997. This increase was partially offset by reductions in
consulting expenses as well as reduced bad debt expense as a result of
improved collections of various receivables.
Amortization of intangible assets increased by $1.4 million, or 22.3%
from $6.2 million for the six months ended June 30, 1997 to $7.6 million
for the six months ended June 30, 1998. The increase in the amortization
of intangible assets occurred as a result of an acquisition in the second
quarter of 1997.
NONOPERATING EXPENSES. Nonoperating expenses increased by $2.7 million,
or 26.8% to $12.9 million for the six months ended June 30, 1998 as
compared to $10.2 million for the six months ended June 30, 1997. This
increase is attributable to the interest expense recognized relative to
nonrecourse debt incurred for the securitization of certain B share fund
assets.
MINORITY INTEREST. The minority interest increased $0.5 million, or
14.3% from $3.7 million for the first half of 1997 to $4.2 million for the
first half of 1998 as a result of higher net income for the subsidiary for
which the Company acts as the general partner with a majority interest of
50.5%. The increase in income is attributable to higher average managed
assets of which the subsidiary advises.
INCOME TAXES. The income tax provision for the six month period ended
June 30, 1998 was $24.0 million as compared to $11.4 million for the same
period in 1997, an increase of $12.6 million or 110.4%. This increase was
due primarily to the increase in the level of income before income taxes
from $29.4 million for the six months ended June 30, 1997 to $65.9 million
for the six months ended June 30, 1998, an increase of 124.6%.
DEFERRED SALES COMMISSIONS AND NONRECOURSE DEBT
Certain subsidiaries of the Company pay commissions to broker/dealers
(deferred sales commissions) to promote investments in certain mutual
funds. For mutual fund shares sold under such marketing programs, the
Company retains certain distribution and servicing fees from the mutual
fund over the outstanding life of such shares. These fees consist of
12b-1, shareholder service and contingent deferred sales charge (CDSC)
fees. Both 12b-1 and shareholder service fees are calculated as a
percentage of average managed assets associated with the related classes
of shares. If shares are redeemed before the end of a specified holding
period as outlined in the related mutual fund prospectus, the mutual fund
shareholder is normally required to pay the Company a CDSC fee based on a
percentage of the assets redeemed, such percentage diminishing over a
recovery schedule not to exceed six years.
The up front commissions the Company pays to broker/dealers are
capitalized and recorded as deferred sales commissions and are amortized
over the estimated benefit period not to exceed CDSC periods. 12b-1 and
shareholder service fees are recognized in the income statement over the
life of the mutual fund class share. Any CDSC fees collected are used to
reduce deferred sales commissions.
In the fourth quarter of 1997, the Company entered into an agreement to
sell certain of the future fee revenue associated with its existing B
shares deferred sales commissions. This agreement also provided for the
Company to sell, on a regular basis, the rights associated with such
future revenue streams during a three year contract period. For accounting
purposes these agreements have been accounted for as financings and
nonrecourse debt was recorded. The statements of income reflect 12b-1 and
shareholder service fees which is included in Other Service Fees, net -
Federated Funds as well as interest expense associated with the
nonrecourse debt and amortization of deferred sales commissions.
In the first six months of 1998, pursuant to the terms of the agreement,
the Company received $74.0 million in cash in exchange for the rights to
certain future revenue streams associated with B share advanced
commissions with a book value of $72.2 million. As of June 30, 1998 the
Company had $234.1 million of nonrecourse debt associated with $216.9
million in book value of deferred sales commission assets related to the B
shares.
CAPITAL RESOURCES AND LIQUIDITY
CASH FLOW.Cash provided by operating activities totaled $18.5 million
for the first half of 1998. The cash flow from operating activities is
primarily utilized for the purchases of equipment, dividend payments, as
well as payments on long term debt.
The recourse debt held by the Company decreased $137 thousand from
December 31, 1997 due to payments on capital leases.
The deferred sales commissions paid to broker/dealers on certain shares
of funds totaled $80.0 million for the first six months of 1998. Also, in
the first six months of 1998, the Company exchanged for $74.0 million the
rights to certain future revenue streams associated with the class B share
advance commission assets with a book value of $72.2 million.
CAPITAL EXPENDITURES. Capital expenditures totaled $1.6 million for the
first six months of 1998. Capital expenditures are not expected to exceed
$10 million in 1998, exclusive of Year 2000 related project costs.
DIVIDENDS.The Board of Directors of the Company adopted a policy to
declare and pay cash dividends on a quarterly basis. A dividend of $0.0208
per share was paid on January 31, 1998. Additionally, a dividend of $0.038
per share was paid on April 30, 1998. In July 1998, the Company amended
the Senior Secured Credit Agreement in order to allow additional
dividends. The Company's Board of Directors declared a dividend of $0.038
per share to be paid on August 10, 1998 to registered shareholders as of
July 31, 1998. After the payment of the August 10th dividend, the Company
will have dividend paying capacity of approximately $32.8 million.
DEBT FACILITIES. The Company has the following recourse debt facilities:
Senior Secured Credit Agreement and Senior Secured Note Purchase Agreement.
SENIOR SECURED CREDIT AGREEMENT. At June 30, 1998, the outstanding
balance under the Senior Secured Credit Agreement was zero with an amount
available to borrow of $149.1 million. The Senior Secured Credit Agreement
contains various financial and other covenants. The Company was in
compliance with all debt covenants at June 30, 1998.
SENIOR SECURED NOTE PURCHASE AGREEMENT. The Senior Secured Note Purchase
Agreement debt totaled $98.0 million as of June 30, 1998. This note is due
in seven annual $14.0 million installments beginning June 27, 2000, and
maturing June 27, 2006. The Senior Secured Note Purchase Agreement
contains various covenants with which the Company was in compliance at
June 30, 1998.
CAPITALIZED LEASE OBLIGATIONS. At June 30, 1998, the Company had
capitalized lease obligations totaling $1.1 million related to certain
telephone equipment. The scheduled principal payments approximate $0.2
million per year for 1998 through 2002.
NONRECOURSE DEBT. The Company had nonrecourse debt obligations aggregating
$234.1 million at June 30, 1998. This obligation was incurred in connection with
the exchange of rights to certain future revenue streams associated with the B
share advance commissions.
SHAREHOLDERS' EQUITY. In May 1998, Federated Investors was merged with
and into the Company, a wholly owned subsidiary. All outstanding Class A
and Class B common shares of Federated Investors were exchanged for an
equal number of shares of no par Class A and Class B common stock of the
Company, respectively, with the same proportionate ownership and
substantially similar rights. All treasury stock of Federated Investors
was retired and additional paid-in-capital was transferred to the no par
Class A and Class B common stock of the Company based on their relative
proportionate values immediately prior to the merger.
Also in May 1998, the Company issued an additional 2,610,000 shares of
Class B common stock in an initial public offering for net proceeds of
approximately $46 million in cash.
YEAR 2000 DISCLOSURE. The Year 2000 ("Y2K") issue is the result of
computer programs using a two-digit format, as opposed to four digits, to
indicate the year. Such computer systems may be unable to interpret dates
beyond the year 1999, which could cause a system failure or other computer
errors, leading to disruptions in operations. The Company has established
an enterprise-wide project to address this issue. The project includes
four phases: inventory / assessment, remediation, testing and
implementation. The project scope includes evaluating both
internally-developed systems and external systems used by the Company, as
well as the progress of key business partners. The project goal is to
complete remediation and initial testing of our corporate systems by the
end of 1998. Further large scale integration and external testing will
continue into 1999.
As of the end of June 1998, the Company has completed the inventory
/assessment phase of its systems. The majority of remediation work is
complete as well, with the remaining work on schedule. After completing
initial testing, approximately half of the applications have been
implemented. Currently, the Company is preparing to conduct more extensive
integration and system testing both internally and with external,
interfacing systems. The Company has created an isolated test environment
for this purpose with testing being conducted in 1998 and continuing into
1999.
Additionally, the Company is participating in the industry-wide testing
being coordinated by the Securities Industry Association. The Company was
one of a limited number of fund companies which participated in the Beta
test in July 1998. The Company will also participate in the remaining
phases: National Securities Clearing Corporation (NSCC) testing scheduled
for October 1998, and the full industry-wide test slated for March 1999.
Certain mission critical processing is performed for the Company by
outside service providers, including the transfer agency, portfolio
accounting, and custody functions. The progress of these companies in
addressing Y2K issues is being monitored. Additionally, the Company has
performed acceptance testing of the core transfer agent system in May and
June of this year.
The Company estimates it will cost at least $10 million to conduct its
Y2K project. This amount is comprehensive and covers the scope of the Y2K
project as outlined above, however is subject to change as testing
continues. The total costs estimated are not considered to have a material
impact on the Company's results of operations or financial position.
It must be realized that, as with all other companies in the financial
services industry, many day-to-day functions of the Company are dependent
on accurate computer processing. Further, this processing is conducted by
an extensive network of systems, both internal to the Company and
external, with both direct and indirect interaction. The potential impact
of Y2K on this scenario is extensive, but often unpredictable.
Accordingly, the Company's Y2K plan includes the development of
contingency plans to address its critical operations in the event of
Y2K-related disruptions. Y2K contingency planning will be integrated into
an update of the Company's overall contingency planning in early 1999;
however no guarantee can be made that Y2K-related disruptions will not
occur due to matters beyond the Company's control.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION. Certain statements
under "Management's Discussion and Analysis of Financial Condition and
Results of Operations" 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, or achievements of the Company, 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 in the Company's registration statement and
quarterly reports of form 10-Q on file with the Securities and Exchange
Commission. As a result of the foregoing and other factors, no assurance
can be given as to future results, levels of activity, or achievements,
and neither the Company nor any other person assumes responsibility for
the accuracy and completeness of such statements.
Part I, Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's investments are primarily in money market funds.
Occasionally, the Company invests in new fluctuating net asset value
mutual funds (priming) sponsored by the Company in order to provide
investable cash allowing the fund to establish a yield history. The
Company uses derivative financial instruments as a hedge to these
investments. As of June 30, 1998, the book value of the priming
investments and the derivative financial instruments were $1.3 million and
$0.1 million, respectively. All of the Company's debt instruments carry
fixed interest rates and therefore are not subject to market risk.
Part II, Item 2 Changes in Securities and Use of Proceeds
On May 13, 1998, the Company's Registration Statement on Form S-1
(Registration Number 333-48405), under which the Company registered
18,733,770 shares of Class B Common Stock (including shares subject to the
Underwriters' over-allotment options), became effective. On May 14, 1998,
the Company filed a Registration Statement on Form S-1 (Registration
Number 333-52611), in which the Company registered an additional 1,455,543
shares of Class B Common Stock (including shares subject to the
Underwriters' over-allotment options) pursuant to Rule 462(b) of the
Securities Act of 1933. The Company's Registration Statements are
collectively referred herein to as "Registration Statements."
The consummation of the offering of Class B Common Stock pursuant to the
Company's Registration Statements occurred on May 19, 1998. Of the
17,557,226 shares of Class B Common Stock sold on that date, 14,045,780
shares were sold in the United States and Canada by the U.S. underwriters
(the "U.S. Offering") and 3,511,446 shares were sold concurrently outside
of the United States and Canada by the international underwriters (the
"International Offering"). In the U.S. Offering, the managing underwriters
were Merrill Lynch, Pierce, Fenner & Smith Incorporated, PaineWebber
Incorporated, and Smith Barney Inc. In the International Offering, the
managing underwriters were Merrill Lynch International, PaineWebber
International (U.K.) Ltd., and Smith Barney Inc. The Underwriters' 30 day
over-allotment options with respect to 2,632,087 shares of Class B Common
Stock expired on June 12, 1998.
Pursuant to the Registration Statements, the Company completed the sale
of 2,610,000 shares of Class B Common Stock on May 19, 1998 for an
aggregate offering price of $49,590,000, before taking into account
underwriting discounts and offering expenses. The balance of the shares,
or 14,947,226 shares, were sold by certain selling shareholders (the
"Selling Shareholders") for an aggregate offering price of $283,997,294.
The amount of expenses incurred by the Company and the Selling
Shareholders in connection with the issuance and distribution of the Class
B Common Stock (excluding any shares subject to the Underwriters' exercise
of their over-allotment options) is set forth below:
Expenses AMOUNT
Underwriting Discounts and Commissions $19,137,376
Finders' Fees 0
Expenses Paid to or for Underwriters 0
Other Expenses (principally legal, accounting,
printing, listing, and insurance fees) 2,300,000 *
--------------
TOTAL $21,437,376
===========
*Based on a reasonable estimate of the amount of expenses incurred.
None of these expenses were paid directly or indirectly to directors or
officers of the Company or its associates, nor were they paid to
affiliates of the Company or persons owning ten (10) percent or more of
the Company's equity securities.
Of these total expenses, the Selling Shareholders paid $17,973,876 and
the Company paid $3,463,500.
The net offering proceeds to the Company from the sale of 2,610,000
shares of Class B Common Stock, after deducting the total expenses set
forth above, were $46,126,500 which have been temporarily invested in a
money market account for later use by the Company for working capital and
other general corporate purposes.
Part II, Item 6 Exhibits and Reports on Form 8-K
(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 - Amendment No. 4 to Credit Agreement,
dated as of May 11, 1998, by and among Federated Investors, Inc. and the Banks
set forth therein and PNC Bank, National Association
Exhibit 10.2. Material Contracts - Amendment No. 5 to Credit Agreement,
dated as of July 17, 1998, by and among Federated Investors, Inc. and the Banks
set forth therein and PNC Bank, National Association
Exhibit 10.3. Material Contracts - Federated Investors, Inc. Employee Stock
Purchase Plan, effective as of July 1, 1998
Exhibit 27. Financial Data Schedule
(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, 1998 By: /S/ J. CHRISTOPHER DONAHUE
-------------------------- -------------------------------
J. Christopher Donahue
President and
Chief Executive Officer
Date AUGUST 14, 1998 By: /S/ THOMAS R. DONAHUE
-------------------------- -------------------------
Thomas R. Donahue
Chief Financial Officer and
Principal Accounting Officer