Exhibit 13.01
Selected Portions of the 1998
Annual Report to Shareholders
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data below should be read in conjunction
with Federated Investors, Inc. and its subsidiaries (Federated) Consolidated
Financial Statements and Notes. The selected consolidated financial data (except
Managed and Administered Assets) of Federated for the five years ended Dec. 31,
1998 have been derived from the audited Consolidated Financial Statements of
Federated. See the "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Consolidated Financial Statements" sections
which follow.
Year Ended Dec. 31,
(dollars in thousands, except per
share data) 1998 1997 1996 1995 1994
STATEMENT OF INCOME DATA:
Total revenue $ 522,127 $ 403,719 $ 321,793 $ 279,831 $ 271,190
Operating expenses:
Compensation and related 146,927 139,373 126,966 101,534 90,003
Other operating expenses 177,845 141,004 134,308 104,885 115,077
Amortization and revaluation of intangible
assets 14,937 13,715 8,886 10,445 105,868
Total operating expenses 339,709 294,092 270,160 216,864 310,948
Operating income (loss) 182,418 109,627 51,633 62,967 (39,758)
Nonoperating expenses 27,614 20,060 20,287 9,826 10,116
Minority interest 8,870 7,584 6,811 5,801 4,070
Income tax provision (benefit) 53,565 30,957 10,930 18,809 (14,608)
Income (loss) before extraordinary item 92,369 51,026 13,605 28,531 (39,336)
Extraordinary item, net of tax 0 449 986 0 0
Net income (loss) 92,369 50,577 12,619 28,531 (39,336)
Dividends on Preferred Stock 0 0 3,025 6,000 6,108
Net income (loss) applicable to Common Stock $ 92,369 $ 50,577 $ 9,594 $ 22,531 $ (45,444)
Cash dividends per common share 1 $ 0.1350 $ 0.0583 $ 0.0417 $ 0.1667 $ 0.00
Earnings (loss) per common share--basic:
Income before extraordinary item 1 $ 1.10 $ 0.62 $ 0.13 $ 0.25 $ (0.53)
Earnings (loss) per common share--
assuming dilution:
Income before extraordinary item 1 $ 1.07 $ 0.61 $ 0.13 $ 0.24 $ (0.53)
Operating margin percentage 35% 27% 16% 23% (15%)
BALANCE SHEET DATA AT PERIOD END:
Cash and cash equivalents $ 185,581 $ 22,912 $ 6,561 $ 7,181 $ 7,968
Deferred sales commissions, net 258,593 164,623 85,905 36,845 36,720
Intangible assets, net 52,953 67,880 69,105 63,703 74,413
Total assets 580,020 337,156 247,377 185,402 178,150
Long-term debt--recourse 98,698 98,950 244,125 68,062 88,690
Long-term debt--nonrecourse 2 272,850 185,388 0 0 0
Total liabilities 490,643 377,800 333,485 155,883 156,284
Shareholders' equity 88,706 (41,110) (86,922) 28,692 20,733
Book value per common share $ 1.03 $ (0.49) $ (1.04) $ 0.32 $ 0.23
MANAGED AND ADMINISTERED ASSETS AT PERIOD
END (in millions):
Money market funds $ 77,055 $ 63,622 $ 51,163 $ 40,610 $ 31,528
Fixed income funds 16,437 15,067 14,109 14,330 14,106
Equity funds 15,503 11,710 7,594 5,287 3,927
Separate accounts 2,558 2,141 1,976 1,486 1,257
Total Managed Assets $ 111,553 $ 92,540 $ 74,842 $ 61,713 $ 50,818
Total Administered Assets $ 28,165 $ 46,999 $ 35,574 $ 22,089 $ 21,304
1 Reflects the one-for-one stock dividend paid in 1996 and the one-for-one stock
dividend and one-for-two stock dividend paid in 1998.
2 See Note 6 to the Consolidated Financial Statements for information concerning
nonrecourse debt.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
AVERAGE MANAGED AND ADMINISTERED ASSETS
Percent
Year Ended Dec. 31, Change
(dollars in millions) 1998 1997 1998
Money market funds $ 69,074 $ 55,636 24%
Fixed income funds 15,851 14,382 10%
Equity funds 13,777 9,690 42%
Separate accounts 2,334 1,872 25%
Total average Managed Assets $101,036 $ 81,580 24%
Total average Administered Assets $ 53,136 $ 42,965 24%
COMPONENTS OF CHANGES IN EQUITY AND FIXED INCOME FUND MANAGED ASSETS
<Caption
Percent
Year Ended Dec. 31, Change
(dollars in millions) 1998 1997 1998
EQUITY FUNDS
Beginning assets $ 11,710 $ 7,594 54%
Sales 5,049 4,017 26%
Redemptions (3,098) (2,196) 41%
Net sales 1,951 1,821 7%
Net exchanges (17) 128 (113%)
Acquisition related -- 353 (100%)
Other* 1,859 1,814 2%
Ending assets $ 15,503 $11,710 32%
FIXED INCOME FUNDS
Beginning assets $ 15,067 $ 14,109 7%
Sales 6,170 4,584 35%
Redemptions (4,831) (4,416) 9%
Net sales 1,339 168 697%
Net exchanges (274) (72) (281%)
Acquisition related -- 175 (100%)
Other* 305 687 (56%)
Ending assets $ 16,437 $ 15,067 9%
* Primarily reinvested dividends and distributions, net investment income and
changes in the value of securities held by the funds.
RESULTS OF OPERATIONS
GENERAL
Federated is a leading provider of investment management products and related
financial services.
Federated derives a majority of its revenue through advising, distributing and
servicing the Federated funds, separately managed accounts and other related
products. Federated also derives revenue through distributing and servicing
third-party mutual funds.
Investment advisory, distribution and the majority of the servicing fees are
based on the net asset value of the investment portfolios that are managed or
administered by Federated. 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.
YEAR ENDED DEC. 31, 1998, COMPARED TO THE YEAR ENDED DEC. 31, 1997
NET INCOME. Net income for the year ended Dec. 31, 1998, was $92.4 million, or
$1.07 per diluted share, an 83% and 78% increase, respectively, over 1997.
Revenue growth of 29% from higher levels of average Managed Assets as well as
improvements in operating margins, from 27% to 35%, were the primary reasons for
the improved financial performance. The higher levels of average Managed Assets
occurred despite the recent market volatility. In 1998, net sales for equity and
fixed income funds were $2.0 billion and $1.3 billion, respectively, resulting
in increases of 7% and 697%, respectively, over 1997, as a result of the
continued strong investment performance and expanded product menu of these asset
classes. Increased assets in money market funds are due to the increased demand
from customers for investment vehicles in which to place cash during periods of
market volatility, as well as efforts to expand the corporate customer base.
REVENUE. Federated's consolidated revenue increased $118.4 million, or 29%, to
$522.1 million for the year ended Dec. 31, 1998, from $403.7 million for 1997
primarily due to higher levels of Managed Assets. Average Managed Assets
increased 24% from $81.6 billion for the year ended Dec. 31, 1997, to $101.0
billion for 1998, including increases of 24%, 10%, 42% and 25% in money market
funds, fixed income funds, equity funds and separate accounts, respectively.
Service-related revenues from sources other than Managed Assets increased by
approximately $3.3 million primarily due to increased revenues within
Federated's clearing and retirement plan recordkeeping services. Interest and
dividends increased by $5.9 million, or 193%, over the prior year as a result of
higher levels of invested cash resulting from the B Share advanced commission
financing program, net proceeds from Federated's initial public offering in May
1998 and higher levels of cash generated from operations. Other income increased
$5.0 million, or 91%, from $5.4 million for the year ended Dec. 31, 1997, to
$10.4 million for 1998, principally as a result of servicing contract buyouts
during 1998 totaling $6.0 million. Collectively, these clients, as well as
certain other clients whose contracts had expired and were not renewed during
1998, had administered assets of $31.6 billion at the time of their departure.
However, these assets accounted for less than 2% of 1998 total revenue. Due to
the relatively lower revenues generated by Administered Assets, changes in the
amount of Administered Assets generally have less impact on Federated's results
of operations than changes in the amount of Managed Assets.
OPERATING EXPENSES. Total operating expenses increased from $294.1 million for
the year ended Dec. 31, 1997, to $339.7 million for 1998, an increase of $45.6
million, or 16%. Expense management continues to be a major focus for Federated,
with expense increases largely attributable to growth in assets under management
and higher levels of profitability. As a result, expense growth has been
contained at levels substantially below the 29% increase in revenues, and,
accordingly, operating margins have improved to 35% for the year ended Dec. 31,
1998, from 27% for 1997.
Compensation and related expenses increased $7.5
million, or 5%, from $139.4 million for the year ended Dec. 31, 1997, to $146.9
million for 1998. This increase was primarily attributed to a 54% increase in
variable-based compensation as a result of increased sales, favorable investment
performance as compared to benchmarks and overall improved financial performance
of Federated, as well as staff growth of 15% within investment research and 6%
within certain service areas. These increases were partially offset by staffing
reductions resulting from the outsourcing of the portfolio accounting function
and the capitalization of certain salaries and employee benefits related to
internally developed software.
Advertising and promotional expenses increased from $34.6 million for the year
ended Dec. 31, 1997, to $46.0 million for 1998, an increase of $11.4 million, or
33%, primarily as a result of higher levels of marketing allowances being paid
to brokers and bank clients for the retailing efforts of marketing funds, as
well as increased spending in printed matter, advertising and promotional
expenses to further build company name and brand awareness.
Office and occupancy expenses increased from $24.9 million for the year ended
Dec. 31, 1997, to $27.2 million for 1998, an increase of $2.3 million, or 9%.
This increase is primarily attributable to increased rent expense for leased
space as a result of general rate increases with respect to current leased space
and to Federated's acquisition of additional office space in the second quarter
of 1998 as part of an effort to consolidate certain servicing functions. This
consolidation eventually resulted in a net reduction of leased office space at
the end of 1998.
Professional service fees increased $12.7 million, or 148%, from $8.5 million
for the year ended Dec. 31, 1997, to $21.2 million for 1998. This increase is
due to fees paid to a third party for portfolio accounting services which were
performed internally throughout most of 1997, and was partially offset by
reductions in consulting and legal fees.
Travel and related expenses declined $1.2 million, or 8%, from $15.0 million for
the year ended Dec. 31, 1997, to $13.8 million for 1998 as a result of continued
expense management.
Amortization of deferred sales commissions increased from $20.9 million for the
year ended Dec. 31, 1997, to $32.1 million for 1998, an increase of $11.2
million, or 54%. This increase is due to higher levels of deferred sales
commissions as a result of the continued sale of shares of funds which require
Federated to advance commissions to the broker/dealers.
Amortization of intangible assets increased from $13.7 million for the year
ended Dec. 31, 1997, to $14.9 million for 1998, an increase of $1.2 million, or
9%, as a result of an acquisition in the second quarter of 1997.
NONOPERATING EXPENSES. Nonoperating expenses increased by $7.5 million, or 38%,
to $27.6 million for the year ended Dec. 31, 1998, as compared to $20.1 million
for 1997. This increase is attributable to the interest and other debt-related
expenses recognized relative to nonrecourse debt incurred for the securitization
of certain B Share fund assets and was partially offset by the elimination of
interest expense on Federated's revolving line of credit as a result of the
reduction of debt previously held within Federated's Senior Secured Credit
Agreement.
MINORITY INTEREST. The minority interest increased from $7.6 million for the
year ended Dec. 31, 1997, to $8.9 million for 1998, an increase of $1.3 million,
or 17%. This increase is a result of higher net income being recorded for the
subsidiary for which Federated acts as the general partner with a majority
interest of 50.5%. The increase in income is attributable to the higher average
Managed Assets of the funds which the subsidiary advises.
INCOME TAXES. The income tax provision for the year ended Dec. 31, 1998, was
$53.6 million as compared to $31.0 million for 1997, an increase of $22.6
million, or 73%. This increase was due primarily to the increase in the level of
income before income taxes from $82.0 million for the year ended Dec. 31, 1997,
to $145.9 million for 1998, an increase of $63.9 million, or 78%.
YEAR ENDED DEC. 31, 1997, COMPARED TO THE YEAR ENDED DEC. 31, 1996
NET INCOME. Net income applicable to Common Stock for the year ended Dec. 31,
1997, was $50.6 million, or $0.60 per diluted share, a 427% and 400% increase,
respectively, over 1996. Revenue growth of 25% from higher levels of average
Managed Assets and improvements in operating margins from 16% to 27% were the
primary reasons for the improved financial performance.
REVENUE. Federated's consolidated revenue increased $81.9 million, or 25%, to
$403.7 million for the year ended Dec. 31, 1997, from $321.8 million for 1996
primarily due to higher levels of Managed Assets. Average Managed Assets
increased 23% from $66.1 billion for the year ended Dec. 31, 1996, to $81.6
billion for 1997, including increases of 26%, 3%, 54% and 11% in money market
funds, fixed income funds, equity funds and separate accounts, respectively.
Service-related revenues from sources other than Managed Assets increased by
approximately $7.7 million, primarily due to increased revenues within
Federated's clearing and retirement plan recordkeeping services, as well as
revenues earned on bank proprietary administration, transfer agency and
portfolio accounting contracts resulting from increased Administered Assets and
accounts. Interest and dividends increased by $0.9 million, or 40%, over the
prior year due to higher levels of invested cash resulting from the B Share
advanced commission financing program initiated in the fourth quarter of 1997.
Marketable securities gains decreased from $2.7 million for the year ended Dec.
31, 1996, to $0.1 million in 1997, a $2.6 million, or 98% decrease resulting
from a reduced level of corporate investments being utilized to prime
corporately sponsored mutual funds.
OPERATING EXPENSES. Total operating expenses increased from $270.2 million for
the year ended Dec. 31, 1996, to $294.1 million for 1997, an increase of $23.9
million, or 9%. Federated's focus on expense management contained the increase
in expenses at levels substantially below the 25% increase in revenues,
improving operating margins to 27% for the year ended Dec. 31, 1997, from 16%
for 1996.
Compensation and related expenses for the year ended Dec. 31, 1997, were $139.4
million as compared to $127.0 million in 1996, an increase of $12.4 million, or
10%. This increase was primarily due to a 56% increase in incentive compensation
expense as a result of increased sales, favorable investment performance as
compared to benchmarks and overall improved financial performance of Federated,
as well as an increase of 7% in the average number of employees. This change
does not reflect the reduction in the number of employees due to the outsourcing
of the portfolio accounting function which occurred late in the fourth quarter
of 1997. Staff growth was experienced in the area of investment research, with
continued emphasis in domestic and global portfolio management, and in various
service areas.
Advertising and promotional expenses increased from $30.6 million for the year
ended Dec. 31, 1996, to $34.6 million for 1997, an increase of $4.0 million, or
13%, primarily as a result of higher levels of marketing allowances being paid
to brokers and bank clients for the retailing efforts of marketing funds.
Systems and communications expense increased by $1.5 million, or 6%, from $25.6
million for the year ended Dec. 31, 1996, to $27.1 million in 1997, primarily as
a result of an increase in costs related to third-party system vendors.
Office and occupancy expense was $24.9 million for the year ended Dec. 31, 1997,
a decrease of $1.6 million, or 6%, as compared to the $26.5 million recorded for
the year ended Dec. 31, 1996. This decrease was primarily due to the reduction
of rent expense as the result of the early termination of leased space, a
reduction in leasehold improvement depreciation and a reduction in other office
expenses.
Professional service fees decreased from $10.0 million for the year ended Dec.
31, 1996, to $8.5 million for 1997, a decrease of $1.5 million, or 15%, as a
result of reduced legal and other professional fee expenses.
Travel and related expenses declined $1.0 million, or 7%, from $16.0 million for
the year ended Dec. 31, 1996, to $15.0 million for 1997 as a result of
management's initiative to reduce discretionary spending in this expense
category by negotiating more favorable discount arrangements with travel-related
vendors and improved overall expense management.
Amortization of deferred sales commissions increased from $12.3 million for the
year ended Dec. 31, 1996, to $20.9 million for 1997, an increase of $8.6
million, or 69%. This increase was due to higher levels of deferred sales
commissions as a result of the continued sale of shares of funds which require
Federated to advance commissions to the broker/dealers.
Amortization of intangible assets increased from $8.9 million for the year ended
Dec. 31, 1996, to $13.7 million for 1997, an increase of $4.8 million, or 54%.
This expense increased as a result of the purchase of several customer
relationships in late 1996 and throughout 1997 and the resulting allocation of a
portion of the purchase price to intangible assets on Federated's balance sheet.
Other expenses decreased $3.2 million, or 24%, from $13.2 million for the year
ended Dec. 31, 1996, to $10.0 million for 1997. This reduction was principally
the result of the reduction of taxes other than income taxes and the reduction
of reserves for errors related to the various service businesses.
NONOPERATING EXPENSES. Nonoperating expenses decreased by 1% from $20.3 million
for the year ended Dec. 31, 1996, to $20.1 million in 1997. The decrease was due
to the early prepayment of term debt as a result of a debt restructuring in
mid-1996 and the prepayment of the remaining term debt in the fourth quarter of
1997 as a result of the B Share financing program. In both instances, the
allocable unamortized portions of the debt issuance costs related to the term
debt which was prepaid were recorded as extraordinary items, net of tax.
MINORITY INTEREST. The minority interest increased from $6.8 million for the
year ended Dec. 31, 1996, to $7.6 million for 1997, an increase of $0.8 million,
or 11%. This increase is a result of the higher net income recorded for the
subsidiary for which Federated acts as the general partner with a majority
interest of 50.5%. The increase in income is attributable to the higher average
Managed Assets of the funds which the subsidiary advises.
INCOME TAXES. The income tax provision for the year ended Dec. 31, 1997, was
$31.0 million as compared to $10.9 million for 1996, an increase of $20.1
million, or 183%. This increase was primarily due to the increase in the level
of income before income taxes from $24.5 million for the year ended Dec. 31,
1996, to $82.0 million for 1997, an increase of $57.5 million, or 234%.
CAPITAL RESOURCES AND LIQUIDITY
CASH FLOW. Cash provided by operating activities totaled $60.1 million for the
year ended Dec. 31, 1998. The cash flow from operating activities was primarily
utilized for the purchase of equipment, dividend payments, distributions to the
minority interest and payments on long-term debt.
DEFERRED SALES COMMISSIONS AND NONRECOURSE DEBT.
Certain subsidiaries of Federated pay commissions to broker/dealers (deferred
sales commissions) to promote investments in certain mutual funds. For mutual
fund shares sold under such marketing programs, Federated 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 Federated a CDSC fee based on a
percentage of the lower of the current market value or the original cost basis
of the redeemed shares, such percentage diminishing over a recovery schedule not
to exceed six years.
For non-B Share related sales, the up-front commissions Federated 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. The
12b-1 and shareholder service fees are recognized in the statements of income
over the life of the mutual fund class share. Any CDSC fees collected are used
to reduce the deferred sales commission asset.
In the fourth quarter of 1997, Federated entered into an agreement to sell
certain of the future revenue streams associated with its existing B Share
deferred sales commissions. This agreement also provided for Federated to sell,
on a regular basis, the rights associated with such future revenue streams of
future B Share deferred sales commissions during a three-year contract period.
For accounting purposes, these agreements were accounted for as financings, and
nonrecourse debt was recorded.
The following table demonstrates the effects of the B Share financing program
since its inception in the fourth quarter of 1997 on both the Consolidated
Balance Sheets and the Consolidated Statements of Income at, and for the periods
ended, Dec. 31, 1998 and 1997, respectively:
4th
Quarter
(in thousands) 1998 1997
DEC. 31
Assets
Deferred sales commissions, net* $ 249,580 $ 162,398
Receivables--Federated funds 6,314 2,773
Other long-term assets 2,798 3,664
Liabilities
Long-term debt--nonrecourse $ 272,850 $ 185,388
Accounts payable 3,951 0
PERIODS ENDED DEC. 31
Revenues
Other service fees, net--
Federated funds $ 51,912 $ 8,582
Expenses
Amortization of deferred sales
commissions $ 28,881 $ 4,191
Debt expense--nonrecourse 18,759 1,936
Other expenses 764 124
* Excludes deferred sales commissions related to B Share revenue streams which
have not been financed as of the end of the period due to the timing of the sale
of the revenue streams to the third party.
Due to the nonrecourse nature of this financing arrangement, the $18.1 million
excess of B Share-related liabilities over the related assets at Dec. 31, 1998,
will be recognized in income over the remaining life of the B Share cash flows.
CAPITAL EXPENDITURES. Capital expenditures totaled $7.5 million for the year
ended Dec. 31, 1998, which excludes Year 2000-related project costs described
below. It is anticipated that 1999 capital expenditures will range from $20.0
million to $25.0 million.
DIVIDENDS. In 1997, Federated paid a cash dividend of $0.0583 per share.
Federated's board of directors adopted a policy in 1998 to declare and
pay cash dividends on a quarterly basis. A dividend of $0.0208 per share
was paid on Jan. 31, 1998, and dividends of $0.038 per share were paid on
April 30, 1998, Aug. 10, 1998, and Nov. 13, 1998. Federated's board of
directors declared a dividend of $0.038 per share that was paid on Feb. 15,
1999. After the payment of the dividend on Feb. 15, 1999, Federated,
given current debt covenants as disclosed in the Common Stock footnote
(Note 10 to the Consolidated Financial Statements), has the ability to
pay dividends of approximately $51.4 million.
DEBT FACILITIES. Federated has the following recourse debt facilities:
Senior Secured Credit Agreement and Senior Secured Note Purchase Agreement.
SENIOR SECURED CREDIT AGREEMENT. At Dec. 31, 1998, the outstanding balance
under the Senior Secured Credit Agreement was zero with an amount available
to borrow of $150.0 million. The Senior Secured Credit Agreement contains
various financial and other covenants. Federated was in compliance with all
debt covenants at Dec. 31, 1998.
SENIOR SECURED NOTE PURCHASE AGREEMENT. The Senior Secured Note Purchase
Agreement debt totaled $98.0 million as of Dec. 31, 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 Federated was in compliance at
Dec. 31, 1998.
CAPITALIZED LEASE OBLIGATIONS. At Dec. 31, 1998, Federated had
capitalized lease obligations totaling $0.9 million related to certain
telephone equipment. The scheduled principal payments approximate $0.2
million per year for 1999 through 2002.
NONRECOURSE DEBT. Federated had nonrecourse debt obligations aggregating $272.9
million at Dec. 31, 1998. This obligation was incurred in connection with a
three-year future commitment to exchange rights to certain future revenue
streams associated with the B Share advance commissions. This debt will be
repaid or amortized based solely on certain cash flows related to B Share
assets. See Note 6 to the Consolidated Financial Statements.
SHAREHOLDERS' EQUITY. In May 1998, Federated Investors was merged with and into
Federated Investors, Inc., its 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 Federated
Investors, Inc., 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 Federated Investors, Inc. based on their relative
proportionate values immediately prior to the merger.
Also in May 1998, Federated issued an additional 2,610,000 shares of Class B
Common Stock in an initial public offering for net proceeds of approximately
$46.2 million in cash.
FUTURE CASH REQUIREMENTS. Management expects that the principal needs for cash
will be to advance sales commissions, fund increased property and equipment
acquisitions, pay shareholder dividends, repurchase company stock, service debt
and fund strategic business acquisitions. Management believes that Federated's
existing liquid assets, together with the expected continuing cash flow from
operations, its borrowing capacity under current credit facilities, its B Share
financing arrangement and its ability to issue stock will be sufficient to meet
its present and reasonably foreseeable cash needs.
YEAR 2000 READINESS DISCLOSURE
Many existing information technology (IT) products and systems and non-IT
products and systems containing embedded processor technology were originally
programmed to represent any date by using six digits (e.g., 12/31/99), as
opposed to eight digits (e.g., 12/31/1999). Accordingly, such products and
systems may experience miscalculations, malfunctions or disruptions when
attempting to process information containing dates that fall after Dec. 31,
1999, or when attempting to recognize the year 2000 as a leap year. These
potential problems are collectively referred to as the "Year 2000," or "Y2K"
problem. Also, the occurrence of such problems may take place before the year
2000 if a computer system utilizes future dates during its processing.
STATE OF READINESS. Computer processing is critical to Federated's business
operations, and the Y2K issue poses a significant potential risk to operations.
Therefore, Federated has established an enterprise-wide project to address this
issue. The project includes four phases: inventory/assessment, which includes
the identification of all components of Federated's computing environment and
the assessment of Y2K issues for these components; remediation of the Y2K issues
identified in the inventory/assessment phase; testing to ensure that remediation
was successful; and implementation of the modified systems.
The project scope has been divided into four segments which comprise Federated's
computing environment as follows:
* systems developed internally by Federated's IT division--this constitutes
the majority of Federated's Y2K efforts;
* mission-critical processing provided by the funds' service providers;
* other critical aspects of systems and operations within the business units,
including both commercially available computer applications and the progress of
key business partners; and
* embedded systems--for Federated's operations, embedded systems mainly consist
of building systems and office equipment.
As of the end of 1998, Federated completed the inventory/assessment phase with
respect to its internally developed systems. Federated has also substantially
completed the remediation and unit testing of individual programs. Approximately
85% of applications have been implemented into production after unit level
testing. In addition, approximately three quarters of these systems have
finished the next phase, system level testing. The focus during 1999 is to
complete implementation and system testing during the first half of the year and
test with external interfacing systems.
Certain mission-critical processing is performed for Federated's funds by
outside service providers, including the transfer agency, portfolio accounting,
and custody functions. Federated has identified these service providers, is
monitoring the progress of these companies in addressing Y2K issues via progress
reports and meetings, and is working with these service providers to test their
systems, as appropriate. As of the end of 1998, the critical service providers
reported good progress and confidence in making their systems compliant.
Assessment and remediation are underway for business unit systems, key business
partners and embedded systems. Federated currently expects to complete
assessment and necessary remediation for these items by mid-1999.
Additionally, Federated is participating in the "industry-wide testing" being
coordinated by the Securities Industry Association. This testing is being
conducted to ensure that major broker/dealers, exchanges, clearing houses, and
depositories are able to communicate properly in the year 2000. Federated
participated in initial tests for processing of mutual fund transactions in both
July and Oct. 1998. Federated is also participating in the full industry-wide
test slated for March/April 1999.
COSTS TO ADDRESS Y2K. Federated estimates its Y2K project will cost
approximately $10 million. Federated has incurred approximately $5.2 million
from the inception of the Y2K project through Dec. 31, 1998, with $4.5 million
being reflected within the current year's financial statements. Y2K costs are
being funded from operating revenue and are being expensed as incurred. These
cost estimates are subject to change as the project continues. The estimated
total costs are not considered to have a material impact on Federated's results
of operations or financial position.
While certain non-time sensitive IT projects have been delayed due to Y2K
efforts and costs, no strategic projects or projects for legal or regulatory
requirements have been deferred or canceled.
RISKS OF YEAR 2000 ISSUES. It must be realized that, as with all other companies
in the financial services industry, many day-to-day functions of Federated are
dependent on accurate computer processing. Further, this processing is conducted
by an extensive network of systems, both internal to Federated and external,
with both direct and indirect interaction. Accordingly, if not addressed, Y2K
issues could result in Federated's inability to perform mission-critical
functions, including the trading of securities and processing of fund shareowner
transactions.
A portion of Federated's business involves international investments, thereby
exposing Federated to operations, custody and settlement processes outside the
United States. Federated is monitoring the progress of the funds' international
custodians in these areas. Federated is also assessing Y2K issues for other
aspects of its international operations.
Y2K is a risk for many of the issuers of the specific securities in which
Federated's funds invest, in both the U.S. and international markets.
Accordingly, Federated has incorporated assessment of Y2K risk into its
investment management process.
CONTINGENCY PLANS. Because Federated's operations are reliant upon systems which
are not under its direct control, Federated's Y2K plan includes the development
of contingency plans to address its critical operations in the event of
Y2K-related disruptions. However, in an operation as complex and geographically
distributed as Federated's business, there are limited alternatives to certain
of its mission-critical systems or public utilities. If certain mission-critical
systems or public utilities are not made Year 2000 compliant or fail, there
would be a material adverse impact upon Federated's business, financial
condition and results of operations. Although Federated is investigating
alternative solutions, it is unlikely that an adequate contingency plan can be
developed to avoid such an adverse impact in the event mission-critical systems
or public utilities fail to achieve compliance.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
Certain statements under "Management's Discussion and Analysis of Financial
Condition and Results of Operations," included in the Year 2000 Readiness
Disclosure 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
Federated, 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 Dec. 31, 1998, and other reports 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, performance, or achievements, and neither Federated nor any other
person assumes responsibility for the accuracy and completeness of such
statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Federated's investments are primarily money market funds. Occasionally,
Federated invests in new fluctuating net asset value mutual funds (priming)
sponsored by Federated in order to provide investable cash to the fund, allowing
the fund to establish a yield history. Federated may use derivative financial
instruments as an attempt to hedge these investments. As of Dec. 31, 1998, the
book value of the priming investments and the derivative financial instruments
were $12.0 million and $0.4 million, respectively. All of Federated's debt
instruments carry fixed interest rates and therefore are not subject to market
risk.
MANAGEMENT'S REPORT
Federated Investors, Inc. (Federated) management takes responsibility for the
integrity and fair presentation of the financial statements in this annual
report. These financial statements were prepared from accounting records which
management believes fairly and accurately reflect the operations and financial
position of Federated.
The financial statements were prepared in conformity with generally accepted
accounting principles and, as such, include amounts based on management's best
estimates and judgements considering currently available information and
management's view of current conditions and circumstances. Management also
prepared the other information in this report and is responsible for its
accuracy and consistency with the financial statements.
Management is responsible for establishing and maintaining effective internal
control designed to provide reasonable assurance that assets are protected from
improper use and accounted for in accordance with its policies and that
transactions are recorded accurately in Federated's records. The concept of
reasonable assurance is based upon a recognition that the cost of the controls
should not exceed the benefit derived. Even effective internal control, no
matter how well designed, has inherent limitations -- including the possibility
of circumvention or overriding of controls -- and therefore can only provide
reasonable assurance with respect to financial statement preparation and
safeguarding of assets.
The financial statements of Federated have been audited by Ernst & Young LLP,
independent auditors. Their accompanying report is based on an audit conducted
in accordance with generally accepted auditing standards.
Federated Investors, Inc.
[Graphic]
J. Christopher Donahue
President and Chief Executive Officer
[Graphic]
Thomas R. Donahue
Chief Financial Officer
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Federated Investors, Inc.
We have audited the consolidated balance sheets of Federated Investors, Inc. and
subsidiaries (Federated Investors) as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of Federated Investors'
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Federated
Investors, Inc. and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.
[Graphic]
Pittsburgh, Pennsylvania
January 26, 1999
CONSOLIDATED BALANCE SHEETS (dollars in thousands, except share data)
Dec. 31,
1998 1997
CURRENT ASSETS
Cash and cash equivalents $ 185,581 $ 22,912
Marketable securities 13,398 8,945
Receivables -- Federated funds 26,097 20,062
Receivables -- other, net of reserve of $1,276 and $3,262, respectively 4,872 7,416
Accrued revenues 3,666 4,600
Prepaid expenses 4,688 2,853
Income taxes receivable 0 7,519
Other current assets 3,958 1,805
Total current assets 242,260 76,112
LONG-TERM ASSETS
Customer relationships, net of accumulated amortization of $39,571 and
$26,907, respectively 17,743 30,398
Goodwill, net of accumulated amortization of $13,762 and $11,512,
respectively 35,107 37,356
Other intangible assets, net of accumulated amortization of $3,608 and
$3,585, respectively 103 126
Deferred sales commissions, net 258,593 164,623
Property and equipment, net 21,550 22,163
Other long-term assets 4,664 6,378
Total long-term assets 337,760 261,044
Total assets $ 580,020 $ 337,156
CURRENT LIABILITIES
Cash overdraft $ 5,932 $ 7,680
Current portion of long-term debt -- recourse 239 280
Accrued expenses 51,096 34,939
Accounts payable 24,864 18,634
Income taxes payable 2,522 0
Other current liabilities 1,675 2,520
Total current liabilities 86,328 64,053
LONG-TERM LIABILITIES
Long-term debt -- recourse 98,698 98,950
Long-term debt -- nonrecourse 272,850 185,388
Deferred tax liability, net 29,949 26,546
Other long-term liabilities 2,818 2,863
Total long-term liabilities 404,315 313,747
Total liabilities 490,643 377,800
Minority interest 671 466
SHAREHOLDERS' EQUITY Common Stock:
Class A, no par value, 20,000 shares authorized, 6,000 and 0 shares
issued and outstanding, respectively 189 0
Class B, no par value, 900,000,000 shares authorized, 86,337,000 and 0 shares
issued, respectively 75,090 0
Class A, $1.00 stated value, 99,000 shares authorized, 0 and 6,000 shares
issued and outstanding, respectively 0 6
Class B, $.01 stated value, 149,700,000 shares authorized, 0 and
90,093,758 shares issued, respectively 0 903
Additional paid-in capital 0 28,574
Retained earnings 14,556 55,137
Treasury Stock, at cost, 138,750 and 6,666,758 shares Class B Common
Stock, respectively (23) (123,373)
Employee restricted stock plan (1,512) (2,266)
Accumulated other comprehensive income 406 (91)
Total shareholders' equity 88,706 (41,110)
Total liabilities, minority interest, and shareholders' equity $ 580,020 $ 337,156
(The accompanying notes are an integral part of these consolidated financial
statements.)
CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except
per share data)
Year Ended Dec. 31,
1998 1997 1996
REVENUE
Investment advisory fees, net -- Federated funds $ 269,971 $ 213,361 $ 174,585
Investment advisory fees, net -- other 7,360 5,507 4,636
Administrative service fees, net -- Federated funds 72,101 60,934 51,239
Administrative service fees, net -- other 25,133 24,495 21,684
Other service fees, net -- Federated funds 101,252 67,494 44,590
Other service fees, net -- other 23,347 20,669 15,741
Commission income -- Federated funds 4,008 2,744 1,652
Interest and dividends 8,887 3,032 2,160
Marketable securities (losses) gains (295) 49 2,651
Other income 10,363 5,434 2,855
Total revenue 522,127 403,719 321,793
OPERATING EXPENSES
Compensation and related 146,927 139,373 126,966
Advertising and promotional 46,042 34,609 30,556
Systems and communications 27,840 27,118 25,630
Office and occupancy 27,215 24,863 26,516
Professional service fees 21,171 8,539 10,018
Travel and related 13,802 14,968 16,020
Amortization of deferred sales commissions 32,117 20,882 12,349
Amortization of intangible assets 14,937 13,715 8,886
Other 9,658 10,025 13,219
Total operating expenses 339,709 294,092 270,160
Operating income 182,418 109,627 51,633
NONOPERATING EXPENSES
Debt expense--recourse 8,855 18,124 20,287
Debt expense--nonrecourse 18,759 1,936 0
Total nonoperating expenses 27,614 20,060 20,287
Income before minority interest, income taxes and extraordinary item 154,804 89,567 31,346
Minority interest 8,870 7,584 6,811
Income before income taxes and extraordinary item 145,934 81,983 24,535
Income tax provision 53,565 30,957 10,930
Income before extraordinary item 92,369 51,026 13,605
Extraordinary item related to debt restructuring costs, net of tax 0 449 986
Net income 92,369 50,577 12,619
Dividends on Preferred Stock 0 0 3,025
Net income applicable to Common Stock $ 92,369 $ 50,577 $ 9,594
EARNINGS PER COMMON SHARE-BASIC
Income before extraordinary item $ 1.10 $ 0.62 $ 0.13
Extraordinary item related to debt restructuring costs, net of tax -- (0.01) (0.01)
Net income per common share -- basic $ 1.10 $ 0.61 $ 0.12
EARNINGS PER COMMON SHARE-ASSUMING DILUTION
Income before extraordinary item $ 1.07 $ 0.61 $ 0.13
Extraordinary item related to debt restructuring costs, net of tax -- (0.01) (0.01)
Net income per common share -- assuming dilution $ 1.07 $ 0.60 $ 0.12
Cash dividends per common share $ 0.1350 $ 0.0583 $ 0.0417
Per share amounts have been restated to reflect the one-for-one stock dividend
paid in 1996 and the one-for-one stock dividend and one-for-two stock dividend
paid in 1998.
(The accompanying notes are an integral part of these consolidated financial
statements.)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (dollars in
thousands, except per share data)
Years Ended Dec. 31, 1998, 1997 and 1996
Employee Accumulated
Additional Restricted Other Total
Preferred Common Paid-in Retained Treasury Stock Comprehensive Shareholders'
Stock Stock Capital Earnings Stock Plan Income Equity
BALANCE AT JAN. 1, 1996 $ 1 $ 153 $ 29,286 $ 4,034 $ (58) $ (5,350) $ 626 $ 28,692
Net income 0 0 0 12,619 0 0 0 12,619
Other comprehensive
income, net of tax:
Unrealized loss on
marketable securities,
net of reclassification
adjustment 0 0 0 0 0 0 (599) (599)
Other 0 0 0 0 0 0 (12) (12)
Comprehensive income 12,008
Amortization of employee
restricted stock plan
and other compensation
plans 0 0 371 0 0 2,183 0 2,554
Dividends declared on:
Common Stock 0 141 0 (3,639) 0 0 0 (3,498)
Preferred Stock, $3,025
per share 0 0 0 (3,025) 0 0 0 (3,025)
Purchase of Treasury Stock 0 0 0 0 (123,653) 0 0 (123,653)
Conversion of Preferred
Stock to Common Stock (1) 53 (52) 0 0 0 0 0
BALANCE AT DEC. 31, 1996 0 347 29,605 9,989 (123,711) (3,167) 15 (86,922)
Net income 0 0 0 50,577 0 0 0 50,577
Other comprehensive
income, net of tax:
Unrealized loss on
marketable securities,
net of reclassification
adjustment 0 0 0 0 0 0 (110) (110)
Other 0 0 0 0 0 0 4 4
Comprehensive income 50,471
Amortization of employee
restricted stock plan
and other compensation
plans 0 0 257 0 0 28 0 285
Dividends declared on
Common Stock 0 562 0 (5,429) 0 0 0 (4,867)
Issuance of stock under
employee restricted
stock plan, net 0 0 (218) 0 440 (197) 0 25
Restricted stock
forfeitures 0 0 (1,070) 0 0 1,070 0 0
Purchase of Treasury Stock 0 0 0 0 (102) 0 0 (102)
BALANCE AT DEC. 31, 1997 0 909 28,574 55,137 (123,373) (2,266) (91) (41,110)
Net income 0 0 0 92,369 0 0 0 92,369
Other comprehensive
income, net of tax:
Unrealized gain on
marketable securities,
net of reclassification
adjustment 0 0 0 0 0 0 502 502
Other 0 0 0 0 0 0 (5) (5)
Comprehensive income 92,866
Amortization of
employee restricted
stock plan and other
compensation plans 0 216 42 0 0 512 0 770
Dividends declared on
Common Stock 0 0 0 (11,480) 0 0 0 (11,480)
Initial public offering
of Class B Common Stock 0 46,202 0 0 0 0 0 46,202
Merger of Federated
Investors into
Federated Investors, Inc. 0 27,707 (27,707) (121,464) 121,464 0 0 0
Issuance/exercise of
stock options 0 487 (909) 0 1,909 0 0 1,487
Restricted stock
forfeitures 0 (242) 0 0 0 242 0 0
Purchase of Treasury Stock 0 0 0 0 (23) 0 0 (23)
Other 0 0 0 (6) 0 0 0 (6)
BALANCE AT DEC. 31, 1998 $ 0 $ 75,279 $ 0 $ 14,556 $ (23) $ (1,512) $406 $ 88,706
(The accompanying notes are an integral part of these consolidated financial
statements.)
CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
Year Ended Dec. 31,
1998 1997 1996
OPERATING ACTIVITIES
Net income $ 92,369 $ 50,577 $ 12,619
ADJUSTMENTS TO RECONCILE NET
INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Extraordinary item related to debt restructuring costs 0 690 1,516
Amortization of intangible assets 14,937 13,715 8,886
Depreciation and other amortization 7,923 8,674 9,398
Amortization of deferred sales commissions 32,117 20,882 12,349
Minority interest 8,870 7,584 6,811
Write-off/loss on sale of property and equipment 1,582 271 403
Amortization of employee restricted stock and other
compensation plans 770 285 2,554
Provision for deferred income taxes 3,123 11,117 17,088
Net realized loss/(gain) on sale of marketable securities 295 (49) (2,651)
Deferred sales commissions paid (149,137) (111,628) (69,600)
Contingent deferred sales charges received 23,050 12,027 8,191
Other (11) 4 (12)
Other changes in assets and liabilities:
Increase in receivables, net (3,491) (5,780) (3,941)
Decrease (increase) in accrued revenues 934 (1,216) (620)
(Increase) decrease in prepaid expenses and other current assets (3,988) 116 684
Decrease (increase) in income taxes receivable/payable 10,052 (961) (2,066)
Decrease (increase) in other long-term assets 348 (1,870) (4,805)
Increase in accounts payable and accrued expenses 22,387 15,790 17,653
(Decrease) increase in other current liabilities (2,022) (4,904) 11,485
(Decrease) increase in other long-term liabilities (45) (257) 1,537
Net cash provided by operating activities 60,063 15,067 27,479
INVESTING ACTIVITIES
Proceeds from sale of property and equipment 0 2,454 14
Additions to property and equipment (7,526) (3,129) (12,362)
Cash paid for acquisitions (580) (14,699) (12,128)
Purchases of marketable securities (16,082) (24,531) (60,769)
Proceeds from redemptions of marketable securities 12,104 29,230 65,122
Net cash used by investing activities (12,084) (10,675) (20,123)
FINANCING ACTIVITIES
Distributions to minority interest (8,665) (7,932) (6,824)
Dividends paid (11,480) (4,867) (6,523)
Proceeds from issuance of Common Stock/options 47,689 25 0
Purchase of Treasury Stock (23) (102) (123,653)
Proceeds from new borrowings -- recourse 0 15,729 234,724
Proceeds from new borrowings -- nonrecourse 142,977 195,156 0
Payments on debt -- recourse (293) (176,282) (105,700)
Payments on debt -- nonrecourse (55,515) (9,768) 0
Net cash provided (used) by financing activities 114,690 11,959 (7,976)
Net increase (decrease) in cash and cash equivalents 162,669 16,351 (620)
Cash and cash equivalents, beginning of period 22,912 6,561 7,181
Cash and cash equivalents, end of period $ 185,581 $ 22,912 $ 6,561
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for:
Interest $ 15,251 $ 21,221 $ 16,758
Income taxes 49,075 20,495 702
(The accompanying notes are an integral part of these consolidated financial
statements.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dec. 31, 1998, 1997 and 1996)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) NATURE OF OPERATIONS
Federated Investors, Inc. and its subsidiaries (Federated) sponsor, market and
provide investment advisory, distribution and administrative services primarily
to mutual funds. Federated also provides investment advisory and administrative
services to corporations, employee benefit plans and private investment advisory
accounts. The operations of Federated are organized into three principal
functions: investment advisory, distribution and services.
A large portion of Federated's revenue is derived from investment advisory
services provided to mutual funds and separately managed accounts through
various subsidiaries and affiliates pursuant to investment advisory contracts.
These subsidiaries are registered as investment advisers under the Investment
Advisers Act of 1940 and with certain states.
Shares of the portfolios or classes of shares under management or administration
by Federated are distributed by indirect wholly owned subsidiaries which are
registered broker/dealers under the Securities Exchange Act of 1934 and under
applicable state laws. Federated's investment products are primarily distributed
within the bank trust, broker/dealer and institutional markets.
Through indirect wholly owned subsidiaries, Federated provides mutual fund
services to support the operation and administration of all mutual funds it
sponsors.
(B) BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Federated
Investors, Inc. and all of its subsidiaries including special purpose entities
(SPEs) (see Note 6). All significant intercompany accounts and transactions have
been eliminated.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements. Actual results will differ
from those estimates, and such differences may be material to the consolidated
financial statements.
(C) CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks and investments which consist of interest-bearing
deposits with banks, overnight federal funds sold, money market accounts, and
other investments with an original maturity of less than three months.
(D) MARKETABLE SECURITIES
Marketable securities consist of equity and fixed income securities which are
classified as "available for sale" and are carried at fair value. The unrealized
gains or losses on these securities are included in the accumulated other
comprehensive income component of shareholders' equity, net of tax. Realized
gains and losses on these securities are computed on a specific identification
basis and recognized in the statements of income.
(E) PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost, or fair value if acquired in
connection with a business combination, and are depreciated using the
straight-line method over their estimated useful lives ranging from 3 to 10
years. Leasehold improvements are depreciated using the straight-line method
over their estimated useful lives or their respective lease terms, whichever is
shorter. As property and equipment is placed out- of-service, the cost and
related accumulated depreciation are removed and any residual net book value is
reflected as other income in the Consolidated Statements of Income.
(F) INTANGIBLE ASSETS
Goodwill and other intangible assets are amortized on a straight-line basis over
the estimated period of benefit, not to exceed 25 years. Customer relationships
are amortized using the straight-line method over their estimated period of
benefit (5 to 9 years). Federated continuously evaluates the remaining useful
lives and carrying values of the intangible assets to determine whether events
and circumstances indicate that a change in the useful life or impairment in
value may have occurred. Indicators of impairment monitored by Federated include
a decline in the level of managed assets, changes to contractual provisions
underlying certain intangible assets and reductions in operating cash flows.
Should there be an indication of a change in the useful life or an impairment in
value, Federated compares the carrying value of the asset and its related useful
life to the projected undiscounted cash flows expected to be generated from the
underlying asset over its remaining useful life to determine whether an
impairment has occurred. If the carrying value of the asset exceeds the
undiscounted cash flows, impairment is measured based on fair value using a
discounted cash flow methodology. The discount rate utilized by Federated
reflects its weighted average cost of capital. Impairment from changes in
contractual provisions is based on the carrying value of the underlying asset,
or component of the underlying asset when the restrictions change.
Measuring impairment for the customer relationship intangible asset is dependent
upon the level of remaining managed assets for those relationships. A decline in
the remaining managed asset balance in excess of the estimated attrition rate
for those managed assets could have a considerable impact on the underlying
value of the customer relationship intangible asset.
(G) DEFERRED SALES COMMISSIONS
Certain subsidiaries of Federated Investors, Inc. pay commissions to broker/
dealers (deferred sales commissions) to promote investments in certain mutual
funds. For mutual fund shares sold under such marketing programs, Federated
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
Federated a CDSC fee based on a percentage of the lower of the current market
value or the original cost basis of the redeemed shares, such percentage
diminishing over a recovery schedule not to exceed six years.
For non-B Share related sales, the up-front commissions Federated 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. The
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 the deferred sales commission asset.
In the fourth quarter of 1997, Federated entered into an agreement to sell
certain of the future fee revenue streams associated with its existing B Share
deferred sales commissions. This agreement also provided for Federated 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
Consolidated Statements of Income reflect 12b-1 and shareholder service fees
which are included in "Other service fees, net -- Federated funds" as well as
debt expense associated with the nonrecourse debt, amortization of deferred
sales commissions and other program-related expenses.
(H) FOREIGN CURRENCY TRANSACTIONS GAINS AND LOSSES
Federated has a foreign subsidiary, in which the subsidiary's financial
statements are reported in U.S. dollars. Transaction gains and losses are
reflected in the statements of income.
(I) REVENUE RECOGNITION
Revenue is recognized during the period in which the services are performed.
Federated may waive certain fees for services (primarily investment advisory
fees) for competitive reasons, or to meet regulatory requirements.
(J) REPORTING ON ADVERTISING COSTS
Federated expenses the cost of all advertising as incurred.
(K) INCOME TAXES
Federated accounts for income taxes under the liability method which requires
the recognition of deferred tax assets and liabilities for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled.
(L) COMPREHENSIVE INCOME
In 1998, Federated adopted Statement of Financial Accounting 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 is reported within the
Consolidated Statements of Changes in Shareholders' Equity.
(M) STOCK-BASED COMPENSATION
As allowed under the provisions of Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation," (SFAS 123) Federated has
elected to apply Accounting Principles Board Opinion No. 25 (APB 25) "Accounting
for Stock Issued to Employees" and related interpretations in accounting for its
stock-based plans.
(N) RECLASSIFICATION OF PRIOR PERIODS' STATEMENTS
Certain items previously reported have been reclassified to conform with the
current year's presentation.
(O) RECENT ACCOUNTING PRONOUNCEMENTS
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 Jan.
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 development costs were
expensed as incurred. Restatement of prior year financial statements was not
required. In 1998, Federated capitalized $1,396,000 of costs as a result of the
adoption of this pronouncement.
Statement of Position No. 98-5, "Reporting on the Costs of Start-Up Activities,"
(SOP 98-5) was adopted in 1998. SOP 98-5 requires costs of start-up activities
and organization costs to be expensed as incurred. Prior to the adoption of SOP
98-5, these costs were capitalized and expensed over a period of time.
Restatement of previously issued financial statements is not permitted. The
adoption of this pronouncement did not have a material effect on the results of
operations in 1998 as Federated did not incur a significant level of
organization costs, as defined by this pronouncement.
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities," (SFAS 133) requires that all derivatives,
including hedges, be recorded at fair value and that all changes in fair value
or cash flow of both the hedge and the hedged item be recognized in earnings in
the same period. SFAS 133 is effective for years beginning after June 15, 1999,
but companies may early adopt as of the beginning of any fiscal quarter that
begins after June 1998. The adoption of SFAS 133 is not expected to have a
significant effect on earnings or the financial position of Federated based on
the current minimal use of derivatives.
(2) MARKETABLE SECURITIES
A summary of the cost and estimated market value of marketable securities is as
follows:
Estimated
Gross Unrealized Market
(in thousands) Cost Gains (Losses) Value
AVAILABLE-FOR-SALE:
Investments in fluctuating
value mutual funds
Dec. 31, 1998 $ 12,757 $ 719 $ (78) $ 13,398
Dec. 31, 1997 $ 9,076 $ 60 $ (191) $ 8,945
Gross realized gains and (losses) on the sale of marketable securities were
approximately $395,000 and $(690,000); $275,000 and $(226,000); and $3,126,000
and $(475,000), respectively, for the years ended Dec. 31, 1998, 1997 and 1996.
Federated enters into future and currency forward contracts (hedge instruments)
to hedge against market and currency fluctuations related to investments in
mutual funds it sponsors. These investments enable the funds to build a
diversified portfolio and are redeemed as outside investors purchase the funds.
To minimize the risk factors, Federated utilizes hedge instruments which
resemble the investment's portfolio. The hedge instruments are carried at fair
value in "Marketable securities" on the Consolidated Balance Sheets. At Dec. 31,
1998, the futures contracts had maturities of less than one year.
(3) PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
Dec. 31,
(in thousands) 1998 1997
Leasehold improvements $ 17,810 $ 18,187
Computer equipment 32,019 32,988
Office furniture and equipment 12,789 10,508
Transportation equipment 1,881 1,851
Total cost/fair value 64,499 63,534
Accumulated depreciation (42,949) (41,371)
Property and equipment, net $ 21,550 $ 22,163
Depreciation expense was $6,557,000, $7,599,000 and $7,961,000 for the years
ended Dec. 31, 1998, 1997 and 1996, respectively.
(4) INTANGIBLE ASSETS
In 1997, Federated assumed the investment management and distribution
responsibilities for seven retail mutual funds. The acquisition was accounted
for as a purchase for which Federated recorded a customer relationship
intangible asset and paid $13,282,000 in cash.
(5) LONG-TERM DEBT--RECOURSE
Federated's long-term debt--recourse consisted of the following:
Dec. 31,
(in thousands) 1998 1997
Senior Secured Note Purchase Agreement $ 98,000 $ 98,000
Capitalized leases 937 1,230
Total debt 98,937 99,230
Less: current portion 239 280
Total long-term debt -- recourse $ 98,698 $ 98,950
In 1996, Federated obtained a bank Senior Secured Credit Agreement (Senior),
maturing in 2001, consisting of a Revolving Credit Facility and a Term Loan
Facility. Also in 1996, Federated entered into a $98,000,000 Senior Secured Note
Purchase Agreement (Note), maturing in 2006. Pursuant to these agreements,
Federated must meet certain financial and nonfinancial covenants. Federated was
in compliance with all such covenants at both Dec. 31, 1998 and 1997.
The obligations of Federated under the Senior and the Note are secured by
pledges of all the outstanding Common Stock or shares of beneficial interest of
all of the subsidiaries owned by Federated Investors, Inc.
(A) SENIOR SECURED CREDIT AGREEMENT
The Term Loan Facility was fully repaid as of Dec. 31, 1997. The Revolving
Credit Facility is used for general business purposes. Federated pays a
commitment fee of 0.25% on the unused portion of the Revolving Credit
Facility. At Dec. 31, 1998, the outstanding balance was $0, with
availability of $150,000,000.
(B) SENIOR SECURED NOTE PURCHASE AGREEMENT
The Note is due in seven equal annual installments beginning in 2000 and
maturing in 2006. The Note carries a fixed interest rate of 7.96%. Under the
terms of the Note, Federated may prepay the debt at any time, however, a
make-whole amount is required at the time of prepayment.
(C) MATURITIES
The aggregate contractual maturities of the recourse debt for
the years following Dec. 31, 1998, are:
(in thousands)
1999 $ 239
2000 14,258
2001 14,280
2002 14,160
2003 14,000
2004 and thereafter 42,000
Total recourse debt $ 98,937
(6) SECURITIZATION OF B SHARE ASSETS AND NONRECOURSE DEBT
In the fourth quarter of 1997, Federated entered into an agreement 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 a program to sell, on a continuous
basis for a three-year period, the future rights associated with future 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.
In the fourth quarter of 1997, Federated exchanged its rights to certain future
cash flows associated with net deferred sales commission assets with a remaining
book value of $88,738,000 for $110,214,000 in cash. Two special purpose entities
(SPEs) were established for the purpose of the initial transaction. A bankruptcy
remote SPE was formed by Federated to purchase the rights to the future cash
flows from a subsidiary, which in turn sold these future cash flows to a
third-party SPE. The third-party SPE funded this purchase by issuing Class A and
Class B notes.
The cash flows of the related B Share assets will be used by the third-party SPE
to first pay trustee fees and other program-related expenses. After these fees
are paid, interest and principal are paid in the following succession: Class A
interest, Class B interest, Class A principal and Class B principal (only upon
full payment of Class A principal). Any residual cash flow after full payment of
all principal on the notes will be paid 90% to Federated and 10% to the holders
of the Class B notes. As a result of Federated's 90% residual interest in the
third-party SPE cash flows, this SPE is a consolidated subsidiary of Federated.
The debt of this SPE is nonrecourse debt to Federated in the event the future
cash flows associated with the rights sold do not cover the full obligation of
the notes.
The outstanding balance of the Class A and Class B notes at Dec. 31
were as follows:
(in thousands) 1998 1997
Class A $ 74,251 $ 97,873
Class B 9,700 9,700
The Class A and Class B notes carry fixed interest rates of 7.44% and 9.80%,
respectively.
Also in the fourth quarter of 1997 and in calendar year 1998, Federated
exchanged additional net deferred sales commission assets with a remaining book
value of $79,190,000 and $139,961,000, respectively, for $81,056,000 and
$143,396,000, respectively, in cash. Additional third-party SPEs were formed,
however, these entities are not consolidated on Federated's financial statements
as a result of Federated having less than a 50% residual interest in these
third-party SPEs' cash flows. These transactions were accounted for as
financings, and the nonrecourse debt has been recorded with imputed interest
rates based on current market conditions at the time of issuance ranging from
6.7% to 7.6%. Cash flows associated with these B Share assets will be applied by
the third-party SPEs in the following succession: fees and other program-related
expenses, interest and principal. Federated will participate in varying levels
of any residual cash flow after full payment of program obligations. The
outstanding balance of this nonrecourse debt was $188,899,000 and $77,815,000 as
of Dec. 31, 1998 and 1997, respectively. The nonrecourse debt does not contain a
contractual maturity but is amortized dependent upon the cash flows of the
related B Share assets.
The third party has agreed into the fourth quarter of 2000 to purchase, on a
semimonthly basis, the rights associated with certain future revenue streams of
B Shares sold.
(7) EMPLOYEE BENEFIT PLANS
(A) 401(K)/PROFIT SHARING PLAN
The employees of Federated participate in a 401(k)/Profit Sharing Plan.
Federated offers a 401(k) plan covering substantially all employees. Under the
401(k) plan, employees can make contributions at a rate of 1% to 15% of their
compensation (as defined in the 401(k) plan), subject to Internal Revenue Code
limitations. Federated makes a matching contribution in an amount equal to 100%
of a participant's first 2% of contributions and 50% of the next 4% of
contributions. Forfeitures of nonvested matching contributions are used to
offset future matching contributions.
In order to vest in Federated's matching contributions, a participant in the
401(k) plan must be employed at least three years and work at least 1,000 hours
per year. Upon completion of three years of service, 20% of a participant's
balance vests and 20% vests for each of the following four years, if the
participant works 1,000 hours per year. Employees are immediately vested in
their 401(k) salary reduction contributions.
Matching contributions to the 401(k) plan amounted to $2,976,000, $2,537,000 and
$2,596,000, for the years ended Dec. 31, 1998, 1997 and 1996, respectively.
An employee of Federated becomes eligible to participate in the Profit Sharing
Plan upon the first day of employment. The Profit Sharing Plan is a defined
contribution plan to which Federated contributes amounts as authorized by its
board of directors. An employee will receive a portion of Federated's
contribution upon completion of 500 hours of service and if employed on the last
day of the plan year. No contributions have been made to the Profit Sharing Plan
in 1998, 1997 and 1996.
(B) EMPLOYEE STOCK PURCHASE PLAN
In July 1998, Federated established an Employee Stock Purchase Plan which allows
employees to purchase a maximum of 500,000 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 or may be shares purchased on the open
market. In 1998, 3,732 shares were purchased by the plan on the open market.
(8) OTHER COMPENSATION PLANS
(A) DEFERRED COMPENSATION PLANS
In 1997, a deferred compensation arrangement was established for a group of key
employees for the purpose of providing incentives to certain individuals who
contribute to the success of Federated. Each annual award provided under this
program is deferred until 2001, with the vesting period beginning in 1997.
Termination of employment for any reason other than death, disability or
retirement prior to the plan's vesting date of the third quarter 2001 causes the
participant's benefit to be forfeited. The liability at Dec. 31, 1998 was
$316,000 and is included in "Other long-term liabilities" on the Consolidated
Balance Sheets. Amounts included in "Compensation and related" expense on the
Consolidated Statements of Income were $232,000 and $71,000 for the years ended
Dec.
31, 1998 and 1997, respectively.
(B) EMPLOYEE RESTRICTED STOCK PLAN
Under the Employee Restricted Stock Plan, Federated has sold to certain key
employees, subject to restrictions, shares of Class B Common Stock. During the
restricted period, the recipient receives dividends on the shares. The
compensation cost to Federated (the difference between the estimated fair value
of the stock and the amount paid by the key employees at issuance) is expensed
over the period of employee performance during which the restrictions lapse, not
to exceed 10 years. In 1998, 1997 and 1996, 0, 75,000 and 0 shares,
respectively, of Class B Common Stock were sold under the Employee Restricted
Stock Plan. Forfeitures of 139,000, 612,000 and 132,000 shares occurred in 1998,
1997 and 1996, respectively. For the years ended Dec. 31, 1998, 1997 and 1996,
compensation expense related to the Employee Restricted Stock Plan was $512,000,
$28,000 and $2,183,000, respectively.
(C) STOCK OPTIONS
Stock options are part of the Stock Incentive Plan offered by Federated to
reward employees and independent directors who have contributed to the success
of Federated and to provide incentive to increase their efforts on behalf of
Federated.
In the first quarter of 1996, 2,997,000 SAR Plan rights were converted to stock
options. In 1997, 1,683,000 stock options were granted to a group of key
employees. In 1998, the remaining 48,000 SAR Plan rights were converted to stock
options, 300,000 employee stock options were granted and 10,000 options were
awarded to independent directors. The weighted-average grant date fair value of
the options granted in 1998 was $4.86 per option. In the event the independent
appraisals (prior to the public registration of Federated's Class B Common Stock
in May 1998) or market value of the Class B Common Stock exceeds the exercise
price of the options at the time of issuance, the difference is charged to
compensation expense over the vesting period. For existing plans, vesting occurs
over a 1- to 10-year period and may be accelerated as a result of meeting
specific performance criteria. Each vested option may be exercised, during the
stated exercise period, for the purchase of one share of Class B Common Stock at
the exercise price.
For the years ended Dec. 31, 1998, 1997 and 1996, compensation expense related
to the stock options was $(57,000), $231,000 and $365,000, respectively.
The following table summarizes the status of and changes in Federated's stock
option plan during the past three years:
Weighted- Weighted-
Average Average
Exercise Options Exercise
Options Price Exercisable Price
Outstanding at
beginning of 1996 0 $0.00 0 $0.00
Granted 2,997,000 1.91
Exercised 0 0.00
Forfeited (264,000) 1.91
Outstanding at
end of 1996 2,733,000 1.91 0 0.00
Granted 1,683,000 5.53
Exercised 0 0
Forfeited (397,200) 1.91
Outstanding at
end of 1997 4,018,800 3.43 0 0.00
Granted 358,000 8.58
Exercised (300,000) 3.33
Forfeited (249,450) 3.13
Outstanding at
end of 1998 3,827,350 $3.94 0 $0.00
Additional information regarding stock options outstanding at Dec. 31, 1998,
follows:
Weighted-
Average
Weighted- Remaining Weighted-
Range of Average Contractual Average
Exercise Exercise Life Exercise
Prices Outstanding Price (in Years) Exercisable Price
$1.91 to $1.93 2,208,600 $ 1.92 6.8 0 $0.00
$6.00 to $9.30 1,608,750 6.62 8.7 0 0.00
$19.00 10,000 19.00 9.7 0 0.00
3,827,350 $ 3.94 7.6 0 $0.00
(D) PRO FORMA NET INCOME
Federated accounts for stock options and employee restricted stock in accordance
with APB 25. The following pro forma information regarding net income assumes
the adoption of SFAS 123 for stock options and employee restricted stock granted
subsequent to Dec. 31, 1994. The estimated fair value of the options is
amortized to expense over the option's vesting period. For stock options and
employee restricted stock granted prior to Federated's initial public offering,
the fair value was estimated at the date of grant using the Minimum Value option
pricing model with the following weighted-average assumptions for 1998:
a risk-free interest rate of 5.72%; a dividend yield of 1.6%; and an expected
life of 9.5 years. The estimated fair value of the restricted stock is expensed
over the vesting period. The fair value was based on the estimated market price
on the grant date. For stock options granted after Federated's initial public
offering, Federated estimated the grant-date fair value using the Black-Scholes
option-pricing model with the following weighted-average assumptions: dividend
yield of 0.89%; expected volatility of 29.6%; risk-free interest rate of 4.63%
and expected lives of 5.5 years. The pro forma results are estimates of
statements of income as if compensation expense had been recognized for all
stock-based compensation plans and are not indicative of the impact on future
periods.
Year Ended Dec. 31,
1998 1997 1996
Pro forma net income
(in thousands) $ 92,235 $ 50,501 $ 12,630
Pro forma basic earnings
per common share $ 1.10 $ 0.61 $ 0.12
Pro forma diluted earnings
per common share $ 1.07 $ 0.60 $ 0.12
(9) MINORITY INTEREST IN SUBSIDIARY
A subsidiary of Federated Investors, Inc. has a majority interest (50.5%) and
acts as the general partner in Passport Research, Ltd., a limited partnership.
Edward Jones is the limited partner with a 49.5% interest. The partnership acts
as investment adviser to two registered investment companies.
(10) COMMON STOCK
On May 19, 1998, Federated Investors was merged with and into Federated
Investors, Inc., its wholly owned subsidiary, with Federated Investors, Inc.
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 Federated Investors, Inc.,
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, Federated Investors,
Inc. 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 Dec.
31, 1998, 6,000 and 86,198,250 shares of Class A and Class B Common Stock were
outstanding, respectively.
The holders of the Class A Common Stock have the entire voting rights of
Federated; however, without the consent of the majority of the holders of the
Class B Common Stock, Class A Common Stock shareholders cannot alter Federated's
structure, dispose of all or substantially all of Federated's assets, amend the
Articles of Incorporation or Bylaws of Federated to adversely affect the Class B
Common Stock shareholders, or liquidate or dissolve Federated.
Federated's Senior Secured Credit Agreement allows dividends in an amount not to
exceed $20 million plus 50% of any net income (less 100% of any loss) of
Federated during the period from Jan. 1, 1998, to and including the date of
payment. The Senior Secured Note Purchase Agreement allows dividends to an
amount of $5,000,000 plus 50% of any net income (less 100% of any loss) of
Federated during the period from Jan. 1, 1996, to and including the date of
payment. As of Dec. 31, 1998, approximately $54.7 million was available to pay
dividends under the more restrictive of the two limitations. Cash dividends of
$0.135, $0.0583 and $0.0417 per share, or $11,480,000, $4,867,000 and $3,498,000
were paid in 1998, 1997 and 1996, respectively, to holders of shares of Common
Stock.
In 1996, Federated Investors entered into an agreement to convert 1,000 shares
of Series A Preferred Stock into 5,302,758 shares of Class B Common Stock and to
buy the converted shares back for $19.09 per share, or $101,233,000. Also in
1996, Federated Investors purchased 1,180,000 shares of Class B Common Stock
from existing shareholders at $19.00 per share for a total of $22,420,000. The
repurchased shares were recorded as Treasury Stock at cost.
(11) LEASES
Federated has various operating lease agreements primarily involving facilities,
office and computer equipment, and vehicles. These leases are noncancellable and
expire on various dates through the year 2007.
The following is a schedule by year of future minimum rental payments required
under the operating leases that have initial or remaining noncancellable lease
terms in excess of one year as of Dec. 31, 1998:
(in thousands)
1999 $ 16,018
2000 13,749
2001 11,446
2002 11,259
2003 11,162
2004 and thereafter 47,937
Total minimum lease payments $ 111,571
Rent expense was approximately $18,204,000, $14,293,000 and $14,674,000 for the
years ended Dec. 31, 1998, 1997 and 1996, respectively.
(12) INCOME TAXES
Federated files a consolidated federal income tax return. Financial statement
tax expense is determined under the liability method.
Income tax expense (benefit) consisted of the following:
Year Ended Dec. 31,
(in thousands) 1998 1997 1996
CURRENT
Federal $ 49,948 $ 19,597 $ (6,672)
State 494 243 514
50,442 19,840 (6,158)
DEFERRED
Federal 3,123 11,117 17,088
Extraordinary item 0 (241) (530)
Total $ 53,565 $ 30,716 $ 10,400
For the years ended Dec. 31, 1998, 1997 and 1996, the foreign subsidiary had net
operating income (losses) of $4,224,000, $1,449,000 and $(257,000),
respectively, for which an income tax expense of $1,478,000, $0 and $0,
respectively, had been provided.
The reconciliation between the federal statutory income tax rate and Federated's
effective income tax rate consisted of the following:
Year Ended Dec. 31,
1998 1997 1996
Expected statutory rate 35.0% 35.0% 35.0%
Increase:
State income taxes 0.2 0.2 1.4
Amortization of goodwill 0.5 1.0 3.2
Meals and entertainment
limitation 0.8 1.2 4.6
Other 0.2 0.4 0.3
Total 36.7% 37.8% 44.5%
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities consisted of the following:
Dec. 31,
(in thousands) 1998 1997
DEFERRED TAX ASSETS
Intangible assets $ 15,419 $ 14,946
Organization costs 1,399 1,399
Employee restricted stock plan 223 170
Property and equipment depreciation 164 0
Reserve for bad debts 926 1,068
Other 1,133 246
Total gross deferred tax asset $ 19,264 $ 17,829
DEFERRED TAX LIABILITIES
Deferred sales commissions $ 33,718 $ 41,753
Deferred 12b-1 fee income 12,252 0
Other 3,243 2,622
Total gross deferred tax liability $ 49,213 $ 44,375
Net deferred tax liability $ 29,949 $ 26,546
(13) EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
Year Ended Dec. 31,
(in thousands, except per share data) 1998 1997 1996
NUMERATOR
Income from continuing operations $ 92,369 $ 50,577 $ 12,619
Preferred stock dividends 0 0 3,025
Numerator for basic and diluted earnings
per share for continuing operations --
income available to common stockholders $ 92,369 $ 50,577 $ 9,594
DENOMINATOR
Denominator for basic earnings per share --
weighted-average shares 84,171 82,392 83,159
Effect of dilutive securities:
Dilutive potential common shares from
stock-based compensation 2,412 1,272 591
Denominator for diluted earnings per
share -- adjusted weighted-average
shares and assumed conversions 86,583 83,664 83,750
Basic earnings per share $ 1.10 $ 0.61 $ 0.12
Diluted earnings per share $ 1.07 $ 0.60 $ 0.12
(14) ACCUMULATED OTHER COMPREHENSIVE INCOME
The components of accumulated other comprehensive income are as follows:
Unrealized
Gain/(Loss)
on Tax
Marketable Other (Expense)/
(in thousands) Securities Adjustments Benefit Total
Balance at
Dec. 31, 1995 $ 960 $ 2 $(336) $ 626
Total change in market value (430) 0 151 (279)
Reclassification adjustment (492) 0 172 (320)
Other adjustments 0 (12) 0 (12)
Balance at
Dec. 31, 1996 38 (10) (13) 15
Total change in market value (253) 0 89 (164)
Reclassification adjustment 84 0 (30) 54
Other adjustments 0 4 0 4
Balance at
Dec. 31, 1997 (131) (6) 46 (91)
Total change in market value 604 0 (211) 393
Reclassification adjustment 168 0 (59) 109
Other adjustments 0 (5) 0 (5)
Balance at
Dec. 31, 1998 $ 641 $(11) $(224) $406
(15) DISCLOSURES OF FAIR VALUE
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments," requires disclosure of estimated fair values of
certain on- and off-balance sheet financial instruments. The fair value
estimates, as well as the related methods and assumptions used to value each of
Federated's significant financial instruments, are set forth below.
(A) CASH AND CASH EQUIVALENTS AND MARKETABLE SECURITIES
The carrying amount of cash and cash equivalents approximates fair value due to
the short maturities of these instruments. The fair value of marketable
securities is based on quoted market prices.
(B) RECEIVABLES, ACCOUNTS PAYABLE, AND ACCRUED EXPENSES
The carrying amounts of these financial instruments approximate fair value due
to the short maturities of these instruments.
(C) LONG-TERM DEBT --RECOURSE
The majority of Federated's recourse debt is comprised of the Note. The fair
value of Federated's Note is estimated based on the current market rates for
debt of the same remaining maturities. The estimated fair values of the Note are
as follows:
Dec. 31,
(in thousands) 1998 1997
Carrying amount $ 98,000 $ 98,000
Fair value $ 102,519 $ 100,035
For accounting purposes, Federated treats the sale of revenue streams related to
the B Share financing program as nonrecourse debt. Based on the nature of this
debt and the uncertainty of the amounts and timing of the cash flows, Federated
is not able to determine the fair value of the nonrecourse debt.
(D) FUTURES AND CURRENCY FORWARD CONTRACTS
Federated entered into futures and currency forward contracts to hedge against
changes in market and currency values related to the shares of mutual funds it
purchased. Federated's carrying value of $389,000 approximates the estimated
fair value at Dec. 31, 1998.
(16) ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED
OR OBTAINED FOR INTERNAL USE
The effect of adopting SOP 98-1 was to increase operating income for the year
ended Dec. 31, 1998 by $1,381,000, or $0.016 per diluted share.
(17) COMMITMENTS AND CONTINGENCIES
Federated has claims asserted against it that result from litigation in the
ordinary course of business. Management believes that the ultimate resolution of
such matters will not materially affect the financial position or results of
operations of Federated.
(18) RELATED PARTY TRANSACTIONS
Federated provides investment advisory, administrative, distribution and
shareholder services to the Federated group of funds (Federated funds). All of
these services provided for the Federated funds are under contracts that
definitively set forth the fees to be charged for these services and are
approved by the funds' independent directors/trustees. Federated may waive
certain fees charged for these services (primarily investment advisory fees) in
order to make the Federated funds more competitive or to meet regulatory
requirements.
(19) SUBSEQUENT EVENTS
In January 1999, Federated issued 750,000 options to certain key employees at an
exercise price at or exceeding the market price at the time of grant. The
contractual life of the options range from 9.5 to 10.5 years.
On Jan. 26, 1999, the board of directors declared a $0.038 per share dividend
which was paid on Feb. 15, 1999.
On Jan. 26, 1999, the board of directors approved a share repurchase program
authorizing Federated to purchase up to $20 million in Federated Class B Common
Stock over the next 12 months. The program authorizes executive management to
make purchases in open market transactions, with the timing of the purchases and
the amount of shares to be determined by the Federated executive management
team. The stock will be held in treasury for employee benefit plans, potential
acquisitions and other corporate activities.
(20) SUPPLEMENTARY QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarter
(in thousands, except per share data) 1st 2nd 3rd 4th
1998
Revenues $122,592 $126,216 $133,068 $140,250
Net income before extraordinary item 20,837 21,071 23,610 26,850
Net income 20,837 21,071 23,610 26,850
Basic earnings per share before
extraordinary item 0.25 0.25 0.28 0.32
Diluted earnings per share before
extraordinary item 0.25 0.24 0.27 0.31
Common Stock price per share1
High -- 20 3/16 18 1/4 19 5/16
Low -- 16 12 7/8 11
1997
Revenues 91,627 93,457 106,560 112,073
Net income before extraordinary item 8,843 9,090 16,009 17,083
Net income 8,843 9,090 16,009 16,634
Basic earnings per share before
extraordinary item 0.11 0.11 0.19 0.20
Diluted earnings per share before
extraordinary item 0.11 0.11 0.19 0.20
Common Stock price per share1
High -- -- -- --
Low -- -- -- --
1 Prior to May 14, 1998, there was no public market for the Common Stock.