Federated Hermes Inc (FHI) 2002 Q1 法說會逐字稿

Good afternoon. My name is Chris. I will be your conference facilitator today. I would like to welcome everyone to the Federated Investors Earnings conference call. All lines are have been placed on mute. After the speakers remarks, there will be a question and answer period. To ask a question during this time, press star, then the number one on your telephone keypad, and questions will be taken in the order they are received. To withdraw your question, press the pound key. Mr. Handily, you may begin.

Thank you and welcome to the call. My way of disclosure, the discussion will including forward-looking statements and actual results may vary materially. For a discussion of the factors that could cause results to vary, see the section titled "risk factors" in the company's registration statement and in the annual report on form 10K for the year-ended December 31st, 2001 on file with the Securities and Exchange Commission. We plan today about a 20-minute presentation before getting to your questions. With us today are Christopher Donahue, Federated's CEO, Thomas Donahue, Chief Financial Officer, Dennis Mcauley and Richard Novak from the Corporate Finance Group. And with that, I turn it over to Chris to talk about another quarter of growth for federated.

Thanks, Ray. Good afternoon and welcome to our fellow shareholders, analysts, media representatives on the call today. The 1st quarter was another period of strong growth for Federated. As noted in the press release, Federated's managed assets reached the highest level ever, $194 billion, year to date. We have had asset growth in all categories and are experiencing positive equity flows in a variety of products. Our fixed income flows remain strongly positive and have begun to manage our largest separate account win, the $13 billion text wool account we discussed last quarter. Looking at each as [INAUDIBLE] class in more detail: Money market average assets in both funds and separate accounts show growth of about $6 billion during Q1, compared to the prior quarter. We started the year with $136 billion in money market fund average assets, averaged $139 billion during the quarter, and ended the quarter at $132 billion. Money market assets stood at $148.5 billion on April 22nd. As I have often commented, money market asset levels will bounce around because they reflect the underlying customer's use of these products as an important cash management service. An example of that is on the last trading day of the quarter, withdrawals from money funds of about $7 billion occurred. In addition to typical quarter end activity, we had a large corporate customer withdrawal about $2 billion for acquisition purposes. Attractive rates in the direct market over the long weekend at quarter-end likely had some impact, as well. Now, so far this month even with April 15th tax withdrawals, we've had net in-flows of about $4 billion. We continue to expand our cash management relationships. In addition to text pool, we added 14 new accounts in the corporate area during the 1st quarter. These accounts had funded balances of about $300 million at quarter end. Also, we passed the $1 billion market in money market fund assets from commodities, future trading commission-related customers, and item REV introduced and [INAUDIBLE] made previous quarters. Turning to the other asset categories, 1st quarter equity fund net sales improved to over $250 million from the prior quarter level of minus $123 million. Gross sales were up 20% and redemptions were down 8% for the quarter. The net in-flows were driven by sales of products in multiple styles area, blend, growth, and value. Our top-selling equity products for the quarter were Federated Capital Depreciation Fund, a highly-rated blend fund with a 25-year history. The Federated Kofman Fund recently cited as the number one ranked multi-cap growth fund by Lipper for the one-year and [INAUDIBLE] year periods, Federated stock trust, a large cap value Fund with a 20-year record, and our 12-month-old market opportunity fund which recently crossed the $200 million number. On the bond side, assets increased 19% over the last 12 months and 6% for the quarter. Gross bond fund sales of $3.2 billion and net sales of just over $1 billion remain strong. Flows were positive in all bond fund categories led by government, corporate and [INAUDIBLE]. We continue to see strong demand for ultra short and short duration fund products in these areas. High-yield funds and our total return and strategic income blended funds were solidly positive for the quarter. In the first three weeks of April, flows in equity and bond funds have remained positive with a bit of a shift toward equities. As always though, we caution against drawing hard conclusions from early returns in the quarter from a performance standpoint as of the end of the year. From funds rated by Morning Star, almost 80% of our equity assets and 2/3 of our bond assets were in funds rated 3, 4 and 5 stars. 40% of equity and bond assets were in 4 and 5 star funds. This means that Federated has 41 funds rated 4 or 5 stars, about 1/3 of those equity and 2/3 of them bond funds. Let's talk about distribution. The combined stock and bond fund sales during the 1st quarter of $4.7 billion are just about equal to the Q1 '00 total, which was an all-time high in the industry and at Federated. Compared to the prior quarter, equity funds sales increase made each channel with the largest increase in the trust channel up 35%, the broker dealer channel up 26%. Bond Fund sales also increase made each channel with the institutional market showing a 15% increase from Q4, '01. In the trust channel, we continue to make gains in bank retirement programs. We continue to have good success both in placing our funds into bank programs and in selling our bundled solutions to banks to offer to their customers. For example, we've had recent success in a number of very large banks, Wells-Fargo, U.S. Bancorp, Wachovia, that have selected the Federated Capital Depreciation Fund as a core equity option in the retirement plans that they offer to their customers. We're also having success at placing our products into the bank's rap or private banking products for high net worth individuals. As in the retirement applications, our [INAUDIBLE] equity and core fixed income total return products are well-suited for these programs and are being added by some of the top banks in the country as they continue to develop open architecture-type products. Let's turn to the broker dealer market where we continued to have success distributing the Federated Kofman Fund. In the first year since the acquisition, we have added $500 million in new assets to the new share classes that have been structured for intermediaries. Q1 gross sales were up 29% and net sales nearly doubled from the prior quarter. Currently we are running at nearly $100 million per month in gross sales. The fund is nearing the $4 billion mark compared to the $3.2 billion a year ago. And Edward Jones, we continue our strong cash management RIM and believe we are commissioned to make excellent progress this year on the equity and fixed income side. Our market share, there is about 4% of mutual fund sales with a target this year of 7%. In our institutional channel, in addition to text pool account that's now in place, we are preparing for cash management from the state of Florida Employee Retirement Plan that will launch during the second half of the year. In the investment advisor segment, we continue to have success developing new distribution opportunities. During the 1st quarter, the Capital Depreciation Fund was selected by two registered investment advisors as part of their core portfolios, resulting in initial allocations of $70 million. Obviously we're exploring other product auctions with them, as well. Now, briefly, an update on some other key initiatives. We've launched our new account -- managed account product that's been structured for accounts between $100,000 and $10 million. Our first new accounts, amounting to about $10 million have been funded, and we are concentrating expanding our distribution into the major programs. In the broker/dealer, we are continuing to move towards a major relaunch of our broker deal variable annuitiy product this quarter with our new insurance wrap provider nationwide. We also plan to add a variable annuitiy version of the Federated Kofman Fund, our offering later this year. On the international front, our newly-added London-based wholesaler is in place, and we look to grow assets from multi-national banks and other organizations that can use our liquidity and other fund products. We continue to develop additional distribution opportunities in Germany and to look for partners in other countries. Next we are developing a 529 plan product offering in partnership with the School House Capital State Street Project that we expect to launch during the second half of the year. We also continue to compete for large separate accounts coming off a string of big wins last year with the addition of the text pool assets. Federated now manages $20 billion in separate accounts [INAUDIBLE] that brief review. I'v asked Tom to comment on the financials.

Thank you, Chris. Our financial results as Chris mentioned were very strong, once again, in the 1st quarter. As I comment on these results, my comparisons to the prior year's period will take into account the changes from our B-share program and the changes in the accounting treatment for goodwill in order to have a proper comparison to the current period results. These adjustments to last year's results are covered in the press release. As indicated [INAUDIBLE] today's release, we have reclassified our income statement to present a clear picture of operating and non-operating results. The press release includes reclassified income statements from prior periods for your reference. Now looking at the Q1 results, investment advisory fees grew 20% year-over-year, due mainly to increases in money funds and the addition of the Federated Kofman Fund last April. And to a lesser extent, growth in fixed income assets. These gains were partially offset by decreases in equity asset revenue [INAUDIBLE]. The sequential [INAUDIBLE] due largely to growth in money fund average assets. In addition, lower fees paid by the funds for SEC registration resulted in a decrease in waiver investment advisory fees for benefit of about $1.4 million. These increases were partially offset by the impact of two fewer days in Q1 versus Q4. Administrative service fees increased year-over-year and sequentially, due to the growth and money market fund assets, and to the Federated Kofman Fund. As we mentioned last quarter, administrative service fees will be impacted over the second half of 2002 by the internalization of the $9 billion Wachovia Funds administrative business as a rule of their acquisition by First Union. -- result of their acquisition by First Union. Other service fees increased from B-share adjusted Q1, 2001 due to the Kofman Fund acquisition and decreased from adjusted Q4, mainly to less days in Q1. On the expense side, compensation and related increased year-over-year due largely to the addition of the Kofman team. Compensation increased from the prior quarter due to resetting of incentive pay accruals for 2002 and to seasonal factors that impact payroll taxes and benefit expense. With GNA, systems and communications expense decreased year-over-year and sequentially due to temporarily lower usage and credit. We expect that for the full year, these expenses will be comparable to last year's totals. Professional service fees decreased from both periods due mainly to lower usage of service and to non-recurring expenses in 2001. Advertising and promotional expense increased year-over-year and for sequential quarters due to higher marking allowance, expenses related to asset and sales growth. Amortization of intangible assets increased compared to the prior year due to the Kofman Fund. The decrease from the prior quarter was due mainly to the change in treatment of goodwill. For Q1, our operating margin was 47.2% compared to 43.7% for the full year 2001. About 1% of this change is due to the impact of the change in the treatment for goodwill and about a half percent is due to the SEC fee adjustment. Also boosting margins is asset growth, including the Federated Kofman Fund and discipline expense management at Federated. As we said before, our goal is to gradually increase margins year-over-year, impacted of course by market conditions. Quickly on the balance sheet, the increase in intangible assets is from the provision for the first earn-out payment expected to be made in May by the Kofman Fund acquisition. In summary, the 1st quarter saw strong top-line growth of 18% and earnings growth of 26%. With these results and our ongoing share repurchases and the increase in our dividend, we continue to produce exceptional shareholder value, Federated continues to be a franchise for all seasons. We will now open up the call to questions.

At this time, I would like to remind everyone in order to ask a question, press star, then the number one on your touch-tone phone. We will pause for a moment for your first question. Our first question from William Katz of Merrill Lynch.

Thank you. Good afternoon everybody.

Hi, Bill.

Two -- two questions. First one is a little more broader. Chris, you talked a lot about a lot of multiple initiatives here that seem like they're gaining traction. I'm curious if you might document the push/pull you see in terms of volumes versus margins going forward? And maybe what kind of magnitude are you talking about in terms of the future exchange? How big can Kofman get? What's your initial expectations for the state of Florida, which seems like it's coming on stream in the early part of 3rd quarter. I will come back with a follow-up.

You want Kofman, the Florida and the three initiatives?

Well, the broader question is, you know, it sounds like a lot of good things going on across, you know, multiple products, multiple distribution channels. I understand the gradual improvements in margins, but what about the timing of a pickup in flows versus a slow down in the incremental change in the margins and so forth?

On Florida, it is hard to say how much we will get because people have to make individual choices. It's $100 billion pool and they will open it up and people are -- in Florida are allowed to stay in the defined benefit part of it or move into the choice part of it. We don't know how much they will get. Naturally we hope to get $1 billion. We are one of two eligible cash management alternatives and if a bunch of that money moves, you know, we -- we feel that, you know, with should be able to get a billion dollars. Those fees are -- are not very high in terms of comparison to other money market mutual fund product. But on the other hand, they are very competitive at that level for that kind of money. And so we feel those are profitable accounts and I don't think they will cause our profit margins to deteriorate. On the CFTC, that's regular money added to regular funds, so that will be very much regular [INAUDIBLE] money which would probably modestly help margins. How much you get there, you know, we've seen various numbers. Maybe they're as much as $90 million, others have said $60 billion. We have $1 billion of it now. There are five or six players eligible to participate in this, and it requires a lot of steady work and sales at several levels as you have to get the commission and then the trading board approval and then the individual firm approval. But we're working hard on those as we speak and would expect that one to grow. On the wrap accounts this year, we have said that we expect to get a $300 million and then have that grow to billions. The margins on that business from our perspective would be less than our -- our regular -- regular broker dealer business. And if we're going going to get $300 million this year, obviously that's not going to be an enhancement to margins for this year, but that's obviously one built off into the future. As regards to the 529 plan and the variable annuitiy, the variable annuitiy is basically from an industry perspective, about 15% of the total of -- of the industry. And so we're looking to grow it to where it becomes that kind of a participation inside the Federated distribution. And since that's coming under regular products, regularly built into the [INAUDIBLE] annuitiy, that would be probably an enhancement to margins because those -- those monies come into RG funds. And on the 529 plans, those things are about a single digit percentage of the industry, and it's a good product and we're enthusiastic I don't have a firm grasp on what we think the margin movement will be there. I'm not sure on the product configuration we're going to have and how we're going handle the average account size there. I would leave that open at this point. And I think I did them all.

Last one is the Kofman Fund which Chris said we had about $500 million in new sales, and so, we bought it at -- we purchased it with 3.2 billion. It has about 3.85 billion now and if we continue at the pace where we're going, it will have a better growth this year -- this coming year than it did in the previous full year of owning it. But, you know, so it's the growth there and what's going happen to the [INAUDIBLE] of it?

Bill, on Kofman, what I would mention is that, you know, that fund used to be over $6 million. Our desire is to return it to its former position. That's what we're trying to do. That's why I've mentioned we got the sales up to the pace of $100 million a month, and so you know, that's -- that's what we're working for there. And the margin impact of adding money to the Kofman Fund is pretty good.

I'm curious. I wonder if it's more of a rising tied or is there an active market share gain going on? What do you attribute the success in terms of the incremental pickups here in each one of your distribution channels? I'm sure there is a broad phenomenon going on here in terms of the marketar capture.

The [INAUDIBLE] is really having the balanced franchise in each of those areas. Because you have the money funds and have good product in equity and fixed in each one of those areas, you are able to solve problems, deal with, grow with, develop relationships with clients, that enable us to continue doing what we're doing. On a broad base, without picking through each one of the distribution channels, that's how I would characterize it.

My question is, on the business with Wachovia, I'm curious, of the $9 million, what's the incremental margin or the earnings impact from them and what's the official timing of it?

Bill, the timing -- it should happen before the end of the 2nd quarter. For margin impact it would be a drag on the margin. We have not [INAUDIBLE] that particular relationship, and we won't isolate that one. If you recall last quarter, we batched it in with other changes to the business and said that we anticipated about 1 cent less per quarter in earnings and the change in that Wachovia business would have been a part of that. You know, we did pick up a new relationship at the beginning of the year for administrative business with the Huntington Bank. We talked about that last time time. And this is a large administrative relationship, obviously the cost adjusts to that to some degree. Both, for example, some of the things that are built in like portfolio accounting charges, so, some of that will just come automatically and reduce some of the drag on the margins.

Your next question is from Steven Schwartz of Raymond James.

Good morning, guys.

Good afternoon.

Yeah, it is afternoon, isn't it? The question that I had, Chris, it sounds like the monies that left the money market funds, that -- that -- at year end, I mean kind of last-minute money outs, that was primarily corporate, would that be accurate?

I think you mean a quarter in, Steve, and yes, it would be, by and large, a [INAUDIBLE] it is corporate. Obviously the -- the client that was doing the acquisition was a corporate client.

There were also some companies that -- where it actually came from a bank, but from knowing the account underneath it was a company.

What I'd like get to [INAUDIBLE] kind of that where are we know if you were to look at end-user institutional versus retail?

Those proportions haven't changed much. We had a decrease in the 1st quarter from retail that was happening underneath -- that happened relatively early in the quarter. Some of that is late money that comes in at the end of the year that comes in every year that we know goes back out and that it happened again. Then we have the activity at quarter-end that was very specific to these corporations and also to some money that would have moved to go after higher rates that were available over the last -- long weekend at the end of the quarter. But we -- we've had a decent portion of that come back in and so the proportion ease an overall basis, Steve, really haven't changed much at all.

And is there any indication -- that was my question. That's what I wanted to know, anyway.

We also, to have net in-flows, after the April 15th tax payments, typically that's been a down period and usually takes longer than any to recover from that. So, we -- we feel good about being positive for the month of April.

Okay. Great, thanks.

Your next question is from Mark Constant of Lehman Brothers.

Good afternoon, guys. A couple of things I want to follow-up on. One, the April 15, you say as of this date that effect has passed, as of checks that have been written and take a while to past.

Yes.

You've seen it all by now?

Yes.

And you characterize those flows, I understand the dynamic of the long weekend and everything, but it sounds like you have not seen end-of- the-rate chase outflow. Do you expect that, still?

Well, we have not had it, but don't forget that the Fed continual has -- has indicated, a lack of enthusiasm for increasing rates.

Understood.

Translation: Money stays with the home team.

Yep.

So, when you say do we expect it, I don't expect it right now at all because the rates remain a very good home for the -- I mean our rates remain a very good home for this cash. So you will know when we know when the Feds start stumping up the rates. If they do it slow, we will keep the lion share of the money.

Got it. A couple of things Tom mentioned, I wanted to clarify. The SEC fee waiver? The tax rate? And the accrual for what you're doing for the Kofman earnout? If you can quickly elaborate on the three adjustments there?

The SEC waiver, they -- in the economic recovery pillow passed, all year end, all mutual funds have to pay an SEC registration fee and they lowered the amount from 2.5 basis points to .9 basis points.

I'm trying to get at how much of that was the retro active adjustment?

1.4 million.

Was entirely the retro active adjustment?

Right.

As opposed to the go-forward part?

Right.

And the tax rate and what you did in the Kofman accrual?

Yeah, the Kofman accrual, it's -- they hit their full target, their growth targets so they're paying the full amount. That comes two forms. One form, you know, payment to the -- to the two principles and another form through compensation.

But you started [INAUDIBLE] in compensation, that's what I'm looking for?

We've accrued already in the numbers as though we're going pay and pay the full amount.

Got it. Okay. And lastly, was the tax rate increase?

On the tax rate, Mark, it bumped up a little bit as -- from adjustments to our tax liabilities out of the share on the B-share residual. That's a temporary thing and you ought to look for the rate for the year to be about 36%.

Okay. Okay. All right. And lastly, the -- you get the Morning Star numbers, I know Morning Star is now using a somewhat more rational, more [INAUDIBLE] to their category than the old silly star system, but using the stars on it, still. Have you looked at how that will change the numbers you talked about earlier for your -- your -- you know, how many of your equity and bond funds will fall in the 3, 4, 5 or 4, 5 categories?

We have looked at it and are looking at it currently. I'm not in a position to give you the chapter inverse on how it will change for us. We don't even have the precise definitions of the new groupings yet. The high yield is flopped in with all bond funds. The high yields end up all the 1's and 2's or all the 4's and 5's. Carving them out of the group will enable to us enhance our relative position because we have a decent relative position to the industry on that kind of a number. You know, every one of these other ones need an individual analysis. We suspect we will do okay in it, but I can't give you a precise answer on it.

Okay. Thank you.

Your next question is from Cynthia Mayer of Salomon Smith Barney.

How you doing?

Fine, thanks.

Quick question. I know it's early in the quarter, but the slight shift you said you saw in sales toward equity; is that across all channels?

It's similar to the 1st quarter. It would be weighted toward -- to trust and to [INAUDIBLE] institutional. Although we're seeing better results in broker dealer, but the traditional flows would be trust and institutional.

You're saying more trust and broker dealer than institutional?

No. More trust and institutional-like in the 1st quarter with broker dealer improving.

And are you seeing that in terms of exchanges, too?

As we've gone through before, we don't really see a lot of exchange activity. We tend to -- to have new sales and to have redemptiones. It isn't so much that somebody is in the Federated family of funds as much as their intermediary selected a fund as part of their -- their customers' overall portfolio. Exchange activity has been positive on both the stock and the -- the bond funds, but we would not be a good read for changes in retail investor sentiment.

One of the other reasons for that, Cynthia, is that the vast majority of our business is handled on an ominous basis with with our largest clients. We would see purchases in one fund and sales in another, et cetera, but wouldn't see the underlying account or underlying customer moving from one to the other. So, we really don't have the best finger on the pulse of watching the actual investor move from one type of security to another because that's being handled by our intermediary and we don't get to see the information.

Okay, gotcha. And on the expenses, you said I think this systems is basically in line with last year's. I'm wondering about the other expenses which also seem lower. Are they sustainable at these levels?

Travel, if we go through each of the GNA components, travel was unusually low, 1st quarter tends to be low, but this was lower by usual standards. Look for that to trend back up more normalized. On the office and occupancy we had a -- a tax refund that had some impact there that benefited us in the 1st quarter. So, you should look for that one to go back up toward what it's been before. On professional service fees, that one, probably the 1st quarter is more indicative of a run rate. Obviously, there's [INAUDIBLE] there with outside use of professional services -- variability there were with outside use of professional services, but it should be lower and lower with what we expect.

Okay, great. And just one more question: Are you still seeing, I think you mentioned this before, that you were seeing some people sort of migrate from money market to -- to funds like the Ultra Short Bond Fund? I'm wondering if you're still seeing that migration?

Well, once again, it is tough to say that it is direct migration of watching a customer go from one to another. We do see a continued strong interest on the Ultra Short product and the short duration type product. So that's still the -- probably the largest component of the increase in sales in the -- in the fixed income area. But when you say migration, it's hard us to see migration. We don't see people moving directly from the money fund into the longer cash position, but would be fairly certain that some people are doing that.

Okay, great, thanks.

I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. At this time, there are no further questions.

Okay, well that concludes our call and thank you very much for joining us today.

Thank you for participating in today's Federated Investor's conference call. This call will be available for replay beginning at 4:00 p.m. eastern time, today through 11:59 eastern time Friday, April 26th, 2002. The conference I.D. Number for the replay is 3609042.