Federated Hermes Inc (FHI) 2002 Q4 法說會逐字稿

Good moring, my name is Janice and I will be your conference facilitator for today. At this time, I would like to welcome everyone to the Federated Investors fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star and the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you, Mr. Hanley, you may begin your conference.

Good morning and welcome. Today leading our call will be Chris Donahue, Federated CEO and Tom Donahue, Federated Chief Financial Officer. By way of Safe Harbor let me say that this discussion will include forward-looking statements and actual results could vary materially. For a discussion of the factors which could cause actual results to vary from these forward-looking statements, see the section titled risk factor in the company's annual report on form 10-K for the year ended December 31, 2001, on file with the SEC. Also with us today from the corporate finance group is Rich Novak with that, I will turn it over to Chris.

Thank you, Ray. Good morning and welcome to our fellow shareholders, analysts and media representatives all who joined us today to discuss our results and our plans for the future.

Federated performed with distinction in 2002. The fourth quarter capped another year of growth against a third straight year of difficult equity markets. With the unique business mix that is diversified across and within product types, investment styles and distribution channels, Federated again produced strong results and we believe we remain well-positioned for further growth.

We ended '02 managing $195 billion, up $16 billion for the year and have since passed the $2 billion mark here in '03. I will comment briefly on our performance within each asset class and distribution channel before further addressing our outlook for '03 and beyond. What did I say?

$200 billion.

Yes. In the money market area, assets in Federated's mutual funds and separate accounts increased by about 12 billion in Q4 compared to the prior quarter.

Average assets grew by about two billion Focusing on money market mutual funds, we ended the quarter managing 126 billion. We averaged 136 billion during the quarter and ended the quarter also at 136 billion. Money market fund assets have averaged more than 140 billion so far in January '03. Assets increased throughout the quarter but grew fastest following the Fed easing in November.

While everyone wants to know about the persistency of those assets, this question tends to miss the central element to this portion of our business. And that is that interest rate changes impact the usage of these products on the margin but are simply not the whole story. Federated's business is built on a foundation of providing its customers a cash management service.

Since the Fed eased in November, industry money market funds have increased by about 165 billion, or less than 8%. There is more than $8 trillion in M3 of which about 2.3 trillion is in money market funds. Now, despite a 50-basis point yield advantage, less than 3% of the portion of M3 that was not invested in money market funds moved into funds. The reason: Is that the yield is not the sole factor in driving the choice for cash management alternatives. Customers, especially ours, look much more at the yields, look much more than at just yields as they allocate their cash across various areas.

Over nearly 30 years of leadership in this business, we have developed more than 50 cash management funds and separate account products. We don't take a one-size-fits-all approach that depends on fleatting rate advantages in order to grow. Our products are strictured the way our customers want them, with key attributes including: True daily liquidity at par scaled to successfully transact large trades, strong credit analysis, highly rated funds, portfolios constructed along specific requirements, broad diversification, and pricing options that help them grow their businesses. Our customers want these products offered in a way that makes it easy to transaction their business. They appreciate value-added services and like dealing with a company that understands and supports their business rather than competes for it. Successfully responding to these customer-driven needs gives us a different position in this business than many other firms.

Of course, as with most financial products, market conditions influence demand. Certainly, where rates derived rapidly or sharply, we would see some of the assets moved to direct market alternatives. Some new money on the margin would tend to move to higher-yielding alternatives; however, these shifts are part of the natural ebb and flow of this business and are generally short lived as the funds quickly catch up to the direct market yields.

Turning to the fixed income side, asset growth was strong for the quarter and the year. On a sequential quarter basis, we were up 5% and on a year-over-year basis, up 26%. Gross and net bond fund sales were down in Q4 from the outsized Q3 levels due to lower-grossed sales and net outflows from ultrashort products. Those products are increasingly used as longer-term cash management vehicles, and this accounts for more volatility in our flows compared to other bond fund products and other industry participants.

Spread products, including high-yield, blended and certain corporate bond products had positive flows as did Munis. Munis were driven by the launch by two new closed end funds in December that raised $200 million in their IPO. We expect the issuance of the preferred shares this quarter to take the total for this offering to over 300 million.

Among our equity funds in Q4, we continued to have strong sales and flows in the Federated capital appreciation fund and the Federated Kaufman fund. Flows were negative in value, equity income, global and indexed products. For the first three weeks of January, both equity and bond fund net sales are comfortably positive, but as usual, we caution against drawing conclusions for this this kind of data for the quarter.

Turning to investment performance, among funds rated by Morning Star, our percentage of assets in equity funds rated four or five star increased from 42% to 46% from Q3. And our percentage of three, four, or five star rated assets decreased slightly hovering around 80%. In the fixed next area, four and five star rated assets decreased from 27 to 22%, while assets in the funded rated three, four, or five increased from 65 to 67%.

Interestingly, nearly 2/3 of our eligible funds that are ranked as lipper leaders in one or more categories at year end. These categories include total return, consistent return, preservation, tax efficiency, and expenses. We continue to further develop our new investment management structure as previously noted. We have hired Tim Shafford to lead this effort last February. He hired Chris Carafi as Director of Research and Jim Gordon as Director of Quantitative Analysis and we're in the early sometimes of adding additional analysts for our equity research effort as we place greater emphasis on proprietary research.

Let's turn to distribution. For '02, sales of both stock and bond funds increased in each of our major channels. In trust, equity fund sales were up 13%. Bond fund sales were up 84%. In broker-dealer, equity fund sales were up 14%, bond fund sales were up 41%. In institutional, equity fund sales were up slightly and bond fund sales grew by 69%. These outstanding results came from a confluence of factors, including demand across fixed income and for certain equity products, our broad line of quality products and, of course, strong relationships and distribution opportunities that we have developed over the years.

Let's look at each one of the distribution channels individually. In trust, we continue to leverage our relationships to find new assets. Recently, two of the top five global banks selected Federated to complement their liquidity offerings. We continue to develop outsourcing timeouts from banks. We're actively working with some of our bank trust clients to convert their common trust funds into our products.

For example, during Q4, a bank client converted 34 million from a common trust fund into our capital appreciation fund, and we're developing more of these opportunities. We're also adding our first bank-managed account business. These are the small accounts that we have talked about in the past. One bank has put $7 million into our strategic value discipline and other banks are including us in their product offerings.

Let's look at broker-dealer channel. Q4 saw the introduction and successful launch of the two closed end Muni funds I mentioned earlier. We continue to place product into retirement programs. For example, in Q4, UBS PaineWebber added the Kaufman and the capital appreciation fund to their 401K source product.

In the Jones System, our top-selling fund products continue to be mostly equity funds, including American Leaders, which is our large-cap value fund, Market opportunity, a mid-cap value fund, and the capital appreciation, a core or blend fund. We recently relaunched our variable annuity product into a tough market, but will be promoting it in the Jones system this quarter, and look to accelerate sales with the goal bringing sales to ten million a month this year.

Among bank broker-dealers, our sales grew 55% in '02. We're beginning to place our managed account product onto bank retail platforms and we're recently added by one of the top five banks for strategic value equity.

During Q4, we picked up $330 million in a money market asset in the broker-dealer channel from a client conversion. In Illinois government entity, which is basically a school district, added a cash management account fended in Q4 for $440 million. We started a new prime money market product with Texpool that started with $68 million initially, now has about $150 million. We also continued to add corporate clients with 13 new cash management customers coming on board in Q4. These customers ended the year with just over a billion in new assets. This brings total new accounts in this area to 49 for the year '02.

In the insurance market, we added a $129 million core fixed income account in Q4. We recently won $140 million mandate, also in core fixed which funded this quarter. We also won a $75 million institutional mandate into the Federated Kaufman fund in Q4 from a defined benefit plan's sponsor for medcap growth. Our sales in Germany with our partner LVM Insurance improved in '02. December was our best month for net sales since we started these funds, about 11 million. We look forward to stronger results from this venture as well as developing new distribution opportunities in '03.

Briefly, some of our '03 initiatives are managed account product has grown to over 40 million in its very early stages, and our goal remains to penetrate the largest wire house programs with our strongest product and to leverage our bank information in this area. Our target for '03 remains $1 billion. We're also finalizing our 529 plan product offerings in partnership with the Schoolhouse Capital State Street organization launched in Q1.

Let's talk about '03. We have stated consistently since we went public that we believe Federated can continue to grow its earnings at 15 to 20% plus 15% over a long-term basis. Even recognizing the volatility of the markets that we face. Our record record over five years since we've gone public has been consistent with our goal and expectation as we achieve compound annual growth over 30% in EPS. Our well-diversified business by both in product and client gives us the ability to grow this franchise consistently even as market changes, but it's within a bandwidth.

During the past three years, we faced the same challenges everyone else did as we experienced unprecedented volatility and yet we were able to grow our earnings at a very healthy and very competitive rate. You did not see Federated take a pause in earnings over the last several years.

During '02, despite slightly positive net fund sales, our equity assets decreased by about $4 1/2 billion from market depreciation. The revenue impact from this market-based decrease on a go-forward basis is more than $40 million. In '02, average assets from our equity funds were 18.5 billion, and we come into '03 managing about 16 billion. Therefore, equity assets will likely have to increase about 30% during '03 to produce a comparable average to '02.

So as we look to '03, the cumulative effect of the three downed years in equity market creates a meaningful head win that may slow our growth rate from this stated goal. While 7 to 10% might be a more realistic estimate for this year, we certainly set our sites higher and are longer-term growth expectations continue to be in the 15 to 20 or plus 15% range. In fact, if '03 surprises us with a quicker and stronger rebound, green charts in everybody's screen then our confidence would be further enhanced for our long-term projections.

In our view, there is a strong investment thesis for owning our stock. It's a growth business. Asset management remains a strong growth business. FII's growth prospects are outstanding. It's gained market share in both up and down markets. Our strongest performing products include the Capital Appreciation fund, the Federated Kaufman fund, the Federated Market Opportunity fund, and these funds led us to positive net sales in '02 despite the difficult environment.

Going forward, our growing reliance on proprietary research, enhancements to our investment process and improved risk management will provide greater consistency and allow us to take our equity effort to an even higher level building strength upon strength. Our fixed income effort is competitive with the industry leaders and we lead in several categories. We continue to pursue and win a broad range of mandates from short-term to core to high yield. Our cash management business is a unique strength. Our product lineup is large, diversified, strong and expanding, managed accounts 529, et cetera.

Our distribution capabilities are unparalleled. Our balance sheet is strong, and we consistently generate high levels of free cash flow. Our capital management is effective and designed for growth and shareholder value. These strengths put us in a good position to complement our organic growth with highly selective acquisitions.

One issue of CEO Lament, we believe that our performance and prospects are not properly reflected in our current share price or multiple with that, I will let Tom discuss the financials. Thank you, Chris. And I wanted to point out we're all proud of Federated to have recently gone over the 200 billion managed asset level, but back to '02, another year in which Federated demonstrated the value of its strong, diversified business, against a third straight year of declines in the equity market, Federated produced another year of strong earnings growth. We continue to produce exceptional shareholder value and our strong financial position allows us to continue investing for growth.

As I comment on '02 results, the comparisons to '01 will take into account previously discussed changes in our B share program and in the accounting treatment for goodwill in order to have proper comparison to current period results. Once again, these adjustments to last year's results are detailed in the press release.

For '02, our revenues increased 40 million or 6% from '01. Adjusted for the B-share change. Revenues were boosted by the full year impact and growth from our distribution channels of the Federated Kaufman fund. In addition, revenues from bonds and money market assets increased more than the markets related decreased from equites in the year.

For Q4, revenues increased from the prior quarter and decreased from Q4 '01. Again, the market-based NAB decreases in equity during Q3, 2002, set the stage for lower Q4 revenues measured year-over-year. In addition, previously discussed changes in the third party's fund administration business earlier this year negatively impacted year-over-year comparisons.

On the expense side, comp and related increase for the year due largely to full impact of the Kaufman acquisition and to previously discuss investments in our investment management area. Professional service fees decreased from 2001 to mainly to lower number of funds resulting in lower fees paid for portfolio accounting. Q4 increased from the prior quarter for two reasons: First, the net fees we paid per portfolio accounting increased 250,000 per month beginning in November. As a credit, we were receiving expires.

Second, professional fees increased from the outsourcing of our legal functions beginning in the fourth quarter. Advertising and promotional expense increased year-over-year and from Q3 due to higher marketing allowance expenses from higher money market and fixed income fund assets. Marketing allowances make up about 2/3 of this line item, which also includes sales, literature, sales conferences, and traditional advertising.

In terms of actual advertising dollars, we spent about $4 1/2 million in the 2002 year. Our results include an impairment charge in the GNA line. The GNA other line item related to writedown of certain software assets from our retirement plan, record keeping, and related technology area. The expected rollout date for software that we're developing internally for our record keeping operations was puts book pushed back due to ongoing development efforts. Since this resulted in the decline of related future expected cash flows we adjusted the caring value of these assets by 2.1 million pretaxed. These assets have a remaining book value of 2.9 million and have approximately a four-year life.

For 2002, our operating margin was 46.6 compared to 43.7 for 2001. We expect to be able to maintain margins in mid-40s going forward. On the balance sheet, our cash level stood at 151 million at the end of the year.

For the year 2002, we used 76 million for share repurchase, 33 million for contingent payments on the Kauffman acquisition, and 25 million for dividends. The potential change in the tax treatment of dividends may cause the relative attractiveness of dividends compared to other pieces of cash to increase. We will look at this closely in the event of such a change and we'll continue to employ cash among alternatives such as dividends, share repurchases, capital investments and acquisitions in the manner that we think is best for producing value for our shareholders.

In summary, we continue to make investments for future growth while producing significant earnings growth in a difficult market. All these results and ongoing share repurchases and dividends, we continue to produce exceptional shareholder value and also have significant financial flexibility.

We would now like to open up the conference call for questions.

At this time time, I would like to remind everyone in order to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment to compile the Q-And-A roster.

Your first question comes from Ken Worthington of CIBC.

Good morning. A couple of questions. First on consolidation and outsourcing in the money fund business, has there been any noticeable change given the additional decline in interest rates and what continues to be a pretty poor equity fund environment?

The -- it isn't exactly related to that change. I think there is a move towards consolidation in money fund product is simply because big is better and people are beginning to recognize that it's competitive and that if you don't have big enough products, you can't really offer daily liquidity at par. People are also beginning to look at one, two, and maybe even now, three years in a row of nongrowth of their products and so the various CFOs and business leaders in those other organizations look at those products and see that there are better or alternatives and naturally, we have a lot of good ideas on the better alternative, namely switching over to Federated.

Are you seeing a benefit from this?

Yes, what we're seeing is a pipeline, I mentioned some of them in the discussions but last year we had First Merit in Akron move a couple million in their money fund over to Federated and we continue to work through the banking community on those kinds of opportunities because a lot of those funds are, as I say, not growing, and not really able to offer the kind of daily liquidity that they -- that they should have, so I can't tell you specifically the names of these people that we're talking to or what -- how much those opportunities would be, but it's there.

Okay. Another question, if I may, ending institutional assets were flat sequentially. Given the interest rate sensitivity of the corporate cash management business, I would have expected to so assets up with the Fed easing, basically did this happen or did it not happen and maybe you could give us the average asset management for the institutional business if that would, you know, maybe portray a more accurate picture of what is going on in that line item.

Ken, on the institutional channel, I don't have the specific average, but would estimate that it was about a billion dollars higher than where we ended. There was growth during the quarter there was growth following the easing. There was also, as Chris mentioned, the edition of new customers coming in. So you have other factors beyond the interest rate environment what.

What we've have seen over the last couple of quarters in that channel is a pretty good range around the point-to-point numbers and there was some of that again in Q4. When you get to the end of the year, you do have people moving money around, and it does distort the point-to-point comparisons.

Final question in the prepared remarks you said that much of the employs you received from the Fed easing remained in your money market funds. Can actually give us a number or an estimate of how much you have been able to retain thus far?

Well, since assets are up, you could argue that we have retained it all and gained some, but you never know which dollars are which, so, you know, assets are up since we're, you know, over 200 billion as we sit here and money fund assets are up over 140 billion as I mentioned in the call and so in total they're up. But it's really hard to tell if it's the same dollars that were here because of the easing because that money goes in and out rather quickly.

We have also tended over the years to have seasonal growth in the fourth quarter. We have retailing clients, we have other people who tend to add cash in the fourth quarter and, so, as Chris said, it's hard to peel the layers back.

We have tried even in talking to sales people, in talking to customers to -- to get some sort of labeling, oh, is this money that would have gone here or there or is this easing money or is this regular, and even the customers themselves can't tell you what it is because they're making a decision at the moment when they have their money available based on what they think they want to do and based on the various services, so they aren't even able to tell you whether this money came because of Fed movement.

Okay. Great. Thank you.

Your next question comes from Mark Costan of Lehman Brothers.

Hi, excuse me. A couple of things, one quickly, Tom, you were referring to some of the increases in GNA that we were aware of professional services and like. I couldn't recall what the comp offset, though, to the to the shift of legal outsourcing was --

For the quarter it was about $800,000.

About 800,000. Was there also an offset for the 250,000 in the month and I can't remember if there was a regular offset.

That was a, -- a, -- a discounter. They were paying us back over time and it ended and there was no offset to it.

Okay, so the offset was just on the comp side for the professional services from legal outsourcing.

The money from -- what we did with the legal outsourcing was the -- the dollars moved from the cost line down to the professional service feed line.

Right.

And from other lines, Mark.

Yep, okay. And a couple of bigger-picture questions, Chris, one with respect to your comment about, if I remember your words correctly, 7 to 10% being more realistic than your previously 15% growth target just given and the lower base of equity assets, but that you're more hopeful than that. You pretty consistently exceeded your own expectations as well as the streets, I think in the past, are you suggesting that more hopeful would inherently acquire equity market appreciation or could you exceed that seven cent, 10% band without market appropriation if other things go in your favor?

First, I want to congratulate you on improving your queueing and questioning ability on this call. Secondly in, answer to the question.

Not as slow as I have been.

I'm not going off to the 7 to 10%. As you imagine, a lot of thought went into putting that number in there. I am not going to go beyond expanding on that what I said in the call.

No, just a sense of what would need to happen for your more hopeful scenerio to pan out.

What would need to happen is first of all, if are you had a robust, very robust equity market, you know, that would help, but just because you may be end the year up some meaningful percentage in the equity market does not mean the average assets are going to climb. If you had it all happen tomorrow, okay, now you would be able to talk about how that happens, but whatever percentage you say the equity market is going up over the year, you have to cut that number in half in terms what have that means on average increase in revenues. Everybody can do their own calculations off of 16 billion and increase the -- .

I'm not really so much from your equity comment. Aside from that. You guys have obviously exceeded those kinds of targets in the past, with obviously, not been anywhere near robust performance in the past three years. My question is, I guess: Do you see potential growth in the money fund product and fixed next product in the margin, et cetera?

Yeah, but I wouldn't say the margin. I can answer that one.

Okay.

Okay, but the money markets do have meaningful growth opportunities. When you tear inside Federated's business, and that's why I spent so much time talking about nonrate type things that are real at Federated. I mean when we're working with the, you know, trying to get this 15C3 money out of the SEC, when we're work on this commodity's future trading group and got that functional equivalence. When we're looking at functional equivalency in other places, England and things like that we're looking at meaningful pots of money that, you know, may hit, may not.

When you couple, you know, the first Texpool with the prime fund Texpool that grew from 61 to 150 million, you know, this thing could get some legs on it and we're seeing other opportunities with our broker-dealer and bank-broker-dealer clients with other opportunities for cash. And so the way I look at it is, and I have said this before on those calls that with this eight plus trillion in money in M3, there is no reason why we can't increase our market share of that from 1.7%, you know, to a lot higher. There is just no reason we shouldn't be able to do that.

Okay, and in a similar related question in the bigger picture as well it seems that, you know, for all the talk of Fed easing and the like that money fund yields, vis-a-vis, spot rates and the retail side, at least the average bank deposit yield out there were unusually uncompetitive for a lot of 2002. Obviously in the fourth quarter after the easing they became extremely competitive, but it seemed like money fund growth earlier in the year was being weighed on by the reverse of that.

Is that a fair characterization?

Yes, it is. That's what happened in the rates. The reason I mentioned that point about the fact that not much money moves because of the rates, I mean you had a 50 basis point disparity and only 3% of the non-money market fund money in M3 moved.

I'm trying to get a sense what have did move if some of that was a, you know, a reversal or a recovery of that unusual relationship as opposed to just a Fed chasing.

You had some decrease in retail moneys that was sort of noticeable.

Uh-huh.

And I don't know that I could add much beyond that.

It likely wasn't so much a reversal. The earlier things with the bank rates would have been more on the retail side and then post Fed easing. That would have had more of an institutional flavoring to it.

The bank rate phenomenon doesn't impact the trust officer's decision then.

Well, let's look at it this way. The bank trust officer has, on average, about $3.00 in bank -- I mean in the direct market compared to every $1.00 in money funds and roughly about the same -- I'm -- a little less in money funds. I mean in the bank product.

Let me restructure that again. Of the $4 trillion in bank trust assets, about 20% of that is in cash. And of that, about 300 billion is in direct instruments, a couple hundred billion in is in money funds and about 100, maybe a little more do you to rounding, is in direct bank instruments.

So if you look at that ratio, that's kind of how the trust officer decides, mostly in the direct secondarily and money funds and then indirect instruments and he has the issues with direct instruments with his clients, with his bank, does the bank really want the money, do they want his money, I mean when they're raising up rates or altering their spot rates, they're usually not doing it in order to incent the trust money. They're doing it because they want to expand their banking franchise, and a lot of times they'll tell the trust officer to lay off these rates because they don't really want to goose the size of the bank, so it's a lot of different factors. But, yes, he is influenced somewhat by what the bank rates are doing.

Okay. Thank you, that's helpful.

Your next question comes from Brian Badel of Merrill Lynch.

Good morning, guys.

Good morning, Brian.

A couple of questions and bigger stuff then. The compensation run rate for the fourth quarter, I guess assuming you might be a flat market. Is that a fair assumption for '03 or you think it's more like the average of '02 for '03?

Well, Ray will follow up on this. In the fourth quarter, we try and go through and true up the comp for the year. So, you know, it's always, you know, driven by the bonus and then the comp numbers. In terms of run rate, thank you. Talk about, that Ray.

Brian, you should not really use Q4 given that you do square up the accruals at the end of the year, and then you get to Q1 and you have the seasonal like things location payroll taxes and benefits and you have a resetting of your expectations for the bonus plans for the entire year. So you should look more to making a judgment from the full year rather than from Q4.

And are you guys keeping the same philosophy about success incentives or success-based compensations?

Absolutely.

Okay. And tax rate guidance for '03?

Tax rate?

Yeah, in terms of what --

I mean 36% is what we're looking at.

Okay and a couple of bigger-picture questions, looking at the distribution channels, especially a lot of your new initiatives that you have started in the past if you years and the new ones now, the 529 being the newer ones, what is your margin target on these? How long does it take to get to break even?

I imagine the managed accounts is probably quite an investment as well as the 529 plans. Maybe you could talk about that and in addition to that, where your advertising dollars are being focused on as well as the promotional dollars, the dealer channels to element your focus there.

Okay, on the managed accounts the billion dollars you could argue that gets us to break even, but if we don't get it on to billions after that, then this will not have been a worth while effort for Federated and I don't really disagree with all of the studies that have been done to indicate that the margins on the managed account business are less than the margins on our regular fund business. I don't know that I agree that they're half the margins because, you know, when you're coming in late to the game with good mandates you're not in charge of rebuilding the systems. They're built and you can rent them, buy them, or use them. And we already have the investment management capability built and so we're adding distribution and administrative capacities. But they're not as high as the regular fund business, but it's still excellent business that will add, in our expectations, meaningful to the growth --

Right.

-- of EPS. Now, in terms of 529 because we're dealing with Schoolhouse/State Street, we have none of the operational costs associated with small accounts and things like that. So, for us, we're not really expecting that to be much of a margin drag.

Now, obviously you have to fill up a basic amount in order to get going, but the long-term prospects for that are that that business is not a whole lot different than any other way of selling funds through banks or broker-dealers at the end of the day from our perspective because we don't have, you know, the burdens of having won some of those contracts directly from the state or creating the infrastructure.

Right. And when you say infrastructure, you mean the sales people in particular?

I mean exactly what State Street did and what others had to do, which is to build an infrastructure to handle the accounting and the tax accounting for the grandchildren and the beneficiaries of the 529 plan. In addition to, meet the promises to the various states that were requiring marketing programs to their state and nonsegmented marketing programs, money to be invested in the state through the -- through that method and things like that this we simply, you know, don't have to participate in.

Right. And take a part of the question, the advertising dollars, the advertising and promotional dollars, are they, within that line item, are you focusing on any other, on any other distribution channels than the broker-dealer channels?

Okay, a couple of comments on that. First on, the line-item, it including a good whack of marketing alliances and fees paid to some of our third-party clients.

Right.

And so, you know, perhaps there is nomenclature that ought to be improved in that line to get people focused on what that really is.

In answer to the question, we're not really changing how we're focusing our advertising or distribution. You know, we remain committed to spend similar amounts of money that we spent in previous years and compared to two years ago, that increases the number of spots or time slots that you're enabled to run with the same amount of money our programs will be similar to what they have been before, a run at the same audiences, picking on the intermediaries, doing a little behind home plate, focusing in on the same TV runs that we had done before, so I don't see a big difference there.

No major changes there. Okay, last question, on the money market business, I guess under two different scenarios, one if we have a rate increase is the standard question but I guess if you could give us an update on what level of assets are exposed to that, I guess it's some part of the [INAUDIBLE] institutional channel and then conversely if we have more of a deflationary environment and get another rate cut and you're talking about microscopic yields. Number one, to what extent would you have to reimburse, fees on some of the money funds and the broker-dealer channel to keep them above zero for yields and secondly, I know you guys have been talking about this as, you know, service business if the rates are microscopic like that, do you see any change in that, any other competing products such as maybe people going out on the spectrum and some of the ultrashort and stuff.

I'll take the microscopic yield question and I'll let Ray talk about the various channels and the propensity for some of those channels to redeem faster than others.

What we have seen is that if there is another quarter dropped by the Fed the impact on us in terms of the net yields to our funds, et cetera, will be meaningless.

Yeah.

If it goes another 50 basis points there will be some modest impact because there are some funds which we would have an idea toward keeping with a positive yield. But I don't think it would have a very meaningful, but it would have some sense per share impact on Federated, but we haven't put out any specific calculations on that, so you would have to get through a 75 basis point reduction in Fed easing in order to start impact us, and I think if we were to forget the first quarter or the second quarter that we would start to do some calculations and answer those questions in advance, but, you know, basically our people aren't really looking for another easing or if there is an easing, there is a raising quickly following it. I talked to one of our managers they said well, you know, maybe there will be an easing in a couple of months and then it will come back in August. Okay, that's not much of an opinion, you know, to change EPS or money market fund behavior and in terms of what your tomorrowing microscopic yields, remember that all of these things are relative to what else they can do for the money from a service standpoint and a yield standpoint, so it's all competitive to the lay of the land and as long as that's going on, we don't see any dramatic changes in how people evaluate where to place their cash. And I'll let -- go ahead.

People do have moved out into the ultrashort products, but when they do that, you know, they are taking risk for risk.

Right.

So there is a lot of people who are unwilling to do that.

And those are particularly the corporate clients I would assume, that are unwilling to do that?

Yeah. Well, given within abandonment, we have good corporate clients who are in the long cash funds. It depends which money and which corporation and which time and which the what their prospects are and what they view is going to happen with interest rates.

So, you know, as I mentioned in the call, we saw the action in the ultrashort decrease a bit in the fourth quarter and , you know, by comparison, added volatility to the fixed income numbers, but we saw some of the business business, you know, it was not as robust as it was before and in part that's because they're saying, oh, there is some, you know, because of the easing, there is benefits in the direct money funds -- funds themselves.

Right.

Ray will comment on the -- .

From a channel standpoint, Brian, the fourth quarter the bulk of the money fund growth would have been out of the bank channel, so that went up by $10 billion and was split between the trust portion and the what we have referred to as the capital market portion, kind of the institutional brokerage part of the bank and we talked earlier about the institutional going up modestly and the retail going up modestly from a rate sensitivity standpoint, we have tended to talk about the capital market's area as being similar to the institutional market. A fair amount money is, in fact, a corporation coming to us through a bank and so it would have the same kind of characteristics as the corporate market direct with perhaps a little less rate sensitivity, but not much. And from a bank trust standpoint, we have generally characterized that as having some interest rate sensitivity but not as much as say the corporate or the capital markets area.

Right, and there was something like, , I don't know, 20, 25% of that market, I think historical amount that was rate sensitive, I think.

Of the trust market?

Of the trust market. Yeah, I don't remember -- I remember it was a portion.

I think maybe you're thinking of the percentage of our total assets, money market asset that would be in the institutional market corporations by and large coming to us director the bank capital markets area. And that is, you know, has been in the 25 to 30% range of our total money market fund assets.

Right. Great. And then just one last follow up question, with the action you're talking about in the ultrashort funds, are you seeing a shift to higher yielding, fixed next funding like high yields, for instance.

If that were happening, we have -- we don't have the evidence to be able to show money going directly out of one of those funds into the other.

Right.

And it's not our experiences that is what happened. The money's in cash because it's in cash because it's going somewhere and when it's time to go, it goes. If it's eventually heading into high yield, that's where it's going. It's not pure rate play money.

No, I meant just in general, if you're seeing more demand for high yield funds.

I can answer that, yes.

That's picking up into the first quarter as well?

Yes.

Great. Thanks a lot, guys.

Okay, Brian.

Your next question is from Cynthia Mayor from Salomon Smith Barney.

Hi, how are you doing?

fine, thank you.

Just a follow on the last question, if money does move to ultrashort, how -- to what extent does that benefit you, how are the fees different?

They're higher.

The fees are higher, Cynthia, compared to the money market funds. They would be lower than the spread product, the high yield and the other spread bond products.

What are the average fees like on the --

For ultrashort funds, they're in the 30-basis-point range.

Okay. And maybe you said this already you but the money that's come in in January that put you over the 200 billion mark, was that from any particular channels?

No, it would have been similar to Q4, , and, again, it's not unusual in January to have inflows, you know, people are lining up to do things with cash and as we have pointed out each year I think as we head later into the first quarter and into the second quarter, that tends to be a pause period for money market growth because of taxes and because corporations and other customers are putting money to work. So that's been the seasonality in the past.

Okay. Fine. And then, you also -- I just wanted to ask a little about Edward Jones. You mentioned, I think, a goal of 10 million a month for this year?

That is in our variable annuity product.

Okay.

That's only the variable annuity.

Right. That makes sense. Overall, do I have a goal for Edward Jones and you can talk a little about the share gains there. I think your past goal was to try to go from 5 to 7%?

Right, we still have the same goal because we didn't make it last year.

Okay.

The real ultimate goal is to get up to 15%. We're only one of seven players, but we're fighting a lifetime of other people's success there, but we would like to take the market share from, you know, 4 to 6, 5 to 7%, , because that didn't happen last year like we thought it was. We're looking at that and coming up with some internal responses, which I'm not going to get into on the call.

Is that a matter of trying to cross sell equity funds or something else?

It's a matter of basic blocking and tackling, we have 15 sales individuals that are exclusively on the Jones' clientele and it involves one product, one at a time, call on this individual offices and showing the beauty of the American leader's fund or the market opportunity fund and getting the business.

Okay.

So it isn't so much switching from, you know, fixed income to equity. It's doing the basic blocking and tackling.

Okay. And finally, can you just go over the numbers of sales people that you have now in the different channels.

Yes, we have roughly 190 sales people and if you break them down, you have 30 in trust, just about a hundred in broker-dealer, 26 in bank broker-dealer, and about 30 in what we call institutional and institutional includes the insurance and it includes the corporate and the investment adviser type markets and that will get you pretty close to 190. Yeah, a couple overseas. Yeah. A couple in Germany as well, and one in London.

And then are you adding managed account people, or are they within that?

The managed account people are within that, we have added one manager and two sales people and have on our sites maybe adding more sales people based on, you know, how the business is going and the timing of that.

Okay. Do you see any impact to comp costs in terms of adding sales people and adding internal research?

Hopefully we have impact from adding sales people because that implies bonuses if they're successful, so we look forward to having impact from that. The impact on the research side, yes, we're looking forward to spending more dollars in adding analysts and, you know, enhancing bonus programs and things like that in the research area as we make the gear shifts I talked about over the last couple of calls under Shafford's leadership.

Would you expect comp to sort of creep up over the year until you through it up at the end of the year?

Now I will let Tom handle that one. We seem to go back to the same thing, Cynthia. The bonus portion of it is so big that we would, you know, the comp and wages, yeah, you might expect to see a bit of an increase, but the bonus portion of it, which is still variable, you know, we just don't know the answer.

That's really the controlling number.

Right.

Okay. Great, I think that's it. Thanks a lot.

Thank you. Thank you.

Your next question comes from Robert Lee of Keefe Bruyette and Woods.

Morning, everyone.

Morning, Bob.

A couple of real -- two sort of house keeping questions and one little bit bigger picture, and I just wanted to make sure I understand the 7-10% guidance, that's EPS, so that would include your sort of normal in the 2% or so reduction in share accounts from share buybacks? Or is that sort of net income?

That, Rob, the 7-10 is EPS.

Okay, great. Second thing is, you know, if I remember correctly, it's probably a question for Tom or Ray, you had some intangible amortization that starts -- that runs off starting this year. Is that correct?

Well, it stopped -- it ran off in the mid-part of the year.

Okay.

From a number of the deals that we had done, you know, five, six years ago.

Okay, so whatever the amortization is in this quarter is pretty indicative of next year.

Actually, Rob, we would expect to have a comparable full year amortization number.

Okay.

Because there are other things that would come online there some of the technology things that we have mentioned before that -- where we would be amortizing, so, we shouldn't up about the same for -- on a full year basis for '03.

Okay, great, and sort of a bigger-picture question, you know, Chris you are still out there looking for, I believe, more Kaufman-type deals, you know, a lot of your competitors, everyone seems to talk about, you know, conserving cash to fund some future deal, seems like there is a lot of, at least, you know, people out there looking for those kinds of things. Are you seeing, you know, a change in the complex one of people, you know, -- complex rain of potential buyers, do you characterize the acquisition right now or sellers waking up to the asset levels, therefore asking prices have to come down.

I would say in answer, unfortunately, we have given before which is that each one of them is so incredibly unique, that their uniqueness in the fact that the human beings that started the firm are still there and they -- they look at their funds more like their children than like a business and that that feature trumps the features that you're talking about in terms of the pricing. So with that said, you know, obviously there have been some change in pricing over the last several years, but that doesn't mean that we have found it easier to found other Kaufmanesque-type opportunities for us, and so that's about as much as I would say on trying to characterize that market. We continue to look at opportunities but we approach it on a basis of, you know, distaste for dilution and commitment to be able to grow the things if we buy them like in the Kaufman sense and here we're only talking about acquisitions where we want the management and the -- and the record and to be able to sell it. Those on the other side where we roll them up into the Federated products, , there we do have a pretty good pipeline of opportunities you know, where people's fund groups have not worked, and , there are opportunities to just merge them in.

Are you seeing any change in the -- in the makeup of, you know, people out there looking? Are you seeing -- are the Europeans sort of gone for now, you're seeing more domestic players weren't around before? I'm just trying to get some characterization of this.

I don't have a good feel for what others are doing or who would be on the other side of the things that we are looking at.

Uh-huh.

I don't think the Europeans are as active as they were before. I can -- I think that's a fairly safe statement.

Uh-huh. Great. Thanks.

Your next question comes from Steven Schwartz of Raymond James.

Good morning, everybody.

Hi, good morning.

A few questions, mostly follow-ups to some things I'm not that clear on. Tom the -- on the comps -- going back on the compensation rate, the 800,000 for the outsourcing was that a monthly or quarterly number?

It was a quarterly number.

Quarterly. Okay, I wanted to touch a little bit on the microscopic yield question and god forbid we had to go down another 50 depths that that might affect a little bit. Have there been any discussions on the other side of the situation with the BDs, whatever them possibly having to cut back their revenue sharing?

Yes.

Okay.

You used the right term, Steve. Sharing.

Right. Are they willing to share?

Well, we have only discussed this with a few and there is I would characterize it as reluctance but openness to the subject.

Okay.

Depending on how close the relationship is, how things work, it's a very logical way to squish the balloon, so naturally, we're in favor of sharing and sharing these concepts with our partners.

Okay.

We're not pressing on it too hard because we don't have to do it yet.

Sure, sure. That makes sense. Ray, going back to your comments about first quarter seasonality, would it make sense to assume historically here that kind of the high levels that maybe we have reached so far earlier in January might peel down to get us back to that historical kind of even for the first quarter?

Yes, that would be a pattern we have seen in the past.

Okay. Is and then just a bigger picture question here, Chris, you're talking about the 7-10% growth in EPS, which seems to make a lot of sense, given where current markets are. I know Ray and I had a quick E-mail discussion last night about option expense that nothing has been decided. You can give us a sense what have Federated is thinking about on that front.

What Federated is thinking about on options is -- I'm inclined to adopt the option accounting rule. What's the number on it?

128. I think is -- No, 148. 123, 148.

123.

123. We want to get that right.

It's not a done deal and, you know, not final regulations and so --

Right, but that's what I'm inclined to. Part of the reason is that I prefer to use restricted stock as compared to options for several reasons.

I think it makes it a clearer statement to the employee and the employee's spouse so that they understand what the deal is. I think that it makes it clearer to the shareholders that, hey, here are shares, they're real, they pay dividends and there they are in shares outstanding, nice and clear and straight forward, and I think that you end up using less shares when you use restricted stock. And then I think that it's -- I prefer getting the employees to put money up in terms of using restricted shares and they put that money up in terms of, you know, whatever the bargain element is that they're charged for the shears and then if they make an 83B election to get cap gains treatment down the road, they put more money in for the shares. So for those reasons I prefer it, and that's why inclined that way.

Okay, the 7-10% number you cited does not include any -- any compensation expense associated with either options or SARs.

Sure, sure it does.

It does.

Yeah.

Okay. That's -- that's something I wanted to make sure about.

Your next question is from Lynn Savage of Fox Pitt Kelton.

Back on the 7 to 10%, I was not clear too. That doesn't include no matter what you decide to adopt on the option. That's included on the option.

That's an EPS number for '03, including everything.

Okay, and then just, Chris, back to something you said that one of the initiatives you talked about was, I think you said 15-3C money from the SEC. That was nothing I was up to date on. Was hoping you would give us more color on that initiative.

Brokers are allowed, for net capital purposes right now to use direct instruments and we have as a theme that we have used in this firm, for over a quarter of a century, what we call functional equivalency, so when something says you can use direct securities, we come up with the idea of making our money funds the functional equivalent of whatever that is. And so on that particular deal, you know, we're trying to see if we can get the money funds to be the functional equivalent of the direct securities, and that's what we're trying to do.

And what is the size of that market?

Well, it's billions, but, you know, it's -- you know, it's a pending deal where we're, you know, with working on the SEC and they seem to be working on a lot of other things, but it's important to us, so it's not a final deal.

Okay. Then just lastly, on managed accounts, going from 40 million to a billion, can you give us some sort of sense on, obviously the sales have to ramp up dramatically at some point in '03, can you give us a sense of what to be looking for from timing perspectives, is that a first half or second half just to see if you actually have a chance of meeting that goal.

Well, I think that -- there's a couple of things that have to occur. We have to get on the big we're houses in the first quarter here, and you know, own talking about, you know, Smith Barney, Merrill Lynch, you know, PaineWebber that type. We're on 21 other platforms right now, and we have a good game going in the bank, Trust World where this is kind of a unique offering by Federated, so I have not scoped out the quarter-by quarter numbers on that, and I wouldn't set those bars like, it's a pretty aggressive by us to -- to say oh, well, we're going to hit a billion by year end, when we said that last year and picked a nice, round number. So having me divide that by quarter is not going to advance the ball. In our budget process it's, you know, weighed heavily at the end of the second two quarters. The last two quarters.

The first quarter is get on the shelf. The first half get on the shelf, the second half --

That's a good way to look at it. We have been trying to get on the shelf for a good bit of time here, so it's not like we're starting today to try to get on the shelf.

Okay, okay. Thank you very much.

Your next question comes from Henry McAfee from Morgan Stanley.

Good morning.

Morning, Henry.

A quick one. When you're talking about the 7 to 10%, what is your revenue growth assumption there?

I think it's about 45, 50 million. Million.

Off of the -- off of the 711?

It's in the 6% range, Henry.

Okay, all right, and I guess -- so -- I'm just trying to understand the organic growth, 6% revenue growth and last year you had about -- if you added back the one-timers, you had 2% growth, that would be 2%, and you're saying 2% from share repurchases and 7% revenue growth, right? Is that the way to think about it?

You can think about it. That's not how we did it. We try to go do our budget and go through whatever the expenses and, you know, there are wide ranges there and, you know, as we said all the time, there is a lot of the success items, you know, you can do it that way. That's not how we do it.

So if revenues of six and then share buyback of 2% and then you would get the addbacks from the one-timers last year, which is 2% earnings growth and come back with the expense number. Is that fair?

I mean I don't do it. It's different than how I do it. I want to sit down and figure out what you said.

Okay, you said on the call you're going to get 2% from share buybacks, so we agree on that. [ Overlapping Speakers ]

We didn't say that.

Someone else suggested that being our -- you can go back and look over it. We did about the same in '02 as we did in '01. It was just under three million shares, but we look at that kind of every day. We don't necessarily have a target for the quarter let alone the year.

Okay. Next question just on the writedown, you said there is still 2.9 million of that left. Right?

Right.

Is that susceptible -- I mean last year we had CDOs, and we had that and this in the first quarter. Is there anything else that is susceptible to writedowns or are we putting a base on that?

We have to look at that every quarter to follow all the proper accounting rules then we're looking at that and finished looking at it, and we feel that's the right and proper number. We're not expecting further writedowns on it.

Okay.

We think it's right sized and done properly and going to be amortized over the next four years and --

Okay. I had one other, just on the first quarter of last year that the occupancy -- excuse me, the compensation was 48 million and was trying to figure out, I know you said you're going to add bodies, I'm trying to figure out was the fourth quarter artificial -- very high. I know you get up at year end, but was there also a fair amount of the performance in the first quarter and then it trailed off by the end?

Yes.

Okay. And is that -- and given, you said, the Morning Star rankings are going up in terms, because of the performance going up. Is that a risk in the first quarter again this year?

We will -- you would expect us to manage the incentive pump in the exact same way. And that is the ultimate thing is to not hit the end of the year with not having accrued enough money.

Right.

I would not look at improved performance with the word "risk" on it.

No, no, the long-term it's excellent. I'm just trying to gauge what we had last year as, I think comps, if you remember, we surprised investors in the first quarter on the upside, and I would say it was tighter throughout the year. I wanted to make sure we were modeling it correctly.

I would say that's how we would expect to do it again.

Okay, and just the final thing, given the necks that you're seeing going into January, the fee rate came down to 23 basis points. Do we think we're stabilizing here just you said that your people spun out on some of the ultra fund stuff. It sounded like high yield picked a little bit and trying to get some gauge there.

The fee rate, as you know, is a blended rate and it falls out from where the changes were so obviously with the third quarter change in equity and the dramatic growth in money market funds and the ongoing growth, I mean even the diminution at the ultrashort bond fund product was minor. The big things that changed the fee rate were the market impact on equites and then the growth of money market funds, so when you ask about the fee rate changing going forward it's really much of a function of what is going to happen in the market as anything else. We think no matter which category is working, we're going to grow and add assets so at the end of the day it becomes a market question as much as anything.

Okay. And then just a final, just on the tax rate, you guys says 36. It looked like it trended down toward the year and you were at 34 for the year. So up a bit?

I think the year was 35 1/2.

Okay.

36.

Okay. Good enough. Thank you.

Thanks.

At this time time, there are no further questions. Do you have any closing remarks.

No, that concludes the call. Thank you.

Thank you for participating in today's Federated Investors fourth quarter earnings conference call. You may now disconnect.