Federated Hermes Inc (FHI) 2003 Q1 法說會逐字稿

Good afternoon. My name is Princess, and I will be your conference facilitator today. At this time , I would like welcome everyone to the Federated Investors first quarter earnings conference call. All lines have been placed on mute to prevent placed any background on noise. After the opening remarks, there will be a question and answer period. If you would like to ask a question during this time,, simply press star then the number 1 on your telephone key pad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Hanley, you may begin your conference.

Welcome. Today we plan about a 20-minute presentation and then we will open to your questions.

Leading today's call is Chris Donahue, Federated CEO, and Tom Donahue, CFO. Also on the call is Dennis McAuley and Rich Novak from the corporate finance group.

By way of safe harbor, let me say that this discussion will contain forward-looking statements and actual statements 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 Factors in the company's annual report on form 10-k for the year ended December 31st, 2002 on file with the Securities and Exchange commission.With that I'll turn it over to Chris.

Thank you, Ray. Good afternoon and welcome. I'll begin with a summary of our performance in the quarter, and then provide updates on various initiatives before turning over the call over to Tom to discuss the financials.

For Q1 our period end assets were up slightly from the prior quarter and average assets were up about 4% sequentially and 9% from Q1 '02. Against a backdrop of continued unsettled equity market conditions, we saw strong demand for fixed income products and growth in money fund average assets. We had a positive net sales of equity assets. Market-based NAV declines led to lower average and lower period-end assets.

In the money market area, assets in Federated's mutual funds and separate accounts increased 13% for the 12-month period mainly due to growth in separate accounts including the addition of text pool last year.

Fund assets increased as well. Money market fund assets since Q4 '02 decreased by just under $4 billion late in Q1. This is a continuation of the pattern we've seen over the past several quarters of money market fund balances decreasing at period ends.

Average assets are a better indicator of the demand throughout the period. Money market assets were up about $2.5 billon from the prior quarter and up slightly from Q1 '02.

Money fund assets stood at about $134 billon as of April 22nd. We'll also remind you that history has shown flat to down money fund balances due in large part to our customers using these monies to make tax payments to the government. The second half of the year has historically shown better growth for our money funds.

Now, turning to the fixed income side, asset and sales growth were strong for the quarter. Positive net sales were recorded in all categories. The breadth of demand across our product line was important with less than 10% of sales coming from the ultrashort products.

Net sales accelerated substantially from the prior quarter. Q4 '02 showed net bond sales of about $600 million including approximately $200 million from the initial public offering of two closed end municipal funds. Q1's net sales of $1.5 billion compares very favorably to Q4's net sales of $400 million excluding the closed end offering.

Among our equity funds in Q1 we continue to have strong sales and flows in the Federated Capital Appreciation Fund, the Federated Kaufman Fund, and the Federated Market Opportunity Fund. Flows were also positive in core value small mid-growth and index funds and were negative in equity income and international products.

Through the first weeks of April, both equity and Bond net fund sales are positive. With equity on a for similar pace to Q1 and fixed down somewhat from Q1's strong pace. But once again, we caution against drawing conclusions from this early in the quarter data.

Turning to investment performance, among funds rated by Morning Star, our percentage of assets in equity funds rated 4 or 5 stars increased from 46 to 48% in Q4and our percentage of 3, 4, or 5-star assets decreased from 79% to 59% as one of our large value funds decreased from 3 stars to 2 stars.

In the fixed income area, 4 and 5 star remained at 22% assets while assets rated 3, 4 or 4, or 5 stars 5 increased from 67% to 69%.

20 funds were rated 4 or 5 stars up from 18 in the fourth quarter. Of the 20 funds, 13 were equity, 7 were bonds. Each increased one from Q4. At March 31st, 56% of our domestic equity assets, 52% of our bond fund assets, and 76% of our money fund assets were ranked in the first or second quartile by Lipper based on one year total return analysis. Nearly 2/3 of our eligible Stock and Bond funds ranked as Lipper leader's at quarter end.

These categories include things that are important to our intermediaries such as total return, consistent return, preservation, tax efficiency and expenses.

We continue to invest in our equity research team as we build a structure that reflects a greater emphasis on proprietary research and becomes more focused on beating benchmarks.

We see this shift to market benchmarks as winning versus peers over the long haul, not as a mere end in itself. In Q-1 we hired four experienced investment professionals and plan to add a few more analysts over the course of the year.

Let's talk about distribution. The first quarter saw the continuation of strong fixed income sales across all channels. Compared to the first quarter of first quarter '02, bond fund sales increased 64% in the brokered dealer channel. They increased 35% in the institutional channel. And increased 26% in the trust channel. Each channel also posted an increase in bond fund sales compared to the rather strong sales of Q4 '02.

Stock fund sales were generally stronger than in the prior quarter as they returned to the levels of the first half of 2002. In the trust market, we continue to leverage our assets to find new relationships. Recently, a major West bank added our money market funds to their global custody product adding about $300 million in new assets for Federated.

Another bank added our offshore money funds as a suite option, which benefits our developing business in London. Assets from the London effort have grown to about $300 million and we are experiencing momentum there by adding new accounts. We also continue to develop new applications for our money funds as evidenced by the DTC announcement last week. Our money funds are the first to be approved for us on the DTC platform.

In addition, the SEC approved a request by the option clearing corporation for a rule change to allow money market funds as eligible form of market collateral. We anticipate that when this program becomes operational within 60 days that option clearing corporation clients will be able to pledge margin collateral using Federated money market funds for transactions through the DTC platform.

Collateral for this type of business are in the $10s of billons and we expect that some of that will begin to use our funds in lieu of individual securities to capture operational efficiencies and a competitive yield.

We also continue to develop outsourcing opportunities from our bank customers. For example, we're working with our bank trust clients to convert their common trust funds into our fund products. We think we'll have a couple $200 million of asset type conversions this year. Recently, a New England bank agreed to outsource its entire fixed income portfolio to us.

They will begin to use six of our funds replacing the process of laddering individual securities in their own department. We expect to pick up over $50 million in managed assets over the next year and more than $300 million over three years.

Though we're very early in the mission we continue to gain momentum in the bank managed account business benefiting from the recent addition of our product into the offering of one of the top banks in the country. We are beginning to add accounts in the $1 million plus range from various banks clients. And we continue to have success adding products into bank retirement platforms including the recent addition of seven R funds into the product offered by a major southeast bank.

Let's turn to broker/dealer channel. Here we're also seeing early signs of growth in the managed account product. Accounts and assets grew in the quarter to reach about $35 million in 200 accounts, up about $20 million in 140 accounts. We are adding a handful of accounts every day and we were recently added to the program at Lehman. We continue on adding our product to the platforms of the major wire houses and this is a platforms of competitive the process. We believe we're making progress but we have not yet reached the finish line.

In the Edward Jones system our sales were up 2% from Q1 '02 levels. Our top selling fund products continued to be mostly equities including our American Leaders large cap fund, the market of opportunity mid-cap value fund, and the Capital Appreciation blend fund and also we've had increasing success with our High Income Bond fund. We continue to promote our recently relaunched variable annuity product in the Jones system, but it's been tough to get much traction in this rough market we've experienced especially when understood in the context of the Bush tax proposal. But we are still committed to this product on a long-term basis. Our sales at Jones continue to run at about a 4% market share with an '03 target of 6%. with a 2003

Looking at institutional during Q1, money market assets grew by $3 billion. This was driven by text school growth were there is some seasonality due to the timing of tax payments to the

municipalities in the pool. We are likely at the high water mark for the year, based on the pattern we've seen in previous years. We have also seen growth in the new prime money market which we launched with text pool last year as assets have increased to over $100 billion at the current time.

We continue to continue to add corporate as well with seven new cash management customers coming on board in Q1. These customers ended the quarter with about $380 million in new assets. In the insurance market, we were selected by Great West Life to subadvise the bond portfolio in their maxim profall retirement series product.

We also have benefited in this channel from increased allocations to fixed income products in various variable annuity products that we participate in.

Now,briefly an update on key initiatives for '03. Our managed account initiatives overall has grown to about $70 million in its very early stages. A key goal as mentioned is to penetrate the key wire house programmed with our strongest products and to leverage our bank relationships in this area. We are on track to launch our 529 plan in partnership with Schoolhouse Capital Statestreet later this quarter.

In Germany our sales have increased over the last two quarters and assets in the retail fund of our LVM partnership are approaching $300 million. -We continue to have success adding separate accounts, adding two recently for a U.S. fixed income recently to the tune of about $100 million.

Let's talk about the '03 outlook. At the beginning of '03, we stated that although we expect to continue long term growth and EPS of 15% or more, a more realistic range for '03 was 7-10% getting the head wind created by down drafts in the equity market over the past three years. This expectation was based on modestly positive equity markets with returns in the mid-single digit range for '03.

During the first quarter, here, equity markets again showed negative returns, with the broad market indices down 3% and the small and mid-cap indices down by almost 4.5%. Since we haven't had the early lift we had hoped for, it will be more difficult to produce the earnings growth we had initially targeted. Reaching the low end of our range, 7% EPS growth, however, is still possible given favorable equity and steady bond market conditions for the rest of the year. We are determined to continue to invest for growth, to come out of cycle stronger and better positioned to compete across market asset categories, particularly within equities where we are building strength upon strength.

We are diligently managing our expenses so that we can continue to make these investments while growing earnings, despite the market-based and equity asset market declines which we have experienced. We believe that these are the right steps to continue to drive growth in shareholder value, as this management team has done for decades.

At this point, I would turn it over to Tom to discuss the financials.

Thank you, Chris. Comparing Q1 revenues to the first quarter of 2002, most of the decrease is due to lower equity assets from market-based net asset decline. In addition, as we discussed last year, first quarter of '02 included $1.4 million in additional revenue from a one-time adjustment to the accrual for SEC fund fees.

In addition, previously discussed changes in third party fund administration business negatively impacted year-over-year comparison. Revenue declined in the prior quarter mainly from the two fewer days in the first quarter.

On the expense side, the variance in equity market performance versus our previous estimates drove the decrease in compensation and related expense compared to Q1 '02. This variance caused a downward adjustment of $2.4 million of incentive compensation. This adjustment included compensation related to the Kaufman acquisition turnout that is measured annually from the closing date of April, 2001.

Going forward the second quarter should return to a more normal run rate with compensation and related expense of approximately $46 million based on our current estimate. Professional service fees increased from the prior year and prior quarter due to the previously discussed legal outsourcing arrangement that began in Q4 '02. And the expiration in mid-Q4 of a credit we were receiving on outsourced portfolio accounting services.

Marketing and promotional expenses decreased year-over-year due to lower advertising spending. The decrease from the prior quarter reflects some seasonality, the launch of our closed-end funds in Q4, and as reductions in advertising and other marketing-related expenses. We expect full year advertising and promotional expenses to be slightly higher than 2002's total.

On the balance sheet, our cash and short-term investments stood at $119 million at quarter end. During the quarter we used $74 million for share repurchase, and $6 million for dividends. As noted in the press release, our board has authorized an additional 5 million shares to the 1.4 million shares remaining on our program at the beginning of Q2.

We remain opportunistic and enthusiastic buyers of our stock which we perceive as a compelling value as evidenced by the purchase of 2.9 million shares at roughly $25 a share in the first quarter. We believe that these purchases add to share holder value particularly when the market price implies a lower long-term growth rate than we expect.

In addition, we increased our quarterly dividend by 23% to $0.07 per share, reflecting both our strong financial position and the success we had in 2002 in growing earnings substantially.

We were gratified by the recent addition of Federated into the S&P 500 index, considered the premier U.S. portfolio index.

S&P states and I quote, "companies selected for inclusion in the S&P 500 are not chosen because they are the largest companies in terms of sales, market value, or profit, rather they tend to be the leading companies within leading industries within the U.S. economy." We are honored to be recognized as a leading company by an outstanding organization like Standard & Poors.

In summary, we continue to take the steps that we believe will build shareholder value. We continue to reinvest for growth by adding strength upon strength in the equities area, developing new products,and maintaining our powerful distribution capabilities. We will now open up the presentation for questions.

At this time, I would like to remind everyone in order to ask a question, please press star and then the number one on your telephone keypad. Your first question comes from Henry McVey, Morgan Stanley.

Can you hear me?

Yes. Hi, Henry.

A couple quick questions. One was just on the tax rate. I thought you guys had got a little bit higher for the year. That was the first thing. The second, I was just trying to get more color on using the money market as collateral. How quickly can that become an opportunity? I know you gave some parameters, but just a little more color there would be helpful.

And then, third, I know in the queue said something about the CVO. I think it was $600 million, can you just update us on that and where we are?

We'll do them in reverse, Ray will do the CBO. I'll do the collateral, and Tom will do the tax rate.

On the CBO, Henry, could you clarify your question?

Yeah. Is there the potential for anymore write-downs?Are you guys comfortable with the value?

The remaining book value is actually about $600,000. It's actually a little under $600,000

That's right.

The assets under management are about $500 million. Nothing has changed there. Essentially that remaining book value is from a support payment that's backed by one of the major banks, one of the top five banks in the country. So it's pretty unlikely that we're going to have any further impairment on that remaining $500,000, roughly, of book value.

And just in terms of 1046, is there any change there?

Well, we're still working through it. I think as it goes to one of our three CBOs, we feel presently that we won't have to consolidate it. The other two, we think, are candidates for consolidation. And it's really the management fee that leads us to that conclusion, the way the FASB guidelines have come down.

So there's at least a possibility for the second half of the year when this takes effect that we would have consolidation of a couple CBOs. I think it's important to recognize that there's no change, no economic impact, no change in our -- in our -- we have we have no recourse for the liabilities of the CBO. We, of course, have no entitlement to the assets of them either. This would strictly be an accounting change.

This is Chris, Henry. I'll make an additional comment on that.

It's unlikely for us to want to get rid of those good revenues in order to improve the accounting treatment. And so we will have to deal with what we have to deal with when those rules are finalized.

On the collateral question and our efforts with the options clearing corp., there are $10s of billons in this pot. And something about near half of it or so is in treasuries. And that is the pot that we think is eligible to come to us down the road here.

And I said that we would probably get these things accomplished within a 60-day period. And so that's the timeframe in which we would expect assets to begin to build. So, you know, by the time we get to the next call, we'll have some updates for you on that. Tax rate?

Tax rate, 35.6, Henry. And last quarter was 36.4. I'm sorry. The whole year last year was 36.4. And we're expecting it to be somewhere around 35.6, maybe just a little bit higher. You know, that's where we are. I don't what guidance you're talking about, but --

We're around 36. And just on the compensation, you said $46 million for the second quarter. Is that something we can extrapolate for the rest of the year or is that just for the second quarter on the comp.?

It would be reflective of where we would go for the rest of the year based on today's estimates. We phrased it as a second quarter estimate. You could read into it that it runs that rate roughly for the course of the year. Again, based on today's estimates and given the variability of the incentive compensation that obviously can swing quarter to quarter.

Hey, Henry, thinking about that tax rate for a second. We have invested a lot of our cash in tax-free. That might be what's throwing you off a little bit.

Okay.

All right. Thank you.

Your next question comes from Bill Katz(ph), Putnam Lovell.

I missed some of your opening remarks and I apologize if this question is redundant. Three quick questions, Chris.

Strategically, you're putting a major effort into building up the equity business internally. You're sitting on a fair amount of liquidity, buying a lot of stock, I was wondering if you could compare and contrast the share buyback thought process against maybe looking out and up an equity manager that might fast forward what you're trying to accomplish internally?

Well, we believe we have enough of cash and enough of financial flexibility to do either one. So, we don't look at it as, oh, if we're buying shares back then we're not buying an equity enterprise or investing in the people or systems or whatever we need to build the equity business. So they aren't usually exclusive. Now, to get to the spirit of the question, when we look at the valuation of Federated we think it's a good deal to be buying that at these prices as Tom indicated. And, of course, we would entertain other types of equity purchases such as Kaufman or other of our rollups that we've looked at. Each one of those metrics is going to be different.

As I mentioned on this call before, it's a lot like having a bunch of kids, each one is different and requires a different kind of handling and analysis. So I can't give you a crisp rule of thumb related to the share buyback ratios which are self-evident cause they're Federated's ratios and how we would comparing buying that to any particular equity shot.

As you look at your three to five-star rated funds, most of the industry flows are in the four and five-stars. It seems you have a fair amount of three-star funds. Is there any thought here as you add a lot of infrastructure here recently and things are generally turning higher, that you might look to set the bar a little higher in terms of the investment performance standards in order to accelerate more market gains?

Yes. That's what we're doing when I said we're changing ourselves in a couple of ways. One is to have more proprietary

research, which is a proxy for giving the research analysts and the industry analysts an eye-to-eye look at the contentof the portfolio with the portfolio manager. This is a different way of doing it then we had been used to previously. and then that's one important thing.

The next one is, when we begin, which we've done, to focus on benchmarks, the whole point of that is to do what you just said, namely to raise the bar on the performance because beating the benchmarks when you look at the statistics, again, depending on how much you set for the target in beating the benchmarks, that will put you in the top quartile over the long haul will beat the competitors, but also gives the clients a more disciplined approach because you are aimed at the benchmark.

The analogy that we've adopted internally for describing this is that a lot of times if you are managing as against the competitors of the peer group, it's lot like a dog a lot chasing -- chasing its tail because everyone is forever correcting against what the other guy did five minutes ago. And this is why we've done what we've done. It's a three-pronged attacks; it's the people, the proprietary research, and it's the hit the benchmarks.

And so, that's the philosophy of what we're doing. If we can augment that with careful selection purchasing of equity enterprises we would that with surely do it.

Okay. Second question I have, maybe this was in your initial comments or imbedded in your comments. Could you comment a little bit about what you're seeing in Florida in conversion from the [inaudible] benefits and contributions? Are you starting to see any flows shake free of that?

No.

Any sense of why at this point? Just market uncertainty?

Uncertainty is a polite way to express what's happened there. It's a little more than way to market uncertainty, because as you recall what we're talking about here is the pension plan of the state of Florida which was basically being -- they were offering the participants in that the ability to switch a portion or all of their account into what amounts to a 401-K .

So, the question is, did the individual investor or participant want to move from a guaranteed, a Florida guaranteed pension investment to a self-selected 401-K type investment. And, you can imagine that in '98, '99, 2000, etc. when this idea was being cooked up this was a very positive kind of a thing.

And so, it just isn't market uncertainty, which causes people to hit the pause button. It's a genuine fear of the dark in terms of leaving the security of that pension plan at this time. So, I don't know that we have any meaningful moneys from that account at this time.

Okay. Last question's a two-parter. I apologize. Could you talk a little more about what you think could be a fair distribution timeline, if you will, and trying to get onto some of the larger wirehouses in terms of their managed account business? And, what it might take you to do so. Is it just a function of the seizing of your products? [Inaudible] of distribution? Face time? And secondly -- let me get you to answer that first.

Okay. On the timeline, if I could have given you a definitive timeline, I would have given it already.We continue to work at it. We get closer, as I said in the comments. We are making progress. We've had meetings very recently. It's not a question of the seasoning of the products.

The products we are offering onto these platforms are solid products with outstanding records, some of them with unique positions and others with very good, competitive positions either with others on their platforms or filling spaces that they need to fill.

There is a lot of processing that goes on in these companies to get on these lists and its just a constant effort. So, I can't really give you a timeline and let me assure you that I've pressed this question right through this phone and right to the people we have working on this on a very constant basis. So I appreciate your support for this kind of a question.

Okay. Last part of the question here is the money market business, I think you said something like you added seven new institutional clients with roughly $300 million. Last couple quarters it's been around ten new clients per quarter. Do you have a sense that these have sort of seasoned into one year track records with these new clients? What were the starting assets and how high have they gotten now? I think it's been a couple $100 million each quarter.

Have these things grown significantly? Have they held flat? Have they gone down? What sort of being the angle(ph) evidence?

Well, the nature of the business is whether they are new clients or existing clients the underlying cash flow is driven by what is happening with that particular company. So, it isn't so much that they become seasoned here. And, after they're in the fold we don't particularly track them.

In fact, the person running that business will tell you that the 6 or 7 of his top customers were different at the end of the year then they were at the beginning of the year even though the top ten in total had higher assets. It's just something that shifts all the time. We don't particularly track that.

Okay. Thanks very much everyone.

Your next question comes from Mark Constant, Lehman Brothers.

Hi guys, couple of things. On FIN 46, have you spoken with lenders, anybody who has covenants that might need to be amended in terms of their looking through it even in terms of a purely cosmetic kind of change?

You mean are lenders for our own loans?

Yeah. Are there any covenants that would need to be amended as a result of financially consolidating them?

I don't think so. Mark, to us it would be analogous to what we dealt with for the first couple of years.

With the recourse, non-recourse?

Yes, with the B share issue.

Yeah. I know they looked through that. I just want to make sure that you are willing to look through this too.

Well, we would expect that they would, but it hasn't progressed to the point where we've actually had those discussions.

Okay. The collateral product that you guys put the release on before, is that a hybrid entry product or is that something where if you did start to see billons of dollars in assets of the next quarters you'd see the G-Sams and the Ames(ph) and everybody else show up with an equivalent product?

I expect that we will see competition as we usually do as much as we might try to get it all for ourselves. That isn't going to be the way this works. We are first. We did plow the field and that will give us a certain amount of advantage. But, I would expect the regular crowd to shuffle in.

If and when that is a matured into a significant piece of assets, is there an unusual kind of driver? If we were to look at the other forms of collateral today, what drives balances of those collaterals or of that collateral, rather? Anything, in particular? Is it particularly rate sensitive, market sensitive, etc.?

It doesn't appear to be rate sensitive because when you look at the collateral pool now it's actually a mixture of cash, equities, treasuries. It seems to vary by client. We just haven't had enough experience with it yet to give you some sense of the seasonality. It does seem to be consistently in the $10s of billons. $30, $40, $50 billon dollars.

Okay. And Tom, to your comments as for guidancy line item comments, the [inaudible] of $48 million would seem to suggest something a little bit inconsistent with your historical periods, even if you add back the $2.4 million. First of all, I would think that portion of the $2.4 million that was related to lower expectations of a Kaufman, I would expect that would be recurring in that sense. That is a lower equity asset base now.

But, wondering why, even if you add the $2.4 back, you're not at $46 and you're typically of the highest account accrual in the first quarter, not the second, or third, or fourth?

Alright, Mark, we -- the way the Kaufman deal works is there's an April deal so the $2.4, portion of the $2.4, would have been accrued in '02 and then adjusted in '03.

So, this is kind of the fourth quarter adjustment for the last year?

So, when you come into the first quarter of this year, well --no, there's no reversal. We just didn't pay anything. So you're kind of missing one quarter of --

Okay. So, you don't have the reversal, but you do have a lower go-forward accrual?

Right. Then looking at next year go-forward accrual, well we have to look at and judge if we think we are going to be paying them. And that's where you're getting the $46 million.

The $46 you're still assuming you pay them next April?

That's right.

Okay. And with respect to the respect to marketing and promo kind in the opposite direction, that's something that seemed to grow with sales and despite market depreciation sales have still been great. I'm a little surprised you don't expect that to be slightly higher year over year.

Right. Well, in there is advertising dollars that we have spent. And, well we have been able to pretty much maintain our exposure a number of times on TV and things like that, we've reduced the dollars there.

So that --

We will get payments that go along with assets increase. That's why the number will still be an increase.

Okay. Is part of it maybe a function of expected lower money fund assets over the balance of the year or part of the reason why it was not grow as much?

No, no, we reduced things other than related to marketing allowances. We reduced direct advertising expenses.

Okay. And last question. Chris, you mentioned the seasonal tax payments in your earlier comments as well as the curious but amazingly persistent quarter-end phenomenon of assets going out and average assets exceeding the end of period numbers for the last several quarters now, just wondering early 2Q on the money fund side did tax payments sort of dwarf that post-window dressing phenomenon? Did the post-window dressing phenomenon even exist this quarter or what should we expect looking at the average assets money fund this quarter?

Well, we're standing at $134 now.

On an average basis quarter to date?

That's the current basis and that average is going to be --that's on a

Right on top of that.

Okay. You said that earlier. I apologize for missing it. Thank you.

And, Mark, it did go up. Just to complete the thought on it, the early part of April saw the money fund assets come back in as they normally do after the late period outflows. Then when you get to the middle of the month you have -- you see the tax moneys go out and since then we've had some money come back in.

Okay. Great. Thank you.

Your next question comes from Steven Schwartz, Raymond James.

I want to follow-up on Mark's last question. Chris, you stated that generally speaking we see in the first quarter and then again in the second quarter flat to down money market assets. And yet on April 22nd after the tax date, they are up a little. So your thought pattern is here that we are likely to stick around the $134 billon mark?

When we talk about the trends, what we have seen historically is this kind of a trend. In a way, what we're talking about is two trends, the movement of the tax moneys out for tax time and restoration of some of that money ongoing, and the other trend is that the second half of the year over many years of being in this business has been better than the first half of the year in terms of either total assets or average assets. Now, any one day you get numbers to move around that you could have anything going on at all related to corporations, changes in interest rates, and a thousand things that would be very hard to pin on those two trends in a precise way.

I want to also follow-up with a comment you made -- I wasn't writing fast enough, on text pool, was this likely. The high water mark did you see that?

Well, the way text pool works is because of tax payments to municipalities in the state of Texas. That tends to swell that account roughly a little before this time of year. And so, the municipalities will be building up cash as people in Texas pay their taxes. Then as the year rolls along they will tend to draw that down a little bit and this is what we saw happen last year with this account.

From our knowledge of having talked to this people and seen it from before it's what has happened before that counter to the trends I mentioned in the last comment, the assets in text pool tend to be higher in the first half of the year then they are in the second half of the year. This is really a function of tax collection in the municipal level in the state of Texas.

Okay. Then I'd like to follow up on another comment you made with regard to the earnings outlook where the low end of the range, that 7 to 10, was still do-able. I think you said given decent equity markets, I was trying to put a number on that, on what you were looking for compared with the fact that we're up over 7% this quarter so far.

Well, I've also learned not to try and rely on what's happening in a given quarter. We're off the beginning quarter. So, this kind of trend continued would be what we had in mind. We want to see green screens the rest of the year. And as we said initially, we were looking forward to mid-single digit type returns during the whole year.

If you don't get that in the first part of the year, i.e. the first quarter, and if, in fact, you get 3% and 4% and 4.5% down then you have to make that up over the rest of the year by a little bit more than that in order to come out in the same spot. So, without putting precise numbers on it, that's what we're trying to say.

Okay. So, I'm going to try to make you put a precise number on it. I apologize. So, that 7% number is looking at, say, 2% per quarter?

Each quarter every day, you see if you go 2% each quarter, you see you could get 2% at the end of the quarter, but you wouldn't have had it during the quarter and you wouldn't have had the earnings.

No, I mean rolled out evenly.

You have to factor in also what is going to happen to sales. When you say the equity market is going to go up, you're making some estimations that your sales are going to pick up too. And they have to go together. You just say, well, the market's going to go up and it's going to be this much and then we see producing some earnings number -- well what happened with sales?

If you had what you said, which is this quarter, meaning the second quarter, up 7%, now notice you are making a forward-looking statement there. You deposit this, then have a steady 2% increase throughout the next quarter and the next following quarter--

No, I'm not talking about the 7%. Let's assume this quarter is 2%, and the next quarter is 2% and the next quarter is 2%.

I don't know about that being so favorable. But, I like the other one where if you go 7, 2 plus 2, and you end up with 11% for the year. You know, now, we've got a favorable deal going.

And, Steve, there's also another point to that, what's happening in the bond market, in interest rates.

I understand. On interest rates, and this will be my final question, we've kind of touched on in the past, I'm surprised we didn't touch on it this time around. I know speaking with a lot of clients, maybe it's dissipated a little over the last week, but there was reasonable fear out there about a 50 bit cut in rates by the fed, what that might do and what might even greater cuts by the fed do to your money market business?

Right. One of the reasons we didn't cover this is before two weeks ago when the market place was building in a high likelihood, almost an uncertainty of some kind of meaningful rate drop, now that isn't the case today if you look at those numbers. Anyway, in order to try and get to the answer, we have approximately $3 billon in assets that currently have net yields of 20 basis points or less.

We have $20-25 billon of assets that currently have net yields of 50 basis points or less. We have an attitude that in the event that further rate decreases cause our funds to have gross yields that are insufficient to cover the operating expenses that we are going to be enthusiastic about considering options to keep the net yields of the funds positive including waivers of fees and sharing with our intermediaries to the extent necessary to keep the waivers positive.

Now, remember that we share some of the fees of these funds with our intermediaries and so, when I say we share some of these reductions that's what I'm talking about. I would add that if any of this actually happens we expect it to be temporary and we expect to be constantly evaluating this for continuing it based on all the facts and circumstances.

Now, I'm going to let Ray do one better so you don't have to ask and give you the sense per share should any of these things occur, i.e. a 25 dip decrease or a 50 dip decrease.

The assets are an indication, but to asses the impact you really have to look to each of the individual funds. They have different structures and make some estimate of how things would react in a 50 basis point decrease. And, of course, we would expect to have money come in on the institutional side as we have typically whenever rates have come down. You would overlay that with the arrangements we have with the clients. Those are not standard either.

When you cut through all of that, we continue to think that if rates were to fall by 50 basis points it would impact us by about $0.04 or $0.05 on a forward 12 months annual basis from the point of the rate decrease. That's not giving a whole lot of offsetting credit to money coming in on the institutional side. Most of that would be from what we estimate we would have to wave from our fees.

Okay. Great. Thanks.

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

Good afternoon, everyone. Just a couple of quick questions since most of them have been asked. But, in prior quarters, Chris, you had talked about from an operating margin perspective that's sort of from this mid-40s range is that where it's going to be? So, in keeping with your longer term perspective of that you can get the company back to 15% earnings growth should we be thinking of that solely as being top-line driven with some contribution from your 1 to 2% share repurchases? How are you thinking of that longer term? Or do you think you can get margins to improve some over time some more?

Well let's first of all talk about the margins. Our comments have been that the 47% was the high water mark and that we are comfortable with saying the margins are in the mid-40s. So, that's the comment on the margins.

Into the future, the idea of increasing those margins would be a stretch in my mind looking at it right now. So, I wouldn't be building into our future increasing margins as a way to get to those answers. Now, if we're able to figure out ways to do that, we would certainly be happy to do that. But, I wouldn't base it on that.

So, what is the source of that. The source of that is getting our assets to go from $200 billon to $400 billon, which is our five year plan if you will. And, we can do that through both organic growth and we have the sales and the history for doing that or we can do it growth by cheating, which is to say our acquisitions which we have done a little of as well.

Now, when you overlay that with the share purchases, I can ascribe to a notion of a given percentage of share buyback in a given year because we don't look at it like that. If they come out to some number that someone could look at over time and say that is in fact what happened because we look at that on an alacard(ph) basis. We bought a larger bunch of shares in the first quarter then we had been historically buying for the last year or two.

So, it's episodic based on our evaluation of what we can do in the marketplace. But, I would expect that since we like buying the shares and remain active that there will be some assistance if you will to the EPS growth from that factor. But, that is not a driver. That is a result.

Okay. Lastly, at the risk of beating a dead horse, you know your guidance for the year -- how do you think of that in terms of growth of your money fund assets? Are we sort of assuming that where you are now is where you finish or that you get your normal sort of end of year pop in assets? In terms of your 7% guidance, how do the money fund assets look?

Let me comment on 7% guidance. What Chris said is that it's still possible for the market and steady bond markets. I just want to reiterate that. In terms of running a scenario that gets you through there, you know we could run 50 different scenarios to get there. And, we run a fair amount ourselves and have come to some basis for saying, look we still see that is a possible thing and put different interest rate scenarios in there.

I would say that a 50 basis point rate cut is not in the scenario of reaching 7% EPS growth.

Let me answer your question about how do we look at the money funds. First answer is that over the long haul we look at them as a growth business for us because of our ability to create new ways to use money funds, gobbling up a larger market share of M3. And this, DTC Clearing Corp. option is part of that.

In the given year, if you look at strategic insights forecast for the year, just as an example, they give you three, the great, the middle, and the poor. And in all three they have money market funds up, which is kind of interesting.

And so, whenever I do any projections on where we're going I always insist on the money market fund assets being up because we don't yet have even 10% of the money market fund assets in trusts. We don't even have a 2% market share of M3. And, it isn't just rating the other money market fund venders and competitors. It is going out and doing the real spade work of creating more opportunities for these funds.

And so, any scenario that we have has them going up. Now, if you ask me well what is going to be looking out the most likely ingredient to growth for the year, then I would look at where we are today and where we've been in the past first quarters, which is to say that fixed income assets and the sales picture remains the story, not a lot different than the prior quarters. Those would tend to be the engines of growth. But, we can't exactly predict what will happen in the next three quarters.

Fair enough. Thanks a lot, guys.

Your next question comes from Casey Ambread(ph) at Millennium.

It's actually been asked and answered. I wanted to talk to you a little bit on the fed cut. But, stepping back, do you even expect the fed cut? Thanks very much.

Several of our portfolio managers expect it next week. There are some who think there will not be fed action. There are some who think they will take action, but nobody thinks they'll take 50 basis points action. And, beyond that I'm a lawyer.

Okay. Thank you.

You have a follow-up question from Mark Constant, Lehman Brothers.

Actually a couple of little ones. You said $20-25 billon is a 50 basis point or less in that yield and what was the 25 basis point or less in that yield?

About $3 billon.

About $3 billon, okay. And to take your lawyer hat off for a second, Chris, and at least paraphrase the other folks. What are your thoughts on the likelihood of short-term investible asset yields, tracking, fed cuts? In other words, if there was a 50 basis point fed cut presumably that doesn't mean every other short-term investible asset falls by the equal proportion.

No. It's kind of amazing in there cause you get sometimes the opposite result inside the municipal area where they want the money to still flow. So, you don't get the normal kind of result there because they want the cash from the money funds and they want the cash in money funds because they are an integral part of the capital market system.

At those kinds of levels, you get some different kinds of effects. Historically, you have not gotten precisely that kind of flow-through in all the markets. You do get it in several of them especially in the treasury market, but I don't think you get as much as you get historically in the corporate market because people are a lot more concerned about two things, diversification and credit, than they were a couple of years ago.

So when you say the 50 basis points scenario, you're really talking about the basis point declines in short yields even if that means 75 of net?

Well, yes. When we do the math, you are correct. If you're doing the math, that's exactly what it is. But, if you look at our -- right now, our gross yields on the muni funds are 145 and this is in one of our series. And our gross yields in the prime fund are 144 and this is supporting part of that reversal that I was talking about where because of the importance of that muni money in the municipal capital market system they want to bid to have that money stay. So you have those kind of factors.

I think that was actually the only question. Thanks

You have a follow-up from Steven Schwartz, Raymond James.

Another quickie. Could you say, looking at the second quarter, assuming no buybacks, what we'd be looking at for the average share count?

Down about 1.5 million from the 113.9 in the press release.

You have a follow-up from Mark Constant.

I just can't quit. You were talking about the 7% plus 2 plus 2 scenario, basically maintaining what we got? I assume that is more bullish than maybe making 7% scenario although you're not comfortable with it. That scenario, what we've had so far in the second quarter, I assume that's not what you're talking about when you say 7% is possible. That would be something more optimistic than 7% is possible?

Yes.

Thank you.

At this time, there are no further questions.

That concludes our call. Thank you for joining us.

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