Federated Hermes Inc (FHI) 2007 Q1 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Federated Investors Inc. first quarter 2007 earnings conference call. At this time all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Ray Hanley, President of Federated Investors Management Company. Mr. Hanley, you may now begin.

Good morning and welcome. Today we plan a brief overview on the quarter before getting to your questions. Leading today will be Chris Donahue, Federated's CEO, and Tom Donahue, Chief Financial Officer. And also with us are Dennis Macalley and Laurie Hansler from the corporate finance group. In terms of forward-looking statements, let me say that certain statements will in this presentation, including those related to money market assets, performance, sales, new products, and acquisitions, constitute forward-looking statements, which involve known and unknown risks and other factors that may cause the actual results to be materially different from any future results implied by such forward-looking statements. For a discussion of the risk factors, see the section titled "Risk Factors and Cautionary Statements" in Federated's annual report on Form 10-K for the year ended 12/31/2006 and on other reports on file with the SEC. As a result, no assurance can be given as to future results, and neither Federated nor any other person assumes responsibility for the accuracy and completeness of such statements in the future.

And so with that as a preamble, I will turn it over to Chris to talk about the quarter.

Thank you very much. Good morning, all. I will begin by reviewing Federated's business performance in the first quarter before turning the call over to Tom to discuss our financials. Starting with the cash business, money market fund assets grew by nearly $9 billion from the prior quarter. The Q1 growth was strongest in the trust and broker dealer channels. Cash separate accounts added another $3.6 billion in assets to reach a seasonal peak of over $22 billion. Following the multi-year seasonal pattern we've seen, we expect these separate account assets to decrease over the next two quarters.

On the institutional side of our money fund business, the interest rate and yield situation of recent quarters remains in place. The net yields on our institutional prime funds are a few basis points below the overnight rate. The money fund portion of the yield curve remains essentially flat to inverted. Therefore, we haven't experienced much growth in this part of our business, though other channels have shown robust growth, especially over the last couple of quarters. So the money market competitive situation we discussed last quarter remains in effect. On this institutional side I've been discussing, certain competitors have grown largely by offering lower-cost products or by waving fees. This impact is meaningful for certain investors, as lower fees enable some funds to offer net yields greater than the overnight rate. We believe that this type of asset does not tend to have much persistency, especially when compared to the rest of our money market fund business.

In terms of market share, we are at about 6.7% as of the end of the first quarter, up from about 6.6% at year end. During Q1, we gained share mostly against the ICI's retail money market data and even gained a few basis point of institutional share. As we've noted before, we believe that short-term metrics on money market share are less useful than share over longer periods. And we expect to continue to grow our market share over time, as we've done over the last ten to 15 years. An update on our functional equivalency efforts for money market funds shows the CFTC application ended the quarter at about $700 million while the OCC, Options [inaudible] Corp., grew to about $500 million. We're working through legislative efforts to enact the changes we've been seeking with the SEC around 15C33, which is broker cash. In fact, a bill has been introduced in the house, number 1171, and we are looking for support from the senate, as well. The cash funds international multicurrency product with BNP Pariba and Henderson continues in its early stages. We are actively working on the product introduction and marketing efforts with our partners.

Turning to equities, assets have increased by about $440 million from the prior quarter. The growth came from market appreciation and from positive flows in separate accounts offset by net outflows in mutual funds. The equity mutual fund outflows increased over the prior quarter. Among our actively managed products,three areas collectively produced more than 100% of the outflows; large cap value, large clap -- cap blend, and the Contrarian Market Opportunities Fund. We continue to work on repairing the records in large value and blend.

The Large Blend Capital Appreciation Fund has improved its performance substantially over the last 18 months, maintaining itself in the top quartile, though the flows here continue to be negative. Large value showed some improvement in the second half of '06, but underperformed in the first quarter of '07. The market opportunity fund is a unique strategy that is not correlated to the U.S. equity market as we've discussed before. Though its relative performance is not significant performance measure, it will tend to outperform its assigned category in down markets and under perform in up markets with the predictable impact on rankings and flows. Thus the fund had outflows in January and February following the up market in Q4, while in March it went back to positive flows when the equity market hit some speed bumps.

The Kaufmann Fund did have modest outflows in Q1, more or less consistent with industry results for domestic growth funds, while the Kaufmann Small Cap Fund continued to produce net inflows. Net outflows in our actively-managed equity funds are running at a lower pace for the first three weeks of April compared to the first quarter. Assets in the MDT Equity Mutual Funds grew 16% in the quarter to reach $531 million. We also continued to have success with MDT in the institutional area, winning two new accounts in Q1 with initial funding of about $50 million expected by the end of the second quarter. Early in Q2, we also won another three accounts with $26 million expected to fund during this quarter.

MDTs SMA strategies were reopened during Q1 as we discussed last quarter. While not reopened for the full quarter, the response was favorable and led to slight net inflows in these products compared to net outflows in Q4. MDT total managed assets in mid April were over $8 billion, up $1.4 billion from the total at acquisition last July. We also continued to expand distribution and produce solid net inflows with a lot of positive momentum in our strategic value SMA product. Our total SMA assets crossed $10 billion during the first quarter. Overall, equity separate accounts, including SMAs and institutional accounts, produced $225 million in net inflows during the first quarter.

Turning to the fixed income side, net redemptions increased modestly from the prior quarter. This was due to the redemption of about $40 million from the LVM Insurance Company, our partner in a family of funds sold in Germany., and this was related to their corporate purposes. Otherwise redemptions would have decreased slightly from Q4. We also had positive flows in our total return, strategic income, total return government bond funds, and in the Federated bond fund, and outflows in GIC product, international bond funds, and return to slight outflows in the ultrashort funds. In Q1, the ultrashorts had net outflows of $25 million. For the fourth quarter they had net inflows of $25 million.

Fixed income fund performance remains strong in most products. For the first couple of weeks of Q2, flows are negative and on a similar pace to Q1 minus the LVM redemption that I discussed. As of April 25th, our managed assets were approximately $252 billion, including $186 billion in money market, including funds and separate accounts, $43 billion in equities, and $23 billion in fixed income. Money market mutual funds stand at about $164 billion. Typically, the industry experiences tax-related outflows in April, and we did see some noise around April 15th, but have so far shown continued growth here in the second quarter.

Turning to investment performance, Q1 was another solid quarter for many of Federated's actively managed equity funds. About half of these funds were in the first or second quartile for the quarter and for the trailing year. In February, the Lipper Baron's annual fund family performance rankings placed Federated as the fourth best firm out of 67 companies for the one-year domestic equity performance. On the fixed income side, and using the lowest expense share class, two-thirds of our funds were top quartile in the first quarter and 62% are top quartile for the trailing year. Looking at the March 31 Lipper rankings for Federated's domestic equity funds, 69% of the rated assets are in the first or second quartile funds over the last year, 64% over three years, 52% over five years, and 59% over ten years. For bond fund assets, the comparable first and second quartile percentages are 92% for one year, 84% for three years, 79% for five years, and 71% for ten years.

Let's talk about distribution. In the wealth management and trust area, we added nine new institutional cash management customers with initial assets of $76 million. Money market assets in this channel grew by about $3.7 billion, driven by gains in bank trust. We also saw solid growth in the equity managed account product, with assets up 14% in the quarter to reach $844 million. In the broker dealer channel, growth in the SMA equity product continued. Assets grew 5% in the quarter to $9.2 billion. Money market assets also continued to grow in this channel, gaining about $3 billion in the quarter. Within Edward Jones, money market assets continued their strong growth. Net sales of equity and bond fund products at Jones improved, but remain negative. We have had four straight months of higher fund sales and we continue to devote substantial resources to improving our results in this area.

In our global institutional channel, we continue to have success on the institutional side, winning two new accounts in Q1 and five more accounts early in Q2. Total assets funded from these wins will be about $219 million. We continue to experience elevated RFP activity and to reach more finals presentations for institutional equity account opportunities since the MDT acquisition and for our stronger fixed income mandates. We announced the acquisition this week of certain assets of Rockdale Investment Management, related to the management of a $321 million top-ranked Rockdale Atlas portfolio. Upon the expected Q3 closing, the assets of this fund will be transitioned into the new Federated Intercontinental Fund. Two of the current portfolio manager -- two of the current portfolio team members will join Federated and will be the co-managers of this new fund.

The acquisition will include Rockdale's proprietary quantitative investment model that focuses on a country selection process that has helped the portfolio outperform its peers over multiple time frames. The investment record will, of course, carry over to the new fund. Rockdale will continue to use the product in its high net worth business, where existing assets have been raised. Federated will develop new distribution across our intermediary channels and we expect to be able to increase assets in the fund given its strong performance record. We remain interested in additional acquisition opportunities and continue to have discussions for both consolidation and center of excellence deals.

Tom? Thank you, Chris, and good morning, everyone. For Q1, revenues increased about 11% compared to Q1 '06, and 2% from the prior quarter. The increases were due mainly to higher money market and higher equity assets, partially offset by lower revenue from fixed income. In addition, the MDT acquisition impacted the year-over-year totals. The revenue growth in sequential quarters came despite the negative impacts of the lower number of days of about $6 million. On the expense side, the increased comp and related expense from the prior quarter was from seasonally-higher payroll taxes and 401K contributions, higher base pay and incentive comp accruals, as well as the $1.1 million in severance expense. Compared to Q1 '06, the increase was mainly from MDT as well as higher incentive comp accrual offset by lower severance expense.

Marketing and distribution expense increased from the prior quarter and from Q1 '06 due largely to money market fund growth, in particular, in the broker dealer channel, where products are structured to pay distribution and services -- service fees. The Q4 expense included a nonrecurring $1.5 million credit. Fewer days in Q1 impacted the sequential comparison by about $1.5 million. Professional service fees -- fee expense decreased from the prior quarter due largely to lower costs related to legal matters, including civil litigation. Costs remain difficult to project in this area due to ongoing civil litigation and the ongoing process to distribute the 2005 SEC settlement. The total level of these costs remains undetermined as does the related insurance reimbursements. The operating margin for the quarter was 31.7%, including the $1.2 million from severance and related expense. We continue to look to grow margins if markets remain favorable, money market assets continue to grow and equity and bond products net sales improve. The Q1 tax rate was 37.5% and we continue to estimate our full-year 2007 tax rate at 37% to 38%.

On the balance sheet, cash and short-term investments were $134 million at the end of Q1. We recently paid $13 million for the second of five earnouts to Alliance for our 2005 money market acquisition. The first of three potential contingent payments from the MDT transaction is expected in Q3 2007 and can be up to $43 million. With the assets up $1.4 billion or 21% since the acquisition in July, we expect to make the maximum payments in Q3. The Rockdale up-front purchase payment will be $5.75 million expected in Q3 '07. We will also likely pay Rockdale contingent purchase amounts over five years based on revenue and performance. In addition, we can pay up to $5 million at the end of the third year and up to $20 million at the end of the fifth year less any amount paid in the third year. All payments are based on asset growth and performance. We expect the Rockdale acquisition to be neutral to book earnings in year one and two.

And that completes the financial, and we would like to open up the conference call to questions now.

Thank you. (OPERATOR INSTRUCTIONS) Our first question's coming from Mike Carrier with UBS.

Thanks, guys. First a question on expenses. Seems like the advertising, the travel and other all were down pretty significantly sequentially in between 20% and 30%. You gave some color on the professional service fees, but anything in those other buckets in terms of unusual items either this quarter or last quarter or kind of a normalized run rate going forward?

Mike, it's Ray. On the travel that's seasonally low, as the first quarter tends to be our lightest for travel and so that's kind of consistent year over year. The advertising and promotional is not traditional advertising as you may see in some of the other companies. It's more to do with the timing of some of the events that we've run, so I would expect that that will come back up to more like a trend. I think that probably was a bit low in the first quarter. And then in the third one you mentioned, the other, that kind of catches everything else. There were a few things we talked about last quarter that were in the Q4 number that were not there in Q1. It's hard to talk about a run rate because there's very little in that category that's predictable, but I think Q4 was probably higher than the trend.

Okay. And then just a question on some related to to your business partners. In your 10-K you note that Edward Jones and Bank of New York both contributed about 26% of your revenues in '06. So given first that Bank of New York announced that due to the BK Mellon deal it plans to bring at least $50 billion of its $100 billion of outsourced in-house to Dreyfus, just trying to get a sense, what do you view is the impacted at Federated and can it be minimized? And then secondly, just what exactly does it mean to be taken off the preferred list at Edward Jones and what do you expect the impact to be, if any, and have you seen any?

Well, let's deal with -- this is Chris. We'll deal with those in reverse order. In terms of the Jones situation, our relationship with Jones remains very, very strong. We have statements made in the letter in which the head of Jones advised us of being put to the focus list as opposed to the preferred list desiring a continuance in and a growth in the relationship and we continue to work to get back on the preferred list, which we would prefer. Since that has happened, we did experience back in the third and fourth quarter lower sales and higher redemptions, but as I mentioned on the call, that has begun to turn around, and our sales are as good as two of the other people who are on the preferred list as we sit here right now, so we continue to work on that. And the efforts with the Jones money fund continue unabated, and in that same letter it was also confirmed that the money market fund remains a strong and vibrant part of the daily life of the Jones system, so it's a very important relationship to us.

And how can difficulties be minimized? Well, as you can imagine as I said in my remarks, we continue to devote substantial resources to this effort. We have increased the number of sales people who can call on the Jones offices. That number is now over 50. And we continue to improve the product offerings there and that includes the MDT offerings, which came in after their analysis. And also the Rockdale product, which will assist us in their analysis and hopefully enable them to see the beauty of putting us back where we belong on the preferred list. So that's kind of the Jones situation.

As regards the Bank of New York and Pershing and Mellon, a couple of introductory points. First of all, it's very difficult to find a large bank in the United States that doesn't have at least $1 billion with us and that includes Mellon, and don't forget that Mellon has had Dreyfus for many, many years. The reason for that is that our relationships with these institutions are long-term, they're deep in terms of size of assets and customer service aspects, and they are many, many faceted, meaning different kinds of products from corporate trust to state tax free and different types of money funds. And they are many products and they're also relationships that are going both ways on several of these accounts, so you have a long, deep, and multifaceted relationship.

Back in '05, we acquired the Alliance money fund business, and as you may recall, the guts of that business was the Pershing clearing platform, which includes a large number, literally hundreds of third-party brokers that used cash sweep systems in their Pershing clearing platform. And at that time that we were doing that deal with Alliance, they put in an open architecture for money market funds that at that time they viewed as being very important to enhancing that business and keeping those customers. And so right at the time we were buying that operation from them, that was made clear to us that that was an open architecture and they were committed to it. The Pershing people have recommitted their desire to keep that open architecture in that Pershing system because it's designed to keep customers and offer the best possible product to the Pershing customers.

Now, when we closed the Alliance deal, there were just under $20 billion, and the lion share of that, of course, was from these third-party brokers that were using Pershing. And we've been working successfully with Pershing and the underlying brokers to grow the business, and these average -- theses assets averaged about $24 billion during '06 and have continued to grow. And importantly, what we've done is helped the brokers grow their own business and addition, have helped Pershing add new customers to their list because we do this as a focused effort. And in terms of the payments, another part of this to remember in terms of analyzing the impact is that we recently made the second of a five-year earnout deal payment to Alliance, which was $13.3 million and that's calculated roughly at 70% of the net revenue from the acquired assets. And so net net, we expect Pershing will to continue to offer open architecture in its platform because it's been so popular with the clients that are using the system.

Now, in addition, Bank of New York, as I said at the beginning of an answer to this question, like most other large banks. works with us with a portion of their cash management needs. And we've found that even large banks with large proprietary money funds don't have the array of product and the character of product that they may need for all of their trust customers. For example, they may not have state tax-free funds, they may not have repo funds, they may not have ton repo funds, government nonrepo funds. And there are various aspects of the cash management business where using Federated becomes the best answer. So obviously Bank of New York and Mellon can decide and have the power to do what they want to do with their money and this is -- remains their right, but we, of course, are working hard to keep the business and grow the business that we have. Now, our filings contain information on the -- pardon me?

I'm sorry, I didn't -- yes the filings have more of the acquisition detail, but we've been through that, so --

Okay. So in other words, we have a good strong relationship there and it's important and so overall it's disclosed and we continue to work it very hard. I know it's a question for everybody, that's why I went so long on the answer.

Okay, thanks for the color.

Our next question's coming from Ken Worthington with JPMorgan.

Hi, good morning. Just as a follow-up to that question, is there a fee sharing relationship between you and Pershing?

Yes, as would be typical with those kind of products and across the whole book of business like that there would be that type of contract.

Okay, great. Thank you. And then if we look at margins year over year, margins increase slightly. I think if we back up the severance last year, margins -- operating margins are somewhat flat, the AUM is up 15% year over year, can you address why we're not seeing more margin expansion given that the assets are -- they are growing nicely?

Yes, Ken, this is Tom. You've got to look at what kind of assets we are getting in there and -- for instance, the CDO that we got $1 billion last year, that's a single-digit fee. If you look at the assets coming from a TexPool arrangement, which doesn't have the same revenue as the -- our money funds. And when we add in the assets from MDT, the majority of the assets there are the -- from the SMA world and those fees are not as high as the mutual fund side of things, so it's really the mix that's driving the margins.

Okay. Thank you. And then, each quarter you have marketing programs. Can you talk about any marketing programs you had in the first quarter and as you ramp up the marketing in the second quarter, which areas do you really plan on focusing on?

What we've done for the year is create a list of focus funds that we have had the sales force take a look at. And naturally, they're different for each channel and that's because there are different needs in each channel. And the focus funds include some of the ones that we keep mentioning on the call; the Kaufmann funds, the MDT funds, and in the fixed income funds, the total returns, strategic value, and there are others. And so in each of the channels, there are specific focused funds and focused programs behind those in order to drive those sales.

Okay, great. Thank you very much.

Our next question is coming from John Fox of Fenimore Asset Management.

Yes, hi, good morning, everyone. I have a few questions. First, I just want to confirm, on the MDT, you said it grew 16% to $531 million and that's from 12/31/06?

Yes.

Okay. And the comment on the marketing and distribution expense and the number of days, are you saying it would have been $1.5 million higher with an equal number of days?

Yes, the same comment as the revenue being $6 million higher, that's daily based, largely passed through from the funds.

Right. Okay. And just on the buy back -- and I know you like to score on all three streets -- but you had about $45 million of buy back in each of the last two quarters, is that kind of the run rate at this point?

We just don't look at it as a run rate. We're opportunistic and where are things going to be this quarter. We don't look at it as a run rate basis at all, and Chris, I don't know if you want to follow up --

That was the run rate historically.

Okay. All right. We'll move on. And can you just talk about the Atlas fund. Obviously the track record's fantastic and I guess you're going to fold that into another fund and what kind of is the potential in your minds at this point?

Well, first of all, fold it into another fund, we have a new Federated shell that we're moving that fund into for a lot of internal [mergeresque]- type reasons. So it really is the same fund. It will carry the same record, you'll be able to find the same record, it would just have the Federated nomenclature, Federated intercontinental fund.

Okay.

So it's not being merged into another Federated fund. We're keeping that fund with its own record and its own portfolio management style, et cetera. Now, the potential for us is multi billions of dollars. We think that there is an overall trend, which is pretty obvious and all of you on the call know about it, about the movement of assets from domestic focus into international focus. And whatever's going on quarter to quarter is one thing, but over the long haul, I think that the investing public has recognized that you can't just go with home cooking only. Intuitively they have recognized what I always refer to as those sideways parabola curves, the efficient frontier, and people begin to see that going international is a good risk-reward type situation.. And if you look at the flows over the recent time, they've been very, very strong. We think that, with our intermediary distribution, this kind of a product that is focused on country selection by a quantitative analysis that has a proven way of doing it will aid not only that fund, but also our other funds, as well. So that's how I would say about the potential there.

Okay. Thank you very much.

Our next question is coming from Prashant Bhatia with Citigroup.

Hi.

Morning, Prashant.

Good morning. Just in terms of the Jones relationship, can you remind us again when you get a shot to get back on the preferred list? Is that coming up soon?

That is ongoing right now. They do that every year.

Okay, so in the next quarter or so we'd have a --?

They have not told us when they'll make their decision, so you can't put a time frame on it.

Okay, but there's potential to get back on that list?

Oh, yes, there's potential to get back on the list.

Okay, and then also on the Alliance funds that you acquired, if that were to move back to, say BK Mellon, would your payouts to Alliance stop -- your earnouts stop?

Yes.

Okay, and how much is left on those earnouts?

Well, we paid two years out of five years, and it's a percentage of the revenue. Our last payment was $13.3 million.

Which was 70% of the number.

Okay.

So 70% of whatever the number is they don't get because it's not there.

Okay. Perfect. And then, on the MDT side, do you have any kind of data in terms of the number of advisors that are now actually distributing the MDT product and do you have a view on how big number that can potentially be, based on your distribution relationship?

When we started the -- when we purchased MDT, they really did business with four big SMA providers and they also has mutual funds sold through those four providers. So we've opened it up on the fund side to our whole distribution. We don't go in and look and see how many have sold it, but it's a pretty substantial amount of our -- through our distribution that have sold the products. I don't have a number for you.

And then, Prashant, the next level underneath that is not only does it get introduced into those systems, but we've been having a lot of success getting it through then another level into particular programs within those systems. So wrap programs and retirement programs and all of that is kind of building quarter by quarter.

Last comment on it would be that the institutional sales in there, as we've mentioned in the last couple of calls, has gone pretty well.

Okay, so it wouldn't be that surprising to see the trend of flows at MDT that based on where you are today, at least on the mutual fund side, grow from here? We're not at a steady state yet?

We -- that is what we would hope and expect. In other words, the sales have been running about $1.3 million or so a day, $1.3 million to $1.4 million, which as I pointed out before, is a little bit ahead, but similar time frame on the similar Kaufmann share classes back when we were doing that roll out. And we would expect that to increase into the future, but we're -- it's a good move now, but it can do a lot better.

Okay. And then finally on the money funds coming in through the brokered dealer channel. Based on where we are, where rates are in money market funds and where deposit rates are, is it reasonable to assume, based on what you're seeing, that pace of flows at least continues at similar levels?

Well, it -- we would be hopeful that we would be able to continue to see that kind of growth from the broker dealer world, but it isn't exactly related to the movements in interest rates. When they're at this kind of a level, meaning in the four's or whatever the net yield happens to be on the retail accounts, then those customers are okay leaving cash and awaiting another investment decision. So if that's what your question is, then yes. But they are not sensitive to what the Fed may be doing or what the repo rate is, and so that business grows because more young people get into the business and start getting customers and want to get a bigger share of wallet and more experienced players get bigger experience and get bigger accounts, and then when they get those accounts, they come into the cash, as well. And that's what's really going on. You're seeing the effects of the success of the intermediary or advice model as these brokers grow all across the country.

Okay, great. Thank you.

Our next question's coming from Marc Irizarry with Goldman Sachs.

Oh, great, thanks. My first question is on your wholesaler productivity. I guess you've made a lot of strides in terms of refocusing your distribution efforts and added some product. I was wondering if you had any update there in terms -- in particular in terms of your distribution away from Edward Jones? Thanks.

Marc, one measure is, if you look at the gross sales sequential quarters, those numbers are up and that's obviously a critical way that we look at wholesaling success. It's a little bit harder for the wholesalers to stem redemptions. They certainly have that among their charges, but the most important thing we're looking for there is for sales to increase and that happens sequentially.

Great. And then, Chris, I think you offered some color in terms of the trends in equities so far quarter to date. Can you maybe differentiate a little bit between the redemptions, maybe the outflows versus the gross sales? Thanks.

Redemptions -- well, look at -- take one of the funds that was most particular, the capital appreciation fund, where Carol Miller has done an excellent job of repairing the investment performance. Basically if you look historically quarter to quarter on the total redemptions in that fund, back in the June quarter, they were over $300 million, in the September quarter they were $230 million, in the December quarter, they were $220 million, and this quarter just concluded, they were a little over $180 million, and they're running at a rate that is meaningfully less than the $180 million right now. So at that point, you're beginning to see some impact, not only t he fact that the fund gets fewer number of shares because it's in net negatives, but because the performance is starting to click into the underlying investors when you have the one-year base -- the one-year numbers being in the top quartile, the five-year number slipping into the top half, and that's part of the effort in that fund. So that's one bit of delving into the color cap ap.

And Marc, another way to look at, the net redemption essentially were heaviest in January. They then improved in February and March, and it's only a couple of data so we can't really make too much of it, but the trend of the first couple weeks of April would have the redemptions down for the quarter. The sales are about the same, but again, that's thin data.

Okay, and I think there was -- was there a calendar shift that impacted this quarter and are you going to see some more leverage, if you will, over next couple of quarters as a result?

You mean number of days in the -- yes, we like quarters with more days. Basically with the funds, compared to the separate accounts, it's daily based revenue and so all else being equal we'll have more revenue in a quarter with more days.

Great. Thanks.

Our next question's coming from Robert Lee with KBW.

Good morning, guys.

Morning, Rob.

Couple questions. First one is, I think I missed, Tom, the comments about what the maximum payment in the Q3 could be to MDT. Was it $40 million? I'm not sure I heard it correctly.

$43 million.

$43 million, okay. And I guess at the risk of beating a dead horse, I know in the 10-K you disclosed what the proportions of revenues that come from obviously Jones and BK, but how should we think of that from an earnings perspective? My gut would be that, given the Alliance transaction, the proportion of rev -- the proportion earnings, at least from the BK portion would be a lot less than suggested by the revenue contribution.

Your instincts are correct, but it is not really our preferred method to talk about clients at all. We were required to talk about those clients because of the nature of the disclosure requirements, but getting into a further detail in terms of the exact assets that we have with the clients and especially the profitability or EPS with those clients is just not something where we can go. That's why I went into as much detail as I could about the 70%, the $13.3 million, the size of the assets, the average assets last year, to try and give you some pointer fingers on that without violating what we think are important relationship elements with our clients.

Fair enough. And let's see, that -- I think that takes care of that. Is there anything -- given the strong growth in money funds and after adjusting for the day count, is there anything that we should be thinking about in the fee rate that there may be a little bit downward trend on or is that pretty much just being offset by the strong growth in the equity side, at least from the market?

Well, Rob, the fee rates don't -- rarely change at the product level. The mix changes, especially if you're looking at it at the fund and separate account combined level, because obviously the large separate account in money market would dilute the overall fee rate and there's been a lot of growth there. But there's no real change there. Now, from an overall standpoint, obviously the blended rate would be better with growth of equities, but that's fairly self evident, I guess.

All right, that was it. Thanks, guys.

Our next question's coming from Bill Katz with Buckingham Research Group.

Okay, thank you. Just a couple of questions. On the new acquisition, I guess I'm struggling a little bit to understand why it's not GAAP accretive for the first two years. It would seem that, with interest rates and cash use and so forth, that it would be accretive. What am I missing?

Probably just missing the size of it, Bill. At $300 million, it would be hard for us to -- it's hard to move the EPS needle. I think it's probably just the size of it and obviously, as Chris said, we're looking to grow it into billions and at that point we would expect it to be accretive.

So are you suggesting that you're not going to grow it for two years, then?

No, we're suggesting in the first two years in the growth when you factor in the additional payments and with what we're guessing to be now the accounting treatment of the intangibles and the related amortization, we don't want to hang an accretive number on it.

Okay. Second question is, can you size the arrogate exposure to large cap value of the blend in the Contrarian fund at the end of the quarter?

Would you ask that question again? Would you size it?

Right, how big is the large cap value large cap blend in Contrarian in total?

The blend is about $2 billion as is the large value and the Contrarian's more like $3+ billion.

Okay. And then sort of curious, at what point on the institutional channel -- I certainly appreciate the fact that you have a number of possible wins here, or at least possible wins -- at what point would you might see a step up in the aggregate level of volume? It seems like a lot of your competitors are talking about mandates getting larger and more complex and their aggregate size of growth seems to be a lot larger. I appreciate the number of account wins is big, but nevertheless it's not really moving the overall AUM level. Is there a seasoning element here that could kick in as we go through '07 into '08?

What's happening is that, yes, there are big hairy mandates that are moving, and what we're finding is that with our clients there are a lot of these intermediate sized mandates that are very worthy business that we are able to get in and win. Some of those bigger clients choose not to come in and bid on these types of accounts and we've looked at it as an excellent opportunity. So yes, we would like to get bigger accounts, obviously, but we are more than happy with these accounts at these sizes. We will continue to respond to RFPs on the bigger size.

And remember too, Bill, there's a critical element in winning these accounts in that frequently there's a consultant working with the underlying client. And in a number of these wins, it's literally the first equity win that we've had with certain of these consultants, and so as they get more comfortable knowing us, knowing our processes, knowing MDT, in particular, then we expect those -- it's about the same process to win accounts at this size as it is the larger ones and so we would expect to have success there too.

Okay. And final question is just, you mentioned the $43 million payment to MDT. Can you just walk through what your capital -- your earnouts look like over the next couple of years, if everything hits the benchmark and thresholds?

the two easy ones to look at are MDT. If it hits the max for three years it's $43 million a year. And we just talked about the Alliance of $13.3 million if the assets stay where they are, it'll be a similar payment on an average basis. The Rockdale one, we're not really quantifying and it's really based on the asset growth and the fund performance there. So that just can be a wide range and we're not really putting a number on it. We did say there's a number that's $5 million and a number -- in third year and a number that's $20 million in the fifth year, that's minus whatever's paid in the third year. But then there are additional payments to them on a five-year basis that we're not putting a number to.

Okay. This final question comes back to the discussion on ED Jones for a moment. What were the performance issues at the end of the day that put you off the preferred list down to the focused list? How is your performance relative to the number -- relative to the players that are currently on that platform? Has it improved or has it weakened?

At the time that we went off and now our fixed income performance was outstanding then and remains outstanding today, and we are just about the top of the list on the fixed income side. What's caused the challenge was the performance in the three-year records in capital depreciation, American Leaders, and in equity income fund. The capital income fund was a part of it, as well. Now to go over each one of those funds, the equity income fund hat a top decile performance last year bringing its the three-year record into very good shape. The capital appreciation fund I've already discussed several times on the phone call. I'm not going to over that again. The capital income fund was changed from a utility fund into a capital income fund. Its five-year record is very low, because it was a utility fund. It's three-year record is outstanding, its one-year record last year was top decile, as well. The American Leaders fund, as I mentioned, had a good second half of last year, didn't do well in the first quarter of this year and it's still lagging.

So with this gang of funds added with the MDT three-year record and one-year record performance and then adding to the Rockdale purchase that we just made, our overall performance has improved meaningfully. And part of that can be underscored because of the rating that we received in Barons; I mean, four out of 67 for the one year. Our five-year record was still in the second half. And so that shows you the way they're doing their methodology an improvement over the year. So that's the answer to how we have improved what the source of the problems were and where our performance is now.

Okay. That's very helpful. Thank you very much.

Our next question's coming from Niamh Alexander with CIBC.

Thanks for taking my questions. Good morning. Following up on the Edward Jones, I guess we've got a lot of questions on it, but maybe we could focus on some of the other channels. I gather that you have been working real hard with some of the other platforms and maybe there's something you can share with us there about the progress and maybe an opportunity to step up and be on a preferred list elsewhere?

Overall, one of the main focuses, which Ray got into a little bit, is to get on more lists. It is true enough that the wholesaler is selling one on one through broker dealer, through bank trust, through advisors and insurance companies. But it's also true that getting various funds on various lists, whether they are 401K lists or other preferred lists is what we're constantly doing, and we've had some very, very good successes at getting on more of these lists. And this is an across the board type effort and it's the kind of effort which will enable us to get each wholesaler to the $200 million we expect from them on an annual basis. So that's the philosophy behind it.

And generally, Niamh, there's been -- we found ourselves advancing in the lead table, so to speak, in the distributors. I mean, Jones is a different situation with the improvement lately, but with the data that we can get, we've found that generally we've moved up in the other channel.

Okay, that's helpful. Thanks. And then if I just wrap up because I had -- most of my other questions have been also answered. Just to go back to --and Chris, if I may, for the strategy you've done the international deal now. Where else would you like to move to maybe broaden and -- the offering in kind of a similar plug-and-play, as it were mode? I know you're not interested in particular in ETF, but is there another area in the mutual fund complex that you'd like to add?

Well, we have been looking in the large cap value area as a potential shopping area and we would look for other opportunities internationally if we happen to see them and they work. We would also be looking to expand to do distribution efforts internationally in situations where we have good partners and can see the whites of the eyes of the distribution. And that's kind of the philosophy that we have there. So we're looking at some other things in other jurisdictions, but they're not mature enough where I can give you chapter and verse or tell you the names of them at this point.

Okay, that's fair enough. Thanks. And just finally, with respect to operating margin, I just want to understand, what do we need to see to be able to to kind of get some growth in that? Is it really a mix shift back towards flows into those higher fee assets? or is there a critical mass in money market flows where you actually start to see some margin expansion?

Well, your instincts are exactly right. If we see a mix shift into higher equity -- higher fee equity products, then I would say we would see margin expansion. On the other hand, if we get a run up in money market assets, we won't be able to help ourselves but to have -- it'll be a short-term thing because the marketing and distribution payments just follow right with it.

Right, that's my concern. It's like -- we've had pretty strong flows into the money market assets, but that hasn't necessarily translated, so I'm just wondering if it does have to be the equity funds, as well?.

Right, and if it comes in the broker dealer side, in the Pershing types, the payments in there, they show up in the marketing and distribution and they're significant.

Okay, there are my questions for now. Thanks so much.

Our next question is coming from Cynthia Mayer with Merrill Lynch.

Hi, good morning. Just a follow up on that last question, I guess in terms of the higher fee equity products, does the Kaufmann fee still -- is it still about 135 basis points?

Yes.

And I'm just wondering why you think it's had outflows recently. I looked and it looks like it had inflows for 1Q '06 and I don't think growth was any more in favor then. Is there something else going on? It seems like a four-star fund with a good record, had a good year last year.

No, I think that what's going on there is that the overall growth category has not been that strong. And I think -- at least I'm convinced that we're, call it this, gaining market share in that space with that fund because its redemption rates are less than what is going on across the industry. So its performance has been outstanding, as you point out, and if you get any kind of return to enthusiastic growth-oriented investing, I think you'll start to see strong positive flows. Now, another thing that goes on, when you have an older fund, which that is, there is a natural situation with redemptions that the investment company allows to occur and that you really can't do much about it, and it's just the life blood of what happens for investors. So there is a natural amount of redemptions that go on there.

Would a turn in the flows to the Kaufmann fund alone, given its higher fee rate, be enough to help your margins?

Help? Sure.

Okay. And just on the Kaufmann, any update, any changes in the compensation agreement with them with the roll off of the noncompete?

No, we had addressed that on previous calls and with our -- the people at the Kaufmann fund many, many months ago, and so that has not been changed. Naturally, we're working on some other ideas with them that we think would be creative, but we're not prepared to let you know what they are yet either.

Okay, great. Thank you.

Our next question's coming from Michael Hecht with Banc of America.

Hey, guys, good morning.

Morning.

Hard to believe there's any questions left. [LAUGHTER[

You want to know about the Pirates?

Maybe later. Just a few quick follow ups. Can you talk about trends that you're seeing in adding new -- and I apologize if I missed this in your prepared remarks -- but new corporate cash management customers recently and how that compares to recent trends you're seeing there?

Well, the trends we've seen there is what we've added at least about a handful every quarter. This quarter it was about nine, so what we're able to do we have a focused group of individuals that are out getting these types of clients signed up, organized, and getting them started, and it's just a steady drum beat of business. We've seen the corporate -- amount of corporate cash that is involved with money funds go from a mid single-digit percentage in the mid 90s to a figure a lot closer to the mid 20s, today. And we think there's a lot more room for growth there. So this is just one of those steady keep -- repeat the sounding joy and add the new clients every quarter type business.

Okay, that's helpful. Thanks. On the fixed income side, how much in assets are left in the ultrashort duration bond funds. I think you talked about $25 million in outflows, and what are your expectations there for flows going forward as it kind of relates to the rate cycle here?

Well, the asset levels are still right around $1 billion. They had peaked around $4 billion back when -- the last easing cycle back in '03, so they've gone from $4 billion down to just under $1 billion. And going forward it really depends on the yield curve situation. At this point with flat to inverted, there's not a big reason to go out beyond cash. If you're looking at ultrashorts as a long cash alternative, you can stay in money markets without the expectation of any kind of principal fluctuation and then you have a little bit of that in the ultrashorts. So it remains a viable product, but it really won't -- where it grew the strongest was when rates were actually decreasing.

Got you, okay. And then just last question. You guys mentioned you continue to be interested in acquisitions, particularly on the center of investment excellence side. I was just curious your thoughts on consolidation on the money fund side and any other opportunities out there like Alliance or other wise and what it would take to spark additional consolidation in the money funds space, you think?

Well, we're not aware of another opportunity exactly like Alliance at this point. And what we would say is that, yes, there are available things to occur in the money market fund business, but they are few and far between and they are not the type that you can force to have happen. What I mean by that is that if the people who are running the money fund have a big say over the redemption, then you can run the money fund for a long, long time. But if you do not have a big say on the redemption, then you have to have a big money fund if you want to have big clients, and we run into this situation periodically and those are good opportunities for us. Our friends in the banking world slowly but surely recognize that running small money funds doesn't add much business, performance, or economics to the bank, and so those continued to be opportunities. But it's very difficult to find the big ones like Alliance.

Okay, great. Thanks, guys.

Our next question's coming from [John Bowland] with Maple Capital Management.

Good morning. Just going beyond the recent quarter and perhaps beating a dead horse here on the margin issue, can you shed any light that you may have on what you might be thinking about or where you might be going on cost control, head count, some kind of -- where we stand on synergy recognition from some of the acquisitions?

Yes, sure. The way we look at the expenses, we kind of have what we call success items, which are marketing and distribution, amortization of intangibles, amortization of deferred sales commissions, and those are things that grow when assets grow, as we're explaining all the time. And while we'd like to manage those down, that's really dealing with our customers and doing the best we can to keep those fees at appropriate levels. But in the end, once we agree with what the terms are and if assets grow and they grow, we're happy that those grow. The thing's that we really are able to do from an expense management point of view, we have really an excellent track record of keeping those in a proper line. And we have done sale and outsource of many of the things that we didn't view as poor or that caused in the past a lot of technology dollars to be spent on and focus that we have moved to parties that were more appropriate to do it than us and we don't really see too many of those opportunities left. We've done a lot of those in the last four or five years, so it's really what's going on in the marketplace and our assets and how are we growing into the future is how we look at it.

And in terms of acquisition synergies, the center of excellence models, like MDT and like the Rockdale fund, we -- Rockdale, the two managers come over and join our staff and we start a new product. In terms of MDT, that operation stays intact up in Cambridge and we wrap into that with some of our processes, but the core operation stays intact. So those really aren't deals where we're looking at expense savings or synergies. And on the other deals, the roll ups, we're moving the assets over and not taking any of the operational costs or management costs, so those are solved on day one. And there's no real further opportunity for expense savings.

Ray, that's a good point. On MDT, it's not only -- their not expense savings available, but it's growing. When it goes up to $8 billion, they're hiring more people to manage the money and to provide the service, so it's actually a growing expense there. Our idea of synergy with MDT is [Mike Bafford's] in charge of all sales at Federated for separately-managed accounts, where he was running that department for MDT. And I know that synergy is sometimes used as an euphemism for a cut, but its original term was to mean that you would actually get synergy, which is what that is.

Okay. Thank you.

Our last question is coming from Robert Lee with KBW.

Actually I'll save you guys, all my questions have been asked already. Thanks.

Okay, good bye, Rob. There are no further questions in queue. I'd like to hand the floor back over to management for any closing comments.

Well, thank you for your questions as always, and with that our call is concluded.

This concludes today's conference. Thank you for your participation.