UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------------- -------------------- Commission File Number 001-14818 ----------- Federated Investors, Inc. ------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 25-1111467 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 ------------------------ ---------- (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) 412-288-1900 ------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No ______. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date: As of August 8, 2001, the Registrant had outstanding 9,000 shares of Class A Common Stock and 117,323,841 shares of Class B Common Stock. Federated Investors, Inc. Form 10-Q For the Three Months and Six Months Ended June 30, 2001 Table of Contents Page No. Part I. Financial Information Item 1.Financial Statements Consolidated Balance Sheets at June 30, 2001, and December 31, 2000 3 Consolidated Statements of Income for the Three Months and Six Months Ended June 30, 2001 and 2000 4 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2001 and 2000 5 Notes to Consolidated Financial Statements 6 Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3.Quantitative and Qualitative Disclosures About Market Risk 14 Part II. Other Information Item 6.Exhibits and Reports on Form 8-K (a) Exhibits required by Item 601 of Regulation S-K 15 (b) Reports on Form 8-K 15 Signatures 16 Part I, Item I. Financial Statements Federated Investors, Inc. Consolidated Balance Sheets (dollars in thousands) (unaudited) June 30, December 31, 2001 2000 ---------- ---------- Current Assets: Cash and cash equivalents $ 59,383 $ 149,920 Securities available for sale 31,317 85,305 Receivables, net of reserve of $199 and $86, 39,977 36,943 respectively Accrued revenues 5,866 6,594 Prepaid expenses 7,783 3,156 Current deferred tax asset, net 2,569 2,349 Other current assets 703 280 ---------- ---------- Total current assets 147,598 284,547 ---------- ---------- Long-Term Assets: Goodwill, net of accumulated amortization of $21,065 and 134,103 32,099 $18,949, respectively Other intangible assets, net of accumulated amortization of $21,489 and 87,272 14,878 $17,527, respectively Deferred sales commissions, net of accumulated amortization of $160,613 and 281,415 315,612 $136,409, respectively Property and equipment, net of accumulated depreciation of $43,562 and 35,640 36,406 $39,479, respectively Other long-term assets 20,751 21,208 ---------- ---------- Total long-term assets 559,181 420,203 ---------- ---------- Total assets $ 706,779 $ 704,750 ========== ========== Current Liabilities: Cash overdraft $ 4,305 $ 1,090 Current portion of long-term debt - recourse 14,293 14,280 Accrued expenses 42,355 56,806 Accounts payable 31,563 30,161 Income taxes payable 347 8,162 Other current liabilities 5,786 5,023 ---------- ---------- Total current liabilities 98,649 115,522 ---------- ---------- Long-Term Liabilities: Long-term debt - recourse 56,008 70,174 Long-term debt - nonrecourse 290,760 323,818 Long-term deferred tax liability, net 38,475 40,565 Other long-term liabilities 6,187 6,265 ---------- ---------- Total long-term liabilities 391,430 440,822 ---------- ---------- Total liabilities 490,079 556,344 ---------- ---------- Minority interest 114 538 ---------- ---------- Shareholders' Equity : Common stock : Class A, no par value, 20,000 shares authorized, 189 189 9,000 shares issued and outstanding Class B, no par value, 900,000,000 shares 82,207 75,287 authorized, 129,505,456 shares issued APIC from treasury stock transactions 3,543 - Retained earnings 338,263 263,456 Treasury stock, at cost, 12,170,315 and 12,384,647 shares of Class B common stock, respectively (202,889) (187,582) Employee restricted stock plan (601) (736) Accumulated other comprehensive income (4,126) (2,746) ---------- ---------- Total shareholders' equity 216,586 147,868 ---------- ---------- Total liabilities, minority $ 706,779 $ 704,750 interest, and shareholders' equity ========== ========== (The accompanying notes are an integral part of these consolidated financial statements.) <TABLE> <CAPTION> Federated Investors, Inc. Consolidated Statements of Income (dollars in thousands, except per share Three Months Six Months Ended data) Ended (unaudited) June 30, June 30, ------------------ ----------------- -------- -------- ------- -------- 2001 2000 2001 2000 -------- -------- ------- -------- -------- -------- ------- -------- <S> <C> <C> <C> <C> Revenue: Investment-advisory fees, net-Federated funds $ 101,753 $ 90,315 $195,200 $ 180,179 Investment-advisory fees, net-other 3,473 3,154 7,028 6,257 Administrative-service fees, net-Federated funds 26,560 21,226 51,160 42,463 Administrative-service fees, net-other 5,250 5,715 10,471 11,743 Other service fees, net-Federated funds 33,353 33,888 65,797 68,730 Other service fees, net-other 7,040 6,906 13,751 14,087 Commission income 759 1,758 1,826 3,362 Interest and dividends 2,419 4,351 6,917 9,061 (Loss) gain on sale of securities available for sale (1) 56 (496) (295) Other income, net 258 918 624 1,574 Total revenue 180,864 168,287 352,278 337,161 Operating Expenses: Compensation and related 43,890 42,021 83,536 84,852 Advertising and promotional 18,034 15,639 33,849 30,809 Systems and communications 7,238 7,405 14,728 14,234 Professional service fees 7,170 5,980 14,150 12,473 Office and occupancy 7,148 6,309 13,610 12,453 Travel and related 3,545 3,942 6,764 6,953 Amortization of deferred sales commissions 11,557 14,624 24,204 29,423 Amortization of intangible assets 4,069 1,833 6,080 3,628 Other 1,000 2,650 2,444 4,529 -------- -------- -------- ------- Total operating expenses 103,651 100,403 199,365 199,354 -------- -------- -------- -------- Operating income 77,213 67,884 152,913 137,807 -------- -------- -------- -------- Nonoperating Expenses: Debt expense - recourse 1,810 2,201 3,607 4,430 Debt expense - nonrecourse 5,880 6,354 12,027 12,515 -------- -------- -------- -------- Total nonoperating expenses 7,690 8,555 15,634 16,945 -------- -------- -------- -------- Income before minority interest and income taxes 69,523 59,329 137,279 120,862 Minority interest 2,710 2,462 5,358 4,996 -------- -------- -------- -------- Income before income taxes 66,813 56,867 131,921 115,866 Income tax provision 23,939 20,237 47,403 41,588 -------- -------- -------- -------- Net income $42,874 $36,630 $84,518 $ 74,278 ======== ======== ======== ======== Earnings per share: Basic 0.37 0.31 0.73 $0.62 ======== ======== ======== ======== Diluted 0.36 0.30 0.70 $0.60 ======== ======== ======== ======== Cash dividends per share 0.046 0.037 0.083 $0.065 ======== ======== ======== ======== </TABLE> (The accompanying notes are an integral part of these consolidated financial statements.) Federated Investors, Inc. Consolidated Statements of Cash Flows Six Months Ended (dollars in thousands) June 30, ------------------ (unaudited) 2001 2000 -------- -------- Operating Activities: Net income $ 84,518 $ 74,278 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of intangible assets 6,080 3,628 Depreciation and other amortization 4,440 3,971 Amortization of deferred sales commissions 24,204 29,423 Minority interest 5,358 4,996 (Gain) loss on disposal of assets (1,763) 251 (Benefit) provision for deferred income (197) 6,291 taxes Tax benefit from exercise of stock options 6,703 - Deferred sales commissions paid (38,632) (87,114) Contingent deferred sales charges received 17,911 25,038 Proceeds from sale of certain future 32,991 - revenues Other changes in assets and liabilities: (Increase) decrease in receivables, net (3,034) 2,340 Increase in other assets (5,190) (3,205) Decrease in accounts payable and accrued (13,050) (5,522) expenses Decrease in income taxes payable (7,815) (1,307) Increase (decrease) in other current 3,978 (325) liabilities (Decrease) increase in other long-term (908) 1,177 liabilities -------- -------- Net cash provided by operating activities 115,594 53,920 -------- -------- Investing Activities: Additions to property and equipment (3,296) (4,109) Proceeds from disposal of property and 25 158 equipment Cash paid for business acquisitions and (171,814) (2,619) joint venture Purchases of securities available for sale (504) (26,201) Proceeds from redemptions of securities 52,846 1,792 available for sale -------- -------- Net cash used by investing activities (122,743) (30,979) -------- -------- Financing Activities: Distributions to minority interest (5,782) (5,195) Dividends paid (9,711) (7,829) Proceeds from exercise of options 1,087 - Purchase of treasury stock (21,771) (72,058) Proceeds from new borrowings - nonrecourse 6,747 80,636 Payments on debt - recourse (14,153) (14,134) Payments on debt - nonrecourse (39,805) (53,848) -------- -------- Net cash used by financing activities (83,388) (72,428) -------- -------- Net decrease in cash and cash equivalents (90,537) (49,487) Cash and cash equivalents, beginning of period 149,920 171,490 -------- -------- Cash and cash equivalents, end of period $ 59,383 $ 122,003 ======== ======== (The accompanying notes are an integral part of these consolidated financial statements.) FEDERATED INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) Summary of Significant Accounting Policies (a) Basis of Presentation The interim consolidated financial statements of Federated Investors, Inc. (Federated) included herein have been prepared in accordance with accounting principles generally accepted in the United States. In the opinion of management, the financial statements reflect all adjustments which are of a normal recurring nature and necessary for a fair statement of the results for the interim periods presented. In preparing the unaudited interim consolidated financial statements, management is required to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results may differ from such estimates and such differences may be material to the financial statements. These financial statements should be read in conjunction with Federated's Annual Report on Form 10-K for the year ended December 31, 2000. Certain items previously reported have been reclassified to conform with the current year's presentation. (b) Recent Accounting Pronouncements On April 1, 2001, Federated adopted Emerging Issues Task Force Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" (EITF 99-20). EITF 99-20 states that interest income earned on retained or purchased beneficial interests in securitized financial assets should be recognized over the life of the investment based on an anticipated yield determined by periodically estimating cash flows. Interest income should be revised prospectively for changes in cash flows. Additionally, impairment should be recognized if the fair value of the beneficial interest has declined below its carrying amount and the decline is other than temporary. Because the book value of Federated's asset-backed securities was less than or equal to the fair value of those investments on April 1, 2001, Federated did not recognize a transition adjustment as a result of adopting this statement. On July 20, 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets." Statement 141 eliminates the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001, and clarifies the criteria to recognize intangible assets separately from goodwill. This statement is effective for all business combinations completed after June 30, 2001. Under Statement 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed at least annually for impairment. Federated will adopt Statement 142 on January 1, 2002, in accordance with its effective date for calendar year companies. As a result of adopting this standard, Federated anticipates that annual amortization expense will decrease by approximately $6 million. (2) Long-Term Debt - Recourse Federated's long-term debt - recourse consisted of the following: Interest June 30, December 31, Rate 2001 2000 -------- ----------- ----------- (in thousands) Recourse Debt: Senior Secured Note 7.96% 70,000 $ 84,000 Purchase Agreements Capitalized leases 7.1%-8.5% 301 454 ----------- ----------- Total recourse debt 70,301 84,454 Less current portion 14,293 14,280 ----------- ----------- ----------- Total long-term debt - 56,008 $ 70,174 recourse =========== =========== (3) Long-Term Debt - Nonrecourse Federated sells the rights to receive future 12b-1 fees, shareholder service fees and contingent deferred sales charges on Class B shares of various Federated mutual funds. For accounting purposes, certain transactions executed under the sales agreements are reflected as financings, and various tranches of nonrecourse debt have been recorded. Below is the activity of the nonrecourse debt tranches: (in thousands) ----------------------------------------- Interest Balance Additional Balance Tranche Rate 12/31/2000 Financings Payments 6/30/2001 --------------- ----------- --------- --------- ---------- --------- 1997-1 Class A 7.44% $ 36,418 $ 0 6,153 30,265 9.80% 9,700 0 0 9,700 Class B Financings 10/97 6.68% - 274,949 0 33,156 241,793 through 9/00 8.60% Financings 10/00 8.60% 2,751 6,747 496 9,002 through 6/01 --------- --------- ---------- --------- $ 323,818 $ 6,747 39,805 290,760 ========= ========= ========== ========= (4) Common Stock (a) Cash Dividends and Stock Repurchases Federated's recourse debt agreements contain restrictions on payments of dividends and purchases of treasury stock. The more restrictive of the agreements limits cash payments for these purposes to $5.0 million plus 50% of net income during the period from January 1, 1996, to and including the payment date, less certain payments for dividends and stock repurchases. As of June 30, 2001, approximately $71.6 million was available to pay dividends or repurchase stock under the more restrictive limitation. Cash dividends of $0.037 and $0.046 per share or approximately $4.3 million and $5.4 million were paid in the first and second quarter of 2001, respectively, to holders of common shares. Additionally, on July 24, 2001, the board of directors declared a dividend of $0.046 per share to be paid on August 15, 2001, to shareholders of record as of August 7, 2001. As of June 30, 2001, under Federated's current share buyback program, Federated can repurchase approximately 3.6 million additional shares subject to the cash payment limit imposed by Federated's debt covenants. (4) Common Stock (continued) (b) Employee Stock Purchase Plan Federated offers an Employee Stock Purchase Plan that allows employees to purchase a maximum of 750,000 shares of Class B common stock. Employees may contribute up to 10% of their salary to purchase shares of Federated's Class B common stock on a quarterly basis at the market price. The shares under the plan may be newly issued shares, treasury shares or shares purchased on the open market. As of June 30, 2001, a total of 41,622 shares had been purchased by employees in this plan. (5) Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share: Three Months Six Months Ended Ended June 30, June 30, 2001 2000 2001 2000 (in thousands, except per share data) Numerator: Net income $ 42,874 $36,630 $84,518 $ 74,278 Denominator: Basic weighted-average 115,389 117,937 115,272 119,011 shares outstanding Dilutive potential shares from stock-based 5,063 4,638 5,112 4,407 compensation Diluted weighted-average shares outstanding 120,452 122,575 120,384 123,418 Basic earnings per share $ 0.37 0.31 0.73 $ 0.62 Diluted earnings per share $ 0.36 0.30 0.70 $ 0.60 ======= ======= ====== ======= (6) Comprehensive Income Comprehensive income was $42.7 million and $34.3 million for the three-month periods ended June 30, 2001 and 2000, respectively, and $83.1 million and $71.6 million for the six-month periods ended June 30, 2001 and 2000, respectively. (7) Business Combination On April 20, 2001, Federated completed the acquisition of substantially all of the business of Edgemont Asset Management Corporation, the former advisor of The Kaufmann Fund. The purchase price for this acquisition was approximately $182 million. This price included cash payments of approximately $173 million, including transaction costs, and approximately 316,000 shares of Federated Class B common stock valued at approximately $9 million. The acquisition agreement provides for additional purchase price payments and incentive compensation payments based upon the achievement of specified revenue growth over the next six years. These payments could aggregate to approximately $200 million if revenue targets are met. This acquisition was accounted for using the purchase method of accounting and, accordingly, the fair value of the assets acquired, approximately $77 million of intangible assets and $105 million of goodwill, as well as the results of those assets were included in Federated's consolidated financial statements beginning on the date of acquisition. The amount assigned to intangible assets represents the fair value of the advisory contract, the noncompete agreement and the workforce as of April 20, 2001. These assets are being amortized on a straight-line basis over their useful lives which range from 4 to 10 years. Acquired goodwill is being amortized on a straight-line basis over 25 years. Upon adoption of SFAS 142 on January 1, 2002 (see footnote (1)(b)), Federated will no longer amortize goodwill. The following unaudited pro forma data for Federated includes the results of the assets purchased from Edgemont Asset Management Corporation, giving effect to the acquisition as if it occurred at the beginning of the periods presented. The pro forma data is based on historical information and does not reflect the actual results that would have occurred nor is it indicative of future results of operations. Pro Forma Data for the Six Months Ended June 30, (In millions except per share data) 2001 2000 ---------------------------------------------------------------------- ---------------------------------------------------------------------- Revenue $ 365.5 $ 361.6 Net income 85.2 78.7 Earnings per share: Basic 0.74 0.66 Diluted 0.71 0.64 ---------------------------------------------------------------------- Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Asset Highlights Managed and Administered Assets at Period End (in millions) As of June 30, Percent 2001 2000 Change Money market funds $117,035 $83,497 40% Equity funds 22,461 22,512 0% Fixed-income funds 15,179 14,660 4% Separate accounts 6,099 5,140 19% Total managed assets $160,774 $125,809 28% Total administered $41,841 $44,332 (6%) assets Average Managed and Administered Assets (in millions) Three Months Six Months Ended Ended June 30, Percent June 30, Percent 2001 2000 Change 2001 2000 Change Money market funds $113,463 $83,511 36% $109,50 $ 83,391 31% Equity funds 21,963 21,951 0% 20,922 22,011 (5%) Fixed-income funds 15,168 14,739 3% 15,080 15,096 0% Separate accounts 6,172 4,690 32% 6,155 4,661 32% Total average managed $156,766 $124,891 26% $151,66 $125,159 21% assets Total average $42,200 $43,442 (3%) $42,139 $ 43,491 (3%) administered assets Components of Changes in Equity and Fixed-Income Fund Managed Assets (in millions) Three Months Six Months Ended Ended June 30, June 30, ------------------ ---------------- 2001 2000 2001 2000 ------- ------- -------- --------- Equity Funds Beginning assets $ 18,249 $23,431 $ 20,641 $ 20,941 -------- --------- ------- ------- Sales 1,337 2,886 3,005 6,635 Redemptions (1,446) (1,978) (3,184) (4,265) -------- --------- ------- ------- Net (109) 908 (179) 2,370 (redemptions) sales Net exchanges 28 (14) (37) 139 Acquisition Related 3,235 - 3,235 - Other* 1,058 (1,813) (1,199) (938) -------- --------- ------- ------- Ending assets $ 22,461 $22,512 $ 22,461 $ 22,512 ======== ========= ======= ======= Fixed-Income Funds Beginning assets $ 15,112 $15,041 $ 14,268 15,857 -------- --------- ------- ------- Sales 1,631 963 3,590 1,985 Redemptions (1,390) (1,359) (2,788) (3,006) -------- --------- ------- ------- Net sales (redemptions) 241 (396) 802 (1,021) Net exchanges (29) (50) (42) (253) Other* (145) 65 151 77 -------- --------- ------- ------- -------- --------- ------- ------- Ending assets $ 15,179 $14,660 $ 15,179 14,660 ======== ========= ======= ======= - ------------------------------------------------------------------------------- * Includes changes in the market value of securities held by the funds, reinvested dividends and distributions and net investment income. The discussion and analysis below should be read in conjunction with the consolidated financial statements appearing elsewhere in this report. We have presumed that the readers of this interim financial information have read or have access to management's discussion and analysis of financial condition and results of operations appearing in Federated's Annual Report on Form 10-K for the year ended December 31, 2000. Results of Operations General. Federated is a leading provider of investment management products and related financial services. The majority of our revenue is derived from advising, distributing and servicing Federated mutual funds, separately managed accounts and other related products, in both domestic and international markets. We also derive revenue through servicing third-party mutual funds. Investment advisory, distribution and the majority of our servicing fees are based on the net asset value of investment portfolios that we manage or administer. As such, these revenues are dependent upon factors including market conditions and the ability to attract and maintain assets. Accordingly, revenues will fluctuate with changes in the total value and composition of the assets under management or administration. The table below presents the highlights of our operations for the three- and six-month periods ended June 30, 2001 and 2000: <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, Percent June 30, Percent 2001 2000 Change Change 2001 2000 Change Change <S> <C> <C> <C> <C> <C> <C> <C> <C> Net income (in millions) $42.9 $36.6 $6.3 17% $84.5 $74.3 $10.2 14% Earnings per share Basic $0.37 $0.31 $0.06 19% $0.73 $0.62 $0.11 18% Diluted $0.36 $0.30 $0.06 20% $0.70 $0.60 $0.10 17% Revenue (in millions) Revenue from $165.9 $150.4 $15.5 10% $321.0 $301.0 $20.0 7% managed assets Service-related revenue from 12.3 12.6 (0.3) (2%) 24.2 25.8 (1.6) (6%) sources other than managed assets Other 2.7 5.3 (2.6) (49%) 7.1 10.4 (3.3) (32%) Total Revenue $180.9 $168.3 $12.6 7% $352.3 $337.2 $15.1 4% Operating margin 42.7% 40.3 2.4% 6% 43.4% 40.9 2.5% 6% </TABLE> Net Income. Net income for the three- and six-month periods ended June 30, 2001, increased 17% and 14%, respectively, compared to the same periods last year. The increases primarily reflect increased revenue from managed assets as a result of significant growth in money market fund assets and the acquisition of substantially all of the business of Edgemont Asset Management Corporation on April 20, 2001 (the Edgemont Acquisition). Diluted earnings per share for the three- and six-month periods ended June 30, 2001, increased 20% and 17%, respectively, compared to the same periods of 2000 due to increased net income and reduced weighted-average diluted shares outstanding resulting from stock repurchases during 2000 and the first half of 2001. Revenue. Revenue for the three- and six-month periods ended June 30, 2001, increased $12.6 million and $15.1 million, respectively, as compared to the same periods of 2000 as a result of growth in Federated's managed assets and the Edgemont Acquisition. Total average managed assets climbed from $124.9 billion for the second quarter 2000 to $156.8 billion for the second quarter of 2001 and from $125.2 billion for the first half of 2000 to $151.7 billion for the first half of 2001. These increases reflect significant growth in Federated's money market funds, which continued to benefit from the interest rate environment, the tendency of investors to increase their allocation to cash during periods of significant equity market fluctuations and an increase in customer relationships among corporations, universities, government entities and broker/dealer organizations. Revenue from managed assets increased as a result of growth in average assets, but to a lesser degree than the growth in assets due to a shift in asset mix from equity products, which earn on average higher fees per invested dollar, to money market funds. Other revenue for the three- and six-month periods ended June 30, 2001, decreased compared to the same periods last year. The decreases primarily reflect a decrease in interest and dividend income resulting from lower investment balances as a result of cash used for the Edgemont Acquisition and a decrease in investment yields since June 2000. The decreases in other revenue also reflect a servicing contract buyout that was recorded in the second quarter 2000. Operating Expenses. Operating expenses for the three- and six-month periods ended June 30, 2001 and 2000 are set forth in the following table: <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, Percent June 30, Percent (in millions) 2001 2000 Change Change 2001 2000 Change Change <S> <C> <C> <C> <C> <C> <C> <C> <C> Compensation and related $43.9 $42.0 $1.9 5% $83.5 $84.9 $(1.4) (2%) Advertising and promotional 18.0 15.6 2.4 15% 33.8 30.8 3.0 10% Amortization of deferred 11.6 14.6 (3.0) (21%) 24.2 29.4 (5.2) (18%) sales commissions Other 30.2 28.2 2.0 7% 57.9 54.3 3.6 7% Total $103.7 $100.4 $3.3 3% $199.4 $199.4 $- - Operating Expenses </TABLE> Total operating expenses for the three- and six-month periods ended June 30, 2001, were generally flat as compared to the same periods last year, however, individual expenses fluctuated as a result of movements in asset classes and the Edgemont Acquisition. Certain expenses such as marketing allowances (included in Advertising and promotional) increased during these periods as compared to the prior year due to significant asset growth, while other expenses such as amortization of deferred sales commissions decreased during these periods as compared to the prior year primarily as a result of decreased net asset values of equity fund assets. Amortization of intangible assets increased in the three- and six-month periods ended June 30, 2001 as compared to the same periods of 2000 as a result of the Edgemont Acquisition. Income Taxes. The income tax provision for the three- and six-month periods ended June 30, 2001, was $23.9 million and $47.4 million, respectively, as compared to $20.2 million and $41.6 million for the same periods of 2000. The effective tax rate was 35.8% and 35.6% for the second quarter 2001 and 2000, respectively, and 35.9% for both the first half of 2001 and 2000. Financial Condition, Capital Resources and Liquidity Deferred Sales Commissions and Nonrecourse Debt. Federated finances up-front commissions paid to broker/dealers on the sale of B shares through the sale of the rights to future revenue streams associated with B-share deferred sales commissions. Under Federated's first B-share financing arrangement that expired September 30, 2000, sales were accounted for as financings for reporting purposes and nonrecourse debt was recorded. In October 2000, as a result of entering into a new financing arrangement, Federated began accounting for the sale of certain B-share-related future revenue streams as true sales and continued to account for the sale of the rights to future servicing fees on the B shares as financings. Consequently, beginning in October, additions to the deferred sales commission and nonrecourse debt balances result only from the sale of future servicing fees on the B shares. Prior to this new financing arrangement and related accounting treatment, the deferred sales commission and nonrecourse debt balances were increased for the sale of all future fees on the B shares. In the first half of 2001, deferred sales commissions related to B shares and nonrecourse debt decreased $31.6 million and $33.0 million, respectively. These decreases reflect continued asset amortization and debt servicing partially offset by additions to the asset and nonrecourse debt balances for new sales of rights to B-share-related future servicing fees. The following table presents the effects of the B-share financing programs on the Consolidated Balance Sheets at June 30, 2001, and December 31, 2000: At June 30, At December 31, (in millions) 2001 2000 ---------------------------------------------------------------------- Assets Deferred sales commissions, net* $273.9 $305.5 Receivables 6.6 7.5 Other assets 1.3 2.6 Liabilities Long-term debt - nonrecourse $290.8 $323.8 Accounts payable 5.4 6.1 ---------------------------------------------------------------------- ---------------------------------------------------------------------- * Excludes deferred sales commissions related to B-share revenue streams that have not been sold as of the end of the period due to the timing of the sale of the revenue streams. Due to the nonrecourse nature of these financing arrangements, the $14.4 million excess of B-share-related liabilities over the related assets at June 30, 2001, will be recognized in income over the remaining life of certain B-share cash flows. Shareholders' Equity. Shareholders' equity increased by $68.7 million in the first six months of 2001 primarily as a result of net income and treasury stock issuances related to the Edgemont Acquisition, partially offset by treasury stock purchases and dividends declared. During the first six months of 2001, Federated continued to purchase shares of Class B common stock under the stock repurchase program. As of June 30, 2001, Federated can repurchase approximately 3.6 million additional shares under the current company buy back program, subject to current debt-covenant restrictions which limit cash payments for additional stock repurchases and dividends to $66.2 million after considering earnings through June 30, 2001, the dividend payment on August 15, 2001, and certain stock repurchases. Cash Flow. Cash and cash equivalents and the current portion of securities available for sale totaled $90.7 million at June 30, 2001, as compared to $235.2 million at December 31, 2000. This decrease is primarily due to cash used in the second quarter 2001 to complete the Edgemont Acquisition. Cash provided by operating activities totaled $115.6 million for the six-month period ended June 30, 2001, as compared to $53.9 million for the same period of 2000. This increase is primarily attributable to a decrease in sales commissions paid to brokers due to reduced sales of B shares, the sales treatment of the B-share transaction and, to a lesser extent, to increased profitability in 2001. Net cash used by investing activities in the first six months of 2001 reflects cash paid for the Edgemont Acquisition, partially offset by proceeds from the sale of certain investments held by Federated in anticipation of the acquisition. Other uses of cash flow from operating activities in the first half of 2001 included payments on debt, the purchase of treasury stock, dividend payments and distributions to the minority interest partner. Business Combination. On April 20, 2001, Federated completed the acquisition of substantially all of the business of Edgemont Asset Management Corporation, the former advisor of The Kaufmann Fund. The purchase price for this acquisition was approximately $182 million. This price included cash payments of approximately $173 million, including transaction costs, and approximately 316,000 shares of Federated Class B common stock valued at approximately $9 million. The acquisition agreement provides for additional purchase price payments and incentive compensation payments based upon the achievement of specified revenue growth over the next six years. These payments could aggregate to approximately $200 million if revenue targets are met This acquisition was accounted for using the purchase method of accounting and, accordingly, the fair value of the assets acquired, approximately $77 million of intangible assets and $105 million of goodwill, as well as the results of those assets were included in Federated's consolidated financial statements beginning on the date of acquisition. The amount assigned to intangible assets represents the fair value of the advisory contract, the noncompete contract and the workforce as of April 20, 2001. These assets are being amortized on a straight-line basis over their useful lives which range from 4 to 10 years. Acquired goodwill is being amortized on a straight-line basis over 25 years. Upon adoption of SFAS 142 on January 1, 2002 (see footnote (1)(b)), Federated will no longer amortize goodwill. Dividends paid. Federated pays cash dividends on a quarterly basis. Dividends of $0.037 and $0.046 per share, or $4.3 million and $5.4 million, were paid in the first and second quarter of 2001, respectively. Federated's board of directors declared a dividend of $0.046 per share to be paid on August 15, 2001, to shareholders of record as of August 7, 2001. After considering earnings through June 30, 2001, the dividend payment on August 15, 2001, certain stock repurchases, and current debt covenants, Federated has the ability to pay cash for dividends and stock repurchases of approximately $66.2 million. Future Cash Requirements. Management expects that the principal needs for cash will be to advance sales commissions, repurchase company stock, service recourse debt, fund property and equipment acquisitions, pay shareholder dividends, seed new products and fund strategic business acquisitions. Management believes that Federated's existing liquid assets, together with the expected continuing cash flow from operations, its borrowing capacity under current credit facilities, the B-share financing arrangement and its ability to issue stock will be sufficient to meet its present and reasonably foreseeable cash needs. Recent Accounting Pronouncements. On April 1, 2001, Federated adopted Emerging Issues Task Force Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" (EITF 99-20). EITF 99-20 states that interest income earned on retained or purchased beneficial interests in securitized financial assets should be recognized over the life of the investment based on an anticipated yield determined by periodically estimating cash flows. Interest income should be revised prospectively for changes in cash flows. Additionally, impairment should be recognized if the fair value of the beneficial interest has declined below its carrying amount and the decline is other than temporary. Because the book value of Federated's asset-backed securities was less than or equal to the fair value of those investments on April 1, 2001, Federated did not recognize a transition adjustment as a result of adopting this statement. On July 20, 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets." Statement 141 eliminates the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001, and clarifies the criteria to recognize intangible assets separately from goodwill. This Statement is effective for all business combinations completed after June 30, 2001. Under Statement 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed at least annually for impairment. Federated will adopt Statement 142 on January 1, 2002, in accordance with its effective date for calendar year companies. As a result of adopting this standard, Federated anticipates that annual amortization expense will decrease by approximately $6 million. Special Note Regarding Forward-Looking Information. Certain statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Future Cash Requirements and elsewhere in this report, constitute forward-looking statements, which involve known and unknown risks, uncertainties, and other factors that may cause the actual results, levels of activity, performance, achievements, or industry results, to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. For a discussion of such risk factors, see the section titled Risk Factors and Cautionary Statements in Federated's Annual Report on Form 10-K for the year ended December 31, 2000, and other reports on file with the Securities and Exchange Commission. As a result of the foregoing and other factors, no assurance can be given as to future results, levels of activity, performance or achievements, and neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. Part I, Item 3. Quantitative and Qualitative Disclosures About Market Risk In the normal course of business, Federated is exposed to the risk of securities market and general economic fluctuations. Federated's approach has been to limit the use of derivative instruments to hedging activities. Federated's investments are primarily in money market funds and mutual funds with investments which have a duration of two years or less. Occasionally, we invest in new mutual funds (performance seeds) that we sponsor in order to provide investable cash to the fund allowing the fund to establish a performance history. Federated may use derivative financial instruments to hedge these investments. As of June 30, 2001, the fair value of the performance seed investments was $30.2 million, none of which were being hedged as of the end of the period. In addition, as of June 30, 2001, we had investments in high-yield asset-backed securities and mortgage-backed securities that are included in "Securities available for sale" and "Other long-term assets" on the Consolidated Balance Sheets. These investments expose Federated to credit and interest rate risk. In periods of either rising default rates or interest rates, the carrying value of Federated's investments in asset-backed securities may be adversely affected by unfavorable changes in cash flow estimates, declines in the value of the underlying fixed-rate securities, and increased expected returns. All of our debt instruments carry fixed interest rates. Part II, Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits required to be filed by Item 601 of Regulation S-K are filed herewith and incorporated by reference herein: (b) Reports on Form 8-K: Form 8-K/A filed on July 3, 2001 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Federated Investors, Inc. (Registrant) Date August 13, 2001 By: /s/ J. Christopher Donahue J. Christopher Donahue President and Chief Executive Officer Date August 13, 2001 By: /s/ Thomas R. Donahue Thomas R. Donahue Chief Financial Officer