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 September 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 November 8, 2001, the Registrant had outstanding 9,000 shares of Class A Common Stock and 116,191,141 shares of Class B Common Stock. Federated Investors, Inc. Form 10-Q For the Three Months and Nine Months Ended September 30, 2001 Table of Contents Page No. Part I. Financial Information Item 1.Financial Statements Consolidated Balance Sheets at September 30, 2001, and December 31, 2000 3 Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2001 and 2000 4 Consolidated Statements of Cash Flows for the Nine Months Ended September 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 11 Item 3.Quantitative and Qualitative Disclosures About Market Risk 16 Part II. Other Information Item 6.Exhibits and Reports on Form 8-K (a) Exhibits required by Item 601 of Regulation S-K 16 (b) Reports on Form 8-K 16 Signatures 17 Part I, Item I. Financial Statements Federated Investors, Inc. Consolidated Balance Sheets (dollars in thousands) (unaudited) September 30, December 31, 2001 2000 ---------- ---------- Current Assets: Cash and cash equivalents $ 88,991 $ 149,920 Securities available for sale 53,620 85,305 Receivables, net of reserve of $229 and $86, 37,309 36,943 respectively Accrued revenues 7,065 6,594 Prepaid expenses 3,447 3,156 Current deferred tax asset, net 2,718 2,349 Other current assets 584 280 ---------- ---------- Total current assets 193,734 284,547 ---------- ---------- Long-Term Assets: Goodwill, net of accumulated amortization of $23,047 and 132,914 32,099 $18,949, respectively Other intangible assets, net of accumulated amortization of $25,587 and 83,174 14,878 $17,527, respectively Deferred sales commissions, net of accumulated amortization of $170,968 and 266,774 315,612 $136,409, respectively Property and equipment, net of accumulated depreciation of $45,631 and 35,392 36,406 $39,479, respectively Other long-term assets 17,559 21,208 ---------- ---------- Total long-term assets 535,813 420,203 ---------- ---------- Total assets $ 729,547 $ 704,750 ========== ========== Current Liabilities: Cash overdraft $ 4,103 $ 1,090 Current portion of long-term debt - recourse 14,230 14,280 Accrued expenses 52,523 56,806 Accounts payable 30,048 30,161 Income taxes payable 23,660 8,162 Other current liabilities 3,642 5,023 ---------- ---------- Total current liabilities 128,206 115,522 ---------- ---------- Long-Term Liabilities: Long-term debt - recourse 56,000 70,174 Long-term debt - nonrecourse 276,438 323,818 Long-term deferred tax liability, net 35,190 40,565 Other long-term liabilities 6,141 6,265 ---------- ---------- Total long-term liabilities 373,769 440,822 ---------- ---------- Total liabilities 501,975 556,344 ---------- ---------- Minority interest 240 538 ---------- ---------- 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 82,253 75,287 authorized, 129,505,456 shares issued APIC from treasury stock transactions 3,543 0 Retained earnings 376,057 263,456 Treasury stock, at cost, 13,103,615 and 12,384,647 shares of Class B common stock, respectively (229,648) (187,582) Employee restricted stock plan (535) (736) Accumulated other comprehensive income (4,527) (2,746) ---------- ---------- Total shareholders' equity 227,332 147,868 ---------- ---------- Total liabilities, minority $ 729,547 $ 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 <s> <c> <c> <c> <c> (dollars in thousands, except per share Three Months Nine Months data) Ended Ended (unaudited) September 30, September 30, ------------------ ----------------- -------- -------- ------- -------- 2001 2000 2001 2000 -------- -------- ------- -------- -------- -------- ------- -------- Revenue: Investment-advisory fees, $105,221 $ 93,203 $ 300,420 $273,381 net-Federated funds Investment-advisory fees, net-other 3,394 3,754 10,422 10,011 Administrative-service fees, 28,072 21,901 79,232 64,364 net-Federated funds Administrative-service fees, 5,184 5,624 15,655 17,367 net-other Other service fees, net-Federated 34,521 35,392 100,318 104,122 funds Other service fees, net-other 7,105 7,428 20,856 21,516 Commission income 595 1,398 2,422 4,760 Interest and dividends 1,409 4,340 8,326 13,401 Loss on sale of securities available 0 (228) (496) (523) for sale Other income, net (4,334) 288 (3,710) 1,862 -------- -------- ------- -------- Total revenue 181,167 173,100 533,445 510,261 -------- -------- -------- -------- Operating Expenses: Compensation and related 45,590 40,570 129,126 125,422 Advertising and promotional 16,803 15,079 50,652 45,888 Systems and communications 7,196 7,753 21,925 21,987 Office and occupancy 6,654 6,258 20,264 18,711 Professional service fees 6,235 6,731 20,384 19,205 Travel and related 3,146 3,449 9,910 10,401 Amortization of deferred sales 10,355 15,560 34,559 44,983 commissions Amortization of intangible assets 6,078 1,982 12,158 5,610 Other 1,950 1,762 4,394 6,291 -------- -------- -------- -------- Total operating expenses 104,007 99,144 303,372 298,498 -------- -------- -------- -------- Operating income 77,160 73,956 230,073 211,763 -------- -------- -------- -------- Nonoperating Expenses: Debt expense - recourse 1,493 1,942 5,100 6,372 Debt expense - nonrecourse 5,647 6,721 17,673 19,236 -------- -------- -------- -------- Total nonoperating expenses 7,140 8,663 22,773 25,608 -------- -------- -------- -------- Income before minority interest and 70,020 65,293 207,300 186,155 income taxes Minority interest 2,773 2,564 8,132 7,560 -------- -------- -------- -------- Income before income taxes 67,247 62,729 199,168 178,595 Income tax provision 24,056 22,717 71,459 64,305 -------- -------- -------- -------- Net income $43,191 $ 40,012 $ 127,709 $114,290 ======== ======== ======== ======== Earnings per share: Basic $ 0.37 $ 0.34 $ 1.11 $0.97 ======== ======== ======== ======== Diluted $ 0.36 $ 0.33 $ 1.06 $0.93 ======== ======== ======== ======== Cash dividends per share $ 0.046 $ 0.037 $ 0.129 $0.102 ======== ======== ======== ======== (The accompanying notes are an integral part of these consolidated financial statements.) </table> Federated Investors, Inc. Consolidated Statements of Cash Flows Nine Months Ended (dollars in thousands) September 30, ------------------ (unaudited) 2001 2000 -------- -------- Operating Activities: Net income $ 127,709 $ 114,290 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of intangible assets 12,158 5,610 Depreciation and other amortization 6,632 6,076 Amortization of deferred sales commissions 34,559 44,983 Minority interest 8,132 7,560 (Gain) loss on disposal of assets (2,611) 696 (Benefit) provision for deferred income (1,583) 6,686 taxes Tax benefit from exercise of stock options 6,703 0 Deferred sales commissions paid (53,772) (113,900) Contingent deferred sales charges received 25,034 36,193 Proceeds from sale of certain future 46,179 0 revenues Other changes in assets and liabilities: (Increase) decrease in receivables, net (366) 418 Decrease (increase) in other assets 2,617 (3,213) Decrease in accounts payable and accrued (4,396) (1,939) expenses Increase (decrease) in income taxes 15,498 (1,344) payable Increase in other current liabilities 1,632 193 (Decrease) increase in other long-term (2,480) 884 liabilities -------- -------- Net cash provided by operating activities 221,645 103,193 -------- -------- Investing Activities: Additions to property and equipment (5,220) (8,238) Proceeds from disposal of property and 43 158 equipment Cash paid for business acquisitions and (172,606) (11,636) joint venture Purchases of securities available for sale (25,504) (28,429) Proceeds from redemptions of securities 53,297 1,720 available for sale -------- -------- Net cash used by investing activities (149,990) (46,425) -------- -------- Financing Activities: Distributions to minority interest (8,430) (7,684) Dividends paid (15,108) (12,214) Proceeds from exercise of options 1,087 0 Purchase of treasury stock (48,529) (86,076) Proceeds from new borrowings - nonrecourse 9,458 107,580 Payments on debt - recourse (14,224) (14,200) Payments on debt - nonrecourse (56,838) (78,415) -------- -------- Net cash used by financing activities (132,584) (91,009) -------- -------- Net decrease in cash and cash equivalents (60,929) (34,241) Cash and cash equivalents, beginning of period 149,920 171,490 -------- -------- Cash and cash equivalents, end of period $ 88,991 $ 137,249 ======== ======== (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. In July 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. In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The primary objectives of this statement were to establish a single accounting model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and to broaden the presentation of discontinued operations to include more disposal transactions. Although Statement 144 supersedes FASB Statement No. 121 on impairment of long-lived assets, many of the requirements of Statement 121 regarding the test for and measurement of impairment losses of long-lived assets were retained. Federated will adopt Statement 144 on January 1, 2002. The adoption of this statement is not expected to have a material impact on Federated's results of operations or financial position. (2) Securities Available For Sale Federated's current and long-term securities available for sale consisted of the following: Gross Unrealized Estimated Market Value ---------------------- ---------------------- (in thousands) Cost Gains (Losses) -------------------------------------------------------------------------- -------------------------------------------------------------------------- Performance seeds $ 35,360 $ 29 $ (6,769) $ 28,620 Securities held in short-term 25,000 0 0 25,000 bond funds Asset-backed securities 12,336 0 0 12,336 -------------------------------------------------------------------------- -------------------------------------------------------------------------- Total as of September 30, 2001 $ 72,696 $ 29 $ (6,769) $ 65,956 ========================================================================== ========================================================================== Performance seeds $ 38,785 $ 68 $ (4,347) $ 34,506 Securities held in short-term 50,017 0 (609) 49,408 bond funds Asset-backed securities 17,374 844 0 18,218 -------------------------------------------------------------------------- -------------------------------------------------------------------------- Total as of December 31, 2000 $ 106,176 $ 912 $ (4,956) $ 102,132 ========================================================================== During the third quarter 2001, Federated recorded a $3.9 million impairment charge in "Other income, net" on the Consolidated Statements of Income related to Federated's high-yield collateralized bond obligation (CBO) investments. As default rates rose during the third quarter, the fair value of these investments declined below carrying value. Under EITF 99-20 (see Note (1)(b)), such a decline results in the recognition of impairment. Federated recorded a $1.1 million charge in "Other income, net" related to other-than-temporary declines in value of two investments in mutual funds sponsored by Federated (performance seeds) in the third quarter 2001. This charge resulted from management's assessment of its ability to recover the unrealized losses in the carrying value of these investments. Management will continue to monitor these investments as appropriate. (3) Long-Term Debt - Recourse Federated's long-term debt - recourse consisted of the following: Interest September 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% 230 454 ------------------------------------------------------------------- ------------------------------------------------------------------- Total recourse debt 70,230 84,454 Less current portion 14,230 14,280 ------------------------------------------------------------------- ------------------------------------------------------------------- Total long-term debt - $ 56,000 $ 70,174 recourse =================================================================== (4) 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 9/30/2001 Payments ------------------------------------------------------------------------- ------------------------------------------------------------------------- 1997-1 Class A 7.44% $ 36,418 $ 0 $ 8,860 $ 27,558 Class B 9.80% 9,700 0 0 9,700 Financings 10/97 through 9/00 6.68% - 8.60% 274,949 0 47,033 227,916 Financings 10/00 through 9/01 5.80% - 8.60% 2,751 9,458 945 11,264 ------------------------------------------------------------------------- ------------------------------------------------------------------------- $ 323,818 $ 9,458 $ 56,838 $ 276,438 ========================================================================= (5) 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 September 30, 2001, approximately $62.0 million was available to pay dividends or repurchase stock under the more restrictive limitation. Cash dividends of $0.037, $0.046 and $0.046 per share or approximately $4.3 million, $5.4 million and $5.4 million were paid in the first, second and third quarters of 2001, respectively, to holders of common shares. Additionally, on October 23, 2001, the board of directors declared a dividend of $0.046 per share to be paid on November 15, 2001, to shareholders of record as of November 7, 2001. As of September 30, 2001, under Federated's current share buyback program, Federated can repurchase approximately 3.1 million additional shares subject to the cash payment limit imposed by Federated's debt covenants. (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 September 30, 2001, a total of 44,163 shares had been purchased by employees in this plan. (6) Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share: Three Months Nine Months Ended Ended September 30, September 30, ---------------- --------------- ---------------- --------------- 2001 2000 2001 2000 ---------------------------------------------------------------- ---------------------------------------------------------------- (in thousands, except per share data) Numerator: Net income $ 43,191 $40,012 $127,70 $114,290 ================================================================ ================================================================ Denominator: Basic weighted-average 115,297 116,598 115,281 118,201 shares outstanding Dilutive potential shares from stock-based 4,876 4,926 5,033 4,579 compensation ---------------------------------------------------------------- ---------------------------------------------------------------- Diluted weighted-average shares outstanding 120,173 121,524 120,314 122,780 ================================================================ ================================================================ Basic earnings per share $ 0.37 $ 0.34 $ 1.11 $ 0.97 ================================================================ ================================================================ Diluted earnings per share $ 0.36 $ 0.33 $ 1.06 $ 0.93 ================================================================ (7) Comprehensive Income Comprehensive income was $42.8 million and $40.0 million for the three-month periods ended September 30, 2001 and 2000, respectively, and $125.9 million and $111.6 million for the nine-month periods ended September 30, 2001 and 2000, respectively. (8) Business Combinations In September 2001, Federated signed a definitive agreement with Lincoln Investment Planning, Inc. and Rightime Econometrics, Inc. As a result of this transaction, assets of three mutual funds currently advised by Rightime Econometrics, Inc., totalling approximately $159.1 million as of October 22, 2001, are planned to be merged into Federated Capital Appreciation Fund on the transaction close date which is anticipated for the fourth quarter 2001. This transaction is not expected to have a material impact on Federated's results of operations or financial position. 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 (Edgemont Acquisition). 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. The purchase price payments will be recorded as additional goodwill at the time of payment while the incentive compensation payments are recognized as compensation expense during the periods in which the payments are earned. 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 identifiable 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 Note (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 Nine Months Ended September 30, (In millions except per share data) 2001 2000 ---------------------------------------------------------------------- ---------------------------------------------------------------------- Revenue $ 546.7 $ 546.8 Net income 128.8 121.4 Earnings per share: Basic 1.11 1.02 Diluted 1.07 0.99 ---------------------------------------------------------------------- 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 September 30, Percent 2001 2000 Change -------- ------- ------ Money market funds $122,263 $87,139 40% Equity funds 18,840 23,222 (19%) Fixed-income funds 16,410 14,340 14% Separate accounts 6,132 5,669 8% -------- ------- Total managed assets $163,645 $130,370 26% ======== ======= Total administered $40,070 $38,905 3% assets ======== ======= Average Managed and Administered Assets (in millions) Three Months Nine Months Ended Ended September 30, Percent September 30, Percent 2001 2000 Change 2001 2000 Change -------- ------- ------ ------ ------ ------- ------ Money market funds $119,892 $85,528 40% $112,96$ 84,055 34% Equity funds 20,841 23,261 (10%) 20,895 22,428 (7%) Fixed-income funds 15,959 14,548 10% 15,373 14,913 3% Separate accounts 6,360 5,677 12% 6,223 5,000 24% -------- ------- ------ ------- ------ ------- Total average managed $163,052 $129,014 26% $155,46$ 126,396 23% assets ======== ======= ====== ======= ====== ======= Total average $41,400 $41,403 0% $41,892$ 42,795 (2%) administered assets ======== ======= ====== ======= Components of Changes in Equity and Fixed-Income Fund Managed Assets (in millions) Three Months Nine Months Ended Ended September 30, September 30, 2001 2000 2001 2000 ------- ------- -------- --------- Equity Funds Beginning assets $ 22,461 $22,512 $ 20,641 $ 20,941 -------- --------- ------- ------- Sales 1,033 1,949 4,038 8,584 Redemptions (1,387) (1,503) (4,571) (5,768) -------- --------- ------- ------- ------- ------- Net (354) 446 (533) 2,816 (redemptions) sales Net exchanges (117) (70) (154) 69 Acquisition related 0 319 3,235 319 Other* (3,150) 15 (4,349) (923) -------- --------- ------- ------- -------- --------- ------- ------- Ending assets $ 18,840 $23,222 $ 18,840 $ 23,222 ======== ========= ======= ======= ======= ======= Fixed-Income Funds Beginning assets $ 15,179 $14,660 $ 14,268 15,857 -------- --------- ------- ------- Sales 2,261 882 5,851 2,867 Redemptions (1,230) (1,168) (4,018) (4,174) -------- --------- ------- ------- ------- ------- Net 1,031 (286) 1,833 (1,307) sales (redemptions) Net exchanges 66 (156) 24 (409) Acquisition related 0 11 0 11 Other* 134 111 285 188 -------- --------- ------- ------- -------- --------- ------- ------- Ending assets $ 16,410 $14,340 $ 16,410 14,340 ======== ========= ======= ======= - ------------------------------------------------------------------------------- * 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 nine-month periods ended September 30, 2001 and 2000: <table> <caption> Three Months Ended Nine Months Ended September 30, Percent September 30, Percent 2001 2000 Change Change 2001 2000 Change Change <s> <c> <c> <c> <c> <c> <c> <c> <c> Net income (in millions) $43.2 $40.0 $3.2 8% $127.7 $114.3 $13.4 12% Earnings per share Basic $0.37 $0.34 $0.03 9% $1.11 $0.97 $0.14 14% Diluted $0.36 $0.34 $0.03 9% $1.06 $0.93 $0.13 14% Revenue (in millions) Revenue from $171.8 $155.6 $16.2 10% $492.8 $456.6 $36.2 8% managed assets Service-related revenue from 12.3 13.1 (0.8) (6%) 36.5 38.9 (2.4) (6%) sources other than managed assets Other (2.9) 4.4 (7.3) (166%) 4.1 14.8 (10.7) (72%) Total Revenue $181.2 $173.1 $8.1 5% $533.4 $510.3 $23.1 5% Operating margin 42.6% 42.7% (0.1%) 0% 43.1% 41.5% 1.6% 4% </table> Net Income. Net income for the three- and nine-month periods ended September 30, 2001, increased 8% and 12%, 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. Diluted earnings per share for the three- and nine-month periods ended September 30, 2001, increased 9% and 14%, 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 nine months of 2001. Net income for the third quarter and the first nine months of 2001 included non-cash, after-tax impairment charges of $3.2 million and $3.4 million, respectively, related to other-than-temporary declines in the fair values of various investments. Excluding the effect of this charge, Federated would have realized net income for the third quarter and the first nine months of 2001 equal to $46.4 million and $131.1 million, respectively. Revenue. Revenue for the three- and nine-month periods ended September 30, 2001, increased $8.1 million and $23.1 million, respectively, as compared to the same periods of 2000 as a result of growth in Federated's managed assets. Total average managed assets climbed from $129.0 billion for the third quarter 2000 to $163.1 billion for the third quarter of 2001 and from $126.4 billion for the first nine months of 2000 to $155.5 billion for the first nine months of 2001. These increases reflect significant growth in Federated's money market funds, which continued to benefit from the declining short-term 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 and fixed-income funds. Other revenue for the three- and nine-month periods ended September 30, 2001, decreased compared to the same periods last year. The decreases primarily reflect non-cash charges equal to $5.0 million and $5.2 million recorded in the third quarter and first nine months of 2001, respectively, to write-down the carrying values of certain Federated investments in CBO products and mutual funds that we sponsor (performance seeds). The decrease also reflects 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 September 2000. For additional information regarding the impairment charges, see Note (2) to the Consolidated Financial Statements. Operating Expenses. Operating expenses for the three- and nine-month periods ended September 30, 2001 and 2000 are set forth in the following table: <table> <caption> Three Months Ended Nine Months Ended September 30, Percent September 30, Percent (in millions) 2001 2000 Change Change 2001 2000 Change Change <s> <c> <c> <c> <c> <c> <c> <c> <c> Compensation and related $45.6 $40.6 $5.0 12% $129.1 $125.4 $3.7 3% Advertising and promotional 16.8 15.1 1.7 11% 50.7 45.9 4.8 10% Amortization of deferred 10.4 15.6 (5.2) (33%) 34.6 45.0 (10.4) (23%) sales commissions Other 31.2 27.8 3.4 12% 89.0 82.2 6.8 8% Total Operating Expenses $104.0 $99.1 $4.9 5% $303.4 $298.5 $4.9 2% </table> Total operating expenses for the three- and nine-month periods ended September 30, 2001, were up 5% and 2%, respectively, as compared to the same periods last year. 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. Increases in compensation and related expense during the three- and nine-month periods ended September 30, 2001 as compared to the same periods last year reflect increased base salary and variable-based compensation attributable to the Edgemont Acquisition. Likewise, amortization of intangible assets increased during the three- and nine-month periods ended September 30, 2001, as compared to the same periods last year, as a result of the Edgemont Acquisition. Income Taxes. The income tax provision for the three- and nine-month periods ended September 30, 2001, was $24.1 million and $71.5 million, respectively, as compared to $22.7 million and $64.3 million for the same periods of 2000. The effective tax rate was 35.8% and 36.2% for the third quarter 2001 and 2000, respectively, and 35.9% and 36.0% for the first nine months of 2001 and 2000, respectively. 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 2000, 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 nine months of 2001, deferred sales commissions related to B shares and nonrecourse debt decreased $45.1 million and $47.4 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 September 30, 2001, and December 31, 2000: At September At December (in millions) 30, 2001 31, 2000 -------------------------------------------------------------------- Assets Deferred sales commissions, net* $260.4 $305.5 Receivables 7.5 7.5 Other assets 1.2 2.6 Liabilities Long-term debt - nonrecourse $276.4 $323.8 Accounts payable 5.5 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 $12.8 million excess of B-share-related liabilities over the related assets at September 30, 2001, will be recognized in income over the remaining life of certain B-share cash flows. Shareholders' Equity. Shareholders' equity increased by $79.5 million in the first nine 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 nine months of 2001, Federated continued to purchase shares of its Class B common stock under the stock repurchase program. As of September 30, 2001, Federated can repurchase approximately 3.1 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 $56.7 million after considering earnings through September 30, 2001, the dividend payment on November 15, 2001, and certain stock repurchases. Cash Flow. Cash and cash equivalents and the current portion of securities available for sale totaled $142.6 million at September 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 $221.6 million for the nine-month period ended September 30, 2001, as compared to $103.2 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, increased income taxes payable due to a one-time extension of the federal government's deadline for paying quarterly tax estimates and increased profitability in 2001. Net cash used by investing activities in the first nine months of 2001 reflects cash paid for the Edgemont Acquisition and the purchase of securities available for sale, partially offset by proceeds from the sale of certain investments held by Federated in anticipation of the Edgemont Acquisition. Other uses of cash flow from operating activities in the first nine months of 2001 included payments on debt, the purchase of treasury stock, dividend payments and distributions to a 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 identifiable 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 Note (1)(b)), Federated will no longer amortize goodwill. Dividends paid. Federated pays cash dividends on a quarterly basis. Dividends of $0.037, $0.046 and $0.046 per share, or $4.3 million, $5.4 million and $5.4 million were paid in the first, second and third quarters of 2001, respectively. Federated's board of directors declared a dividend of $0.046 per share to be paid on November 15, 2001, to shareholders of record as of November 7, 2001. After considering earnings through September 30, 2001, the dividend payment on November 15, 2001, certain stock repurchases, and current debt covenants, Federated has the ability to pay cash for dividends and stock repurchases of approximately $56.7 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 of the company, 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. Many of these factors may be more likely to occur as a result of the ongoing threat of terrorism. As a result, 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. We invest in new Federated-sponsored mutual funds (performance seeds) in order to provide investable cash to the fund allowing the fund to establish a performance history. In the third quarter 2001, Federated recorded a $1.1 million charge related to other-than-temporary declines in value of two of Federated's performance seed investments. At September 30, 2001, the fair value of Federated's performance seed investments was $28.6 million and related unrealized losses were $6.8 million. As of November 8, 2001, net unrealized losses for performance seeds were $5.9 million. Management will continue to monitor these investments as appropriate. Federated also has investments in asset-backed securities. During the third quarter 2001, Federated recorded a $3.9 million impairment charge related to other-than-temporary declines in the fair value of Federated's high-yield collateralized bond obligation investments. As of September 30, 2001, Federated's remaining investments in asset-backed securities totaled $12.3 million. 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: 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 November 13, 2001 By: /s/ J. Christopher Donahue ----------------------------- --------------------------------- J. Christopher Donahue President and Chief Executive Officer Date November 13, 2001 By: /s/ Thomas R. Donahue ----------------------------- --------------------------- Thomas R. Donahue Chief Financial Officer