Franklin Resources, Inc. (Franklin Templeton) — FY2019 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended September 30, 2019; it is not a quarterly filing. Franklin is a global investment manager whose revenues largely depend on assets under management (AUM), investment performance, asset mix and distribution. The company reported one operating segment: investment management and related services.
Financial performance and position
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Operating revenue | $5.775 billion | $6.319 billion | Down 9% |
| Operating income | $1.557 billion | $2.119 billion | Down 26% |
| Operating margin | 27.0% | 33.5% | Down 6.5 percentage points |
| Net income attributable to Franklin Resources | $1.196 billion | $764.4 million | Up 56% |
| Diluted EPS | $2.35 | $1.39 | Up 69% |
| Operating cash flow | $201.6 million | $2.230 billion | Down substantially |
- Investment management fees were $3.985 billion, down 9%; sales and distribution fees were $1.445 billion, down 10%. Average AUM fell 6% to $697.0 billion, and the effective management fee rate excluding performance fees declined to 56.4 basis points from 58.7 basis points.
- Ending AUM was $692.6 billion, down 3% year over year. Net outflows of $31.8 billion and negative market change, distributions and other of $19.1 billion were partly offset by $26.4 billion from an acquisition. Long-term sales were $100.6 billion versus redemptions of $155.9 billion.
- Operating expenses were nearly flat at $4.217 billion. Lower sales, distribution and marketing expenses were offset by higher compensation, technology and general and administrative costs.
- At year-end, cash and cash equivalents were $5.803 billion, total liquid assets were $8.573 billion, and corporate debt was $696.9 million. Corporate stockholders’ equity was $9.907 billion. The $50.8 million of consolidated investment-product debt is separate and nonrecourse to Franklin beyond its direct investments.
- FY2019 investing cash outflow was $1.077 billion, including acquisition and property spending; financing cash outflow was $40.5 million. Operating cash flow fell mainly because consolidated investment products made net investment purchases, rather than net liquidations as in FY2018.
- Franklin repurchased 24.6 million shares for $756.3 million and declared regular dividends of $1.04 per share. FY2018 dividends of $3.92 per share included a $3.00 special dividend.
Material changes and unusual items
- FY2019 net income benefited from comparison with FY2018, which included a $968.8 million estimated Tax Act charge. FY2019 also included an $86.0 million transition-tax charge; the effective tax rate was 26.8%, versus 66.5% in FY2018.
- Franklin acquired Benefit Street Partners, a U.S. alternative credit manager, on February 1, 2019 for $720.1 million in cash. The acquisition added $26.4 billion of AUM and increased goodwill and intangible assets.
- Compensation and benefits rose 14%, including acquisition-related retention costs and termination benefits. The company reported voluntary separation of approximately 250 employees and an additional 2% workforce reduction.
- General and administrative costs included a $13.9 million litigation settlement accrual. The related 401(k) plan class action received final court approval in October 2019; settlement terms also increased the company’s matching contribution rate from 75% to 85% for three years starting January 2020.
- Management reported $9.3 million of impairment of indefinite-lived Canadian management-contract intangibles and $4.0 million of definite-lived intangible impairment.
Outlook, management commentary and risks
The filing provides no formal revenue, earnings or AUM guidance. Management emphasized investment performance, client service, expense management, talent retention and investment in systems and technology. It expects approximately $80 million of acquisition-related retention expense in FY2020, about $6 million of termination-benefit expense related to fund-administration outsourcing, and roughly $12 million of additional annual occupancy expense from new facilities. Additional rental income of approximately $9 million is expected from leases commencing in FY2020.
- Investment results were mixed: U.S. equity products generally lagged benchmarks, while global/international equity and several fixed-income categories also showed weak benchmark or peer comparisons. The filing notes stronger relative peer results in some U.S. equity and multi-asset periods and in global/international fixed income over selected horizons.
- Key risks include market declines and volatility, persistent net outflows, fee pressure and shifts to lower-fee products, investment underperformance, reliance on third-party distributors and vendors, cybersecurity and operational disruptions, foreign-exchange exposure, and extensive changing regulation.
- Regulatory developments highlighted include U.S. Regulation Best Interest, California privacy rules effective in 2020, MiFID II and Brexit uncertainty, and LIBOR replacement after 2021. Management said it expected Brexit to have limited operational impact, while acknowledging uncertainty.
- The company expects to adopt lease accounting in FY2020, initially recognizing an estimated $270 million right-of-use asset and $315 million lease liability. Transition-tax payments remaining at September 30, 2019 totaled $827.9 million, scheduled over seven years.
- Unrecognized tax benefits were $202.6 million, with ongoing tax examinations. Management stated that it had accrued probable estimable legal losses and did not expect other ordinary-course claims to materially affect the company; outcomes remain uncertain.
Important facts for investors to verify
- Whether AUM outflows continue, especially in global/international equity, and whether market returns or acquisitions offset them.
- How average AUM, product mix and effective fee rates affect fee revenue and operating margins.
- Benefit Street Partners’ contribution to AUM, earnings and retention costs, and the integration of outsourced fund administration.
- The recurring cash-generation trend: FY2019 operating cash flow was unusually low and was affected by investment activity in consolidated products.
- Future capital returns, including regular dividends and share repurchases, alongside acquisition spending and tax payments.
- Progress on tax examinations, the 401(k) settlement obligations, and regulatory, cybersecurity and other contingencies.
Audit note: The independent auditor expressed unqualified opinions on the consolidated financial statements and internal control over financial reporting as of September 30, 2019.