FRANKLIN TEMPLETON INC annual report, FY2018

Business context and reporting period

Franklin Resources, Inc. (NYSE: BEN), operating as Franklin Templeton Investments, filed this Form 10-K for the fiscal year ended September 30, 2018. The company is a global asset manager; fiscal fourth-quarter figures are for the three months ended September 30, 2018. The filing reports $717.1 billion in ending assets under management (AUM).

Financial performance and position

Fourth-quarter 2018 revenue was $1.527 billion, operating income $478.7 million, net income attributable to Franklin Resources $502.5 million, and diluted EPS $0.96. Fourth-quarter 2017 comparatives were $1.617 billion, $557.7 million, $425.2 million, and $0.76, respectively.

• FY 2018 operating revenue declined 1%; operating income declined 6%, as expenses rose 2%. The operating margin contracted 1.9 percentage points.
• Annual attributable net income fell 55%, primarily reflecting an estimated $968.8 million income-tax charge related to the Tax Cuts and Jobs Act. The estimated transition-tax expense was $983.2 million at year-end; excluding one-time Tax Act impacts, the company reported a 22.7% effective tax rate.
• Net cash used in investing activities was $290.4 million and net cash used in financing activities was $3.762 billion. Financing outflows included $2.117 billion of common dividends and $1.425 billion of share repurchases.
• At September 30, 2018, cash and cash equivalents were $6.611 billion, total liquid assets were $9.475 billion, and company debt was $695.9 million. Debt was fixed-rate notes; the company said it complied with covenants and believed available resources could meet foreseeable cash needs. Some subsidiary liquid assets are restricted or held for operating and regulatory needs.
• FY 2018 declared dividends totaled $3.92 per share, including a $3.00 special dividend. The company repurchased 39.9 million shares for $1.427 billion during the year.

Material changes and management commentary

Ending AUM decreased 5% year over year. Net outflows of $38.0 billion and negative net market change, distributions and other of $7.9 billion were partly offset by $9.8 billion from an acquisition. Average AUM was broadly flat. Long-term sales fell 7% to $105.0 billion, while redemptions fell 4% to $162.1 billion.

Revenue mix shifted: investment management fees were nearly flat at $4.368 billion, while sales and distribution fees declined 6% to $1.600 billion, largely reflecting a 26% decrease in commissionable sales. Management cited volatile markets, rising interest rates, trade tensions and political uncertainty. It emphasized expense management, client service, investment performance, and continued investment in systems and technology. Equity markets rose during the fiscal year, while global bond markets declined; the filing says performance mostly lagged benchmarks and peer medians for equity and U.S./tax-free fixed-income products.

Outlook, risks, contingencies and unusual items

• No specific financial guidance or numerical forecast is provided. Management expects to continue regular quarterly dividends at comparable levels, subject to earnings and other factors.
• On October 24, 2018, after fiscal year-end, the company agreed to acquire Benefit Street Partners for approximately $683 million in cash, including $130 million to retire debt. It also acquired Edinburgh Partners in May 2018.
• Key risks include market-driven AUM and fee volatility, persistent net outflows and investment performance, fee pressure and lower-cost passive products, dependence on third-party distributors, foreign-exchange exposure, cybersecurity and operational disruption, and extensive changing regulation.
• A consolidated ERISA class action alleges excessive fees and fiduciary breaches concerning Franklin-sponsored funds in the company’s 401(k) plan. Plaintiffs allege losses exceeding $79 million and $60 million in the related actions, which were consolidated. The company disputes the claims; it cannot predict the outcome or reasonably estimate potential loss.
• The company reports $299.0 million in discretionary unfunded capital commitments and $367.4 million in future operating lease payments. The federal transition-tax liability is estimated at $965.3 million, payable over eight years beginning January 2019. It also voluntarily purchased $32.6 million of securities from two sponsored funds during the year.
• The auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective.

Most important facts for investors to verify

• Whether AUM outflows and weaker investment performance persist, and how they affect average AUM, fees and margins.
• The final transition-tax amount and cash payment schedule, including whether the fourth-quarter tax benefit could be reduced or eliminated.
• Benefit Street Partners’ closing, funding, debt retirement and expected contribution to results; the filing provides no quantified forecast of benefits.
• The status and potential financial exposure of the consolidated ERISA litigation, which the company says it cannot currently estimate.
• Capital allocation after the special dividend and elevated repurchases, alongside regulatory liquidity needs and the $299.0 million of commitments.