Business context and reporting period
Franklin Resources, Inc. (ticker BEN), the parent of the Franklin and Templeton investment businesses, filed this unaudited Form 10-Q for the fiscal quarter ended June 30, 2019. The filing covers the three- and nine-month periods ended June 30, 2019; financial amounts below are in U.S. dollars unless noted. Revenue is primarily driven by assets under management (AUM), fee rates and product mix.
Key financial metrics
| Metric | Three months ended June 30, 2019 | Year-over-year | Nine months ended June 30, 2019 | Year-over-year |
|---|---|---|---|---|
| Operating revenue | $1,476.7 million | Down 5% | $4,322.0 million | Down 10% |
| Operating income | $374.9 million | Down 25% | $1,165.9 million | Down 29% |
| Operating margin | 25.4% | 32.3% prior year | 27.0% | 34.2% prior year |
| Net income attributable to Franklin Resources | $245.9 million | Down 39% | $889.3 million | Up 240% |
| Diluted EPS | $0.48 | Down 36% | $1.74 | Up 287% |
- Revenue and margins: Quarterly investment management fees fell 5% and sales and distribution fees fell 6%. Average AUM declined 3% for the quarter and 7% for the nine-month period. Management also cited lower effective fee rates and a less favorable product mix. Excluding performance fees, the effective investment management fee rate was 56.3 basis points for both periods, versus 58.6 and 58.9 basis points, respectively, a year earlier.
- Cash flow: Nine-month operating cash flow was $169.3 million, versus $1,508.5 million in the prior-year period; investing cash outflow was $1,008.8 million and financing cash outflow was $302.0 million. The operating cash-flow decline was primarily attributed to consolidated investment products’ net purchases of investments, compared with net liquidations a year earlier. Investing outflows included the Benefit Street Partners acquisition and higher property spending.
- Liquidity and debt: At June 30, company cash and equivalents were $5.51 billion; liquid assets, as defined by the company and excluding third-party consolidated investment product assets, were $8.53 billion, down from $9.48 billion at September 30, 2018. Of liquid assets, $3.79 billion was used for operational and regulatory purposes, including $264 million restricted by regulation. Company debt was $697 million; $700 million face value of senior notes bears fixed rates of 2.80% and 2.85% and matures in 2022 and 2025. The company reported compliance with debt covenants.
- AUM and flows: Period-end AUM was $715.2 billion, down 1% from June 30, 2018 and comparable to September 30, 2018. Nine-month net outflows were $19.0 billion and market change, distributions and other reduced AUM by $9.3 billion; the $26.4 billion addition from acquisitions largely offset those declines. Global/international equity AUM fell 16% year over year, while U.S. taxable fixed-income AUM rose 46%. Quarterly net outflows were $5.4 billion, partly offset by $8.3 billion of market appreciation and other changes.
Material changes, outlook, risks and unusual items
- Nine-month attributable net income and EPS rose sharply mainly because the prior-year period included approximately $1.1 billion of Tax Act transition-tax expense. Conversely, quarterly net income fell, reflecting weaker operating income and an $86.4 million tax charge related to reversal of a previously recognized tax benefit following final Treasury regulations. The nine-month effective tax rate was 28.4%, versus 84.6% a year earlier.
- The company acquired Benefit Street Partners, a U.S. alternative credit manager, on February 1, 2019, for $720.1 million in cash; $135 million was used to retire debt. The purchase added $318.3 million of goodwill and $383.3 million of acquired intangible assets under the revised purchase-price allocation.
- Compensation and benefits expense rose 22% in the quarter and 15% over nine months, including termination benefits, acquisition-related retention pay and higher staffing from acquisitions. Management said it expected about $15 million of additional fourth-quarter expense for workforce and business-optimization actions, and about $20 million of fourth-quarter acquisition-related retention expense, followed by about $80 million in fiscal 2020; that latter amount is expected to decline by approximately $10 million annually for the next four years. The company reported voluntary separations of approximately 250 employees and an additional 2% workforce reduction.
- The company substantially completed two San Mateo buildings and purchased an office building in Poznan. It expects roughly $3 million of additional depreciation and occupancy expense per quarter beginning in the quarter ending September 30, 2019. It also recorded $9.3 million of impairment on Canadian management-contract intangible assets in the June quarter.
- The company accrued a $13.9 million proposed settlement of consolidated 401(k) fiduciary-duty litigation. The agreement, which remains subject to final court approval, also includes an increase in the employer match for three years. Plaintiffs alleged plan losses exceeding $79 million; management stated it believes the claims are without merit.
- No formal earnings or AUM guidance was provided. Management said it expects to continue comparable regular quarterly dividends, subject to earnings and other factors, and emphasized expense management, investment performance, client service and investment in systems and technology. It cited continuing global economic uncertainty.
- Principal disclosed risks include market declines and AUM outflows, weak relative investment performance, fee and product-mix pressure, regulatory and tax changes, cyber and operational disruptions, reliance on distribution intermediaries and key personnel, and litigation. The filing stated there were no material changes to previously disclosed risk factors or market-risk disclosures.
Important facts for investors to verify
- Confirm the scale and persistence of net outflows, especially in global/international equity, and how investment performance affects future AUM and fee revenue.
- Assess whether lower effective fee rates and the shift in AUM mix continue to pressure revenue and operating margins.
- Separate underlying operating performance from the substantial tax-driven comparison effects in nine-month net income and EPS.
- Track actual restructuring, retention, acquisition-integration and new-building costs against management’s stated expectations.
- Verify court approval and final terms of the $13.9 million 401(k) settlement and related plan changes.
- Monitor liquidity available after operational and regulatory uses, acquisition-related cash needs, capital spending, dividends and share repurchases; the company repurchased $592.9 million of shares during the nine months.