Franklin Resources, Inc. — Form 10-Q Summary
Business context and reporting period
The filing is for the three months ended December 31, 2017, Franklin Resources’ fiscal first quarter. The company is a global investment manager whose revenue depends substantially on assets under management (AUM), investment performance, asset mix and investor flows. The filing identifies the registrant as Franklin Resources, Inc.
Financial results and key metrics
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Operating revenue | $1,615.5 million | $1,560.8 million |
| Operating income | $581.1 million | $586.9 million |
| Operating margin | 36.0% | 37.6% |
| Income before taxes | $651.6 million | $619.7 million |
| Net income (loss) attributable to Franklin Resources | $(583.3) million | $440.2 million |
| Diluted earnings (loss) per share | $(1.06) | $0.77 |
| Operating cash flow | $320.4 million | $446.2 million |
- Revenue increased 4% year over year, led by investment management fees, up 5%, as average AUM rose 4% and the effective management fee rate increased to 59.2 basis points from 58.8 basis points.
- Operating expenses rose 6% to $1,034.4 million. General, administrative and other expense increased 44%, partly reflecting a $16.2 million year-over-year increase in contingent consideration expense related to the K2 acquisition.
- The reported net loss primarily reflects $1,120.7 million of estimated one-time U.S. transition tax expense under the Tax Cuts and Jobs Act. The company recorded a $53.1 million net tax benefit from revaluing deferred taxes. The effective tax rate was 187.8%.
- Management expected a fiscal 2018 effective tax rate of approximately 70%, or approximately 24%–25% excluding one-time Tax Act impacts; the federal statutory rate was expected to be 21% in future fiscal years. The transition-tax estimate may be revised.
- At December 31, 2017, cash and cash equivalents were $8,707.5 million, company liquid assets were $11,387.1 million, and company debt was $1,044.5 million. The liquid-assets measure excludes third-party assets and liabilities of consolidated investment products. The federal transition-tax liability was estimated at $1,101.5 million, payable over eight years beginning January 2019.
- Operating cash flow declined from the prior-year quarter, primarily reflecting movements in consolidated investment product assets and liabilities. Investing cash flow was $(58.6) million and financing cash flow was $(51.1) million. The company paid $111.7 million in common dividends and repurchased $198.7 million of shares.
Material changes and management commentary
- Quarter-end AUM was $753.8 billion, up 5% from a year earlier and comparable to September 30, 2017. Average AUM was up 4% year over year. In the quarter, $2.9 billion of net market appreciation and other was mostly offset by $2.3 billion of net outflows.
- Long-term sales increased 15% to $28.1 billion and redemptions decreased 16% to $39.4 billion versus the prior-year quarter. Net outflows were most significant in global/international equity products.
- Management reported mixed investment performance: global/international fixed income had strong five- and ten-year comparisons but weaker recent one- and three-year comparisons; equity and several other categories mostly lagged benchmarks and peer medians in periods presented.
- Management said it remained focused on investment performance, client service, expense management, and strategic investment in systems and technology. It expected to continue comparable regular quarterly dividends, subject to earnings and other relevant factors, and was reassessing capital management and repatriation policies following the Tax Act.
- On January 17, 2018, the company agreed to acquire Edinburgh Partners Limited, a U.K.-based global value investment manager. The filing does not provide purchase consideration.
Risks, contingencies and unusual items
- Two putative ERISA class actions allege fiduciary breaches related to Franklin-sponsored funds in the company retirement plan. Plaintiffs allege losses exceeding $79 million and $60 million, respectively. Management considers the claims without merit, but cannot predict outcomes or reasonably estimate potential loss.
- Key business risks include market declines and AUM outflows, investment underperformance, fee and product-mix pressure, regulation and litigation, cybersecurity and operational disruption, competition, and foreign exchange and international-market exposure.
- The company noted potential changes in its tax estimate as further technical guidance and tax filings become available. It was in compliance with debt covenants and reported no material changes to other commitments or contingencies from fiscal year-end.
- Disclosure controls were assessed as effective at December 31, 2017; the filing reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How the estimated $1,120.7 million transition-tax expense and $1,101.5 million federal liability evolve, including the eventual cash-tax schedule and any revisions.
- Whether net outflows persist and how AUM, fee rates and asset mix respond to investment performance and market conditions.
- Whether expense growth, particularly compensation and K2-related contingent consideration, affects operating margins in subsequent quarters.
- The outcomes and potential financial exposure from the Cryer and Fernandez lawsuits, which the company cannot currently estimate.
- The terms, closing conditions and financial impact of the Edinburgh Partners acquisition, which are not quantified in this filing.