Business context and reporting period
Franklin Resources, Inc. (the registrant; an investment manager operating under Franklin Templeton and other brands) filed this unaudited Form 10-Q for the quarter and nine months ended June 30, 2015. The fiscal third quarter covered April–June 2015. Revenue and earnings depend substantially on assets under management (AUM), fee rates, sales and investor flows.
Financial performance and position
| Metric | Three months ended June 30, 2015 | Year-over-year change | Nine months ended June 30, 2015 | Year-over-year change |
|---|---|---|---|---|
| Operating revenue | $2.001 billion | Down 6% | $6.075 billion | Down 4% |
| Operating income | $769.8 million | Down 2% | $2.310 billion | Down 3% |
| Operating margin | 38.5% | Up from 36.9% | 38.0% | Up from 37.7% |
| Net income attributable to Franklin Resources | $504.2 million | Down 13% | $1.677 billion | Down 4% |
| Diluted EPS | $0.82 | Down 11% | $2.70 | Down 3% |
- Quarterly revenue declines reflected lower investment management fees and sales and distribution fees. The effective investment management fee rate fell to 60.8 basis points from 61.7 basis points; average AUM was down 2%. Commissionable sales fell 26% in both the quarter and nine-month period.
- Operating expenses declined 8% in the quarter and 5% year to date, led by lower sales, distribution and marketing costs. The reported margin improved despite lower revenue.
- Investment and other income was a $4.7 million loss in the quarter, versus $107.6 million of income a year earlier; the nine-month amount declined to $149.9 million from $172.8 million. The quarter included $30.4 million of net foreign-exchange losses. Lower gains from consolidated investment products and lower equity-method income also weighed on results.
- Operating cash flow was $1.815 billion for nine months, versus $1.411 billion. Investing cash flow provided $235.3 million; financing used $1.097 billion. Cash and cash equivalents at period-end were $8.263 billion on the balance sheet, excluding consolidated investment-product cash.
- Company liquid assets (cash, receivables and certain investments) were $11.312 billion, versus $10.627 billion at September 30, 2014. Company debt was $1.348 billion, up from $1.198 billion; the company issued $400 million of 2.85% notes due 2025 and used proceeds in part to repay $250 million of notes at maturity. It reported compliance with debt covenants.
- Quarterly dividend was $0.15 per share, compared with $0.12 a year earlier. The nine-month period included regular dividends of $0.45 and a special dividend of $0.50 per share. Share repurchases totaled $559.5 million for nine months.
Material changes and operating trends
- AUM was $866.5 billion at June 30, down 6% year over year and 4% from September 30, 2014. The quarter’s $11.1 billion of net new outflows and $2.1 billion of depreciation and other reduced AUM; year-to-date net new outflows were $20.2 billion.
- Quarterly sales declined 21% to $37.7 billion while redemptions rose 9% to $49.0 billion. Global/international equity and fixed-income AUM were down 10% year over year; total equity was down 7% and fixed income down 6%.
- Management reported strong taxable fixed-income performance relative to benchmarks and peers, but equity performance mostly lagged benchmarks and peer medians. Hybrid performance had weakened from September 2014, largely reflecting the Franklin Income Fund.
- Foreign-exchange translation reduced AUM by $10.5 billion for the nine-month period. Currency movements also materially affected reported investment and other income.
Outlook, risks, contingencies and unusual items
- No specific earnings or revenue guidance was provided. Management emphasized investment performance, client service, expense management, talent retention and strategic systems and technology investment. It expected to continue comparable regular quarterly dividends, subject to earnings and other factors.
- Key business risks include market declines, redemptions and net outflows; fee-rate and product-mix pressure; uneven investment performance; currency and interest-rate movements; competition, including lower-fee passive products; reliance on third-party distribution; and complex, changing global regulation. The filing also highlights cybersecurity, operational, litigation and tax risks.
- Management stated that ordinary-course litigation was not expected to materially affect the company and that an adequate accrual had been recorded for estimable probable losses. No material changes to previously disclosed commitments and contingencies were reported. Contractual obligations, commitments and contingent liabilities totaled $2.283 billion, including $138.5 million of contingent consideration, primarily related to acquiring remaining K2 interests.
- The company adopted accounting guidance for consolidated collateralized financing entities; the adoption increased consolidated VIE debt by $14.2 million and reduced retained earnings by $0.3 million. It was evaluating consolidation guidance effective in fiscal 2017.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing reported no material changes to the risk factors in the prior Form 10-K.
Important facts for investors to verify
- Whether net outflows, lower commissionable sales and fee-rate compression persist, and how they affect average AUM and revenue.
- Whether equity and hybrid investment performance improves, given its potential effect on sales, redemptions and AUM.
- How much of the sharp quarterly earnings decline reflected market-sensitive investment and currency items versus recurring operating trends.
- The availability and transferability of liquidity: the filing notes regulatory, operational and repatriation restrictions on some subsidiary cash.
- Exposure to K2 contingent consideration, legal and tax matters, and valuation assumptions for Level 3 investments and liabilities.