Business context and reporting period
Franklin Resources, Inc. (the filing’s registrant) filed this unaudited Form 10-Q for its fiscal first quarter ended December 31, 2015. The company is a global investment manager whose revenues depend substantially on assets under management (AUM), investment performance, sales and investor flows.
Financial and operating performance
| Metric | Quarter ended Dec. 31, 2015 | Prior-year quarter | Change |
|---|---|---|---|
| Operating revenue | $1.758 billion | $2.064 billion | Down 15% |
| Operating income | $653.6 million | $782.0 million | Down 16% |
| Operating margin | 37.2% | 37.9% | Down 0.7 percentage point |
| Net income attributable to Franklin Resources | $447.8 million | $566.4 million | Down 21% |
| Diluted EPS | $0.74 | $0.91 | Down 19% |
| Operating cash flow | $295.2 million | $572.4 million | Down 48% |
| AUM at quarter-end | $763.9 billion | $880.1 billion | Down 13% |
Investment management fees fell 14% to $1.187 billion, reflecting lower average AUM and a lower effective fee rate (60.7 basis points versus 61.8). Sales and distribution fees declined 20% to $478.4 million, including a 33% reduction in commissionable sales. Total operating expenses declined 14% to $1.104 billion; sales, distribution and marketing expenses fell 20%, and compensation and benefits fell 9%. The effective tax rate was 31.2%, broadly level with 31.1% a year earlier.
Quarter-end company liquid assets, defined by management as cash, receivables and certain investments, were $11.006 billion, versus $11.107 billion at September 30, 2015. Company debt was $1.348 billion, with $1.350 billion aggregate face value of senior notes. Management reported compliance with debt covenants. Cash and cash equivalents on the balance sheet were $8.125 billion; the cash-flow statement’s $8.269 billion ending balance includes consolidated investment-product cash.
Changes versus the prior comparable period
- AUM fell 13% year over year, driven mainly by $65.9 billion in net outflows, $33.8 billion of market depreciation and $12.1 billion of foreign-exchange revaluation over the year.
- During this quarter, net new outflows were $20.6 billion and total net flows, including reinvested distributions, were negative $9.1 billion. Market appreciation and other effects added $15.0 billion, partly offsetting the outflows; this amount included a $1.6 billion foreign-exchange decline.
- Quarterly operating cash flow was lower, primarily due to reduced net income and a swing in trading securities of consolidated sponsored investment products. Financing outflows increased, chiefly because share repurchases were higher.
- Net investment and other income fell to $30.5 million from $51.7 million, notably reflecting lower foreign-exchange gains and investment valuations, partly offset by higher equity-method investee income.
Outlook, commentary, risks and unusual items
- Management gave no specific earnings or revenue guidance. It said it expects to continue comparable regular quarterly dividends, subject to earnings and other factors, and believes existing liquid assets, operating cash flows and financing options can meet foreseeable operating needs and commitments.
- The company repurchased 10.5 million shares for $404.1 million during the quarter. The board authorized an additional 30 million shares; 26.7 million remained available at quarter-end. The regular dividend was $0.18 per share, compared with $0.65 a year earlier, which included a $0.50 special dividend.
- About 300 employees accepted voluntary separation, generating $9.4 million of special termination benefits in the quarter. Management expected approximately $36 million of additional related expenses over the remainder of the fiscal year and said further costs could arise from continuing cost-reduction initiatives.
- Performance was mixed: the filing reports that equity products mostly lagged benchmarks and peer-group medians, and that a large hybrid fund weighed on category comparisons. Global/international fixed-income performance was comparatively strong over longer periods. Poor investment performance can contribute to redemptions and lower AUM.
- Key risks include market volatility, continued outflows, foreign-exchange movements, fee and product-mix pressure, investment underperformance, competition (including lower-fee passive products), evolving regulation, cybersecurity and operational disruption, and tax or legal matters. Management said there were no material changes to previously disclosed commitments or risk factors and that litigation accruals were adequate for probable estimable losses; it did not expect current claims to materially affect the company.
- Management identified no material market-risk disclosure changes from the 2015 Form 10-K. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported for the quarter.
Important facts for investors to verify
- Whether AUM outflows persist and how sales, redemptions and investment performance develop by asset class and region.
- Whether fee rates and revenue stabilize, especially given lower average AUM and the reduced effective management fee rate.
- The timing and full cost of employee separations and other expense-reduction measures, and their effect on margins.
- Share-repurchase pace, remaining authorization, dividend policy and the balance between capital returns and investment needs.
- Liquidity available for corporate use after operational, regulatory and international transfer restrictions; the filing notes that some subsidiary cash is restricted.
- Potential exposure from investment valuations, including Level 3 holdings and the K2 contingent-consideration liability, whose fair value was $115.8 million at quarter-end.