Franklin Resources, Inc. (Franklin Templeton Investments) — FY2012 Form 10-K
Reporting period: Fiscal year ended September 30, 2012; this is an annual filing, not a quarterly report. Franklin Resources, Inc. is the registrant; “Franklin Templeton Investments” is its operating name. The company is a global investment manager, with $749.9 billion in assets under management (AUM) at year-end.
Financial performance and condition
| Metric | FY2012 | FY2011 | Change |
|---|---|---|---|
| Operating revenue | $7.101 billion | $7.140 billion | Down 1% |
| Operating income | $2.515 billion | $2.660 billion | Down 5% |
| Operating margin | 35.4% | 37.3% | Down 1.9 percentage points |
| Net income attributable to Franklin Resources | $1.931 billion | $1.924 billion | Up 0.4% |
| Diluted earnings per share | $8.95 | $8.62 | Up 4% |
| Operating cash flow | $1.066 billion | $1.622 billion | Down 34% |
| Ending AUM | $749.9 billion | $659.9 billion | Up 14% |
- Revenue mix: Investment management fees were $4.459 billion (63% of operating revenue), sales and distribution fees $2.259 billion (32%), shareholder servicing fees $302.5 million, and other revenue $80.5 million.
- Margins and earnings: Operating expenses rose 2% to $4.586 billion. A $197.9 million increase in investment and other income, net, helped keep attributable net income slightly above the prior year despite lower operating income. The effective tax rate fell to 28.5% from 30.6%.
- AUM and flows: AUM growth primarily reflected $96.4 billion of market appreciation. Average AUM increased 2% to $705.7 billion. Long-term sales fell 23% to $170.8 billion, redemptions declined 7% to $172.7 billion, and net new flows were negative $2.3 billion.
- Liquidity and debt: Company liquid assets were $8.875 billion, comprising cash and cash equivalents of $5.784 billion, receivables of $823.8 million, and investments of $2.267 billion. Company debt was $1.566 billion, including $1.497 billion of senior notes and $69 million of Federal Home Loan Bank advances. Separately consolidated sponsored-product and VIE debt is generally nonrecourse to Franklin beyond its direct investments.
- Capital returns: Franklin paid regular dividends of $1.08 per share and a special dividend of $2.00 per share. It repurchased 7.5 million shares for $797.4 million during the year.
Material changes versus FY2011
- Revenue and operating income declined, while attributable net income was nearly flat and diluted EPS increased, partly reflecting fewer diluted shares outstanding and higher investment income.
- Ending AUM rose substantially on market gains, but sales weakened and net new flows turned negative, compared with $36.4 billion of net new flows in FY2011.
- Operating cash flow decreased by $555.6 million, primarily reflecting higher purchases of trading securities, gains of consolidated VIEs versus prior-year losses, and lower income taxes payable.
- Effective July 1, 2012, the company consolidated its reporting into one operating segment, investment management and related services, after significantly reducing banking and consumer-lending activities. Retail banking and consumer lending were discontinued; select private banking continued.
- Company debt increased to $1.566 billion from $998.2 million, principally following the September 2012 issuance of $600 million in senior notes. The proceeds were used after year-end to redeem $300 million of notes due 2013 and help finance the K2 acquisition.
Outlook, commentary, risks and unusual items
- Management provided no specific financial guidance. It cited ongoing economic and regulatory uncertainty, and said it expects the shift in average AUM mix toward fixed-income products to continue in the near future.
- Management emphasized long-term investment performance, client service, expense management, employee retention, and investment in systems and technology. FY2012 markets were strong but volatile amid concerns about the European sovereign-debt crisis and the global recovery.
- Key business sensitivities include market-driven AUM changes, investor redemptions, investment performance, fee-rate and product-mix shifts, and dependence on third-party distributors. Regulatory changes—including Dodd-Frank, the Volcker Rule, FATCA, and evolving non-U.S. requirements—could increase costs or constrain activities.
- In September 2012, the OCC advised that it generally would no longer charter uninsured national trust banks, following Franklin’s application to restructure its banking subsidiaries. The company was evaluating alternatives; there was no assurance it could complete a restructuring or end bank-holding-company regulation.
- Other notable items: investment and other income, net, increased to $199.7 million from $1.8 million, including improved fair-value results for consolidated CLOs and gains from equity-method investees and trading securities. The company reported $101.3 million of unrecognized tax benefits and $14.6 million of related accrued interest; timing of payments beyond the next 12 months was uncertain. Management said litigation accruals were adequate and did not expect current claims to materially affect the company.
- Subsequent events: Franklin redeemed its 2.000% notes due 2013 for $305.4 million in October 2012 and acquired approximately 69% of K2 Advisors for $182.9 million in November 2012; it agreed to acquire the remaining interest beginning in FY2017.
- PricewaterhouseCoopers issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective.
Important facts for investors to verify
- Whether AUM growth is sustained by net sales and retention rather than market appreciation alone, including trends in global/international fixed-income demand.
- How the lower effective management fee rate and higher fixed-income share of AUM affect revenue and operating margins.
- Drivers of the substantial operating-cash-flow decline and whether cash conversion improves in subsequent periods.
- The company’s post-acquisition debt, liquidity, and capital-return capacity, including the K2 purchase and remaining staged acquisition commitment.
- Developments in banking-subsidiary restructuring, regulatory compliance costs, tax examinations, and other contingencies disclosed in the filing.