Business context and reporting period
Franklin Resources, Inc. (operating globally under the Franklin Templeton brands) filed this unaudited Form 10-Q for its fiscal first quarter, the three months ended December 31, 2011. Its principal business is investment management and related services; banking and finance is a smaller segment. Figures below are in U.S. dollars.
Financial results and key metrics
- Revenue: $1.702 billion, essentially unchanged from $1.700 billion in the prior-year quarter. Investment management fees rose 1% to $1.075 billion; sales and distribution fees fell 5% to $524.3 million; shareholder servicing fees rose 5% to $75.4 million.
- Profit and margins: Operating income was $632.4 million, down 4%; operating margin was 37.2%, versus 38.8%. Net income attributable to Franklin Resources was $480.8 million, down 4%; diluted EPS was $2.20 versus $2.23. Consolidated net income increased slightly to $493.7 million, but the amount attributable to Franklin fell, partly reflecting changes in noncontrolling interests.
- Cash flow: Operating cash flow was $167.7 million, down from $245.8 million. Investing activities provided $236.4 million; financing activities used $681.4 million, chiefly reflecting $546.9 million in dividends and $290.9 million in share repurchases. Ending cash and cash equivalents, including consolidated entities, were $4.912 billion.
- Liquidity and debt: Management reported $7.653 billion of liquid assets and $993.2 million of debt for its liquidity analysis, which excludes debt of consolidated sponsored products and VIEs. The balance sheet reports $2.059 billion total debt including those entities. Management said it expected existing liquid assets, operating cash flow, and borrowing capacity to meet foreseeable needs. Corporate senior notes had $900 million face value; the company reported compliance with their covenants.
- Assets under management (AUM): Ending AUM was $670.3 billion, up 2% from September 30, 2011 and essentially unchanged year over year. Quarterly net new flows were negative $15.6 billion; market appreciation added $27.2 billion. Long-term sales fell 30% year over year to $38.2 billion.
Material changes versus the prior comparable quarter
- Reported operating income and attributable net income declined despite broadly flat revenue. Management attributed much of the decline to a $26.5 million net insurance recovery recognized in the prior-year quarter for earlier losses.
- Investment management fees benefited from a 3% increase in average AUM and a higher share of international fixed-income assets, but the effective management fee rate declined to 63.7 basis points from 65.1 basis points. Performance-based fees were minimal, versus $10.8 million in the prior-year quarter.
- Net outflows replaced prior-year net inflows of $3.2 billion. Sales weakened across most investment objectives, while redemptions were broadly stable; management cited investor concerns about Europe and weaker sentiment.
- Other income rose to $62.6 million from $38.4 million, mainly due to valuation gains on consolidated CLO assets and liabilities and the absence of prior-year investment impairments. The gains were partly offset by losses on certain consolidated limited-partnership investments; many gains and losses in consolidated products are offset by noncontrolling interests.
- The board declared a $0.27 regular quarterly dividend and a $2.00 special dividend, both paid December 30, 2011. Reported dividends per share were $2.27, versus $0.25 in the prior-year quarter. The company repurchased approximately 3.0 million shares for $290.9 million and authorized up to 10 million additional repurchases.
Outlook, management commentary, and risks
Management provided no quantified earnings or revenue guidance. It said market conditions improved during the quarter, but the European sovereign debt crisis remained unresolved and volatility could continue. Priorities included investment performance, customer service, expense management, strategic technology investment, and maintaining distribution and client relationships.
- Results remain sensitive to market levels and the amount and mix of AUM, client flows, investment performance, fee rates, and distribution costs. Management highlighted the potential effect of a shift toward lower-fee fixed-income assets.
- Key risks include financial-market and economic volatility, sovereign debt and currency risks, competition and fund outflows, complex and changing regulation including implementation of the Dodd-Frank Act, tax uncertainty, operational and cybersecurity failures, and the retention of key personnel.
- Level 3 assets were 18.6% of assets measured at fair value, primarily investments in less actively traded securities held by consolidated sponsored products. Fair-value estimates therefore involve significant judgment.
- Two market-timing-related lawsuits were dismissed and resolved in December 2011. A separate derivative action remained pending; the company said it did not anticipate additional losses from that litigation. Management considered accruals adequate for probable, estimable claims.
- The company disclosed $3.8 million maximum potential payments under auto-loan securitization guarantees, $11.8 million of fully collateralized standby letters of credit, and $51.3 million of credit commitments. It also held $403.2 million off balance sheet as agent or trustee for investors and affiliated funds.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether net outflows and reduced sales continued after the quarter, and how they affected average AUM, fee rates, and revenue.
- How much of earnings and other income came from investment valuations, consolidated entities, and noncontrolling interests, versus recurring operating performance.
- The sustainability of cash generation and capital returns after the special dividend and elevated share repurchases; note the timing and size of future dividends are not assured.
- The distinction between corporate debt and consolidated-product/VIE debt, including the latter’s limited recourse to Franklin Resources’ assets.
- Developments in the remaining legal proceeding, regulatory implementation, and the valuation and liquidity of Level 3 investments.
- Comparability of prior-year revenue categories: the company reclassified certain non-U.S. fees between investment management and sales and distribution fees, with no effect on total revenue, net income, or financial position.