Franklin Resources, Inc. — Q1 FY2023 10-Q
Reporting period: Three months ended December 31, 2022; compared with the three months ended December 31, 2021, and balance-sheet amounts compared with September 30, 2022. The filing is for Franklin Resources, Inc., which operates under the Franklin Templeton and other brands.
Financial performance
| Metric | Q1 FY2023 | Prior-year quarter | Change |
|---|---|---|---|
| Operating revenue | $1,967.1 million | $2,224.0 million | Down 12% |
| Operating income / margin | $194.0 million / 9.9% | $557.7 million / 25.1% | Income down 65% |
| Net income attributable to Franklin Resources | $165.6 million | $453.2 million | Down 63% |
| Diluted EPS | $0.32 | $0.88 | Down 64% |
| Adjusted operating income / margin | $395.1 million / 27.5% | $685.9 million / 39.8% | Income down 42% |
| Adjusted net income / diluted EPS | $262.4 million / $0.51 | $553.6 million / $1.08 | Income down 53% |
Adjusted measures are non-GAAP and exclude specified items, including acquisition-related costs, intangible amortization and certain investment effects; they are not substitutes for GAAP results.
- Revenue detail: Investment management fees fell 7% to $1,631.8 million; sales and distribution fees fell 27% to $291.9 million; shareholder servicing fees fell 30% to $33.4 million.
- Expenses and earnings drivers: Operating expenses rose 6% to $1,773.1 million. Compensation and benefits increased 22% to $979.2 million, including $144.5 million of acquisition-related performance-fee pass-through compensation. Intangible amortization rose 43% to $83.2 million. Lower AUM-related revenues and weaker consolidated investment-product results also affected comparisons.
- AUM: Quarter-end AUM was $1,387.7 billion, up 7% from September 30, 2022, but down 12% year over year. Average AUM fell 13% year over year to $1,353.5 billion. Long-term net outflows were $10.9 billion, partly offset by $17.5 billion of cash-management net inflows, $48.8 billion of market change, distributions and other, and $34.9 billion from acquisitions.
- Cash flow: Operating cash flow was negative $256.3 million, versus positive $166.4 million a year earlier; investing cash flow was negative $1,042.6 million, including acquisitions; financing cash flow was positive $958.9 million. Cash and cash equivalents, including consolidated investment products (CIPs), ended at $4,502.2 million.
- Balance sheet and liquidity: Total assets were $29,335.1 million and total liabilities $14,800.4 million. Company debt was $3,370.5 million. Excluding third-party CIP assets and liabilities, liquid assets were $5,577.5 million and debt was $3,370.5 million. The company reported covenant compliance and no borrowings under its $500 million revolving credit facility.
Material changes and notable items
- On November 1, 2022, Franklin acquired BNY Alcentra for $587.3 million cash at closing, plus $60.4 million deferred consideration and up to $350.0 million contingent consideration. Alcentra contributed $27.7 million of revenue in the quarter and did not materially affect attributable net income.
- Quarter-end AUM improved sequentially with positive markets and acquisition contributions, but remained substantially below the prior-year level; fixed-income and equity AUM were down 23% and 26% year over year, respectively. Alternative AUM increased 67%, including acquisition effects.
- GAAP earnings included materially lower gains from consolidated investment products than in the prior-year quarter. The company also recorded $27.1 million of foreign-currency exchange losses in investment and other income, compared with $3.9 million of gains a year earlier.
- Company cash and cash equivalents on the balance sheet were $3,547.8 million, down from $4,134.9 million at September 30, 2022. This differs from cash-flow-statement ending cash, which includes cash held by CIPs.
Outlook, risks and contingencies
- No specific revenue, earnings or AUM guidance is provided. Management described the global economic and regulatory environment as complex and uncertain, and said it remains focused on investment performance, client service, expense management, talent and strategic technology investment.
- Management expected approximately $190 million of additional acquisition-related retention expense during the remainder of fiscal 2023, followed by annual amounts beginning at approximately $220 million in fiscal 2024 and declining over the next two fiscal years.
- The company expected to continue comparable quarterly regular dividends, subject to earnings and other relevant factors. It paid a $0.30-per-share dividend in the quarter and repurchased $14.2 million of shares.
- Capital commitments include a New York City office lease with an expected aggregate commitment of $766.7 million over 16 years, and remaining Lexington acquisition payments, including an expected $250 million payment in Q2 FY2023. Alcentra repurchase agreements were backed by investments with a $198.9 million carrying value and mature between 2029 and 2034.
- Management cited market and volatility, investment performance, competition, operational, technology and security, human-capital, cash-management, legal and regulatory risks. It reported no material change in previously disclosed risk factors or market-risk disclosures.
- India Credit Fund closure matters continued; the filing reported aggregate distributions to fund unitholders of INR 26,843.0 crore (approximately $3.2 billion). Management said other litigation was not expected to materially affect the company and that no material indemnification or guarantee loss was considered probable or reasonably possible.
- Management said disclosure controls were effective. A new financial reporting system was deployed in October 2022 and modified certain internal controls; no other change was reported as materially affecting, or reasonably likely to materially affect, internal control over financial reporting.
Investor verification priorities
- Assess whether the sharp year-over-year decline in average AUM, long-term flows and GAAP operating margin is stabilizing, and how much sequential AUM growth depended on market appreciation and acquisitions.
- Review the reconciliation of GAAP to adjusted earnings, particularly acquisition-related retention costs, performance-fee pass-through compensation and intangible amortization.
- Track Alcentra and Lexington integration, deferred and contingent purchase consideration, and the expected retention and office-lease costs.
- Distinguish Franklin corporate liquidity and debt from consolidated investment-product balances; CIP debt is described as nonrecourse to Franklin beyond its direct investments.
- Monitor operating cash generation, which was negative in the quarter, and the use of cash for acquisitions, product investments, dividends and debt service.