Business context and reporting period
Franklin Resources, Inc. (NYSE: BEN), operating under Franklin Templeton and other brands, filed this unaudited Form 10-Q for its fiscal first quarter ended December 31, 2020. The filing’s results include Legg Mason, acquired July 31, 2020; comparisons with the prior-year quarter therefore reflect a materially larger business. Unless otherwise noted, figures are in U.S. dollars.
Financial and operating performance
- Revenue: Operating revenue was $1,995.1 million, up 44% from $1,389.2 million. Investment management fees rose 57% to $1,540.4 million, primarily reflecting Legg Mason; sales and distribution fees increased 13% to $396.9 million.
- Profit and margins: Operating income increased 10% to $409.1 million, but GAAP operating margin fell to 20.5% from 26.8%. Net income attributable to Franklin Resources declined 1% to $345.3 million; diluted EPS decreased to $0.67 from $0.70. The effective tax rate rose to 26.5% from 21.9%. Adjusted operating income increased 36% to $549.9 million, adjusted operating margin was 37.2% versus 42.6%, and adjusted diluted EPS rose to $0.73 from $0.67. Adjusted figures are non-GAAP.
- AUM and flows: Assets under management were $1.498 trillion at quarter-end, up 6% from September 30, 2020 and 115% from December 31, 2019, largely due to Legg Mason. Quarterly average AUM was $1.444 trillion, up 108% year over year. The quarter had $14.7 billion of total net outflows, comprising $4.5 billion in long-term net outflows and $10.2 billion in cash-management net outflows; market change, distributions and other added $93.8 billion.
- Cash flow: Operating cash flow was $290.0 million, compared with $31.7 million a year earlier. Investing cash flow was negative $521.8 million, mainly reflecting CLO investment purchases; financing cash flow was positive $666.1 million, including $748.3 million of debt proceeds. Consolidated cash and cash equivalents ended at $4,419.5 million, including consolidated investment product cash.
- Liquidity and debt: The company reported $6,231.8 million of liquid assets and $3,753.1 million of corporate debt at December 31, excluding third-party assets and liabilities of consolidated investment products from its liquidity analysis. It said existing liquid assets, operating cash flows and financing capacity should meet present and reasonably foreseeable needs. Debt covenants were met.
- Shareholder returns: The company declared a quarterly dividend of $0.28 per share and repurchased 2.1 million shares for $45.6 million. It expected to continue comparable quarterly dividends, subject to earnings and other relevant factors.
Material changes versus the prior comparable period
Legg Mason contributed $738.6 million of revenue and $123.7 million of net income attributable to Franklin Resources in the quarter. Its inclusion was a principal driver of higher revenue, AUM and expenses. Total operating expenses rose 56% to $1,586.0 million, including higher compensation, technology costs and $58.2 million of intangible-asset amortization, versus $4.8 million a year earlier. Corporate debt increased from $3,017.1 million at September 30, 2020 to $3,753.1 million, including the October 2020 issuance of $750 million of 1.600% notes due 2030.
Outlook, commentary and risks
- Management cited strong equity and bond markets in the quarter, but gave no specific revenue, earnings or AUM guidance. It emphasized investment performance, client service, expense management and strategic investment in technology and the business.
- The company expected approximately $110 million of additional acquisition-related retention expense during the remainder of fiscal 2021, followed by annual amounts beginning at approximately $130 million in fiscal 2022 and declining over the next two years. Management also noted that fee rates were diluted by Legg Mason’s greater mix of institutional and fixed-income AUM.
- COVID-19, market volatility, investor redemptions, fee pressure, investment performance, acquisition integration, cybersecurity and regulatory change were identified as risks that could affect AUM, revenue, liquidity and results.
- India fund matters: Proceedings continue regarding the 2020 wind-up of six Indian fixed-income funds. A substantial majority of voting unitholders supported winding up, but appeals and objections remain pending. SEBI issued show-cause notices alleging deficiencies and non-compliance and contemplated monetary sanctions and restrictions on launching new funds in India. The company said it could not predict the outcome or reasonably estimate potential losses.
- The company had authorized up to approximately $66.2 million in loans to certain Indian sponsored funds; $14.5 million was outstanding at quarter-end. It reported no financial support to sponsored funds during the quarter. Separately, it announced an intention, subject to board approval, to redeem $250 million of Legg Mason 6.375% junior notes on March 15, 2021.
Most important facts for investors to verify
- How much of reported growth and future earnings is attributable to Legg Mason, and whether integration benefits offset ongoing retention, amortization and other acquisition costs.
- Whether long-term and cash-management net outflows persist, and how AUM mix and fee-rate trends affect revenue and margins.
- The progression and potential financial, regulatory and reputational consequences of the India fund litigation and SEBI proceedings; the filing does not provide a clear estimate of possible losses.
- Corporate debt, liquidity available after operational and regulatory requirements, and the status of the proposed junior-note redemption.
- Performance of investment products and the sustainability of GAAP and non-GAAP earnings, including the assumptions and exclusions used in adjusted measures.