FRANKLIN TEMPLETON INC annual report, FY2020

Business context and reporting period

Franklin Resources, Inc. (NYSE: BEN), operating under Franklin Templeton and other brands, filed this Form 10-K for the fiscal year ended September 30, 2020. The company is a global investment manager whose revenues primarily depend on assets under management (AUM) and related fees. The filing covers the full fiscal year, not only the fourth quarter.

On July 31, 2020, Franklin completed its $4.5 billion cash acquisition of Legg Mason and assumed its debt; Legg Mason contributed results for approximately two months. The acquisition added $797.4 billion of AUM at closing and substantially expanded the company’s investment platform.

Financial performance and position

• Revenue declined 2%, while GAAP operating income fell 28% and net income fell 33%. Higher compensation—including acquisition-related retention costs—and higher amortization and impairment expenses pressured results. Net investment and other losses were $38.4 million, versus $141.4 million of gains in FY2019.
• Management’s non-GAAP adjusted operating income was $1.49 billion, down 10%; adjusted operating margin was 38.5%, versus 42.6%. Adjusted net income was $1.31 billion, down 2%, and adjusted diluted EPS was $2.61, versus $2.62. These measures exclude specified acquisition, impairment, investment and other items; they are not GAAP results.
• Ending AUM rose 105% to $1.419 trillion, mainly due to acquisitions. Average AUM increased 19% to $832.9 billion. Excluding acquisitions, long-term net outflows were $61.6 billion and cash-management net outflows were $9.9 billion; net market change, distributions and other reduced AUM by $8.7 billion.
• Company liquid assets, excluding consolidated investment products, were $5.12 billion, including $3.03 billion of cash and cash equivalents. The filing says $3.29 billion of liquid assets was used for operational and regulatory requirements, including $316.6 million restricted by regulation.
• Debt at year-end was $3.02 billion, including $2.32 billion carrying value of Legg Mason notes; its notes had $2.0 billion aggregate principal due. Debt of consolidated investment products was an additional $1.33 billion and is described as nonrecourse beyond Franklin’s direct investments. Franklin reported compliance with debt covenants.
• FY2020 dividends declared were $1.08 per share. The company repurchased 9.0 million shares for $219.4 million, down from 24.6 million shares for $756.3 million in FY2019.

Material changes versus the prior period

• The acquisition drove most of the increase in ending AUM and increased reported debt, goodwill and intangible assets. Franklin recorded $2.3 billion of goodwill and significant acquired management-contract and trade-name intangibles.
• Operating expenses increased 7% to $4.52 billion. Compensation and benefits rose 18% to $1.87 billion, including $195.8 million of acquisition-related retention expense; amortization of intangible assets rose to $54.0 million.
• The effective investment management fee rate, excluding performance fees, declined to 47.3 basis points from 56.4, partly reflecting Legg Mason’s greater institutional and fixed-income mix. Management expected the rate to decline further in FY2021 with a full year of Legg Mason results.
• The effective income tax rate was 22.7%, versus 26.8% in FY2019. The company reported $798.9 million of GAAP net income attributable to Franklin, compared with $1.20 billion a year earlier.

Outlook, risks and unusual items

• No specific revenue, earnings or AUM guidance is provided. Management emphasized investment performance, client service, expense discipline and investment in systems and technology. It expected approximately $150 million of acquisition-related retention expense in FY2021, declining by about $20 million annually over the following three fiscal years.
• Management warned that COVID-19-related market volatility, economic weakness, redemptions, liquidity needs, remote-work and cybersecurity risks could continue to affect AUM, revenues, operations and results; the impact remained uncertain.
• Six Indian fixed-income funds with approximately $3.4 billion in AUM were subject to a decision to wind them up. Court challenges and a SEBI forensic review were ongoing. An October 2020 court judgment upheld the wind-up decision but required unitholder consent to implement it; the company could not estimate a potential loss. Franklin had authorized loans of up to approximately $66.2 million to the funds and had $42.4 million outstanding at year-end.
• FY2020 included $55.4 million of goodwill and intangible-asset impairment, including a $23.7 million goodwill impairment related to the planned wind-down of Onsa and $30.0 million of indefinite-lived intangible impairment. Franklin also issued $750 million of 1.600% notes due 2030 on October 19, 2020, after year-end.
• The auditor issued unqualified opinions on the financial statements and internal controls. However, the internal-control assessment excluded Legg Mason, representing 12% of consolidated assets and 9% of FY2020 revenue, because of the timing and complexity of the acquisition.

Important facts for investors to verify

• Progress on Legg Mason integration, expected synergies and retention costs, and whether acquired AUM and fee revenue are retained.
• Underlying net flows and fee-rate trends, separately from acquisition-driven AUM growth; FY2020 long-term net outflows were $61.6 billion.
• Resolution of the Indian fund wind-up process, SEBI review and related litigation, including any impact on redemptions, fee income or regulatory permissions.
• Post-acquisition leverage, scheduled debt service and liquidity available after required operating and regulatory reserves; distinguish Franklin debt from nonrecourse investment-product debt.
• Whether Legg Mason’s internal controls are incorporated into subsequent reporting, and whether the material acquired intangibles remain recoverable.