Franklin Resources, Inc. (Franklin Templeton) — FY2016 Form 10-K
Reporting period: Fiscal year ended September 30, 2016; filed November 14, 2016. The issuer is Franklin Resources, Inc., which operates as Franklin Templeton Investments. It is a global investment manager whose revenues depend primarily on assets under management (AUM), fee rates, product mix and sales.
Financial performance and key metrics
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Operating revenues | $6.618 billion | $7.949 billion | -17% |
| Operating income | $2.366 billion | $3.028 billion | -22% |
| Operating margin | 35.7% | 38.1% | -2.4 percentage points |
| Net income attributable to Franklin Resources | $1.727 billion | $2.035 billion | -15% |
| Diluted EPS | $2.94 | $3.29 | -11% |
| Operating cash flow | $1.728 billion | $2.252 billion | Lower |
| Ending AUM | $733.3 billion | $770.9 billion | -5% |
| Average AUM | $749.3 billion | $869.5 billion | -14% |
- Investment management fees were $4.472 billion (-16%); sales and distribution fees were $1.806 billion (-20%). Management fees fell mainly with lower average AUM and a lower effective fee rate, which declined to 59.7 basis points from 61.3.
- Net new flows were negative $86.5 billion, as $101.7 billion of long-term sales were outweighed by $186.9 billion of redemptions. Market appreciation and other added $53.4 billion, partly offsetting outflows.
- Cash and cash equivalents were $8.247 billion and total liquid assets were $10.890 billion, excluding assets of consolidated investment products. Company debt was $1.401 billion, including $1.349 billion of senior notes and a $52.7 million Indian subsidiary loan. Debt of consolidated sponsored products and VIEs was a separate $682.2 million and is generally nonrecourse to Franklin beyond its direct investments.
- Cash flow from investing activities was $192.2 million; financing activities used $1.801 billion. Franklin repurchased 36.6 million shares for $1.324 billion and declared $0.72 per share in regular dividends. FY2015 dividends included a $0.50 special dividend.
- For FY2016 Q4, revenue was $1.612 billion, operating income $579.4 million, net income attributable to Franklin $472.1 million and diluted EPS $0.82.
Material changes and operating context
- Markets appreciated during FY2016: the S&P 500 rose 15.4%, MSCI World rose 12.0% and Bloomberg Barclays Global Aggregate rose 8.8%. Despite this, outflows reduced ending AUM; average AUM fell across all major investment objectives.
- Sales and redemptions both declined, with weaker long-term sales across most objectives. Global/international products were a significant source of outflows. Equity AUM was $303.7 billion, hybrid $137.4 billion and fixed income $286.1 billion.
- Operating expenses declined 14% to $4.252 billion, mainly reflecting lower sales, distribution and marketing costs alongside lower compensation expense. Compensation included increased termination benefits, substantially related to voluntary separations of approximately 300 employees.
- Investment and other income, net rose to $184.0 million from $40.4 million, including improved equity-method and trading investment results. This partially cushioned lower operating income.
- Investment performance was mixed: most equity products lagged benchmarks over the periods presented. Global/international fixed income had strong five- and ten-year results against benchmarks and peer groups, while some three-year comparisons weakened.
Outlook, risks and unusual items
- Management provided no quantified earnings, revenue or AUM guidance. It said it would focus on investment performance, client service, expense management, strategic investment in systems and technology, and maintaining distribution and client relationships. It expected comparable regular quarterly dividends, subject to earnings and other factors.
- Management cited uncertainty in global economic and regulatory conditions. Principal business risks include market declines and volatility, continued outflows or poor relative investment performance, shifts toward lower-fee passive products, and dependence on third-party distributors and key investment personnel.
- Regulatory and distribution changes may raise costs or affect product sales, including the U.S. Department of Labor fiduciary rule, EU MiFID II and derivatives requirements. The filing says Brexit’s eventual effects were uncertain but management did not expect a major operational impact.
- Franklin recognized $28.2 million of impairment of definite-lived intangible assets, primarily related to K2, reflecting lower AUM growth and fee-rate assumptions, redemptions and fee renegotiations. Goodwill and indefinite-lived intangible assets were not impaired.
- A putative ERISA class action filed in July 2016 alleges that Franklin-related funds in the company’s 401(k) plan were costly and underperformed alternatives. The complaint alleges plan losses exceeding $88 million; Franklin moved to dismiss and for summary adjudication and said it would defend vigorously. The outcome and potential material impact were uncertain.
- Other exposures include tax audits and $82.1 million of unrecognized tax benefits, plus $9.6 million of accrued interest. Approximately $8.5 billion of undistributed non-U.S. earnings was treated as indefinitely reinvested. Some cash is subject to regulatory or contractual transfer restrictions.
- Franklin purchased $182.7 million of debt securities from six India-domiciled funds to provide liquidity. Although it has no general contractual obligation to support its funds, it may choose to provide financial support.
Important facts for investors to verify
- Whether net outflows continue, particularly in global/international and fixed-income products, and how average AUM and fee rates affect future revenue.
- Updated investment performance versus benchmarks and peers, especially across equity products and the large funds driving category results.
- The status and potential financial or reputational impact of the 401(k) lawsuit, tax examinations and other contingencies.
- How much reported cash is available to the parent, given operating needs and restrictions on moving non-U.S. cash, and the timing of debt maturities and K2 contingent payments.
- Whether the regular dividend and share repurchases remain sustainable if earnings and AUM weaken; the filing gives no formal forward earnings guidance.
- The effects of regulatory changes and the planned adoption of revised consolidation accounting guidance beginning October 1, 2016, which management expected to change which investment products are consolidated.