Franklin Resources, Inc. — Q1 FY2014 Form 10-Q
Reporting period: Three months ended December 31, 2013. The filing is for Franklin Resources, Inc., the parent of Franklin Templeton Investments; financial statements are unaudited and amounts are in U.S. dollars.
Business context and performance
The company is a global investment manager whose results depend substantially on assets under management (AUM), market values, asset mix, investment performance and investor flows. Strong equity markets supported AUM and fee revenue during the quarter; bond markets were weaker.
Key financial metrics
| Metric | Q1 FY2014 | Prior-year quarter | Change |
|---|---|---|---|
| Operating revenue | $2,109.5 million | $1,901.8 million | +11% |
| Operating income | $813.1 million | $685.1 million | +19% |
| Operating margin | 38.5% | 36.0% | +2.5 percentage points |
| Net income attributable to Franklin Resources | $603.8 million | $516.1 million | +17% |
| Diluted EPS | $0.96 | $0.81 | +19% |
| Operating cash flow | $324.7 million | $286.4 million | Higher |
Investment management fees rose 14% to $1,373.8 million, mainly reflecting 13% growth in average AUM; the annualized effective management fee rate was 63.5 basis points versus 62.9 basis points. Sales and distribution fees increased 5%, while sales-based fees declined 9%. Performance-based management fees increased to $26.0 million from $2.9 million, primarily related to K2-managed products. The effective tax rate was 29.8%, compared with 29.5%.
Ending AUM was $879.1 billion, up 12% year over year and 4% from September 30, 2013. Average AUM rose 13% year over year to $865.9 billion. Quarterly AUM appreciation and other added $36.0 billion, but long-term sales of $49.8 billion were nearly offset by redemptions of $49.7 billion; net new flows were zero before reinvested distributions. Over the prior twelve months, AUM benefited from $77.3 billion of market appreciation and $24.0 billion of net new flows.
Cash and cash equivalents on the balance sheet were $6,552.2 million, excluding cash held by consolidated investment entities. Company liquid assets, as defined in the filing, totaled $9,931.7 million, compared with $9,448.9 million at September 30, 2013. Company debt was $1,197.8 million, essentially unchanged; all outstanding notes carried fixed rates. Cash flow from investing was $115.8 million and financing used $72.5 million. The company paid $64.1 million in common dividends and repurchased $137.1 million of shares. The prior-year quarter’s financing outflow was $1,140.4 million, including $757.9 million of dividends and $479.4 million of debt payments.
Material changes and unusual items
- Operating income growth exceeded revenue growth, and operating margin expanded, as higher AUM-driven fees more than offset expense growth.
- Total operating expenses rose 7% to $1,296.4 million. General, administrative and other expenses increased 19%, partly reflecting K2 acquisition-related costs, higher professional and servicing fees, and a $3.3 million increase in the fair value of K2 contingent consideration.
- Net other income was $35.6 million versus $31.0 million. The year-over-year comparison included $5.7 million of net gains on consolidated CLO assets and liabilities versus $19.1 million of net losses in the prior-year quarter; consolidated SIP investments recorded $5.3 million of net losses versus $20.9 million of net gains.
- Loans receivable of $189.2 million were transferred to loans held for sale. The filing does not provide a clear explanation of a completed sale in this quarter.
- In December, the board authorized up to 30.0 million additional shares for repurchase; 38.7 million shares remained available under the program at quarter-end.
Outlook, risks and contingencies
Management provided no specific earnings or revenue guidance. It said it expects to continue comparable regular quarterly dividends, subject to earnings and other relevant factors, and plans to invest in the business, technology and SIPs while managing expenses. Management cited uncertainty in economic and regulatory conditions and emphasized investment performance and client service.
Principal risks include market declines or shifts in AUM mix, redemptions, investment underperformance, competition and dependence on third-party distribution, foreign exchange movements, regulatory and compliance costs, tax exposures, cybersecurity and operational disruption, and reliance on key personnel. The filing highlights upcoming or evolving requirements including the Volcker Rule, FATCA and Basel III. Management stated that no material changes had occurred to previously disclosed risk factors or contractual obligations. It considered probable legal losses adequately accrued and did not expect the resolution of ordinary-course litigation to materially affect the company. Banking regulatory capital ratios exceeded stated minimums; disclosure controls were reported effective.
Important facts for investors to verify
- Whether AUM growth persists if market appreciation moderates, given that current-quarter long-term sales and redemptions were almost equal and net new flows were zero.
- Whether performance-based fees and the higher effective management fee rate are repeatable; also monitor U.S. equity results, which largely lagged benchmarks and peer groups in the periods reported.
- How expense growth, K2 contingent consideration and acquisition-related costs evolve relative to revenue.
- Cash availability across jurisdictions: $617.5 million of U.S. liquid assets and $338.4 million of non-U.S. liquid assets were restricted from transfer to Franklin and other subsidiaries.
- Whether any legal, regulatory, tax or market developments materially change the company’s risk profile; the filing gives no quantified estimate for potential future exposure.