Franklin Resources, Inc. (Franklin Templeton) — Form 10-Q Summary
Business context and reporting period
The filing covers the first quarter of fiscal 2013, the three months ended December 31, 2012, compared with the quarter ended December 31, 2011. Franklin Resources is a global investment manager whose revenue is primarily driven by assets under management (AUM), investment performance, sales, and fee rates.
Financial performance and key metrics
- Total operating revenue was $1.902 billion, up 12%; investment management fees rose 12% to $1.200 billion and sales and distribution fees rose 15% to $604.1 million.
- Operating income was $685.1 million, up 8%. Net income attributable to Franklin Resources was $516.1 million, up 7%; diluted EPS was $2.42 versus $2.20.
- Operating margin declined to 36.0% from 37.2%, as operating expenses increased 14% to $1.217 billion—faster than revenue. Sales, distribution and marketing expense rose 16%; compensation and benefits rose 12%.
- Other income, net, declined to $31.0 million from $62.6 million. The effective tax rate was 29.5%, compared with 29.0%.
- Operating cash flow was $286.4 million, versus $167.7 million. Investing cash flow was $34.5 million, versus $236.4 million; financing cash outflow was $1.140 billion, versus $681.4 million. Cash and cash equivalents decreased $808.7 million during the quarter.
- At December 31, cash and cash equivalents were $5.087 billion and company debt was $1.263 billion. Liquid assets, as defined by management and excluding assets of consolidated investment entities, totaled $8.140 billion. Cash on the balance sheet differs from the $5.243 billion ending cash-flow figure because the latter includes cash of consolidated entities.
- Total AUM was $781.8 billion, up 17% year over year and 4% from September 30. Average AUM rose 13% year over year. Quarterly net flows were positive $9.4 billion, including $9.1 billion of reinvested distributions; market appreciation and other added $24.8 billion and the K2 acquisition added $8.7 billion.
Material changes versus the prior comparable period
- Revenue growth was supported by higher average AUM and increased commissionable sales. The effective investment management fee rate edged down to 62.9 basis points from 63.7 basis points, partly reflecting a less favorable asset mix.
- Long-term sales increased 20% to $46.0 billion and redemptions decreased 16% to $44.7 billion. Net new flows turned positive at $0.3 billion, compared with $15.6 billion of net outflows in the prior-year quarter.
- Profit growth was slower than revenue growth, and operating margin contracted. Higher compensation, distribution costs, and other expenses contributed.
- Other income was pressured by a $19.1 million net loss from consolidated CLO fair-value changes, compared with a $22.7 million gain a year earlier, and $11.3 million of foreign-exchange losses, versus $5.2 million of gains. These items were partly offset by improved gains on securities held by consolidated sponsored investment products.
- Financing outflows increased, reflecting $479.4 million of debt payments and $757.9 million of common-stock dividends paid. The company also repurchased $98.0 million of shares, less than the $290.9 million repurchased in the prior-year quarter.
Outlook, management commentary, risks and unusual items
- Management cited ongoing global economic and regulatory uncertainty and anticipated continued market volatility. It emphasized investment performance, client service, expense management, employee development, and strategic investment in systems and technology. The filing provides no quantified earnings or revenue guidance.
- In November 2012, Franklin acquired approximately 69% of K2 Advisors, a fund-of-hedge-funds provider, for a $182.9 million cash investment. K2 had $8.7 billion of AUM at acquisition. The company committed to acquire the remaining interests beginning in fiscal 2017; the contingent consideration liability was valued at $90.3 million at quarter-end and depends on K2’s future revenue and profits.
- In October 2012, the company redeemed $300 million face value of 2.000% notes due in May 2013 for $305.4 million. It reported compliance with debt covenants. Substantially all company debt was fixed-rate.
- Management said it believes existing liquid assets, operating cash flows, and financing capacity are sufficient for present and reasonably foreseeable needs. However, some cash is subject to operational, regulatory, or repatriation restrictions. The filing also notes possible voluntary support for sponsored funds, although none was provided during fiscal 2012 or the quarter.
- Key risks include market-driven AUM and fee declines, redemptions, investment underperformance, competition and distribution-channel dependence, foreign-exchange exposure, complex and changing regulation (including Dodd-Frank and FATCA), cybersecurity and operational disruptions, and legal or tax exposures. Management said pending litigation was not expected to materially affect the company and that an accrual had been recorded for probable estimable losses.
- The quarter included a special cash dividend of $3.00 per share in addition to the regular $0.29 dividend. Management expected comparable regular quarterly dividends, subject to earnings and other relevant factors; the special dividend should not be treated as recurring guidance.
Important facts for investors to verify
- Whether AUM growth and positive net flows persist, and how market appreciation, redemptions, and asset mix affect fee revenue.
- Whether expense growth moderates and operating margin stabilizes after its decline to 36.0%.
- The performance and integration of K2, and the future amount and timing of its contingent consideration.
- The composition and availability of reported liquidity, including cash held outside the United States and funds subject to restrictions.
- The sensitivity of results to fair-value estimates, consolidated CLOs, currency movements, and investment-market volatility.
- The distinction between the one-time special dividend and the company’s stated expectation for regular quarterly dividends.