FRANKLIN TEMPLETON INC annual report, FY2011

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Franklin Resources, Inc. — FY2011 Form 10-K

Reporting period: Fiscal year ended September 30, 2011; this is an annual filing, not a quarterly report. The company operates as Franklin Templeton Investments (NYSE: BEN), primarily in investment management and related services, with a smaller banking/finance business.

Financial performance and key metrics

  • Revenue: $7.14 billion, up 22% from FY2010. Investment management fees rose 27% to $4.53 billion; sales and distribution fees rose 16% to $2.26 billion.
  • Profit: Operating income was $2.66 billion, up 36%; operating margin expanded to 37.3% from 33.5%. Net income attributable to Franklin Resources was $1.92 billion, up 33%. Diluted EPS was $8.62, up 36%.
  • Cash flow: Operating cash flow was $1.62 billion, compared with $1.65 billion in FY2010. Investing activities provided $436 million; financing activities used $968 million.
  • Assets under management (AUM): Ending AUM was $659.9 billion, up 2%; average AUM increased 22% to $694.4 billion. Net new flows were $36.4 billion, acquisitions added $12.5 billion, and market depreciation reduced AUM by $30.5 billion.
  • Debt and liquidity: The company reported $5.03 billion of liquid assets in its liquidity discussion and $998 million of company/banking debt, including $899 million of long-term debt. Consolidated balance-sheet debt was $2.17 billion, including debt of sponsored investment products and variable-interest entities (VIEs) that generally has no recourse to company assets beyond its investment in those entities. The company stated it expected to meet reasonably foreseeable cash needs from liquid assets, operating cash flows and borrowing capacity.
  • Shareholder returns: Regular dividends totaled $1.00 per share for FY2011; the company repurchased 8.2 million shares for $954 million. It said it expected comparable regular quarterly dividends to continue, subject to earnings and other factors.

Changes versus the prior comparable period

  • Growth in average AUM and a higher effective investment management fee rate (65.3 basis points versus 62.6) drove much of the revenue and operating-profit increase. International AUM contributed to the higher fee rate.
  • Long-term sales rose 17% to $220.8 billion, but redemptions increased 50% to $184.8 billion; net new flows fell 48% from FY2010. Global/international fixed-income products led net inflows, while global/international equity and hybrid products experienced outflows.
  • Markets weakened sharply late in the year: FY2011 ending AUM included $30.5 billion of market depreciation, following $54.3 billion of appreciation in FY2010. The MSCI World Index fell 4% for FY2011; the S&P 500 rose 1%.
  • Sales, distribution and marketing expense increased 19% to $2.71 billion, principally reflecting higher asset-based distribution costs. Compensation and benefits increased 14% to $1.23 billion.
  • Other income and expenses moved from net income of $111 million in FY2010 to a net expense of $36 million in FY2011, including an $80 million net loss on assets and liabilities of consolidated CLOs and losses on securities held by consolidated sponsored products.

Outlook, risks and unusual items

  • The filing provides no formal numerical earnings or AUM guidance. Management cautioned that investment management fees in FY2012 could fall from FY2011 because September 30, 2011 AUM was below FY2011 average AUM.
  • Management emphasized long-term investment performance, client service, expense management, investment in systems and technology, and maintaining distribution and client relationships. It described economic, market and regulatory conditions as uncertain.
  • Key business risks include market declines and redemptions reducing fee-based AUM; investment underperformance; dependence on third-party distribution firms and key personnel; foreign-exchange exposure; cybersecurity and operational disruptions; and evolving regulation, including implementation of the Dodd-Frank Act and possible changes to Rule 12b-1.
  • Legacy market-timing litigation remained unresolved. The company agreed in principle to pay $2.75 million toward a proposed class settlement, subject to court approval; related derivative cases remained stayed. Management said it could not estimate potential additional losses in the derivative actions.
  • New consolidation guidance brought automobile-loan securitization trusts and CLOs onto the balance sheet during FY2011. Separately, the company identified prior accounting errors involving certain limited partnerships and consolidated them as of September 30, 2011; it said prior-period financial statements were not materially misstated and shareholder net income, EPS and retained earnings were unchanged.
  • FY2011 included acquisitions of Rensburg, a U.K. equity manager, for $72.9 million and Balanced Equity Management, an Australian manager, for $65.1 million. A $38.5 million net insurance recovery for prior-year losses substantially offset other general and administrative expense increases.

Important facts for investors to verify

  • Review the drivers and durability of AUM flows, especially elevated redemptions and the concentration of inflows in global/international fixed income.
  • Check subsequent AUM, fee rates and FY2012 fee trends against the company’s warning that fees could decline from FY2011.
  • Distinguish company obligations from consolidated sponsored-product and VIE debt; assess the nonrecourse terms and any retained exposure or support commitments.
  • Track the outcome of the proposed market-timing settlement, remaining derivative litigation, tax examinations and related contingencies.
  • Assess the effect of regulatory implementation, distribution costs, market volatility and the reported CLO valuation losses on future margins and earnings.
  • The filing reports an unqualified audit opinion and effective internal control over financial reporting as of September 30, 2011; confirm later filings for any changes.