Franklin Resources, Inc. — Q2 FY2012 Form 10-Q
Reporting period: Three and six months ended March 31, 2012. The filing’s registrant is Franklin Resources, Inc.; the supplied company label, Franklin Templeton Inc., is not the legal issuer named in the filing. Amounts below are in U.S. dollars.
Business context
Franklin is a global investment manager operating primarily through investment management and related services, with a smaller banking/finance business. Revenue and earnings depend substantially on assets under management (AUM), market performance, product mix, sales and investor redemptions.
Financial performance
| Metric | Quarter ended Mar. 31, 2012 | Six months ended Mar. 31, 2012 | Change vs. prior year |
|---|---|---|---|
| Operating revenue | $1.799 billion | $3.501 billion | +3% quarter; +1% six months |
| Operating income | $617.2 million | $1.250 billion | -2% quarter; -3% six months |
| Operating margin | 34.3% | 35.7% | Prior year: 36.0% and 37.4% |
| Net income attributable to Franklin | $503.2 million | $984.0 million | Flat quarter; -2% six months |
| Diluted EPS | $2.32 | $4.53 | +3% quarter; +1% six months |
| Operating cash flow | Not stated quarterly | $478.3 million | Prior-year six months: $488.3 million |
- Investment management fees rose 2% for the quarter and 1% for six months. Average AUM increased 3% in both comparisons, but effective investment management fee rates declined.
- Quarterly sales and distribution fees increased 4%; six-month fees were essentially unchanged. General, administrative and other expense rose 29% for the quarter and 60% for six months, partly reflecting prior-year insurance recoveries that did not recur.
- Other income, net was $72.8 million for the quarter and $135.4 million for six months, helped by trading gains and equity-method income; investment losses and lower realized gains partly offset these increases.
- Cash and cash equivalents were $5.079 billion at March 31, 2012, versus $5.199 billion at the start of the fiscal year. Six-month investing cash flow was positive $441.6 million; financing cash flow was negative $1.047 billion, including $547.4 million in dividends paid and $416.8 million in share repurchases.
- Company-defined liquid assets were $8.046 billion, versus $7.987 billion at September 30, 2011. Company-level debt in the MD&A liquidity table was $993.3 million, excluding debt of consolidated sponsored products and VIEs; reported consolidated total debt was $1.993 billion. Management said it believed available liquidity, operating cash flows and borrowing capacity could meet foreseeable needs.
- Total assets were $13.663 billion and total liabilities were $4.287 billion at March 31, 2012. The company reported $900 million face value of senior notes and compliance with their covenants.
Changes and operating trends
- Ending AUM was $725.7 billion, up 10% from September 30, 2011 and 3% from March 31, 2011. Six-month market appreciation of $78.1 billion more than offset $10.0 billion of net new outflows.
- Quarterly net new flows were positive $5.6 billion, while long-term sales fell 13% to $48.5 billion. For six months, long-term sales fell 22% to $86.7 billion and long-term redemptions fell 4% to $95.7 billion.
- Fixed-income AUM increased 15% year over year; equity AUM decreased 3% and hybrid AUM decreased 9%. Management attributed weaker sales and flows in some products to investor concerns about Europe’s sovereign-debt crisis and the global recovery.
- Operating income was lower partly because the prior-year periods included net insurance recoveries of $12.0 million for the quarter and $38.5 million for six months. Higher diluted EPS also reflected fewer shares outstanding after repurchases.
- The six-month dividend per share was $2.54, including a $2.00 special dividend and regular quarterly dividends; the comparable prior-year amount was $0.50. The Board declared a further $0.27 quarterly dividend, paid April 13, 2012.
Outlook, risks and unusual items
- No numerical earnings, revenue or AUM guidance is provided. Management noted continued uncertainty and potential market volatility, while emphasizing investment performance, client service, expense management and strategic investment in systems and technology.
- Principal business risks include market declines and AUM outflows, changing asset and geographic mix, investment underperformance, competition and reliance on third-party distribution channels, foreign-exchange exposure, regulatory change, technology and operational disruption, and retaining key personnel.
- Management expected FATCA to create significant administrative and compliance costs. Dodd-Frank implementation, the Volcker Rule and possible money-market-fund reforms were additional regulatory uncertainties. Fiduciary Trust had applied to convert to an uninsured national trust bank; approval and completion were not assured.
- Fair-value exposure includes Level 3 assets of $643.3 million and Level 3 liabilities of $65.3 million. The filing notes sensitivity to unobservable valuation assumptions; consolidated VIE and sponsored-product assets and debt generally do not give their creditors recourse to Franklin beyond its direct investments.
- The company repurchased 4.0 million shares for $416.8 million during the six months and had approximately 10.7 million shares remaining under its repurchase authorization. The prior market-timing derivative action was dismissed with prejudice in February 2012 without settlement. Management said other litigation was not expected to materially affect the company and that adequate accruals had been made for estimable probable losses.
Important facts for investors to verify
- Whether subsequent AUM, sales and redemption trends improved from the six-month net outflow position, and how market appreciation versus flows affected growth.
- Whether lower effective fee rates and the shift toward fixed-income and international products affected future revenue and margins.
- The sustainability of investment and equity-method gains in other income, and the effect of their volatility on reported earnings.
- Cash available for corporate use after considering subsidiary regulatory, operational and repatriation restrictions; distinguish corporate debt from consolidated product and VIE debt.
- Future dividend and repurchase levels, including the effect of capital returns on liquidity and share count.
- Developments in regulatory approvals and implementation costs, particularly the trust-bank conversion, FATCA, Dodd-Frank and Volcker Rule requirements.