Franklin Resources, Inc. (Franklin Templeton) — FY2010 Form 10-K
Reporting period: Fiscal year ended September 30, 2010; comparisons are with FY2009 unless otherwise noted. The registrant is Franklin Resources, Inc., traded on the NYSE as BEN. Its primary business is global investment management and related services; banking and finance is a smaller segment.
Business and financial performance
- Assets under management (AUM): $644.9 billion at year-end, up 23% from $523.4 billion. FY2010 net new flows were $69.9 billion and market appreciation and other changes added $54.3 billion. Average monthly AUM rose 29% to $571.1 billion.
- Revenue: $5.853 billion, up 40%. Investment management fees were $3.478 billion (+39%); underwriting and distribution fees were $2.044 billion (+45%); shareholder servicing fees were $284 million (+6%).
- Profitability: Operating income was $1.959 billion (+63%); operating margin was 33%, versus 29%. Net income attributable to Franklin Resources was $1.446 billion (+61%). Diluted EPS was $6.33, up 64%.
- Cash flow and liquidity: Operating cash flow was $1.651 billion, versus $641 million. Cash and cash equivalents were $4.124 billion; reported total liquid assets were $6.684 billion. Total assets were $10.708 billion.
- Debt and equity: Total debt was $979.9 million, compared with $121.2 million; this included $898.9 million of long-term debt issued in May 2010 and $51 million of Federal Home Loan Bank advances. Franklin Resources stockholders’ equity was $7.727 billion.
- Capital returns: The company paid $3.88 per share in dividends, including a $3.00 special dividend. It repurchased 6.6 million shares for $675.8 million during the year.
Changes versus FY2009
- Recovery in financial markets, net inflows, and higher AUM drove revenue and earnings recovery from FY2009. Management cited improved global markets, while noting continued volatility, particularly during the third quarter amid European sovereign-debt concerns.
- Long-term net new flows moved to positive $69.9 billion from outflows of $5.5 billion. Fixed-income AUM rose 48% to $253.8 billion, while equity AUM rose 11% to $273.7 billion. Management said the asset mix continued to shift toward lower-risk investments.
- Operating expenses increased 30% to $3.894 billion, including higher distribution costs, variable compensation, marketing support, and deferred sales commission amortization. Compensation rose 13%; management attributed much of the increase to higher performance-based bonuses and commissions.
- Other income, net, increased to $111 million from $86 million, reflecting improved investment valuations and lower impairment losses, partly offset by higher interest expense. The effective tax rate was 29.87%, versus 29.82%.
- Banking/finance net interest margin declined to 2.62% from 3.45%. The segment reported pretax income of $37 million, compared with a $50 million pretax loss in FY2009.
Outlook, risks, and unusual items
- Management provided no specific numerical earnings or revenue guidance. It said recovery remained uncertain and emphasized investment performance, customer service, expense management, employee retention, technology investment, and distribution relationships.
- The Dodd-Frank Act was expected to bring additional restrictions, scrutiny, and compliance costs; the company said its financial impact was not yet known. Proposed changes to mutual fund Rule 12b-1 could limit recovery of distribution expenses.
- Key business risks include market-driven AUM and fee volatility, poor investment performance and redemptions, dependence on third-party distribution, competition, foreign-exchange exposure, regulatory and tax changes, technology or operational failures, and potential loss of key personnel. The company may voluntarily support sponsored funds, although it has no general contractual obligation to do so.
- Legal matters include U.S. and Canadian litigation related to previously investigated market-timing practices. A proposed settlement of approximately $5 million for two Canadian actions was awaiting final court approval; U.S. matters remained unresolved. Management said it considered the unresolved claims without merit, but could not predict outcomes.
- Effective October 1, 2010, new consolidation requirements were expected to bring certain automobile-loan securitization trusts and collateralized loan obligations onto the balance sheet. The company estimated increases of about $337 million in assets and debt for the trusts, and about $1.038 billion in assets, $937 million in debt, and $101 million in equity for the CLOs.
- Automobile securitization guarantees had a maximum potential payment of $6.2 million. The company had $144.1 million in loan origination commitments and $96.9 million in capital contribution commitments. It did not securitize automobile loans in FY2009 or FY2010 and did not expect new transactions in FY2011.
- The company reported effective internal control over financial reporting, and its auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether AUM growth and positive flows persisted after year-end, and how much fee revenue depends on market appreciation versus net inflows.
- Whether the pronounced shift toward fixed income affects the effective fee rate and future margins.
- The terms, use of proceeds, and ongoing interest burden of the $900 million note issuance, alongside the company’s substantial cash and liquid-asset balances.
- The actual balance-sheet and earnings effects of the October 2010 VIE consolidations, including elimination of management and performance fees.
- Developments and potential costs in the unresolved U.S. litigation and the Canadian settlement process, as well as tax examinations and unrecognized tax benefits.