Franklin Resources, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2011. The filing is by Franklin Resources, Inc., whose investment business is marketed under the Franklin Templeton brands.
Business context and results
The company is primarily a global investment manager; it also operates a smaller banking and finance business. Management said improving markets lifted assets under management (AUM), fee revenue, and operating income.
| Metric | Three months ended Mar. 31, 2011 | Change year over year | Six months ended Mar. 31, 2011 | Change year over year |
|---|---|---|---|---|
| Operating revenue | $1.750 billion | +24% | $3.450 billion | +24% |
| Operating income | $629.5 million | +37% | $1.289 billion | +39% |
| Net income attributable to Franklin Resources | $503.1 million | +41% | $1.004 billion | +41% |
| Diluted EPS | $2.25 | +45% | $4.47 | +44% |
| Operating margin | 36.0% | 32.6% prior year | 37.4% | 33.3% prior year |
Investment management fees rose 29% in both comparison periods, reflecting higher average AUM and higher effective fee rates. Sales and distribution fees increased 18%. The reported effective management fee rate was 0.627% for the quarter and 0.631% for the six-month period, up from 0.596% and 0.600%, respectively.
Assets under management and operating drivers
- Period-end AUM was $703.5 billion, up 20% year over year and 9% from September 30, 2010. Average AUM rose 22% for the quarter and 23% for the six months versus prior-year periods.
- Six-month long-term sales were $110.5 billion, up 25%; redemptions were $99.2 billion, up 73%. Net new flows were $11.6 billion, down from $31.7 billion a year earlier. Global/international taxable fixed income was the main source of net new flows.
- Management cited market appreciation of $47.5 billion during the six months. Tax-free fixed-income AUM declined, amid investor concerns about municipal-bond default risk.
- Expenses grew more slowly than revenue overall, but sales, distribution and marketing expense rose 21% and compensation and benefits rose 16% in both the quarter and six-month comparison. Lower general, administrative and other expense included insurance recoveries for prior-year losses of $12.0 million in the quarter and $38.5 million for six months.
Cash flow, liquidity, and debt
- Six-month operating cash flow was $488.3 million, compared with $696.4 million in the prior year. Management attributed the decline, despite higher net income, primarily to increased purchases of trading securities, taxes paid, and compensation payments.
- Investing cash flow was positive $553.7 million, versus negative $31.0 million; financing cash flow was negative $513.8 million, versus negative $734.0 million. Ending cash and cash equivalents were $4.668 billion, including cash of consolidated variable-interest entities (VIEs).
- Management’s liquidity presentation, which excludes VIE assets and liabilities, showed $7.387 billion of liquid assets and $980.0 million of debt at March 31, 2011. The company reported $899.0 million of its own long-term debt, $51.0 million of Federal Home Loan Bank advances, and $30.0 million of commercial paper.
- Reported total debt including consolidated VIE debt was $2.159 billion. VIE obligations are generally payable only from the VIEs’ collateral and, according to the filing, do not affect the company’s liquidity and capital resources.
- Management said existing liquid assets, operating cash flows, borrowing capacity, and potential capital-market access should meet present and reasonably foreseeable cash needs. The company was in compliance with its debt covenants.
Material changes, unusual items, and risks
- New consolidation guidance adopted October 1, 2010 brought automobile-loan securitization trusts and collateralized loan obligations onto the balance sheet. At adoption, this increased assets by $1.385 billion, long-term debt by $1.278 billion, and stockholders’ equity by $106.6 million. The related VIE balances materially affect reported debt and assets.
- The company acquired U.K. equity manager Rensburg Fund Management for $72.4 million cash in January 2011; it had approximately $1.5 billion of AUM at acquisition. It also purchased a Fort Lauderdale office building for $29.7 million.
- Six-month investment and other income included $53.9 million of realized gains on available-for-sale securities, $43.4 million of equity-method income, $13.6 million of investment impairments, and $14.9 million of net losses from consolidated CLOs. Management also cited foreign-exchange losses.
- The board authorized repurchases of up to 10 million additional shares in December 2010. The company repurchased 3.5 million shares for $413.5 million in the six-month period; approximately 9.5 million shares remained authorized for repurchase at quarter-end.
- The quarterly dividend was $0.25 per share. The filing reports six-month dividends of $0.50 per share, compared with $3.44 in the prior-year period; it does not explain the prior-year difference in the text provided.
- Management gave no quantified earnings or AUM guidance. It emphasized investment performance, client service, expense management, and continued investment in systems and technology. It said the impact of the Dodd-Frank Act was not yet known.
- Risks include market-driven AUM and fee volatility, elevated redemptions, investment-performance and distribution-channel competition, foreign-exchange exposure, regulatory changes, technology and operational risks, and litigation. Management said there were no material changes to the risk factors in the prior Form 10-K.
- In a market-timing class action, the company agreed to contribute $2.75 million toward settlements and legal fees; the agreement was subject to court approval. Related derivative cases remain unresolved, and the company said it could not estimate possible additional losses. A separate case concerning payments to broker-dealers was dismissed at the district-court level and was on appeal.
Important facts for investors to verify
- Whether stronger AUM and fee growth can persist, given the sharp increase in redemptions and lower net new flows.
- The degree to which earnings benefited from market appreciation, the higher international AUM mix, insurance recoveries, and realized investment gains.
- How consolidation of CLOs and securitization trusts affects reported debt, earnings volatility, and interpretation of liquidity; distinguish nonrecourse VIE debt from corporate debt.
- The ultimate resolution and financial exposure from the pending litigation, including court approval of the $2.75 million settlement agreement.
- Whether regulatory implementation, market conditions, investment performance, and foreign-exchange movements alter the outlook; the filing provides no quantified guidance.