Business context and reporting period
Franklin Resources, Inc. (the filing registrant; described in the request as Franklin Templeton Inc.) filed this unaudited Form 10-Q for its fiscal third quarter and nine months ended June 30, 2017. The company is a global investment manager whose revenue depends primarily on assets under management (AUM), fee rates, product mix, and sales.
Financial and operating performance
| Metric | Three months ended June 30, 2017 | Nine months ended June 30, 2017 |
|---|---|---|
| Operating revenue | $1.614 billion, down 1% year over year | $4.775 billion, down 5% |
| Operating income / margin | $564.2 million / 35.0%, versus 36.4% | $1.707 billion / 35.7%, unchanged |
| Net income attributable to Franklin Resources | $410.6 million, down 8% | $1.272 billion, up 1% |
| Diluted EPS | $0.73, down 5% | $2.25, up 6% |
| Operating cash flow | Not provided for the quarter | $958.3 million, versus $1.165 billion |
For the nine-month period, investment management fees fell 4%, sales and distribution fees fell 6%, and shareholder servicing fees fell 8%. Average AUM was down 3% year over year; the effective investment management fee rate was 59.1 basis points, compared with 59.8 basis points a year earlier.
- AUM and flows: Ending AUM was $742.8 billion, up 1% from June 30, 2016. Over nine months, $42.2 billion of market change and other was more than offset by $32.7 billion of net outflows. Third-quarter net outflows were $7.3 billion.
- Cash and liquidity: At June 30, cash and cash equivalents were $8.565 billion on the balance sheet, or $8.786 billion including consolidated sponsored investment products (SIPs). Management reported $11.386 billion of liquid assets excluding SIP assets, compared with $10.890 billion at September 30, 2016.
- Debt: Debt was $1.375 billion, versus $1.401 billion at September 30, 2016. This included $1.344 billion carrying value of senior notes and a $30.9 million Indian-rupee loan. The company reported compliance with debt covenants.
- Capital returns: Dividends declared were $0.20 per share for the quarter and $0.60 for nine months. The company repurchased 15.2 million shares for $603.1 million over nine months; 35.5 million shares remained authorized for repurchase.
Material changes and unusual items
- Operating income declined 5% for the quarter and 4% for nine months. Nine-month net income attributable to the company nevertheless rose 1%, mainly because investment and other income increased.
- Investment and other income included $59.8 million of gains on consolidated SIP investments for the quarter, versus a $0.6 million loss a year earlier; for nine months, gains were $52.6 million versus a $12.7 million loss. These investment results helped lift nine-month other income, net to $184.1 million from $77.2 million.
- Adoption of revised consolidation guidance on October 1, 2016 changed which investment products were consolidated. The company consolidated 59 SIPs at June 30, 2017 versus 40 at September 30, 2016. This materially increased reported SIP assets and redeemable noncontrolling interests; SIP debt is generally nonrecourse to the company beyond its direct investment.
- Cash from operations decreased to $958.3 million from $1.165 billion for nine months, primarily reflecting a larger increase in trading securities of consolidated SIPs. Cash used in financing was $730.8 million, including dividends and share repurchases.
- Investment performance was mixed: global/international fixed income was notably strong, while tax-free and U.S. taxable fixed income and equity products mostly lagged benchmarks and peer medians over the periods shown. Management cited continued focus on investment performance, client service, expense management, and strategic investment in systems and technology.
Outlook, risks, and contingencies
The filing provides no numerical earnings or revenue guidance. Management said it believes existing liquid assets, operating cash flows, potential capital-market access, and borrowing capacity can meet present and reasonably foreseeable cash needs. It expects to continue comparable quarterly dividends, subject to earnings and other relevant factors.
Key risks include market declines and asset volatility, continued net outflows, investment underperformance, fee and product-mix pressure, competition from lower-fee passive products, regulatory and compliance costs, foreign-exchange exposure, and cybersecurity or operational disruption. Management also noted that cash held outside the U.S. may be subject to regulatory, contractual, or other transfer restrictions.
A former employee’s ERISA putative class action alleges excessive plan costs and imprudent selection of company-sponsored funds, claiming losses exceeding $79 million. The court certified a class on July 26, 2017; management disputes the claims, but said it cannot predict the outcome or reasonably estimate a possible loss. The filing reported no material changes to other commitments and contingencies. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether AUM outflows persist and whether market appreciation continues to offset them; monitor flows by investment objective and sales region.
- Whether operating revenue and margins stabilize, particularly given lower average AUM, fee-rate mix, and pressure on several revenue categories.
- How much reported earnings depend on investment gains, including gains from consolidated SIPs and equity-method investments, rather than recurring management fees.
- The status and potential financial exposure of the newly certified ERISA class action; the filing does not provide a reasonably estimable loss range.
- How consolidation changes affect reported assets, redeemable noncontrolling interests, and cash-flow comparability; distinguish company resources from SIP assets that are not generally available to the company.
- The September 2017 maturity of $300 million of senior notes, and the extent to which overseas cash and other liquid assets are transferable when needed.