Franklin Resources, Inc. — Form 10-Q Summary
Reporting period: Fiscal quarter and six months ended March 31, 2017. The filing’s registrant is Franklin Resources, Inc. (Franklin Templeton). Figures are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context and results
Franklin is a global investment manager whose revenue depends substantially on assets under management (AUM), asset mix, sales and fee rates. At March 31, 2017, AUM was $740.0 billion, approximately level with a year earlier and 1% above September 30, 2016. Average AUM was down 1% for the quarter and 4% for the six-month period versus the prior-year periods.
| Metric | Three months ended March 31, 2017 | Change year over year | Six months ended March 31, 2017 | Change year over year |
|---|---|---|---|---|
| Operating revenue | $1,600.6 | (1%) | $3,161.4 | (6%) |
| Operating income | $555.5 | +3% | $1,142.4 | (4%) |
| Operating margin | 34.7% | 33.3% prior year | 36.1% | 35.3% prior year |
| Net income attributable to Franklin | $420.7 | +17% | $860.9 | +7% |
| Diluted EPS | $0.74 | +21% | $1.52 | +12% |
Quarterly revenue declines reflected lower investment management, distribution and shareholder servicing fees; six-month declines were broader. Average AUM pressure was partly offset by lower operating expenses. Net income rose despite lower six-month operating income, mainly because investment and other income increased substantially. Quarterly other income, net, was $72.0 million versus $5.2 million a year earlier; six-month other income, net, was $104.8 million versus $23.7 million. Drivers included stronger equity-method investment results, interest income and gains on consolidated investment products. These investment-related gains can vary with markets.
Quarterly investment management fees were $1,089.2 million, down 1%; six-month fees were $2,152.4 million, down 6%. The annualized effective investment management fee rate was 59.5 basis points for the quarter and 59.1 basis points for the six months, compared with 59.4 and 60.2 basis points, respectively, a year earlier. The six-month rate decline reflected asset mix. Operating expenses fell 3% for the quarter and 7% for the six months, including lower compensation and benefits and lower general, administrative and other expense. The latter included lower prior-year impairment expense; Franklin recorded a $3.8 million impairment of definite-lived intangible assets in the current quarter.
Cash flow, balance sheet and capital
- Cash flow, six months: Operating activities provided $614.3 million, up from $429.7 million. Investing activities provided $74.1 million; financing activities used $361.8 million, versus $866.5 million used a year earlier.
- Cash and liquidity: Franklin reported $8,287.6 million of cash and cash equivalents excluding consolidated sponsored investment products (SIPs), and $11,088.6 million of liquid assets including receivables and selected investments. The cash-flow statement’s ending cash balance was $8,776.1 million, including consolidated SIP cash. Management said existing liquid assets, operating cash flows and available financing should meet present and reasonably foreseeable needs. Some cash is needed for operational and regulatory requirements or is restricted from transfer.
- Debt: Corporate debt was $1,374.1 million at March 31, 2017, down from $1,401.2 million at September 30, 2016. It included $1,343.3 million of senior notes and a $30.8 million Indian-rupee loan. A $300 million senior note matures in September 2017. Franklin reported compliance with debt covenants and had an inactive, uncommitted $500 million commercial-paper program. Consolidated SIP debt of $306.1 million is separate and, according to the filing, generally non-recourse to Franklin beyond its direct investment.
- Shareholder returns: Franklin declared dividends of $0.20 per share quarterly ($0.40 per share over six months), compared with $0.18 quarterly a year earlier. It repurchased 11.1 million shares for $428.5 million in the six months; 39.6 million shares remained authorized for repurchase. Management expected to continue comparable quarterly dividends, subject to earnings and other factors.
Material changes, outlook and risks
- Quarterly AUM grew $20.0 billion, as $31.0 billion of market change and other gains more than offset $11.0 billion of net outflows. For six months, AUM rose $6.7 billion: $32.1 billion of market change and other gains were partly offset by $25.4 billion of net outflows. Outflows were concentrated in long-term products, particularly global/international strategies.
- Management attributed notable outflows to global/international fixed-income funds with global-macro strategies that had underperformed peer groups during much of fiscal 2016, as well as certain institutional and sub-advised mandates. The filing reports strong global/international fixed-income performance against benchmarks and peer medians, but says equity products mostly lagged benchmarks and peer medians over the periods shown; some hybrid comparisons were also weak.
- Adoption of revised consolidation guidance on October 1, 2016 changed the scope of SIP consolidation. Franklin consolidated 63 SIPs at March 31, 2017 versus 40 at September 30, 2016. This significantly increased reported SIP assets and redeemable noncontrolling interests; SIP assets and liabilities generally do not represent resources available to Franklin, and their debt holders have no recourse to Franklin beyond its direct investment.
- No specific earnings, revenue or AUM guidance was provided. Management highlighted continued expense discipline alongside strategic investment in systems and technology, client service, employees and brand development. It cautioned that AUM and results depend on markets, investor flows, investment performance, fee and asset mix, and economic and regulatory conditions.
- Key risks include market declines and redemptions reducing AUM and fee revenue; investment-performance weakness and competition, including lower-cost passive products; changing distribution arrangements and regulation; foreign-exchange and international-market exposure; cybersecurity and operational disruptions; and regulatory, tax and litigation risks. Management noted no material changes to previously disclosed risk factors.
- A putative ERISA class action alleges excessive fees and imprudent selection of Franklin funds in the company’s 401(k) plan, claiming losses exceeding $79 million. Motions to dismiss and for summary adjudication were denied; the case was in an early stage. Franklin disputes the claims, but said it could not predict the outcome or reasonably estimate a possible loss range.
Most important facts for investors to verify
- Whether net outflows persist or improve, especially in global/international fixed income, and how investment performance affects future flows.
- Whether strong reported earnings are supported by operating results or remain materially influenced by variable investment income and market gains.
- The effect of average AUM, asset mix and fee rates on recurring fee revenue and operating margins.
- Near-term debt maturities, usable liquidity after operational and regulatory constraints, and the pace of repurchases and dividends.
- Developments in the 401(k) lawsuit and any material changes in contingent consideration, impairments or SIP consolidation.