Franklin Resources, Inc. — Q1 FY2015 Form 10-Q
Reporting period: Three months ended December 31, 2014, compared with the three months ended December 31, 2013. The filing identifies the registrant as Franklin Resources, Inc. (the request metadata names Franklin Templeton Inc.). Amounts are in U.S. dollars.
Business context and performance
The company is a global investment manager whose results depend largely on assets under management (AUM), asset mix, market returns, sales and redemptions. Ending AUM was $880.1 billion, essentially flat year over year but down 2% from September 30, 2014. Quarterly average AUM rose 3% year over year to $894.1 billion.
| Metric | Q1 FY2015 | Prior-year quarter | Change |
|---|---|---|---|
| Operating revenue | $2,064.3 million | $2,109.5 million | Down 2% |
| Operating income | $782.0 million | $813.1 million | Down 4% |
| Operating margin | 37.9% | 38.5% | Down 0.6 percentage points |
| Net income attributable to Franklin Resources | $566.4 million | $603.8 million | Down 6% |
| Diluted EPS | $0.91 | $0.96 | Down 5% |
| Operating cash flow | $572.4 million | $324.7 million | Up |
Financial position and capital
- At December 31, 2014, cash and cash equivalents were $7,758.0 million and total assets were $16,296.8 million. Total liabilities were $4,068.3 million and stockholders’ equity was $12,154.5 million.
- Company debt was $1,198.3 million, principally fixed-rate notes; $250 million was due in May 2015. The company reported compliance with debt covenants and had an inactive, uncommitted $500 million commercial-paper program.
- Management reported $10,890.7 million of liquid assets, defined as cash, receivables and certain investments, excluding assets of consolidated investment products. It said existing liquidity, operating cash flow and potential capital-market access should meet present and reasonably foreseeable needs.
- Financing cash outflows included $151.2 million of share repurchases and $75.8 million of dividends paid. The quarter’s declared dividend was $0.65 per share, comprising a $0.15 regular dividend and a $0.50 special dividend. 27.1 million shares remained authorized for repurchase.
Material changes and management commentary
- Investment management fees increased 1% to $1,382.4 million as average AUM grew, but the effective fee rate fell to 61.8 basis points from 63.5 basis points. Performance-based management fees declined to $2.6 million from $26.0 million.
- Sales and distribution fees fell 7%, primarily reflecting a 23% decline in commissionable sales; shareholder servicing fees fell 14%, largely due to a Canadian fee-structure change. Lower revenue was partly offset by a 1% reduction in operating expenses; compensation and benefits rose 8%.
- Quarterly AUM fell $17.9 billion: $12.1 billion from market depreciation and other effects, including $4.6 billion from foreign-exchange revaluation, and $3.5 billion of net new outflows. Long-term sales declined 6% year over year to $46.7 billion.
- Results included $23.3 million of net foreign-exchange gains, compared with $10.5 million of losses in the prior-year quarter. This benefit was partly offset by lower equity-method investment income and realized gains on available-for-sale securities.
- The effective tax rate was 31.1%, versus 29.8%. A new tax ruling was estimated to increase current-fiscal-year tax expense by approximately $25 million, potentially offset by tax benefits from expiring statutes of limitations.
- Management highlighted strong longer-term taxable fixed-income performance, while equity products mostly lagged benchmarks and peer medians. Hybrid performance had weakened from September 2014, largely due to the Franklin Income Fund’s one-year performance.
Outlook, risks and contingencies
No specific revenue, earnings or AUM guidance was provided. Management said it expects to continue comparable regular quarterly dividends, subject to earnings and other relevant factors, and emphasized investment performance, client service, expense management and strategic technology investment.
- Key risks include market and AUM volatility, investor outflows, foreign-exchange movements, fee and product-mix pressure, relative investment performance, competition and dependence on third-party distribution channels.
- The filing also emphasizes extensive and changing regulatory requirements, tax uncertainty, cybersecurity and operational risks, and the possibility of higher compliance costs. Management reported no material changes to the risk factors in its fiscal 2014 Form 10-K.
- Management believed ordinary-course litigation would not materially affect the company and said accruals had been made for probable, estimable losses. No material changes to other reported commitments and contingencies were noted.
- Effective October 1, 2014, new accounting guidance changed measurement of consolidated CLO liabilities. Adoption increased consolidated VIE debt by $14.2 million and reduced opening retained earnings and appropriated retained earnings; subsequent CLO earnings reflect the company’s own economic interests rather than gains or losses primarily attributable to noncontrolling interests.
Investor verification priorities
- Track AUM flows, sales and redemptions by investment objective, especially global/international products and equity performance.
- Assess whether the lower effective fee rate and sharply reduced performance fees persist, and whether revenue mix continues to pressure margins.
- Review the May 2015 $250 million note maturity, liquidity available for operations and repurchases, and the extent of cash subject to transfer restrictions.
- Monitor the estimated tax-ruling impact and any offsetting tax benefits, along with foreign-exchange gains and losses.
- Examine the assumptions behind Level 3 valuations and K2 acquisition contingent consideration, and confirm developments in litigation and regulatory matters.