Business context and reporting period
Franklin Resources, Inc. (the Franklin Templeton parent) filed this Form 10-Q for its fiscal first quarter ended December 31, 2018. The company is a global investment manager whose revenue depends mainly on assets under management (AUM), investment performance, product mix and fee rates. Unless otherwise noted, financial amounts below are in U.S. dollars.
Financial and operating performance
- Revenue: $1.412 billion, down 13% from $1.616 billion. Investment management fees fell 13% to $971.8 million; sales and distribution fees fell 15% to $354.8 million.
- Profit and margins: Operating income was $411.5 million, down 29%; operating margin declined to 29.2% from 36.0%. Net income attributable to Franklin Resources was $275.9 million, or $0.54 per diluted share, versus a prior-year attributable net loss of $583.3 million, or $1.06 per share. The prior-year loss included an estimated $1.1 billion Tax Act charge. Current-quarter investment and other income was a net loss of $59.1 million, compared with income of $81.3 million a year earlier.
- Cash flow: Operating cash flow was $266.0 million, versus $320.4 million. Investing cash outflow was $110.3 million and financing cash outflow was $396.1 million. Reported ending cash and cash equivalents, including consolidated investment products, were $6.659 billion.
- Liquidity and debt: Company-defined liquid assets, excluding third-party assets of consolidated investment products, were $9.140 billion at quarter-end, versus $9.475 billion at September 30, 2018; debt was $697.7 million. Subsidiaries held $3.340 billion of liquid assets for operational, regulatory and product-capital needs, including $242.8 million restricted from transfer to the parent and other subsidiaries. Management said existing liquid assets, operating cash flows and available financing sources should meet present and reasonably foreseeable needs. The company reported compliance with debt covenants.
- AUM: Quarter-end AUM was $649.9 billion, down 9% from September 30 and 14% year over year. The quarterly decline of $67.2 billion reflected $59.9 billion of market change, distributions and other effects and $7.3 billion of net outflows. Average AUM fell 9% year over year to $683.2 billion.
Material changes versus the prior comparable period
- Sharp equity-market declines contributed to a $43.5 billion market depreciation during the quarter; the S&P 500 and MSCI World indexes fell 13.5% and 13.3%, respectively. Long-term sales decreased 23% and redemptions increased 8% year over year.
- Lower average AUM and a lower effective investment management fee rate (56.9 basis points versus 59.2) pressured fee revenue. The company also cited a shift in product and geographic mix. A new revenue accounting standard reclassified $15.5 million from investment management fees to distribution fees; this presentation change did not affect operating income or net income.
- Operating expenses declined 3% overall, principally as sales, distribution and marketing costs fell 16%. This was partly offset by higher compensation and benefits (+7%) and general, administrative and other expense (+22%), which included a $13.9 million litigation accrual and higher professional and third-party service fees.
- Net financing cash outflow rose substantially from the prior year, mainly due to lower net subscriptions in consolidated investment products and increased share repurchases. The company repurchased 10.7 million shares for $326.9 million during the quarter.
Outlook, risks and unusual items
- No specific financial or AUM guidance was provided. Management cited continuing global economic uncertainty and said it would focus on investment performance, client service, expense management, and strategic investment in systems and technology.
- Management expected comparable regular quarterly dividends to continue, subject to earnings and other relevant factors. A $0.26-per-share dividend was declared during the quarter; 61.0 million shares remained authorized for repurchase.
- On October 24, 2018, the company entered an acquisition agreement with approximately $683 million of cash consideration. The filing identifies Benefit Street Partners in discussing costs related to the imminent acquisition.
- A January 2019 voluntary buyout offer to certain U.S. employees is expected to increase compensation and benefits expense during the remainder of fiscal 2019; the impact was not yet known.
- The company accrued $13.9 million for an agreement-in-principle to settle consolidated ERISA class-action litigation. The settlement also includes an increase in matching contributions for eligible employees for three years and remains subject to court approval. Management said it believes the claims are without merit.
- The Tax Act transition-tax liability was $982.8 million at quarter-end, net of an $87.6 million tax benefit that could be reduced or eliminated by future regulation or legislation. The liability may also change with state-law updates and completion of tax filings.
- Key risks include market declines and AUM outflows, investment performance and fee competition, regulatory and tax changes, cybersecurity and operational disruptions, and litigation. Management reported no material change in the risk factors previously disclosed in its fiscal 2018 Form 10-K.
Important facts for investors to verify
- Whether AUM flows, investment performance and market conditions continue to pressure fee revenue and margins.
- The acquisition’s completion, final consideration and effect on liquidity, expenses and results.
- Court approval and final terms of the ERISA settlement, including the matching-contribution commitment.
- The cost and timing of the employee buyout program and any other restructuring expenses.
- Developments affecting the $982.8 million transition-tax liability and the availability of subsidiary-held liquid assets.