Franklin Resources, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2019. The filing registrant is Franklin Resources, Inc., which operates its investment management business under Franklin Templeton and other brands.
Business context and financial results
The company earns most revenue from investment management and related services. Revenue and earnings are sensitive to assets under management (AUM), investment performance, market levels, product mix and client flows.
| Metric | Three months ended March 31, 2019 | Year-over-year change | Six months ended March 31, 2019 |
|---|---|---|---|
| Operating revenue | $1,433.8 million | Down 11% | $2,845.3 million; down 12% |
| Operating income | $379.5 million | Down 32% | $791.0 million; down 30% |
| Operating margin | 26.5% | 34.3% prior year | 27.8%, versus 35.2% |
| Net income attributable to Franklin Resources | $367.5 million | Down 17% | $643.4 million |
| Diluted EPS | $0.72 | $0.78 prior year | $1.25 |
Six-month 2018 results included an estimated $1.1 billion income tax charge related to the Tax Cuts and Jobs Act, resulting in a reported attributable net loss of $140.1 million and diluted loss per share of $0.29 in that prior-year period. The current six-month effective tax rate was 23.5%.
AUM, revenue drivers and material changes
- AUM was $712.3 billion at March 31, 2019, down 3% from a year earlier and 1% from September 30, 2018. Average AUM fell 8% year over year in both the three- and six-month comparisons.
- For the quarter, AUM rose $62.4 billion from the prior quarter-end, reflecting $42.3 billion of market change, distributions and other, plus $26.4 billion from the Benefit Street Partners acquisition, partly offset by $6.3 billion of net outflows. Six-month net outflows were $13.6 billion.
- Investment management fees fell 11% for the quarter and 12% for six months, primarily reflecting lower average AUM and lower effective fee rates. Sales and distribution fees declined 13% and 14%, respectively. The adoption of revenue-recognition guidance shifted certain fee presentation between categories but did not affect operating or net income.
- Operating expenses declined 1% for the quarter and 2% for six months. Lower sales, distribution and marketing costs were offset in part by higher compensation, technology and general and administrative expenses. Compensation and benefits increased 15% for the quarter, including acquisition-related retention costs, higher staffing and termination benefits.
- Management reported that global equity markets rebounded strongly in the quarter, while equity markets remained lower fiscal year to date. Investment performance was mixed: global/international fixed income had strong long-term comparisons, while equity and several other categories lagged benchmarks or peer medians.
Cash flow, liquidity and debt
- Six-month operating cash flow was $444.2 million, compared with $897.0 million a year earlier. Investing cash use was $734.2 million, including cash paid for the acquisition; financing cash use was $662.8 million.
- Company cash and cash equivalents were $5.68 billion at March 31, 2019, down from $6.61 billion at September 30, 2018. Company-defined liquid assets totaled $8.47 billion, versus $9.48 billion.
- Debt was $697.9 million, compared with $695.9 million at September 30, 2018. The company reported compliance with debt covenants. It had $500 million of commercial-paper capacity under an uncommitted program, which had been inactive since 2012.
- Subsidiaries held $3.66 billion of liquid assets for operational, regulatory and product-capital needs; $255.8 million was restricted from transfer to Franklin and other subsidiaries. Management said existing liquid assets, operating cash flow and potential financing sources should meet present and reasonably foreseeable needs.
- The company repurchased 15.3 million shares for $471.6 million in the six months and paid $255.4 million in common dividends. It declared regular dividends of $0.26 per share each quarter during the period.
Outlook, risks and unusual items
- No quantified revenue, earnings or AUM guidance was provided. Management emphasized investment performance, client service, expense management, and strategic investment in systems and technology, while noting continuing uncertainty in the global economy.
- The February 1, 2019 acquisition of Benefit Street Partners, a U.S. alternative credit manager, had cash consideration of $717.4 million, including $135.0 million used to retire debt. The company expects approximately $30 million of additional acquisition-related retention expense for the rest of fiscal 2019 and similar annualized amounts over the next four fiscal years.
- The company expects approximately $34 million of additional termination-benefit expense during the remainder of fiscal 2019, following voluntary separation benefits relating to about 250 employees; further costs may arise as it evaluates cost-optimization initiatives.
- In consolidated ERISA litigation concerning the company’s 401(k) plan, Franklin agreed in principle to a $13.9 million cash settlement, accrued in the period, and to increase its matching contribution from 75% to 85% for eligible deferrals for three years. Court approval remained pending.
- Principal disclosed risks include market declines and AUM outflows, investment underperformance, competitive fee and distribution pressures, changing regulation and tax rules, foreign-exchange and international-market exposure, cybersecurity and operational disruptions, litigation, and dependence on key personnel. Management said there were no material changes to the risk factors reported in its prior Form 10-K.
- Revenue-recognition guidance adopted October 1, 2018 changed certain revenue and expense classifications and contract-cost treatment, with no impact on operating or net income. New equity-investment accounting also caused fair-value changes on many equity holdings to be recognized in earnings.
Important facts for investors to verify
- Whether AUM outflows, weaker average AUM and lower fee rates persist, and how client flows and investment performance develop by product category.
- The acquisition’s contribution to AUM, earnings and cash generation relative to its purchase price, integration needs and expected retention costs.
- The timing and final terms of court approval for the $13.9 million 401(k) settlement and the related matching-contribution commitment.
- The extent of future severance, retention, technology and other expenses, and whether expense reductions can offset continuing revenue pressure.
- Liquidity available after regulatory and operating restrictions, and the impact of ongoing dividends, share repurchases and acquisition spending on cash balances.
- How market-sensitive investment income, consolidated investment-product results and fair-value estimates affect reported earnings, particularly given the prior-year tax charge and current-year accounting changes.