Franklin Resources, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2018. The filing is for Franklin Resources, Inc., the parent of the Franklin Templeton investment-management businesses. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise.
Business context and reporting period
The company earns most revenue from investment management and related services, with results heavily influenced by assets under management (AUM), investment performance, markets, and investor flows. At June 30, 2018, AUM was $724.1 billion, down 3% from a year earlier and 4% from September 30, 2017. Average AUM was down 1% year over year for the quarter but up 2% for the nine-month period.
Key financial metrics
| Metric | Three months ended June 30, 2018 | Nine months ended June 30, 2018 |
|---|---|---|
| Total operating revenue | $1,558.6; down 3% year over year | $4,791.9; up approximately 0% |
| Operating income | $503.1; down 11% | $1,639.9; down 4% |
| Operating margin | 32.3%, versus 35.0% | 34.2%, versus 35.7% |
| Net income attributable to Franklin Resources | $402.0; down 2% | $261.9; down 79% |
| Diluted earnings per share | $0.75; up 3% | $0.45; down 80% |
| Operating cash flow | $1,508.5 for nine months, versus $958.3 |
Quarterly sales and distribution fees fell 10% to $391.4 million, driven primarily by a 39% decrease in commissionable sales. Investment management fees fell 2% for the quarter, partly reflecting lower average AUM and performance fees. For the nine months, management fees rose 2%, while sales and distribution fees declined 5%.
Cash and cash equivalents were $6.42 billion at June 30, compared with $8.52 billion at September 30, 2017. The company reported $9.57 billion of liquid assets, including receivables and certain investments. Of that, subsidiaries held $3.25 billion for operational, regulatory, and product-capital needs; $181.8 million was restricted from transfer to the parent or other subsidiaries.
Company debt was $695.7 million, down from $1.04 billion. The company redeemed $350 million of 4.625% notes due 2020 for $361.9 million in May, including $12.5 million of accelerated interest expense. It reported compliance with debt covenants and had $500 million of commercial-paper capacity available under an inactive, uncommitted program. Cash flow from financing was negative $3.32 billion, including $1.995 billion of common dividends, $1.056 billion of share repurchases, and debt repayment.
Material changes versus prior comparable periods
- Quarterly operating revenue and operating income declined, and operating margin narrowed by 2.7 percentage points. Diluted EPS nevertheless rose, helped by a 4% decrease in diluted average shares outstanding, primarily from repurchases.
- Nine-month attributable net income fell to $261.9 million from $1.27 billion. The principal driver was a $1.075 billion estimated Tax Act transition-tax expense; this is a major distortion in the year-over-year comparison.
- Quarterly other income and expenses shifted to a net expense of $55.9 million from net income of $79.3 million, primarily reflecting losses on investments held by consolidated investment products (CIPs), lower equity-method income, and higher interest expense.
- AUM fell $29.1 billion during the nine months: $24.4 billion of net outflows and $14.5 billion of negative market change, distributions, and other items were partly offset by $9.8 billion from an acquisition. Long-term sales declined 3%, while redemptions declined 7%.
- The company declared $3.69 per share in dividends for the nine months, including a $3.00-per-share special dividend, compared with $0.60 per share in the prior-year period. The board authorized repurchases of up to an additional 80 million shares in April.
Outlook, management commentary, risks, and contingencies
- Tax outlook: Management expected an approximately 71% effective tax rate for fiscal 2018, or approximately 23%–24% excluding one-time Tax Act impacts. The estimated federal transition-tax liability was $1.0596 billion, payable over eight years beginning January 2019; the estimate could change with further guidance and tax-return filings. The federal corporate tax rate was expected to be 21% in future fiscal years.
- Capital and dividends: Management stated it expected existing liquid assets, operating cash flows, and available financing sources to meet foreseeable operating needs and commitments. It expected to continue comparable regular quarterly dividends, subject to earnings and other relevant factors. The company was reassessing its capital-management and repatriation policies following the Tax Act.
- Market and business conditions: Management cited market volatility and uncertainty, including concerns about rising interest rates and U.S.–China trade tensions. It emphasized investment performance, customer service, expense management, and strategic investment in systems and technology. Actual results remain sensitive to AUM, flows, markets, product mix, and fee rates.
- Investment performance: The filing reported that equity products had mostly lagged benchmarks and peer medians over the periods presented; fixed-income results were mixed. At least 79% of global/international fixed-income AUM exceeded benchmark and peer comparisons over ten years, but performance weakness during the nine-month period reduced shorter-term comparisons.
- Legal contingency: Two ERISA class actions concerning investments in Franklin-sponsored funds in the company’s 401(k) plan were consolidated. Plaintiffs alleged losses exceeding $79 million and $60 million, respectively. The company disputed the claims and was defending the case, but could not predict the outcome or reasonably estimate a possible loss range.
- Other risks: The filing highlights exposure to market and currency movements, redemptions and investment performance, extensive and changing regulation, cybersecurity and operational disruptions, competition and distribution-channel changes, and tax uncertainty. Management reported no material change to the risk factors in the prior Form 10-K.
Most important facts for investors to verify
- Reconcile the nine-month earnings decline and reported tax expense to the Tax Act transition-tax estimate, and monitor subsequent revisions and cash-payment timing.
- Track AUM flows, especially continued net outflows, and the effect of investment performance, market movements, and currency changes on fee revenue.
- Assess whether the sharp reduction in cash, special dividend, and elevated repurchases leave adequate flexibility after considering operationally restricted subsidiary liquidity.
- Review the consolidated ERISA litigation’s progress and any developments that could make the potential loss estimable or material.
- Monitor expense growth, contingent-consideration estimates, and investment results in product categories that have lagged benchmarks or peers.