Business context and reporting period
Franklin Resources, Inc. (the Franklin Templeton investment-management group) filed this unaudited Form 10-Q for the fiscal quarter and six months ended March 31, 2014. The company earns most of its revenue from investment management and related services; revenue is strongly tied to assets under management (AUM), asset mix and investor flows.
Financial results and key metrics
| Metric | Three months ended March 31, 2014 | Six months ended March 31, 2014 |
|---|---|---|
| Operating revenue | $2,095.9 million, up 4% | $4,205.4 million, up 7% |
| Operating income | $786.0 million, up 8% | $1,599.1 million, up 13% |
| Operating margin | 37.5%, versus 36.2% | 38.0%, versus 36.1% |
| Net income attributable to Franklin Resources | $561.0 million, down 2% | $1,164.8 million, up 7% |
| Diluted earnings per share | $0.89, versus $0.90 | $1.84, versus $1.70 |
| Operating cash flow | Not separately stated in the provided cash-flow table | $639.4 million, versus $771.8 million |
For the quarter, investment management fees rose 8%, primarily with higher average AUM, while sales and distribution fees fell 1% and shareholder servicing fees fell 12%. For the six months, investment management fees rose 11%; sales and distribution fees increased 2%, while shareholder servicing fees declined 5%. The effective investment management fee rate was 62.4 basis points for the quarter and 63.0 basis points for the six months.
At March 31, 2014, total AUM was $886.9 billion, up 8% from a year earlier and 5% from September 30, 2013. Average AUM increased 9% for the quarter and 11% for the six months year over year. Six-month AUM growth reflected $51.9 billion of market appreciation, partly offset by $7.1 billion of net new outflows. Long-term sales were $99.6 billion, down 6%, and redemptions were $106.4 billion, up 24%.
Liquidity, debt and capital allocation
Company liquid assets, excluding assets of consolidated investment products, were $10.15 billion at March 31, 2014, including $6.81 billion of cash and cash equivalents. Company debt was $1.20 billion, consisting of fixed-rate notes; $249.9 million matures in fiscal 2015. The company reported compliance with debt covenants and stated it expects to meet foreseeable cash needs from liquid assets, operating cash flow and available financing. Some subsidiary cash is subject to regulatory, operational or repatriation restrictions.
Six-month investing cash flow was $1.9 million, versus $98.0 million; financing cash flow was a use of $63.4 million, compared with a use of $1.35 billion in the prior-year period. The company repurchased 5.9 million shares for $315.9 million and paid $139.9 million in cash dividends. It declared regular dividends of $0.24 per share for the six months; the prior-year comparable amount included a $1.00-per-share special dividend. The board authorized repurchases of up to 30 million additional shares, and 35.3 million shares remained available under the program at quarter-end.
Changes, outlook, risks and unusual items
- Despite higher operating income, quarterly net income attributable to Franklin Resources declined because investment and other income fell sharply. That income was $17.0 million for the quarter, versus $96.5 million a year earlier, reflecting net losses on consolidated sponsored-product securities and foreign-exchange losses, compared with gains in the prior period.
- Market appreciation supported AUM and fee growth, but investor flows weakened: quarterly net outflows were $3.8 billion, compared with $21.7 billion of net inflows a year earlier. Management cited lower long-term sales and higher redemptions, particularly in global/international fixed-income products. Tax-free fixed-income AUM also declined amid concerns about certain municipalities.
- The effective income tax rate rose to 30.2% for the quarter and 30.0% for the six months, versus 27.2% and 28.3%, respectively, mainly due to lower forecast non-U.S. earnings in lower-tax jurisdictions, state tax changes and current-period losses attributable to noncontrolling interests.
- Management gave no numerical earnings or revenue forecast. It said it expects to continue comparable regular quarterly dividends, subject to earnings and other relevant factors. Priorities include investment performance, customer service, expense management, talent and strategic technology investment.
- Key risks include market declines and AUM volatility, client redemptions and investment performance, foreign-exchange exposure, competition and distribution-channel dependence, cybersecurity and operational disruption, litigation, and complex or changing regulation. Management expects regulatory developments to add compliance costs. Volatility in the quarter was associated with mixed economic data, Ukraine-related concerns and China’s slowdown.
- Legal matters arose in the ordinary course; management said resolution was not expected to materially affect the business, financial position, results or liquidity and that accruals covered probable estimable losses. No material changes to previously reported commitments were identified. On April 10, 2014, the company sold its remaining loans held for sale for an insignificant gain.
- Fair-value estimates warrant attention: $104.2 million of contingent consideration liabilities related substantially to the commitment to acquire the remaining K2 Advisors interests, and Level 3 valuations depend on significant unobservable assumptions. The company reported no impairment of goodwill or definite-lived intangible assets in the six-month period.
Important facts for investors to verify
- Whether AUM flows improve or continued redemptions offset market-driven asset appreciation, especially in global/international fixed income and tax-free products.
- Whether investment performance supports retention and growth of AUM; U.S. equity products generally lagged benchmarks and peer medians over the periods presented, while several fixed-income and hybrid categories showed stronger results.
- How recurring investment and foreign-exchange gains or losses affect earnings, given the large year-over-year change in investment and other income.
- Cash availability after considering subsidiary restrictions, planned repurchases, dividends, technology investment and other capital needs.
- Potential changes in regulatory costs, tax rates, market valuations, and the assumptions underlying K2 contingent consideration and other Level 3 fair values.