Franklin Resources, Inc. — Form 10-Q summary
Business context and period: The filing is for the fiscal third quarter and first nine months ended June 30, 2016. Franklin Resources is a global investment manager whose revenues depend largely on assets under management (AUM), investment performance, product mix and sales. The statements are unaudited. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Financial performance
| Metric | Three months ended June 30, 2016 | Year-over-year change | Nine months ended June 30, 2016 | Year-over-year change |
|---|---|---|---|---|
| Operating revenue | $1,634.3 | (18%) | $5,006.2 | (18%) |
| Operating income | $595.4 | (23%) | $1,786.3 | (23%) |
| Operating margin | 36.4% | 38.5% prior year | 35.7% | 38.0% prior year |
| Net income attributable to Franklin Resources | $446.4 | (11%) | $1,254.6 | (25%) |
| Diluted EPS | $0.77 | (6%) | $2.12 | (21%) |
- Quarterly investment management fees declined 18% to $1,093.5 million; sales and distribution fees fell 21% to $450.2 million. For the nine-month period, those categories declined 17% and 22%, respectively. Lower average AUM was the main driver, with lower effective investment management fee rates also contributing.
- Average AUM fell 16% year over year in both the quarter ($739.8 billion) and nine-month period ($752.7 billion). AUM at June 30 was $732.1 billion, down 16% from June 30, 2015.
- Quarterly net new outflows were $19.2 billion; nine-month net new outflows were $64.4 billion. Nine-month long-term sales fell 40% to $79.0 billion, while redemptions declined 6% to $142.3 billion. Global/international and hybrid products were prominent sources of outflows.
- Operating expenses decreased 16% in the quarter and 14% year to date, less than the 18% revenue decline. Sales, distribution and marketing costs fell with AUM and sales; compensation costs also declined, partly reflecting lower variable compensation and staffing.
- Quarterly other income, net, was $53.5 million versus an $18.4 million expense a year earlier, mainly reflecting trading investment gains and favorable currency effects. For nine months, other income, net, was $77.2 million, down from $123.2 million, primarily because prior-year foreign-exchange and consolidated-fund investment gains were not repeated to the same extent.
Cash flow, balance sheet and capital
- Nine-month operating cash flow was $1,165.4 million, down from $1,814.9 million. Investing cash flow was $92.0 million, versus $235.3 million; financing used $1,375.7 million, versus $1,097.2 million.
- Cash and cash equivalents were $8,115.8 million at June 30, 2016, compared with $8,184.9 million at September 30, 2015. The cash-flow statement reports $8,242.1 million at period-end including consolidated investment products; the company’s liquidity discussion excludes those products.
- Company liquid assets, as defined by management (cash, receivables and certain investments), totaled $10,871.5 million, compared with $11,107.2 million at September 30, 2015. Company debt was $1,441.0 million, including $1,348.4 million of senior notes and a $92.6 million Indian-rupee loan. The company reported covenant compliance.
- Consolidated sponsored products and variable-interest entities carried an additional $722.8 million of debt. The filing states that their creditors have no recourse to Franklin’s assets beyond Franklin’s direct investment; this debt is distinct from company borrowings.
- Nine-month common-stock repurchases totaled $1,068.1 million; common dividends paid were $304.6 million. The company declared $0.54 per share in regular dividends during the nine months and had 57.9 million shares remaining under its repurchase authorization at quarter-end.
Material changes, outlook and risks
- Declining AUM and sustained net outflows pressured fee revenue and operating income. Management attributed AUM decline to $93.0 billion of net outflows and $36.8 billion of market depreciation and other effects compared with June 30, 2015. In the nine months to June 30, 2016, market appreciation and other effects partly offset outflows.
- The company recorded $28.2 million of definite-lived intangible-asset impairment in the nine months, primarily related to the K2 Advisors acquisition. The charge reflected increased investor redemptions, lower future-sales estimates and renegotiated management fees. No impairment was recorded in the quarter; goodwill and indefinite-lived intangibles were not impaired.
- Management cited market volatility, economic uncertainty and increased uncertainty following the U.K. referendum on leaving the EU. It said it was focused on investment performance, client service, expense management, strategic investment in systems and technology, and reviewing the business. No quantitative earnings or AUM guidance was provided.
- Management expected to continue paying comparable regular quarterly dividends, subject to earnings and other relevant factors. It also noted that additional termination-benefit costs could arise as business reviews and changes continue.
- Principal disclosed risks include further market declines or redemptions reducing AUM and fees; investment performance lagging benchmarks; regulatory and distribution-channel changes, including implementation of the U.S. DOL fiduciary rule; foreign-exchange and international-market exposure; cyber and operational risks; and potential liquidity support to sponsored products. The company reported no material change in risk factors from its fiscal 2015 Form 10-K.
- Management considered ordinary-course litigation not expected to materially affect the company and said an adequate accrual had been recorded for probable, reasonably estimable losses. No material changes in other commitments and contingencies were reported.
- Adoption of revised consolidation guidance was expected on October 1, 2016, with some sponsored products expected to become consolidated and certain CLOs and limited partnerships expected to be deconsolidated. The financial impact was not quantified in this filing.
Key facts for investors to verify
- Whether net outflows persist or improve, particularly in global/international and hybrid products, and how that affects AUM, fee rates and revenue.
- Investment performance by product category: the filing reports that equity and U.S. taxable fixed-income performance mostly lagged benchmarks and peer medians over the periods shown, while some fixed-income categories performed better over longer horizons.
- Whether management’s cost actions offset continued revenue pressure without impairing investment performance, service quality or growth capabilities; monitor potential further severance costs.
- The effect of the K2-related impairment and revised assumptions on future AUM, fees, contingent consideration and any further impairment testing.
- Liquidity and capital allocation: cash held outside the U.S. is subject to regulatory or contractual transfer restrictions; monitor buybacks, dividends, debt maturities and any further support for sponsored products.
- The financial and consolidation effects of the October 2016 accounting-guidance adoption, which the filing does not quantify.