Business context and reporting period
Franklin Resources, Inc. (the filing registrant; operating under Franklin Templeton and other brands) is a global investment manager. This Form 10-Q covers the quarter and nine months ended June 30, 2013, in fiscal 2013. Financial amounts below are in millions unless noted; share and per-share figures reflect the subsequent three-for-one stock split.
Financial and operating performance
| Metric | Three months ended June 30, 2013 | Year-over-year change | Nine months ended June 30, 2013 | Year-over-year change |
|---|---|---|---|---|
| Operating revenue | $2,084.8 | +17% | $6,000.2 | +14% |
| Operating income | $771.7 | +20% | $2,186.2 | +16% |
| Net income attributable to Franklin Resources | $552.3 | +21% | $1,641.2 | +14% |
| Diluted EPS | $0.86 | +21% | $2.57 | +16% |
| Operating margin | 37.0% | 36.1% prior year | 36.4% | 35.8% prior year |
- Quarterly revenue growth reflected higher average AUM: investment management fees rose 18% and sales and distribution fees rose 17%; shareholder servicing fees were essentially flat.
- Expenses increased 15% in the quarter and 12% for the nine-month period. Sales, distribution and marketing was the largest expense category; higher compensation and K2-related costs also contributed.
- Effective tax rates were 27.2% for the quarter and 27.9% for the nine months, down from 30.1% and 29.4%, respectively.
- Ending AUM was $815.0 billion, up 15% from June 30, 2012. Average AUM increased 17% for the quarter and 15% for the nine months. Over the prior 12 months, market appreciation contributed $73.8 billion and net new flows contributed $29.9 billion.
- Quarterly AUM fell $8.7 billion, as $16.3 billion of market depreciation exceeded $8.4 billion of net new flows. For the nine months, AUM increased $65.1 billion, including $33.0 billion of appreciation and $27.0 billion of net new flows.
Cash, liquidity and debt
- At June 30, 2013, corporate cash and cash equivalents were $6,069.0; total liquid assets, as defined by management, were $9,255.6, compared with $8,874.8 at September 30, 2012.
- Corporate debt was $1,252.1, down from $1,566.1 at September 30, 2012. The balance comprised $1,197.6 of senior notes and $54.5 of FHLB advances. The company reported compliance with debt covenants.
- For the nine months, operating cash flow was $1,527.6, investing cash flow was $177.6, and financing cash outflow was $1,507.8. Operating cash flow increased from $885.8 in the prior-year period.
- Financing outflows included $821.1 of common dividends, $226.4 of share repurchases, and $490.9 of debt payments. The company had $16.8 million shares remaining available for repurchase at quarter-end.
- Some cash is subject to operating, regulatory, or repatriation restrictions. U.S. and non-U.S. subsidiaries held $745.9 and $304.3, respectively, in liquid assets restricted from transfer to the parent or other subsidiaries.
Material changes versus the prior comparable period
- Revenue and earnings rose with higher average AUM; operating margin expanded 0.9 percentage points in the quarter and 0.6 points for the nine months.
- Quarterly market conditions weakened, particularly for fixed income: the Barclays Global Aggregate Index fell 3%. Long-term sales increased 49% year over year, but redemptions increased 46% to $53.9 billion.
- Nine-month net new flows were $27.0 billion, compared with $5.2 billion of net outflows in the prior-year period.
- Investment and other income was $10.3 in the quarter versus a loss of $18.0 a year earlier. The improvement included better results from consolidated investment products and equity-method investees, partly offset by trading-security and currency losses. For nine months, this income increased to $152.3 from $135.6.
- Cash dividends paid and share repurchases were lower or higher, respectively, than in the prior-year comparison: nine-month dividends paid were $821.1 versus $605.5, while repurchases were $226.4 versus $698.8.
Outlook, management commentary, risks and unusual items
- Management gave no quantified earnings, revenue, or AUM guidance. It expected continued market volatility amid global economic uncertainty and investor concern about possible Federal Reserve reductions in bond purchases. Management said it expected to continue comparable regular quarterly dividends, subject to earnings and other relevant factors.
- Management highlighted investment performance, client service, expense management, talent retention, and strategic technology investment as priorities. It also expected regulatory developments to add administrative and compliance costs.
- Key risks include market declines and AUM outflows; fixed-income sensitivity to rising or uncertain interest rates; investment performance and reputation; dependence on third-party distribution; regulatory and tax changes; foreign exchange exposure; cyber and operational disruption; and competition for clients and personnel.
- A 100-basis-point interest-rate movement was not expected by management to materially affect operating revenue or results over the next 12 months. A 10% change in specified investment carrying values would change pre-tax earnings by approximately $165.8.
- The November 2012 acquisition of approximately 69% of K2 Advisors involved $182.9 of cash consideration. The estimated fair value of contingent consideration for remaining interests was $96.8 at June 30, 2013; future payments depend on K2 revenue and profits.
- The company reported no material change in previously disclosed risk factors, no material effect expected from ordinary-course litigation, and no material change to internal control over financial reporting during the quarter. Basel III rules adopted in July 2013 were scheduled to take effect beginning in 2015, subject to phase-in periods.
Most important facts for investors to verify
- Whether AUM growth and net inflows persist, particularly given higher quarterly redemptions and market-driven AUM declines.
- How investment performance and asset mix affect average AUM, fee rates, and revenue; reported performance rankings exclude some products and may be revised.
- Whether higher operating expenses, distribution costs, compensation, and K2 contingent consideration affect margins as revenue trends change.
- The availability of cash for parent-company uses in light of subsidiary, regulatory, and cross-border transfer restrictions.
- The valuation assumptions and eventual cash cost of the K2 contingent consideration, plus integration and acquisition-related results.
- Exposure to evolving financial regulation, including Basel III, and the resulting compliance costs and capital requirements.