Franklin Resources, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2018. The filing is by Franklin Resources, Inc. (the parent of Franklin Templeton), rather than an issuer named “Franklin Templeton Inc.” Financial amounts are in U.S. dollars.
Financial results
| Metric | Three months ended March 31, 2018 | Change vs. prior year | Six months ended March 31, 2018 |
|---|---|---|---|
| Operating revenue | $1.618 billion | +1% | $3.233 billion, +2% |
| Operating income | $555.7 million | Approximately unchanged | $1.137 billion, approximately unchanged |
| Operating margin | 34.3% | Down from 34.7% | 35.2%, down from 36.1% |
| Net income attributable to Franklin Resources | $443.2 million | Up from $420.7 million | Loss of $140.1 million, versus income of $860.9 million |
| Diluted earnings (loss) per share | $0.78 | Up from $0.74 | $(0.29), versus $1.52 |
- Quarterly investment management fees rose 3% to $1.117 billion, supported by 3% higher average AUM; sales and distribution fees fell 5%, mainly as sales-based fees declined 24%.
- Six-month operating expenses increased 4% to $2.097 billion. Higher compensation, technology, occupancy and general and administrative costs were partly offset by lower sales-based expenses.
- Six-month net results include an estimated $1.120 billion transition tax charge under the Tax Cuts and Jobs Act. The charge drove the reported loss; the quarter itself had a 23.7% effective tax rate and $150.2 million tax expense.
AUM and business trends
- AUM was $737.5 billion at March 31, down 2% from September 30, 2017 and approximately flat year over year. Average AUM increased 3% year over year in both the quarter and six-month period.
- Net outflows were $10.0 billion for the quarter and $12.3 billion for the six months. Six-month outflows improved from $25.4 billion a year earlier, as redemptions declined 11% to $81.1 billion.
- Investment performance was mixed: the filing says equity products and most tax-free and U.S. taxable fixed-income products mostly lagged benchmarks and peer medians over reported periods. Global/international fixed income had strong ten-year comparisons, but weaker recent performance reduced its one-, three- and five-year rankings.
- Management cited market volatility, rising-rate concerns and U.S.–China trade tensions. It said it would continue focusing on investment performance, client service, expense management, talent and strategic technology investment.
Cash, debt and capital allocation
- At March 31, cash and cash equivalents were $8.545 billion; company liquid assets, as defined in the filing, were $11.246 billion, versus $11.286 billion at September 30, 2017. Debt was $1.045 billion. The company reported compliance with debt covenants.
- Six-month operating cash flow was $897.0 million, compared with $614.3 million. This included a $1.104 billion increase in income taxes payable, an important factor in interpreting cash generation. Investing cash flow was a use of $181.5 million; financing cash flow was a use of $764.5 million.
- The company declared a $3.00-per-share special dividend and regular dividends totaling $0.46 per share in the six-month period. It repurchased 15.7 million shares for $632.6 million. On April 11, the board authorized repurchases of up to an additional 80 million shares.
- Subsidiaries held $3.576 billion of liquid assets for operational, regulatory and product-capital needs; $171 million was restricted from transfer to the parent or other subsidiaries.
Outlook, unusual items and risks
- Management expected an effective tax rate of approximately 70% for fiscal 2018, including Tax Act effects, and approximately 24%–25% excluding one-time Tax Act impacts. The estimated federal transition-tax liability was $1.101 billion, payable over eight years beginning January 2019; the estimate may change.
- After quarter-end, the company gave notice that it would redeem $350 million of 4.625% notes due 2020 on May 21, 2018, at an expected make-whole price of approximately $363 million. It expected about $13 million of accelerated interest expense in the June quarter.
- Quarterly other income benefited from investment gains at consolidated investment products (CIPs). The company noted that significant CIP gains or losses are substantially offset by noncontrolling interests; third-party CIP assets are not available to the company, and CIP creditors generally have no recourse to its assets.
- A consolidated ERISA class action alleges excessive plan fees and fiduciary breaches; claimed losses exceed $79 million in one complaint and $60 million in another. The cases were consolidated, the company disputes the claims, and it said it could not estimate a possible loss or predict the outcome.
- Key risks include market declines and AUM outflows, weak relative investment performance, fee and product-mix pressure, competition, regulatory and compliance costs, tax uncertainty, cybersecurity and operational disruption, and litigation. Management reported no material change in the risk factors from its prior Form 10-K.
Important facts for investors to verify
- How the Tax Act transition-tax estimate and future tax payments develop, and the effect on reported earnings and cash flows.
- Whether AUM outflows persist and whether investment performance improves in categories that have lagged benchmarks or peers.
- The sustainability of operating margins amid expense growth and revenue dependence on AUM, product mix and market levels.
- The expected cost and timing of the $350 million note redemption, and actual execution of the expanded share-repurchase authorization and dividend policy.
- Developments in the consolidated ERISA litigation, for which the company could not estimate potential loss.
- The availability of parent-company liquidity, given subsidiary operating and regulatory needs and restrictions on transfers.