Business context and reporting period
Franklin Resources, Inc. (operating as Franklin Templeton Investments; NYSE: BEN) filed this Form 10-K for the fiscal year ended September 30, 2017. It is a global investment manager whose revenue is primarily tied to assets under management (AUM), investment-management fees, and fund distribution and servicing.
Ending AUM was $753.2 billion, up 3% year over year. Market appreciation and other factors added $58.5 billion, while net flows were negative $38.6 billion. Average AUM, a key driver of fee revenue, fell 2% to $736.9 billion. AUM mix at year-end: equity 42%, multi-asset/balanced 19%, fixed income 38%, and cash management 1%.
Financial performance and condition
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Operating revenue | $6,392.2 million | $6,618.0 million | Down 3% |
| Operating income | $2,264.3 million | $2,365.7 million | Down 4% |
| Operating margin | 35.4% | 35.7% | Down 0.3 percentage points |
| Net income attributable to Franklin Resources | $1,696.7 million | $1,726.7 million | Down 2% |
| Diluted EPS | $3.01 | $2.94 | Up 2% |
| Operating cash flow | $1,135.4 million | $1,727.7 million | Down 34% |
- Investment-management fees declined 3% to $4,359.2 million, reflecting lower average AUM and a lower effective fee rate (59.2 basis points versus 59.7). Sales and distribution fees fell 6% to $1,705.6 million; shareholder-servicing fees fell 7% to $225.7 million.
- Operating expenses declined 3% to $4,127.9 million. Sales, distribution and marketing costs fell 4%; technology expense increased 6% to $219.8 million.
- Other income, net rose to $284.8 million from $134.1 million, largely due to gains on investments held by consolidated investment products and increased equity-method investee and interest income. This helped offset lower operating income.
- Company cash and cash equivalents were $8,523.3 million; total liquid assets, including receivables and certain investments, were $11,286.3 million. Company debt was $1,044.2 million, down from $1,401.2 million. The company repaid $300 million of notes at maturity and fully repaid an Indian-rupee loan. Consolidated investment-product debt of $53.4 million is separate and, according to the filing, is non-recourse beyond the company’s direct investment.
- Stockholders’ equity was $12,620.0 million, versus $11,935.8 million. The company declared $0.80 per share in dividends and repurchased 19.1 million shares for $771.5 million.
Material changes versus the prior comparable period
Fiscal 2017 revenue and operating income continued to decline, but at a slower pace than in fiscal 2016, when revenue fell 17% and operating income fell 22%. Ending AUM recovered from $733.3 billion to $753.2 billion due to market gains, despite continued net outflows. Net outflows improved from $62.4 billion in FY2016 to $38.6 billion in FY2017; long-term sales rose 10% and redemptions fell 9%. Diluted EPS increased despite lower attributable net income, partly reflecting a 4% decline in diluted average shares, primarily from repurchases.
Operating cash flow decreased materially, principally because of a larger net increase in trading securities of consolidated investment products. A new consolidation accounting standard adopted October 1, 2016 changed which investment products were consolidated; this increased reported consolidated assets and redeemable noncontrolling interests and makes some balance-sheet comparisons less directly comparable.
Outlook, management commentary, risks and unusual items
The filing provides no quantified earnings or AUM guidance. Management said it would continue to focus on investment performance, client service, expense management, talent, technology and maintaining distribution and client relationships; it also expected to continue comparable quarterly dividends, subject to earnings and other relevant factors.
- Investment performance was mixed: global/international fixed income performed strongly across several measurement periods, while equity and some U.S. fixed-income products mostly lagged benchmarks and peer medians. Management identifies performance as important to retaining and attracting AUM.
- Key business risks include market declines, fee pressure and shifts toward lower-fee products, persistent net redemptions, dependence on third-party distributors, foreign-exchange exposure, regulatory change, cybersecurity and operational risks, and loss of key investment personnel.
- Regulatory changes expected to affect operations included MiFID II in January 2018 and EU data-protection requirements in May 2018. Management anticipated added compliance and administrative costs. Brexit’s eventual terms remained uncertain.
- Two putative class actions allege ERISA fiduciary breaches relating to Franklin funds offered in the company’s 401(k) plan. Plaintiffs allege plan losses exceeding $79 million and $60 million, respectively. The company said it considers the claims without merit, will defend them, and could not estimate any possible loss or outcome.
- The company reported $81.1 million of unrecognized tax benefits and $10.4 million of related accrued interest. It also had $73.5 million of discretionary, unfunded capital commitments and $58.2 million of contingent consideration obligations, primarily related to acquiring the remaining K2 interests.
Management and the independent auditor concluded internal control over financial reporting was effective as of September 30, 2017; the auditor issued unqualified opinions on the financial statements and controls.
Most important facts for investors to verify
- Whether net outflows continue to moderate, particularly in equity and global/international strategies, and how average AUM and fee rates trend.
- Investment performance by product category and the resulting effects on redemptions, sales and performance fees.
- Whether operating cash flow recovers from the FY2017 decline and how much cash is available for dividends, repurchases and investment after regulatory or other restrictions.
- Progress and potential financial effects of the ERISA lawsuits, tax examinations and remaining K2 contingent consideration.
- Effects of regulatory changes, lower-fee ETF competition, distribution economics and technology or cybersecurity spending on margins.