Franklin Resources, Inc. (Franklin Templeton) — Q1 FY2017 10-Q
Reporting period: Three months ended December 31, 2016; comparative period ended December 31, 2015. The filing is for Franklin Resources, Inc., the parent company of the Franklin Templeton investment management business. Dollar amounts are in millions unless noted.
Business context and key financial metrics
- Business: Global investment manager whose revenue is largely tied to assets under management (AUM), investment performance, product mix, and fee rates.
- Revenue: $1,560.8, down 11% year over year. Investment management fees were $1,063.2 (down 10%); sales and distribution fees $419.3 (down 12%).
- Profit and margins: Operating income was $586.9, down 10%; operating margin was 37.6%, versus 37.2%. Net income attributable to Franklin Resources was $440.2, down 2%; diluted EPS was $0.77, up 4%. EPS benefited from fewer shares outstanding after repurchases. Consolidated net income was $418.8; the difference from parent-attributable income reflects noncontrolling interests.
- Cash flow and capital returns: Operating cash flow was $446.2, versus $295.2. Investing cash flow was negative $58.4 and financing cash flow negative $365.9. The company repurchased $261.7 of stock and paid $103.4 in common dividends. Dividends declared were $0.20 per share.
- Liquidity and debt: Company cash and cash equivalents were $8,223.6 at quarter-end. Management-defined liquid assets, excluding assets and liabilities of consolidated sponsored investment products (SIPs), were $10,895.6, compared with $10,890.2 at September 30, 2016. Company debt was $1,394.4, down from $1,401.2. Management said existing liquid assets, operating cash flows, potential capital-market access, and borrowing capacity should meet present and reasonably foreseeable needs.
- AUM: Quarter-end AUM was $720.0 billion, down 2% from September 30, 2016 and 6% year over year. Average AUM fell 8% year over year to $722.7 billion. Quarterly net flows were negative $14.4 billion, versus negative $8.9 billion a year earlier.
Material changes versus the prior comparable period
- Lower AUM and a lower effective investment management fee rate (58.8 basis points versus 60.7) contributed to reduced fee revenue. Net outflows were concentrated across long-term investment objectives, particularly global/international products.
- Operating expenses declined 12% to $973.9, partly offsetting the revenue decline. General, administrative and other expense fell 33%, including a $12.2 decrease in the fair value of K2 acquisition contingent consideration, compared with a $16.2 increase in the prior-year quarter.
- Other income, net increased to $32.8 from $18.5, supported by foreign-exchange gains, higher interest income, and equity-method income; increased losses on investments held by consolidated SIPs partly offset these gains.
- Operating cash flow improved, while investing cash flow moved from positive $89.2 to negative $58.4. Stock repurchases were lower than the prior-year quarter ($261.7 versus $404.1).
- Adoption of revised consolidation guidance on October 1, 2016 changed the consolidation of investment products. The company consolidated 61 SIPs at December 31, versus 40 at September 30; this materially changed reported balance-sheet amounts, including redeemable noncontrolling interests. The filing says consolidated SIPs did not significantly affect parent-attributable net income and their debt is generally nonrecourse to the company.
Outlook, management commentary, risks, and unusual items
- No quantitative earnings, revenue, or AUM guidance was provided. Management emphasized investment performance, customer service, expense management, and strategic investment in systems and technology. It expects to continue paying comparable quarterly dividends, subject to earnings and other relevant factors.
- Performance was mixed: global/international fixed income performed strongly against benchmarks and peers, while equity and U.S. taxable fixed-income products mostly lagged the comparisons presented. Management cautioned that past performance does not predict future results.
- Key business risks include market volatility, continued redemptions and net outflows, fee-rate and asset-mix pressure, investment underperformance, foreign-exchange movements, competition and distribution-channel changes, and evolving regulation. The filing also identifies cybersecurity, operational, personnel, litigation, and tax risks.
- A putative ERISA class action alleges excessive plan costs and fiduciary breaches concerning Franklin-sponsored funds in the company’s 401(k) plan. The plaintiff alleges losses exceeding $79 million and seeks damages and other relief. Motions to dismiss and for summary adjudication were denied January 17, 2017. Management disputes the claims and intends to defend the case; the outcome and any material effect cannot be predicted.
- The company reported no material changes in other commitments and contingencies or market-risk disclosures from its fiscal 2016 Form 10-K. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether AUM outflows persist, especially in global/international products, and whether investment performance improves in lagging categories.
- How average AUM, asset mix, and effective fee rates affect future revenue and margins.
- How much reported balance-sheet movement reflects the new consolidation guidance rather than changes in the company’s own economic resources or obligations.
- The outcome and potential financial or reputational impact of the 401(k) ERISA lawsuit.
- Liquidity available for corporate use, considering regulatory, operational, and international transfer restrictions; also monitor debt maturities and capital returns.