Business context and reporting period
Franklin Resources, Inc. (Franklin Templeton) filed this Form 10-Q for the fiscal third quarter ended June 30, 2012, and the nine months ended June 30, 2012. It is a global investment manager; substantially all revenue comes from investment management and related services. Banking and finance is a smaller segment. Financial figures below are in U.S. dollars.
Financial and operating performance
- Quarter revenue: $1.784 billion, down 4% year over year. Investment management fees fell 5% to $1.114 billion; sales and distribution fees fell 4% to $569 million.
- Quarter earnings: Operating income was $643 million, down 6%; operating margin was 36.0%, versus 36.8%. Net income attributable to Franklin was $455 million, down 10%; diluted EPS was $2.12, versus $2.26.
- Nine-month results: Revenue was $5.285 billion, essentially flat year over year. Operating income declined 4% to $1.892 billion; operating margin was 35.8%, versus 37.2%. Net income attributable to Franklin declined 5% to $1.439 billion; diluted EPS was $6.65, versus $6.73.
- Assets under management (AUM): $707.1 billion at June 30, down 4% from a year earlier but up 7% from September 30, 2011. Quarterly average AUM declined 2% year over year to $710.7 billion. Quarter net new flows were positive $4.8 billion, while nine-month net new flows were negative $5.2 billion. Nine-month AUM growth was primarily market-driven.
- Cash flow: Nine-month operating cash flow was $886 million, versus $1.009 billion. Investing activities provided $610 million; financing activities used $1.291 billion. Cash and cash equivalents totaled $5.385 billion at period-end.
- Liquidity and debt: Management-defined liquid assets were $8.009 billion, compared with $7.987 billion at September 30, 2011. Management-defined debt was $968 million, down from $998 million, excluding debt of consolidated investment entities. Total consolidated debt reported on the balance sheet was $1.946 billion. The company said it could meet foreseeable operating and commitment needs using liquid assets, operating cash flow and potential debt or equity issuance.
- Capital returns: The company repurchased 6.7 million shares for $699 million during the nine months. It paid $606 million in common dividends; nine-month dividends per share were $2.81, including the $2.00 special dividend. A regular quarterly dividend of $0.27 per share was declared.
Material changes versus comparable periods
- Quarter revenue and earnings weakened amid lower average AUM, a lower effective management fee rate and market depreciation. Market depreciation reduced AUM by $22.5 billion in the quarter, partly offset by $4.8 billion of net new flows.
- Long-term sales fell 28% year over year in the quarter to $41.6 billion; redemptions rose 3% to $36.8 billion. Management cited investor concerns about European sovereign debt and global growth.
- For the nine months, operating income was affected by the prior-year period’s $38.5 million net insurance recovery. General and administrative expenses also included $9.2 million of expenses from newly consolidated investment structures.
- Quarter investment and other income turned to a $18 million loss from $15 million of income, principally reflecting trading-security and equity-method investment losses. Nine-month investment and other income increased to $136 million, with CLO and foreign-exchange gains partly offset by investment losses.
- Comparative 2011 revenue classifications were reclassified between investment management fees and sales and distribution fees; total revenue, net income and financial position were unchanged.
Outlook, commentary and risks
- No quantified earnings, revenue or AUM guidance was provided. Management said ongoing market concerns could sustain volatility and emphasized investment performance, client service, expense management, employee retention and strategic investment in systems and technology.
- Key exposures include market declines and AUM mix changes, redemptions, weaker investment performance, foreign-exchange movements, competition and dependence on third-party distribution. Regulatory uncertainty, including Dodd-Frank/Volcker Rule implementation and FATCA compliance costs, was highlighted.
- Management reported that the prior market-timing and late-trading lawsuits had been resolved or dismissed. Other ordinary-course litigation remained; management believed related accruals were adequate and expected no material effect from resolution of those claims.
- Fair-value estimation is relevant: Level 3 assets were 23% of assets measured at fair value. Management reported no impairment of definite-lived intangible assets for the nine months, but said a 23% decline in related AUM could prompt an impairment evaluation.
- The company applied to convert Fiduciary Trust into an uninsured national trust bank; approval and completion were not assured. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported for the quarter.
Most important facts for investors to verify
- Subsequent AUM, net sales and redemptions, especially in global/international equity and fixed-income products, and whether the quarter’s fee-rate pressure continued.
- Underlying investment and other income volatility, including the effect of consolidated sponsored products, CLOs, foreign exchange and Level 3 valuations.
- Cash availability across jurisdictions and regulatory requirements, and the distinction between corporate debt and debt of consolidated investment entities.
- Progress and potential costs of regulatory changes, the proposed bank conversion, and any material developments in litigation or contingencies.
- Whether expense growth, capital returns and investment in technology remain sustainable if markets or AUM weaken.