Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
FORWARD-LOOKING STATEMENTS
This Form 10-Q and the documents incorporated by reference herein may include forward-looking statements that reflect our current views with respect to future events, financial performance and market conditions. Such statements are provided under the “safe harbor” protection of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts and generally can be identified by words or phrases written in the future tense and/or preceded by words such as “anticipate,” “believe,” “could,” “depends,” “estimate,” “expect,” “intend,” “likely,” “may,” “plan,” “potential,” “seek,” “should,” “will,” “would,” or other similar words or variations thereof, or the negative thereof, but these terms are not the exclusive means of identifying such statements.
Forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that may cause actual results and outcomes to differ materially from any future results or outcomes expressed or implied by such forward-looking statements, including pandemic-related risks, market and volatility risks, investment performance and reputational risks, global operational risks, competition and distribution risks, third-party risks, technology and security risks, human capital risks, cash management risks, and legal and regulatory risks. The forward-looking statements contained in this Form 10-Q or that are incorporated by reference herein are qualified in their entirety by reference to the risks and uncertainties disclosed in this Form 10-Q and/or discussed under the headings “Risk Factors” and “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2022 (“fiscal year 2022”).
While forward-looking statements are our best prediction at the time that they are made, you should not rely on them and are cautioned against doing so. Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other possible future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. They are neither statements of historical fact nor guarantees or assurances of future performance. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them.
If a circumstance occurs after the date of this Form 10-Q that causes any of our forward-looking statements to be inaccurate, whether as a result of new information, future developments or otherwise, we undertake no obligation to announce publicly the change to our expectations, or to make any revision to our forward-looking statements, to reflect any change in assumptions, beliefs or expectations, or any change in events, conditions or circumstances upon which any forward-looking statement is based, unless required by law.
In this section, we discuss and analyze the results of operations and financial condition of Franklin Resources, Inc. (“Franklin”) and its subsidiaries (collectively, the “Company”). The following discussion should be read in conjunction with our Annual Report on Form 10-K for fiscal year 2022 filed with the U.S. Securities and Exchange Commission, and the consolidated financial statements and notes thereto included elsewhere in this Form 10-Q.
OVERVIEW
Franklin is a holding company with subsidiaries operating under our Franklin Templeton® and/or subsidiary brand names. We are a global investment management organization that derives operating revenues and net income from providing investment management and related services to investors in jurisdictions worldwide. We deliver our investment capabilities through a variety of investment products, which include our sponsored funds, as well as institutional and high-net-worth separate accounts, retail separately managed account programs, sub-advised products, and other investment vehicles. Related services include fund administration, sales and distribution, and shareholder servicing. We may perform services directly or through third parties. We offer our services and products under our various distinct brand names, including, but not limited to, Franklin®, Templeton®, Legg Mason®, Alcentra®, Benefit Street Partners®, Brandywine Global Investment Management®, Clarion Partners®, ClearBridge Investments®, Fiduciary Trust International™, Franklin Bissett®, Franklin Mutual Series®, K2®, Lexington Partners®, Martin Currie®, O’Shaughnessy® Asset Management, Royce® Investment Partners and Western Asset Management Company®. We offer a broad product mix of fixed income, equity, alternative, multi-asset and cash management asset classes and solutions that meet a wide variety of specific investment goals and needs for individual and institutional investors. We also provide sub-advisory services to certain investment products sponsored by other companies which may be sold to investors under the brand names of those other companies or on a co-branded basis.
The level of our revenues depends largely on the level and relative mix of assets under management (“AUM”). As noted in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year 2022, the amount and mix of our AUM are subject to significant fluctuations that can negatively impact our revenues and income. The level of our revenues also depends on the fees charged for our services, which are based on contracts with our funds and customers, fund sales, and the number of shareholder transactions and accounts. These arrangements could change in the future.
During our second fiscal quarter, global equity markets provided positive returns as indications that interest rate increases by central banks may soon end, declines in inflation and receding concerns about a recession outweighed the impact of regional bank failures and concerns about a potential banking crisis. The S&P 500 Index and MSCI World Index increased 7.5% and 7.9% for the quarter and 15.6% and 18.5% for the fiscal year to date. The global bond markets remained positive as the Bloomberg Global Aggregate Index increased 3.0% during the quarter and 7.7% for the fiscal year to date, reflecting declines in inflation and expectations of easing monetary policy.
Our total AUM at March 31, 2023 was $1,422.1 billion, 10% higher than at September 30, 2022 and 4% lower than at March 31, 2022. Monthly average AUM (“average AUM”) for the three and six months ended March 31, 2023 decreased 6% and 9% from the same periods in the prior fiscal year.
On November 1, 2022, we acquired BNY Alcentra Group Holdings, Inc. (together with its subsidiaries, “Alcentra”), one of the largest European credit and private debt managers, with global expertise in senior secured loans, high yield bonds, private credit, structured credit, special situations and multi-strategy credit strategies. Total purchase price included cash consideration of $594.1 million, which includes $188.3 million for certain securities held in Alcentra’s collateralized loan obligations; deferred consideration of $62.0 million due November 1, 2023; and contingent consideration to be paid upon the achievement of certain performance thresholds over the next four years of up to $350.0 million that had an acquisition-date fair value of $24.6 million.
The business and regulatory environments in which we operate globally remain complex, uncertain and subject to change. We are subject to various laws, rules and regulations globally that impose restrictions, limitations, registration, reporting and disclosure requirements on our business, and add complexity to our global compliance operations.
Uncertainties regarding the global economy remain for the foreseeable future. As we continue to confront the challenges of the current economic and regulatory environments, we remain focused on the investment performance of our products and on providing high quality service to our clients. We continuously perform reviews of our business model. While we remain focused on expense management, we will also seek to attract, retain and develop personnel and invest strategically in systems and technology that will provide a secure and stable environment. We will continue to seek to protect and further our brand recognition while developing and maintaining broker-dealer and client relationships. The success of these and other strategies may be influenced by the factors discussed in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year 2022.
RESULTS OF OPERATIONS
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
March 31, | | Percent
Change | | Six Months Ended
March 31, | | Percent
Change |
| (in millions, except per share data) | | 2023 | | 2022 | | | 2023 | | 2022 | |
| Operating revenues | | $ | 1,927.2 | | $ | 2,081.0 | | (7 | %) | | $ | 3,894.3 | | $ | 4,305.0 | | (10 | %) |
| Operating income | | 255.1 | | 463.0 | | (45 | %) | | 449.1 | | 1,020.7 | | (56 | %) |
Operating margin1 | | 13.2 | % | | 22.2 | % | | | | 11.5 | % | | 23.7 | % | | |
| | | | | | | | | | | | |
| Net income attributable to Franklin Resources, Inc. | | $ | 194.2 | | $ | 349.6 | | (44 | %) | | $ | 359.8 | | $ | 802.8 | | (55 | %) |
| Diluted earnings per share | | 0.38 | | 0.68 | | (44 | %) | | 0.70 | | 1.57 | | (55 | %) |
| | | | | | | | | | | | |
As adjusted (non-GAAP):2 | | | | | | | | | | | | |
| Adjusted operating income | | $ | 440.2 | | $ | 576.6 | | (24 | %) | | $ | 835.3 | | $ | 1,262.5 | | (34 | %) |
| Adjusted operating margin | | 28.9 | % | | 35.7 | % | | | | 28.2 | % | | 37.8 | % | | |
| | | | | | | | | | | | |
| Adjusted net income | | $ | 316.7 | | $ | 491.6 | | (36 | %) | | $ | 579.1 | | $ | 1,045.2 | | (45 | %) |
| Adjusted diluted earnings per share | | 0.61 | | 0.96 | | (36 | %) | | 1.13 | | 2.04 | | (45 | %) |
_________________
1Defined as operating income divided by operating revenues.
2“Adjusted operating income,” “adjusted operating margin,” “adjusted net income” and “adjusted diluted earnings per share” are based on methodologies other than generally accepted accounting principles. See “Supplemental Non-GAAP Financial Measures” for definitions and reconciliations of these measures.
ASSETS UNDER MANAGEMENT
AUM by asset class was as follows:
| | | | | | | | | | | | | | | | | | | | |
| (in billions) | | March 31,
2023 | | March 31,
2022 | | Percent
Change |
| Fixed Income | | $ | 510.1 | | | $ | 595.0 | | | (14 | %) |
| Equity | | 437.1 | | | 515.4 | | | (15 | %) |
| Alternative | | 258.2 | | | 157.9 | | | 64 | % |
| Multi-Asset | | 146.1 | | | 151.9 | | | (4 | %) |
| Cash Management | | 70.6 | | | 57.3 | | | 23 | % |
| Total | | $ | 1,422.1 | | | $ | 1,477.5 | | | (4 | %) |
Average AUM and the mix of average AUM by asset class are shown below.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in billions) | | Average AUM | | Percent
Change | | Mix of Average AUM |
| for the three months ended March 31, | | 2023 | | 2022 | | | 2023 | | 2022 |
| Fixed Income | | $ | 504.9 | | | $ | 619.0 | | | (18 | %) | | 36 | % | | 41 | % |
| Equity | | 433.4 | | | 528.7 | | | (18 | %) | | 31 | % | | 35 | % |
| Alternative | | 257.5 | | | 155.5 | | | 66 | % | | 18 | % | | 10 | % |
| Multi-Asset | | 144.7 | | | 151.5 | | | (4 | %) | | 10 | % | | 10 | % |
| Cash Management | | 79.0 | | | 61.4 | | | 29 | % | | 5 | % | | 4 | % |
| Total | | $ | 1,419.5 | | | $ | 1,516.1 | | | (6 | %) | | 100 | % | | 100 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in billions) | | Average AUM | | Percent
Change | | Mix of Average AUM |
| for the six months ended March 31, | | 2023 | | 2022 | | | 2023 | | 2022 |
| Fixed Income | | $ | 498.0 | | | $ | 629.0 | | | (21 | %) | | 36 | % | | 41 | % |
| Equity | | 426.3 | | | 535.5 | | | (20 | %) | | 31 | % | | 35 | % |
| Alternative | | 247.7 | | | 152.2 | | | 63 | % | | 18 | % | | 10 | % |
| Multi-Asset | | 141.7 | | | 151.3 | | | (6 | %) | | 10 | % | | 10 | % |
| Cash Management | | 72.7 | | | 61.0 | | | 19 | % | | 5 | % | | 4 | % |
| Total | | $ | 1,386.4 | | | $ | 1,529.0 | | | (9 | %) | | 100 | % | | 100 | % |
Components of the change in AUM are shown below. Net market change, distributions and other includes appreciation (depreciation), distributions to investors that represent return on investments and return of capital, and foreign exchange revaluation.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in billions) | | Three Months Ended
March 31, | | Percent
Change | | Six Months Ended
March 31, | | Percent
Change |
| 2023 | | 2022 | | | 2023 | | 2022 | |
| Beginning AUM | | $ | 1,387.7 | | | $ | 1,578.1 | | | (12 | %) | | $ | 1,297.4 | | | $ | 1,530.1 | | | (15 | %) |
| Long-term inflows | | 61.8 | | | 76.1 | | | (19 | %) | | 132.3 | | | 183.1 | | | (28 | %) |
| Long-term outflows | | (65.5) | | | (87.8) | | | (25 | %) | | (146.9) | | | (170.7) | | | (14 | %) |
| Long-term net flows | | (3.7) | | | (11.7) | | | (68 | %) | | (14.6) | | | 12.4 | | | NM |
| Cash management net flows | | (4.3) | | | (7.1) | | | (39 | %) | | 13.2 | | | (1.3) | | | NM |
| Total net flows | | (8.0) | | | (18.8) | | | (57 | %) | | (1.4) | | | 11.1 | | | NM |
| Acquisitions | | — | | | — | | | NM | | 34.9 | | | 7.7 | | | 353% |
| Net market change, distributions and other | | 42.4 | | | (81.8) | | | NM | | 91.2 | | | (71.4) | | | NM |
| Ending AUM | | $ | 1,422.1 | | | $ | 1,477.5 | | | (4 | %) | | $ | 1,422.1 | | | $ | 1,477.5 | | | (4 | %) |
Components of the change in AUM by asset class were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in billions) | | Fixed Income | | Equity | | Alternative | | Multi-Asset | | Cash
Management | | Total |
for the three months ended
March 31, 2023 | | | | | | |
| AUM at January 1, 2023 | | $ | 494.8 | | | $ | 419.1 | | | $ | 257.4 | | | $ | 141.4 | | | $ | 75.0 | | | $ | 1,387.7 | |
| Long-term inflows | | 31.5 | | | 17.1 | | | 4.9 | | | 8.3 | | | — | | | 61.8 | |
| Long-term outflows | | (29.7) | | | (25.4) | | | (3.6) | | | (6.8) | | | — | | | (65.5) | |
| Long-term net flows | | 1.8 | | | (8.3) | | | 1.3 | | | 1.5 | | | — | | | (3.7) | |
| Cash management net flows | | — | | | — | | | — | | | — | | | (4.3) | | | (4.3) | |
| Total net flows | | 1.8 | | | (8.3) | | | 1.3 | | | 1.5 | | | (4.3) | | | (8.0) | |
| | | | | | | | | | | | |
Net market change, distributions and other | | 13.5 | | | 26.3 | | | (0.5) | | | 3.2 | | | (0.1) | | | 42.4 | |
| AUM at March 31, 2023 | | $ | 510.1 | | | $ | 437.1 | | | $ | 258.2 | | | $ | 146.1 | | | $ | 70.6 | | | $ | 1,422.1 | |
AUM increased $34.4 billion or 2% during the three months ended March 31, 2023 due to the positive impact of $42.4 billion of net market change, distributions and other, partially offset by $4.3 billion of cash management net outflows and $3.7 billion of long-term net outflows. Fixed income net inflows included the funding of a $7.5 billion institutional mandate invested across fixed income strategies. Net market change, distributions and other primarily consists of $48.1 billion of market appreciation and a $0.9 billion increase from foreign exchange revaluation, partially offset by $6.6 billion of long-term distributions. The market appreciation occurred in all asset classes, most significantly in the equity and fixed income asset classes and reflected positive returns in the global equity and fixed income markets.
AUM decreased $55.4 billion or 4%, as compared to the prior year period. Long-term inflows decreased 19% to $61.8 billion, driven by lower inflows in equity and fixed income open end funds, equity separately managed accounts, and fixed income institutional separate accounts. Long-term outflows decreased 25% to $65.5 billion driven by lower redemptions in fixed income and equity open end funds, equity separately managed accounts and fixed income institutional separate accounts.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in billions) | | Fixed Income | | Equity | | Alternative | | Multi-Asset | | Cash
Management | | Total |
for the three months ended
March 31, 2022 | | | | | | |
| AUM at January 1, 2022 | | $ | 642.1 | | | $ | 563.4 | | | $ | 154.3 | | | $ | 154.0 | | | $ | 64.3 | | | $ | 1,578.1 | |
| Long-term inflows | | 33.3 | | | 29.8 | | | 4.6 | | | 8.4 | | | — | | | 76.1 | |
| Long-term outflows | | (41.2) | | | (35.9) | | | (4.6) | | | (6.1) | | | — | | | (87.8) | |
| Long-term net flows | | (7.9) | | | (6.1) | | | — | | | 2.3 | | | — | | | (11.7) | |
| Cash management net flows | | — | | | — | | | — | | | — | | | (7.1) | | | (7.1) | |
| Total net flows | | (7.9) | | | (6.1) | | | — | | | 2.3 | | | (7.1) | | | (18.8) | |
| | | | | | | | | | | | |
Net market change, distributions and other | | (39.2) | | | (41.9) | | | 3.6 | | | (4.4) | | | 0.1 | | | (81.8) | |
| AUM at March 31, 2022 | | $ | 595.0 | | | $ | 515.4 | | | $ | 157.9 | | | $ | 151.9 | | | $ | 57.3 | | | $ | 1,477.5 | |
AUM decreased $100.6 billion or 6% during the three months ended March 31, 2022 due to the negative impact of $81.8 billion of net market change, distributions and other, $11.7 billion of long-term net outflows and $7.1 billion of cash management net outflows. Net market change, distributions and other primarily consists of $77.0 billion of market depreciation and $4.6 billion of long-term distributions. The market depreciation occurred primarily in the equity and fixed income asset classes.
AUM decreased $21.4 billion or 1%, as compared to the prior year period. Long-term inflows decreased 25% to $76.1 billion, driven by lower inflows in fixed income institutional separate accounts and equity and fixed income open end funds. Long-term outflows decreased 17% to $87.8 billion driven by lower redemptions in fixed income institutional separate accounts related to a single fixed income institutional redemption of nearly $6 billion and $1.3 billion of outflows from our India credit funds that did not earn management fees and are in the process of winding up.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in billions) | | Fixed Income | | Equity | | Alternative | | Multi-Asset | | Cash
Management | | Total |
for the six months ended
March 31, 2023 | | | | | | |
| AUM at October 1, 2022 | | $ | 490.9 | | | $ | 392.3 | | | $ | 225.1 | | | $ | 131.5 | | | $ | 57.6 | | | $ | 1,297.4 | |
| Long-term inflows | | 60.0 | | | 44.3 | | | 11.4 | | | 16.6 | | | — | | | 132.3 | |
| Long-term outflows | | (71.5) | | | (52.3) | | | (10.4) | | | (12.7) | | | — | | | (146.9) | |
| Long-term net flows | | (11.5) | | | (8.0) | | | 1.0 | | | 3.9 | | | — | | | (14.6) | |
| Cash management net flows | | — | | | — | | | — | | | — | | | 13.2 | | | 13.2 | |
| Total net flows | | (11.5) | | | (8.0) | | | 1.0 | | | 3.9 | | | 13.2 | | | (1.4) | |
| Acquisition | | — | | | — | | | 34.9 | | | — | | | — | | | 34.9 | |
Net market change, distributions and other | | 30.7 | | | 52.8 | | | (2.8) | | | 10.7 | | | (0.2) | | | 91.2 | |
| AUM at March 31, 2023 | | $ | 510.1 | | | $ | 437.1 | | | $ | 258.2 | | | $ | 146.1 | | | $ | 70.6 | | | $ | 1,422.1 | |
AUM increased $124.7 billion, or 10%, during the six months ended March 31, 2023 due to the positive impact of $91.2 billion of net market change, distributions and other, $34.9 billion from an acquisition, and $13.2 billion of cash management net inflows, partially offset by $14.6 billion of long-term net outflows. Long-term net outflows included a $2.1 billion fixed income institutional redemption that had minimal impact on revenue. Net market change, distributions and other primarily consists of $106.6 billion of market appreciation, a $9.7 billion increase from foreign exchange revaluation, partially offset by $25.1 billion of long-term distributions. The market appreciation occurred in all asset classes, most significantly in the equity and fixed income asset classes and reflected positive returns in the global equity and fixed income markets. Foreign exchange revaluation from AUM in products that are not U.S. dollar denominated was primarily due to a weaker U.S. dollar compared to the Euro, Pound Sterling, Japanese Yen and Australian dollar.
Long-term inflows decreased 28% to $132.3 billion, as compared to the prior year period, driven by lower inflows in equity, fixed income, and multi-asset open end funds, fixed income institutional separate accounts and sub-advised CITs, and equity retail separate accounts. Decreased inflows for open end mutual funds include the impact of lower reinvested distributions, which were $14.4 billion in the current year period, as compared to $32.0 billion in the prior year period. Long-term outflows decreased 14% to $146.9 billion due to lower outflows in equity and fixed income open end funds, multi-asset sub-advised mutual funds and equity separately managed accounts, partially offset by higher outflows in fixed income institutional separate accounts.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in billions) | | Fixed Income | | Equity | | Alternative | | Multi-Asset | | Cash
Management | | Total |
for the six months ended
March 31, 2022 | | | | | | |
| AUM at October 1, 2021 | | $ | 650.3 | | | $ | 523.6 | | | $ | 145.2 | | | $ | 152.4 | | | $ | 58.6 | | | $ | 1,530.1 | |
| Long-term inflows | | 77.0 | | | 75.9 | | | 10.7 | | | 19.5 | | | — | | | 183.1 | |
| Long-term outflows | | (76.8) | | | (69.3) | | | (7.7) | | | (16.9) | | | — | | | (170.7) | |
| Long-term net flows | | 0.2 | | | 6.6 | | | 3.0 | | | 2.6 | | | — | | | 12.4 | |
| Cash management net flows | | — | | | — | | | — | | | — | | | (1.3) | | | (1.3) | |
| Total net flows | | 0.2 | | | 6.6 | | | 3.0 | | | 2.6 | | | (1.3) | | | 11.1 | |
| Acquisitions | | — | | | 4.6 | | | 0.8 | | | 2.3 | | | — | | | 7.7 | |
Net market change, distributions and other | | (55.5) | | | (19.4) | | | 8.9 | | | (5.4) | | | — | | | (71.4) | |
| AUM at March 31, 2022 | | $ | 595.0 | | | $ | 515.4 | | | $ | 157.9 | | | $ | 151.9 | | | $ | 57.3 | | | $ | 1,477.5 | |
AUM decreased $52.6 billion or 3% during the six months ended March 31, 2022 due to the negative impact of $71.4 billion of net market change, distributions and other and $1.3 billion of cash management net outflows, partially offset by $12.4 billion of long-term net inflows and $7.7 billion from acquisitions. Net market change, distributions and other primarily consists of $35.2 billion of market depreciation, $34.7 billion of long-term distributions. The market depreciation occurred primarily in the fixed income and equity asset classes, partially offset by appreciation in the alternative asset class.
Long-term inflows decreased 7% to $183.1 billion, as compared to the prior year period, driven by lower inflows in the equity and fixed income asset classes related to decreased sales in institutional separate accounts and open end funds, partially offset by higher reinvested distributions in equity and multi-asset open end funds. Long-term outflows decreased 17% to $170.7 billion due to lower outflows in fixed income institutional separate accounts.
AUM by sales region was as follows:
| | | | | | | | | | | | | | | | | | | | |
| (in billions) | | March 31,
2023 | | March 31,
2022 | | Percent
Change |
| United States | | $ | 1,017.1 | | | $ | 1,107.2 | | | (8 | %) |
| International | | | | | | |
| Europe, Middle East and Africa | | 159.9 | | | 143.4 | | | 12 | % |
| Asia-Pacific | | 127.7 | | | 148.3 | | | (14 | %) |
| Americas, excl. U.S. | | 117.4 | | | 78.6 | | | 49 | % |
| Total international | | 405.0 | | | 370.3 | | | 9 | % |
| Total | | $ | 1,422.1 | | | $ | 1,477.5 | | | (4 | %) |
Investment Performance Overview
A key driver of our overall success is the long-term investment performance of our investment products. A measure of the performance of these products is the percentage of AUM exceeding peer group medians and benchmarks. We compare the relative performance of our mutual funds against peers, and of our strategy composites against benchmarks.
The performance of our mutual fund products against peer group medians and of our strategy composites against benchmarks is presented in the table below.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Peer Group Comparison1 | | Benchmark Comparison2 |
| | % of Mutual Fund AUM
in Top Two Peer Group Quartiles | | % of Strategy Composite AUM
Exceeding Benchmark |
| as of March 31, 2023 | | 1-Year | | 3-Year | | 5-Year | | 10-Year | | 1-Year | | 3-Year | | 5-Year | | 10-Year |
| Fixed Income | | 46 | % | | 39 | % | | 39 | % | | 69 | % | | 24 | % | | 90 | % | | 61 | % | | 89 | % |
| Equity | | 69 | % | | 46 | % | | 68 | % | | 63 | % | | 76 | % | | 39 | % | | 47 | % | | 40 | % |
Total AUM3 | | 67 | % | | 53 | % | | 63 | % | | 56 | % | | 64 | % | | 63 | % | | 61 | % | | 66 | % |
__________________
1Mutual fund performance is sourced from Morningstar and measures the percent of ranked AUM in the top two quartiles versus peers. Total mutual fund AUM measured for the 1-, 3-, 5- and 10-year periods represents 36%, 36%, 35% and 33% of our total AUM as of March 31, 2023.
2Strategy composite performance measures the percent of composite AUM beating its benchmark. The benchmark comparisons are based on each account’s/composite’s (strategy composites may include retail separately managed accounts and mutual fund assets managed as part of the same strategy) return as compared to a market index that has been selected to be generally consistent with the asset class of the account/composite. Total strategy composite AUM measured for the 1-, 3-, 5- and 10-year periods represents 51%, 51%, 50% and 47% of our total AUM as of March 31, 2023.
3Total mutual fund AUM includes performance of our alternative and multi-asset funds, and total strategy composite AUM includes performance of our alternative composites. Alternative and multi-asset AUM represent 18% and 10% of our total AUM at March 31, 2023.
Mutual fund performance data includes U.S. and cross-border domiciled mutual funds and exchange-traded funds, and excludes cash management and fund of funds. These results assume the reinvestment of dividends and are subject to revision.
Past performance is not indicative of future results. For strategy composite AUM included in institutional and retail separately managed accounts and investment funds managed in the same strategy as separate accounts, performance comparisons are based on gross-of-fee performance. For investment funds which are not managed in a separate account format, performance comparisons are based on net-of-fee performance. These performance comparisons do not reflect the actual performance of any specific separate account or investment fund; individual separate account and investment fund performance may differ. The information in this presentation is provided solely for use in connection with this document, and is not directed toward existing or potential clients of Franklin.
OPERATING REVENUES
The table below presents the percentage change in each operating revenue category.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in millions) | | Three Months Ended
March 31, | | Percent
Change | | Six Months Ended
March 31, | | Percent
Change |
| 2023 | | 2022 | | | 2023 | | 2022 | |
| Investment management fees | | $ | 1,573.3 | | | $ | 1,649.2 | | | (5 | %) | | $ | 3,205.1 | | | $ | 3,409.7 | | | (6 | %) |
| Sales and distribution fees | | 301.4 | | | 370.2 | | | (19 | %) | | 593.3 | | | 768.4 | | | (23 | %) |
| Shareholder servicing fees | | 43.3 | | | 52.2 | | | (17 | %) | | 76.7 | | | 99.9 | | | (23 | %) |
| Other | | 9.2 | | | 9.4 | | | (2 | %) | | 19.2 | | | 27.0 | | | (29 | %) |
| Total Operating Revenues | | $ | 1,927.2 | | | $ | 2,081.0 | | | (7 | %) | | $ | 3,894.3 | | | $ | 4,305.0 | | | (10 | %) |
Investment Management Fees
Investment management fees decreased $75.9 million and $204.6 million for the three and six months ended March 31, 2023 primarily due to a 6% and 9% decrease in average AUM, partially offset by higher performance fees. The decrease in average AUM occurred primarily in the fixed income and equity asset classes, partially offset by an increase in the alternative asset class that includes the acquisition of Lexington Partners L.P. (“Lexington”) and Alcentra.
Our effective investment management fee rate excluding performance fees (annualized investment management fees excluding performance fees divided by average AUM) increased to 41.8 and 41.7 basis points for the three and six months ended March 31, 2023, from 41.3 and 41.5 basis points for the same period in the prior fiscal year.
Performance fees were $111.2 million and $320.2 million for the three and six months ended March 31, 2023, and $105.1 million and $245.0 million for the same periods in the prior fiscal year. The increase for both periods was primarily due to $8.0 million and $152.5 million of performance fees earned by Lexington, which were passed through as compensation expense per the terms of the acquisition agreement, partially offset by lower performance fees earned by our other alternative specialist investment managers for the six months ended March 31, 2023.
Sales and Distribution Fees
Sales and distribution fees by revenue driver are presented below.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in millions) | | Three Months Ended
March 31, | | Percent
Change | | Six Months Ended
March 31, | | Percent
Change |
| 2023 | | 2022 | | | 2023 | | 2022 | |
| Asset-based fees | | $ | 247.7 | | | $ | 296.1 | | | (16 | %) | | $ | 492.7 | | | $ | 618.0 | | | (20 | %) |
| Sales-based fees | | 53.7 | | | 74.1 | | | (28 | %) | | 100.6 | | | 150.4 | | | (33 | %) |
| Sales and Distribution Fees | | $ | 301.4 | | | $ | 370.2 | | | (19 | %) | | $ | 593.3 | | | $ | 768.4 | | | (23 | %) |
Asset-based distribution fees decreased $48.4 million and $125.3 million for the three and six months ended March 31, 2023 primarily due decreases of 15% and 18% in the related average AUM and a higher mix of lower-fee assets.
Sales-based fees decreased $20.4 million and $49.8 million for the three and six months ended March 31, 2023 primarily due to decreases of 24% and 32% in commissionable sales.
Shareholder Servicing Fees
Shareholder servicing fees decreased $8.9 million and $23.2 million for the three and six months ended March 31, 2023 primarily due to a reduction in fee rates charged for transfer agency services in the U.S., lower levels of related AUM, and fewer transactions.
Other
Other revenue decreased $0.2 million and $7.8 million for the three and six months ended March 31, 2023 primarily due to lower real estate transaction fees earned by certain of our alternative asset managers.
OPERATING EXPENSES
The table below presents the percentage change in each operating expense category.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended
March 31, | | Percent
Change | | Six Months Ended
March 31, | | Percent
Change |
| (in millions) | | 2023 | | 2022 | | | 2023 | | 2022 | |
| Compensation and benefits | | $ | 847.3 | | | $ | 752.5 | | | 13 | % | | $ | 1,826.5 | | | $ | 1,555.1 | | | 17 | % |
| Sales, distribution and marketing | | 406.6 | | | 482.4 | | | (16 | %) | | 795.2 | | | 992.5 | | | (20 | %) |
| Information systems and technology | | 128.0 | | | 126.9 | | | 1 | % | | 249.4 | | | 250.7 | | | (1 | %) |
| Occupancy | | 59.7 | | | 53.0 | | | 13 | % | | 114.2 | | | 109.3 | | | 4 | % |
| Amortization of intangible assets | | 86.0 | | | 60.4 | | | 42 | % | | 169.2 | | | 118.7 | | | 43 | % |
| General, administrative and other | | 144.5 | | | 142.8 | | | 1 | % | | 290.7 | | | 258.0 | | | 13 | % |
| Total Operating Expenses | | $ | 1,672.1 | | | $ | 1,618.0 | | | 3 | % | | $ | 3,445.2 | | | $ | 3,284.3 | | | 5 | % |
Compensation and Benefits
The components of compensation and benefits expenses are presented below.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
March 31, | | Percent
Change | | Six Months Ended
March 31, | | Percent
Change |
| (in millions) | | 2023 | | 2022 | | | 2023 | | 2022 | |
| Salaries, wages and benefits | | $ | 397.1 | | | $ | 362.6 | | | 10 | % | | $ | 757.7 | | | $ | 712.4 | | | 6 | % |
| Incentive compensation | | 366.2 | | | 366.6 | | | 0 | % | | 750.1 | | | 772.1 | | | (3 | %) |
| Acquisition-related retention | | 23.2 | | | 34.2 | | | (32 | %) | | 86.8 | | | 74.2 | | | 17 | % |
| Acquisition-related performance fee pass through | | 8.0 | | | — | | | NM | | 152.5 | | | 0.4 | | | NM |
Other1 | | 52.8 | | | (10.9) | | | NM | | 79.4 | | | (4.0) | | | NM |
| Compensation and Benefits Expenses | | $ | 847.3 | | | $ | 752.5 | | | 13 | % | | $ | 1,826.5 | | | $ | 1,555.1 | | | 17 | % |
_______________
1Includes impact of gains and losses on investments related to deferred compensation plans, which is offset in investment and other income (losses), net; minority interests in certain subsidiaries, which is offset in net income (loss) attributable to redeemable noncontrolling interests; and special termination benefits.
Salaries, wages and benefits increased $34.5 million and $45.3 million for the three and six months ended March 31, 2023, primarily due to the recent acquisitions and annual salary increases, partially offset by the impact of headcount reductions.
Incentive compensation remained flat for the three months ended March 31, 2023 and decreased $22.0 million for the six months ended March 31, 2023 primarily due to lower incentive compensation at specialist investment managers and lower expectations of our annual performance. These decreases were partially offset by the recent acquisitions, and an increase in expense for deferred compensation awards, due, in part, to an increase in annual acceleration for retirement-eligible employees in the six-month period.
Acquisition-related retention expenses decreased $11.0 million for the three months ended March 31, 2023 primarily due to lower costs from the acquisition of Lexington, partially offset by an increase due to the acquisition of Alcentra. Acquisition-related retention expenses increased $12.6 million for the six months ended March 31, 2023, primarily due to the acquisition of Alcentra.
Acquisition-related performance fee pass through increased $8.0 million and $152.1 million for the three and six months ended March 31, 2023, due to higher performance fees earned by Lexington.
Other compensation and benefits were $52.8 million and $(10.9) million for the three months ended March 31, 2023 and 2022 and $79.4 million and $(4.0) million for the six months ended March 31, 2023 and 2022. Special termination benefits increased $27.4 million and $35.6 million for the three and six months ended March 31, 2023 primarily due to workforce optimization initiatives and the acquisition of Alcentra. The three and six months ended March 31, 2023 include the impact of $10.6 million and $16.2 million of market gains on investments related to our deferred compensation plans and $10.4 million and $20.5 million of compensation related to minority interests, while the three and six months ended March 31, 2022 include the impact of $15.3 million and $11.1 million of losses on investments related to our deferred compensation plans.
We expect to incur additional acquisition-related retention expenses of approximately $130 million during the remainder of the current fiscal year, and annual amounts beginning at approximately $230 million in the fiscal year ending September 30, 2024 and decreasing over the following two fiscal years by approximately $80 million and $20 million. At March 31, 2023, our global workforce had decreased to approximately 9,200 employees from approximately 9,500 at March 31, 2022.
Sales, Distribution and Marketing
Sales, distribution and marketing expenses by cost driver are presented below.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended
March 31, | | Percent
Change | | Six Months Ended
March 31, | | Percent
Change |
| (in millions) | | 2023 | | 2022 | | | 2023 | | 2022 | |
| Asset-based expenses | | $ | 343.0 | | | $ | 396.2 | | | (13 | %) | | $ | 674.9 | | | $ | 815.8 | | | (17 | %) |
| Sales-based expenses | | 51.0 | | | 69.6 | | | (27 | %) | | 95.3 | | | 141.7 | | | (33 | %) |
| Amortization of deferred sales commissions | | 12.6 | | | 16.6 | | | (24 | %) | | 25.0 | | | 35.0 | | | (29 | %) |
| Sales, Distribution and Marketing | | $ | 406.6 | | | $ | 482.4 | | | (16 | %) | | $ | 795.2 | | | $ | 992.5 | | | (20 | %) |
Asset-based expenses decreased $53.2 million and $140.9 million for the three and six months ended March 31, 2023 primarily due to decreases of 12% and 16% in the related average AUM and a higher mix of lower-fee assets. Distribution expenses are generally not directly correlated with distribution fee revenues due to certain fee structures that do not provide full recovery of distribution costs.
Sales-based expenses decreased $18.6 million and $46.4 million for the three and six months ended March 31, 2023 due to lower commissionable sales.
Amortization of deferred sales commissions decreased $4.0 million and $10.0 million for the three and six months ended March 31, 2023, primarily due to lower sales of shares sold without a front-end sales charge.
Occupancy
Occupancy expenses increased $6.7 million and $4.9 million for the three and six months ended March 31, 2023, primarily due to lease charges for vacated office space for the three months ended March 31, 2023 and higher utility costs and leasehold depreciation for both the three and six months ended March 31, 2023.
Information Systems and Technology
Information systems and technology expenses increased $1.1 million for the three months ended March 31, 2023 primarily due to higher consulting and software costs and decreased $1.3 million for the six months ended March 31, 2023 primarily due to lower outsourced data services.
Amortization of intangible assets
Amortization of intangible assets increased $25.6 million and $50.5 million for the three and six months ended March 31, 2023, primarily due to intangible assets recognized as part of the acquisition of Lexington and Alcentra.
General, Administrative and Other
General, administrative and other operating expenses increased $1.7 million and $32.7 million for the three and six months ended March 31, 2023, primarily due to $12.1 million and $21.0 million increases in travel and entertainment and conference costs as activity has resumed post-pandemic, and a $10.3 million credit adjustment to increase the fair value of a contingent consideration asset in the prior year quarter. The increases in the three months ended March 31, 2023 were substantially offset by a $13.1 million decrease in acquisition-related costs, primarily due to costs associated with our global brand campaign in the prior year quarter, and a $6.2 million decrease in professional fees.
OTHER INCOME (EXPENSES)
Other income (expenses) consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended
March 31, | | Percent
Change | | Six Months Ended
March 31, | | Percent
Change |
| (in millions) | | 2023 | | 2022 | | | 2023 | | 2022 | |
| Investment and other income, net | | $ | 125.6 | | | $ | 27.7 | | | 353 | % | | $ | 216.7 | | | $ | 84.7 | | | 156 | % |
| Interest expense | | (33.5) | | | (22.9) | | | 46 | % | | (64.4) | | | (42.2) | | | 53 | % |
| Investment and other income of consolidated investment products, net | | 87.2 | | | 3.0 | | | NM | | 73.6 | | | 107.7 | | | (32 | %) |
| Expenses of consolidated investment products | | (3.4) | | | (4.6) | | | (26 | %) | | (14.9) | | | (8.8) | | | 69 | % |
| Other Income, Net | | $ | 175.9 | | | $ | 3.2 | | | NM | | $ | 211.0 | | | $ | 141.4 | | | 49 | % |
Investment and other income, net increased $97.9 million and $132.0 million for the three and six months ended March 31, 2023 primarily due to an increase in dividend and interest income and higher gains on investments, partially offset by foreign currency exchange losses in each current year period.
Investments held by the Company generated net gains of $3.0 million and net losses of $23.1 million for the three months ended March 31, 2023 and 2022. The net gains in the current year period were primarily from assets invested for deferred compensation plans, partially offset by net losses on investments in nonconsolidated funds and separate accounts and net losses from investments measured at cost adjusted for observable price changes. The net losses in the prior year period were primarily from net losses on assets invested for deferred compensation plans and investments in nonconsolidated funds and separate accounts. Investments held by the Company generated net gains of $48.5 million and $2.7 million for the six months ended March 31, 2023 and 2022. The net gains in the current year were primarily from investments in nonconsolidated funds and separate accounts and assets invested for deferred compensation plans, partially offset by net losses from investments measured at cost adjusted for observable price changes and in the prior year were primarily from net gains on investments measured at cost adjusted for observable price changes, partially offset by net losses on assets invested for deferred compensation plans and investments in nonconsolidated funds and separate accounts.
Equity method investees generated income of $85.6 million and $118.8 million for the three and six months ended March 31, 2023, $65.8 million of which was fully offset in noncontrolling interest, primarily related to various alternative and global equity funds, as compared to income of $27.0 million and $51.7 million in the prior year, primarily related to a $52.6 million gain recognized on the sale of our investment in Embark. The gain on sale in the prior year was partially offset by losses from various global equity and alternative funds.
Net foreign currency exchange losses were $6.5 million and $33.6 million for the three and six months ended March 31, 2023, as compared to net gains of $5.8 million and $9.7 million for the three and six months ended March 31, 2022. The decrease was primarily due to the impact of the weakening of the U.S. dollar against the Euro and British Pound on cash and cash equivalents denominated in U.S. dollars held by our European subsidiaries.
Dividend and interest income increased $27.2 million and $57.6 million for the three and six months ended March 31, 2023, as compared to the prior year periods, primarily due to higher yields.
Interest expense increased $10.6 million and $22.2 million for the three and six months ended March 31, 2023 primarily due to accretion on Lexington deferred consideration and, for the six-month period, an increase in interest recognized on tax reserves.
Investments held by consolidated investment products (“CIPs”) generated investment gains and other income of $87.2 million and $73.6 million in the three and six months ended March 31, 2023, largely related to gains on holdings of various equity and fixed income funds. Investments held by CIPs generated investment gains and other income of $3.0 million and $107.7 million during the three and six months ended March 31, 2022, largely related to gains on holdings of various alternative funds, partially offset by losses on holdings of various equity funds and fixed income funds.
Expenses of consolidated investments products decreased $1.2 million and increased $6.1 million for the three and six months ended March 31, 2023, due to activity of the funds.
Our cash, cash equivalents and investments portfolio by asset class and accounting classification at March 31, 2023, excluding third-party assets of CIPs, was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Accounting Classification1 | | | | Total |
| (in millions) | | Cash and
Cash
Equivalents | | Investments
at
Fair Value | | Equity
Method
Investments | | Other Investments | | Direct
Investments
in CIPs | |
| Cash and Cash Equivalents | | $ | 3,471.3 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 3,471.3 | |
| Investments | | | | | | | | | | | | |
| Alternative | | — | | | 350.5 | | | 872.1 | | | 62.7 | | | 471.9 | | | 1,757.2 | |
| Equity | | — | | | 379.3 | | | 206.8 | | | 152.9 | | | 85.1 | | | 824.1 | |
| Fixed Income | | — | | | 205.1 | | | 48.0 | | | 37.2 | | | 293.2 | | | 583.5 | |
| Multi-Asset | | — | | | 52.2 | | | 11.2 | | | — | | | 59.3 | | | 122.7 | |
| Total investments | | — | | | 987.1 | | | 1,138.1 | | | 252.8 | | | 909.5 | | | 3,287.5 | |
Total Cash and Cash Equivalents and Investments2, 3 | $ | 3,471.3 | | | $ | 987.1 | | | $ | 1,138.1 | | | $ | 252.8 | | | $ | 909.5 | | | $ | 6,758.8 | |
______________
1See Note 1 – Significant Accounting Policies in the notes to consolidated financial statements in Item 8 of Part II of our Annual Report on Form 10-K for fiscal year 2022 for information on investment accounting classifications.
2Total cash and cash equivalents and investments includes $4,133.9 million used for operational activities, including investments in sponsored funds and other products, and $333.3 million necessary to comply with regulatory requirements.
3Total cash and cash equivalents and investments includes $293.4 million attributable to employee-owned and other third-party investments made through partnerships which are offset in nonredeemable noncontrolling interests.
TAXES ON INCOME
Our effective income tax rate was 21.6% and 23.2% for the three and six months ended March 31, 2023, as compared to 23.0% and 22.2% for the three and six months ended March 31, 2022. The rate decrease for three-month period was primarily due to activity of CIPs for which there is no related tax impact, partially offset by an increase in tax audit settlements. The rate increase for the six-month period was primarily due to tax audit settlements, state tax provision to return adjustments, and tax expenses related to stock-based compensation, offset by activity of CIPs for which there is no related tax impact.
Our effective income tax rate reflects the relative contributions of earnings in the jurisdictions in which we operate, which have varying tax rates. Changes in our pre-tax income mix, tax rates or tax legislation in such jurisdictions may affect our effective income tax rate and net income.
SUPPLEMENTAL NON-GAAP FINANCIAL MEASURES
As supplemental information, we are providing performance measures for “adjusted operating income,” “adjusted operating margin,” “adjusted net income” and “adjusted diluted earnings per share,” each of which is based on methodologies other than generally accepted accounting principles (“non-GAAP measures”). Management believes these non-GAAP measures are useful indicators of our financial performance and may be helpful to investors in evaluating our relative performance against industry peers.
“Adjusted operating income,” “adjusted operating margin,” “adjusted net income” and “adjusted diluted earnings per share” are defined below, followed by reconciliations of operating income, operating margin, net income attributable to Franklin Resources, Inc. and diluted earnings per share on a U.S. GAAP basis to these non-GAAP measures. Non-GAAP measures should not be considered in isolation from, or as substitutes for, any financial information prepared in accordance with U.S. GAAP, and may not be comparable to other similarly titled measures of other companies. Additional reconciling items may be added in the future to these non-GAAP measures if deemed appropriate.
Adjusted Operating Income
We define adjusted operating income as operating income adjusted to exclude the following:
•Elimination of operating revenues upon consolidation of investment products.
•Acquisition-related items:
◦Acquisition-related retention compensation.
◦Other acquisition-related expenses including professional fees, technology costs and fair value adjustments related to contingent consideration assets and liabilities.
◦Amortization of intangible assets.
◦Impairment of intangible assets and goodwill, if any.
•Special termination benefits related to workforce optimization initiatives related to past acquisitions and certain initiatives undertaken by the Company.
•Impact on compensation and benefits expense from gains and losses on investments related to deferred compensation plans, which is offset in investment and other income (losses), net.
•Impact on compensation and benefits expense related to minority interests in certain subsidiaries, which is offset in net income (loss) attributable to redeemable noncontrolling interests.
Adjusted Operating Margin
We calculate adjusted operating margin as adjusted operating income divided by adjusted operating revenues. We define adjusted operating revenues as operating revenues adjusted to exclude the following:
•Elimination of operating revenues upon consolidation of investment products.
•Acquisition-related performance-based investment management fees which are passed through as compensation and benefits expense.
•Sales and distribution fees and a portion of investment management fees allocated to cover sales, distribution and marketing expenses paid to the financial advisers and other intermediaries who sell our funds on our behalf.
Adjusted Net Income and Adjusted Diluted Earnings Per Share
We define adjusted net income as net income attributable to Franklin Resources, Inc. adjusted to exclude the following:
•Activities of CIPs.
•Acquisition-related items:
◦Acquisition-related retention compensation.
◦Other acquisition-related expenses including professional fees, technology costs and fair value adjustments related to contingent consideration assets and liabilities.
◦Amortization of intangible assets.
◦Impairment of intangible assets and goodwill, if any.
◦Write off of noncontrolling interests related to the wind down of an acquired business.
◦Interest expense for amortization of Legg Mason debt premium from acquisition-date fair value adjustment.
•Special termination benefits related to workforce optimization initiatives related to past acquisitions and certain initiatives undertaken by the Company.
•Net gains or losses on investments related to deferred compensation plans which are not offset by compensation and benefits expense.
•Net compensation and benefits expense related to minority interests in certain subsidiaries not offset by net income (loss) attributable to redeemable noncontrolling interests.
•Unrealized investment gains and losses.
•Net income tax expense of the above adjustments based on the respective blended rates applicable to the adjustments.
We define adjusted diluted earnings per share as diluted earnings per share adjusted to exclude the per share impacts of the adjustments applied to net income in calculating adjusted net income.
In calculating our non-GAAP measures, we adjust for the impact of CIPs because it is not considered reflective of our underlying results of operations. Acquisition-related items and special termination benefits are excluded to facilitate comparability to other asset management firms. We adjust for compensation and benefits expense related to funded deferred compensation plans because it is partially offset in other income (expense), net. We adjust for compensation and benefits expense and net income (loss) attributable to redeemable noncontrolling interests to reflect the economics of certain profits interest arrangements. Sales and distribution fees and a portion of investment management fees generally cover sales, distribution and marketing expenses and, therefore, are excluded from adjusted operating revenues. In addition, when calculating adjusted net income and adjusted diluted earnings per share we exclude unrealized investment gains and losses included in investment and other income (losses) because the related investments are generally expected to be held long term.
The calculations of adjusted operating income, adjusted operating margin, adjusted net income and adjusted diluted earnings per share are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in millions) | | Three Months Ended
March 31, | | Six Months Ended
March 31, |
| 2023 | | 2022 | | 2023 | | 2022 |
| Operating income | | $ | 255.1 | | | $ | 463.0 | | $ | 449.1 | | $ | 1,020.7 |
Add (subtract): | | | | | | | | |
Elimination of operating revenues upon consolidation of investment products1 | | 9.1 | | 17.2 | | 14.2 | | 25.5 |
Acquisition-related retention | | 23.2 | | 34.2 | | 86.8 | | 74.2 |
| Compensation and benefits expense from gains (losses) on deferred compensation, net | | 10.6 | | (15.3) | | 16.2 | | (11.1) |
| Other acquisition-related expenses | | 14.0 | | 12.7 | | 36.6 | | 27.4 |
Amortization of intangible assets | | 86.0 | | 60.4 | | 169.2 | | 118.7 |
Special termination benefits | | 31.8 | | 4.4 | | 42.7 | | 7.1 |
| Compensation and benefits expense related to minority interests in certain subsidiaries | | 10.4 | | — | | | 20.5 | | — | |
| Adjusted operating income | | $ | 440.2 | | $ | 576.6 | | $ | 835.3 | | $ | 1,262.5 |
| | | | | | | | |
| Total operating revenues | | $ | 1,927.2 | | $ | 2,081.0 | | $ | 3,894.3 | | $ | 4,305.0 |
Add (subtract): | | | | | | | | |
Acquisition-related pass through performance fees | | (8.0) | | — | | (152.5) | | (0.4) |
Sales and distribution fees | | (301.4) | | (370.2) | | (593.3) | | (768.4) |
Allocation of investment management fees for sales, distribution and marketing expenses | | (105.2) | | (112.2) | | (201.9) | | (224.1) |
Elimination of operating revenues upon consolidation of investment products1 | | 9.1 | | 17.2 | | 14.2 | | 25.5 |
| Adjusted operating revenues | | $ | 1,521.7 | | $ | 1,615.8 | | $ | 2,960.8 | | $ | 3,337.6 |
| | | | | | | | |
| Operating margin | | 13.2% | | 22.2% | | 11.5% | | 23.7% |
| Adjusted operating margin | | 28.9% | | 35.7% | | 28.2% | | 37.8% |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in millions, except per share data) | | Three Months Ended
March 31, | | Six Months Ended
March 31, |
| 2023 | | 2022 | | 2023 | | 2022 |
Net income attributable to Franklin Resources, Inc. | | $ | 194.2 | | | $ | 349.6 | | | $ | 359.8 | | | $ | 802.8 | |
Add (subtract): | | | | | | | | |
Net loss of consolidated investment products1 | | 8.5 | | | 0.1 | | | 4.9 | | | 10.1 | |
Acquisition-related retention | | 23.2 | | | 34.2 | | | 86.8 | | | 74.2 | |
| Other acquisition-related expenses | | 20.1 | | | 12.7 | | | 48.8 | | | 27.8 | |
Amortization of intangible assets | | 86.0 | | | 60.4 | | | 169.2 | | | 118.7 | |
| | | | | | | | |
Special termination benefits | | 31.8 | | | 4.4 | | | 42.7 | | | 7.1 | |
| Net (gains) losses on deferred compensation plan investments not offset by compensation and benefits expense | | (6.0) | | | 2.8 | | | (13.6) | | | 2.5 | |
| Unrealized investment (gains) losses | | (1.9) | | | 70.3 | | | (32.6) | | | 72.1 | |
| Interest expense for amortization of debt premium | | (6.4) | | | (6.3) | | | (12.7) | | | (12.6) | |
| Net compensation and benefits expense related to minority interests in certain subsidiaries not offset by net income (loss) attributable to redeemable noncontrolling interests | | (0.3) | | | — | | | 0.1 | | | — | |
| Net income tax expense of adjustments | | (32.5) | | | (36.6) | | | (74.3) | | | (57.5) | |
| Adjusted net income | | $ | 316.7 | | | $ | 491.6 | | | $ | 579.1 | | | $ | 1,045.2 | |
| | | | | | | | |
| Diluted earnings per share | | $ | 0.38 | | | $ | 0.68 | | | $ | 0.70 | | | $ | 1.57 | |
| Adjusted diluted earnings per share | | 0.61 | | | 0.96 | | | 1.13 | | | 2.04 | |
__________________
1The impact of CIPs is summarized as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| (in millions) | | Three Months Ended
March 31, | | Six Months Ended
March 31, |
| 2023 | | 2022 | | 2023 | | 2022 |
| Elimination of operating revenues upon consolidation | | $ | (9.1) | | | $ | (17.2) | | | $ | (14.2) | | | $ | (25.5) | |
| Other income, net | | 62.9 | | | 9.9 | | | 60.1 | | | 82.4 | |
| Less: income (loss) attributable to noncontrolling interests | | 62.3 | | | (7.2) | | | 50.8 | | | 67.0 | |
| Net loss | | $ | (8.5) | | | $ | (0.1) | | | $ | (4.9) | | | $ | (10.1) | |
LIQUIDITY AND CAPITAL RESOURCES
Cash flows were as follows:
| | | | | | | | | | | | | | |
| | Six Months Ended
March 31, |
| (in millions) | | 2023 | | 2022 |
| Operating cash flows | | $ | (289.7) | | | $ | 270.5 | |
| Investing cash flows | | (2,195.0) | | | (1,151.3) | |
| Financing cash flows | | 1,920.6 | | | 1,275.9 | |
Net cash used by operating activities during the six months ended March 31, 2023 as compared to net cash provided in the prior year was primarily due to lower net income, higher net purchases of investments by CIPs, and higher payments of accrued compensation and benefits, partially offset by increases of accounts payable, accrued expenses and other liabilities and adjustments for losses of CIPs as compared to gains in the prior year. Net cash used in investing activities increased primarily due to net purchases of investments as compared to net liquidations in the prior year, higher net purchases of investments by CLOs, and cash paid for acquisitions in the current year. Net cash provided by financing activities increased primarily due to higher net subscriptions in CIPs by noncontrolling interests, proceeds from repurchase agreements, and higher net proceeds on debt of consolidated investment products.
The assets and liabilities of CIPs attributable to third-party investors do not impact our liquidity and capital resources. We have no right to the CIPs’ assets, other than our direct equity investment in them and investment management and other fees earned from them. The debt holders of the CIPs have no recourse to our assets beyond the level of our direct investment, therefore we bear no other risks associated with the CIPs’ liabilities. Accordingly, the assets and liabilities of CIPs, other than our direct investments in them, are excluded from the amounts and discussion below.
Our liquid assets and debt consisted of the following:
| | | | | | | | | | | | | | |
| (in millions) | | March 31,
2023 | | September 30,
2022 |
| Assets | | | | |
| Cash and cash equivalents | | $ | 3,369.9 | | | $ | 4,086.8 | |
| Receivables | | 1,229.4 | | | 1,130.8 | |
| Investments | | 1,003.2 | | | 830.0 | |
| Total Liquid Assets | | $ | 5,602.5 | | | $ | 6,047.6 | |
| | | | |
| Liability | | | | |
| Debt | | $ | 3,364.6 | | | $ | 3,376.4 | |
Liquidity
Liquid assets consist of cash and cash equivalents, receivables and certain investments. Cash and cash equivalents at March 31, 2023 primarily consist of money market funds and deposits with financial institutions. Liquid investments consist of investments in sponsored and other funds, direct investments in redeemable CIPs, other equity and debt securities, and time deposits with maturities greater than three months.
We utilize a significant portion of our liquid assets to satisfy operational and regulatory requirements and fund capital contributions to sponsored and other products. Certain of our subsidiaries are required by our internal policy or regulation to maintain minimum levels of cash and/or capital, and may be restricted in their ability to transfer cash to their parent companies. Should we require more capital than is available for use, we could elect to reduce the level of discretionary activities, such as share repurchases or investments in sponsored and other products, we could raise capital through debt or equity issuances, or utilize existing or new credit facilities. These alternatives could result in increased interest expense, decreased dividend or interest income, or other dilution to our earnings.
Capital Resources
We believe that we can meet our present and reasonably foreseeable operating cash needs and future commitments through existing liquid assets, continuing cash flows from operations, amounts available under the credit facility discussed below, the ability to issue debt or equity securities and borrowing capacity under our uncommitted commercial paper private placement program.
In prior fiscal years, we issued senior unsecured unsubordinated notes for general corporate purposes and to redeem outstanding notes. At March 31, 2023, Franklin’s outstanding senior notes had an aggregate principal amount due of $1,600.0 million. The notes have fixed interest rates from 1.600% to 2.950% with interest paid semi-annually and have an aggregate carrying value, inclusive of unamortized discounts and debt issuance costs, of $1,594.7 million. At March 31, 2023, Legg Mason’s outstanding senior notes had an aggregate principal amount due of $1,250.0 million. The notes have fixed interest rates from 3.950% to 5.625% with interest paid semi-annually and have an aggregate carrying value, inclusive of unamortized premium, of $1,480.5 million at March 31, 2023. Effective August 2, 2021, Franklin agreed to unconditionally and irrevocably guarantee all of the outstanding notes issued by Legg Mason.
The senior notes contain an optional redemption feature that allows us to redeem each series of notes prior to maturity in whole or in part at any time, at a make-whole redemption price. The indentures governing the senior notes contain limitations on our ability and the ability of our subsidiaries to pledge voting stock or profit participating equity interests in our subsidiaries to secure other debt without similarly securing the notes equally and ratably. In addition, the indentures include requirements that must be met if we consolidate or merge with, or sell all of our assets to, another entity.
We maintain a 364-day revolving credit facility with an aggregate commitment of $500.0 million that matures September 2023. As of the time of this filing, there are no amounts outstanding with respect to the 364-day revolving credit facility. We have a 3-year term loan with an aggregate commitment of $300.0 million. The 364-day revolving credit facility and term loan credit agreement contain a financial performance covenant requiring that the Company maintains a consolidated net leverage ratio, measured as of the last day of each fiscal quarter, of no greater than 3.00 to 1.00. We were in compliance with all debt covenants at March 31, 2023.
At March 31, 2023, we had $500.0 million of short-term commercial paper available for issuance under an uncommitted private placement program which has been inactive since 2012 and is unrated.
Our ability to access the capital markets in a timely manner depends on a number of factors, including our credit rating, the condition of the global economy, investors’ willingness to purchase our securities, interest rates, credit spreads and the valuation levels of equity markets. If we are unable to access capital markets in a timely manner, our business could be adversely impacted.
Uses of Capital
We expect that our main uses of cash will be to invest in and grow our business including through acquisitions, pay stockholder dividends, invest in our products, pay income taxes and operating expenses of the business, enhance technology infrastructure and business processes, repurchase shares of our common stock, and repay and service debt. While we expect to continue to repurchase shares to offset dilution from share-based compensation, and expect to continue to repurchase shares opportunistically from time to time, we will likely spend more of our post-dividend free cash flow investing in our business, including seed capital and acquiring resources to help grow our investment teams and operations.
We typically declare cash dividends on a quarterly basis, subject to approval by our Board of Directors. We declared regular dividends of $0.60 per share during the six months ended March 31, 2023 and $0.58 per share during the six months ended March 31, 2022. We currently expect to continue paying comparable regular dividends on a quarterly basis to holders of our common stock depending upon earnings and other relevant factors.
We maintain a stock repurchase program to manage our equity capital with the objective of maximizing shareholder value. Our stock repurchase program is effected through open-market purchases and private transactions in accordance with applicable laws and regulations, and is not subject to an expiration date. The size and timing of these purchases will depend on business conditions, price, market and other factors. During the three and six months ended March 31, 2023, we repurchased 0.1 million and 0.6 million shares of our common stock at a cost of $3.6 million and $17.8 million. At March 31, 2023, 23.7 million shares remained available for repurchase under the authorization of 80.0 million shares approved by our Board of Directors in April 2018. During the three and six months ended March 31, 2022, we repurchased 2.7 million and 3.4 million shares of our common stock at a cost of $80.8 million and $102.5 million.
We invested $242.0 million, net of redemptions, into our sponsored products during the six months ended March 31, 2023 and redeemed $122.6 million, net of investments, in the prior year period.
On September 27, 2022 we entered into a lease agreement for office space in New York City located at One Madison Avenue with occupancy expected to begin in early fiscal year 2024 with an aggregate expected commitment of $766.7 million over 16 years. This is part of an initiative to consolidate our existing office space in New York City.
On November 1, 2022, we acquired all of the outstanding ownership interests in BNY Alcentra Group Holdings, Inc. from The Bank of New York Mellon Corporation. Total purchase consideration consisted of cash consideration of approximately $594.1 million, which includes $188.3 million for certain securities held in Alcentra’s collateralized loan obligations (“CLOs”); deferred consideration of $62.0 million; and contingent consideration of up to $350.0 million to be paid upon the achievement of certain performance thresholds over the next four years that has an acquisition-date fair value of $24.6 million. We paid the purchase price from our existing cash.
On December 15, 2022, we entered into repurchase agreements with a third-party financing company for certain securities held in Alcentra’s CLOs. Under the terms of the repurchase agreements, we received cash proceeds of approximately $175.0 million with pledged collateral consisting of Alcentra investments with a carrying value of $201.4 million at March 31, 2023. The repurchase agreements have contractual maturity dates ranging between 2029 to 2034.
On April 1, 2022, we acquired all of the outstanding ownership interests in Lexington for cash consideration of approximately $1.0 billion and additional payments of $750 million to be paid in cash over the next three years. The first additional payment of $250 million was made during the third quarter of fiscal year 2023 from our existing cash.
The funds that we manage have their own resources available for purposes of providing liquidity to meet shareholder redemptions, including securities that can be sold or provided to investors as in-kind redemptions, and lines of credit. Increased liquidity risks and redemptions have required, and may continue to require, increased cash in the form of loans or other lines of credit to help settle redemptions and for other related purposes. While we have no legal or contractual obligation to do so, we have in certain instances voluntarily elected to provide the funds with direct or indirect financial support based on our business objectives. We did not provide financial or other support to our sponsored funds during the six months ended March 31, 2023.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. These estimates, judgments and assumptions are affected by our application of accounting policies. Further, concerns about the global economic outlook have adversely affected, and may continue to adversely affect, our business, financial condition and results of operations including the estimates and assumptions made by management. Actual results could differ from the estimates. Described below are the updates to our critical accounting policies disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for fiscal year 2022.
Consolidation
We consolidate our subsidiaries and investment products in which we have a controlling financial interest. We have a controlling financial interest when we own a majority of the voting interest in a voting interest entity or are the primary beneficiary of a variable interest entity (“VIE”). Our VIEs are primarily investment products and our variable interests consist of our equity ownership interests in and investment management fees earned from these products. As of March 31, 2023, we were the primary beneficiary of 59 investment product VIEs.
Business Combinations
Business combinations are accounted for by recognizing the acquired assets, including separately identifiable intangible assets, and assumed liabilities at their acquisition-date estimated fair values. Any excess of the purchase consideration over the acquisition-date fair values of these identifiable assets and liabilities is recognized as goodwill. Goodwill and indefinite-lived intangible assets are tested for impairment annually and when an event occurs or circumstances change that more likely than not reduce the fair value of the related reporting unit or indefinite-lived intangible asset below its carrying value. Definite-lived intangible assets are tested for impairment quarterly.
Subsequent to the annual impairment tests performed as of August 1, 2022, we monitored both macroeconomic and entity-specific factors, including changes in our AUM to determine whether circumstances have changed that would more likely than not reduce the fair value of the reporting unit below its carrying value or indicate that the other indefinite-lived intangible assets might be impaired. We also monitored fluctuations of our common stock per share price to evaluate our market capitalization relative to the reporting unit as a whole. During the six months ended March 31, 2023, there were no events or circumstances which would indicate that goodwill, indefinite-lived intangible assets or definite-lived intangible assets might be impaired.
While we believe that the assumptions used to estimate fair value in our impairment tests are reasonable and appropriate, future changes in the assumptions could result in recognition of impairment.
Fair Value Measurements
Our investments are primarily recorded at fair value or amounts that approximate fair value on a recurring basis. We use a three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value based on whether the inputs to those valuation techniques are observable or unobservable.
As of March 31, 2023, Level 3 assets represented 6% of total assets measured at fair value, which primarily related to CIPs’ investments in equity and debt securities. There were insignificant transfers into and out of Level 3 during the six months ended March 31, 2023.