FRANKLIN RESOURCES, INC. 
FORWARD-LOOKING STATEMENTS The following discussion and analysis of the results of operations and financial condition ofFranklin Resources, Inc. ("Franklin") and its subsidiaries (collectively, the "Company") should be read in conjunction with the "Forward-looking Statements" disclosure set forth in Part I and the "Risk Factors" set forth in Item 1A of Part I of this Annual Report on Form 10K (this "Annual Report") and in any more recent filings with theU.S. Securities and Exchange Commission (the "SEC"), each of which describe our risks, uncertainties and other important factors in more detail. OVERVIEW We are a global investment management organization and derive our operating revenues and net income from providing investment management and related services in jurisdictions worldwide for investors in our 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. In addition to investment management, our 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®, Balanced Equity Management®, Benefit Street Partners®, Darby®,Edinburgh Partners™, Fiduciary Trust™, Franklin Bissett®, Franklin Mutual Series®, K2® and LibertyShares®. In addition, pursuant to our acquisition ofLegg Mason, Inc. ("Legg Mason") onJuly 31, 2020 , we acquired certain additional brand names including Brandywine Global Investment Management®, Clarion Partners®, ClearBridge Investments®, Martin Currie®, QS Investors®, Royce® Investment Partners and Western Asset Management Company®. We offer a broad product mix of fixed income, equity, multi-asset, alternative 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 set forth above in Item 1A of Part I of this Annual Report, the amount and mix of our AUM are subject to significant fluctuations and can negatively impact our revenues and income. The level of our revenues also depends on mutual fund sales, the number of shareholder transactions and accounts, and the fees charged for our services, which are based on contracts with our funds and our clients. These arrangements could change in the future. As further noted in the "Risk Factors" section, the outbreak and spread of contagious diseases such as the coronavirus disease 2019 ("COVID-19"), a highly transmissible and pathogenic disease, has adversely affected, and we expect will continue to adversely affect, our business, financial condition and results of operations. Global health concerns, and uncertainty regarding the impact of COVID-19, could lead to further and/or increased volatility in global capital and credit markets, adversely affect our key executives and other personnel, clients, investors, providers, suppliers, lessees, and other third parties, and negatively impact our AUM, revenues, income, business and operations. As of the time of this filing, as the COVID-19 pandemic continues to evolve, it is not possible to predict the full extent to which COVID-19 will adversely impact our business, liquidity, capital resources, financial results and operations due to numerous developing factors that are highly uncertain and rapidly changing. During the fiscal year endedSeptember 30, 2020 ("fiscal year 2020"), the global equity markets experienced volatility reflecting, among other things, ongoing global concerns about the COVID-19 pandemic, but provided overall strong positive returns. Despite easing of shutdown measures and some signs of economic recovery following significant accommodative economic efforts by governments and central banks, concerns about the severe economic impact of the ongoing COVID-19 pandemic persist. The S&P 500 Index and MSCI World Index increased 15.2% and 11.0% for the fiscal year. Our total AUM was$1,418.9 billion atSeptember 30, 2020 , which was 105% higher than atSeptember 30, 2019 reflecting an increase of$806.5 billion from acquisitions, partially offset by$61.6 billion of long-term net outflows,$9.9 billion of cash management net outflows and$8.7 billion from net market change, distributions and other. Simple monthly average AUM ("average AUM") increased 19% during fiscal year 2020. The business and regulatory environments in which we operate globally remain complex, uncertain and subject to change. We are subject to various laws, rules and regulations globally that impose restrictions, limitations, registration, reporting and disclosure requirements on our business, and add complexity to our global compliance operations. 35
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Uncertainties regarding the global economy remain for the foreseeable future. As we continue to confront the challenges of the current economic and regulatory environments, we remain focused on the investment performance of our products and on providing high quality service to our clients. We continuously perform reviews of our business model. While we remain focused on expense management, we will also seek to attract, retain and develop personnel and invest strategically in systems and technology that will provide a secure and stable environment. We will continue to seek to protect and further our brand recognition while developing and maintaining broker-dealer and client relationships. The success of these and other strategies may be influenced by the factors discussed in the "Risk Factors" section. RESULTS OF OPERATIONS (in millions, except per share data) for the fiscal years ended September 30, 20201 2019 2018 2020 vs. 2019 2019 vs. 2018 Operating revenues2$ 5,566.5 $ 5,669.4 $ 6,204.5 (2 %) (9 %) Operating income2 1,048.9 1,466.9 2,028.2 (28 %) (28 %) Operating margin3 18.8 % 25.9 % 32.7 % Net income attributable to Franklin Resources, Inc.$ 798.9 $ 1,195.7 $ 764.4 (33 %) 56 % Diluted earnings per share$ 1.59 $ 2.35 $ 1.39 (32 %) 69 % As adjusted (non-GAAP):4 Adjusted operating income$ 1,491.1 $ 1,654.2 $ 2,093.5 (10 %) (21 %) Adjusted operating margin 38.5 % 42.6 % 49.8 % Adjusted net income$ 1,311.0 $ 1,331.3 $ 798.1 (2 %) 67 %
Adjusted diluted earnings per share
0 % 81 %
___________________
1 Includes the impact of the Company's acquisition of
was effective
consolidated financial statements in Item 8 of Part II of this Annual Report
for information.
2 In fiscal year 2020, the Company changed the presentation of itsconsolidated statements of income to include dividend and interest income
and other expenses from consolidated investment products in non-operating
income (expense). Amounts for the comparative prior fiscal years have been
reclassified to conform to the current presentation. These reclassifications
had no impact on previously reported net income attributable to Franklin
Resources, Inc. 3 Defined as operating income divided by total operating revenues.
4 "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.
The Company acquired Legg Mason effectiveJuly 31, 2020 , and the results of operations for fiscal year 2020 include two months of Legg Mason's results. Operating income decreased$418.0 million in fiscal year 2020 due to a 2% decrease in operating revenues and a 7% increase in operating expenses which reflected higher levels of compensation and benefits expense, including acquisition-related retention costs, other acquisition-related expenses, and amortization and impairments of intangible assets and goodwill. Net income attributable toFranklin Resources, Inc. decreased$396.8 million primarily due to the decrease in operating income, as the impact of declines in market valuations amid global concerns about the COVID-19 pandemic resulted in net investment and other losses of$38.4 million , as compared to net gains of$141.4 million in the prior year, less the portion attributable to noncontrolling interests, was largely offset by lower taxes on income. Operating income decreased$561.3 million in the fiscal year endedSeptember 30, 2019 ("fiscal year 2019") due to a 9% decrease in operating revenues and a 1% increase in operating expenses. Net income attributable toFranklin Resources, Inc. increased$431.3 million primarily due to a prior year estimated income tax charge of$968.8 million resulting from enactment of the Tax Cuts and Jobs Act of 2017 (the "Tax Act"), partially offset by the decrease in operating income. Diluted earnings per share decreased in fiscal year 2020 and increased in fiscal year 2019, consistent with the changes in net income and the impacts of 2% and 6% decreases in diluted average common shares outstanding primarily resulting from repurchases of shares of our common stock. 36
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Adjusted operating income decreased$163.1 million in fiscal year 2020 primarily due to a 10% increase in compensation and benefits expense, excluding non-GAAP adjustments. Adjusted net income decreased$20.3 million primarily due to the decrease in adjusted operating income substantially offset by lower taxes on income, excluding the net income tax expense of non-GAAP adjustments. Adjusted operating income decreased$439.3 million in fiscal year 2019 primarily due to an 8% decrease in adjusted operating revenues and a 6% increase in compensation and benefits expense, excluding non-GAAP adjustments. Adjusted net income attributable toFranklin Resources, Inc. increased$533.2 million primarily due to a prior-year estimated income tax charge of$968.8 million resulting from enactment of the Tax Act, partially offset by the decrease in adjusted operating income. Adjusted diluted earnings per share decreased in fiscal year 2020 and increased in fiscal year 2019, consistent with the changes in adjusted net income and the impacts of the decreases in diluted average common shares outstanding. ASSETS UNDER MANAGEMENT In the fourth quarter of fiscal year 2020, we revised our presentation of AUM to disclose AUM by asset class and introduced a simplified presentation of long-term net flows to incorporate all client-driven flow activity, which is defined as long-term inflows net of long-term outflows. Additionally, we report cash management net flows as a separate component of total net flows. These changes reflect the new breadth of our business and the expansion of our client base and investment vehicle offerings, both of which expanded significantly beyond retail mutual funds following the acquisition of Legg Mason. AUM by asset class was as follows: (in billions) as of September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Fixed Income$ 656.7 $ 250.6 $ 258.5 162 % (3 %) Equity 432.0 263.9 304.6 64 % (13 %) Multi-Asset 133.8 123.6 126.7 8 % (2 %) Alternative 124.0 45.0 18.0 176 % 150 % Cash Management 72.4 9.5 9.3 662 % 2 % Total$ 1,418.9 $ 692.6 $ 717.1 105 % (3 %) Average for the Year$ 832.9 $ 697.0 $ 740.5 19 %
(6 %)
AUM atSeptember 30, 2020 increased 105% fromSeptember 30, 2019 driven by$806.5 billion from acquisitions, partially offset by$61.6 billion of long-term net outflows,$9.9 billion of cash management net outflows and$8.7 billion from net market change, distributions and other. AUM atSeptember 30, 2019 decreased 3% fromSeptember 30, 2018 as$31.8 billion of long-term net outflows and$20.0 billion of net market change, distributions and other, were partially offset by$26.4 billion from an acquisition and$0.9 billion of cash management net inflows. Changes in average AUM are generally more indicative of trends in revenue for providing investment management services than the year-over-year change in ending AUM. 37
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Average AUM and the mix of average AUM by asset class are shown below. (in billions)
Average AUM
for the fiscal years ended September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018
Fixed Income $ 330.5 $ 256.1 $ 275.2 29 % (7 %)
Equity 290.3 275.5 310.8 5 % (11 %)
Multi-Asset 123.0 122.2 129.3 1 % (5 %)
Alternative 63.8 33.7 17.2 89 % 96 %
Cash Management 25.3 9.5 8.0 166 % 19 %
Total $ 832.9 $ 697.0 $ 740.5 19 % (6 %)
Mix of Average AUM
for the fiscal years ended September 30, 2020 2019 2018
Fixed Income 39 % 37 % 37 %
Equity 35 % 40 % 42 %
Multi-Asset 15 % 17 % 18 %
Alternative 8 % 5 % 2 %
Cash Management 3 % 1 % 1 %
Total 100 % 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)
for the fiscal years ended September
30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018
Beginning AUM $ 692.6 $ 717.1 $ 753.2 (3 %) (5 %)
Long-term inflows 182.4 175.0 165.5 4 % 6 %
Long-term outflows (244.0 ) (206.8 ) (203.5 ) 18 % 2 %
Long-term net flows (61.6 ) (31.8 ) (38.0 ) 94 % (16 %)
Cash management net flows (9.9 ) 0.9 3.5 NM (74 %)
Total net flows (71.5 ) (30.9 ) (34.5 ) 131 % (10 %)
Acquisitions 806.5 26.4 9.8 NM 169 %
Net market change, distributions and
other (8.7 ) (20.0 ) (11.4 ) (57 %) 75 %
Ending AUM $ 1,418.9 $ 692.6 $ 717.1 105 % (3 %)
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Components of the change in AUM by asset class were as follows: (in billions) for the fiscal year ended Fixed
Cash
September 30, 2020 Income Equity Multi-Asset Alternative Management Total
AUM at October 1, 2019 $ 250.6 $ 263.9 $ 123.6 $ 45.0 $ 9.5 $ 692.6
Long-term inflows 79.7 64.3 27.8 10.6 - 182.4
Long-term outflows (112.9 ) (90.2 ) (33.6 ) (7.3 ) - (244.0 )
Long-term net flows (33.2 ) (25.9 ) (5.8 ) 3.3 - (61.6 )
Cash management net flows - - - - (9.9 ) (9.9 )
Total net flows (33.2 ) (25.9 ) (5.8 ) 3.3 (9.9 ) (71.5 )
Acquisitions 449.4 183.2 22.5 75.8 75.6 806.5
Net market change,
distributions and other (10.1 ) 10.8 (6.5 ) (0.1 ) (2.8 ) (8.7 )
AUM at September 30, 2020 $ 656.7 $ 432.0 $ 133.8 $ 124.0 $ 72.4 $ 1,418.9
(in billions)
for the fiscal year ended Fixed Cash
September 30, 2019 Income Equity Multi-Asset Alternative Management Total
AUM at October 1, 2018 $ 258.5 $ 304.6 $ 126.7 $ 18.0 $ 9.3 $ 717.1
Long-term inflows 75.6 58.5 34.8 6.1 - 175.0
Long-term outflows (81.9 ) (83.5 ) (35.9 ) (5.5 ) - (206.8 )
Long-term net flows (6.3 ) (25.0 ) (1.1 ) 0.6 - (31.8 )
Cash management net flows - - - - 0.9 0.9
Total net flows (6.3 ) (25.0 ) (1.1 ) 0.6 0.9 (30.9 )
Acquisition - - - 26.4 - 26.4
Net market change,
distributions and other (1.6 ) (15.7 ) (2.0 ) - (0.7 ) (20.0 )
AUM at September 30, 2019 $ 250.6 $ 263.9 $ 123.6 $ 45.0 $ 9.5 $ 692.6
(in billions)
for the fiscal year ended Fixed Cash
September 30, 2018 Income Equity Multi-Asset Alternative Management Total
AUM at October 1, 2017 $ 286.0 $ 311.7 $ 132.5 $ 16.7 $ 6.3 $ 753.2
Long-term inflows 71.2 63.9 25.6 4.8 - 165.5
Long-term outflows (82.4 ) (88.5 ) (29.0 ) (3.6 ) - (203.5 )
Long-term net flows (11.2 ) (24.6 ) (3.4 ) 1.2 - (38.0 )
Cash management net flows - - - - 3.5 3.5
Total net flows (11.2 ) (24.6 ) (3.4 ) 1.2 3.5 (34.5 )
Acquisition - 9.8 - - - 9.8
Net market change,
distributions and other (16.3 ) 7.7 (2.4 ) 0.1 (0.5 ) (11.4 )
AUM at September 30, 2018 $ 258.5 $ 304.6 $ 126.7 $ 18.0 $ 9.3 $ 717.1
AUM increased $726.3 billion or 105% during fiscal year 2020 as $806.5 billion
from acquisitions was partially offset by $61.6 billion of long-term net
outflows, $9.9 billion of cash management net outflows and $8.7 billion of net
market change, distributions and other. Acquisitions included $797.4 billion
from the acquisition of Legg Mason and $9.1 billion from other acquisitions.
Long-term inflows increased 4% to $182.4 billion , as compared to the prior year,
due to higher inflows in all long-term asset classes except multi-asset.
Long-term outflows increased 18% to $244.0 billion due to higher outflows in all
long-term asset classes except multi-asset, most significantly in fixed income
products. Long-term net outflows included outflows of $27.6 billion from six
fixed income funds, $7.3 billion from seven institutional products, $6.2 billion
from three equity funds and $3.6 billion from a multi-asset fund, partially
offset by inflows of $6.0 billion in two equity funds, $4.0 billion in three
fixed income funds, $2.0 billion in two institutional products and $1.3 billion
in a private open-end product. Net
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market change, distributions and other primarily consists of$24.8 billion of long-term distributions, partially offset by$15.8 billion of market appreciation. The market appreciation occurred primarily in the equity asset class, and reflected positive returns in global equity markets as evidenced by increases of 15.2% and 11.0% in the S&P 500 Index and MSCI World Index. AUM decreased$24.5 billion or 3% during fiscal year 2019 due to$31.8 billion of long-term net outflows and$20.0 billion of net market change, distributions and other, partially offset by$26.4 billion from an acquisition. Long-term inflows increased 6% to$175.0 billion due to higher inflows in all the long-term asset classes except the equity asset class, and long-term outflows increased 2% to$206.8 billion due to higher outflows in the multi-asset and alternative asset classes, partially offset by lower outflows in the equity asset class. Long-term net outflows included outflows of$7.0 billion from six institutional clients, of which$2.9 billion was from Canadian mandates and$2.1 billion was due to two clients' mandatory redemption policies following portfolio manager departures;$4.3 billion from two equity funds;$2.7 billion from a fixed income fund;$1.4 billion from an institutional fixed income product;$1.3 billion from a multi-asset fund;$1.2 billion from two sub-advised institutional products and$1.0 billion from a sub-advised variable annuity client. The outflows were partially offset by inflows of$1.9 billion in a fixed income fund and$1.8 billion in an equity fund. Net market change, distributions and other primarily consists of$31.5 billion of long-term distributions and a$2.9 billion decrease from foreign exchange revaluation, partially offset by$14.4 billion of market appreciation. The foreign exchange revaluation resulted from AUM in products that are notU.S. dollar denominated, which represented 14% of total AUM as ofSeptember 30, 2019 , and was primarily due to strengthening of theU.S. dollar against the Euro, Canadian dollar, Australian dollar and Pound Sterling. The market appreciation occurred in all long-term asset classes except equity, and reflected positive returns in global fixed income markets as evidenced by a 7.6% increase in the Bloomberg Barclays Global Aggregate Index. AUM by sales region was as follows: (in billions) as of September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 United States$ 1,024.0 $ 477.9 $ 482.0 114 % (1 %) International Asia-Pacific 168.6 89.0 91.4 89 % (3 %) Europe, Middle East and Africa 141.8 87.9 98.3 61 % (11 %) Latin America1 59.4 13.5 15.6 340 % (13 %) Canada 25.1 24.3 29.8 3 % (18 %) Total international$ 394.9 $ 214.7 $ 235.1 84 % (9 %) Total$ 1,418.9 $ 692.6 $ 717.1 105 % (3 %) ______________
1
Average AUM by sales region was as follows: (in billions) for the fiscal years ended September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 United States$ 587.2 $ 473.3 $ 491.1 24 % (4 %) International Asia-Pacific 102.4 90.4 95.2 13 % (5 %) Europe, Middle East and Africa 97.8 91.5 105.8 7 % (14 %) Latin America1 23.1 14.6 17.3 58 % (16 %) Canada 22.4 27.2 31.1 (18 %) (13 %) Total international$ 245.7 $ 223.7 $ 249.4 10 % (10 %) Total$ 832.9 $ 697.0 $ 740.5 19 % (6 %) ______________
1
The percentage of average AUM in
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The region in which investment products are sold may differ from the geographic
area in which we provide investment management and related services to the
products.
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 our institutional
products against benchmarks. Approximately half of our mutual fund AUM exceeded
the peer group median comparisons for all periods presented. Our institutional
products generated strong long-term results with at least 63% of AUM exceeding
the benchmark comparisons for all periods presented, primarily driven by the
performance of our fixed income products which had at least 73% of AUM exceeding
the benchmark comparisons.
The performance of our mutual fund products against peer group medians and of
our institutional products against benchmarks is presented in the table below.
Peer Group Comparison1 Benchmark Comparison2
% of Mutual Fund AUM % of Institutional AUM
in Top Two Peer Group Quartiles Exceeding Benchmarkas of September 30, 2020 1-Year 3-Year 5-Year 10-Year 1-Year 3-Year 5-Year 10-Year Fixed Income 58 % 53 % 51 % 56 % 73 % 80 % 92 % 97 % Equity 48 % 56 % 56 % 47 % 28 % 33 % 27 % 50 % Total AUM3 47 % 48 % 47 % 58 % 63 % 69 % 73 % 84 % _______________
1 Mutual 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 39%, 38%, 38% and
36% of our total AUM as of
2 Institutional performance measures the percent of institutional AUM beating
its benchmark. The benchmark comparisons are based on each
account's/composite's (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
institutional AUM measured for the 1-, 3-, 5- and 10-year periods represents
55%, 54%, 52% and 48% of our total AUM as of
3 Total AUM includes performance of our multi-asset and alternative AUM, which
each represent 9% of our total AUM at
Mutual fund performance data includesU.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, are based on data available as ofOctober 12, 2020 and are subject to revision. While we remain focused on achieving strong long-term performance, our future peer group and benchmark rankings may vary from our past performance. 41
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OPERATING REVENUES The table below presents the percentage change in each operating revenue category. (in millions) for the fiscal years ended September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Investment management fees$ 3,981.7 $ 3,985.2 $ 4,367.5 0 % (9 %) Sales and distribution fees 1,362.0 1,444.6 1,599.8 (6 %) (10 %) Shareholder servicing fees 195.1 216.3 221.9 (10 %) (3 %) Other 27.7 23.3 15.3 19 % 52 % Total Operating Revenues$ 5,566.5 $ 5,669.4 $ 6,204.5 (2 %) (9 %) Investment Management Fees Investment management fees are generally calculated under contractual arrangements with our investment products and the products for which we provide sub-advisory services as a percentage of AUM. Annual fee rates vary by asset class and type of services provided. Fee rates for products sold outside of theU.S. are generally higher than forU.S. products. Investment management fees decreased$3.5 million in fiscal year 2020 primarily due to a 7% decrease in average AUM, lower effective investment management fee rate and lower performance fees of the legacy Franklin business, largely offset by$427.6 million of revenue earned by Legg Mason subsequent to the acquisition. The decrease in average AUM of the legacy Franklin business occurred primarily in the fixed income and equity asset classes, partially offset by an increase in the alternative asset class, and across all sales regions exceptEurope ,Middle East andAfrica . Investment management fees decreased$382.3 million in fiscal year 2019 primarily due to a 6% decrease in average AUM, a$59.6 million decrease from a change in presentation of certain fees from investment management fees to distribution fees upon adoption of new revenue recognition accounting guidance onOctober 1, 2018 , and a lower effective investment management fee rate, partially offset by higher performance fees. The decrease in average AUM occurred primarily in the equity, fixed income and multi-asset asset classes, partially offset by an increase in the alternative asset class, and across all sales regions, most significantly in theU.S. andEurope ,Middle East andAfrica . Our effective investment management fee rate excluding performance fees (investment management fees excluding performance fees divided by average AUM) was 47.3, 56.4 and 58.7 basis points for fiscal years 2020, 2019 and 2018. The rate decrease in fiscal year 2020 was primarily due to the Legg Mason acquisition, as Legg Mason generally has a lower overall effective fee rate due to a higher mix of institutional and fixed income AUM. The fee rate decrease is also due to higher weighting of AUM in lower-fee products, a shift from higher-fee products in theU.S. sales region to lower-fee products inEurope ,Middle East andAfrica sales regions for the fixed income asset class, and certain sponsored funds inIndia with total AUM of$3.4 billion atSeptember 30, 2020 , which are subject to the decision of the funds' trustees to wind up the funds (see Note 16 - Commitments and Contingencies in the notes to consolidated financial statements in Item 8 of Part II of this Annual Report for further information), and for which the Company no longer earns investment management fees. Performance-based investment management fees were$44.0 million ,$52.9 million and$21.2 million for fiscal years 2020, 2019 and 2018. The decrease in fiscal year 2020 was primarily due to lower performance fees earned from a private debt fund, separate accounts, and a real estate fund, while the increase in fiscal year 2019 was primarily due to the higher fees earned from the same funds. The decrease in fiscal year 2020 was partially offset by$15.0 million of performance fees earned by Legg Mason subsequent to the acquisition. 42
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Industry Average1
for the fiscal years ended September 30, 2020 2019 2018
Fixed Income2 27 29 30
Equity3 32 33 36
Multi-Asset 37 38 40
Alternative4 62 72 77
Cash Management 16 16 16
________________1 U.S. industry asset-weighted average management fee rates were calculated
using information available from Lipper, a
funds that reported expense data to Lipper as of the funds' most recent
annual report date, and for which expenses were equal to or greater than
zero. As defined by Lipper, management fees include fees from providing
advisory and fund administration services. The averages combine retail and
institutional funds data and include all share classes and distribution
channels, without exception. Variable annuity and fund of fund products are
not included.
2 The decreases in the average rate in fiscal years 2020 and 2019 reflect
higher weightings of two large low-fee passive funds and lower weightings of
two large higher-fee actively managed funds.
3 The decreases in the average rate in fiscal years 2020 and 2019 reflect
higher weightings of two large low-fee passive funds.
4 The decreases in the average rate in fiscal years 2020 and 2019 reflect
higher weightings of one large low-fee passive fund.
The declines inU.S. industry average management fee rates for long-term asset classes generally reflect increased investor demand for lower-fee passive funds. Our actual effective investment management fee rates are generally higher than theU.S. industry average rates as we actively manage substantially all of our products and have a higher level of international AUM, both of which generate higher fees. Our fiscal year 2020 effective fee rates in theU.S. generally decreased to a greater extent than the average industry rates following the acquisition of Legg Mason onJuly 31, 2020 and are expected to decrease further in the fiscal year endingSeptember 30, 2021 which will include a full year of Legg Mason results. Our product offerings and global operations are diverse. As such, the impact of future changes in AUM on investment management fees will be affected by the relative mix of asset class, geographic region, distribution channel and investment vehicle of the assets. Sales and Distribution Fees Sales and distribution fees primarily consist of upfront sales commissions and ongoing distribution fees. Sales commissions are earned from the sale of certain classes of sponsored funds at the time of purchase ("commissionable sales") and may be reduced or eliminated depending on the amount invested and the type of investor. Therefore, sales fees generally will change with the overall level of gross sales, the size of individual transactions, and the relative mix of sales between different share classes and types of investors. Our sponsored mutual funds generally pay us distribution fees in return for sales, marketing and distribution efforts on their behalf. The majority of ourU.S. mutual funds, with the exception of certain money market funds and certain other funds specifically designed for purchase through separately managed account programs, have adopted distribution plans under Rule 12b-1 (the "Rule 12b-1 Plans") promulgated under the Investment Company Act of 1940. The Rule 12b-1 Plans permit the funds to pay us for marketing, marketing support, advertising, printing and sales promotion services relating to the distribution of their shares, subject to the Rule 12b-1 Plans' limitations on amounts based on daily average AUM. We earn distribution fees from our non-U.S. funds based on daily average AUM. We pay substantially all of our sales and distribution fees to the financial advisers, broker-dealers and other intermediaries that sell our funds on our behalf. See the description of sales, distribution and marketing expenses below. 43
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Sales and distribution fees by revenue driver are presented below. (in millions) for the fiscal years ended September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Asset-based fees$ 1,096.3 $ 1,188.2 $ 1,314.3 (8 %) (10 %) Sales-based fees 245.9 244.0 270.3 1 % (10 %) Contingent sales charges 19.8 12.4 15.2 60 % (18 %) Sales and Distribution Fees$ 1,362.0 $ 1,444.6 $ 1,599.8 (6 %) (10 %) Asset-based distribution fees decreased$91.9 million in fiscal year 2020 primarily due to decreases of$79.2 million from a 7% decrease in the related average AUM and$38.6 million from a higher mix of lower-feeU.S. assets, partially offset by a$35.3 million increase from fees earned by Legg Mason subsequent to the acquisition. Asset-based distribution fees decreased$126.1 million in fiscal year 2019 primarily due to decreases of$120.5 million from a 9% decrease in the related average AUM and$67.6 million from a lower mix ofU.S. Class C assets which have higher fee rates than other share classes, partially offset by a$59.6 million increase from a change in presentation of certain fees to distribution fees from investment management fees upon adoption of new revenue recognition accounting guidance onOctober 1, 2018 . Sales-based fees increased$1.9 million in fiscal year 2020 primarily due to increases of$9.8 million from fees earned by Legg Mason subsequent to the acquisition,$7.2 million from higherU.S. product commissionable sales and,$2.9 million from a higher mix of equity sales, which typically generate higher sales fees than fixed income products. The increases were substantially offset by a decrease of$18.7 million from lower non-U.S. product commissionable sales. Sales-based fees decreased$26.3 million in fiscal year 2019 primarily due to decreases of$18.2 million from lower total commissionable sales and$5.3 million from a lower mix ofU.S. product commissionable sales. Contingent sales charges are earned from investor redemptions within a contracted period of time. Substantially all of these charges are levied on certain shares sold without a front-end sales charge, and vary with the mix of redemptions of these shares. Contingent sales charges increased$7.4 million in fiscal year 2020 and decreased$2.8 million in fiscal year 2019 primarily due to changes in redemptions. Shareholder Servicing Fees Substantially all shareholder servicing fees are earned from our sponsored funds for providing transfer agency services, which include providing shareholder statements, transaction processing, customer service and tax reporting. These fees are primarily determined based on a percentage of AUM and either the number of transactions in shareholder accounts or the number of shareholder accounts, while fees from certain funds are based only on AUM. In addition, fund reimbursements of expenses incurred while providing transfer agency services are recognized as revenue effectiveOctober 1, 2018 under new revenue recognition guidance. Shareholder servicing fees decreased$21.2 million in fiscal year 2020 primarily due to lower levels of related AUM and transactions. Shareholder servicing fees decreased$5.6 million in fiscal year 2019 primarily due to lower levels of related AUM and transactions, partially offset by$8.6 million of fund expense reimbursement revenue. Other Other revenue increased$4.4 million and$8.0 million in fiscal years 2020 and 2019 primarily due to higher miscellaneous fee revenues. 44
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OPERATING EXPENSES The table below presents the percentage change in each operating expense category. (in millions) for the fiscal years ended September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Compensation and benefits$ 1,873.9 $ 1,584.7 $ 1,390.6 18 % 14 % Sales, distribution and marketing 1,703.1 1,819.6 2,039.7 (6 %) (11 %) Information systems and technology 288.4 258.5 243.9 12 % 6 % Occupancy 147.9 133.6 128.6 11 % 4 % Amortization of intangible assets 54.0 14.7 1.8 267 % 717 % General, administrative and other 450.3 391.4 371.7 15 % 5 % Total Operating Expenses$ 4,517.6 $ 4,202.5 $ 4,176.3 7 % 1 % Compensation and Benefits The components of compensation and benefits expenses are presented below. (in millions) for the fiscal years ended September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Salaries, wages and benefits$ 1,072.1 $ 974.9 $ 928.4 10 % 5 % Variable compensation 551.2 490.6 454.3 12 % 8 % Acquisition-related retention 195.8 63.7 7.9 207 % 706 % Special termination benefits 54.8 55.5 - (1 %) NM
Compensation and Benefits Expenses
18 % 14 %
Salaries, wages and benefits increased $97.2 million and $46.5 million in fiscal
year 2020 and 2019, primarily due to increases of $56.9 million and
$23.8 million from higher average staffing levels primarily resulting from
acquisitions, and $19.3 million and $24.5 million for annual salary increases
that were effective December 1 of each fiscal year, partially offset by
decreases of $5.9 million and $12.5 million from favorable foreign currency
impacts. The increase in fiscal year 2020 also included a $16.2 million increase
in other termination benefits.
Variable compensation increased $60.6 million and $36.3 million in fiscal year
2020 and 2019, primarily due to increases of $67.7 million and $52.4 million
related to acquired firms' bonus plans and $10.0 million and $2.2 million
related to private equity and other product performance fees, partially offset
by decreases of $9.6 million and $18.0 million in bonus expense primarily due to
lower expectations of our annual performance. Variable compensation related to
unvested mutual fund awards decreased $11.3 million in fiscal year 2020 and
increased $3.8 million in fiscal year 2019. The increases in fiscal year 2019
were also partially offset by a $7.9 million decrease in stock and stock unit
award amortization.
Acquisition-related retention expenses increased $132.1 million in fiscal year
2020 primarily related to the acquisition of Legg Mason, and increased
$55.8 million in fiscal year 2019 primarily related to the acquisition of
Benefit Street Partners, L.L.C. ("BSP").
Special termination benefits relate to workforce optimization initiatives
related to the acquisition of Legg Mason in fiscal year 2020, and voluntary
separation and workforce reduction initiatives of 4.5% of our global workforce
in fiscal year 2019.
We expect to incur acquisition-related retention expenses of approximately
$150 million during the fiscal year ending September 30, 2021 ("fiscal year
2021"), and amounts that decrease by approximately $20 million per year in the
following three fiscal years. At September 30, 2020 , our global workforce had
increased to approximately 11,800 employees from approximately 9,600 at
September 30, 2019 .
We continue to place a high emphasis on our pay for performance philosophy. As
such, any changes in the underlying performance of our investment products or
changes in the composition of our incentive compensation offerings could have an
impact on compensation and benefits expenses going forward. However, in order to
attract and retain talented individuals, our level of compensation and benefit
expenses may increase more quickly or decrease more slowly than our revenue.
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Sales,Distribution and Marketing Sales, distribution and marketing expenses primarily relate to services provided by financial advisers, broker-dealers and other intermediaries to our sponsored funds, including marketing support services. Substantially all sales expenses are incurred from the same commissionable sales transactions that generate sales fee revenues and are determined as a percentage of sales. Substantially all distribution expenses are incurred from assets that generate distribution fees and are determined as a percentage of AUM. Marketing support expenses are based on AUM, sales or a combination thereof. Also included is the amortization of deferred sales commissions related to upfront commissions on shares sold without a front-end sales charge. The deferred sales commissions are amortized over the periods in which commissions are generally recovered from related revenues. Sales, distribution and marketing expenses by cost driver are presented below. (in millions) for the fiscal years ended September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Asset-based expenses$ 1,369.0 $ 1,476.0 $ 1,703.9 (7 %) (13 %) Sales-based expenses 253.8 257.8 255.1 (2 %) 1 %
Amortization of deferred sales commissions 80.3 85.8
80.7 (6 %) 6 % Sales, Distribution and Marketing$ 1,703.1 $ 1,819.6 $ 2,039.7 (6 %) (11 %) Asset-based expenses decreased$107.0 million in fiscal year 2020 primarily due to decreases of$107.4 million from an 8% decrease in the related average AUM and$53.4 million from a higher mix of lower-feeU.S. assets, partially offset by a$58.6 million increase in expenses incurred by Legg Mason subsequent to the acquisition. Asset-based expenses decreased$227.9 million in fiscal year 2019 primarily due to decreases of$161.4 million from a 10% decrease in the related average AUM, and$64.3 million from a lower mix ofU.S. Class C assets which have higher expense rates than other share classes. Distribution expenses are generally not directly correlated with distribution fee revenues due to certain international fee structures that do not provide full recovery of distribution costs. Sales-based expenses decreased$4.0 million in fiscal year 2020 primarily due to a$20.3 million decrease from lower non-U.S. product commissionable sales, largely offset by an$8.6 million increase in expenses incurred by Legg Mason subsequent to the acquisition and a$7.5 million increase from higherU.S. product commissionable sales.U.S. products typically generate higher sales commissions than non-U.S. products. Sales-based expenses increased$2.7 million in fiscal year 2019 primarily due to increases of$22.6 million from the recognition of sales commissions onU.S. Class C shares as expense at the time of sale and$10.0 million from revisedU.S. dealer commission pricing effectiveSeptember 2018 , partially offset by decreases of$14.2 million from lower total commissionable sales and$12.6 million inIndia primarily related to regulatory-driven changes in fee structure. The recognition of sales commissions onU.S. Class C shares as expense at the time of sale is consistent with the treatment of contract costs with a useful life of one year or less under new revenue recognition accounting guidance adopted onOctober 1, 2018 . The commissions relate to shares sold without a front-end sales charge and were deferred and amortized over one year in prior years. Amortization of deferred sales commissions decreased$5.5 million in fiscal year 2020, primarily due to a$15.0 million decrease from lower sales of non-U.S. shares sold without front-end sales charge, partially offset by an$8.6 million increase from higher sales ofU.S. shares. Amortization of deferred sales commissions increased$5.1 million in fiscal year 2019, as the impact of higher sales of shares sold without a front-end sales charge was largely offset by the change in accounting forU.S. Class C shares discussed above, which resulted in no further deferral and amortization. The unamortized deferred Class C commission balance of$9.1 million atSeptember 30, 2018 was reversed against retained earnings upon adoption of the new accounting guidance. Information Systems and Technology Information systems and technology expenses increased$29.9 million in fiscal year 2020 primarily due to expenses of Legg Mason subsequent to closing of the acquisition. Information systems and technology expenses increased$14.6 million in fiscal year 2019 primarily due to higher external data service and software costs. 46
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Occupancy
We conduct our worldwide operations using a combination of leased and owned facilities. Occupancy expenses include rent and other facilities-related costs including depreciation and utilities. Occupancy expenses increased$14.3 million in fiscal year 2020 primarily due to expenses of Legg Mason subsequent to closing of the acquisition, and higher depreciation expense related to our buildings inSan Mateo, California and Poznan,Poland which we occupied beginning in the second half of fiscal year 2019, partially offset by lower levels of rent expense and building maintenance costs. Occupancy expenses increased$5.0 million in fiscal year 2019 primarily due to higher levels of rent expense and building depreciation and maintenance costs, partially offset by a$6.3 million decrease in equipment impairment. Amortization of intangible assets Amortization of intangible assets increased$39.3 million in fiscal year 2020 primarily related to the acquisition of Legg Mason, and increased$12.9 million in fiscal year 2019 primarily related to the acquisition of BSP. See Note 9 -Goodwill and Other Intangible Assets in the notes to consolidated financial statements in Item 8 of Part II of this Annual Report for information on definite-lived intangible assets. General, Administrative and Other General, administrative and other operating expenses primarily consist of professional fees, fund-related service fees payable to external parties, impairments of intangible assets and goodwill, advertising and promotion, travel and entertainment, and other miscellaneous expenses. General, administrative and other operating expenses increased$58.9 million in fiscal year 2020, primarily due to increases of$48.0 million in acquisition-related professional fees and$19.3 million of post-acquisition general and administrative expenses, both related to Legg Mason. Additionally, impairments of intangible assets and goodwill increased$42.1 million primarily related to assets recognized from the acquisitions ofBSP and Onsa, Inc. , (formally known asTokenVault, Inc. ). The increases were partially offset by decreases of$24.6 million in travel and entertainment expenses and$13.8 million in advertising and promotion expenses, both primarily due to lower activity levels, and by a prior year litigation settlement. General, administrative and other operating expenses increased$19.7 million in fiscal year 2019 primarily due to a$13.9 million litigation settlement and higher third-party service fees and professional fees. Third-party fees primarily for sub-advisory and fund administration services increased$13.7 million , including$8.6 million from the recognition of certain payments reimbursed by funds as expense upon adoption of new revenue recognition accounting guidance onOctober 1, 2018 . Professional fees increased$10.6 million primarily related to the acquisition of BSP. The increases were partially offset by decreases of$11.1 million in contingent consideration expense for theK2 Advisors Holdings, LLC ("K2") acquisition and$8.6 million in advertising and promotion. 47
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OTHER INCOME (EXPENSES) Other income (expenses) consisted of the following: (in millions) for the fiscal years ended September 30, 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Investment and other income (losses), net$ (38.4 ) $ 141.4 $ 200.3 NM (29 %) Interest expense (33.4 ) (22.4 ) (46.3 ) 49 % (52 %) Investment and other income of consolidated investment products, net 70.2 78.8 59.6 (11 %) 32 % Expenses of consolidated investment products (29.4 ) (16.9 ) (26.6 ) 74 % (36 %) Other Income (Expenses), Net$ (31.0 ) $ 180.9 $ 187.0 NM (3 %) In fiscal year 2020, the Company changed the presentation of its consolidated statements of income to include dividend and interest income and other expenses from consolidated investment products ("CIPs") in non-operating income (expense). Amounts for the comparative prior fiscal years have been reclassified to conform to the current presentation. See Note 1 - Significant Accounting Policies in the notes to consolidated financial statements in Item 8 of Part II of this Annual Report for more information. Investment and other income (losses), net consists primarily of income (losses) from equity method investees, dividend and interest income, rental income from excess owned space in ourSan Mateo, California corporate headquarters and other office buildings which we lease to third parties, foreign currency exchange gains (losses), and gains (losses) on investments held by the Company. Investment and other income (losses), net decreased$179.8 million in fiscal year 2020 primarily due to the impact of steep declines in market valuations on investment income, lower dividend and interest income, and foreign exchange losses, partially offset by an increase in rental income. Losses from equity method investees increased$87.7 million , primarily related to investments in two global equity funds. Dividend income decreased$48.1 million primarily due to lower yields on money market funds. Net foreign currency exchange losses were$22.3 million in fiscal year 2020 as compared to net gains of$13.1 million in the prior year. The decrease was primarily due to the impact of the weakening of theU.S. dollar against the Euro on cash and cash equivalents denominated inU.S. dollars held inEurope . Interest income decreased$16.7 million primarily due to lower levels of cash equivalents and debt securities and lower interest rates. The decreases were partially offset by a$10.2 million increase in rental income due to additional leases which took effect in fiscal year 2020. Investment and other income (losses), net decreased$58.9 million in fiscal year 2019 primarily due to losses from equity method investees, as compared to income in the prior year, lower interest income and losses on investments held by the Company, as compared to gains in the prior year. These decreases were largely offset by higher dividend income and higher foreign exchange gains. Equity method investees generated losses of$10.4 million as compared to income of$44.4 million in the prior year primarily due to changes in market valuations of investments held by two global equity funds. Interest income decreased$45.5 million primarily due to lower levels of cash equivalents and debt securities, partially offset by higher interest rates. Investments held by the Company generated net losses of$9.7 million primarily due to$9.0 million of other-than-temporary impairment of an available-for-sale debt security, as compared to net gains of$6.0 million in the prior year. The decreases were partially offset by a$45.9 million increase in dividend income primarily due to higher yields on, and investments in, money market funds. Net foreign currency exchange gains increased$12.5 million primarily from the impact of strengthening of theU.S. dollar against the Euro on cash and cash equivalents denominated inU.S. dollars held inEurope . Interest expense increased$11.0 million in fiscal year 2020 primarily due to interest expense recognized on debt of Legg Mason subsequent to the acquisition. Interest expense decreased$23.9 million in fiscal year 2019 primarily due to$12.5 million of prior year costs related to early redemption of senior notes and lower debt balances. Investment and other income of consolidated investment products, net consists of dividend and interest income and investment gains (losses) on investments held by CIPs. Expenses of consolidated investment products primarily consists of fund-related expenses, including professional fees and other administrative expenses, and interest expense. Significant portions of the investment and other income of consolidated investment products, net and expenses of consolidated investment products are offset in noncontrolling interests in our consolidated statements of income. 48
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Investment and other income of consolidated investment products, net decreased$8.6 million in fiscal year 2020. Net losses on investments held by CIPs increased$12.6 million primarily from holdings of various alternative funds partially offset by gains from holdings of various equity funds and aU.S. fixed income fund. This decrease was partially offset by a$4.0 million increase in dividend and interest income of CIPs. Investment and other income of consolidated investment products, net increased$19.2 million in fiscal year 2019. Net losses on investments held by CIPs decreased$28.7 million primarily from holdings of various global/international funds and aU.S. fixed income fund. This increase was partially offset by a$9.5 million decrease in investment income of CIPs. Expenses of consolidated investment products increased$12.5 million in fiscal year 2020, primarily due to higher expenses incurred by two alternative funds. Expenses of consolidated investment products decreased$9.7 million in fiscal year 2019, primarily due to lower expenses incurred by an equity fund and a fixed income fund. Our investments in sponsored funds include initial cash investments made in the course of launching mutual fund and other investment product offerings, as well as investments for other business reasons. The market conditions that impact our AUM similarly affect the investment income earned or losses incurred on our investments in sponsored funds. Our cash, cash equivalents and investments portfolio by asset class and accounting classification atSeptember 30, 2020 , excluding third-party assets of CIPs, was as follows: Accounting Classification 1 Investments, Cash and Cash at Equity Method Other Direct Investments Total Direct (in millions) Equivalents Fair Value Investments Investments in CIPs Portfolio Cash and Cash Equivalents$ 3,026.8 $ - $ - $ - $ -$ 3,026.8 Investments Fixed Income - 198.7 139.7 40.8 242.9 622.1 Equity - 209.4 308.9 22.8 67.9 609.0 Multi-Asset - 64.4 50.2 - 64.3 178.9 Alternative - 32.3 183.4 19.9 410.2 645.8 Total investments - 504.8 682.2 83.5 785.3 2,055.8 Total Cash and Cash Equivalents and Investments$ 3,026.8 $ 504.8 $ 682.2$ 83.5 $ 785.3$ 5,082.6
______________
1 See Note 1 - Significant Accounting Policies and Note 6 - Investments in the
notes to consolidated financial statements in Item 8 of Part II of this
Annual Report for information on investment accounting classifications.
TAXES ON INCOME The Tax Act, which was enacted into law in theU.S. inDecember 2017 , includes various changes to the tax law, including a permanent reduction in the corporate income tax rate from 35% to 21% effectiveJanuary 1, 2018 and assessment of a one-time transition tax on the deemed repatriation of post-1986 undistributed foreign subsidiaries' earnings. We completed our analysis of the Tax Act impact during the quarter endedDecember 31, 2018 with no significant adjustment to the provisional amounts previously recorded. The transition tax expense recognized in fiscal year 2018 was net of an$87.6 million tax benefit related toU.S. taxation of deemed foreign dividends. This benefit was reversed in fiscal year 2019 upon issuance of final regulations by theU.S. Department of Treasury . Our effective income tax rate for fiscal year 2020 was 22.7% as compared to 26.8% in fiscal year 2019 and 66.5% in fiscal year 2018. The rate decrease in fiscal year 2020 was primarily due to the prior-year reversal of the tax benefit included in the transition tax related toU.S. taxation of deemed foreign dividends upon issuance of final regulations by theU.S. Department of Treasury for the Tax Act , tax benefits from capital losses subsequent to the change in corporate tax structure of a foreign holding company to aU.S. branch, and a statutory rate reduction enacted inIndia inDecember 2019 . These decreases were partially offset by an increase in the tax rate due to a lower mix of earnings in lower tax jurisdictions. The Coronavirus Aid, Relief, and Economic Security Act, which includes several corporate tax provisions and was signed into law onMarch 27, 2020 , did not have a material impact on our income taxes. The rate decrease in fiscal year 2019 was primarily 49
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due to the prior year impact of the transition tax, net of the tax benefit from the revaluation of net deferred tax liabilities at the lower statutory rate, and the current year impact of the lower 21% statutory rate as compared to the prior-year blended statutory rate of 24.5%, partially offset by the reversal of the tax benefit related to theU.S. taxation of deemed foreign dividends. Our effective income tax rate excluding the one-time impacts of the Tax Act was 21.6% and 22.7% for fiscal years 2019 and 2018. 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 as these measures exclude the impact of CIPs and mitigate the margin variability related to sales and distribution revenues and expenses across multiple distribution channels globally. These measures also exclude performance-based investment management fees which are fully passed through as compensation and benefits expense per the terms of a previous acquisition by Legg Mason and have no impact on net income. These non-GAAP measures also exclude acquisition-related expenses, certain items which management considers to be nonrecurring, unrealized investment gains and losses included in investment and other income (losses), net, and the related income tax effect of these adjustments, as applicable. These non-GAAP measures also exclude the impact on compensation and benefits expense which is offset by gains and losses in investment and other income (losses), net on investments made to fund deferred compensation plans and on seed investments under certain historical revenue sharing arrangements. "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 toFranklin Resources, Inc. and diluted earnings per share on aU.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 withU.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 retention compensation.
• Impact on compensation and benefits expense from gains and losses on
investments related to Legg Mason deferred compensation plans and seedinvestments, which is offset in investment and other income (expense),
net.
• Other acquisition-related expenses including professional fees and fair
value adjustments related to contingent consideration liabilities.
• Amortization and impairment of intangible assets and goodwill.
• Special termination benefits related to workforce optimization initiatives
related to the acquisition of Legg Mason in fiscal year 2020, and
voluntary separation and workforce reduction initiatives of 4.5% of our
global workforce in fiscal year 2019.
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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: • 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.
• Elimination of operating revenues upon consolidation of investment products.
Adjusted Net Income We define adjusted net income as net income attributable toFranklin Resources, Inc. adjusted to exclude the following: • Activities of CIPs, including investment and other income (losses), net,
other expenses and income (loss) attributable to noncontrolling interests,
net of revenues eliminated upon consolidation of investment products.
• Acquisition-related retention compensation.
• Other acquisition-related expenses including professional fees and fair
value adjustments related to contingent consideration liabilities and the
market-based component of retention awards.
• Amortization and impairment of intangible assets.
• Impairment of goodwill and write off of noncontrolling interests related
to the wind down of a recently acquired business.
• Special termination benefits related to workforce optimization initiatives
related to the acquisition of Legg Mason in fiscal year 2020, and
voluntary separation and workforce reduction initiatives of 4.5% of our
global workforce in fiscal year 2019.
• Net gains or losses on investments related to Legg Mason deferred
compensation plans which are not offset by compensation and benefits
expense.
• Unrealized investment gains and losses included in investment and otherincome (losses), net, other than those that are offset by compensation and
benefits expense.
• Interest expense for amortization of Legg Mason debt premium from
acquisition-date fair value adjustment.
• Net income tax expense of the above adjustments based on the respective
blended rates applicable to the adjustments.
Adjusted Diluted Earnings Per Share
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 adjusted operating income, adjusted operating margin, adjusted
net income and adjusted diluted earnings per share, we adjust for activities of
CIPs because the impact of consolidated products are not considered reflective
of the underlying results of our operations. We adjust for acquisition-related
retention compensation, other acquisition-related expenses, amortization and
impairment of intangible assets and goodwill, the write-off of noncontrolling
interests, and interest expense for amortization of the Legg Mason debt premium
to facilitate comparability of our operating results with the results of other
asset management firms. We adjust for special termination benefits related to
workforce optimization initiatives related to the acquisition of Legg Mason in
fiscal year 2020 and certain voluntary separation and workforce reduction
initiatives because these items are deemed nonrecurring. In calculating adjusted
net income and adjusted diluted earnings per share, we adjust for unrealized
investment gains and losses included in investment and other income (losses),
net and net gains or losses on investments related to Legg Mason deferred
compensation plans which are not offset by compensation and benefits expense
because these items primarily relate to seed and strategic investments which
have been and are generally expected to be held long term.
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The calculations of adjusted operating income, adjusted operating margin,
adjusted net income and adjusted diluted earnings per share are as follows:
(in millions)
for the fiscal years ended
2020 2019 2018
Operating income$ 1,048.9 $ 1,466.9 $ 2,028.2 Add (subtract): Elimination of operating revenues upon consolidation of investment products¹ 23.6 30.7 35.2 Acquisition-related retention 195.8 63.7 7.9 Compensation and benefits expense from gain on deferred compensation and seed investments, net 1.2 - - Other acquisition-related expenses 57.4 9.4 14.7 Amortization of intangible assets 54.0 14.7 1.8 Impairment of goodwill and intangible assets 55.4 13.3 5.7 Special termination benefits 54.8 55.5 - Adjusted operating income$ 1,491.1 $ 1,654.2 $ 2,093.5 Total operating revenues$ 5,566.5 $ 5,669.4 $ 6,204.5 Add (subtract): Acquisition-related pass through performance fees (9.4 ) - - Sales and distribution fees (1,362.0 ) (1,444.6 ) (1,599.8 ) Allocation of investment management fees for sales, distribution and marketing expenses (341.1 ) (375.0 ) (439.9 ) Elimination of operating revenues upon consolidation of investment products¹ 23.6 30.7 35.2 Adjusted operating revenues$ 3,877.6 $ 3,880.5 $ 4,200.0 Operating margin 18.8 % 25.9 % 32.7 % Adjusted operating margin 38.5 % 42.6 % 49.8 % 52
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(in millions, except per share data) for the fiscal years ended September 30, 2020 2019
2018
Net income attributable to Franklin Resources, Inc.$ 798.9 $ 1,195.7 $ 764.4 Add (subtract): Net income of consolidated investment products¹ (4.6 ) (3.7 ) (5.8 ) Acquisition-related retention 195.8 63.7 7.9 Other acquisition-related expenses 58.6 9.4 14.5 Amortization of intangible assets 54.0 14.7 1.8 Impairment of goodwill and intangible assets 55.4 13.3 5.7 Special termination benefits 54.8 55.5 - Net gains on deferred compensation plan investments not offset by compensation and benefits expense (0.1 ) - - Unrealized investment losses included in investment and other income (losses), net 221.0
20.0 15.3 Interest expense for amortization of debt premium (4.7 ) -
-
Write off of noncontrolling interests (16.7 ) - -
Net income tax expense of adjustments (101.4 ) (37.3 ) (5.7 )
Adjusted net income $ 1,311.0 $ 1,331.3 $ 798.1
Diluted earnings per share $ 1.59 $ 2.35 $ 1.39
Adjusted diluted earnings per share 2.61 2.62 1.45
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1 The impact of consolidated investment products is summarized as follows:
(in millions) for the fiscal years ended September 30, 2020 2019
2018
Elimination of operating revenues upon consolidation$ (23.6 ) $ (30.7 ) $ (35.2 ) Other income, net 33.6 39.8
18.6
Less: income (loss) attributable to noncontrolling interests 5.4 5.4 (22.4 ) Net income$ 4.6 $ 3.7 $ 5.8 LIQUIDITY AND CAPITAL RESOURCES Cash flows were as follows: (in millions) for the fiscal years ended September 30, 2020 2019 2018 Operating cash flows$ 1,021.4 $ 201.6 $ 2,229.7 Investing cash flows (3,243.1 ) (1,077.1 ) (290.4 ) Financing cash flows 194.2 (40.5 ) (3,761.7 ) Net cash provided by operating activities increased in fiscal year 2020 primarily due to lower net purchases of investments by CIPs, decreases in investments, net, decreases in receivables and other assets, and a smaller decline in taxes payable, partially offset by decreases in accounts payable and accrued expenses, and decreases in net income. Net cash used in investing activities increased as compared to the prior year, primarily due to higher cash paid for acquisitions, and net purchases of investments by CLOs, partially offset by net consolidation of CIPs as compared to net deconsolidation in the prior year, higher net liquidation of our investments as compared to the prior year, and lower net additions of property, plant and equipment. Net cash provided by financing activities, as compared to net cash used in the prior year, primarily resulted from proceeds from debt of CIPs and lower repurchases of stock, partially offset by lower net subscriptions in CIPs by noncontrolling interests and payments on debt by CIPs. 53
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Net cash provided by operating activities decreased in fiscal year 2019 primarily due to activities of CIPs which had net purchases of investments as compared to net liquidations in the prior year. Net cash used in investing activities increased primarily due to cash paid for BSP and higher net additions of property and equipment primarily related to construction of two new buildings at our corporate headquarters campus inSan Mateo, California and a purchased office building in Poznan,Poland . Net cash used in financing activities decreased primarily due to lower dividends paid on, and repurchases of, common stock, higher net subscriptions in CIPs by noncontrolling interests, and a prior-year debt payment. 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) as of September 30, 2020 2019 2018
Assets
Cash and cash equivalents$ 3,026.8 $ 5,803.4 $ 6,610.8 Receivables 1,114.8 740.0 733.7 Investments 982.2 2,029.4 2,130.6 Total Liquid Assets$ 5,123.8 $ 8,572.8 $ 9,475.1 Liability Debt$ 3,017.1 $ 696.9 $ 695.9 Liquidity Liquid assets consist of cash and cash equivalents, receivables and certain investments. Cash and cash equivalents atSeptember 30, 2020 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. Liquid assets used to satisfy these purposes were$3,290.9 million atSeptember 30, 2020 and$3,429.0 million atSeptember 30, 2019 , including$316.6 million and$263.3 million that was restricted by regulatory requirements. 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, or we could raise capital through debt or equity issuance. 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, the ability to issue debt or equity securities and borrowing capacity under our uncommitted private placement program. In prior fiscal years, we issued senior unsecured unsubordinated notes for general corporate purposes, to redeem outstanding notes and to finance an acquisition. AtSeptember 30, 2020 ,$699.5 million of the notes were outstanding with an aggregate principal amount due of$700.0 million . The notes were issued at fixed interest rates and consist of$300.0 million at 2.800% per annum which mature in 2022 and$400.0 million at 2.850% per annum which mature in 2025. 54
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Additionally, Legg Mason has outstanding senior and junior unsecured unsubordinated notes with an aggregate principal amount due of$2,000.0 million atSeptember 30, 2020 . The notes have fixed interest rates from 3.950% to 6.375% with interest payable semi-annually for senior notes and quarterly for junior notes, and have an aggregate carrying value, inclusive of unamortized premium, of$2,319.7 million atSeptember 30, 2020 . 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 junior notes dueMarch 2056 andSeptember 2056 may only be redeemed in whole prior toMarch 2021 andSeptember 2021 , respectively. 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 were in compliance with all debt covenants atSeptember 30, 2020 . OnOctober 19, 2020 , the Company completed its offering and sale of the 1.600% Notes due 2030 with a principal amount of$750.0 million . The notes contain an optional redemption feature that allows the Company to redeem each series of notes prior to maturity in whole or in part at any time, at a make-whole redemption price. AtSeptember 30, 2020 , 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, 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, fund property and equipment purchases, and service and repay 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, affiliates and operations. We repatriate the earnings in excess of regulatory, capital or operational requirements for all non-U.S. subsidiaries. We declare dividends on a quarterly basis. We declared regular dividends of$1.08 per share ($0.27 per share per quarter) in fiscal year 2020, and of$1.04 per share ($0.26 per share per quarter) in fiscal year 2019. 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 regular 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 fiscal years 2020 and 2019, we repurchased 9.0 million and 24.6 million shares of our common stock at a cost of$219.4 million and$756.3 million . AtSeptember 30, 2020 , 38.2 million shares remained available for repurchase under the authorization of 80.0 million shares approved by our Board of Directors inApril 2018 . We redeemed$636.6 million , net of investments, in our sponsored products during fiscal year 2020, and invested$128.0 million , net of redemptions, during fiscal year 2019. OnJuly 31, 2020 , we acquired all of the outstanding common stock of Legg Mason for a purchase consideration of$4.5 billion in cash and$0.2 billion related to the settlement of historical compensation arrangements. During the fiscal year 2020, we completed additional acquisitions with a total purchase consideration of$94.8 million in cash, including the acquisitions ofPennsylvania Trust Company ,AdvisorEngine Inc. ,Athena Capital Advisors, LLC andOnsa, Inc. OnFebruary 1, 2019 , we acquired all of the outstanding ownership interests in BSP for a purchase consideration of$720.1 million in cash. 55
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InFebruary 2020 , we purchased an office building inEdinburgh, Scotland with a total cost of approximately$40 million . During fiscal year 2019, we completed construction of two new buildings at our corporate headquarters campus inSan Mateo, California with a total cost of approximately$130 million and purchased an office building in Poznan,Poland with a total cost of approximately$86 million . The buildings are used in our business operations, and portions of theEdinburgh building andCalifornia campus are leased to third parties. 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. Current increased liquidity risks and redemptions in these funds 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. InApril 2020 , we authorized loans aggregating up to5.0 billion Indian Rupees (approximately$66.2 million ) to certain sponsored funds inIndia that had experienced increased liquidity risks and redemptions and that are subject to the decision of the fund's trustee to wind up the funds. See Note 16 - Commitments and Contingencies in the notes to consolidated financial statements in Item 8 of Part II of this Annual Report for further information. The loans have a fixed interest rate of 8.0% per annum, are secured by the funds' assets and are due upon demand. AtSeptember 30, 2020 , the loans have an aggregate outstanding balance of$42.4 million , and the remaining authorization available is approximately$4.9 million . We did not provide financial or other support to our sponsored funds during fiscal year 2019. 56
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CONTRACTUAL OBLIGATIONS AND COMMITMENTS AND CONTINGENT LIABILITIES
The following table summarizes our contractual obligations and commitments.
(in millions) Payments Due by Fiscal Year
There-
as of September 30, 2020 2021 2022 2023 2024 2025 after Total
Debt1
Principal $ - $ 300.0 $ - $ 250.0 $ 400.0 $ 1,750.0 $ 2,700.0
Interest 125.2 125.2 116.8 116.8 101.2 1,913.9 2,499.1
Operating leases 134.8 131.5 125.4 89.0 50.2 153.5 684.4
Purchase obligations2 186.7 112.4 60.9 46.2 28.7 8.2 443.1
Purchase consideration
obligation3 47.9 31.9 - - - - 79.8
Total Contractual
Obligations 494.6 701.0 303.1 502.0 580.1 3,825.6 6,406.4
Committed capital
contributions4 335.6 - - - - - 335.6
Contingent consideration
liabilities5 1.7 10.2 8.1 7.1 - - 27.1
Federal transition tax
liability6 53.3 74.1 74.1 138.9 185.2 231.6 757.2
Total Contractual
Obligations, Commitments,
and Contingent Liabilities $ 885.2 $ 785.3 $ 385.3 $ 648.0 $ 765.3 $ 4,057.2 $ 7,526.3
__________________1 Debt principal represents amounts due on maturity. Excludes 1.600% notes
with a principal amount of $750.0 million due 2030 which were issued on
October 19, 2020 . See Note 22 - Subsequent Event in the notes to
consolidated financial statements in Item 8 of Part II of this Annual
Report.
2 Purchase obligations include contractual amounts that will be due topurchase goods and services to be used in our operations and may be canceled
at earlier times than those indicated under certain conditions that may
include termination fees.
3 Represents purchase consideration payments to be made in connection with the
acquisition of Legg Mason.
4 Committed capital contributions relate to discretionary commitments to
invest in sponsored funds and other investment products and entities,including CIPs. Generally, the timing of the funding of these commitments is
unknown as they are callable on demand at any time prior to the expiration
of the commitment periods.
5 The amount of contingent consideration liabilities reflected for any year
represents the expected settlement amounts as of
fair value of the aggregate contingent consideration liability at
September 30, 2020 totaled $25.3 million and is included in other
liabilities in the consolidated balance sheet.
6 Transition tax on the deemed repatriation of post-1986 undistributed foreign
subsidiaries' earnings under the Tax Act.
The debt holders of CIPs have no recourse to our assets beyond the level of our direct investments, therefore we bear no risks associated with these entities' liabilities and have not included them in the table above. See Note 11 - Consolidated Investment Products in the notes to consolidated financial statements in Item 8 of Part II of this Annual Report. AtSeptember 30, 2020 , our consolidated balance sheet included liabilities for unrecognized tax benefits of$262.9 million and related accrued interest of$24.6 million (see Note 14 - Taxes on Income in the notes to consolidated financial statements in Item 8 of Part II of this Annual Report). Because of the high degree of uncertainty regarding the timing and amounts of future cash outflows, unrecognized tax benefits and related accrued interest are not included in the table above. CRITICAL ACCOUNTING POLICIES Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted inthe 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, global concerns about the COVID-19 pandemic have adversely affected, and we expect will 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 accounting policies that we believe are most critical to understanding our financial position and results of operations. For additional information about our accounting policies, see Note 1 - Significant Accounting Policies in the notes to consolidated financial statements in Item 8 of Part II of this Annual Report. 57
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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 ("VOE") or are
the primary beneficiary of a variable interest entity ("VIE").
A VIE is an entity in which the equity investment holders have not contributed
sufficient capital to finance its activities or do not have defined rights and
obligations normally associated with an equity investment. The assessment of
whether an entity is a VIE or VOE involves judgment and analysis on a
structure-by-structure basis. When performing the assessment we consider factors
such as the entity's legal organization and capital structure, the rights of the
equity investment holders and our contractual involvement with and ownership
interest in the entity. Substantially all of our VIEs are investment products
and our variable interests consist of our equity ownership interests in and
investment management fees earned from these products.
We are the primary beneficiary of a VIE if we have the power to direct the
activities that most significantly impact the VIE's economic performance and the
obligation to absorb losses of or right to receive benefits from the VIE that
could potentially be significant to the VIE. Investment management fees earned
from VIEs are excluded from the primary beneficiary determination if they are
deemed to be at market and commensurate with service. The key estimates and
assumptions used in the analyses include the amount of AUM and the life of the
investment product. These estimates and assumptions are subject to variability.
For example, AUM is impacted by market volatility and the level of sales,
redemptions, distributions to investors and reinvested distributions. There is
judgment involved in assessing whether we have the power to direct the
activities that most significantly impact VIEs' economic performance and the
obligation to absorb losses of or right to receive benefits from VIEs that could
potentially be significant to the VIEs. As of September 30, 2020 , we were the
primary beneficiary of 43 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. Determining the fair value of assets
acquired and liabilities assumed involves the use of significant estimates and
assumptions. During the measurement period, which is not to exceed one year from
the acquisition date, we may record adjustments to the assets acquired and
liabilities assumed, with the corresponding offset to goodwill. Upon the
conclusion of the measurement period, any subsequent adjustments are recorded in
earnings.
Intangible assets acquired in business combinations consist primarily of
investment management contracts and trade names. The fair values of the acquired
management contracts are based on the net present value of estimated future cash
flows attributable to the contracts, which include significant assumptions about
forecasts of the AUM growth rate, pre-tax profit margin, discount rate, average
effective fee rate and effective tax rate. The fair value of trade names is
determined using the relief from royalty method based on net present value of
estimated future cash flows, which include significant assumptions about royalty
rate, revenue growth rate, discount rate and effective tax rate. Our estimates
are based on assumptions believed to be reasonable, but are inherently uncertain
and unpredictable and, as a result, may differ from actual results.
The Company's management contract intangible assets are amortized over their
estimated useful lives, which range from three to fifteen years, using the
straight-line method, unless the asset is determined to have an indefinite
useful life. Indefinite-lived intangible assets represent contracts to manage
investment assets for which there is no foreseeable limit on the contract
period. Trade names are amortized over their estimated useful lives which range
from five to twenty years using the straight-line method.
On July 31, 2020 , the Company acquired all outstanding shares of Legg Mason
common stock for purchase consideration of $4.5 billion in cash and $0.2 billion
related to the settlement of historical compensation arrangements, and
recognized $2.3 billion of goodwill, $2.7 billion of indefinite-lived intangible
assets related to investment management contracts and $1.4 billion of
definite-lived intangible assets primarily related to investment management
contracts and trade names.
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. We have one reporting unit,
investment management and related services, consistent with our single operating
segment, to which all goodwill has been assigned. We make significant estimates
and assumptions when evaluating goodwill and other intangible assets for
impairment.
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We may first assess goodwill and indefinite-lived intangible assets for qualitative factors to determine whether it is necessary to perform a quantitative impairment test. The qualitative analysis considers entity-specific and macroeconomic factors and their potential impact on the key assumptions used in the determination of the fair value of the reporting unit or indefinite-lived intangible asset. A quantitative impairment test is performed if the results of the qualitative assessment indicate that it is more likely than not that the fair value of the reporting unit is less than its carrying value or an indefinite-lived intangible asset is impaired, or if a qualitative assessment is not performed. Quantitative tests compare the fair value of the asset to its carrying value. The fair values of the reporting unit and indefinite-lived intangible assets are based on the net present value of estimated future cash flows, which include significant assumptions about the AUM growth rate, pre-tax profit margin, discount rate, average effective fee rate and effective tax rate. The most relevant of these assumptions to the determination of estimated fair value are the AUM growth rate, pre-tax profit margin and the discount rate. We performed our annual impairment tests for goodwill and indefinite-lived intangible assets as ofAugust 1, 2020 . We performed a qualitative test for goodwill and a substantial portion of the indefinite-lived intangible assets and concluded it is more likely than not that the fair value of the specific intangible assets exceeds their carrying value. We performed a quantitative test for approximately 21% of indefinite-lived intangible assets, and recognized$30.0 million of impairments of indefinite-lived intangible assets. The Company recognized$23.7 million of impairment of goodwill directly attributable to the Company's decision to wind-downOnsa, Inc. which was acquired onOctober 24, 2019 and had not been integrated into the Company. The impairments of indefinite-lived intangible assets were primarily due to a reduction in the revenue growth rate assumption for aBenefit Street Partners' private debt fund resulting from declines in interest rates and continued market volatility. The estimated fair values of substantially all of the other indefinite-lived intangible assets exceeded their carrying values by more than 47%. We estimated the discounted future cash flows for indefinite-lived intangible assets using compounded annual AUM growth rates ranging from (10.0%) to 11.6%, which were developed taking into account ongoing volatility in the capital markets, and a discount rate of 8.1%, which is based on our weighted average cost of capital. A hypothetical 200 basis point decline in the AUM growth rates or a 200 basis point increase in the discount rate would not reduce the estimated fair values of the other indefinite-lived intangible assets below their carrying values. We subsequently monitored market conditions and their potential impact on the assumptions used in the annual calculations of fair value 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 considered, among other things, changes in our AUM and weighted-average cost of capital by assessing whether these changes would impact the reasonableness of the assumptions used in the impairment tests as ofAugust 1, 2020 . We also monitored fluctuations of our common stock per share price to evaluate our market capitalization relative to the reporting unit as a whole. Subsequent toAugust 1, 2020 , there were no impairments of goodwill or indefinite-lived intangible assets as no events occurred or circumstances changed that would indicate these assets might be impaired. We test definite-lived intangible assets for impairment quarterly. Impairment is indicated when the carrying value of an asset is not recoverable and exceeds its fair value. Recoverability is evaluated based on estimated undiscounted future cash flows using assumptions about the AUM growth rate, pre-tax profit margin, average effective fee rate and expected useful life as well as royalty rate for trade name intangible assets. The most relevant of these assumptions to determine future cash flows is the AUM growth rate. If the carrying value of an asset is not recoverable through undiscounted cash flows, impairment is recognized in the amount by which the carrying value exceeds the asset's fair value, as determined by discounted cash flows or other methods as appropriate for the asset type. We recognized$1.7 million of impairment of definite-lived intangible assets during fiscal year 2020 related toEdinburgh Partners management contracts due to the loss of a significant mandate. 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 A substantial amount of our investments is 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. The assessment of the hierarchy level of the assets or liabilities measured at fair value is determined based on the lowest level input that is significant to the fair value measurement in its entirety. See Note 1 - Significant Accounting Policies in the notes to consolidated financial statements in Item 8 of Part II of this Annual Report for more information on the fair value hierarchy. 59
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As ofSeptember 30, 2020 , Level 3 assets represented 24% of total assets measured at fair value, substantially all of which related to CIPs' investments in equity and debt securities, and real estate. There were$2.3 million of transfers into and$1.1 million of transfers out of Level 3 during fiscal year 2020. The following are descriptions of the significant assets measured at fair value and their fair value methodologies. Sponsored funds and separate accounts consist primarily of investments in nonconsolidated sponsored funds and to a lesser extent, separate accounts. Changes in the fair value of the investments are recognized as gains and losses in earnings. The fair values of funds are determined based on their published NAV or estimated using NAV as a practical expedient. The fair values of separate accounts are determined using quoted market prices, or independent third-party broker or dealer price quotes if quoted market prices are not available. Investments related to long-term incentive plans consist primarily of investments in sponsored funds related to certain compensation plans that have certain vesting provisions. Changes in fair value are recognized as gains and losses in earnings. The fair values of the investments are determined based on the funds' published NAV or estimated using NAV as a practical expedient. Other equity and debt securities consist of other equity investment securities and debt securities classified as trading or available-for-sale. Changes in the fair value of other equity and trading debt securities are recognized as gains and losses in earnings. Unrealized gains and losses on available-for-sale securities are recorded net of tax as part of accumulated other comprehensive income (loss) until realized, at which time they are recognized in earnings using the average cost method. The fair values of equity securities other than funds are determined using independent third-party broker or dealer price quotes or based on discounted cash flows using significant unobservable inputs. The fair values of debt securities are determined using independent third-party broker or dealer price quotes or based on discounted cash flows using significant unobservable inputs. Investments of CIPs consist of marketable debt and equity securities and other investments that are not generally traded in active markets. Changes in the fair value of the investments are recognized as gains and losses in earnings. The fair values of marketable securities are determined using quoted market prices, or independent third-party broker or dealer price quotes if quoted market prices are not available. The investments that are not generally traded in active markets consist of equity and debt securities of entities in emerging markets, fund products, other equity and debt instruments, real estate and loans. The fair values are determined using significant unobservable inputs in either a market-based or income-based approach, except for fund products, for which fair values are estimated using NAV as a practical expedient. Noncontrolling interests consist of third-party equity interests in CIPs and minority interests in certain subsidiaries. Noncontrolling interests that are redeemable or convertible for cash or other assets at the option of the noncontrolling interest holders and are classified as temporary equity at fair value, except when the fair value is less than the issuance date fair value, the reported amount is the issuance date fair value. Changes in fair value of redeemable noncontrolling interest is recognized as an adjustment to retained earnings. Nonredeemable noncontrolling interests do not permit the noncontrolling interest holders to request settlement, are reported at their issuance value and undistributed net income (loss) attributable to noncontrolling interests. The fair value of third-party equity interests in CIPs are determined based on the published NAV or estimated using NAV a practical expedient. The fair value of redeemable noncontrolling interests related to minority interest in certain subsidiaries are derived using discounted cash flows and guideline public company methodology, which include significant assumptions about forecasts of the AUM growth rate, pre-tax profit margin, discount rate and operating income multiples. Revenues We earn revenue primarily from providing investment management and related services to our customers. In addition to investment management, services include fund administration, sales and distribution, and shareholder servicing. Revenues are recognized when our obligations related to the services are satisfied and it is probable that a significant reversal of the revenue amount would not occur in future periods. The obligations are satisfied over time as the services are rendered, except for the sales and distribution obligations for the sale of shares of sponsored funds, which are satisfied on trade date. Multiple services included in customer contracts are accounted for separately when the obligations are determined to be distinct. Management judgement is involved in assessing the probability of significant revenue reversal and in the identification of distinct services. 60
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Fees from providing investment management and fund administration services
("investment management fees"), other than performance-based investment
management fees, are determined based on a percentage of AUM, primarily on a
monthly basis using daily average AUM, and are recognized as the services are
performed over time. Performance-based investment management fees are generated
when investment products' performance exceeds targets established in customer
contracts. These fees are recognized when the amount is no longer probable of
significant reversal and may relate to investment management services that were
provided in prior periods.
Sales and distribution fees primarily consist of upfront sales commissions and
ongoing distribution fees. Sales commissions are based on contractual rates for
sales of certain classes of sponsored funds and are recognized on trade date.
Distribution service fees are determined based on a percentage of AUM, primarily
on a monthly basis using daily average AUM. As the fee amounts are uncertain on
trade date, they are recognized over time as the amounts become known and may
relate to sales and distribution services provided in prior periods.
AUM is generally based on the fair value of the underlying securities held by
investment products and is calculated using fair value methods derived primarily
from unadjusted quoted market prices, unadjusted independent third-party broker
or dealer price quotes in active markets, or market prices or price quotes
adjusted for observable price movements after the close of the primary market.
The fair values of securities for which market prices are not readily available
are valued internally using various methodologies which incorporate significant
unobservable inputs as appropriate for each security type. Pricing of the
securities is governed by our global valuation and pricing policy, which defines
valuation and pricing conventions for each security type, including practices
for responding to unexpected or unusual market events.
As substantially all of our AUM is valued based on observable market prices or
inputs, market risk is the most significant risk underlying the valuation of our
AUM.
Income Taxes
Deferred tax assets and liabilities are recorded for temporary differences
between the tax basis of assets and liabilities and the reported amounts in the
consolidated financial statements using the statutory tax rates in effect for
the year when the reported amount of the asset or liability is expected to be
recovered or settled, respectively. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income tax expense in the
period that includes the enactment date. A valuation allowance is recorded to
reduce the carrying values of deferred tax assets to the amount that is more
likely than not to be realized. For each tax position taken or expected to be
taken in a tax return, we determine whether it is more likely than not that the
position will be sustained upon examination based on the technical merits of the
position, including resolution of any related appeals or litigation. A tax
position that meets the more likely than not recognition threshold is measured
at the largest amount of benefit that is greater than 50% likely of being
realized upon settlement.
As a multinational corporation, we operate in various locations outside the U.S.
and generate earnings worldwide. We repatriate the foreign earnings that are in
excess of regulatory, capital or operational requirements of all of our non-U.S.
subsidiaries.
Loss Contingencies
We are involved in various lawsuits and claims encountered in the normal course
of business. When such a matter arises and periodically thereafter, we consult
with our legal counsel and evaluate the merits of the claims based on the facts
available at that time. In management's opinion, an adequate accrual has been
made as of September 30, 2020 to provide for any probable losses that may arise
from such matters for which we could reasonably estimate an amount. See also
Note 16 - Commitments and Contingencies in the notes to consolidated financial
statements in Item 8 of Part II of this Annual Report.
NEW ACCOUNTING GUIDANCE
See Note 2 - New Accounting Guidance in the notes to consolidated financial
statements in Item 8 of Part II of this Annual Report.
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Selected Quarterly Financial Data (Unaudited) (in millions, except per share data) Quarter ended December 31 March 31 June 30 September 30 Fiscal year 20201 Operating revenues$ 1,389.2 $ 1,311.2 $ 1,161.1 $ 1,705.0 Operating income 372.9 339.9 232.5 103.6 Net income attributable to Franklin Resources, Inc.2 350.5 79.1 290.4 78.9 Earnings per share Basic$ 0.70 $ 0.16 $ 0.58 $ 0.15 Diluted 0.70 0.16 0.58 0.15 Dividends declared per share$ 0.27 $ 0.27 $ 0.27 $ 0.27 AUM (in billions) Ending$ 698.3 $ 580.3 $ 622.8 $ 1,418.9 Average 693.8 655.8 605.0 1,227.8 Fiscal year 20191 Operating revenues$ 1,385.4 $ 1,412.8 $ 1,448.4 $ 1,422.8 Operating income 385.3 367.3 349.2 365.1 Net income attributable to Franklin Resources, Inc.3 275.9 367.5 245.9 306.4 Earnings per share Basic$ 0.54 $ 0.72 $ 0.48 $ 0.61 Diluted 0.54 0.72 0.48 0.61 Dividends declared per share$ 0.26 $ 0.26 $ 0.26 $ 0.26 AUM (in billions) Ending$ 649.9 $ 712.3 $ 715.2 $ 692.6 Average 683.2 688.6 710.8 702.0 __________________
1 In the quarter ended
presentation of its consolidated statements of income to include dividend
and interest income and other expenses from consolidated investment products
in non-operating income. Amounts for the comparative prior fiscal quarters
have been reclassified to conform to the current presentation. These
reclassifications had no impact on previously reported net income
attributable to Franklin Resources, Inc. 2 Information presented for the quarter ended
impact of the
3 - Acquisitions in the notes to consolidated financial statements in Item 8
of Part II of this Annual Report for more information.
3 The quarter ended June 30, 2019 includes an income tax charge of
2018 upon issuance of final regulations by the
Risk Factors
For a description of certain risk factors and other important factors that may
affect us, our subsidiaries and our business, please see the description of the
risk factors set forth under Item 1A of Part I of this Annual Report, which is
incorporated herein by reference.
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