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Impacted by higher expenses, Franklin Resources Inc.’s (BEN - Analyst Report) fiscal second-quarter 2014 earnings of 89 cents per share missed the Zacks Consensus Estimate as well as the prior-year quarter earnings by a penny.

Our proven model predicted that Franklin may not post an earnings beat as it did not have the right combination of two key ingredients – positive Earnings ESP and a Zacks Rank #3 (Hold) or higher. It had a Zacks Rank #3 (Hold), but the Earnings ESP was 0.00%.

Lower-than-expected results were an outcome of a rise in expenses reflecting undisciplined expense management. However, increased level of assets under management (AUM) and a strong capital position were the tailwinds.

Net income was $561.0 million in the quarter compared with $572.8 million in the prior-year quarter.

Performance in Detail

Total operating revenue increased 4% year over year to $2.10 billion, mainly due to growth in investment management fees. However, revenue results were below the Zacks Consensus Estimate of $2.13 billion.

Investment management fees increased 8% year over year to $1.37 billion, while sales and distribution fees declined 1% year over year to $638.6 million. Moreover, shareholder servicing fees descended 12% on a year-over-year basis to $67.7 million, with other net revenue decreasing 19% year over year to $21.6 million.

Total operating expenses increased 2% year over year to $1.31 billion. The upsurge mainly resulted from increased information systems and technology expenses and elevated compensation and benefits and general, administrative and other expenses, partially offset by lower sales, distribution and marketing expenses.

As of Mar 31, 2014, total AUM was $886.9 billion, up from $823.7 billion as of Mar 31, 2013, driven by market appreciation of $68.7 billion. Simple monthly average AUM of $876.4 billion during the quarter climbed 9% year over year. Notably, net outflows of $7.1 billion were recorded in the quarter.

Capital Position

As of Mar 31, 2014, cash and cash equivalents along with investments were $9.4 billion compared with $8.6 billion as of Sep 30, 2013. Moreover, total stockholders' equity was $11.5 billion versus $10.7 billion as of Sep 30, 2013.

During the reported quarter, Franklin repurchased 3.4 million shares of its common stock at a total cost of $178.8 million.

Our Viewpoint

Franklin's global footprint is an exceptionally favorable strategic point as its AUM is well diversified. The company is also poised to benefit from its strong balance sheet. However, regulatory restrictions and sluggish economic recovery could mar AUM growth and increase costs. Additionally, higher expenses remain a matter of concern.

Currently, Franklin carries a Zacks Rank #3 (Hold). Among other investment managers, Legg Mason Inc. (LM - Analyst Report), Invesco Ltd. (IVZ - Analyst Report) and Lazard Ltd. (LAZ - Analyst Report) are scheduled to report March quarter-end results on May 1.

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