Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

FORWARD-LOOKING STATEMENTS

This Form 10-Q and the documents incorporated by reference herein may include forward-looking statements that reflect our current views with respect to future events, financial performance and market conditions. Such statements are provided under the “safe harbor” protection of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts and generally can be identified by words or phrases written in the future tense and/or preceded by words such as “anticipate,” “believe,” “could,” “depends,” “estimate,” “expect,” “intend,” “likely,” “may,” “plan,” “potential,” “seek,” “should,” “will,” “would,” or other similar words or variations thereof, or the negative thereof, but these terms are not the exclusive means of identifying such statements.

Forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that may cause actual results and outcomes to differ materially from any future results or outcomes expressed or implied by such forward-looking statements, including pandemic-related risks, market and volatility risks, investment performance and reputational risks, global operational risks, competition and distribution risks, third-party risks, technology and security risks, human capital risks, cash management risks, and legal and regulatory risks. The forward-looking statements contained in this Form 10-Q or that are incorporated by reference herein are qualified in their entirety by reference to the risks and uncertainties disclosed in this Form 10-Q and/or discussed under the headings “Risk Factors” and “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2022 (“fiscal year 2022”).

While forward-looking statements are our best prediction at the time that they are made, you should not rely on them and are cautioned against doing so. Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other possible future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. They are neither statements of historical fact nor guarantees or assurances of future performance. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them.

If a circumstance occurs after the date of this Form 10-Q that causes any of our forward-looking statements to be inaccurate, whether as a result of new information, future developments or otherwise, we undertake no obligation to announce publicly the change to our expectations, or to make any revision to our forward-looking statements, to reflect any change in assumptions, beliefs or expectations, or any change in events, conditions or circumstances upon which any forward-looking statement is based, unless required by law.

In this section, we discuss and analyze the results of operations and financial condition of Franklin Resources, Inc. (“Franklin”) and its subsidiaries (collectively, the “Company”). The following discussion should be read in conjunction with our Annual Report on Form 10-K for the fiscal year 2022 filed with the U.S. Securities and Exchange Commission, and the consolidated financial statements and notes thereto included elsewhere in this Form 10-Q.

OVERVIEW

Franklin is a holding company with subsidiaries operating under our Franklin Templeton® and/or subsidiary brand names. We are a global investment management organization that derives operating revenues and net income from providing investment management and related services to investors in jurisdictions worldwide. We deliver our investment capabilities through a variety of investment products, which include our sponsored funds, as well as institutional and high-net-worth separate accounts, retail separately managed account programs, sub-advised products, and other investment vehicles. Related services include fund administration, sales and distribution, and shareholder servicing. We may perform services directly or through third parties. We offer our services and products under our various distinct brand names, including, but not limited to, Franklin®, Templeton®, Legg Mason®, Alcentra®, Benefit Street Partners®, Brandywine Global Investment Management®, Clarion Partners®, ClearBridge Investments®, Fiduciary Trust International™, Franklin Bissett®, Franklin Mutual Series®, K2®, Lexington Partners®, Martin Currie®, O’Shaughnessy® Asset Management, Royce® Investment Partners and Western Asset Management Company®. We offer a broad product mix of fixed income, equity, alternative, multi-asset and cash management asset classes and solutions that meet a wide variety of specific investment goals and needs for individual and institutional investors. We also provide sub-advisory services to certain investment products sponsored by other companies which may be sold to investors under the brand names of those other companies or on a co-branded basis.

The level of our revenues depends largely on the level and relative mix of assets under management (“AUM”). As noted in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year 2022, the amount and mix of our AUM are subject to significant fluctuations that can negatively impact our revenues and income. The level of our revenues also depends on the fees charged for our services, which are based on contracts with our funds and customers, fund sales, and the number of shareholder transactions and accounts. These arrangements could change in the future.

During our first fiscal quarter, global equity markets provided positive returns reflecting indications that central banks may begin to slow the pace of monetary policy tightening, signs that elevated inflation could be softening, and strong corporate earnings in certain sectors. The S&P 500 Index and MSCI World Index increased 7.6% and 9.9% for the quarter. The global bond markets remained positive as the Bloomberg Global Aggregate Index increased 4.6% during the quarter, reflecting expectations of easing monetary policy.

Our total AUM at December 31, 2022 was $1,387.7 billion, 7% higher than at September 30, 2022 and 12% lower than at December 31, 2021. Monthly average AUM (“average AUM”) for the three months ended December 31, 2022 decreased 13% from the same period in the prior fiscal year.

On November 1, 2022, we acquired BNY Alcentra Group Holdings, Inc. (together with its subsidiaries, “Alcentra”), one of the largest European credit and private debt managers, with global expertise in senior secured loans, high yield bonds, private credit, structured credit, special situations and multi-strategy credit strategies, for cash consideration of $587.3 million, which includes $188.3 million for certain securities held in Alcentra’s collateralized loan obligations; deferred consideration of $60.4 million due November 1, 2023; and contingent consideration to be paid upon the achievement of certain performance thresholds over the next four years of up to $350.0 million that had an acquisition-date fair value of $24.6 million.

The business and regulatory environments in which we operate globally remain complex, uncertain and subject to change. We are subject to various laws, rules and regulations globally that impose restrictions, limitations, registration, reporting and disclosure requirements on our business, and add complexity to our global compliance operations.

Uncertainties regarding the global economy remain for the foreseeable future. As we continue to confront the challenges of the current economic and regulatory environments, we remain focused on the investment performance of our products and on providing high quality service to our clients. We continuously perform reviews of our business model. While we remain focused on expense management, we will also seek to attract, retain and develop personnel and invest strategically in systems and technology that will provide a secure and stable environment. We will continue to seek to protect and further our brand recognition while developing and maintaining broker-dealer and client relationships. The success of these and other strategies may be influenced by the factors discussed in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year 2022.

RESULTS OF OPERATIONS


	Three Months Ended December 31,						Percent Change
(in millions, except per share data)		2022				2021
Operating revenues			$	1,967.1			$	2,224.0		(12	%)
Operating income			194.0				557.7			(65	%)
Operating margin1			9.9		%		25.1		%

Net income attributable to Franklin Resources, Inc.			$	165.6			$	453.2		(63	%)
Diluted earnings per share			0.32				0.88			(64	%)

As adjusted (non-GAAP):2
Adjusted operating income			$	395.1			$	685.9		(42	%)
Adjusted operating margin			27.5		%		39.8		%

Adjusted net income			$	262.4			$	553.6		(53	%)
Adjusted diluted earnings per share			0.51				1.08			(53	%)

1Defined as operating income divided by operating revenues.

2“Adjusted operating income,” “adjusted operating margin,” “adjusted net income” and “adjusted diluted earnings per share” are based on methodologies other than generally accepted accounting principles. See “Supplemental Non-GAAP Financial Measures” for definitions and reconciliations of these measures.

ASSETS UNDER MANAGEMENT

AUM by asset class was as follows:


(in billions)	December 31, 2022		December 31, 2021		Percent Change
Fixed Income	$	494.8	$	642.1	(23	%)
Equity	419.1		563.4		(26	%)
Alternative	257.4		154.3		67	%
Multi-Asset	141.4		154.0		(8	%)
Cash Management	75.0		64.3		17	%
Total	$	1,387.7	$	1,578.1	(12	%)

Average AUM and the mix of average AUM by asset class are shown below.


(in billions)	Average AUM				Percent Change			Mix of Average AUM
for the three months ended December 31,	2022		2021				2022			2021
Fixed Income	$	490.3	$	642.4	(24	%)		36	%		41	%
Equity	417.3		549.3		(24	%)		31	%		35	%
Alternative	240.4		149.4		61	%		18	%		10	%
Multi-Asset	138.6		151.7		(9	%)		10	%		10	%
Cash Management	66.9		61.4		9	%		5	%		4	%
Total	$	1,353.5	$	1,554.2	(13	%)		100	%		100	%

Components of the change in AUM are shown below. Net market change, distributions and other includes appreciation (depreciation), distributions to investors that represent return on investments and return of capital, and foreign exchange revaluation.


(in billions)	Three Months Ended December 31,			Percent Change
	2022	2021
Beginning AUM		$	1,297.4	$	1,530.1	(15	%)
Long-term inflows		70.5		107.0		(34	%)
Long-term outflows		(81.4)		(82.9)		(2	%)
Long-term net flows		(10.9)		24.1		NM
Cash management net flows		17.5		5.8		202%
Total net flows		6.6		29.9		(78%)
Acquisitions		34.9		7.7		353%
Net market change, distributions and other		48.8		10.4		369%
Ending AUM		$	1,387.7	$	1,578.1	(12	%)

Components of the change in AUM by asset class were as follows:


(in billions)	Fixed Income		Equity		Alternative		Multi-Asset		Cash Management		Total
for the three months ended December 31, 2022
AUM at October 1, 2022	$	490.9	$	392.3	$	225.1	$	131.5	$	57.6	$	1,297.4
Long-term inflows	28.5		27.2		6.5		8.3		—		70.5
Long-term outflows	(41.8)		(26.9)		(6.8)		(5.9)		—		(81.4)
Long-term net flows	(13.3)		0.3		(0.3)		2.4		—		(10.9)
Cash management net flows	—		—		—		—		17.5		17.5
Total net flows	(13.3)		0.3		(0.3)		2.4		17.5		6.6
Acquisition	—		—		34.9		—		—		34.9
Net market change, distributions and other	17.2		26.5		(2.3)		7.5		(0.1)		48.8
AUM at December 31, 2022	$	494.8	$	419.1	$	257.4	$	141.4	$	75.0	$	1,387.7

AUM increased $90.3 billion, or 7%, during the three months ended December 31, 2022 due to the positive impact of $48.8 billion of net market change, distributions and other, $34.9 billion from an acquisition, and $17.5 billion of cash management net inflows, partially offset by $10.9 billion of long-term net outflows. Long-term net outflows included a $2.1 billion fixed income institutional redemption that had minimal impact on revenue. Net market change, distributions and other primarily consists of $58.5 billion of market appreciation, an $8.8 billion increase from foreign exchange revaluation, partially offset by $18.5 billion of long-term distributions. The market appreciation occurred in all asset classes with the exception of the alternative asset class and reflected positive returns in the global equity and fixed income markets. Foreign exchange revaluation from AUM in products that are not U.S. dollar denominated was primarily due to a weaker U.S. dollar compared to the Euro, Japanese Yen, Australian dollar and Pound Sterling.

Long-term inflows decreased 34% to $70.5 billion, as compared to the prior year period, driven by lower inflows in equity, multi-asset, and fixed income open end funds, fixed income institutional separate accounts, sub-advised CITs, and equity retail separate accounts. Decreased inflows for open end mutual funds include the impact of lower reinvested distributions, which were $12.1 billion in the current year quarter, as compared to $23.5 billion in the prior year quarter. Long-term outflows decreased 2% to $81.4 billion due to lower outflows in equity open end funds and multi-asset and equity sub-advised mutual funds, partially offset by higher outflows in fixed income and alternative institutional separate accounts, fixed income open end funds, and alternative private open end funds.


(in billions)	Fixed Income		Equity		Alternative		Multi-Asset		Cash Management		Total
for the three months ended December 31, 2021
AUM at October 1, 2021	$	650.3	$	523.6	$	145.2	$	152.4	$	58.6	$	1,530.1
Long-term inflows	43.7		46.1		6.1		11.1		—		107.0
Long-term outflows	(35.6)		(33.4)		(3.1)		(10.8)		—		(82.9)
Long-term net flows	8.1		12.7		3.0		0.3		—		24.1
Cash management net flows	—		—		—		—		5.8		5.8
Total net flows	8.1		12.7		3.0		0.3		5.8		29.9
Acquisitions	—		4.6		0.8		2.3		—		7.7
Net market change, distributions and other	(16.3)		22.5		5.3		(1.0)		(0.1)		10.4
AUM at December 31, 2021	$	642.1	$	563.4	$	154.3	$	154.0	$	64.3	$	1,578.1

AUM increased $48.0 billion, or 3%, during the three months ended December 31, 2021 due to $24.1 billion of long-term net inflows, the positive impact of $10.4 billion of net market change, distributions and other, $7.7 billion from acquisitions and $5.8 billion of cash management net inflows. Net market change, distributions and other consists of $41.8 billion of market appreciation, partially offset by $30.1 billion of long-term distributions and a $1.3 billion decrease from foreign exchange revaluation. The market appreciation occurred primarily in the equity asset class, partially offset by depreciation in the fixed income asset class. The foreign exchange revaluation resulted from AUM in products that are not U.S. dollar denominated, which represented 11% of total AUM as of December 31, 2021, and was primarily due to the strengthening of the U.S. dollar against the Japanese Yen, Euro and Brazilian Real, partially offset by weakening of the U.S. dollar against the Australian dollar.

Long-term inflows increased 29% to $107.0 billion, as compared to the prior quarter period, due to higher inflows in all long-term asset classes including $7.4 billion in net client accounts related to the newly joined Investment Grade Credit team as well as $23.5 billion of reinvested distributions. Long-term outflows decreased 11% to $82.9 billion due to lower outflows in the fixed income and equity asset classes. Long-term outflows in the multi-asset asset class included a $3.6 billion institutional redemption.

AUM by sales region was as follows:


(in billions)	December 31, 2022		December 31, 2021		Percent Change
United States	$	993.1	$	1,186.5	(16	%)
International
Asia-Pacific	123.4		155.0		(20	%)
Europe, Middle East and Africa	156.4		156.2		0	%
Americas, excl. U.S.	114.8		80.4		43	%
Total international	394.6		391.6		1	%
Total	$	1,387.7	$	1,578.1	(12	%)

Investment Performance Overview

A key driver of our overall success is the long-term investment performance of our investment products. A measure of the performance of these products is the percentage of AUM exceeding peer group medians and benchmarks. We compare the relative performance of our mutual funds against peers, and of our strategy composites against benchmarks.

The performance of our mutual fund products against peer group medians and of our strategy composites against benchmarks is presented in the table below.


	Peer Group Comparison1								Benchmark Comparison2
	% of Mutual Fund AUM in Top Two Peer Group Quartiles								% of Strategy Composite AUM Exceeding Benchmark
as of December 31, 2022	1-Year		3-Year		5-Year		10-Year		1-Year		3-Year		5-Year		10-Year
Fixed Income	45	%	44	%	39	%	69	%	27	%	40	%	50	%	90	%
Equity	52	%	50	%	56	%	61	%	58	%	49	%	52	%	37	%
Total AUM3	57	%	56	%	57	%	55	%	52	%	54	%	59	%	67	%

1Mutual fund performance is sourced from Morningstar and measures the percent of ranked AUM in the top two quartiles versus peers. Total mutual fund AUM measured for the 1-, 3-, 5- and 10-year periods represents 35%, 35%, 35% and 33% of our total AUM as of December 31, 2022.

2Strategy composite performance measures the percent of composite AUM beating its benchmark. The benchmark comparisons are based on each account’s/composite’s (strategy composites may include retail separately managed accounts and mutual fund assets managed as part of the same strategy) return as compared to a market index that has been selected to be generally consistent with the asset class of the account/composite. Total strategy composite AUM measured for the 1-, 3-, 5- and 10-year periods represents 56%, 56%, 55% and 47% of our total AUM as of December 31, 2022.

3Total mutual fund AUM includes performance of our alternative and multi-asset funds, and total strategy composite AUM includes performance of our alternative composites. Alternative and multi-asset AUM represent 19% and 10% of our total AUM at December 31, 2022.

Mutual fund performance data includes U.S. and cross-border domiciled mutual funds and exchange-traded funds, and excludes cash management and fund of funds. These results assume the reinvestment of dividends, are based on data available as of January 10, 2023, and are subject to revision.

Past performance is not indicative of future results. For AUM included in institutional and retail separately managed accounts and investment funds managed in the same strategy as separate accounts, performance comparisons are based on gross-of-fee performance. For investment funds which are not managed in a separate account format, performance comparisons are based on net-of-fee performance. These performance comparisons do not reflect the actual performance of any specific separate account or investment fund; individual separate account and investment fund performance may differ. The information in this presentation is provided solely for use in connection with this document, and is not directed toward existing or potential clients of Franklin.

OPERATING REVENUES

The table below presents the percentage change in each operating revenue category.


(in millions)	Three Months Ended December 31,			Percent Change
	2022	2021
Investment management fees		$	1,631.8	$	1,760.5	(7	%)
Sales and distribution fees		291.9		398.2		(27	%)
Shareholder servicing fees		33.4		47.7		(30	%)
Other		10.0		17.6		(43	%)
Total Operating Revenues		$	1,967.1	$	2,224.0	(12	%)

Investment Management Fees

Investment management fees decreased $128.7 million for the three months ended December 31, 2022 primarily due to a 13% decrease in average AUM, partially offset by higher performance fees. The decrease in average AUM occurred primarily in the fixed income and equity asset classes, partially offset by an increase in the alternative asset class that includes the acquisition of Lexington Partners L.P. (“Lexington”) and Alcentra.

Our effective investment management fee rate excluding performance fees (annualized investment management fees excluding performance fees divided by average AUM) increased to 41.7 basis points for the three months ended December 31, 2022, from 41.4 basis points for the same period in the prior fiscal year.

Performance fees were $209.0 million and $139.9 million for the three months ended December 31, 2022 and 2021. The increase was primarily due to $144.5 million of performance fees earned by Lexington, which were passed through as compensation expense per the terms of the acquisition agreement, partially offset by lower performance fees earned by our other alternative specialist investment managers.

Sales and Distribution Fees

Sales and distribution fees by revenue driver are presented below.


(in millions)	Three Months Ended December 31,			Percent Change
	2022	2021
Asset-based fees		$	245.0	$	321.9	(24	%)
Sales-based fees		46.9		76.3		(39	%)
Sales and Distribution Fees		$	291.9	$	398.2	(27	%)

Asset-based distribution fees decreased $76.9 million for the three months ended December 31, 2022 primarily due to a 21% decrease in the related average AUM and a higher mix of lower-fee assets.

Sales-based fees decreased $29.4 million for the three months ended December 31, 2022 primarily due to a 40% decrease in commissionable sales.

Shareholder Servicing Fees

Shareholder servicing fees decreased $14.3 million for the three months ended December 31, 2022 primarily due to lower levels of related AUM, a reduction in fee rates charged for transfer agency services in the U.S., and fewer transactions.

Other

Other revenue decreased $7.6 million for the three months ended December 31, 2022 primarily due to lower real estate transaction fees earned by certain of our alternative asset managers.

OPERATING EXPENSES

The table below presents the percentage change in each operating expense category.


	Three Months Ended December 31,					Percent Change
(in millions)		2022			2021
Compensation and benefits			$	979.2		$	802.6	22	%
Sales, distribution and marketing			388.6			510.1		(24	%)
Information systems and technology			121.4			123.8		(2	%)
Occupancy			54.5			56.3		(3	%)
Amortization of intangible assets			83.2			58.3		43	%
General, administrative and other			146.2			115.2		27	%
Total Operating Expenses			$	1,773.1		$	1,666.3	6	%

Compensation and Benefits

The components of compensation and benefits expenses are presented below.


	Three Months Ended December 31,					Percent Change
(in millions)		2022			2021
Salaries, wages and benefits			$	360.6		$	349.8	3	%
Incentive compensation			383.9			405.5		(5	%)
Acquisition-related retention			63.6			40.0		59	%
Acquisition-related performance fee pass through			144.5			0.4		NM
Other1			26.6			6.9		286	%
Compensation and Benefits Expenses			$	979.2		$	802.6	22	%

1Includes impact of gains and losses on investments related to deferred compensation plans and seed investments, which is offset in investment and other income (losses), net; minority interests in certain subsidiaries, which is offset in net income (loss) attributable to redeemable noncontrolling interests; and special termination benefits.

Salaries, wages and benefits increased $10.8 million for the three months ended December 31, 2022, primarily due to the recent acquisitions and a $4.3 million increase in termination benefits, which were substantially offset by the impact of headcount reductions.

Incentive compensation decreased $21.6 million for the three months ended December 31, 2022 primarily due to lower incentive compensation at specialist investment managers and lower expectations of our annual performance, offset in part by the recent acquisitions, and an increase in expense for deferred compensation awards, due in part to an increase in annual acceleration for retirement-eligible employees.

Acquisition-related retention expenses increased $23.6 million for the three months ended December 31, 2022, primarily due to the acquisitions of Lexington and Alcentra.

Acquisition-related performance fee pass through increased $144.1 million due to higher performance fees earned by Lexington.

Other compensation and benefits increased $19.7 million for the three months ended December 31, 2022 primarily due to compensation related to minority interests and an increase in special termination benefits, primarily due to the acquisition of Alcentra and workforce optimization initiatives.

We expect to incur additional acquisition-related retention expenses of approximately $190 million during the remainder of the current fiscal year, and annual amounts beginning at approximately $220 million in the fiscal year ending September 30, 2024 and decreasing over the following two fiscal years by approximately $70 million and $20 million. At December 31, 2022, our global workforce had decreased to approximately 9,400 employees from approximately 10,400 at December 31, 2021.

Sales, Distribution and Marketing

Sales, distribution and marketing expenses by cost driver are presented below.


	Three Months Ended December 31,					Percent Change
(in millions)		2022			2021
Asset-based expenses			$	331.9		$	419.6	(21	%)
Sales-based expenses			44.3			72.1		(39	%)
Amortization of deferred sales commissions			12.4			18.4		(33	%)
Sales, Distribution and Marketing			$	388.6		$	510.1	(24	%)

Asset-based expenses decreased $87.7 million for the three months ended December 31, 2022 primarily due to a 20% decrease in related average AUM and a higher mix of lower-fee assets. Distribution expenses are generally not directly correlated with distribution fee revenues due to certain fee structures that do not provide full recovery of distribution costs.

Sales-based expenses decreased $27.8 million for the three months ended December 31, 2022 substantially due to a 40% decrease in commissionable sales.

Information Systems and Technology

Information systems and technology expenses decreased $2.4 million for the three months ended December 31, 2022, primarily due to lower technology depreciation.

Amortization of intangible assets

Amortization of intangible assets increased $24.9 million for the three months ended December 31, 2022, primarily due to intangible assets recognized as part of the acquisition of Lexington.

General, Administrative and Other

General, administrative and other operating expenses increased $31.0 million for the three months ended December 31, 2022, primarily due to a $12.4 million increase in acquisition-related expenses, a $10.1 million increase in platform and placement fees and a $6.2 million increase in professional fees.

OTHER INCOME (EXPENSES)

Other income (expenses) consisted of the following:


	Three Months Ended December 31,					Percent Change
(in millions)		2022			2021
Investment and other income, net			$	91.1		$	57.0	60	%
Interest expense			(30.9)			(19.3)		60	%
Investment and other income (losses) of consolidated investment products, net			(13.6)			104.7		NM
Expenses of consolidated investment products			(11.5)			(4.2)		174	%
Other Income, Net			$	35.1		$	138.2	(75	%)

Investment and other income, net increased $34.1 million for the three months ended December 31, 2022 primarily due to an increase in dividend and interest income and higher gains on investments, partially offset by foreign currency exchange losses in the current period.

Investments held by the Company generated net gains of $45.5 million for the three months ended December 31, 2022, primarily from investments in nonconsolidated funds and separate accounts and assets invested for deferred compensation plans, partially offset by net losses from investments measured at cost adjusted for observable price changes. Investments held by the Company generated net gains of $25.8 million in the prior year period, primarily from investments measured at cost adjusted for observable price changes, investments in nonconsolidated funds and separate accounts, and assets invested for deferred compensation plans.

Equity method investees generated income of $33.2 million for the three months ended December 31, 2022, primarily related to various global fixed income and equity funds, as compared to income of $24.7 million in the prior year, primarily related to various global equity funds.

Net foreign currency exchange losses were $27.1 million for the three months ended December 31, 2022, as compared to net gains of $3.9 million for the three months ended December 31, 2021. The decrease was primarily due to the impact of the weakening of the U.S. dollar against the Euro and British Pound on cash and cash equivalents denominated in U.S. dollars held by our European subsidiaries.

Dividend and interest income increased $30.4 million for the three months ended December 31, 2022, as compared to the prior year period, primarily due to higher yields.

Interest expense increased $11.6 million for the three months ended December 31, 2022 primarily due to accretion on Lexington deferred consideration and an increase in interest recognized on tax reserves in the current year period.

Investments held by consolidated investment products (“CIPs”) generated losses of $13.6 million in the three months ended December 31, 2022, largely related to losses on holdings of various equity and fixed income funds, partially offset by

gains on various alternative funds. Investments held by CIPs generated gains of $104.7 million in the prior year period, primarily related to gains on various holdings of alternative funds, partially offset by losses on holdings of various equity and fixed income funds.

Expenses of consolidated investments products increased $7.3 million for the three months ended December 31, 2022, due to activity of the funds.

Our cash, cash equivalents and investments portfolio by asset class and accounting classification at December 31, 2022, excluding third-party assets of CIPs, was as follows:


	Accounting Classification1										Total
(in millions)	Cash and Cash Equivalents		Investments at Fair Value		Equity Method Investments		Other Investments		Direct Investments in CIPs
Cash and Cash Equivalents	$	3,547.8	$	—	$	—	$	—	$	—	$	3,547.8
Investments
Alternative	—		409.4		599.8		55.3		617.4		1,681.9
Equity	—		292.8		191.8		152.8		113.0		750.4
Fixed Income	—		234.4		28.1		37.4		248.4		548.3
Multi-Asset	—		33.0		11.0		—		73.7		117.7
Total investments	—		969.6		830.7		245.5		1,052.5		3,098.3
Total Cash and Cash Equivalents and Investments2, 3	$	3,547.8	$	969.6	$	830.7	$	245.5	$	1,052.5	$	6,646.1

1See Note 1 – Significant Accounting Policies in the notes to consolidated financial statements in Item 8 of Part II of our Annual Report on Form 10-K for fiscal year 2022 for information on investment accounting classifications.

2Total cash and cash equivalents and investments includes $4,053.3 million used for operational activities, including investments in sponsored funds and other products, and $206.2 million necessary to comply with regulatory requirements.

3Total cash and cash equivalents and investments includes $300.0 million attributable to employee-owned and other third-party investments made through partnerships which are offset in nonredeemable noncontrolling interests.

TAXES ON INCOME

Our effective income tax rate was 26.3% and 21.7% for the three months ended December 31, 2022, and 2021. The rate increase for three-month period was primarily due to activity of CIPs for which there is no related tax impact, benefits in the prior year related to the release of tax reserves due to statute of limitation expiration and a decrease in foreign earnings.

Our effective income tax rate reflects the relative contributions of earnings in the jurisdictions in which we operate, which have varying tax rates. Changes in our pre-tax income mix, tax rates or tax legislation in such jurisdictions may affect our effective income tax rate and net income.

SUPPLEMENTAL NON-GAAP FINANCIAL MEASURES

As supplemental information, we are providing performance measures for “adjusted operating income,” “adjusted operating margin,” “adjusted net income” and “adjusted diluted earnings per share,” each of which is based on methodologies other than generally accepted accounting principles (“non-GAAP measures”). Management believes these non-GAAP measures are useful indicators of our financial performance and may be helpful to investors in evaluating our relative performance against industry peers.

“Adjusted operating income,” “adjusted operating margin,” “adjusted net income” and “adjusted diluted earnings per share” are defined below, followed by reconciliations of operating income, operating margin, net income attributable to Franklin Resources, Inc. and diluted earnings per share on a U.S. GAAP basis to these non-GAAP measures. Non-GAAP measures should not be considered in isolation from, or as substitutes for, any financial information prepared in accordance with U.S. GAAP, and may not be comparable to other similarly titled measures of other companies. Additional reconciling items may be added in the future to these non-GAAP measures if deemed appropriate.

Adjusted Operating Income

We define adjusted operating income as operating income adjusted to exclude the following:

Elimination of operating revenues upon consolidation of investment products.
Acquisition-related items:

◦Acquisition-related retention compensation.

◦Other acquisition-related expenses including professional fees, technology costs and fair value adjustments related to contingent consideration assets and liabilities.

◦Amortization of intangible assets.

◦Impairment of intangible assets and goodwill, if any.

Special termination benefits related to workforce optimization initiatives related to past acquisitions and certain initiatives undertaken by the Company.
Impact on compensation and benefits expense from gains and losses on investments related to deferred compensation plans, which is offset in investment and other income (losses), net.
Impact on compensation and benefits expense related to minority interests in certain subsidiaries, which is offset in net income (loss) attributable to redeemable noncontrolling interests.

Adjusted Operating Margin

We calculate adjusted operating margin as adjusted operating income divided by adjusted operating revenues. We define adjusted operating revenues as operating revenues adjusted to exclude the following:

Elimination of operating revenues upon consolidation of investment products.
Acquisition-related performance-based investment management fees which are passed through as compensation and benefits expense.
Sales and distribution fees and a portion of investment management fees allocated to cover sales, distribution and marketing expenses paid to the financial advisers and other intermediaries who sell our funds on our behalf.

Adjusted Net Income and Adjusted Diluted Earnings Per Share

We define adjusted net income as net income attributable to Franklin Resources, Inc. adjusted to exclude the following:

Activities of CIPs.
Acquisition-related items:

◦Acquisition-related retention compensation.

◦Other acquisition-related expenses including professional fees, technology costs and fair value adjustments related to contingent consideration assets and liabilities.

◦Amortization of intangible assets.

◦Impairment of intangible assets and goodwill, if any.

◦Write off of noncontrolling interests related to the wind down of an acquired business.

◦Interest expense for amortization of Legg Mason debt premium from acquisition-date fair value adjustment.

Special termination benefits related to workforce optimization initiatives related to past acquisitions and certain initiatives undertaken by the Company.
Net gains or losses on investments related to deferred compensation plans which are not offset by compensation and benefits expense.
Net compensation and benefits expense related to minority interests in certain subsidiaries not offset by net income (loss) attributable to redeemable noncontrolling interests.
Unrealized investment gains and losses.
Net income tax expense of the above adjustments based on the respective blended rates applicable to the adjustments.

We define adjusted diluted earnings per share as diluted earnings per share adjusted to exclude the per share impacts of the adjustments applied to net income in calculating adjusted net income.

In calculating our non-GAAP measures, we adjust for the impact of CIPs because it is not considered reflective of our underlying results of operations. Acquisition-related items and special termination benefits are excluded to facilitate comparability to other asset management firms. We adjust for compensation and benefits expense related to funded deferred compensation plans because it is partially offset in other income (expense), net. We adjust for compensation and benefits expense and net income (loss) attributable to redeemable noncontrolling interests to reflect the economics of certain profits interest arrangements. Sales and distribution fees and a portion of investment management fees generally cover sales, distribution and marketing expenses and, therefore, are excluded from adjusted operating revenues. In addition, when calculating adjusted net income and adjusted diluted earnings per share we exclude unrealized investment gains and losses included in investment and other income (losses) because the related investments are generally expected to be held long term.

The calculations of adjusted operating income, adjusted operating margin, adjusted net income and adjusted diluted earnings per share are as follows:


(in millions)	Three Months Ended December 31,
	2022	2021
Operating income		$	194.0	$	557.7
Add (subtract):
Elimination of operating revenues upon consolidation of investment products1		5.1		8.3
Acquisition-related retention		63.6		40.0
Compensation and benefits expense from gains on deferred compensation and seed investments, net		5.6		4.2
Other acquisition-related expenses		22.6		14.7
Amortization of intangible assets		83.2		58.3
Special termination benefits		10.9		2.7
Compensation and benefits expense related to minority interests in certain subsidiaries		10.1		—
Adjusted operating income		$	395.1	$	685.9

Total operating revenues		$	1,967.1	$	2,224.0
Add (subtract):
Acquisition-related pass through performance fees		(144.5)		(0.4)
Sales and distribution fees		(291.9)		(398.2)
Allocation of investment management fees for sales, distribution and marketing expenses		(96.7)		(111.9)
Elimination of operating revenues upon consolidation of investment products1		5.1		8.3
Adjusted operating revenues		$	1,439.1	$	1,721.8

Operating margin		9.9%		25.1%
Adjusted operating margin		27.5%		39.8%


(in millions, except per share data)	Three Months Ended December 31,
	2022	2021
Net income attributable to Franklin Resources, Inc.		$	165.6	$	453.2
Add (subtract):
Net (income) loss of consolidated investment products1		(3.6)		10.0
Acquisition-related retention		63.6		40.0
Other acquisition-related expenses		28.7		15.1
Amortization of intangible assets		83.2		58.3

Special termination benefits		10.9		2.7
Net gains on deferred compensation plan investments not offset by compensation and benefits expense		(7.6)		(0.3)
Unrealized investment losses (gains)		(30.7)		1.8
Interest expense for amortization of debt premium		(6.3)		(6.3)
Net compensation and benefits expense related to minority interests in certain subsidiaries not offset by net income (loss) attributable to redeemable noncontrolling interests		0.4		—
Net income tax expense of adjustments		(41.8)		(20.9)
Adjusted net income		$	262.4	$	553.6

Diluted earnings per share		$	0.32	$	0.88
Adjusted diluted earnings per share		0.51		1.08

1The impact of CIPs is summarized as follows:


(in millions)	Three Months Ended December 31,
	2022	2021
Elimination of operating revenues upon consolidation		$	(5.1)	$	(8.3)
Other income (expenses), net		(2.8)		72.5
Less: income (loss) attributable to noncontrolling interests		(11.5)		74.2
Net income (loss)		$	3.6	$	(10.0)

LIQUIDITY AND CAPITAL RESOURCES

Cash flows were as follows:


	Three Months Ended December 31,
(in millions)	2022		2021
Operating cash flows	$	(256.3)	$	166.4
Investing cash flows	(1,042.6)		(728.6)
Financing cash flows	958.9		467.3

Net cash used by operating activities during the three months ended December 31, 2022 as compared to net cash provided in the prior year was primarily due to lower net income, a decrease in accrued compensation and benefits and higher net purchases of investments by CIPs, partially offset by adjustments for losses from CIPs as compared to gains in the prior year and decreases in receivables and other assets. Net cash used in investing activities increased primarily due to cash paid for acquisitions in the current year, higher net purchases of investments by CLOs, and net purchases of investments as compared to net liquidations in the prior year. Net cash provided by financing activities increased primarily due to proceeds from repurchase agreements, higher net proceeds from the debt of CIPs and higher net subscriptions in CIPs by noncontrolling interests.

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)	December 31, 2022		September 30, 2022
Assets
Cash and cash equivalents	$	3,449.4	$	4,086.8
Receivables	1,200.2		1,130.8
Investments	927.9		830.0
Total Liquid Assets	$	5,577.5	$	6,047.6

Liability
Debt	$	3,370.5	$	3,376.4

Liquidity

Liquid assets consist of cash and cash equivalents, receivables and certain investments. Cash and cash equivalents at December 31, 2022 primarily consist of money market funds and deposits with financial institutions. Liquid investments consist of investments in sponsored and other funds, direct investments in redeemable CIPs, other equity and debt securities, and time deposits with maturities greater than three months.

We utilize a significant portion of our liquid assets to satisfy operational and regulatory requirements and fund capital contributions to sponsored and other products. Certain of our subsidiaries are required by our internal policy or regulation to maintain minimum levels of cash and/or capital, and may be restricted in their ability to transfer cash to their parent companies. Should we require more capital than is available for use, we could elect to reduce the level of discretionary activities, such as share repurchases or investments in sponsored and other products, we could raise capital through debt or equity issuances, or utilize existing or new credit facilities. These alternatives could result in increased interest expense, decreased dividend or interest income, or other dilution to our earnings.

Capital Resources

We believe that we can meet our present and reasonably foreseeable operating cash needs and future commitments through existing liquid assets, continuing cash flows from operations, amounts available under the credit facility discussed below, the ability to issue debt or equity securities and borrowing capacity under our uncommitted commercial paper private placement program.

In prior fiscal years, we issued senior unsecured unsubordinated notes for general corporate purposes and to redeem outstanding notes. At December 31, 2022, Franklin’s outstanding senior notes had an aggregate principal amount due of $1,600.0 million. The notes have fixed interest rates from 1.600% to 2.950% with interest paid semi-annually and have an aggregate carrying value, inclusive of unamortized discounts and debt issuance costs, of $1,594.4 million. At December 31, 2022, Legg Mason’s outstanding senior notes had an aggregate principal amount due of $1,250.0 million. The notes have fixed interest rates from 3.950% to 5.625% with interest paid semi-annually and have an aggregate carrying value, inclusive of unamortized premium, of $1,486.8 million at December 31, 2022. Effective August 2, 2021, Franklin agreed to unconditionally and irrevocably guarantee all of the outstanding notes issued by Legg Mason.

The senior notes contain an optional redemption feature that allows us to redeem each series of notes prior to maturity in whole or in part at any time, at a make-whole redemption price. The indentures governing the senior notes contain limitations on our ability and the ability of our subsidiaries to pledge voting stock or profit participating equity interests in our subsidiaries to secure other debt without similarly securing the notes equally and ratably. In addition, the indentures include requirements that must be met if we consolidate or merge with, or sell all of our assets to, another entity.

We maintain a 364-day revolving credit facility with an aggregate commitment of $500.0 million that matures September 2023. As of the time of this filing, there are no amounts outstanding with respect to the 364-day revolving credit facility. We have a 3-year term loan with an aggregate commitment of $300.0 million. The 364-day revolving credit facility and term loan credit agreement contain a financial performance covenant requiring that the Company maintains a consolidated net leverage ratio, measured as of the last day of each fiscal quarter, of no greater than 3.00 to 1.00. We were in compliance with all debt covenants at December 31, 2022.

At December 31, 2022, we had $500.0 million of short-term commercial paper available for issuance under an uncommitted private placement program which has been inactive since 2012 and is unrated.

Our ability to access the capital markets in a timely manner depends on a number of factors, including our credit rating, the condition of the global economy, investors’ willingness to purchase our securities, interest rates, credit spreads and the valuation levels of equity markets. If we are unable to access capital markets in a timely manner, our business could be adversely impacted.

Uses of Capital

We expect that our main uses of cash will be to invest in and grow our business including through acquisitions, pay stockholder dividends, invest in our products, pay income taxes and operating expenses of the business, enhance technology infrastructure and business processes, repurchase shares of our common stock, and repay and service debt. While we expect to continue to repurchase shares to offset dilution from share-based compensation, and expect to continue to repurchase shares opportunistically from time to time, we will likely spend more of our post-dividend free cash flow investing in our business, including seed capital and acquiring resources to help grow our investment teams and operations.

We typically declare cash dividends on a quarterly basis, subject to approval by our Board of Directors. We declared regular dividends of $0.30 per share during the three months ended December 31, 2022 and $0.29 per share during the three months ended December 31, 2021. We currently expect to continue paying comparable regular dividends on a quarterly basis to holders of our common stock depending upon earnings and other relevant factors.

We maintain a stock repurchase program to manage our equity capital with the objective of maximizing shareholder value. Our stock repurchase program is effected through open-market purchases and private transactions in accordance with applicable laws and regulations, and is not subject to an expiration date. The size and timing of these purchases will depend on business conditions, price, market and other factors. During the three months ended December 31, 2022, we repurchased 0.5 million shares of our common stock at a cost of $14.2 million and we repurchased 0.7 million shares of our common stock at a cost of $21.7 million in the prior year period. At December 31, 2022, 23.9 million shares remained available for repurchase under the authorization of 80.0 million shares approved by our Board of Directors in April 2018.

We invested $111.0 million, net of redemptions, into our sponsored products during the three months ended December 31, 2022 and redeemed $4.2 million, net of investments, in the prior year period.

On September 27, 2022 we entered into a lease agreement for office space in New York City located at One Madison Avenue with occupancy expected to begin in early fiscal year 2024 with an aggregate expected commitment of $766.7 million over 16 years. This is part of an initiative to consolidate our existing office space in New York City.

On November 1, 2022, we acquired all of the outstanding ownership interests in BNY Alcentra Group Holdings, Inc. from The Bank of New York Mellon Corporation for cash consideration of approximately $587.3 million paid at close, which includes $188.3 million for certain securities held in Alcentra’s collateralized loan obligations (“CLOs”); deferred consideration of $60.4 million; and contingent consideration of up to $350.0 million to be paid upon the achievement of certain performance thresholds over the next four years that has an acquisition-date fair value of $24.6 million. We paid the purchase price from our existing cash.

On December 15, 2022, we entered into repurchase agreements with a third-party financing company for certain securities held in Alcentra’s CLOs. Under the terms of the repurchase agreements, we received cash proceeds of approximately $175.0 million with pledged collateral consisting of Alcentra investments with a carrying value of $198.9 million at December 31, 2022. The repurchase agreements have contractual maturity dates ranging between 2029 to 2034.

On April 1, 2022, we acquired all of the outstanding ownership interests in Lexington for cash consideration of approximately $1.0 billion and additional payments of $750 million to be paid in cash over the next three years. A payment of $250 million is expected to be made during the second quarter of fiscal year 2023 from our existing cash.

The funds that we manage have their own resources available for purposes of providing liquidity to meet shareholder redemptions, including securities that can be sold or provided to investors as in-kind redemptions, and lines of credit. Increased liquidity risks and redemptions have required, and may continue to require, increased cash in the form of loans or other lines of credit to help settle redemptions and for other related purposes. While we have no legal or contractual obligation to do so, we have in certain instances voluntarily elected to provide the funds with direct or indirect financial support based on our business objectives. We did not provide financial or other support to our sponsored funds during the three months ended December 31, 2022.

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. These estimates, judgments and assumptions are affected by our application of accounting policies. Further, concerns about the global economic outlook have adversely affected, and may continue to adversely affect, our business, financial condition and results of operations including the estimates and assumptions made by management. Actual results could differ from the estimates. Described below are the updates to our critical accounting policies disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for fiscal year 2022.

Consolidation

We consolidate our subsidiaries and investment products in which we have a controlling financial interest. We have a controlling financial interest when we own a majority of the voting interest in a voting interest entity or are the primary beneficiary of a variable interest entity (“VIE”). Our VIEs are primarily investment products and our variable interests consist of our equity ownership interests in and investment management fees earned from these products. As of December 31, 2022, we were the primary beneficiary of 56 investment product VIEs.

Business Combinations

Business combinations are accounted for by recognizing the acquired assets, including separately identifiable intangible assets, and assumed liabilities at their acquisition-date estimated fair values. Any excess of the purchase consideration over the acquisition-date fair values of these identifiable assets and liabilities is recognized as goodwill. Goodwill and indefinite-lived intangible assets are tested for impairment annually and when an event occurs or circumstances change that more likely than not reduce the fair value of the related reporting unit or indefinite-lived intangible asset below its carrying value. Definite-lived intangible assets are tested for impairment quarterly.

Subsequent to the annual impairment tests performed as of August 1, 2022, we monitored both macroeconomic and entity-specific factors, including changes in our AUM to determine whether circumstances have changed that would more likely than not reduce the fair value of the reporting unit below its carrying value or indicate that the other indefinite-lived intangible assets might be impaired. We also monitored fluctuations of our common stock per share price to evaluate our market capitalization relative to the reporting unit as a whole. During the three months ended December 31, 2022, there were no events or circumstances which would indicate that goodwill, indefinite-lived intangible assets or definite-lived intangible assets might be impaired.

While we believe that the assumptions used to estimate fair value in our impairment tests are reasonable and appropriate, future changes in the assumptions could result in recognition of impairment.

Fair Value Measurements

A substantial amount of our investments are recorded at fair value or amounts that approximate fair value on a recurring basis. We use a three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value based on whether the inputs to those valuation techniques are observable or unobservable.

As of December 31, 2022, Level 3 assets represented 10% of total assets measured at fair value, which primarily related to CIPs’ investments in equity and debt securities. There were no transfers into and out of Level 3 during the three months ended December 31, 2022.

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