富蘭克林資源 (BEN) 2010 Q4 法說會逐字稿

Good afternoon and welcome to Franklin Resources earnings conference call for the quarter ended September 30, 2010.

I will be your conference operator today.

Please note that the financial results to be discussed in this conference call are preliminary.

Statements made in this conference call regarding Franklin Resources Inc., which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements.

These and other risks, uncertainties and other important factors are described in more detail in Franklin's recent filings with the Securities and Exchange Commission including in the risk factors and MD&A sections of Franklin's most recent Form 10-K and Form 10-Q filings.

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions).

The Company asks that you limit questions to one initial and one follow-up question.

Now, I would like to turn the call over to Mr.

Greg Johnson.

Thank you, and good afternoon, everyone.

Thank you for taking the time to join us on the call today.

I'm Greg Johnson, CEO.

Joining me today is Ken Lewis, our CFO.

As we highlighted on the pre-recorded commentary, we were pleased to report another strong quarter for flows, capping off a record fiscal year.

Most importantly, relative investment performance remains strong and with assets under management ending the fiscal year near pre-crisis levels, we believe we're well-positioned for future growth.

I would like to open it up to your questions.

(Operator Instructions).

Your first question comes from the line of Jeff Hopson from Stifel Nicolaus.

Okay, thank you.

So you've had very strong growth outside the US.

It seems like some of your spending increased in the quarter for advertising and such.

So I guess the question is, do you expect any change of the margin in the non-US business going forward?

I'll take that, Greg.

This is Ken.

Typically the advertising line in the first quarter, if you are just focusing on the US spend, goes down.

But as I mentioned in the comments, we are spending a little bit more in international advertising, and so it is possible that the seasonality trend might not be as it has been in the past.

Regarding the profitability of the international products, I don't think that that would really change the profitability at all because it is not that big of a spend.

Okay.

And in terms of the weaker US dollar, any change in behavior if you're seeing by US investors in reaction to that?

I think it is still a little bit early.

Obviously the weaker dollar tends to accelerate any toward global equities, global bonds but that weakness has been fairly recent and the areas were doing quite well, so I think -- (inaudible -- multiple speakers).

Okay, thank you.

your next question comes from the line of Roger Freeman with Barclays Capital.

Please go ahead with your question.

Hi, good evening.

I guess, two questions, both around the unusual items in the quarter.

I just want to understand on Darby, I see there is a comp reversal, as well.

Does that mean that this is like a Darby issue?

Or did they miscalculate the returns or something since there had to be a comp?

No.

Not at all.

It's -- we have performance fees on other products other than Darby's, as well.

And so we did -- we just -- we adjusted our recognition of the revenue and the corresponding expense categories to take a more conservative point of view.

Okay.

So it's not due to reevaluating the private equity portfolio or anything?

No, no.

Okay.

I guess second thing is, on the investment, the C Portfolio, what was that?

Is that evaluation?

It's not evaluation, we did an analysis looking at how our accounting model for investments in all of the consolidated sponsored investment products and just made the determination that we shouldn't be consolidating some of the international funds and so going forward, we won't ,and that will reduce the number of funds that we have to consolidate so it should make things a little simpler.

Okay.

All right thanks the clarification.

Your next question comes from Cynthia Mayer with Bank of America.

Please go ahead with your question.

Hi, good afternoon.

Let's see.

Maybe just to clarify on the last one.

Can you give a sense of what the AUM is of the funds that you're consolidating now?

I think it was -- I don't want to misspeak, but I think it is around $70 million.

It used to be $200 million.

Okay, great.

And then, can you talk a little about the distribution margin.

I think in your pre-recorded commentary, you said the expenses rose a bit faster than the revenues because of the different cost overseas and the shift to overseas investors and different ways of accounting for them.

So assuming the proportion of international assets keeps rising, would you head into a negative distribution margin and, maybe just to clarify, can you give a sense of what the international assets have as a distribution margin on a stand-alone basis?

Right.

I can try to help you out on a couple of things there.

It is possible that if you're looking at it on a margin basis, that it could go negative, but I would say that it is a reasonable assumption that if your estimate of asset-based commission expenses is off by $1, you are going to make it up on the investment management fee line by a dollar.

Got it.

Thank you.

Your next question comes from the line of Bill Katz with Citigroup.

Okay, I just want to keep pounding away on the margin discussion a little bit because it is still obtuse to me in terms of the conversation here.

Is your -- let me ask it a different way, when you look at your incremental AUM growth, is non-US all in distribution, manufacturing, what have you, is that more or less profitable than your US business?

It is about the same.

About the same?

So the offset here would be a rising fee realization rate relative to this distribution discussion?

Correct.

Okay.

Second question is, just in terms of the very strong growth you're seeing in the non-US, can you walk through a little bit about maybe geographically, break it down between Europe, Asia, elsewhere and maybe by product of where you're seeing the greatest leverage?

Thank you.

The two areas, we've talked a bit in the past, the global bond fund has been very successful throughout Europe and especially in Italy over the past year.

We've got probably three or four bond funds, Templeton Global Total Return funds, Emerging Markets Bond funds, all of those, and an Asian bond fund as well that has done extremely well in Europe.

The Asia growth fund is now our top-selling fund on the equity side and that's run by Dr.

Mobius of the Emerging Markets Group and has had excellent performance.

So really that's -- I don't have the breakdown in front of me between how much of that is coming from Europe versus Asia.

But I think the real big movers for us have been in Europe this year as far as net in-flows in Taiwan, as well.

Okay, thank you.

Your next question comes from the line of Michael Kim with Sandler O'Neill.

Please go ahead with your question.

Hi, guys, good afternoon.

Just first equity mutual fund net flows across the industry have turned positive more recently in aggregate, following kind of about six months of persistent outflows.

So you feel like we could be at an inflection point or do you think it is going to take a bit more time before equity flows really start to meaningfully reaccelerate?

And then it seems like the trends are a bit different as you look at overseas investors.

So any additional color there?

Well, I think that that's been the question for awhile now, is when does this turn around.

And obviously a very strong quarter and that's going to help investors' confidence move back into equities, but like most in the industry, we haven't seen a big swing and we've seen some movement in some of our funds, especially with the rising dividend fund.

For us, those type of equity income funds are very popular in this kind of environment, but I just don't think we're seeing a big turnaround in investor confidence yet.

But certainly a quarter like we just had will help that.

But I do think it is going to take awhile and I think the kind of flows we've seen over the last six months will continue in the near-term, as far as fixed-income versus equities.

Okay.

And then in terms of the institutional channel, any noticeable changes in either activity levels or shifts in terms of which strategies might be in demand?

Is it still global equities, global fixed-income?

Exactly, and I was just looking down the list, it is probably 95%, 90% of the search activity that we are involved in is in the global fixed and global equity area.

Okay.

Thank you.

your next question comes from the line of Craig Siegenthaler with Credit Suisse.

Thanks for taking my questions.

Just to follow up on the international sales topic, and maybe to ask that a different way, is on your C-Cap product, what is the average asset-based distribution expense, and also are there any distribution revenues or do they all flow through management fees from an accounting perspective?

Yes, they flow through management fees from an accounting perspective.

So that's the non-US assets.

And as I mentioned, the profitability on the C--Cap products is probably a little bit higher than the US products, but we -- that's not the only type of asset we have in the international arena.

So on average, the profitability of the International products and the US products are about the same.

So if you are having -- if you are incurring asset-based distribution expenses on the international products you should see that on a dollar-for-dollar basis in the investment management fee line.

Just a follow-up on the balance sheet, saw that your cash went up.

I'm just wondering if you can update us on where the level of access cash is?

How much is domiciled outside the US and if you have any plans for a special dividend in the calendar year fourth quarter?

If you look at cash and investments, it is split about evenly US and non-US, on a cash and cash equivalents basis, it's probably about 40% to 45% US.

We will clarify that in the 10-K.

And then in terms of share repurchases and dividends, really no change from the prior.

Still committed to both of those.

And still committed to returning a great proportion of earnings to shareholders through repurchases and dividends.

All right, great.

Thanks for taking my questions.

Your next question comes from the line of Robert Lee with KBW.

Please go ahead with your question.

Thanks.

Good afternoon, guys.

Wanted to ask questions on the comp.

You guys have done a pretty good job over the last several years keeping comp down.

In part because I think you've grown -- to an extent, youve grown headcount on a net basis or there's been a lot of shift toward lower cost regions, I'll use that phrase.

But do you feel like you have more room there?

Are you starting to feel the comp pressures maybe they're starting to grow?

You're back toward peak asset levels, pretty close to peak revenue levels, profitabilities have been pretty much restored.

Are you starting to see building pressures on the comp line, or is there ability to continue to kind of manage, relatively speaking, manage down comp as you move bodies around the world?

I think there are two different components to that.

The fixed component and the variable component.

Certainly, we think we're -- we've done a pretty good job and we're pretty good at utilizing those low cost regions, and that's where we are in headcount.

And we could have maybe like 25%, 30% of the total employee population in those centers.

So on a fixed-cost basis, we're managing it down.

On the variable side, it will vary with revenue as it has, and that will continue.

I don't think that we're seeing any particular pressure to change any of that.

Okay.

Maybe on a different topic, you have Darby and I believe you have a real estate business and some other alternate products here or there.

But can you talk about what your plans are for the alternative space?

Certainly you're seeing a lot of demand there broadly speaking and a lot of your traditional competitors thinking about odds for lift-outs, acquisitions or internal development of expanding their own portfolio of alternative strategies, absolute return strategies, however you want to define them.

Can you update us on your thinking there?

Is there anything on the drawing board or is that part of your M&A strategy at this point?

I'll take that one.

I think, as we've stated before, we believe it is going to be important and growing area in our business, it is a natural complement to what we do, and as you said -- or stated, we'd do a pockets what would be categorized as alternatives within the firm.

We think we'll have more of those type pockets in the future.

We've had a lot of discussions with a lot of different type of alternative managers and are continuing to do that.

We expect the next year or so that we would see some additions to the firm.

I think one of our concerns has always been that we want to make sure that especially, whether it is hedge funds or people-intensive of businesses, that it is something that has a process that is transferable and that we can make sure that we're locking up the value that created those returns.

We have been somewhat careful there.

I think another area that we've had a lot of conversations around is our strategy has always been generally to own more than 50%.

I think we have recognized that maybe a stepped approach makes more sense when looking at some of the newer alternative managers.

So, we are looking for minority stakes to build toward majority over time.

Another area that we're building out, and it is a word you hear a lot in the business, is around solutions, and to me, it fits also in with what we're doing with alternatives and we have added resources there and whether it is building more outcome-oriented products, more tactical asset allocation funds, those are all the kind of things we're building as well as inflation hedge-type products where we can bring commodities and have a place to go if rates move up.

So that -- I think as far as an area that we're the most active in, it would be certainly in building out that solutions capability and then within that bringing in alternative managers to complement that.

Great.

Thank you for taking my questions.

Your next question comes from the line of Michael Carrier with Deutsche Bank.

Please go ahead with your question.

Thanks, guys.

Just one more question on the institutional.

I think you guys might have, in the past, broken this down.

I don't see it now.

You might have done it on the pre-recording call.

But do you have the breakdown of just where the flows are, and maybe ex-ing out the Romanian mandate, just overall.

So, if you take the $14 billion, $15 billion, how much of that is retail versus institutional?

And then on the institutional side, just what you're seeing in terms of trends, US institutional versus non-US institutional?

Well, first of all, we don't have it broken out between the institutional and retail and, as we mentioned, $4.6 billion of the net number was due to the one institutional account (inaudible) fund in Romania.

As far as trends quarter-over-quarter, I think I would -- other than global bonds in some case declining outside of the US, really looking at global equities in every other category between retail institutional, I would say it was very stable as far as the mix.

Looking at, again, the backlog in searches and the pipeline and the wins and losses, there was nothing really significant over the quarter.

A lot of $200 million, $300 million accounts that were funded during the quarter and some that went out, as well.

And both of them in the global equity category, as well as the global AG, and we continue to see a lot of searches, especially in fixed-income outside of the United States.

We expect to fund some of those in the quarter ahead that we won over this quarter.

It is really the same trends that we've been talking about, I think, over the last probably three or four quarters with regard to the institutional pipeline.

Okay.

And then, Ken, you gave some color on the different expense lines on the pre-recorded call.

The two line items that stick out is the IT tech occupancy and advertising.

Both you've guided towards that they were heading higher.

It is just the increase sequentially was roughly $10 million in each bucket.

So you mentioned some could be seasonal, there could be one-off items, but just is this a good run rate or maybe it pulls back a little bit but there is going to be growth over the next couple of quarters.

Any sense there?

Yes.

It did -- IT bump up this quarter by a fair amount.

I think that some of that was -- I talked about on earlier calls, just increased business activity.

Because we knew that we were embarking on new projects after the slowdown a couple of years ago.

So I think that will continue.

But certainly, some of it was for things that were unique that they may reoccur at some future quarter, but it is not like a trend that I'd say.

So I think this quarter's numbers was a little high in terms of a run rate.

That's on the IT side.

On the advertising and promotion, that, too, was a little high.

But keep in mind of that some that is driven by sales and assets under management, and we are spending more.

Do I don't think that it goes back to levels we saw last year, but I think it is probably a little high for a run rate as well.

Okay.

Thanks, guys.

Your next question comes from the line of Ken Worthington with JPMorgan.

Please go ahead with your question.

Hi, good afternoon.

Q on the underwriting and distribution expense.

So, first, what portion of the underwriting expense are actually from international products?

So you have $529 million, what portion is attributed to international?

I would say the piece -- well, first of all, international assets are about 30% of total.

And then, I would say the distribution expense is around that level, as well.

But I think the piece that everybody is thinking about where there is a mismatch between line items,that's probably like in the 12% to 15% of the total line item, if that makes sense.

What's the 12% to 15% of the line item?

There is a piece where that expense goes up and you should see $1 more of investment management fee revenue.

That's about -- I would call it 10% to 15% of the total underwriting distribution expense line.

Okay, great.

In the second question there is how are foreign distributors paid?

What portion would be up-front on a sale versus over time on the assets?

That's what makes this conversation so difficult because it is very dependent on the class of shares.

And there is a lot of share classes on the products.

So there are some that are up-front and some that are ongoing, and it is hard to quantify the mix.

So I guess what I'm ultimately after is you had a negative underwriting revenue this quarter.

If it is all based on assets, then there's no reason for that negative number to perk up next quarter, but if you've got a lot up-front and you had a good sales quarter, sales go down or normalize, then the underwriting -- the net underwriting revenue can pop back nicely to positive.

So I guess what your answer is, it can pop nicely back to positive because the fees are up-front?

Some are up-front.

But I think as the percentage -- the asset-based fee, the one that goes up with assets under management, as we see the increase in the international assets under management, then you would -- it is possible that would go the other way.

So you could see that pop to negative.

But again, it doesn't affect the overall Company's profitability.

Yes.

Understood.

Thank you very much.

Your next question comes from the line of Mark Arazari with Goldman Sachs.

Please go ahead with your question.

Great, thanks.

Just on the operating margin again, it seems like there is a lot of geography issues in terms of where in the P&L certain items are coming up.

But when you think about the core margin for this quarter and you think about the advertising expense and the mix shift in the business potentially towards equity that you're trying to drive with the advertising, what's the expectation for the operating margin going forward?

So, as you know, since so much of the revenue is driven by the market, it is a futile exercise to try to pinpoint a margin in any given quarter.

But you can just see by the mere fact that the assets under management have increased last quarter, just based on that fact alone, it would be reasonable to expect some improvement in the operating margin next quarter.

Okay, good.

And then just on capital, redeployment, in terms of priorities, f there were to be a change in tax laws as far as dividend tax laws go, next year, how are you guys thinking about the special dividend relative to buying back stock?

Where is our taxes paying into that thinking?

Yes, certainly that is a consideration in the decision.

At the end of the day, it is up to the Board of Directors to decide and that's kind of where we're at.

But there's really been no change in sentiment.

But certainly we're keeping an eye on what's going on with the taxes and that would be part of the decision process.

Okay, great, thanks.

Your next question comes from the line of Douglas Sipkin with Ticonderoga.

Please go ahead with your question.

Thank you and good afternoon.

So obviously we've seen a lot of acquisitions in this space of some of your competitors and lot of consolidation on the distribution front.

You guys have been pretty constant throughout.

Can you just talk about how you're standing amongst distributors, wirehouses, et cetera, has changed, if at all, over the last year to two years and how is that playing at all to some of the flows you guys are seeing?

I think we're in very good shape and obviously it is having the right mix and what we think it is a pretty good marketing and distribution effort behind it.

But this year, as far as net flows within the non-proprietary channel, we were the top seller on a net basis and I think No.

2 on a gross basis, and then in terms of distribution outside of the US or cross-border sales, we're No.

1 both on a gross and net.

You're not No.

1 with every one of your distributors, but, again, looking at the entire universe of distribution, we're probably one or two in most of the major distributors out there.

So I would say that we're extremely well-positioned and not only really gross and net, but we were fortunate to increase market share in fixed-income.

So it really wasn't just about having the right funds and having the big wave come with it, we actually significantly increased our share in the fixed-income space, again both in the US and offshore in equity as well.

If you look at -- I mentioned rising dividends, Franklin Growth fund, which in the top quartile for the one, three, five and 10, and for us really addresses what has been a significant deficiency as far as our asset concentration.

That is gaining market share.

So that's positive as well.

Just a follow-up.

In terms of the big mandate for global equity this quarter, I believe that came in right at the end of the quarter so really not too much of a revenue contributor.

I don't know if you guys provided the revenue yield on that maybe we should be thinking about moving forward and getting a full quarter of it now?

The way to look at it is it is in line with institutional mandate of that investment objective.

It is $4 billion on $600-plus billion, so it won't have a material impact effect on the effective fee rate, I don't think.

Okay, great, thanks.

your next question comes from the line of Glenn Schorr with Nomura Securities.

Please go ahead with your question.

Thanks.

Ken, on the interest expense, I want to make sure I remember correctly, the debt raised in May, that's a semi-annual pay, first and third quarter?

Semi-annual pay -- in calendar quarter terms?

Yes, that's what I wanted to make sure actually.

Yes, it is fourth and second.

Second and fourth.

Fourth calendar.

Got it.

And then maybe, Greg, I think a lot of us talk to you all the time about the cyclical component of the flows.

But I guess given your dominant presence in the retail channel, I'm curious what your wholesalers tell you, what the field tells you, in terms of clear where the flows are going now, whether it be fixed-income passable alternatives, how do you assess the cyclical versus secular argument of domestic equity and how does that impact how you think about the infrastructure you have now and building new funds, strategic stuff?

I think it's -- as I mentioned before, I don't see a big shift taking place to equities right now based on what we've seen at the start of the year.

I think how we think about it is that we recognize that we need more shelf space on the equity front and that's something we've been pushing very hard over the last two years.

And we debated long and hard about going out and acquiring a firm to fill that.

I think what we realized is that we have it all in house and the performance records -- Franklin equity in the last year, 80% of the assets were in the top quartile.

That's on top of very strong long-term performance.

So those funds are getting recognition now, and that -- again, we mentioned the 20/20 vision campaign.

So we've been out talking about equities in the decade ahead despite the headwinds that we're facing right now.

So that's really our strategy is -- just like it was when equities were selling and fixed-income was not doing a lot in flows, we were out there telling the fixed-income story.

So we think it is a great opportunity for us .

The distribution, they're not just paid on selling the global bond fund, their incentives really work around talking about equities and even if it's incremental gains and just getting on a 401(k) platform, that's the goal right now.

Really, in terms of defining that in numbers, I think that's hard to do.

But I can tell you it has been a major priority for distribution to make sure that we're well-positioned when it does move.

I just don't think it is moving right

And to all of those points, maybe next time we'll have this call, it would be helpful to see what incremental placements there are.

Because we can see how good the performance records are, right?

So if you're -- however you define it in terms of on the focus list, on the approved list, on the buy list, however each firm does their individual focus list.

That could help because the performance looks like it is there to your point, if and when the flows turn, you should benefit.

We would be happy to share that.

Alright.

Thank you.

Your next question comes from the line of Roger Freeman with Barclays Capital.

Please go ahead with your question.

I just had one follow-up.

Just on ETS, I know it's a product that you haven't really shown much interest in the past, but as I look across some of your peers, several of them are at least putting the exemptive relief apps in because they take awhile, just to have it as a placeholder.

Maybe they don't know what they want to do with it yet.

Thinking Janus, T.

Rowe, Legg, Eaton Vance.

Is that anything you would think of doing, or not?

Well, I think you want to keep your options open so that's probably not a bad strategy.

As we said before, they're here to stay and they're going to grow quickly and make the active manager's job more difficult.

But our feeling is still that the majority of the flows are going to go into the bigger funds with the top three managers and it is going to be a fee battle that we're already starting to see unfold.

So, like money funds, we think there is a big enough pool to focus on active management and that's really where we think -- why the value proposition of the Company.

But I think that's a valid point.

You want to keep your options open and if our changing thinks around actively managed DTFs, we would want to be able to participate in that.

But it's also, we feel there is enough out there where acquisition would be a quicker route, too, if we really wanted to move into that space.

Versus building.

Sure.

Okay.

Great, thanks.

Your next question comes from the line of Jonathan Casteleyn with Susquehanna.

Please go ahead with your question.

Thanks, good afternoon.

You alluded to it in your commentary about the global bonds activity continuing, but can you give us an idea how this compares to past periods?

Is this search activity increasing or decreasing?

Well, the majority of the global bond flows are in retail.

So I think I was just speaking in general terms about equity versus fixed-income, and also our fourth quarter tends to be the slower summer months.

So you would expect to see that tick up as people get back in the offices, and I think those trends are all -- are very much in place.

There's not a lot of searches in pure global bonds.

It is global AG and Emerging Markets funds, which we have seen just a consistent level of searches, and I think, for us, with the strength we have in many of the Emerging Markets and many areas with sovereign wealth funds, it is a natural fit for those type of funds.

So we're continuing to see good opportunities there.

That's helpful.

How do you articulate any capacity issues in global bonds, just generally?

To me, and this is a question we get quite a bit, but it is probably the largest and most liquid market out there.

So we really haven't seen any restraints.

I think if anything, you could argue that this fund historically moved into a little bit more esoteric markets, less liquid ones and with size, it has been a little bit more restricted on doing that over time.

But the bigger markets that it moves in and really adds alpha from making currency bets are a huge market.

S we're not seeing any real constraints there.

That's helpful.

Lastly, on the cash balances, any increase in dividends or buybacks has to be sourced by the US portion, is that correct?

That's correct.

So, what are the options for the European portion?

Or the foreign portion, sorry?

Well, the non-US portion is definitely reinvested in the operations outside the US.

That's our approach and we're going to continue with that.

I guess there's talk on the hill about repatriation laws changing and all of that, so we'll keep an eye on that as well.

If something develops on that front, we would consider that as well.

Great.

Thank you very much.

Your final question comes from the line of Bill Katz with Citigroup.

Please go ahead with your question.

Sure, thanks.

Just a quick follow-up, this is more of a modeling question.

Given your fiscal year-end versus the calendar year-end, as you think about the December quarter, historically, there hasn't really been much movement in comp.

When will we expect to see merit increase and so forth?

Will that be in the March quarter?

No, you'll see that -- probably one month of that in next quarter and then the full amount in the quarter ended March.

Okay.

Given your comment before about not seeing any upward pressure on variable comp, all else ,being equal, anything -- as we look at this year, is this year -- would you consider it to be a run rate or a/normalized backdrop for compensation?

I think so, I think this is a representative year.

Terrific.

Thank you.

At this time, I would like to turn the call back to Management for any closing remarks.

I would just like to thank everyone again for participating on the call and we look forward to speaking next quarter.

Thank you.

Thank you, ladies and gentlemen.

This does conclude today's conference call.

You may now disconnect.