富蘭克林資源 (BEN) 2012 Q2 法說會逐字稿

Good afternoon and welcome to Franklin Resources earnings conference call for the quarter ended March 31, 2012.

My name is John and I'll be your conference operator today.

Statements made in this conference call regarding Franklin Resources Incorporated 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 other risks, uncertainties, and other important factors are described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including the risk factors and MD&A sections of Franklin's most recent Form 10-Q filing.

(Operator Instructions).

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

Greg Johnson.

Hello and welcome to the second quarter earnings commentary.

I'm Greg Johnson, CEO, along with Ken Lewis, our CFO.

Net new flows turned positive again this quarter, driven by the increase in sales with long-term flows positive across all investment objectives for the first time in nearly three years.

Most importantly, long-term relative investment performance remained strong across the firm.

Net income also rebounded in quarterly earnings per share of $2.32, which is a record high.

I'd like to now open it up for your questions.

(Operator Instructions).

Michael Carrier, Deutsche Bank.

The first question, on the distribution in revenue and expenses this quarter and you guys mentioned a little bit on the prerecorded call some of the drivers there, but can you give a little color?

First, typically in the past when we've seen some unusual trends in those line items, it's been either some product lines or some incentive for some type of a product or initiative, but when we look across the products, you mentioned the diversity of the flows and the sales, it seems like it was pretty much broad-based so it doesn't necessarily stand out.

You also mentioned the timing of revenues and expenses sometimes being -- meaning expenses coming in before the revenues.

Any color on, one, the issues in the quarter and then just in terms of the outlook, what we should be expecting there?

The first thing to mention in this expense line was there's about $9 million of non-recurring items so, going forward I discount that.

Secondly, it really wasn't product-specific, the increase in expenses, as we've been disclosing this now for awhile.

There's two components to it.

There's a smaller component that's based on the sales volumes, so that would be your up front commission loads and the revenue and expense, they tend to directionally go in sync.

Then there's an asset based component and the asset based component is what we're referencing and it's really a timing difference.

It's the way that it is calculated and the short quarter did have an impact on it, making the expenses grow more the revenue on the asset based distribution item.

Going forward, I think it's probably safe to say that, that line item should be flat to a little bit down next quarter because of the non-recurring items and this timing issue.

Just on that, from a timing standpoint, are you saying if we look at the number of days, the revenues versus the expenses, there is one day of a delta between the two or is it not that simple?

That's right.

The revenue is based on a month-end amount and the expense is based on daily.

A follow-up on the flow side, on the retail side it just seems you had broad-based in-flows across all the products, which we really haven't seen across many of the other firms.

What are you -- what would you categorize that?

What's the driver of that, generating the diversity of the flows?

How much of that was more seasonal, versus are you seeing more traction and more interest, not only on the fixed income side where you have done well, but also on the equity side?

It speaks to the mix of assets that we have in the market environment, and the hybrid funds, and we talked about the strength of the Franklin Income Fund and we saw about a 35% pick up in that category, a rising dividend fund, again a conservative equity based fund with a dividend.

Those are doing well.

I wouldn't say they are seasonal.

I think they're very much in vogue today.

The third was the strength in munis, so you really saw a nice rebound in US retail.

You didn't see as much of a rebound in international sales because they don't have that mix to count on where you have the income fund and munis making up for some of the drop in the global bond sales.

You had a nice pick up in Asian growth and we also saw a nice net flow number in US Opportunities Fund in our CCAV, but much smaller as a percentage when you look at the net pick up that we've seen in munis in the hybrid category, which is more US-based.

Bill Katz, Citigroup.

Coming back to the margin for a second, and I appreciate the seasonality of the business and some one-timers.

If you back that out and you look year-on-year and you look at the change in operating income relative to the change in revenues, seems like a very low incremental margin.

I'm curious if you can talk to the dynamics of the margin impact from product sales, both maybe by mix at the end of the day?

I feel like I may have misspoke in answering Michael's question, so let me correct it or clarify.

The revenue is based on the number of days in the quarter and expense is accrued on a monthly basis.

I think I might have had that backwards.

I don't know that we're seeing any significant differences, even on a year-over-year basis due to the product mix or the geographical mix.

I think all the effective fee rates are in line.

Maybe this quarter we had a slight up tick in the distribution items because there were some more equity sales, so there was a little bit, maybe slight upward pressure on -- or slight upward movement on the distribution lines because the equity products have higher rates.

I wouldn't say that was significant.

Even on a year-over-year basis, I don't think there's a significant change due to mix.

As you think about the mix of the business today and the dynamics between US, non-US and some of the statutory rate change going on around the world, what's your outlook for tax rate?

Our tax rate, we think it's going to be fairly stable and it has been and we don't see anything on the horizon that would change that in the short term.

Ken Worthington, JPMorgan.

First, in the prepared remarks you mentioned Global Bond, CCAV managers reducing their model portfolio allocations to global bond.

It seems interesting that a number of the managers did this at the same time.

What's going on here?

Is this a global bond asset class issue or is this a Franklin Global Bond issue or is it something else?

I think it's hard to say.

I think part of it, though, we've seen a pick up in the Global Total Return Fund, which had fairly strong net in-flows outside the of the US where the Global Bond still had out flows.

It's the nature of those type of sales, are much more gate keeper controlled.

I think the volatility that fund experienced probably, some of those gate keepers felt that was more volatile than what they're comfortable with or they had too much exposure based on the strong sales in the past.

You tend to see big, lumpier movement when that happens, when you have a market shock, and that's somewhat of a newer category.

Overall, I don't think that's a trend that should continue as far as the reallocation by the gate keepers.

Seems like you think they stayed in global bond, the global bond category and actually within Franklin as well by going to the total return?

Right.

That's what we've seen.

And that's been a steady trend that the sales in the Global Total Return continues to gain share versus the Global Bond.

For the other question, you got a lot of cash in the balance sheet.

If the US were to let the dividend tax at 15% expire at the end of the year, which I guess is what is on the table, to what extent does this influence your decision to dividend before that new tax rate goes into effect?

Does that influence your decision or is that irrelevant to your decision?

I think the after tax return to shareholders is always a relevant input that the Board considers, and in the discussions we've had, we've done a couple of specials in the last year, that certainly was part of the discussion.

I think, just to add, even the consideration of doing it last year, the Board considered the possibility of that even happening retroactively this year.

That certainly goes into the thinking.

Craig Siegenthaler, Credit Suisse.

Starting on compensation expense, I was wondering if you could break out how much was from the seasonal merit increase and higher payroll.

I think maybe somewhere in the neighborhood of in the $10 million to $12 million would be due to those two items.

If we think about the roughly $323 million, if we take $10 million to $12 million out, you also have the variable component which is also elevated versus the fourth quarter.

Should we expect that variable component to stay roughly at a similar level for the next few quarters?

Given certain revenue levels, I think that's fair.

At the current revenue levels, I think that's a fair comment.

The $10 million to $12 million is something we shouldn't expect to roll into the next quarter?

Not as incremental.

On the international redemptions, they're a little higher quarter-over-quarter, but two of your strongest international markets, Germany and Italy, net flows got even better there, I'm wondering which international markets on a flow basis or redemption basis got weaker driving that?

Weaker is relative.

I can tell you that during the course, some of the bigger detractors from net sales were Asia, Hong Kong and the MENA region, the Gulf and eastern Mediterranean.

Michael Kim, Sandler O'Neill.

In terms of the Global Bond Fund, is it reasonable to think flows will continue to reaccelerate mostly a function of better trends here in the US, but on the flip side, we likely won't see the types of in-flows that you saw in prior cycles until the non-US investors get back on board, if you will?

Yes, I think that's right.

It's still -- the Global Bond, both US and offshore, was still our best selling two funds on a gross basis.

I think the US trend is getting better, is improving and I think that will continue.

I think the global one is always a little harder to answer because you have so many different markets and distribution, and generally newer investors that tend to have -- redemption tends to be sometimes a little bit faster, but so does the sale coming back in.

I think that is a harder one to get a handle on going forward, but I think the trend for the US investor still looks very solid.

Second, can you talk a little bit about product innovation, what strategies are you working on, is it still mostly focused on multi-asset class and alternative products?

From a seed capital standpoint, are you still in a net realization mode or would you expect to be more neutral going forward?

I think, as we've mentioned, we have started some new funds in the global [tactical] allocation fund.

We'll continue to look at more alternatives.

I think we feel like that's a trend that's going to continue providing commodity exposure into our funds as an inflation hedge.

Those are all new for us and we got those funds up and running, so we're going to continue to talk about those.

Another fund that's interesting to me is the International Growth Fund which just passed its three-year record and has outstanding performance for the one and three years so, we think that could get some traction in the category that's new for us as well.

The second part of the question as it relates to seed capital investing and on a net basis, where do you see that going forward?

I think we have a pretty good system of keeping the absolute amount of seed capital stable.

I think we talked about that in the past where we look at ideas we had maybe a couple years ago and they're either greatly successful or not, and then we use that seed money and repurpose it for new products.

In terms of the balance sheet, I don't see any significant changes increasing or decreasing our amount of seed money.

Luke Montgomery, Sanford Bernstein.

Your non-US cash balance was about 51% of total at year end 2010 and now it's about 62%.

You acknowledged that you're funding shareholder distributions out of the US cash balance and just very rough math it looks like you're paying out 70%, 75% of your US free cash flow.

I'm wondering whether you view that as sustainable and how much of a constraint it could be on your ability to reinvest in the US side of the business?

Obviously the cash coffer abroad is growing, so any comments on how you plan to deploy that to generate a return?

I think we would agree that over an extended period of time, the levels of share repurchase can't be sustained at historical levels, but that said, we are growing in the US.

A lot of our successful products are US managed.

The Gold Bond Fund is an example.

I think that we've seen some pretty good US cash flow and there's not a lot of cash needs in the US.

Most of the cash needs are outside the US.

That's where we plan to deploy the cash to grow the international business.

You've seen that with some of the small acquisitions we did.

That is going to continue to be the focus.

Any comments on how you plan to deploy the non-US cash assuming no change in the tax code?

We have a pretty, I think, innovative but conservative investment strategy for offshore cash.

We do use some of our own products.

We do consult with our investment professionals on the best way to do that.

Obviously we keep things relatively short and conservative and I think we would just continue on that path.

Alan Straus, Schroder's.

Did foreign currency have a big effect on the reported results, especially on your expense line?

It did not.

Because of where we operate, we do tend to have offsetting currency impacts and on a quarter and a year to date basis, it was not material.

Cynthia Mayer, Bank of America.

I'm just wondering the increase in flows in the US, for instance to the Income Fund, do you see any of that as seasonal; likely to slow ahead?

I don't know whether that one is particularly in, for instance, 401(k) menus?

I don't think it's seasonal.

I think most of those flows are coming outside of a 401(k).

I think it's the attraction right now of the yield that it offers and track record is very strong, so I would expect that to continue.

Also any color you could give on institutional demand?

I think you mentioned that you're seeing demand for global and US equity strategies, but in terms of types of clients, are you seeing US pension funds?

Are you seeing sovereign funds?

Where are you seeing the demand?

Are you seeing variable annuities?

Any color you can give.

I think it is more of the same.

I wouldn't say there has been a change away from -- fixed income is still the big opportunity.

I think our largest funding in the quarter was about a $760 million global agg with sovereign wealth.

I think that's where the big opportunities continue to be for us and we're seeing some in high yield as well.

We're still seeing specialized demand in India, China, things for more regionalized management but smaller ticket items with better fees on it.

Overall, it's still really fixed income, international equity and specialty and we're seeing some US equity searches, but not any significant change there.

Jeff Hopson, Stifel.

I realize Europe is many different countries, but it seems like your flows have perhaps turned the corner in the region.

Any thoughts there?

I think you're right.

I think Europe rebounded more favorably than, certainly, Asia did over the last quarter, and the two big markets for us, Germany and Italy, we've seen a return to decent net flows there.

I think that's going to continue for us, but I couldn't add much color around the opportunities within Europe.

Follow-up, Ken, it sounds like on the distribution margin that as far as you're concerned there's no permanent change that's affecting this quarter and some of this will reverse in the future quarters?

That's correct.

As I mentioned, I don't really expect that line item to increase in the short term given in a stable environment like the current quarter.

I would mention a couple things on the expense line.

(Inaudible) variable compensation, but we have been pretty diligent on our cost management efforts in the first half of the year.

Given that we've had some success in the first half of the year; we're going to loosen that up a little bit.

You would expect to see some of the line items increase and expect to see a little bit more headcount in the next few quarters, and some of the other line items increase.

Not significantly, but a little bit.

Roger Freeman, Barclays.

First, it sounded like you were saying that you've seen some investors in the Global Bond Fund move into Global Total Return.

I know track exchange, exchanges within fund families.

Do you have any stats on how much that's occurring?

We do track that.

I don't have that in front of me between the two.

My other somewhat unrelated question is can you update us on the alternative [supply] for the Pelagos that you acquired a stake in?

I think the commodities product you mentioned might be an outcome of that, but where you are in developing (Inaudible) alternatives product?

It's part of a new fund that we just introduced in the tactical asset allocation that has a sleeve with managed futures in that.

That was really the first step for us in using Pelagos' capabilities in our funds, so we don't anticipate a separate fund of managed futures right now.

It's just a sleeve or a portion of our asset allocation within our larger tactical fund.

Dan Fannon, Jefferies.

As we think about the second half of the year, we should see modest increases from the IT occupancy and G&A numbers from this quarter?

I think primarily you'll see small increases in the comp line and maybe the IT line.

The other should be relatively flat, but they do vary from period to period.

All of these comments exclude the impact of consolidating our VIEs and sponsored investment products, which tend to affect lines like G&A other.

Some of that impact goes through that line.

Excluding all of that, I would expect a slight increase in IT and comp.

On the prerecorded call you guys mentioned a global bond retention campaign that you guys have out.

If you could just expand upon that and how that's being received?

Well, it's hard to -- I think what we're trying to do is get as much timely information.

I think we've done a pretty good job of that on what's happening in that marketplace and try to anticipate as best we can where redemptions are coming from and try to get information there quickly.

It's a little early to tell how much success we're having with that to really measure it.

Marc Irizarry, Goldman Sachs.

Greg, can you talk a little bit about the acquisition environment out there?

Obviously you are still sitting on a nice amount of cash, maybe also discuss the capital priorities and where acquisitions fit in?

I don't think a whole lot has changed.

We're still seeing opportunities around the globe and we'll continue to do that.

I think as we've stated before, we don't have an appetite for or a major need for a major category that we think would fill a big gap in our line up, but we do feel like there's going to be strategic acquisition.

We are firm believers that the retail market will continue, as the institutional market has, to look for alternatives, especially given where rates are and people looking for other options.

I think we're very much open to that.

We'll continue to look at that, and whether or not that's in the US or outside of the US, our appetite's for both, but I wouldn't say that M&A looks like it's picking up or there's more available than there has been.

I think it's a fairly steady state.

Michael Carrier, Deutsche Bank.

On the recorded call you mentioned on the revenues about $14 million of non-recurring items that depressed revenues and on the expenses, you mentioned the $9 million on the distribution side.

I wanted to make sure, do those numbers include or exclude the consolidation of the Vs or the investments?

They would exclude the Vs.

Then we show on, I guess it's slide maybe 18 or something, the amount from that.

Given that it's starting to impact --

Correction.

There was one exception to that in the other net line, there was about -- so the other net revenue line, there was maybe $9 million of the $14 million was related to the VIEs.

Given that the consolidation is impacting your core revenues and then some of the expense lines, instead of it just being in the non-op area, have you guys considered doing the adjusted P&L like some of the peers have done?

It's obviously been a topic not only as a result of adopting the new accounting rules, but in anticipation of.

We've been tracking it and we started pro forma-ing it and we've been tracking it.

To date, the conclusion is overall it's not that material even on some of the line items, like over time it hasn't been that material, but it's something that we continuously monitor and I certainly wouldn't rule out doing that in the future if we feel like it helps the investors understand the financials better.

We have no further questions at this time.

Do you have any closing remarks?

Well, thank you, everyone, for participating on our call and we look forward to speaking next quarter.

Thank you.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.