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Franklin Resources, Inc. (NYSE:BEN)

F3Q09 (Qtr End 6/30/09) Earnings Q&A Call

July 30, 2009 4:30 pm ET

Executives

Greg Johnson - CEO

Ken Lewis - CFO

Analysts

Robert Lee - KBW

Craig Siegenthaler - Credit Suisse

William Katz - Buckingham Research

Michael Kim - Sandler O'Neill

Jeff Hopson - Stifel Nicolaus

Mike Carrier - Deutsche Bank Securities

Cynthia Mayer - Bank of America-Merrill Lynch

Keith Walsh - Citigroup

Marc Irizarry - Goldman Sachs

Douglas Sipkin - Pali

Mike Carrier - Deutsche

Operator

Welcome to Franklin Resources' earnings conference call for the quarter ended June 30, 2009. Please note that the financial results to be discussed in this conference call are preliminary.

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

Good afternoon. My name is Casey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Franklin Templeton quarterly conference call. All lines have been placed on mute to prevent background noise. (Operator Instructions). Thank you.

Now I would like to turn today's call over to the CEO of Franklin Resources, Greg Johnson for opening remarks. Sir, you may begin.

Greg Johnson

Good afternoon, everyone and thanks for joining us on our quarterly call. I'm Greg Johnson, the CEO along with Ken Lewis, our CFO.

Hopefully, everybody had a chance to listen to the prerecorded commentary this morning, but just to recap, while there are many highlights for the quarter, none were more important than the continued relative strength in investment performance and the turnaround in net flows.

The recent recovery in most global financial markets has also driven a substantial recovery in our assets under management and run rate revenues, and we continue to see tangible benefits from our cost management efforts with operating results improving substantially from recent quarters.

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

Question-and-Answer Session

(Operator Instructions). Our first question will come from Robert Lee with KBW.

Robert Lee - KBW

Thanks. Good afternoon. One or two modeling questions first maybe. Just on compensation, obviously, you had the full impact I'm assuming the headcount reductions in Q2. Is there any reason to expect, assuming you can continue with the solid asset top line growth and performance, we shouldn't start to see that kind of at least trend up a little bit from these levels or do you expect this is kind of be where this is as you just keep a close tab on expenses for at least the next several quarters?

Ken Lewis

Thanks, Robert. I think that June is a pretty good quarter in terms of run rate reflecting the headcount reductions pieces. Most of that was behind us in the previous quarters, but of course, variable compensation's a big component of the compensation. So, that will fluctuate with revenue. So, if revenue does go up, you can expect that line to go up as well.

The only thing I'd mention is there's other expenses in there. So, that could have a little bit, I wouldn't say material, but a little bit of an upward pressure, things like compensation tied to the price of our stock, for example, could have upward pressure if the markets continue to go up.

Robert Lee - KBW

Okay. Maybe a question for Greg. You gave some tables and color on US versus non-US

business trends, but can you maybe give us a little bit of sense on at least from a retail perspective, how investors outside the US and in the US, and maybe compare and contrast them. Are you seeing investors outside the US start to come back and take more risks? Is there kind of a little bit more of a lag effect there? How do you think that would kind of play out?

Greg Johnson

I think there is bit more of a lag effect versus the institutional, but between the US and international for us, the reason you haven't seen the kind of turnaround in net flows outside of the US is because of the strength of fixed income within the US, and we really don't have the benefit of the muni funds and other fixed income products that really were the story for the last three or six months in our industry.

We are seeing a pickup in the retail investor as these markets have been very strong, but clearly there is a bit of a lag there. Then I think just comparing the two probably by region, I think as I mentioned last time, you tend to see retail investors move back quicker in some markets like Asia, where they're more conditioned to these kind of swings versus the US one.

The US one now has kind of moved from money funds back into riskier high yield longer term government securities type products, and then some dipping back into equity. So, I do think it takes a little bit longer there.

Robert Lee - KBW

Okay. Then maybe the inevitable question on capital. Notwithstanding the comments on the prerecorded message about, obviously still interested in acquisition, and acquisition makes sense, but if we look down the road and let's say, for example, you don't find one and you've got five and a half billion of cash and investments, substantial mass of liquidity, how would you think about maybe deploying that at some point? I think it was four years ago already maybe when you did that special dividend. Is that something you, would ever consider again?

Greg Johnson

I wouldn't rule anything out, and including that. Obviously, the priority is to grow the business, and that would be our first use of capital, to invest in the business, but I wouldn't rule anything out.

Operator

Our next question will come from Craig Siegenthaler with Credit Suisse.

Craig Siegenthaler - Credit Suisse

Thanks, and Good afternoon. First, just a question here on M&A on the back of the commentary in the prerecorded call. I'm just wondering, it sounds like the chances that a deal gets done in the second half of this year are now lower, especially after listening to the comments in your prior call. Is that conclusion justified or can you provide any commentary on that?

Ken Lewis

I'll start and then Greg can chime in. I think the last sentence of that comment is that, we continue to look at opportunities, and the key point is that, while we look at opportunities, we do it in a very disciplined way. M&A in general, I would say, a higher risk way of growing a business than organically.

In this business particularly, such a people business that, you have to be very disciplined in evaluating a property, and that's what we've done, and that's what prove the results. That's what's given the great results we have for our shareholders in the past, and that's why we've been so successful in the acquisitions that we've made.

So we'll continue it. The point is that, we continue to look at all the opportunities that are out there as we've been doing for the last couple years.

Greg Johnson

So the quick answer is you shouldn't read into that comment one way or another on the probability. I think we just wanted to make the point that we don't treat it as a goal or an objective to complete an acquisition in the year ahead, and we're trying to be thoughtful about it, and that may mean something will get done, and it may not.

Craig Siegenthaler - Credit Suisse

Thanks. Understood. One other question. On that prerecorded call, you also provided some commentary on the South American, Brazilian market, on the opportunities there. I'm just wondering, the retail market there is very concentrated around a few large banks, and you talked about a new relationship that you have with one of the bank there. Are you allowed to disclose which bank that is?

Ken Lewis

I wouldn't say it's a new relationship. It's specific to the Brazilian market through Citibank where we have four funds, and the plan is to continue to launch more funds with other banks in that marketplace. It was really an example of even when the markets were down, and we were reducing expenses and headcount, it was still an area that we felt warranted additional investment, and we did add people into that region. We are now starting to see some benefit from that, albeit relatively small right now.

Craig Siegenthaler - Credit Suisse

You have a few businesses in Brazil, and the other emerging markets like two in China, some large ones in India. Are you still looking at new businesses in those regions or other regions in parts of Asia where you've been underexposed or are you comfortable with the businesses that you have there on the ground now?

Greg Johnson

Well, I think we're always looking at new markets, and one of the examples of a new market we were looking at building out local capabilities would be Malaysia. We had the benefit of $300 million or so dollars that came from opening of that office here in the last quarter.

You know, I think there's areas where we feel like we could penetrate the markets greater, but as far as newer markets go, I don't think there's anything right now that we feel like we have to enter, just other markets, where we feel like we could maybe do a better job in.

Operator

Our next question will come from William Katz with Buckingham Research.

William Katz - Buckingham Research

Thank you. Good afternoon. Still sticking on the capital discussion for a moment. On the last page of your slide presentation, you have the payout ratio, and I'm sort of curious if you can talk a little bit about that directionally. It's down pretty sharply for the first couple of quarters, but it is consistent year-on-year. Is it just seasonality that plays into the payout ratio or is there anything else I should be thinking about here?

Greg Johnson

I think it's seasonality. I think it's a function of earnings. I think you shouldn't read too much into it. Nothing's really changed in our strategy. We've had a practice, if you will, of returning 75%, 80% of earnings, and we kind of stick in that ballpark, but in any given quarter, it might be a little bit off.

William Katz - Buckingham Research

Okay. My second question is on the advertising and promotion line, we thought that line may have been trended a little bit higher. So, sort of curious as to how you're thinking about that line item. Obviously, you have good performance, and then with the Templeton funds and then the income fund going back into above medium on a one and three year basis, would you look to ramp that meaningfully to take advantage of that, and probably inflect flows even faster?

Ken Lewis

I think that we did see a pickup in the advertising expense this quarter, and we would expect to see a little bit more in the next couple of quarters or at least in the short-term for those very reasons that you stated. It was a little bit offset by other expenses that went the other way, but core advertising was up this quarter.

William Katz - Buckingham Research

Okay. So the support was just lower?

Ken Lewis

Yes, correct.

Operator

Our next question will come from Michael Kim with Sandler O'Neill.

Michael Kim - Sandler O'Neill

Hi, guys. Good afternoon. First, just to kind of follow-up on the capital question once again. I think you mentioned in your prerecorded comments that you passed or you may have passed on a number of potential acquisitions more recently. I know each deal is kind of different, but any color on your thinking in terms of why you decided to kind of stand back? Was it more kind of structuring, the strategic fit, or was it maybe a function of the pricing as well?

Ken Lewis

I think your opening comment sums it up. Every deal is unique and it's hard to generalize, and all of those reasons that you mentioned are reasons why you would or would not do a deal.

Greg Johnson

I think with the amount of comments that have been in the press, we really wouldn't want to comment and have people read into that that may not be accurate. So, I don't think we can really say much about why these deals didn't happen.

Michael Kim - Sandler O'Neill

Okay. Fair enough. Then in terms of the institutional channel, maybe if you could give us some sense of what you're seeing in terms of the decision making process, whether that has kind of picked up more recently as well as what you're seeing in terms of risk appetites more generally?

Greg Johnson

Yes. I think we talked about it last quarter that things look like they were starting to move, and I think that's been the case or that's what really has been our experience in the last quarter. Some mandates that were won that hadn't been funded yet, and we saw some funding start, and that really is a good sign that people are feeling more comfortable know overall about the market.

I think as far as the opportunities and the pipeline, we are seeing increased RFP activity and it's really been, as you'd expect on the fixed income side along with the global equities side, and really not much US equities, but those two areas would be the highest.

The other area that, whether you call it institutional or retail or somewhere in between, in the VA market, we had a lot of activity in the quarter, and it was in the variable annuities side and some new funding there, and some big moneys moving both ways that resulted in about a half million net going into that area.

So, our group is pretty optimistic right now about the pipeline and the opportunities that we're seeing, again, both in fixed income and the global equity side.

Michael Kim - Sandler O'Neill

Okay. Maybe just a final question for Ken. How should we be thinking about margins going forward or maybe put in a different way, at what point do you maybe start to ramp up spending assuming your assets continue to rebuild, and what areas would you focus on first in terms of the expenses?

Ken Lewis

We're going through a budget process now, and I think it's fair to say that, there is from the business unit, some demand for increased spending, but at the same time, we haven't forgotten what a painful year it's been. So, we're being very selective, and I would say strategic in how we would allocate dollars going forward if the revenue was there to support it.

I think it wouldn't be across the board like I said. It would be based on the individual business case, where we thought the spend would result in the most benefit, and in terms of line items, we do think it's probably a good time to do some advertising. I think on the technology side, there is probably some good reasons to increase spending in that area as well.

Greg Johnson

Just adding to Ken's comments. Where you would see the increases would be more around the variable numbers like marketing support and things that go up as assets go up, but as far as headcount and things, I think our outlook is that we're still being very cautious and very careful about adding headcount in this environment.

Operator

Our next question come from Jeff Hopson with Stifel Nicolaus.

Jeff Hopson - Stifel Nicolaus

Thank you. In regard to the global bond product, it appears that most of the flows were on the retail side, and I'm just thinking that on the institutional side, given that the demand for fixed income, that would be a natural product that institutions would be interested in. So, I'm just curious what the outlook is there, and what the pipeline is?

Greg Johnson

I think that’s a fair comment. I think if you look at the global bond category within the retail space, if one had looked at that category a couple years ago, you probably would have ignored it because it was very small. I think it again points to when you have strong output in any category, you will attract money.

I think it's a little bit harder in the institutional market where it has not been a large traditional allocation. It doesn't fit neatly into a specific box, so there the searches are going to be a lot less than a typical category. So, we're seeing some interest, but that really has not been an area where we're seeing the real potential.

It's really continuing to build out the retail side, and another are kind of in between would be variable annuities where, again, in the last quarter that product was added to some variable annuities where's they hadn't had global bonds in there before, and they were very significant dollars going in there.

So, we think that trend will continue, but I think the greater opportunity is still in the retail channel, and that's really just growing every month for us.

Jeff Hopson - Stifel Nicolaus

Okay. I assume that as the quarter has gone on in July that, international foreign product flows have improved. Is that a fair comment?

Greg Johnson

As always, we can't really comment on that. I think as long as the markets are continuing to be strong and the dollar's getting hit, you'd expect foreign funds to be doing relatively well.

Operator

Our next question comes from Mike Carrier with Deutsche.

Mike Carrier - Deutsche Bank Securities

Thanks, guys. Just a quick question on the retail side. I think you gave some indication that the retail investor's taken a little bit more risk, but I guess industry flows, your guys inflows is still weighted towards the fixed income product. So, is it just increasingly that you're seeing them take on more on the equity side or is it just something, through the comments, from the wholesale force talking to the different channels that you're just starting to see some activity there?

Greg Johnson

I think if you look at the overall flows, I mean the change in the net outflow versus a slight inflow into equities is a fairly significant shift in the quarter. So, if that trend continues, it would be a fairly significant shift towards positive flow. So, I think you could conclude from that that it is a significant shift in the investor now.

It's not the same kind of numbers that you're looking at on the fixed income side, but they never had the net big outflow number anyway, and we do think that it is just part of the natural process of getting people back into long-term funds. Some people may have just gone out of the market completely, and then they feel like, geez, now it's no longer a systemic risk of the banks, and they're willing to go back into longer rated fixed income-type products.

So, I think that will continue. As a company, we just kicked off a big push on our own Franklin Equity and Flex Cap and growth products, and so we're pretty optimistic that we can get some momentum there.

Operator

Our next question comes from Cynthia Mayer with Bank of America-Merrill Lynch.

Cynthia Mayer - Bank of America-Merrill Lynch

Hi, good afternoon. Just a question on homebuyers. I'm not sure what, if any, impact this would have on your business, but what trends are you seeing in terms of investors moving into or out of securities from their own countries? Are you, for instance, seeing non-US investors moving out of dollar denominated assets or as risk appetite improves are you seeing investors move more outside their own countries. I don't know if that would benefit you or not.

Ken Lewis

I think any time you tend to see the dollar weakening you will see a shift with the investor moving in more global equities and I think that's definitely taking place today. Outside of the US, again, it's hard to generalize because some markets, they don't have the ability to invest outside of their country. So I wouldn't be able to answer that question except from the US investor's perspective and I think the answer is that that is shifting and it seems to be more pressed about why it's important to do that.

Cynthia Mayer - Bank of America-Merrill Lynch

Okay. Just circling back to the institutional just to try to put it in perspective, how's the RFP pipeline and traffic look compared to, say, a year ago?

Ken Lewis

I actually just spent some time with our head of distribution a few hours ago and he said that the RFPs are probably up two to three times from the bottom. I'm not sure where they are right now relative to a year ago, but I would guess it's somewhere still below or maybe near that level, but there is increased activity right now that's fairly significant from where we were where everything seemed to be somewhat frozen.

Cynthia Mayer - Bank of America-Merrill Lynch

Great. And last question, it looked like in the quarter the headcount came down a little bit more and I was wondering where that came from.

Ken Lewis

That's a result of headcount reductions we had last quarter.

Cynthia Mayer - Bank of America-Merrill Lynch

Okay. So nothing new there. Thanks a lot.

Operator

Our next question comes from Keith Walsh with Citi.

Keith Walsh - Citigroup

Hi, everybody. Most of my questions have been asked and answered, so I've just got one. Just on the wire-house distribution side with the consolidation we've been seeing, I know we've asked this in the past, just any thoughts on pressure on fees for asset managers in general going forward?

Greg Johnson

I think it's the same answer that we had. We haven't seen any shifts. I think that the more you concentrate distribution in fewer hands it's not necessarily a good thing, but it's also that percentage of our sales is decreasing, as well. So you can look at it another way that other channels are becoming more important as the problems that some of the big wire-houses have had and the consolidation that's taken place. So it's not as big a percentage of our sales as it used to be, but we're concerned with that concentration just like you are, but it hasn't resulted in any changes to date.

Keith Walsh - Citigroup

Great. Thank you very much.

Operator

Our next question comes from Marc Irizarry with Goldman Sachs.

Marc Irizarry - Goldman Sachs

Greg, just on the fixed income mandates that you've been winning, can you give us a sense of, I don't know if you can really tell or not, but the business that you're winning, is it rebalancing activity or replacement? Do you think you're taking share there or is this part of new folks who are coming in to look at credit, maybe more opportunistically?

Greg Johnson

Yes. I think it's all the above. I think you do have a shift in allocation, a little bit heavier fixed income away from equities that you would expect after and probably the wrong time to do that, but I really don't have the data in front of me to know how much of it's changing managers versus new allocation.

Marc Irizarry - Goldman Sachs

Okay. And just in terms of consolidation, obviously we've seen a pretty big deal from one of your competitors, and I think the thinking behind that is that there's more mandates going to fewer managers. a, is that a trend that you think is going to be meaningful going forward; and, b, how are you guys positioned to take advantage of it?

Greg Johnson

I don't know if I agree. I think there's some strategic rationale in getting access to more clients, but I also think one could argue that the concentration of mandates within one organization is more of a negative than a positive, that people tend to do business with multiple firms and it really doesn't complicate their world. You could argue I have one single point of contact but sometimes that's even more difficult because of the risk of that one entity, something occurring.

So I don't think that's a real reason, one that we would think would be a big benefit of doing a large scale deal like that, that more people are going to be dealing with less firms. I just don't think that's the case. I think there's always an appetite for boutiques and specialists that are recognized specifically for being best of class in that certain sector.

Marc Irizarry - Goldman Sachs

Then just maybe an update on the sorts of acquisitions that would make sense given your product set.

Greg Johnson

Ones that enhance shareholder value over time. I think that that's what we try to look at and there's really no simple answer. It can still be a consolidation of assets, that you get cost savings and synergies out of it. It could be a new asset category to leverage. It could be entering a market that will help us sell other of our products. So we keep a pretty open mind and look again at what's out there. So I don't think, other than the markets that we've stated in the past, that there's anything specific type of firm that we would go after.

Marc Irizarry - Goldman Sachs

Great. Thanks.

Operator

Our next question comes from Douglas Sipkin with Pali.

Douglas Sipkin - Pali

Yes. Most of my questions have been answered, just one additional one. Just hoping to get some color maybe on the investor sentiment, particularly in the California muni-market. I know it's a big product for you guys and I know you have put some literature on your website. So, just curious where investors' heads are as it relates to that particular product and the state in general.

Greg Johnson

I think, the tradeoff, you've never had yields that are available today versus inflation. So many experts argue it's a good buy and that keeps some support of the purchasing. So despite the headlines and all the difficulties that the state has had in getting a hold of its budget, the muni market has held in fairly well and it's not been a market that we've seen big inflows into, but it hasn't been a market where there's been a lot of redemptions. I think that's the unique part of fixed income. When things get tough, the yields get attractive and bring in new buyers and probably a good buy with these kinds of spreads. I think people do separate the two. The headlines of the budgets versus the probability of GOs getting repaid, and we still feel pretty good about it.

Douglas Sipkin - Pali

Great. Just to follow up, it sounds like, from your perspective, the investor preference, or I should say demands for fixed incomes on the taxable side, remains fairly high. Would you make the same statement on the tax free side for broader munis?

Greg Johnson

Yes. And I think the flows speak for themselves. Those are categories whether it's high yield, strategic income, global bond or munis that had fairly strong inflows last quarter. Those have been areas that have been treading water to outflows over the last couple years. So clearly there is an appetite for fixed income.

Douglas Sipkin - Pali

Great. Thanks for taking my questions.

Operator

Our last question comes from Mike Carrier with Deutsche.

Mike Carrier - Deutsche

Just one follow-up; on the tax rate you mentioned from going from 35% to 32%. Just wanted to make sure that's fiscal year '09. And then just any color, I know it's far out but when you look at 2010, are we back to look at 35 rate or will it remain a little lower? Thanks.

Ken Lewis

Yes, 32% fiscal year '09, that's our current estimate, and we'll take a look at it in first quarter. It's super hard to predict given it's all based on the earnings mix. So we'll do an estimate in December based on the information we have then and let you know.

Mike Carrier - Deutsche

Okay. Thanks.

Operator

Mr. Johnson, do you have any closing remarks?

Greg Johnson

Again, just want to thank everybody for participating on the call and we look forward to speaking next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you. You may now disconnect.

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