Gregory Eugene Johnson - Chairman, Chief Executive Officer, President and Member of Special Equity Awards Committee
Vijay Chandur Advani - Executive Vice President of Global Advisory Services
Kenneth Allan Lewis - Chief Financial Officer, Principal Accounting officer and Executive Vice President
Franklin Resources (BEN) Q4 2013 Pre Recorded Earnings Call October 24, 2013 ET
Welcome to Franklin Resources earnings commentary for the quarter and fiscal year ended September 30, 2013.
Please note that the financial results to be presented in this commentary are preliminary.
Statements made in this commentary 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 10-Q filings.
This commentary was prerecorded.
Gregory Eugene Johnson
Hello, and welcome to our Fourth Quarter Earnings Commentary. I'm Greg Johnson, CEO. Today, I'm joined by Ken Lewis, our CFO; and Vijay Advani, Executive Vice President of Global Advisory Services.
I am pleased to report a solid quarter of operating results to cap off a record year for the company in terms of revenue, operating income and net income. Assets under management ended the fiscal year near an all-time high, an increase of 13%, due to the strong investment performance of our funds both absolute and relative, and net new flows of $24 billion, a marked improvement from 2012. Although, there continues to be a number of headwinds facing asset managers, I'm encouraged by the improved flows to equity and hybrid strategies, which collectively had their strongest quarter of flows in 3 years, with net new flows of $5.6 billion. The improvement was due to steadily increasing sales, which were up 33% from the prior year, and net exchanges from fixed-income funds that helped to offset fixed-income outflows.
Importantly, Templeton Global equity performance continues to improve, with approximately 90% of assets ranked in the top 2 quartiles versus its peer group for the 1-, 3- and 5-year periods, and returned to positive flows for the first time in a while.
Turning to Slide 6. Overall relative investment performance of our U.S. retail fund range was little changed over the past 3 months despite the increased volatility we experienced. Franklin equity relative performance rankings improved this quarter, especially over the 1-year period. Long-term performance remained strong, notably among our larger dividend and income-paying products. The Franklin Income Fund continues to have great performance across all time periods, which benefits us at a time when investors are re-risking by transitioning into income-paying stock funds and hybrid products.
Templeton equity relative performance remains outstanding, especially global equity funds that have been overweight European equities, which outperform U.S. equities again this quarter.
Mutual Series equity performance generally improved but remains challenged versus its peer group over the short term. The long-term performance is strong. Mutual Series deep value approach, including the tendency to hold above-average cash, tends to underperform during periods of strong market appreciation and outperform during market declines. Risk-adjusted returns, though, continue to outperform the peer group and are a better measure of performance for these funds.
Taxable fixed-income relative investment performance remained strong, with the majority of assets in the top quartile across all time periods, including the Templeton Global Bond and Global Total Return Funds.
From a macro perspective, emerging markets experienced continued volatility for most of the quarter due to currency pressure caused by the U.S. Federal Reserve tapering expectations. When this did not materialize in September, markets rebounded strongly.
Tax-free fixed-income short-term relative investment performance continues to lag due primarily to the impact of rising rates given the longer duration of these funds. However, long-term relative performance in this category is exceptional, with 99% of the assets in the top 2 quartiles for the 10-year period.
Recently, our municipal bond funds have suffered selling pressure driven by the rising rate environment. Negative press on the muni bond market has been driven by narrowly focused headlines around Detroit and Puerto Rico, and this further contribute to the selling. Consequently, we view the current selloff as a reflection of weak demands stemming from fears of high interest rates and negative headlines, as opposed to a fundamental change in the underlying credit outlook for the asset class as a whole. Importantly, these funds are not without their appeal in this environment. We believe their tax-exempt nature may also be seen as more valuable to investors at a time when income taxes have increased.
Assets under management ended the period at almost $845 billion, a 4% increase from last quarter and 13% from the prior year. Average assets under management were $828 billion, a 14% increase from a year ago but 1% lower than the prior quarter.
The mix of assets under management by investment objective shifted toward equities in the quarter but remains well diversified, with a near 50-50 split between equities and fixed-income. It's also worth reiterating the point that our fixed-income business does not fit the stereotype of a rate-sensitive U.S.-based portfolio due to its weighting in nontraditional, global and international strategies, which are defensively positioned with respect to interest rates.
Assets under management by sales region were unchanged since last quarter.
Long-term net new flows turned negative this quarter due in part to a 47% decrease in sales in the global fixed-income strategies and an increase in redemptions from tax refunds, though total long-term redemptions actually decreased as investors paused in the face of heightened uncertainty. $400 million of long-term outflows were exchanged into cash management funds, which helped to limit total net new outflows to $2.7 billion. Market appreciation of $33 billion was the primary driver of the net increase of assets under management this quarter.
Now I'll turn it over to Vijay to give additional color on the flows.
Vijay Chandur Advani
Thanks, Greg. My comments refer to the data illustrated in Slides 11 to 14.
As Greg mentioned, similar to the industry, investor concerns over rising interest rates and fields of municipal defaults was the primary contributing factor to the outflows we experienced this quarter. That said, long-term sales of $215.6 billion for the fiscal year was just shy of the all-time high reported in 2011, and net new flows of $24.3 billion were one of our best years ever and a strong rebound for the modest net outflows reported last year. This quarter's flows, while at negative $2.7 billion, do illustrate the benefits of the diversification of our business.
In the U.S., municipal bond markets have been experiencing a negative feedback loop as fears of rising interest rates and consequent selling pressures caused yields to move higher, followed by a further selling pressure in the retail-dominated market. Regular headlines on Detroit's bankruptcy and Puerto Rico's debt obligation only added to the problem, leading to net new outflows of $5.4 billion from tax-free fixed-income funds.
Global fixed-income came under pressure during the quarter as sales slowed by almost half and redemptions moderated only later in the quarter. Our large flagship U.S.-registered and cross-border global fixed-income funds experienced volatility in performance last quarter, and again in August, which caused investors to pause. The decline in sales was most notably in the cross-border SICAV global bond and Global Total Return Funds. Their clients tend to be more reactive. This is reflected in international long-term sales that fell from their all-time high. The volatility in performance was driven primarily by fluctuations in currency valuations and not by expectations of rising interest rates.
In the current market environment, we leveraged a marketing campaign to talk to investors about strategies for investing in a rising rate environment.
U.S. fixed-income net new flows were up again this quarter as sales and redemptions both decreased, reflecting investor preference for shorter-duration and floating-rate funds. Floating-rate and high-yield offerings attracted solid inflows, which more than offset outflows from our longer-duration investment-grade strategies.
On a positive note, we saw increased sales activity in U.S. and global equity categories, with both generating positive net new flows for the quarter. We continued to discuss our popular Time to Take Stock campaign, promoting investor diversification into equities, which was adopted across our international businesses, with 21 countries leveraging the content and 15 countries publishing campaign-specific content on their local websites.
U.S. equity sales continued to trend upwards, increasing by more than 60% since the fourth quarter of 2012. In line with market improvements, redemptions declined and net new flows turned positive at $1.2 billion.
The Franklin Rising Dividends fund continues to be a strong seller, leading the category this quarter, with sales growing 10% from the previous quarter. The fund hit an all-time high in sales in the month of July. The Rising Dividends fund had $13 billion in assets under management as of September 30, 2013, compared with only $2 billion as recently as 2009.
Global equity also saw a return to positive net new flows of $1.2 billion after being in outflows last quarter. Our top-selling fund was our cross-border SICAV Franklin European Growth Fund, which had a very strong increase in sales and net new flows in excess of $1 billion, the second best flow gainer this quarter. Several European-centric funds such as the U.S. and cross-border versions of the mutual European fund and the Templeton Foreign Fund, which is heavily overweight Europe currently, were amongst the top-selling funds in the category.
We continue to promote the strength of our European equity product offering and are producing a new and more robust Franklin European equity story promoting the Pan-European local asset management team and the funds they manage. The mutual global discovery fund, one of our flagship funds in the global equity category, had a third straight quarter with solid long-term sales and inflows. In addition, this quarter, we saw net new flows in institutional accounts of $600 million.
Amid concerns over market volatility in emerging markets, the cross-border SICAV Templeton Asian Growth Fund and the cross-border SICAV Templeton China Fund experienced net outflows of $1.1 billion and $400 million, respectively.
Lastly, in the hybrid category, the Franklin Income Fund remains our top-selling fund. The fund recently celebrated its 65th anniversary, and we launched a campaign to highlight the benefits of the fund in providing a steady stream of income to investors throughout its history. We're also beginning a new retirement income campaign which will promote the fund as a core holding in generating income for investors and retirement. The cross-border SICAV version has also been gaining traction internationally and was the second best seller in the category this quarter.
We think of our business as a well-knit tapestry. Each region, asset class or fund may perform at a different pace or a different point in time, providing long-term depth and stability to our business model. This year, Europe continues to be a key driver of our sales.
Now I will hand it over to Ken to discuss operating results.
Kenneth Allan Lewis
All right, thank you, Vijay.
As Greg mentioned in his opening remarks, fiscal 2013 was a record year for revenue, operating income and net income. Total revenue of nearly $8 billion was a 12% increase from last year, driven by the strong growth of average assets under management of 15%. Operating income of $2.9 billion increased 16% and outpaced the growth of assets under management as we continue to focus on profitably growing the business over the long term. For the quarter, operating income was down 5% due mostly to seasonal expense increases.
Fiscal year net income increased 11% from the prior year, topping $2 billion for the first time. Earnings per share growth of 13% outpaced the increase of net income due to net share repurchases that have been about 2% accretive to earnings annually over the past 5 years.
For the quarter, net income was $509 million and diluted earnings per share was $0.80.
Now looking at revenue on Slide 17. Investment management fees were down 2% for the quarter, and there are a few moving parts to consider here. First, we had performance fees of $6.2 million and a small benefit from the additional day in the quarter. And this was offset by the decrease in average assets under management, as well as an adjustment for the classification of customer rebates of investment management, and sales and distribution fees that did not impact operating income or earnings. The total adjustment reduced the asset base component of sales and distribution expense by $47.4 million, with offsetting reductions to investment management fees of $31.2 million and sales and distribution fees of $16.2 million. About 3 quarters of each of these adjustments should be considered nonrecurring, as they reflect catch-ups for the full year.
Now sales and distribution fee revenue were $605 million this quarter, down 9% from the previous quarter. The asset-based revenue was essentially flat, excluding the impact of the accounting adjustments, with asset declines offset by a mix shift to equity and the impact of an additional day in the quarter. Most of the overall decline came from the sales-based revenue component due to lower U.S. and international commissionable sales. Shareholder servicing fees were down 3% due to a lower asset base and a decrease in the number of open accounts. Additionally, the number of closed accounts decreased due to the annual purge of approximately 1.2 million U.S.-based accounts in July.
Other net revenue was $19 million, and this was lower than prior periods due to decreases in dividend and interest income in certain consolidated sponsored investment products this quarter.
Now moving on to expenses on Slide 18. Operating expenses were down 5% overall for the quarter, but a couple of subcategories increased more than anticipated. The decrease in sales, distribution and marketing expense to $718 million was due mostly to the reclassification of investment management fee rebates to investment management and distribution fee revenue that I mentioned earlier. Again, no impact to operating income, but a decline in both the average assets under management and sales for the quarter also contributed to the decrease.
Compensation and benefits expense was little changed this quarter at $349 million. Information systems and technology expense was $58 million. This line tends to be seasonal, as we've discussed in the past, and this quarter was no exception. About half of the increase was driven by seasonal and one-off items.
In terms of the quarterly seasonal pattern, 2013 unfolded similar to 2012, with the aggregate annual spend up approximately 4.5%. We're expecting the historical seasonal spending pattern by quarter to continue in 2014 and also for general spending levels in this line to increase by 7% to 8%.
Occupancy expense was $35 million, up 3% over the prior quarter, reflecting higher energy use and rent expense, which reflects our global expansion in 2013. We expect this line item to also increase slightly in 2014 in the range of 3% to 5% for the full year.
General, administrative and other expense also tends to be seasonally higher in the fourth quarter but can also be difficult to predict because of the variety of expenses that are included here, including those that are market driven. This quarter's increase was mainly due to increased advertising and marketing expenses, as well as various legal and professional fees. And lastly, an additional $2.8 million increase in accounting adjustments relating to the amortization of intangibles also contributed to the increase. Now about $2 million of that is not expected to recur. Looking forward and assuming neutral markets, we would expect this line item to decrease slightly in 2014, as there were some unusual and nonrecurring items in 2013.
Other income, net of controlling interest, generated a net loss of $11.4 million this quarter compared with a loss of $3.3 million in the prior quarter. Slide 19 does a good job of illustrating the components, but this quarter, investment gains and losses were largely offsetting and we're essentially left with interest expense.
We incurred some fairly significant foreign exchange losses this quarter driven by the continued volatility in the currency markets. As a reminder, foreign exchange revaluations are part of the other category and were the primary contributor to the decrease in this category. It's worth mentioning that, on an annual basis, foreign exchange typically has an immaterial impact on our P&L, and that was true in 2013 as well.
Other net also included a nonrecurring charge of $4.5 million related to prepayment penalties on early retirement of Federal Home Loan Bank advances as we continue to wind-down our banking business. During the quarter, we also sold the related real estate mortgage loan portfolio to a third party and expect to close the sale of our brokered CDs this coming quarter.
Turning to Slide 20. The tax rate for the quarter was 29.4%, which brings the full year rate to 28.3%, which is in line with last quarter's guidance and essentially unchanged from 2012's rate. At this time, we anticipate the fiscal 2014 rate to be around 29%.
Now turning to Slide 21. We saw a 16% increase in operating income over the prior year, which was a record high of $2.9 billion. As our asset base has grown and as we build scale within key strategies and products, our revenue growth has outpaced corresponding expense growth, and that has contributed to our margin expansion over time. While it may appear as though the year-over-year effective investment management fee rate declined, the year-over-year operating income, in basis points of assets under management, actually increased by 0.5 basis points.
Moving on to capital management. The payout ratio was 64% for the fiscal year. During the quarter, we significantly increased the pace of share repurchases, buying additional 5.5 million post-split shares, which was more than we repurchased the prior 3 quarters combined, as we took advantage of a pullback in the stock and forward earnings multiple. The dividend payout remained consistent, but the Board of Directors did round up the last dividend to $0.10 per share, which represented a 3% increase from the prior quarter.
Net cash and investments increased $200 million this quarter to $7.3 billion. We understand investor questions about this growing number but continue to focus on returning available U.S. cash flow and believe that it is in the best interest of stockholders to maintain our current policy with respect to investing most foreign-sourced earnings given the substantial tax penalty that will result from investing that cash in the United States under current U.S. corporate tax structure.
So that concludes our prepared remarks. Thank you for taking the time to listen. If you have any questions about our comments, please contact our Investor Relations team.
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