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Franklin Resources, Inc. (NYSE:BEN)

F1Q10 (Qtr End 12/31/09) Earnings Call

January 28, 2010 04:30 pm ET

Executives

Greg Johnson - CEO

Ken Lewis - EVP & CFO

Analysts

James Shanahan - Wells Fargo Securities

Robert Lee - KBW

Jeff Hopson - Stifel Nicolaus

Mike Carrier - Deutsche Bank

Craig Siegenthaler - Credit Suisse

Roger Freeman - Barclays Capital

William Katz - Buckingham Research

Michael Kim -Sandler O'Neill

Dan Fannon - Jefferies & Company

Marc Irizarry - Goldman Sachs

Cynthia Mayer - Bank of America

Ken Worthington - JPMorgan

Operator

Good afternoon. And welcome to the Franklin Resources earnings conference call for the quarter ended December 31, 2009. My name is Michael and 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 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 including and the risk factors and MD&A sections of Franklin’s most recent Form 10-K and 10-Q filings.

After the speakers' remarks, there'll be a question and answer session. (Operator Instructions). The company asks that you limit questions to one initial and one follow-up question. (Operator Instructions).

I would now like to turn the call over Mr. Greg Johnson CEO for some opening remarks.

Greg Johnson

Good afternoon and thanks for taking time out to join us for this call. I am Greg Johnson, along with Ken Lewis, our CFO. We are please to report another solid quarter across the board as our company continues its strong recovery from the prior year. At least 85% of our longer term assets outperformed our Lipper peer group for the three, five, and 10 year periods. And long term net new flows exceeded $15 billion.

Operating income increased 21% this quarter. On the capital management front, we paid a special dividend of $3 that have now returned almost $1.4 billion to shareholders over the last 12 months alone.

Before we open it up to questions I want to take a moment to note with great regret that one of our Independent Directors Bob Joffe passed away today from cancer. Bob was a partner at the law firm of Cravath Swaine & Moore and served as the firm's presiding partner from 1999 to 2006. He joined our board in 2003 and served as Chair of our corporate governance committee.

Bob also was a member of the board of Fiduciary Trust of subsidiary. All of us at Franklin benefited greatly from Bob's guidance and oversight. He will be missed. Our thoughts go out to his family.

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

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of James Shanahan with Wells Fargo Securities.

James Shanahan - Wells Fargo Securities

I'm sorry to hear the news about the loss in the Franklin family and kicking of the call in such a somber tone but I wanted to ask a couple of questions here about expenses. First with regards to advertising. There is a discussion in the prepared remarks about the seasonality in advertising and how it seems to be sort of weighted towards the back half of the fiscal year. However on a year-over-year basis, there was a relatively large advertising expenditure. And I'm curious what your view is on the sort of the outlook for advertising expense. What it really takes to protect the value of the franchise and perhaps to grow it in this market environment.

Ken Lewis

Hey James thanks this is Ken. There is usually some seasonality in the advertising in the first quarter as I mentioned in the prepared remarks. And maybe it would help to just explain a little bit further that there are other things in the advertising and promotional line other than just adverting and for example a large component of that line relates to marketing support payments to intermediaries that are a function of gross sales and asset levels and in this quarter, that's probably about two-thirds of the total line item. Normally, when advertising is at its kind of full level, that's about half. So half for the marketing support and half for the advertising.

Going forward, just on the advertising line. I do expect it to ramp up a little bit. We still think we still have a good story to tell. I think it might even be just pure advertising might even be a little bit more than we advertised last year.

James Shanahan - Wells Fargo Securities

Can we expect to maybe perhaps see advertising expense at some point reaching levels that you reached in the fiscal 2008 calendar year or fiscal year.

Ken Lewis

Maybe not in the short term. More like 2009.

Greg Johnson

I think it's important to note that the larger driver there is going to be assets and sales for that line. And advertising as a whole would probably be higher than the prior year because it was cut quite a bit.

Ken Lewis

And to that point, 2008 a large part of that higher level was due to the expenses that are function of asset under management.

James Shanahan - Wells Fargo Securities

The way assets have also grown considerably in recent quarters and with the favorable flow trends, it wouldn't be unreasonable to assume that we're talking about higher sort of run rate for advertising. But obviously with that I'd like to ask one other quick question on other operating expenses its clear in the recent downturn that there were items that were discretionary namely travel expenditures, that sort of thing. Why do you think it’s very comfortable with the run rate for other operating expenses? Thank you.

Ken Lewis

I think generally speaking, there will be some pressure on the expenses. I keep saying we're being really thoughtful about how we do that. But I would expect to see some increase, but not a lot in most of the line items, including other expenses.

Operator

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

Robert Lee - KBW

Real quickly, Greg, can you may be give us a little bit of color, and I apologize if I may be blanked out in the prerecorded calls. It's been a busy day but can you give us a little color on if we are looking at flows from a retail versus institutional perspective. Maybe starting with the global fixed income products. Maybe [you] can say you try to split that down between how much of that is institutional versus retail or domestic and global basis?

Greg Johnson

Unfortunately, I don't have that breakdown in front of me between what is retail and institutional. But the majority of it is going to be institutional. We did have one large addition, I think it was $1.2 billion into an existing emerging markets debt account during the quarter. But really no other large separate accounts in global bonds. The majority of that number is driven by retail. Most of that in the US probably two-thirds and the rest coming from international.

Robert Lee - KBW

Okay. And, you had a pretty substantial pickup I guess and I guess it was gross sales. And obviously, and one of the equity categories I think. But it was kind of offset as you mentioned with the heightened redemptions. Could you may be just give us a little color of what you know (inaudible) where the increase was in gross sales, kind of the what the way you see kind of driving back.

Greg Johnson

Well, again the big increase is around the global bond side. If you look at most of the categories, they were relatively flat or close to flat as far as the gross sales numbers. Really the global bond category where we saw the biggest pick up.

Robert Lee - KBW

I guess it wasn't that as big an increase as I thought (inaudible) so just kind of as you said normal flow, little bit more activity among retail and the US maybe but, nothing else.

Greg Johnson

Of note, there was a pickup in the redemption line, and I do know that there were some lumpy redemptions. We had a couple of large accounts go to passive during the quarter that affected the global equity redemption line. So this will again I think the retail numbers were fairly stable and the only really movement of note in that category was some institutional redemptions.

Operator

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

Jeff Hopson - Stifel Nicolaus

Greg I'm still a little surprised that the international equity hasn't picked up or the global equity, I guess. I know equity flows in general been kind of modest. But surprised they haven't been a little bit better. And then Fiduciary trust I think you did mention that flows through that channel picked up here in the quarter. I haven't really heard much about that name in a little while. So I'm curious if you can give us any more insight into what's going on there.

Greg Johnson

I think it's a very positive story for the quarter. And Fiduciary probably had one of their best quarters to date certainly since we have been a part of the organization, and part of that shows up in the hybrid line and that’s part of the reason you see the increase from $1 billion about $500 million to $600 million of that was inflow into Fiduciary balanced accounts so obviously good momentum there. A lot of positive developments brought on some new people. And we have seen some real growth there and I think that is a very, very positive story.

Jeff Hopson - Stifel Nicolaus

Okay and when you say Fiduciary, you are talking about their private client business, I guess.

Greg Johnson

Correct.

Jeff Hopson - Stifel Nicolaus

Yeah okay great. You know on the global equity?

Greg Johnson

Yeah I think it is similar to the whole equity story I mean you'd hope you'd see a bit more of a pick up I think some of the momentum may be between the dollar being a little stronger overall on the quarter may be a contributor to a pickup in redemptions. And I just think the overall uncertainty some of the headwinds that we've seen on the US equity side are still there on the global equity side as well. Not a whole lot of confidence overall in equities today.

Operator

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

Mike Carrier - Deutsche Bank

Question on the international side. The sales were up 37% in the quarter. A lot of strain product wise. You've given some color on it, but I guess from a client perspective, it's always harder for us to know how the distribution is structured outside the US. So whether it's coming from Europe or Asia and then more importantly the distribution channels on the retail side are institutional and whether it's retirement or through banks, just trying to get some color on where the demand is coming from?

Greg Johnson

Well, it was a very strong quarter on the retail side in both Europe and Asia and Europe again driven by global bond sales, very strong in Italy, Switzerland. Some of that could be more platform driven where you're getting bigger chunks on to platforms and those kind of markets. Asia growth, very strong again for the quarter for us. Those are really the two drivers as far as products and most of that is just your typical retail distribution. I don't have a breakdown between banks, planners or the rest.

Mike Carrier - Deutsche Bank

Okay and then the only other thing is the underwriting distribution margin looks like it just ticked up in the quarter. Just curious if there is anything going on there and more importantly just going forward?

Greg Johnson

There was one non-recurring item that probably bumped up a little bit, about $3 million and I think if you back that out, the margin was about the same as it was last quarter.

Operator

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

Craig Siegenthaler - Credit Suisse

Just a question on compensation expenses and just maybe you can go a little bit deeper on how you are thinking about them, but with the calendar year 2010 likely being a very strong year for revenue growth that the markets can continue the way they're going and if your flows can continue the way they are going, how do you think about comp stepping up relative to revenue and maybe that’s a function of how much of comp is really variable and will correlate with earnings and kind of revenue and how much is fixed?

Greg Johnson

Well, I did try to give some guidelines for that in the prepared remarks, that we certainly do think that there'll be upward pressure in compensation and for a number of factors. One is there's a little bit of seasonality that you see in the first quarter and there was also just one month of expense in last quarter for things like bonuses and performance shares and also there was some salary rollbacks that happened last year that are being reinstated this year. So in general, I do see that line going up about 2% to 4% and that is in the context of flat revenues. If revenues increase, then I think you will see that line increase a little bit more.

Operator

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

Roger Freeman - Barclays Capital

It looks like the outflows and equities were really institutionally driven I think as you indicated. Do you think is there anything more really than to the year end derisking among institutions that would be consistent with the temporary jump in institutional money market balance that we saw as opposed to any kind of interruption of the trends towards higher risk that the institutions have been moving towards.

Greg Johnson

I think that’s probably right, and I wouldn't draw any conclusions. I think the pipeline is still very active and strong as far as global equity surges for us. We really haven't seen any change there.

Roger Freeman - Barclays Capital

Just as a complementary to that I mean that’s, has that changed at all in the first quarter here so far in January?

Greg Johnson

I don't think so. I think it's been pretty consistent. Just this quarter we had a couple of larger redemptions and they weren’t due to performance there just due to a couple going passive.

Roger Freeman - Barclays Capital

The second question is on capital plans, opposed to special dividend and you still have significant cash on the balance sheet. Do we look at that dividend as really just you acknowledging a less sort of less risky environment? And willing to run with a lower cash cushion such that there's still a future return of cash potential.

Greg Johnson

Yes, I would say that you really shouldn't look at our capital management activity last quarter. It should not be a signal I should say that any change in our philosophy going forward. There were a number of factors that were considered in declaring that special dividend. They looked at US cash flow. US cash flow has been increasing because we’ve talked about the shift in investor preference to fixed income assets, all of those assets are managed in the United States.

So we're getting some free cash flow in the United States from that. Certainly, the low tax rate was a consideration. I just want to emphasize it really shouldn't be a signal that we're changing any of our philosophy whether that’s our philosophy on acquisitions or share repurchases in the future.

Operator

Your next question comes from the line of William Katz with Buckingham Research.

William Katz - Buckingham Research

A question on the equity, new advertising program that you have underway. You sort of highlighted that you interacted with 1800 incremental financial advisors in terms of cross-selling a Franklin product, just wondering if you could give me a sense of how many people had you initially targeted, what the target size of your audience might be and then what the capacity opportunity might be on that?

Greg Johnson

I don't have the numbers in front of me on the size. We're really targeting all of the advisors that we are in contact with. And we just think that right now, especially with all the press around the last decade in equity investing that we need to give advisors more tools to deal with what is a growing trend of people feeling that equities are too risky or just not providing the returns. So the 20/20 vision campaign is just a nice, clean, quick facts on equity investing over various periods.

And it's consistent with our theme in marketing of increasing our equity presence. And it's something we've talked about for prior calls and we are seeing an incremental numbers of actually some of our US equity funds had positive inflows during the quarter. They're just not large enough really to mention, but the trend is good there.

Ken Lewis

I would just add to that that the campaign is starting at US, but it's going to be leveraged globally, which is something new for us to be able to get that out there quickly.

William Katz - Buckingham Research

My second question is some of these newer countries that you're entering or getting a little more scale in, whether it be Thailand, Malaysia et cetera, where are we in terms of the opportunity set for some of that as well?

Could these be similar to what's going on in some of the European or Asian opportunities as well?

Greg Johnson

I think those two examples, Malaysia, Thailand are two different market and one in Malaysia for us, we got the immediate benefit of being there on the institutional side, and got some significant wins just this past month from the government there. Thailand’s more of a investment management office for us.

I think Malaysia for us, we just received the [Shariah] license, which is something we're going to start in that market, and hopefully, it would be portable into other markets and could leverage our existing global equity funds into a whole new audience. So it's going to take time. There's been no portable [Shariah] kind of funds to date, but that market is moving pretty quickly and we think we're in a pretty good position there.

William Katz - Buckingham Research

Just to qualify it, when you said there are a couple of wins this past month, are we talking January or December?

Greg Johnson

January.

Operator

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

Michael Kim - Sandler O'Neill

First in terms of kind of reinvesting in the business, assuming cooperative equity markets from here, would you expect to see your margins continue to rise from here or does maybe the step up in expenses work as about an equal offset?

Greg Johnson

That's relative to what the revenue increase is. I think you're going to see some, like I said you're going to see some increase in spending across all the categories. But it's not going to be dramatic and if you see a sharp uptick in revenue, the expenses will definitely not keep up with that, and all the same if you see a sharp downturn.

We're kind of cognizant and days like today remind us that we're not out of the woods yet in terms of this market environment. So we're just being pretty cautious. But we are committed to increase our investment in the business.

Michael Kim - Sandler O'Neill

And then just in terms of the institutional business, it seems like a majority of your wins in the last couple of quarters have been centered in global equities and fixed income strategies, just curious as rebalancing and replacement activity starts to pick up at some point more broadly, do you expect to see rising demand for some of your other strategies?

Greg Johnson

Well, we would hope so. We've had some wins that we think we have a pretty good product right now, and are on a lot of platforms and we're getting good visibility through a lot of consultants as the Franklin global advisers and our global growth product, and that would be an area that I think we'll start to see some wins, and that would be a new category for us, but as far as the opportunity set to date, immediate, it's still global equities, it's global [ag], emerging markets debt.

Michael Kim - Sandler O'Neill

Operator

Your next question comes from the line of Dan Fannon with Jefferies & Company.

Dan Fannon - Jefferies & Company

Can you give us some color around, as you look at your backlog for RFP activity here into the March quarter or even a little bit beyond relative to what you guys were seeing in the fall of last year, the September quarter or even December?

Greg Johnson

I think as I mentioned, it really has not shifted for us. Those are the areas that we're seeing demand. We've been fairly consistent with getting decent sized mandates every quarter and we think that's going to continue. Putting it relative to a few quarters ago, I think it's still improving.

Dan Fannon - Jefferies & Company

Then anything on the regulatory front, that you guys are watching or following whether it be tax related or just kind of general potential impacts to your business?

Greg Johnson

I think the obvious area of concern for the industry is just the potential of some tax and what’s being proposed to the banks today. We are a bank holding company. We're working with the ICI to make sure that A; asset management company is not included in that. That's our understanding, we wouldn't be. But we want to make sure that if anybody is thinking that, that we're making sure, we're making the case on why we shouldn't be included in that.

So that's the one area of risk. I think for us, our structure is somewhat flexible. We don't have to be a bank holding company. If anything happened that was problematic whether it’s taxes or regulatory environment, we have the flexibility to get out of the businesses that make us qualify as a holding company too pretty quickly.

Operator

Your next question comes from the line of Marc Irizarry with Goldman Sachs.

Marc Irizarry - Goldman Sachs

Greg, can give your perspective on the size of the redemption you saw in global equities and then also where we sort of stand in the pipeline of RFP activity in the global fixed arena? And do you see any notable change in what the pipeline looks like there?

Greg Johnson

I think there were two redemptions right around $700 million in global equities. The total was about $700 million, and another one in Japan for $330 million, so that's about a $1 billion of those redemptions were related to just three accounts. As far as the RFP activity goes, again, global equities continue to be very strong.

Marc Irizarry - Goldman Sachs

On the fixed income side, are you seeing a notable change in demand for global fixed, for global bonds?

Greg Johnson

I think we're still seeing strong demand. I just spent two weeks in Asia, and the relationships are very strong with the central banks, with the retirement, with the government retirement plans.

So, I would continue to see that as a huge opportunity for us where I think we have a bit of a unique position, it's not consultant driven in those markets, it's more direct relationships and if you look at trade flow and everything else, those accounts and surpluses should continue to grow and that means additional monies into additional accounts and additional opportunities.

Operator

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

Cynthia Mayer - Bank of America

Just some added color maybe, when you say global equities are strong, what strategy in particular is in demand? Is there a mutual fund we can look that’s a proxy for what's really in demand right now?

Greg Johnson

I don't think there's a specific mutual fund. We've gotten some Asia, ex-Japan mandates. We've gotten just kind of pure global equities. Templeton has always been somewhat two organizations as far as portfolio management goes and the institutional has a little bit of a different style than retail as far as matching a fund per se. So there are some differences there, but really just your typical broad based global equity mandates.

Cynthia Mayer - Bank of America

In terms of comp, I how are you thinking about headcount for the coming year?

Greg Johnson

I think you will probably see some additions to headcount and it wouldn't be anything dramatic, I don't expect, it would be pretty slow. But we'll see some uptick in headcount in the next couple of quarters.

Operator

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

Ken Worthington - JPMorgan

So to beat a dead horse here on the global equity, I'll try and take a slightly different tact. Your big retail funds all have very good performance, the top decile, the second quartile. And yet none of the big ones have seen sales in two years and it seems like the market appetite for global equity product is pretty good. Why the disconnect? It seems like everything is in place for you guys to just be knocking the cover off the ball and there's not follow through. Is it a sales issue? Is it something in distribution or it's the fact that they've got a lot of Europe in them? What am I missing?

Greg Johnson

I think what you're missing, one; we've been very successful with our global discovery Mutual Series five star fund and that continues to have very strong flows. So we have been getting very strong net flows in that category. Templeton remember, I mean a year ago was lagging and had a fairly significant lag that has been caught up with fairly quickly and I think it's just a matter of getting advisors back to selling.

You always have your core group there that continue to sell but getting new share just it is more of a lag than it would be on the institutional side. So we're still optimistic, but remember those funds had huge outflows just a few years ago and every quarter are still getting a little bit better on that front.

Operator

Your next question comes from the line of William Katz with Buckingham Research.

William Katz - Buckingham Research

Follow-ups, in the quarter just completed, both the revenue yield and operating profits were stronger than I was anticipating. I'm just really curious, systematically how do the assets generate outside the United States compared to those in the United States? I know you don't necessarily run the model that way, but inherently is non-US volume more or less profitable than your US business?

Greg Johnson

It's a slightly more profitable in that asset mix, you tend to have more equities and then even global bonds is a better margin than say Munis.

William Katz - Buckingham Research

Just to go back to discussion which I presume was talking about the bank holdings of owning property (inaudible) private equity. If push came to shove, are you leaning more to potentially getting rid of the bank holding structure and to underlying businesses of that or would you be looking potentially carve out Darby or other type of things that might be exposed?

Greg Johnson

I think it's premature to speculate what we would do. We feel we have flexibility and we don't feel that that legislation should affect us. That doesn't mean it won't. But I'd rather not speculate on what we can and can't do for obvious reasons. It's just important to note that we do have flexibility there and it's not core to our businesses.

Operator

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

Roger Freeman - Barclays Capital

I actually want to follow-up on that same issue. So I saw that ICI letter, so that was your initiative? Or are there other asset managers that are backing this as well [or is it both]?

Greg Johnson

Obviously, you fix many asset managers, so we participate along with the ICI, and it's not our single initiative, no.

Roger Freeman - Barclays Capital

Just to clarify, I'm looking at a summary balance sheet here. This fee would be like 15 basis points on a wholesale funding which would pertain to your securitization business, which at most is like $700 million, it's probably less than that. You're talking about a pretty tiny impact, right? Like a $1 million max a quarter?

Greg Johnson

I think it's too early again to know how the fee is going to work and that's part of the problem for everyone to assess and it's somewhat of a moving target right now. Initially, they were talking about having fees on mutual fund buys and sells. So things are moving quickly, and we stay involved through the ICI. But at this stage, there's just nothing concrete to go on.

Roger Freeman - Barclays Capital

It would be pretty hard to imagine that you'd be caught up in this, but better safe than sorry.

Operator

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

Robert Lee - KBW

A quick question actually on deferred sales commission. The last couple of quarters ramped up a fair amount while the related assets has been declining. Should we expect that's going to run at an accelerated rate for a while or is there something in the last two quarters?

I guess maybe it's related to exiting that JV, but make us think that the data expense line is going to decline pretty sharply soon?

Greg Johnson

I think you have two things at work here and they're both counteracting each other. On the one hand, you will see a reduction in amortization and expense on the B shares as that runs off and that'll be fairly dramatic, but on the other hand, we've been seeing increased volumes on the other share classes that have deferred commissions.

So they tend to be offsetting, muddying the waters a little bit. Because of the B share decline, I would not expect to see that line item accelerating in future quarters. But because of the offset, it would probably be flat to slightly less.

Operator

There are no further questions at this time. I would like to turn the call back to management.

Greg Johnson

I'd just like to thank everyone for participating on the call and we look forward to speaking next quarter. Thank you.

Operator

Thank you, ladies and gentlemen for participating. You may now disconnect.

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