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Franklin Resources (NYSE:BEN)

Q4 2010 Earnings Call

October 28, 2010 4:30 pm ET

Executives

Kenneth Lewis - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Gregory Johnson - Chief Executive Officer, President and Director

Analysts

Glenn Schorr - UBS

Craig Siegenthaler - Crédit Suisse AG

Michael Kim - Sandler O'Neill & Partners

William Katz - Citigroup Inc

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc.

Michael Carrier - Deutsche Bank AG

Douglas Sipkin - Ticonderoga Securities LLC

Kenneth Worthington - JP Morgan Chase & Co

Robert Lee - Keefe, Bruyette, & Woods, Inc.

Marc Irizarry - Goldman Sachs Group Inc.

Jonathan Casteleyn - Susquehanna Financial Group, LLLP

Cynthia Mayer - BofA Merrill Lynch

Roger Freeman - Barclays Capital

Operator

Good afternoon, and welcome to Franklin Resources Earnings Conference Call for the quarter ended September 30, 2010. 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, 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. [Operator Instructions]

Now I would like to turn the call over to Mr. Greg Johnson.

Gregory Johnson

Thank you, and good afternoon, everyone. Thank you for taking the time to join us on the call today. I'm Greg Johnson, CEO. Joining me today is Ken Lewis, our CFO.

As we highlighted on the pre-recorded commentary, we're pleased to report another strong quarter for flows, capping off a record fiscal year. Most importantly, relative investment performance remains strong and with assets under management ending the fiscal year near pre-crisis levels, we believe we are well positioned for future growth.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Jeff Hopson with Stifel, Nicolaus.

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc.

So you've had very strong growth outside the U.S. It seems like some of your spending increased in the quarter for advertising and such. So I guess, the question is, do you expect any change of the margin in the non-U.S. business going forward?

Kenneth Lewis

I'll take that, Greg. This is Ken. Typically, in the advertising line in the first quarter, if you just focus in on the U.S., spend goes down. But as I mentioned in the comments, we are spending a little bit more in international advertising. And so it's possible that, that seasonality trend might not be as it has been in the past. Regarding the profitability of the international products, I don't think that, that would really change the profitability at all because it's not that big of a spend.

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc.

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

Kenneth Lewis

I mean, I think it's still a bit early. I mean, obviously, the weaker dollar tends to accelerate and it trend towards global equities, global bonds. But that weakness has been fairly recent in those areas where we're doing quite well. So I think, just a little tailwind that's exactly going forward [ph].

Operator

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

Roger Freeman - Barclays Capital

I guess, two questions just about both around sort of the unusual items in the quarter. I just want to understand on Darby, I see it a comp reversal as well. Does that mean that -- I guess this is like a Darby issue or did they miscalculate their returns or something since there had to be comp reversal on that?

Kenneth Lewis

No, not at all. We have performances in other products other than Darby as well. So we adjusted our recognition of the revenue and the corresponding expense categories to take a more conservative point of view.

Roger Freeman - Barclays Capital

Okay, it was not due to revaluing the private equity portfolio or anything?

Kenneth Lewis

No, not at all.

Roger Freeman - Barclays Capital

And then, I guess, second thing is on the, I guess, on the investment, the C portfolio. What was that? I mean, is that a valuation issue?

Kenneth Lewis

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

Operator

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

Cynthia Mayer - BofA Merrill Lynch

Let's see, maybe just to clarify on the last one. Can you give a sense of what the AUM is of the funds that you are consolidating now?

Kenneth Lewis

I don't want to misspeak, but I think it's around $70 billion. It used to be $200 million.

Cynthia Mayer - BofA Merrill Lynch

And then, can you talk a little about the distribution margin? I think in your pre-recorded commentary, you said the expenses rose a bit faster than the revenues because of the different costs overseas and a shift to overseas investors and different ways accounting for them. So assuming the proportion of international assets keeps rising, would you then head into a negative distribution margin? And maybe just to clarify, can you give a sense of what the international assets have as the distribution margin on a stand-alone basis?

Kenneth Lewis

I can try to help you out in a couple of things there. It is possible that if you're looking at it on a margin basis, that it could go negative. But I would say that it's a reasonable assumption that if your estimate of asset-based commission expenses is off by a dollar, you're going to make it off on the investment management fee line by a dollar.

Operator

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

William Katz - Citigroup Inc

I just want to keep pounding away on the margin discussion a little bit because it's still obtuse to me in terms of the conversation here. When you look at your incremental AUM growth, is non-U.S., all-in, distribution manufacture and what have you, is that more or less profitable than your U.S. business?

Kenneth Lewis

It's about the same.

William Katz - Citigroup Inc

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

Kenneth Lewis

Correct.

William Katz - Citigroup Inc

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

Kenneth Lewis

The two areas we've talked a bit in the past, I mean the global bond fund, has been very successful throughout Europe, and especially in Italy over the past year. We've got probably three or four bond funds, Templeton Global, total return, emerging markets bond fund and then, Asian bond fund as well. That's done extremely well in Europe. The Asia growth fund is now our top-selling fund on the equity side. And that's run by Dr. Mobius of the Emerging Markets group and has had excellent performance. So really, I don't have the breakdown in front of me between how much of that is coming from Europe versus Asia. But I think the real big movers for us have been in Europe this year as far as net inflows and in Taiwan as well.

Operator

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

Michael Kim - Sandler O'Neill & Partners

Just first, equity mutual fund net flows across the industry have turned positive more recently in aggregate following kind of about six months of kind of persistent outflows. And do you feel like we could be in an inflection point? Or do you think it's going to take a bit more time before equity flows really start to meaningfully reaccelerate? And then, it seems like the trends are a bit different as you look at overseas investors. So any additional color there?

Kenneth Lewis

Well, I think that's been the question for a while now is when does this turnaround. And obviously a very strong quarter and that's going to help investors confidence move back into equities. But like most of the industry, I mean, we haven't seen a big swing. And we've seen some movements in some of our funds, especially with the rising dividend fund. For us, those type of equity income funds are very popular in this kind of environment. But I just don't think we're seeing a big turn around in investor confidence yet. But certainly, in a quarter like we just had will help that. But I do think it's going to take a while, and I think the kind of flows that we have seen over the last six months will continue in the near term, as far as fixed income versus equities.

Michael Kim - Sandler O'Neill & Partners

And then in terms of the institutional channel, any kind of noticeable changes in either activity levels? Or shifts in terms of which strategies might be in demand? Is it still kind of global equities, global fixed income?

Gregory Johnson

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

Operator

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

Craig Siegenthaler - Crédit Suisse AG

Just a follow-up on the international sales topic. And maybe to ask it in a different way is on your SICAV product, what is the average asset-based distribution expense? And also, are there any distribution revenues, or did they all flow through management fees from an accounting perspective?

Kenneth Lewis

Yes, they flow through management fees from an accounting perspective. So that's the non-U.S. assets. And as I've mentioned, it's the profitability. The profitability on the SICAV product is probably a little bit higher than the U.S. products. But that's not the only type of assets that we have in the international arena. So on average, the profitability of the international products and the U.S. products are about the same. So if you are incurring asset-based distribution expenses on the international products, you should see that on a dollar-for-dollar basis in the investment management fee line.

Craig Siegenthaler - Crédit Suisse AG

And just a follow-up on the balance sheet, saw that your cash went up, I'm just wondering if you can update on where the level of excess cash is? How much is domiciled outside the U.S. and if you have any plans for a special dividend in the account to your fourth quarter.

Kenneth Lewis

If you look at cash and investments, it's split about evenly, U.S. and non-U.S. on a like cash and cash equivalents basis. It's probably about 40% to 45% U.S. We'll clarify that in the 10-K. And then in terms of share repurchases and dividends, really, no change from the prior, still committed to both of those and still committed to returning a great proportion of earnings to shareholders through repurchases and dividends.

Operator

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

Robert Lee - Keefe, Bruyette, & Woods, Inc.

I have questions on the comp. I mean, you guys have done a pretty good job over the, I think, the last several years, keeping comp down in part because I think peak season you've grown headcount on a net basis or there's been a lot of shift towards lower cost regions, I guess, I'll use that phrase. But did you feel like you have more room there? Are you starting to feel the comp pressures maybe are starting to grow? I mean you're back towards kind of peak asset levels and pretty close to peak revenue levels, profitabilities' been pretty much restored. I mean are starting to see kind of building pressures on the comp line? Or is there ability to continue to kind of manage, relatively speaking, manage down comp as you move bodies around the world?

Gregory Johnson

I think there are two different components to that, kind of the fixed component and the variable component. Certainly, we think we've done a pretty good job and we're pretty good at utilizing those low-cost regions. And that's where having headcount. We can have maybe like 25%, 30% of the total employee population in those centers. So on a fixed-cost basis, we're managing it down on the variable side. I think it will vary with revenue as it has, and that will continue. I don't think that we're seeing any particular pressure to change any of that.

Robert Lee - Keefe, Bruyette, & Woods, Inc.

Maybe on a different topic.You have Darby and I believe you have a real estate business and some other alternative products here and there. But can you talk about kind of your plans are for the alternative space? I mean, certainly, you're seeing a lot of demand there broadly speaking and a lot of your conditional competitors thinking about through lift-outs, acquisitions or internal development of expanding their own portfolio, alternative strategies, obsolete return strategies, however you want to define them. I mean, can you update us on you're thinking there? Is there anything kind of on the drawing board? Is that a part of your M&A strategy at this point?

Kenneth Lewis

I'll take that one. I think as we've stated before, we believe it's going to be an important in growing area in our business. It's a natural complement to what we do. And as you've said or stated, we do have pockets what would be categorized as alternatives within the firm. And we think we will have more of those type pockets in the future. We've had lot of discussions with a lot of different type of alternative managers and are continuing to do that. And we expect in the next year or so, that we would see some additions to the firm. I think one of our concerns has always been that we want to make sure that, especially whether it's hedge funds or people-intensive businesses, that it's something that has a process that is transferable all and that we can make sure that we're locking up the value that created those returns. So we have been somewhat careful there. And I think another area we've had a lot of conversations around is our strategy has always been generally to own more than 50%. And I think we've recognized that maybe a stepped approach makes more sense when looking at some of the newer alternative managers. So we are looking for minority stakes to build towards majority over time. Another area that we're building out and where you'd hear a lot in the business is around solutions. And to me, it's also in with what we're doing with alternatives. And we have added resources there, and whether it's building more outcome-oriented products, more tactical asset allocation funds, those are all the kind of things that we're building, as well as inflation hedge-type products, where we can bring commodities and have a place to go if rates move up. So that, I think as far as an area that we're the most active in, it would be certainly, in building out that solutions capability. And then within that, bringing in alternative managers to complement that.

Operator

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

Michael Carrier - Deutsche Bank AG

I guess one more question on the institutional, and think you guys might have in the past broken this down. I don't see it now and you might have done that in the pre-recording call. But do you have the breakdown of just where the flows are, and maybe X-ing out the remaining mandate, just overall? So if you could take like the $14 billion, $15 billion, how much of that is retail versus institutional? And then on the institutional side, just what you're seeing in terms of the trends, U.S. institutional versus like non-U.S. institutional?

Gregory Johnson

Well, first of all, we don't have it broken out between the institutional and retail. And as we mentioned, $4.6 billion of the net number was due to the one institutional account with the dual fund in Romania. As far as trends, quarter-over-quarter, I mean, I think, I would, other than global bonds, in some case declining outside of U.S., really looking at global equities and every other category between retail institutions, I'd say it's very stable as far as the mix. And looking at again, the backlog, in searches, in the pipeline, in the wins and losses, there was nothing really significant over the quarter. A lot of 200 , 300 -- $200 million accounts that were funded during the quarter and some went out as well and both of them in the global equity category, as well as the global ag. And we continue to see a lot of searches, especially in fixed income outside of the United States. We expect to fund some of those in the quarter ahead that we won over this quarter. And it's really the same trends that we've been talking about, I think, over the last probably three or four quarters with regard to the institutional pipeline.

Michael Carrier - Deutsche Bank AG

And then, Ken, you gave some color on the different expense lines on the pre-recording call. I guess the two line items that stick out is the IT tech occupancy and in advertising. Both, you've guided towards that they were heading higher. It's just the increase sequentially was roughly $10 million in each bucket. So you mentioned some could be seasonal. There could be one-off items. But is this a good run rate? Or maybe it pulls back a little bit, but there's going to be growth over the next couple of quarters. Just any sense there?

Kenneth Lewis

Yes, it did. IT did it. It bumped up this quarter by a fair amount. And I think that some of that was -- I talked about earlier calls, just increased business activity because we knew that we were embarking on new projects after the slowdown a couple of years ago. So I think that will continue. But certainly, some of it was for things that were unique. They may reoccur in future quarters but it's not like a trend that I'd say. So I think just the quarter numbers was a little high in terms of the run rate. That's on the IT side. And on the advertising and promotion, that, too, is a little high. But keep in mind that some of that is driven by sales and assets under management, so I don't think that we are spending more. So I don't think that it goes back to levels we saw last year, but I think it's probably a little high for a run rate as well.

Operator

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

Kenneth Worthington - JP Morgan Chase & Co

Q on the underwriting and distribution expense. So first, what portion of the underwriting expense are actually from international products? So you have like $529 million. What portion is attributed to international?

Kenneth Lewis

I'd say the piece -- well, first of all, international assets are about 30% of total. And then, I'd say the distribution expenses is around that level as well. But I think the piece that everybody's thinking about where there's a mismatch between line items, that's probably like in the 12% to 15% of the total line item, if that make sense.

Kenneth Worthington - JP Morgan Chase & Co

What's that 12% to 15% of what line item?

Kenneth Lewis

There's a piece where that expense goes up, and you should see $1 more of investment management fee revenue. That's about, I'd call it, 10% to 15% of the total underwriting distribution expense line.

Kenneth Worthington - JP Morgan Chase & Co

And the second question there is, how are foreign distributors paid? I guess, what portion would be upfront on a sale versus over time on the assets?

Kenneth Lewis

That's what makes this conversation so difficult because it's very dependent on the class of shares. And there's a lot of share classes on the products. So there's some that are upfront and there's some that are ongoing, and it's hard to quantify the mix.

Kenneth Worthington - JP Morgan Chase & Co

So I guess, what I'm hopefully after is, you had a negative underwriting revenue this quarter. If it's all based on assets and there's no reason for that negative number to perk up next quarter, but if you got a lot up front, you had a good sales quarter, sales go down our normalize then the net underwriting revenue can pop back nicely to positive. So I guess, what your answer is it can pop nicely back to positive because of some of the fees are upfront.

Kenneth Lewis

Yes, some are upfront. But I think as the percentage of the asset-based fee, the one that goes up with assets under management, as we see the increase in international assets under management, then it's possible that, that would go the other way. So you could see that pop to negative. But again, it doesn't affect the overall company's profitability.

Operator

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

Marc Irizarry - Goldman Sachs Group Inc.

Just on the operating margin again. It seems like there's a lot of geography issues in terms of where in the P&L sort of items are coming up. But when you think about the core margins for this quarter and you think about the advertising expense and the mix shift in the business potentially towards equity that you're trying to drive with some of the advertising, what's the expectation for the operating margin here going forward?

Kenneth Lewis

So, as you know, since so much of that revenue is driven by the margin is kind of a futile exercise of trying to pinpoint the margin in any given quarter. But you can just see by the mere fact that the assets under management have increased last quarter, just based on that fact alone, it would be reasonable to expect some improvement in the operating margin next quarter.

Marc Irizarry - Goldman Sachs Group Inc.

And then just on capital redeployment, in terms of priorities, if there were to be a change in tax laws and as far as dividend tax laws go next year, how are you guys thinking about the special dividend relative to buying back stock? I mean, where is sort of taxes playing into that thinking?

Kenneth Lewis

Yes, certainly that is a consideration and a decision. At the end of the day, it's up to the Board of Directors to decide and that's kind of where we're at. But there's really been no change in sentiment. But certainly, we'll be keeping an eye on what's going on with the taxes. And that would be an part of the decision process.

Operator

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

Douglas Sipkin - Ticonderoga Securities LLC

So obviously, we've seen a lot of acquisitions in this space in some of your competitors and a lot of consolidation on the distribution front. You guys have been pretty constant throughout. Can you just talk about how you're standing amongst distributors, wire houses or that has changed? Is that all over the last year or two years? And how is that playing at all to some of the flows you guys are seeing?

Kenneth Lewis

Well, I think we're in very good shape. And obviously, it's having the right mix and we think is a pretty good marketing and distribution effort behind it. But this year, as far as net flows within the non-proprietary channel, we were the top seller on a net basis. And I think number two, on a gross basis. And in terms of distribution outside of the U.S. across the border sales, we were number 1 both on gross and net. So you're not number 1 with everyone of your distributors. But again looking at the entire universe of distribution, we're probably 1 or 2 in most of the nature distributors out there. So I would say that we are extremely well positioned. And not only really gross and net, but we were fortunate to increase market share in fixed income. So it really wasn't just having the right funds and having the big wave come with it. We actually, significantly increased our share in the fixed income space, again, both in the U.S. and offshore and equity as well. And if you look at -- I mentioned rising dividends with Franklin growth bond, which is in the top quartile for the 1, 3, 5 and 10. For us, it really addresses what has been a significant deficiency. As far as our asset concentration, that's gaining market share. So that's positive as well.

Douglas Sipkin - Ticonderoga Securities LLC

And just to follow up, in terms of the big mandate for global equity this quarter, I believe that came in right at the end of quarter's who are really not too much of a revenue contributor. I don't know if you guys have provided the revenue yield on that, that maybe we should be thinking about moving forward to getting a full quarter of it now?

Kenneth Lewis

The way to look at it is it's in line with institutional mandate of that investment objective. And it's $4 billion on 600 plus, so it won't have the material impact on the effective fee rate, I don't think.

Operator

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

Glenn Schorr - UBS

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

Kenneth Lewis

Semi-annual pay in calendar quarter terms?

Glenn Schorr - UBS

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

Kenneth Lewis

Yes. it's fourth and second.

Glenn Schorr - UBS

And then maybe, Greg, I think a lot of us talk to you all the time about the cyclical component of the flows. But I guess, given your dominant presence in the retails channel, I'm curious what your wholesalers tell you, what the field tells you in terms of clearly where the flows are going now, whether it'd be fixing compares of alternatives? How do you assess the cyclical versus secular argument of domestic equity? And how does that impact just how you think about the infrastructure you have now and building new funds, strategic stuff?

Gregory Johnson

Yes, I think as I've mentioned before, I don't see a big shift taking place to equities right now based on what we've seen at the start of the year. I think how we think about it is that we recognize that we need more shelf space on the equity front, and that's something we've been the big pushing very hard over the last two years. And we've debated long and hard about going out and acquiring a firm to fill that. But I think what we realize is that we have it all in-house. And the performance record in Franklin Equity in the last year, 80% of the assets were in the top quartile. That's on top of a very strong long-term performance. So those funds are getting recognition now. And again, we mentioned the 20-20 vision campaign. So we've been out talking about equities in the decade ahead despite the headwinds that we're facing right now. So that's really our strategy is just like it was when equities were selling and fixed income was not doing a lot in inflows. We were out there telling the fixed-income story. So we think it's a great opportunity for us I mean, the distribution, they're not just paid on selling the global bond fund, they're incentives really work around talking about equities and even if it's incremental gains and just getting on a 401(k) platform. That's the goal right now. And really, I mean, in terms of defining that in numbers, I mean, I think that's hard to do but I can tell you, it's been a major priority for distribution to make sure that we're well positioned when it does move. I just don't think it's moving right now.

Glenn Schorr - UBS

And to all those points and maybe next time, we will have this color. It would be helpful to see what incremental placements there are because we can see how good the performance records are, right? However you define it in terms of on the focus list, on approved list, on the buy list, however each firm does their individual focus list, that could help because the performance looks like it's there, to your point, if and when the flows turn, you should benefit.

Gregory Johnson

I would be happy to share that.

Operator

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

Roger Freeman - Barclays Capital

On EPS, I know it's a product that you haven't really shown much interest in the past. But as I look at across some of your peers, several of them are at least putting the exempt of relief absent because they take a while just to sort of have it as a placeholder. Maybe they don't know what they want to do with it yet but I kind of think about how it's organic to your leg, in event. Is there any thing you would think of doing or not?

Gregory Johnson

Well, I think you want we want to keep your options open, so that's probably not a bad strategy. As we've said before, they're here to say and they're going to grow quickly and make the active manager's job more difficult. But our feeling is still that the majority of those flows are going to go into the bigger funds with the top three managers, and it's going to be a fee battle that we're already starting to see unfold. So like money funds, we just think there's a big enough pool to focus on active management. And that's just really we think why the value proposition of the company. But I think that is a valid point. I mean, you want to keep your options and if they're changing things around, actively managed EPS, we'd want to be able to participate in that. But it's also -- we feel like there's enough out there where acquisition would be a quicker route to if we really want to move into that space versus building.

Operator

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

Jonathan Casteleyn - Susquehanna Financial Group, LLLP

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

Gregory Johnson

Well, the majority of the global bond flows are in retail. So I think I was just speaking in general terms about equity versus fixed income. And also, our fourth quarter tends to be the slower summer months. So you would expect to see that pick up as people get back in the offices. And I think those trends are all are very much in place. There's not a lot of searches in pure global bond, that's global lag and emerging market bonds, which we've seen just a consistent level of searches. And I think for us, with the strength we have in many of the emerging markets and many areas of sovereign wealth funds, it's a natural fit for those type of funds. So we're continuing to see good opportunities there.

Jonathan Casteleyn - Susquehanna Financial Group, LLLP

And then, how do you articulate any capacity issues in global bonds, just generally?

Gregory Johnson

I mean to me, this is a question we get quite a bit. But it's probably the largest and most liquid market out there. So we really haven't seen any restraints. I think if anything, you could argue that this fund historically moved into a little bit esoteric market, less liquid ones and with size, it has been a little bit more restricted on doing that over time. But the bigger markets that it moves in and really adds outlook from making currency bits are huge markets. So we're not seeing any real constraints there.

Jonathan Casteleyn - Susquehanna Financial Group, LLLP

And then just lastly, on the cash balances. Any increase in dividends or buybacks has to be sourced by the U.S. portion, is that correct?

Kenneth Lewis

That's correct.

Jonathan Casteleyn - Susquehanna Financial Group, LLLP

What are the options for the foreign portion?

Kenneth Lewis

Well, I mean, the non-U.S. portion is indefinitely reinvested in the operations outside the U.S. and that's kind of our approach, and we're going to continue with that. I guess, there's talk on the hill about repatriation laws changing and all that. So we'll keep an aye on that as well and if something develops in that front, we'll consider that as well.

Operator

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

William Katz - Citigroup Inc

Just a quick follow up, just more of a modeling question. Given your fiscal year end versus the calendar year end, as you think about the December quarter and historically there hasn't been much movement in comp. When we expect to see merit increases and so forth, would that be in the March quarter?

Gregory Johnson

You'll see that probably one month to that in the next quarter and then the full amount in the quarter ended March.

William Katz - Citigroup Inc

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

Gregory Johnson

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

Operator

And at this time, I would like to turn the call back to management for any closing remarks.

Gregory Johnson

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

Operator

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.

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