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Executives

Gregory Eugene Johnson - Chief Executive Officer, President, and Director

Kenneth Allan Lewis - Chief Financial Officer and Executive Vice President

Analysts

Michael Carrier - Deutsche Bank AG, Research Division

Jonathan E. Casteleyn - Susquehanna Financial Group, LLLP, Research Division

William R. Katz - Citigroup Inc, Research Division

Cynthia Mayer - BofA Merrill Lynch, Research Division

Kenneth B. Worthington - JP Morgan Chase & Co, Research Division

Douglas Sipkin - Ticonderoga Securities LLC, Research Division

Steven M. Truong - Barclays Capital, Research Division

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

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

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Franklin Resources (BEN) Q4 2011 Earnings Call October 27, 2011 4:30 PM ET

Operator

Good afternoon, and welcome to Franklin Resources Earnings Conference Call for the quarter ended September 30, 2011. My name is John, and I'll be your operator for 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 the actual results to differ materially from the 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-Q filing. [Operator Instructions]

Now I'd like to turn the call over to Mr. Greg Johnson. Mr. Johnson, you may begin.

Gregory Eugene Johnson

Thank you. Good afternoon, everyone, and welcome. Thanks for taking time out to join Ken Lewis and I today for our call. I think, first of all, considering the volatility during the quarter, we are pleased to report positive net flows of just over $3 billion. We are also pleased to report record operating earnings of $688 million.

And now, we'd like to open it up for your questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Cynthia Mayer from Bank of America.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Just maybe a question on the institutional global international flows you guys mentioned in the recorded commentary. It seems like given how good the 1- and 3-year performances for Templeton equity, I'm wondering what's behind the institutional redemptions you mentioned. And also I think you mentioned some inflows, so I'm wondering what the net is of institutional flows to international global equity overall?

Gregory Eugene Johnson

I think that's a good question. And there were, I think, 5 different lumpy -- and each of them was for a different reason within global equities. There were 2 kind of long-standing state relationships that -- one in emerging markets and one in

[Audio Gap]

and some of that is performance, and some of it's moving to passive, but it did result in, I think, about $1.6 billion or $1.7 billion, between the 2 of those. And then we had another significant account in the variable annuity side on the Mutual Series Discovery side that moved to an in-house manager within one of the large insurance companies that wasn't as much performance-related. And sometimes there's just timing differences. When these redemptions were made, it could have been lagging at that time and then taken a while. And more of the recent rebound in performance may not have been considered.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay. And just as a follow-up, I think you mentioned Italy was your top-selling area. Was that sales of Global Bond? And what if any impact, do you think, the European agreement on recapitalizing the banks would have on European's appetite for Global Bond Fund?

Gregory Eugene Johnson

Well, I think it's probably a little early to assess that. I still think it's viewed as an alternative category, and obviously, a positive overall for how that fund is positioned and how well it's done. And some of the weakness, which we felt was more short term certainly turned around here in the last few weeks. So as far as what happens in terms of flows, I think, just overall, as you would expect the last week we had negative outflows within the Global Bond category and that pressure continued early into the New Year. We don't really like to comment a whole lot on where fund flows are going, but I think in this case, just due to some of the misinformation that's been out there, we'll say that we have been pleased to see how it has been very steady despite that one short period of underperformance. And net-net, year-to-date, probably around breakeven overall with an improving trend and U.S. doing better than Europe as far as looking at the flows within the 2 regions.

Operator

Our next question comes from Michael Kim from Sandler O'Neill.

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Just a follow-up with the Global Bond Fund. I understand the performance has snapped back pretty sharply in the last month other so. But just given the performance hiccup, if you will, are you concerned at all that you might be at risk of somewhat of a kind of a reverse halo effect where maybe some of your other global fixed income funds might be susceptible to a slowdown in flows, either across kind of retailer institutional channels?

Gregory Eugene Johnson

I don't think so. I think any time you have that kind of volatility, yes, it'll be a speed bump and slow things down. And certain people will have a new appreciation for the kind of volatility that you can see in that kind of a fund. And we've always said that this is a fund that's not really benchmark-oriented. And as far as how it's run and how its performance has been so outstanding over time that you will have short-term periods of underperformance. And if we look back in the history of this fund, it's had a couple of periods where it's been down 7% or 8%. So it's not unusual to have that. And it's the kind of style that I think a lot of people are looking for as far as trying to get that outflow from active management in there. So we've already been encouraged by the snapback in flows and positive flows with the U.S. -- certainly on the U.S. side with Global Bond. I think if you look at the absolute numbers and for the year, nobody's lost money in that. Our relative performance is down a little bit, but that's been coming back. But as far as the -- it has a positive return for the year, close to a positive return today. So that -- I think that, that's very important in the psychology of money and new money coming in. And we're still encouraged by the tremendous overall record that it has. And short-term things can move very quickly especially with currencies.

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Okay. And then just given kind of the decline in AUM and the slowdown in net flows more recently, are you at the stage where you may be starting to kind of tap the brakes on some projects or reinvestment spending? And then just more broadly, how much flexibility do you have on the expense side to kind of defend margins looking forward, assuming the markets remain volatile?

Kenneth Allan Lewis

Right. This is Ken, I'll take that one. As you probably expect in the answer, we are definitely closely monitoring the expenses. I'd say in the short term, our objective is to keep expenses relatively flat for the next quarter, and some lines will be more successful than others for that. But certainly, that's the message for the troops, that we're watching expenses, though we haven't decided to take any formal programs of cost reductions or any of that. But certainly, we're delaying and deferring projects. So I think there is a fair amount of flexibility, but it takes a little bit of time. And so just as we were back in the global financial crisis in 2008 -- 2007, 2008, we're pretty thoughtful about it seeing if the markets come back, if it's a protracted decline or what have you, and then we kind of make decisions real time.

Operator

Our next question comes from Bill Katz from Citi.

William R. Katz - Citigroup Inc, Research Division

Just one more yet again on the Global Bond Fund. Just from a bigger picture perspective, given the diversification of the platform, any thoughts around capacity and potentially closing that fund to avoid some of the -- maybe some of the redemption stresses and you get some market dislocations. Just sort of curious if you have thoughts on that.

Gregory Eugene Johnson

I don't think anything's changed. I think we have seen a pickup in the total return fund that has corporates in there as well in addition to sovereign debt, so I think that, that's taken some of the pressure off the growth on the Global Bond side. Certainly, if there's any silver lining in the last quarter is one could argue you have more capacity on the selloff and some redemptions. But the reality is sovereign debt it's a huge and liquid pool, and we don't see any constraints at this time.

William R. Katz - Citigroup Inc, Research Division

And maybe one a little bit on to beaten path, but congratulations on becoming the new head of the ICI Board. Just sort of curious and I know you haven't really been in it for very long, in fact, but money market reform -- I think you're on tape as saying, everything's was on the drawing board, if you will, so maybe your initial thoughts on where you see the money market reform, seems to be a lot of uncertainty, sort of curious to your thoughts.

Gregory Eugene Johnson

I don't think there's much news there from what's been published in the press, and it's a high priority in Washington. And they're looking at ways to deal with the perception of the systemic risk involved with maintaining the dollar NAV. I think it's important to note that the changes have been made to date to improve the credit and liquidity in money funds. But there's an urgency to do more than that. And that's really when I say everything's on the table -- everything is on the table as far as looking at alternatives from capital requirements and different ways just to deal with first losses in funds and things like that. So it's going to continue and you're going to hear things, but I don't really have anything new to report from what's been already out there.

Operator

Our next question comes from Jeff Hopson from Stifel, Nicolaus.

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

Okay. Two questions: First, the compensation expense in the quarter, was there any, I guess, accrual adjustment? And then, Greg, as you kind of look across Europe, a lot of upset there with, I guess, distribution and potentially asset managers of banks being sold off. Does this present any new opportunity potentially for you there?

Gregory Eugene Johnson

I'll take the comp question first. Yes, there were some accrual adjustments. There was also -- there's some expense line items that are correlated to market values, so the valuation of mutual fund performance awards and all of that, so you saw some credits in there reducing the expense. So in general, I would say that for this level of revenue, the expense line items a little bit below what you would normally expect to see going forward. And I don't see any real changes on some of the recent actions in Europe as far as the banks, and the banks are critical to distribution. But I think the overall trend of open architecture and being more receptive to outside managers is something that still continues today. And I don't really have anything to add on anything else on that.

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

Okay, and in terms of the Global Bond Funds, the weakness in Europe, I mean any particular market where there's been kind of newer money that's come out right back out, I guess, because they didn't understand the product or anything? You can add to kind of the flavor of what's happened there.

Gregory Eugene Johnson

No, I think there's been -- there hasn't been one market that you point to as having a higher redemption rate. I think the comment I made earlier about just overall higher redemptions in Europe than what we saw in the U.S. as far as what had been sold on a retail basis, but nothing that caused any concern or looked abnormal as far as the percentage basis.

Operator

Our next question comes from Mike Carrier from Deutsche Bank.

Michael Carrier - Deutsche Bank AG, Research Division

Again just maybe one more on the expenses. Seasonally, typically like occupancy, some of the IT things tend to be a little bit elevated. I guess just when you think about next quarter, anything unusual in there in terms of a step down and grow from there?

Gregory Eugene Johnson

Sure. One of the line items that have some seasonality in it is the general, administrative and other. With the reclassification that we did last year, I mean, that still has advertising in it. And seasonally, that does decrease in the first quarter, so I would expect to see that. And as well, as we talked about kind of watching the expenses, that's usually the quickest item that we can control and react to, so reduced travel, that kind of thing. On the technology side, I think this is a pretty good run rate. It might be -- there might be a little bit of seasonal uptick in that line, but I wouldn't call it significant.

Michael Carrier - Deutsche Bank AG, Research Division

Okay. And then Greg, just -- you mentioned some of the new products that you guys have been working on: the asset allocation, the World Perspective Fund. I think those were hitting the 3 years. I guess, where is -- like, what are you seeing from a traction standpoint? Where is the interest? And then in terms of these products, do they fund into a variety of your products or are they just specific products in and of themselves?

Gregory Eugene Johnson

I think it's still early to -- they've only been out there a few months as far as the tactical asset allocation. They do feed into multiple funds, probably over 10. So our expectations there are that will take a little bit of time to get going. I think the World Perspectives Fund just gives us another arrow on the global equities side where we have leveraged the local asset managers and really built a very strong record that in hitting the 3-year number, we highlight that because that's always a hurdle for getting on platforms and making sure you've been out there for 3 years. So that hasn't gotten a lot of attention in the system, but now it that it has strong performance and have been out there for a while and has a unique story, it's one that, that we'll be talking about in the next year. But really, as far as flows, I think we're pleased to see that munis have come back and continue to come back and hopefully it will be in a positive net mode this quarter, which is a long way from where we were a few quarters ago. I think the Franklin Income Fund had a -- Hybrid had an unusually tough quarter and most of that again was due to a variable annuity account that affected the flow number there. And I expect the income fund to come back as well as far. So those will be the areas that I think are going to continue to do well.

Operator

Our next question comes from Jonathan Casteleyn from Susquehanna.

Jonathan E. Casteleyn - Susquehanna Financial Group, LLLP, Research Division

One of your competitors recently talked about more indexing initiatives in fixed income because of low current yields. Have you heard of any conversations within some of your some of product speaks [ph] about lowering some of your abnormally higher fixed-income fees, say, in some of your other products?

Gregory Eugene Johnson

Well, I think the good news is that we're on the lower end of that as far as expenses and have always been that way if you look at the munis in governments. I think the Global Bond is in a category of its own, not your typical fixed income that would be under the normal kind of pressure. But I think that's fair. Anybody on the higher to mid- end in fixed income in a lower-yield environment, it's going to put pressure, not only on the yield you can pay, but also where you fall in your Lipper categories. And the expenses become very important in how you're ranked in total returns. So we haven't felt that pressure in many of our funds.

Jonathan E. Casteleyn - Susquehanna Financial Group, LLLP, Research Division

Okay. And then can you talk about the contribution from Balanced Equity Management in investment management fees for the quarter? Just trying to strip that out to understand what the normalized result was.

Gregory Eugene Johnson

It's very small, very small. And basis points on the effective fee rate, like 0.1 or 0.2 or something like that.

Operator

Our next question comes from Marc Irizarry from Goldman Sachs.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Greg, maybe you can address your strategy outside the U.S., particularly in parts of Asia, where maybe the growth outlook is a bit stronger. How are you thinking about acquisitions? You've got also a decent amount of cash, I guess, overseas. And is that sort of an advantage for you to go out and maybe start to accelerate your growth in some of those faster-growing regions, particularly if some of the competitions are looking there as well?

Gregory Eugene Johnson

Well, I think we've addressed that question on many different calls. And for us, the answer is we're always out there looking for what we think makes sense. And I think the one problem you have is if you're in these markets and you're a local manager, you're not going to pay a strategic premium to buy another manager in that market and there's many U.S. managers or European managers that are doing the same thing that want to get into those markets. And if you look at India and some of the prices that were paid to get into that market, that wouldn't make sense for us if we're already in it. I think that's a barrier today that's still very much in place. But we're certainly looking at anything that we think fills the gap or can make us stronger and we can combine and get cost savings that way. But a lot of these faster-growing markets are going to be at much higher premium and higher multiple to buy into, and we're already in it.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Okay. And then could you just talk about capital priorities. Obviously, you guys have been busy buying back some stock, but will have -- could you just maybe run through how you're thinking about your capital priorities?

Gregory Eugene Johnson

I think no news -- no new news on that front. In terms of returning dollars to shareholders, preference to buybacks, focusing on the dividend growth rate, that should continue. And as you saw, we're opportunistic and when we see an opportunity like that, we'll do that again.

Operator

Our next question comes from Ken Worthington from JPMorgan.

Kenneth B. Worthington - JP Morgan Chase & Co, Research Division

To follow up on Cynthia's question, in terms of the sales in Templeton equity, is there any merit to the thought that the success in the bond fund has monopolized the sales effort or maybe diverted sales from the equity side of Templeton? And could it be that the choppiness in Global Bond or total return may be becoming a catalyst to better sales on the equity side of Templeton? Because, again, to Cynthia's point, it seems like the performance is there, the asset costs has been in favor, but maybe the bond fund has been so successful it was just the easy thing to sell. So any merit to that?

Gregory Eugene Johnson

I think, one, I would -- and I probably should have done this earlier is point to -- if you look at where we had most of our add-ons and wins on the institutional side, there were in global equity and global bonds during this quarter, so you just had some big large ones that overshadowed those numbers come out. But we had a lot of $200 million, $300 million wins. So that tells you it's not really a performance issue, and we had some add-ons that were significant to existing accounts as well. There's always reasons that certain fund on the institutional side -- and it maybe that, that one underperformed the overall composite. There's things that can happen that way and that could be the case in one of those. I don't -- I think the distribution effort has been very much focused. One of our priorities for the year was to make sure that Templeton was getting the right exposure in the system. And we actually saw that the Templeton Foreign Fund improved its sales quite a bit, market share within the nonproprietary channel here. And we're going to continue that. The campaign that we're running now is global. It's a new core and very much highlights Templeton. So our goal is to make sure that we're always balanced in what we're talking about despite sometimes that the sales flows may not reflect that.

Kenneth B. Worthington - JP Morgan Chase & Co, Research Division

I know this is a teeny one, but you had announced last quarter about the carry earned at Darby. Does that mean -- was there a big distribution made? And I guess, does that mean -- are they out raising a new fund right now? And if so, how is that going?

Gregory Eugene Johnson

This particular transaction related to one of the oldest Darby funds and doesn't -- so they're still kind of actively managing their current portfolios. They might have some plans for new funds, but none that are going to occur in the near term. So this transaction was just the crystallization of gains in an old Darby fund.

Operator

Our next question comes from Roger Freeman from Barclays Capital.

Steven M. Truong - Barclays Capital, Research Division

It's Steven Truong here for Roger. Can you update us on your seed portfolio? I recall earlier this year there were some realized gains. And going forward, how should we think about that?

Gregory Eugene Johnson

Sure. So there was a lot of noise within an operating line this quarter related to the market volatility, and it was unrealized. And the whole book when you look at it, it's still in a net gain position. And so we kind of -- keep in mind that a lot of this is seed capital, so we're keeping that contained and, if you will, re-purposing old investments that have either been successful or didn't work out into new investments. But that does leave you exposed to equity markets and the like. But that's our approach. It's kind of -- we have pools of investments that we used for product development purposes that are, in a sense, fixed -- notionally fixed, if you will. And the business units know that, that's a limited resource. But you still get this exposure, and so -- and I would add, obviously, as markets pick up, there'll be a reasonable assumption to see a lot more green bars on that Slide 17 replacing the red ones this quarter.

Operator

Our next question comes from Douglas Sipkin from Ticonderoga.

Douglas Sipkin - Ticonderoga Securities LLC, Research Division

Most of my questions have been asked and answered. I guess, just a general one. I know it's sort of early in this market move, but are you guys picking up at all any increased interest of the retail side to get back into equities given -- usually people go to fixed income first, but given where rates have been, I'm just wondering maybe if you're seeing a little bit more light in the tunnel for retail equities given the move in the markets in October?

Gregory Eugene Johnson

I'd definitely say there's more light, but that probably means that redemptions will slow down versus sales picking up. And it's just going to take, I think, a little bit more time to convince the equity buyer that it's time to jump back in. And there's just been a lot of volatility in the marketplace. And I think that, that just works against a long-term investor right now.

Operator

Our next question comes from Bill Katz from Citi.

William R. Katz - Citigroup Inc, Research Division

Just a follow-up. You partially answered it before but just a little more clarity. In terms of the world allocation funds where the 3-year performance has moved to the favor [ph] anniversary, where might you see the greatest lift with that given some of the volatility around. Do you think it's the U.S.? Do you think it's outside the Unites States, Asia? Just sort of curious of where you might see the best short-term opportunity.

Gregory Eugene Johnson

I don't -- I think it could be either one. I mean, it just depends which group. I think the good news with Europe is that you can get on platforms and that can mean faster growth of assets, more like an institutional account versus the U.S. where it may take you more time as the distribution system has to work with the advisers to get them comfortable with it. So probably on the immediate term, you could argue that Europe would be a quicker immediate opportunity, but I think it remains to be seen and I wouldn't bet either way.

William R. Katz - Citigroup Inc, Research Division

And just one more. In terms of -- I think you mentioned in your prepared remarks earlier today that some funds into Romania, you sort of laid it out a whole set of funds and also some SICAV shifting it to actually some conversion to OEICs with the new platforms. What kind of ramp would you, I think, from here in terms of that new business?

Gregory Eugene Johnson

I mean I don't think that the Rensburg, it's just getting that positioned properly, and if the European market continues to move, that's something that would again be a new offering for us and one that we're going to try to build, and that's been a priority in the U.K. market. But again, they're not -- these are not big initiatives that we expect. They're going to take time to build.

Operator

We have no further questions at this time.

Gregory Eugene Johnson

Okay. Well, thank you, everyone, for participating today. And we look forward to speaking next quarter. Thank you.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participation. You may now disconnect.

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