Gregory Eugene Johnson - Chief Executive Officer, President, and Director
Kenneth Allan Lewis - Chief Financial Officer, Principal Accounting officer and Executive Vice President
Franklin Resources (BEN) Q3 2012 Pre Recorded Earnings Call July 30, 2012 8:30 AM ET
Welcome to Franklin Resources Earnings Commentary for the quarter ended June 30, 2012.
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 the third quarter earnings commentary. I'm Greg Johnson, CEO; along with Ken Lewis, our CFO. We're pleased to report another strong quarter of results despite persistent global market headwinds. Most importantly, relative investment performance remains solid across all time periods.
Long-term net new flows were $4.7 billion, reflecting continued penetration of our global investment capabilities into institutional distribution channels. And profitability remains strong, as did capital management for a combination of opportunistic share repurchases, and cash dividends have returned $1.7 billion or 92% of net income to shareholders over the trailing 4 quarters.
Overall, U.S. relative performance rankings remain strong, especially within our fixed income and hybrid funds, taxable and tax-free fixed income. Relative performance percentages were essentially unchanged for March with strong long-term performance in municipal bonds and global fixed income. Franklin equity performance continues to be a standout with strong relative performance across hybrid growth and value strategies.
Mutual Series was essentially unchanged, although we did see modest improvements in long-term performance since March. Eurozone exposure in a corresponding underweight to a more resilient U.S. market contributed to weakness in Templeton equity performance. As and when Eurozone market conditions improve, we expect to see a rebound in the performance of Templeton products.
Assets under management ended the quarter about 2.5% lower at $707 billion, and the simple monthly average AUM increased slightly to almost $711 billion. The change in monthly average AUM, however, does not fully reflect the daily market movements that we experienced. Daily average AUM, which was about $711 billion in Q2, decreased almost 1% to $705 billion this quarter. And as you know, it's the daily average AUM that drives much of our revenue.
The European debt crisis and concerns of a weakening global economy pushed equity markets lower during the quarter, reflected in the 7% decrease in equity AUM. However, as I already mentioned, AUM ended the quarter only about 2.5% lower because of the strength of our fixed income and hybrid products, illustrating a key benefit of diversification.
The decline in equity AUM is also evident in the change in AUM by sales region, where internationally sourced AUM declined almost 5% compared with only a 1% decrease in U.S. AUM. This is due to the mix of international AUM that is more heavily weighted in global equities compared with the U.S., which has the benefit of our strong hybrid and tax-free strategies.
Long-term sales decreased by 14% this quarter as all investment objectives in sales regions experienced slowing sales as investors stepped to the sidelines. The one exception to this was our institutional business that attracted slightly higher sales. Redemptions also decreased 14% resulting in long-term net new flows of $4.7 billion.
The U.S. based and CCAB-based Templeton Global Bond Fund remained our two top-selling funds on a gross basis this quarter. However, both funds experienced slightly negative net flows this quarter. Overall, global fixed income net new flows were $2.4 billion, a strong improvement from last quarter due to the continued interest in our CCAB Global Total Return Fund and several institutional global fixed income and emerging market debt offerings.
Although we continue to promote equity investing in the U.S. and internationally through a number of ongoing campaigns, equity sales decreased 18%. The CCAB Templeton Asian Growth Fund remained our top-selling equity fund on a gross basis, but it did experience modest outflows due mostly to lower sales. Interest in our rising dividend in Franklin Growth Funds remained strong, and we did have several institutional fundings this quarter, primarily into emerging markets equity mandates.
Within hybrid, the Franklin Income Fund remains one of our most popular strategies, but also had lower net new flows. In June, we initiated the launch of the next phase of the U.S.-based 2020 Vision equity campaign with the sub-campaign themed, Time to Take Stock. The pullback of the stock market in 2008 left a lasting impression on many investors causing anxiety about investing in equities and trillions of dollars sitting in low-yielding savings instruments. The new campaign is designed to help advisors and investors take stock of their current situation. It discusses key emotional biases that may be holding investors back and the key points that most investors are missing. It also shows how investors can rebuild their portfolios to reach their long-term goals, including actionable solutions to help them get back in the stock market.
Focused campaigns and themes are an important part of our approach because they align our messaging across all delivery channels and represent a value add to the advisor intended to help them grow their business. During the quarter, we also expanded our product offering in the cross border and private fund markets. Our cross-border CCAB umbrella has been an important part of our international growth.
In South Africa, we received regulatory approval for the launch of 3 local funds designed to meet the needs of the domestic retail market. We also received regulatory approval to complete the launch of our 4 local Malaysian funds. Regulatory approval was granted to launch the Franklin Templeton Shariah Fund. It will be the first Sukuk sub-fund launched as a UCITS in Luxembourg. Since opening our office in Malaysia in 2009, our assets have grown to $2.4 billion.
And now, I'll turn it over to Ken for operating results.
Kenneth Allan Lewis
Thanks, Greg. We're pleased to report another solid quarter of operating results, despite the challenging market backdrop for asset managers.
Operating income for the quarter was $643 million, a 4% increase from the prior quarter due to a combination of lower expenses in the current quarter and the nonrecurring items that impacted last quarter's results. Net income was $455 million, a 10% decrease from last quarter, as net nonoperating expenses were $28 million.
Earnings per share was $2.12, only a 9% decrease due to the continued net decrease in shares outstanding. Investment management fees decreased 1% due to the several elements of the change in assets under management that Greg highlighted.
First, it's important to remember that we earn much of our revenue based on daily average assets under management. And sometimes, the daily average can differ from the monthly average as it often does during more volatile quarters.
For example, the daily average of the MSCI All Country World Index was 1.6% lower than the monthly average this quarter. And second, the slight mix shift in assets under management away from equities and internationally sourced assets under management factored into the quarter's effective fee rate. I'd like to remind everyone that the effective fee rate is only a ratio of revenues to assets under management and does not reflect a change in product level fees. Those factors were partially offset by $10 million of performance fees in the quarter.
Sales and distribution fees were lower by 3%, reflecting both the decline in average assets under management and lower sales in the quarter. Shareholder servicing fees increased a bit, reflecting the increase in billable accounts and the normal shift between open and closed accounts. During the quarter, 200,000 closed accounts were purged in Canada. In July, about 4.3 million U.S. closed accounts are expected to be purged from the system and will be reflected in next quarter's results.
Other net revenue was $23 million due more to the lack of nonrecurring items that affected the prior quarter than anything else. Operating expenses came in at 4% lower this quarter. Sales distribution and marketing was lower as expected due to lower average assets under management and sales, as well as the nonrecurring items that pushed the second quarter's expense higher.
Compensation and benefits was $314.6 million, a decrease of 3% from last quarter, due mostly to lower payroll taxes and variable compensation. We added to headcount this quarter, and now have 8,563 employees. While many of these staffing increases were located in lower-cost jurisdictions, we should see an increase in this line item next quarter.
Information systems and technology and occupancy expenses were in the range we expected, and I expect these lines to be a bit higher next quarter as we tend to see some seasonality here, particularly with technology projects wrapping up and being expensed in the fourth quarter.
General, administrative and other expenses was $10 million lower this quarter. This line has several moving parts, but the majority of the decrease was related to the consolidation of sponsored investment products, which was a net benefit of $1 million this quarter compared to $6.2 million expense last quarter. You can see this on Slide 18 of the presentation as well.
Other income net of noncontrolling interest was a loss of only $1.2 million. As you can see from the waterfall chart on Slide 17, there are a number of moving parts that contributed to the net loss this quarter.
Equity method investment losses and the mark-to-market losses on trading investments of consolidated sponsored investment products were the primary detractors this quarter, as expected, given the market declines this quarter. Our shares of these losses were largely offset by other items, including about $17 million of foreign exchange gains caused by the strengthening of the U.S. dollar. These gains reflect the revaluation of U.S. dollar cash and cash equivalents held by non-U.S. subsidiaries with a non-U.S. dollar functional currency.
While the consolidation of our sponsored investment products, variable interest entities and limited partnerships had a $17.1 million impact on earnings this quarter, it should be noted that their impact is immaterial on a year-to-date basis increasing net income by less than $1 million.
Looking at Slide 19. The effective tax rate for the year-to-date period edged up to 29.4% due largely to the losses incurred by consolidated investments. And that caused the quarterly rate to come in at 30.1% as we had to catch up for prior quarters that were accrued at the lower rate.
Slide 20 is a new addition to the deck this quarter and focuses on longer-term profitability. Borrowing a phrase from our Head of Global Distribution, we manage the business with bifocal vision, that is to say while we're focused on the long-term growth of the business, we also have to be mindful of the near-term environment.
Last quarter has a lot of attention on the reported short-term margin where seasonal and nonrecurring items can have a more pronounced impact. We believe that a better metric is our fiscal year-to-date margin. At almost 36%, this margin is lower than fiscal year 2011, not unexpected given the market environment, but still very strong. It's worth noting that fiscal year 2011's margin also benefited from insurance recoveries and higher-than-normal carried interest from the Darby products in the fourth quarter.
Profitability versus nominal assets under management is a characteristics of asset management that seems to be unappreciated relative to the focus on nominal net flows. We don't manage the business with the goal that we need to be bigger just for the sake of being bigger from an assets under management perspective. We focus on serving the needs of our clients with value-added products and generated profitable growth. In our view, strictly looking at nominal assets under management growth ignores the quality of the flows. What should matter is our ability to translate assets under management into earnings, and we believe that we do that better than most peers. Fiscal year-to-date, our return on average assets under management was 27.6 basis points, essentially flat versus 2011.
Moving on to capital management. We've made some enhancements to this presentation as well. The strength of our balance sheet allows us the ability to invest in long-term growth projects and the seeding of new products around the globe. We're also giving comfort to clients that are understandably more focused on the financial strength of the firm. It also allows us to return available U.S. cash to stockholders through stock repurchases and a regular dividend that has increased annually since its inception in 1981.
We steadily decrease shares outstanding as share repurchases have significantly exceeded equity grants, adding compound annual earnings per share accretion of 3% over the past 5 years. The payout ratio for the trailing 12 months increased to 92%, reflecting over $1 billion in stock repurchases, as well as $660 million in regular and special dividends.
And finally, included on this slide is a snapshot of our net cash and investment, which excludes non-Franklin interest in consolidated sponsored investment products and variable interest entities, as well as the banking business and is net of debt. While this calculation could be derived from our disclosures, hopefully, you'll find its inclusion here helpful in your analysis.
That concludes our comments, and we look forward to the live call at 4:30 Eastern Time.