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Operator
Good morning and welcome to Franklin Resources Earnings Conference Call for the quarter-ended March 31, 2019. 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.
Jenny Johnson
Good morning. My name is Jessie, and I'll be your call operator today. At this time, all participants are on a listen-only mode. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate that your line is in the question queue. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. At this time, I would like to turn the call over to Franklin Resources Chairman and CEO, Mr. Greg Johnson. Mr. Johnson, you may begin.
Johnson
Good morning, and welcome to our second quarter earnings conference call. Joining me for his final earnings call as CFO is Ken Lewis. We also have Jenny Johnson, our President and Chief Operating Officer, with us today. Importantly, strong investment performance translated to better flows for many of our flagship funds. Retail sales and redemptions improved significantly, particularly for global fixed income that once again attracted inflows, as did Franklin income. Earnings per share improved to 72 cents, a 33% increase from last quarter. Higher investment income more than offset the initial impact of the cost structure optimization initiatives intended to increase operational efficiencies and streamline the organization. We'd now like to open the line for your questions.
Jenny Johnson
Thank you. At this time, we will be conducting the question and answer session. We ask that you please limit yourself to one question and one follow-up, then re-queue for any additional questions. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate that your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from the line of Glenn Shore with Evercore ISI. Please proceed with your question.
Glenn Shore
Hi, thanks very much. I'm curious to see what you think, what's behind the lowest redemption since 2011. Obviously, the market got better, and we're coming off a crap fourth quarter. Your performance is better. There's a lot of interesting things in there, but To be lowest level since 2011, I'm curious on how much environmental versus Franklin-specific, and are you doing anything to obviously bring that on in the retail channel?
Johnson
Well, I think partly sometimes coming off a volatile quarter, it does slow down redemption activity. We've seen that in the past. But I think nothing else other than better performance comes to mind and Certainly, the pickup and focus on some of the flagship funds where we've had larger redemptions and then had better performance I'm sure has helped as well.
Jenny
I'll just add that I think some of the investments we've made on adding talent to the distribution channels, we've seen upticks in our New York Stock Exchange channel and had some additional placements with gatekeepers and things. most recently hired in the private wealth and the SMA channel. So I think that that's probably also helping.
Glenn Shore
And have we seen a slowing in the list consolidation that went on around the retail channel?
Jenny
You know, you're still seeing some of that. I mean, obviously firms are rationalizing it, but we're also in some cases, winning in those channels.
Glenn Shore
Just one other follow-up, if I could. I know we're not there yet on Benefit Street, but what's going on beyond the scenes to start driving growth so you can hit the ground running? What's the overall plan once you're closed and out the door?
Johnson
Well, I think the plan is to first get Benefit Street, I mean, get our distribution comfortable with the investment process and team and then really go tackle. And that's really what they've done, I'd say, in the early months. And now we're going out with roadshows around the globe to introduce Benefit Street to many of our global clients. We're also... looking at expanding the retail part of the equation and developing some products there. But it's still early stage, but the focus has really been on making sure that our entire team is up to speed on Benefit Street and then attacking the clients in an optimal way.
Glenn Shore
Great. I appreciate that. Thanks. Sure.
Jenny Johnson
Thank you. Our next question is from the line of Bill Katz with Citigroup. Please proceed with your question.
Bill Katz
Hi, good morning. Patience has taken the question, and it's Ben Herbert on for Bill. Just wanted to follow up on the expense commentary, 20 versus 18. Are you still expecting to potentially be able to bend it a bit lower than 18, or is that maybe pushed out a bit further? Thank you.
Ben Herbert
Thanks, Bill. No, our guidance, we're pretty confident that we can get the run rate expenses to be at the 2018 levels. That's, you know, as a result of all the cost savings initiatives that we're doing right now.
Bill Katz
And so we're not expecting to maybe come in a little bit lower in 2020?
Ben Herbert
In 2020, we expect 2020 expenses to be at the 2018 level.
Bill Katz
Right, but any opportunity to come in a bit lower? Hopefully.
Johnson
Yeah, working on it.
Bill Katz
Thanks, and then maybe just one unrelated follow-up would be on any change in capital management priorities with the CFO change. Thank you.
Johnson
No, I think we all work with the board on the strategy around optimizing the capital management, and certainly you'll have a new input to that, but nothing at this stage to really speak about. Thank you.
Jenny Johnson
Thank you. Our next question is from the line of Brian Vidal with Deutsche Bank. Please proceed with your question.
Jenny
Great. Thanks. Thanks. Good morning. Maybe, Greg, can you talk a little bit about your views on the approval of the active non-transparent ETF, whether it's something that you would look to license for some of your active strategies, maybe how that would potentially fit with your LibertyShares effort right now that I think spans both passive, smart beta, and active, and then also whether you'd be interested in accelerating the ETF effort with any acquisitions, say, in the smart beta space.
Johnson
Well, I will turn that over to Jenny, who is a Liberty Share board member.
Jenny
You know, we obviously have been paying close attention to the various blind trusts that are coming through the SEC, and, you know, with the most recent approval of the Presidium, you know, it's limited in that it's really U.S.-listed equities, and you're talking about ones that can be replaced So, you know, it tended to be mid and large cap. So, you know, in that space, if we have an active product that we think that makes sense, we would certainly consider it. You know, we have active fixed income that are performing very well, and they don't need that kind of blind trust. And so, it just depends. We're open and looking at all of them. And, you know, right now we're seeing some good growth that we're just about to hit $4 billion in ETFs. With this quarter, we had one, our FLQL, which is our Liberty Shares U.S. Equity ETF that is now at $1.1 billion. And, you know, one of the key things with ETFs is just scale attracts more institutional players, and our smart beta performed very well through this volatile market.
Johnson
And I would just add, you know, I think as we've always said in M&A, if we see something that you know, accelerates our ETF and potentially complements the offerings and things, we're certainly still looking at that as well.
Jenny
Okay, great. And then maybe just on that M&A theme, you know, obviously the Invesco-Appenheimer deal is about to close, and that's a fairly sizable one. If that ends up being successful in terms of rekindling organic growth and obviously getting the cost saved, do you think that would potentially spur more industry consolidation for these types of properties? Would that lead you to think potentially it might make sense for you to even consolidate more on a sort of a scale basis? And maybe just any updated thoughts on, I think you had mentioned distribution agreements potentially in Europe in the past calls. Any updated thoughts on that?
Johnson
Yeah, I mean, I think we just pointed that it's a challenge to combine entities of that size, but certainly there's a huge opportunity for cost savings and synergies there. And I don't think we have a strong opinion one way or another other than if we have the right fit and right culture and right complement, we would certainly take that on. I just pointed to how disruptive it can be and difficult, but certainly there's opportunity if executed well on that, and it's something that every firm, I think, has to be open to when looking at margins and other ways to reduce expenses in a challenged revenue environment. I don't think there's much new to report on, and Jenny can add maybe, but on looking at distribution plays in M&A. I think that's certainly something that, as we've said on past calls, that we're more open to doing in certain markets, and we'll continue to look, but there's nothing really new to say there.
Jenny
Okay, great. Thanks very much for the comments.
Johnson
Thanks.
Jenny Johnson
Thank you. Our next question is from the line of Michael Carrier with Bank of America Merrill Lynch. Please proceed with your question.
Michael Carrier
Good morning, and thanks for taking the question. First, on some of the efficiency initiatives, can you just provide maybe a little detail on where you're pursuing those? You mentioned outsourcing, but any other areas? And then in terms of redirecting those savings, You guys have talked about the multi-asset solutions distribution, but specifically, over the next two years, as you're getting those efficiencies, what are some of those priorities?
Ben Herbert
Okay, I'll start with the cost savings. It is an enterprise-wide effort. So essentially all the business units participated in it. So it's difficult. And I will point out that the outsourcing announcement is just in the early stages. So there's going to be more to come on that in the year 2020. But the cost savings initiatives that we're referring to in the text and on this call relate to just every department in the company looking at their operations and finding ways to become more efficient, maybe to leverage our low-cost jurisdictions, and maybe just to eliminate processes that we're not doing. So it's enterprise-wide. And you want to handle what we're going to invest the money in?
Jenny
Yeah. No, obviously, multi-asset solutions and distribution are two big areas and You know, in that, in distribution, it's both in people, so we've added key talent in important areas, as well as technology, you know, technologies that support the distribution channels, whether we're partnering or developing some capabilities on our own. And then, of course, data science, data science that supports our distribution so that we can be smarter at providing the right products through the distribution channels and of course, on the investment management side. We believe that active managers need to have the ability to leverage AI and machine learning and data science to gain insights, and that's really nascent, but it's important. We think it's very important over the long run, and so developing capabilities around that is critical.
Michael Carrier
Okay, thanks for the color, and then Just for the follow-up on the flows, you guys had some good pockets of improvement. Greg mentioned the global bond and then international retail. Just on the institutional side, it seems like that continues to be a bit of a headwind. I think you mentioned during the quarter some items that impacted you, but just maybe a little color there and then just on the outlook, what you're seeing in that channel.
Johnson
Yeah, you know, I think we do consider, I think you're correct in saying that there's, you know, that's where we had some headwinds continuing. And I think, you know, the majority of our assets historically have been on the Templeton side and institutional and, you know, another, as the markets have rebounded, they value trailed growth by about 400 basis points over the quarter. So that hasn't helped, you know, the relative numbers there. And as we enter our 10th, 11th year of this cycle, You know, it's just you still have pressure on redemptions and certainly not new sales to support that. You know, so that's where we saw some global equity accounts go, as well as some variable annuity. You know, that's been a continued headwind. We probably have another billion next quarter coming. And, you know, that VA business, some of it's going passive. A lot of it's just, you know, they've gotten out of the business. and are looking whether it's low vol or other type of fund managers or indexing. We've seen a lot of that, and that represented a large number of the redemptions as well for the past quarter. So those are the two that continue, I think, to put pressure on the net numbers, and overall retail would have been just about break-even or positive if it wasn't for the institutional side where we see some of the larger redemptions redemptions. The good news is they're in lower cost separate accounts or funds.
Michael Carrier
Okay. Thanks a lot.
Jenny Johnson
Thank you. Our next question is from the line of Ken Worthington with JP Morgan. Please proceed with your question.
Ken Worthington
Good morning. This is Will Cuddy filling in for Ken. First, Ken, thank you for your perspective over the years. Turning to questions, Franklin has been investing in its RIA and advisory distribution. Could you please update us on your progress on those investments? And within retail, how much of the retail flows are coming from RIAs and advisory? Are we beginning to see your investment in those channels pay off?
Jenny
You know, we are beginning to see it pay off. We actually had a good uptick this quarter, but it is still a much smaller part of our U.S. retail distribution and one that we're very focused on growing. And there's a lot of different ways to be able to attack that market. We have our multi-asset solutions has launched some models that we think will be appealing to that market. We also have come up with sleeves that can be incorporated into more of open architecture models. We look at strategic investments in tools that RIAs use because they tend to be more independent in some of the technology that they use. And so whether we do strategic investments or whether we support those applications through our own models and content. So all of those things are a focus for us on the RIA channel. Obviously, the ETFs, we're getting some good traction on the ETF space in the RIA channel. They tend to like ETFs. But we definitely see it as a very important strategic focus going forward.
Ken Worthington
Great. Thank you. Turning to tax-free fixed income, there has been commentary on the impact of tax reform on the muni market. Have you seen changes in broker sales patterns in the attributed tax reform broadly? And more recently, we're coming off of tax season. Have you seen a change in behavior as a result of tax season and some of the speculation about lower refunds this year for the tax-free fixed income bonds?
Johnson
Yeah, I just would say in general, I mean, it was a stronger quarter for – tax-free flows, and for us, a positive inflow, which it hasn't been in a while, so that was good. I think everybody becomes more aware of taxes, and especially in those states that no longer have the state deduction, the double tax-free is very attractive, and our Cal tax-free has done pretty well in performance on top of that. I think it's an area that clearly had improved gross sales and flows, and hopefully that will continue as people have to pay up more on their estimated taxes and things to make up the difference of not having that state deduction.
Ken Worthington
Great. Thanks for taking our questions. Thanks.
Jenny Johnson
Thank you. Our next question is from the line of Patrick DeVitt with Autonomous Research. Please proceed with your question.
Patrick DeVitt
Hey, good morning. Thank you. On the expense guidance, I just want to make sure I'm thinking about it right. So you kept the 2020 guide basically flat with 2018, excluding Benefit Street. So is the 15% to 16% 2019 comp guidance excluding Benefit Street as well? And through that lens, that was just the – pardon me?
Ben Herbert
Yes? Oh, sorry, I didn't hear this. I cut you off there.
Patrick DeVitt
This year includes Benefit Street.
Ben Herbert
This year includes Benefit Street.
Patrick DeVitt
I guess it still would suggest the vast majority of that guide is basically severance. Could you kind of separate out how much it would be up without kind of one-timer severance type items?
Ben Herbert
You're right, it is severance. I think we can give you perhaps a range for what we think the execution costs for all this cost savings are. We think it's about 2% increase, 2% of the increase is related to the execution costs on our cost initiatives.
Patrick DeVitt
Including severance? Yeah. Okay, yeah, cool. On Benefit Street again, Did they add to the $16 million performance fee at all, and do you have any updates on your views of the timing of potential accretion from the deal?
Ben Herbert
I do. Performance fees were minimal in total and inclusive of Benefit Street this quarter, and I think we are still pretty confident in our projections today. This year, as we said, it's going to be neutral. Next year, slightly accretive, and then as a result, the revenue growth accretive after that.
Patrick DeVitt
Any update on the potential non-cash expense that's in numbers from that deal?
Ben Herbert
Yes. Yeah, the cash, you know, you can see that cash went down this quarter. You know, it's pretty much related to Benefit Street and a couple of other things. No, I meant like non-cash. We just closed the purchase price and other cash price of that.
Patrick DeVitt
Okay. Thank you.
Jenny Johnson
Thank you. Our next question is from the line of Robert Lee with KBW. Please proceed with your question.
Robert Lee
Great, thanks. So thanks for taking my questions, and Ken, best of luck in your next chapter. Thanks. Can you maybe just go back to your answer to Patrick's question on the 2% increase? Did you mean 2% increase in total expense excluding sales expense?
Ben Herbert
Yeah, I'll simplify that even more.
Robert Lee
Okay.
Ben Herbert
Our estimate is like between 50 – for the remainder of this fiscal year, between 50 and 60 million dollars of execution costs.
Robert Lee
Great. And that – obviously, that includes severance and whatnot. Okay.
Ben Herbert
That's right. Exactly.
Robert Lee
That's right. Right. Okay. Perfect. All right. Maybe shifting gears, you know, I'm just kind of curious, you know, you've seen the rebound in demand for global fixed in particular, both in the U.S., outside the U.S. I'm just kind of curious outside the U.S. where you're seeing some of the best traction. I know in years past, it was Italy, for example, was a big market for you. Are you seeing it? Is it relatively concentrated in a couple of places? Are you seeing it spread out? Just trying to get some color on that.
Johnson
Yes, I actually just returned from Asia yesterday and spent nine days traveling around. And we're actually seeing most of the growth or rebound in sales coming from Asia. If you look at Hong Kong, Singapore in particular, Europe secondarily. But as we said before, a lot of these type of retail sales are driven – from the home office and the platform and putting it back on. And we're really seeing a renewed interest in the Global Bond Fund. And I think part of that is just the fear of retail investors right now, having gone through December. And even with the rebound, there's just a lot of caution out there. And this fund had a positive return in December, which I think just highlighted how it can lower the overall risk in a portfolio. and people looking for alternatives that are not as beta and duration related. So, you know, just had a strong renewed interest there and very optimistic that that, you know, that will continue, you know, as markets reach new highs as well. So it's really been more Asia, you know, than Europe and then the U.S.
Robert Lee
Okay. And then maybe going back, if I could, one last question. Going back to capital management from earlier, Peter, and I apologize if you had addressed this, but share repurchase was, I mean, at the lowest level it's been at in a while, understanding you did benefit street this quarter. But, you know, with the cash investment levels now having come down as you used it and returned it, I don't know to what extent, you know, the change in CFO and, Clearly, to someone who has a background in M&A, is that at all kind of impacting how you think about the level of excess cash you prefer to keep on hand versus what you may have done otherwise? I mean, just trying to see if that – maybe I'm reading too much into it, but just trying to get your take on that.
Johnson
Yeah, I don't think, as I said before, that the change in the CFOs has a whole lot to do with the buybacks. I think you had a very choppy December period and redemptions, and you had the acquisition, and we've been pretty aggressive in buying back. And if you're opportunistic, you really don't want to set a given level at any time. And also, there was much lower volume in the stock through that period, so we don't like to be the marketplace. in the stock as well and just backed off a little bit. But I don't think it should indicate anything going forward other than we're going to continue to be opportunistic and use the cash and then have, as we said before, we think the balance sheet provides us with a lot of options and we're going to continue to look at whether it's alternatives or other things that we think can add shareholder value over time.
Ben Herbert
And there are market issues, too. Like, for example, this quarter, our 10B18 volume dropped more than 40% versus last quarter. So there's those execution issues as well.
Robert Lee
Okay. Great. Thanks for taking my questions.
Jenny Johnson
Thanks. Thank you. Our next question is from the line of Alex Blostein with Goldman Sachs. Please proceed with your question.
Alex Blostein
Thanks. Good morning, everybody. Question around another one around expenses. So I guess in the written remarks, you guys highlighted decision to outsource a portion of the fund admin business. Can you walk us through what percentage of AUM and what products will be outsourced? Who are you guys outsourcing to? And whether or not there's going to be an opportunity to outsource more over time?
Ben Herbert
You know, we're not looking at the... We don't look at the outsourcing decision on a product basis. It's more of a process basis. And so I think specifically we're talking about aspects of the fund accounting, fund reporting process. And the decision to outsource we feel brings it more in line with our peers, and it's part of a broader effort. to kind of advance our capabilities. And I think one of the things that's changed for the providers is that, you know, they've reached a scale where they can meet our global and unique needs on a cost-efficient basis, and that wasn't the case before. Got it. I guess that's it, yeah.
Johnson
And it would cover most of our funds, I would guess.
Ben Herbert
Yeah, it covers, yeah, exactly, yeah, most.
Alex Blostein
Okay, that's helpful.
Ben Herbert
It's not product specific. It's across all the funds process.
Alex Blostein
Got it. Okay. And I guess when you guys look out beyond 2020 and, you know, that guidance is fairly clear, but I guess as once you get through these cost-cutting initiatives and it sounds like, you know, you have the program but the cost initiatives might end up being ongoing over time, how should we think about the organic kind of net expense growth for the business taking account kind of the initiatives you guys have in place both on the cost side and the growth side?
Ben Herbert
One thing I think is important to point out is we will continue to, while we'll continue to invest in the strategic initiatives that Jenny mentioned, there was some front-loading of that last year, some investments we've made last year. And, you know, so you did see an increase in expenses there. And now we're kind of, if you will, backfilling or, you know, kind of normalizing the expense base as a result of that. So we'll continue to make those investments. I think that... This process that we're going through makes us more efficient and more scalable. So normally, you know, we might have seen a certain growth rate as the business grows. I think a certain growth rate of expenses as the business grows, I don't think we'll see that in the future because of our, you know, we're increasing our scale. So, you know, I think inflation is a good guideline to think about expense growth, but we'll try to keep it under that.
Bill Katz
Great. Thanks a lot.
Jenny Johnson
Thank you. We do have a follow-up question from the line of Patrick DeVitt with Autonomous Research. Pleased to see with your question.
Patrick DeVitt
Hey, thanks for the follow-up. You mentioned $1 billion coming out from the VA. Could you scale that relative to what you saw last quarter and remind us how much is left in that bucket?
Johnson
It's probably similar to this quarter where I had about $1.5 one as well go out this quarter and distant you know we've identified another billion next quarter and I don't have the assets yeah we'll get back on that but there's nothing you know I think any of the older assets you could put at risk just because that they're at change but nothing beyond that billion as far as visibility for the next quarter that we're aware of.
Patrick DeVitt
Thanks.
Jenny Johnson
Thank you. Our next question is from the line of Dan Fannin with Jefferies. Please proceed with your question.
Dan Fannin
Good morning. This is actually James Steele filling in for Dan. Sorry, just one more on the outsourcing of the fund administration. Is this going to entail Any sort of a different ongoing fund admin cost, just sort of outside of the one-time cost associated with it?
Jenny
I'll just answer a couple things. I think that, no, you wouldn't see a dramatic reduction, but there will be some reductions to the fund's expenses. So there is some savings to the individual funds.
Dan Fannin
Got it. Thank you.
Jenny
And if anything, it's as much as a risk. And as Ken mentioned, you know, just historically one of the reasons that we had it in-house is that the providers just didn't have the global footprint that we had to be able to do it. Now they can, and they have a scale that can meet our, you know, our cost level. And for us, it's also as much a risk mitigation as they're able to continue to invest in the technology.
Dan Fannin
Okay, and then is there, could you size the difference in, you know, all-in fund expense?
Ben Herbert
Let me just say that this is, I mean, there'll be more to come on this, you know, next year. It's kind of, it is a pretty early announcement on this, and so even the execution of it will take us beginning of the execution will take us into 2020 and so it's really a 10-year uh you know a 10-year cost benefit analysis on that um so there'll be more to come on that in the future okay thanks guys thanks thank you it appears we have no further questions at this time so i'd like to pass the floor back over to mr johnson for any additional concluding comments
Johnson
Well, thank you very much, everyone, for attending. And I want to thank Ken Lewis for his tremendous service to our organization over his career. He will still be with us through the transition here. But I just want to thank him on behalf of all of us.
Ben Herbert
Thanks, Greg. Just a few words. Yeah, so, you know, it's been over 30 years and over 50 earnings calls here. As Greg said, I'll stay in an advisory capacity until September 30th. You know, the 30-year march just felt like a good time to try to make a change, including a little R&R before the next opportunity. There's no shortage of opportunities in the Bay Area, as I'm sure you can guess. But I do want to say I feel very confident I leave you in good hands. I know the executive team here will be successful. One of the reasons that I've worked here for so long is the company's deep culture of honesty Honesty and integrity, I know those values will serve them well, and I want to thank all of you for your thoughtful and thought-provoking questions over the past 13 years. I'm sure I'll miss that quarterly challenge, so hopefully our paths will cross in the future. So thanks a lot, everyone.
Jenny Johnson
Ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation, and you may disconnect your lines at this time.
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