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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Quarterly Period Ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File No. 1-9318
FRANKLIN RESOURCES, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-2670991
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
One Franklin Parkway, San Mateo, CA 94403
(Address of Principal Executive Offices)
(Zip Code)
(650) 312-2000
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
described in Rule 12b-2 of the Exchange Act).
YES X NO
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Outstanding: 253,468,709 shares, common stock, par value $.10 per share at April
30, 2003.
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PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 MARCH 31
(in thousands, except per share data) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------
OPERATING REVENUES:
Investment management fees $347,897 $365,778 $699,309 $722,576
Underwriting and distribution fees 194,158 197,537 380,095 389,544
Shareholder servicing fees 55,315 48,024 103,366 95,365
Other, net 15,765 14,629 35,816 36,690
- ---------------------------------------------------------------------------------------------
TOTAL OPERATING REVENUES 613,135 625,968 1,218,586 1,244,175
- ---------------------------------------------------------------------------------------------
OPERATING EXPENSES:
Underwriting and distribution 173,068 177,327 341,915 349,594
Compensation and benefits 160,809 159,764 319,927 319,907
Information systems, technology and
occupancy 71,404 73,197 143,999 147,791
Advertising and promotion 24,226 25,481 46,870 51,906
Amortization of deferred sales commissions 17,040 17,047 33,085 33,790
Amortization of intangible assets 4,238 4,258 8,472 8,633
Other 22,644 20,875 45,157 41,670
- ---------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 473,429 477,949 939,425 953,291
- ---------------------------------------------------------------------------------------------
Operating income 139,706 148,019 279,161 290,884
OTHER INCOME/(EXPENSES):
Investment and other income 15,558 14,782 27,861 33,111
Interest expense (3,037) (2,808) (6,069) (5,976)
- ---------------------------------------------------------------------------------------------
Other income, net 12,521 11,974 21,792 27,135
- ---------------------------------------------------------------------------------------------
Income before taxes on income 152,227 159,993 300,953 318,019
Taxes on income 42,624 39,997 81,590 79,504
- ---------------------------------------------------------------------------------------------
NET INCOME $109,603 $119,996 $219,363 $238,515
- ---------------------------------------------------------------------------------------------
Earnings per share:
Basic $0.43 $0.46 $0.85 $0.91
Diluted $0.43 $0.46 $0.85 $0.91
Dividends per share $0.075 $0.070 $0.150 $0.140
See accompanying notes to the consolidated financial statements.
2
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FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
MARCH 31 SEPTEMBER 30
(in thousands) 2003 2002
- ------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $701,020 $829,237
Receivables 286,594 292,325
Investment securities, available-for-sale 1,286,326 1,103,463
Prepaid expenses and other 95,559 97,783
- ------------------------------------------------------------------------------------------------
Total current assets 2,369,499 2,322,808
- ------------------------------------------------------------------------------------------------
Banking/finance assets:
Cash and cash equivalents 123,866 151,367
Loans receivable, net 516,679 444,338
Investment securities, available-for-sale 474,194 449,629
Other 39,769 45,889
- ------------------------------------------------------------------------------------------------
Total banking/finance assets 1,154,508 1,091,223
- ------------------------------------------------------------------------------------------------
Non-current assets:
Investments, other 258,346 263,927
Deferred sales commissions 162,670 130,617
Property and equipment, net 379,571 394,172
Intangible assets, net 690,479 697,246
Goodwill 1,327,582 1,321,939
Receivable from banking/finance group 183,200 100,705
Other 80,450 100,101
- ------------------------------------------------------------------------------------------------
Total non-current assets 3,082,298 3,008,707
- ------------------------------------------------------------------------------------------------
TOTAL ASSETs $6,606,305 $6,422,738
- ------------------------------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
3
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FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
MARCH 31 SEPTEMBER 30
(in thousands except share data) 2003 2002
- ------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Compensation and benefits $171,848 $228,093
Current maturities of long-term debt 4,216 7,830
Accounts payable and accrued expenses 125,510 117,246
Commissions 81,408 81,033
Income taxes 14,166 12,510
Other 8,363 8,307
- ------------------------------------------------------------------------------------------------
Total current liabilities 405,511 455,019
- ------------------------------------------------------------------------------------------------
Banking/finance liabilities:
Deposits 720,188 733,571
Payable to Parent 183,200 100,705
Other 59,769 49,660
- ------------------------------------------------------------------------------------------------
Total banking/finance liabilities 963,157 883,936
- ------------------------------------------------------------------------------------------------
Non-current liabilities:
Long-term debt 636,086 595,148
Deferred taxes 187,466 175,176
Other 45,598 46,513
- ------------------------------------------------------------------------------------------------
Total non-current liabilities 869,150 816,837
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
Total liabilities 2,237,818 2,155,792
- ------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 10)
Stockholders' equity:
Preferred stock, $1.00 par value, 1,000,000 shares authorized; none - -
issued
Common stock, $0.10 par value, 500,000,000 shares authorized; 25,546 25,856
255,463,878 and 258,555,285 shares issued and outstanding, for March
and September
Capital in excess of par value 504,810 598,196
Retained earnings 3,883,497 3,702,636
Accumulated other comprehensive loss (45,366) (59,742)
- ------------------------------------------------------------------------------------------------
Total stockholders' equity 4,368,487 4,266,946
- ------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $6,606,305 $6,422,738
- ------------------------------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
4
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FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED SIX MONTHS ENDED
MARCH 31
(in thousands) 2003 2002
- ------------------------------------------------------------------------------------------------
NET INCOME $219,363 $238,515
Adjustments to reconcile net income to net cash
provided by operating activities:
Decrease in receivables, prepaid expenses and other 29,863 133,644
Net advances of deferred sales commissions (65,381) (76,118)
Increase in other current liabilities 2,290 64,925
Increase in income taxes payable 1,656 7,468
Increase in commissions payable 374 2,249
Decrease in accrued compensation and benefits (27,870) (38,756)
Depreciation and amortization 87,926 91,134
Losses/(gains) on disposal of assets 2,240 (5,433)
- ------------------------------------------------------------------------------------------------
Net cash provided by operating activities 250,461 417,628
- ------------------------------------------------------------------------------------------------
Purchase of investments (1,114,217) (787,795)
Liquidation of investments 897,620 981,974
Purchase of banking/finance investments (108,547) (84,780)
Liquidation of banking/finance investments 168,596 143,115
Net proceeds from securitization of loans receivable 124,989 299,980
Net origination of loans receivable (198,589) (239,147)
Additions of property and equipment (32,052) (27,992)
Proceeds from sale of property 143 9,534
- ------------------------------------------------------------------------------------------------
Net cash (used in)/provided by investing activities (262,057) 294,889
- ------------------------------------------------------------------------------------------------
(Decrease)/increase in bank deposits (13,382) 72,362
Exercise of common stock options 729 12,010
Net put option premiums and settlements 2,862 895
Dividends paid on common stock (37,404) (35,129)
Purchase of stock (133,322) (8,070)
Increase in debt 42,686 43,799
Payments on debt (6,291) (4,146)
- ------------------------------------------------------------------------------------------------
Net cash (used in)/provided by financing activities (144,122) 81,721
- ------------------------------------------------------------------------------------------------
(Decrease)/increase in cash and cash equivalents (155,718) 794,238
Cash and cash equivalents, beginning of period 980,604 622,775
- ------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $824,886 $1,417,013
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SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION:
Value of common stock issued, principally restricted stock $28,376 $28,151
See accompanying notes to the consolidated financial statements.
5
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FRANKLIN RESOURCES, INC.
Notes to Consolidated Financial Statements
March 31, 2003
(Unaudited)
1. Basis of Presentation
---------------------
We have prepared these unaudited interim financial statements of
Franklin Resources, Inc. and its consolidated subsidiaries in
accordance with the instructions to Form 10-Q and the rules and
regulations of the Securities and Exchange Commission. Under these
rules and regulations, we have shortened or omitted some information
and footnote disclosures normally included in financial statements
prepared under generally accepted accounting principles. We believe
that we have made all adjustments necessary for a fair statement of
the results of operations for the periods shown. All adjustments are
normal and recurring. You should read these financial statements
together with our audited financial statements included in our Annual
Report on Form 10-K for the year ended September 30, 2002. Certain
amounts for the comparative prior year periods have been reclassified
to conform to the financial presentation for and at the periods ended
March 31, 2003.
2. Comprehensive Income
--------------------
The following table shows comprehensive income for the three and six
months ended March 31, 2003 and 2002.
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 MARCH 31
(in thousands) 2003 2002 2003 2002
---------------------------------------------------------------------------------------------
Net income $109,603 $119,996 $219,363 $238,515
Net unrealized (loss)/gain on available-for-sale
securities, net of tax (4,629) 3,610 3,155 6,181
Foreign currency translation adjustments 3,464 (2,217) 11,221 (8,852)
---------------------------------------------------------------------------------------------
Comprehensive income $108,438 $121,389 $233,739 $235,844
---------------------------------------------------------------------------------------------
6
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3. Earnings per Share
------------------
We computed earnings per share as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 MARCH 31
(in thousands except per share
amounts) 2003 2002 2003 2002
----------------------------------------------------------------------------------------
Net income $109,603 $119,996 $219,363 $238,515
----------------------------------------------------------------------------------------
Weighted-average shares
outstanding - basic 257,023 261,596 257,315 261,284
Incremental shares from assumed
conversions 631 515 603 697
----------------------------------------------------------------------------------------
Weighted-average shares
outstanding - diluted 257,654 262,111 257,918 261,981
----------------------------------------------------------------------------------------
Earnings per share:
Basic and diluted $0.43 $0.46 $0.85 $0.91
----------------------------------------------------------------------------------------
4. Employee Stock Option and Investment Plans
------------------------------------------
Under our stock option plan, we may award options to some employees.
In addition, we have a qualified, non-compensatory Employee Stock
Investment Plan ("ESIP"), which allows participants who meet certain
eligibility criteria to buy shares of common stock at 90% of their
market value on defined dates. We account for these plans using the
intrinsic value method under Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" and related
interpretations. Accordingly, no compensation costs are recognized
with respect to stock options granted that have an exercise price
equal to the market value of the underlying stock at the date of
grant, or with respect to shares issued under the ESIP.
If we had determined compensation costs for our stock option plans and
our ESIP based upon fair values at the grant dates in accordance with
the provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation", our net income and earnings
per share would have been reduced to the pro forma amounts indicated
below. For pro forma purposes, the estimated fair value of options was
calculated using the Black-Scholes option-pricing model and is
amortized over the options' vesting periods.
7
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THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 MARCH 31
(in thousands) 2003 2002 2003 2002
---------------------------------------------------------------------------------------
Net Income, as reported $109,603 $119,996 $219,363 $238,515
Less: additional stock-based compensation
expense determined under the fair value
method, net of tax 17,414 15,012 33,949 28,056
---------------------------------------------------------------------------------------
PRO FORMA NET INCOME $92,189 $104,984 $185,414 $210,459
---------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
As reported $0.43 $0.46 $0.85 $0.91
Pro forma $0.36 $0.40 $0.72 $0.81
DILUTED EARNINGS PER SHARE
As reported $0.43 $0.46 $0.85 $0.91
Pro forma $0.36 $0.40 $0.72 $0.80
---------------------------------------------------------------------------------------
5. Cash and Cash Equivalents
-------------------------
Cash and cash equivalents at March 31, 2003 and September 30, 2002
consisted of the following:
MARCH 31, SEPTEMBER 30,
(in thousands) 2003 2002
----------------------------------------------- -------------------- -------------------
Cash and due from banks $245,970 $224,214
Federal funds sold and securities purchased under
agreements to resell 50,445 82,150
Other 528,471 674,240
----------------------------------------------- -------------------- -------------------
Total $824,886 $980,604
----------------------------------------------- -------------------- -------------------
Cash and cash equivalents - other includes money market mutual fund
investments and U.S. Treasury bills. Federal Reserve Board regulations
require reserve balances on deposits to be maintained with the Federal
Reserve Banks by banking subsidiaries. The required reserve balance was
$2.4 million as of March 31, 2003 and $5.3 million as of September 30,
2002.
6. Securitization of Loans Receivable
----------------------------------
From time to time, we enter into auto loan securitization transactions
with qualified special purpose entities and record these transactions
as sales. The following table shows details of auto loan
securitization transactions for the three and six months ended March
31, 2003 and 2002:
8
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THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 MARCH 31
(in thousands) 2003 2002 2003 2002
---------------------------------------------------------------------------------------
Gross sale proceeds $- $- $131,620 $319,616
Net carrying amount of loans sold - - 126,104 306,260
---------------------------------------------------------------------------------------
Pre-tax gain $- $- $5,516 $13,356
---------------------------------------------------------------------------------------
When we sell auto loans in a securitization transaction, we record an
interest-only strip receivable. The interest-only strip receivable
represents our contractual right to receive interest from the pool of
securitized loans after the payment of required amounts to holders of
the securities and certain other costs associated with the
securitization. Gross sales proceeds include the fair value of the
interest-only strips.
We generally estimate fair value based on the present value of future
expected cash flows. The key assumptions used in the present value
calculations of our securitization transactions at the date of
securitization were as follows:
THREE MONTHS SIX MONTHS
ENDED ENDED
MARCH 31 MARCH 31
2003 2002 2003 2002
--------------------------------------------------------------------------------------
Excess cash flow discount rate (annual rate) - - 12% 12%
Cumulative life loss rate - - 4.27% 3.75%
Pre-payment speed assumption (average monthly rate) - - 1.76% 1.50%
--------------------------------------------------------------------------------------
We determined these assumptions using data from comparable
transactions, historical information and management's estimate.
Interest-only strip receivables are generally restricted assets and
subject to limited recourse provisions.
We generally estimate the fair value of the interest-only strips at
each period-end based on the present value of future expected cash
flows, consistent with the methodology used at the date of
securitization. The following shows the carrying value and the
sensitivity of the interest-only strip receivables at March 31, 2003
and September 30, 2002 to adverse changes in the key economic
assumptions used to measure fair value, which are hypothetical:
9
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MARCH 31, SEPTEMBER 30,
(in thousands) 2003 2002
---------------------------------------------------------------------------------------
Carrying amount/fair value of interest-only strips $27,146 $29,088
---------------------------------------------------
Excess cash flow discount rate (annual rate) 12% 12%
--------------------------------------------
Impact on fair value of 10% adverse change $(388) $(400)
Impact on fair value of 20% adverse change $(765) $(789)
Cumulative life loss rate 3.95% 3.63%
-------------------------
Impact on fair value of 10% adverse change $(1,827) $(1,787)
Impact on fair value of 20% adverse change $(3,651) $(3,579)
Pre-payment speed assumption (average monthly rate) 1.70% 1.73%
--------------------------------------------------
Impact on fair value of 10% adverse change $(2,896) $(2,632)
Impact on fair value of 20% adverse change $(5,461) $(5,155)
---------------------------------------------------------------------------------------
This sensitivity analysis shows the hypothetical effect of a change in
the assumptions used to determine the fair value of the interest-only
strip receivable. Actual future market conditions may differ
materially and accordingly, this sensitivity analysis should not be
considered our projections of future events or losses.
With respect to retained servicing responsibilities relating to the
securitization trusts, we receive annual servicing fees ranging from
1% to 2% of the loans securitized. We also receive the rights to
future cash flows, if any, arising after the investors in the
securitization trust have received their contracted return.
The following is a summary of cash flows received from and paid to
securitization trusts.
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 MARCH 31
(in thousands) 2003 2002 2003 2002
---------------------------------------------------------------------------------------
Servicing fees received $2,696 $2,092 $5,069 $3,397
Other cash flows received 4,266 4,603 9,132 5,922
Purchase of loans from trusts 10,363 7,964 10,363 8,380
---------------------------------------------------------------------------------------
Amounts payable to the trustee for servicing income collected on
behalf of the trusts of $26.5 million at March 31, 2003 and $24.9
million at September 30, 2002 are included in other banking/finance
liabilities.
The securitized loan portfolio that we manage and the related
delinquencies as of March 31, 2003 and September 30, 2002 were as
follows:
10
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March 31, September 30,
(in thousands) 2003 2002
---------------------------------------------------------------------------------------
Securitized loans held by securitization trusts $521,560 $530,896
Delinquencies 10,991 9,317
---------------------------------------------------------------------------------------
Net charge-offs on the securitized loan portfolio were $3.0 million
and $1.6 million during the three months ended March 31, 2003 and 2002
and $6.0 million and $2.7 million during the six months ended March
31, 2003 and 2002.
7. Intangible Assets and Goodwill
------------------------------
Intangible assets at March 31, 2003 and September 30, 2002 were as
follows:
GROSS CARRYING ACCUMULATED NET CARRYING
(in thousands) AMOUNT AMORTIZATION AMOUNT
---------------------------------------------------------------------------------------
AS OF MARCH 31, 2003
Amortized intangible assets:
Customer base $232,321 $(31,182) $201,139
Other 31,546 (18,917) 12,629
---------------------------------------------------------------------------------------
263,867 (50,099) 213,768
Non-amortized intangible assets:
Management contracts 476,711 - 476,711
---------------------------------------------------------------------------------------
Total $740,578 $(50,099) $690,479
---------------------------------------------------------------------------------------
AS OF SEPTEMBER 30, 2002
Amortized intangible assets:
Customer base $231,935 $(23,358) $208,577
Other 31,546 (18,181) 13,365
---------------------------------------------------------------------------------------
263,481 (41,539) 221,942
Non-amortized intangible assets:
Management contracts 475,304 - 475,304
---------------------------------------------------------------------------------------
Total $738,785 $(41,539) $697,246
---------------------------------------------------------------------------------------
Estimated amortization expense for each of the next 5 fiscal years is
as follows:
FOR THE FISCAL YEARS ENDING
(in thousands) SEPTEMBER 30,
---------------------------------------- -----------------------------
2003 $16,959
2004 16,959
2005 16,959
2006 16,959
2007 16,959
---------------------------------------- -----------------------------
11
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The change in the carrying value of goodwill was as follows:
(in thousands)
----------------------------------------------------------------------
Goodwill as of September 30, 2002 $1,321,939
Foreign currency movements 5,643
----------------------------------------------------------------------
Goodwill as of March 31, 2003 $1,327,582
----------------------------------------------------------------------
We adopted Statement of Financial Accounting Standards No. 142
"Goodwill and Other Intangible Assets" ("SFAS 142") on October 1,
2001. SFAS 142 addresses the initial recognition and measurement of
intangible assets acquired outside a business combination and the
recognition and measurement of goodwill and other intangible assets
after acquisition. Under the new standard, all goodwill and
indefinite-lived intangible assets, including those acquired before
initial application of the standard, are not amortized but are tested
for impairment at least annually. Accordingly, on October 1, 2001, we
ceased to amortize goodwill and indefinite-lived assets. All of our
goodwill and intangible assets relate to our investment management
operating segment. Indefinite-lived intangible assets represent the
value of management contracts related to our mutual funds and other
investment products.
As of March 31, 2003, we completed the annual impairment testing of
goodwill and indefinite-lived intangible assets under the guidance set
out in SFAS 142 and we determined that there was no impairment in the
value of goodwill and indefinite-lived assets recorded in our books
and records as of October 1, 2002.
8. Segment Information
-------------------
We have two operating segments: investment management and
banking/finance. We based our operating segment selection process
primarily on services offered. The investment management segment
derives substantially all its revenues and net income from providing
investment advisory, administration, distribution and related services
to the Franklin, Templeton, Mutual Series, Fiduciary Trust and Bissett
funds, and institutional, high net-worth and private accounts and
other investment products. The banking/finance segment offers consumer
lending and selected retail-banking services to individuals.
Financial information for our two operating segments for the three and
six months ended March 31, 2003 and 2002 is presented in the table
below. Operating revenues of the banking/finance segment are reported
net of interest expense and provision for loan losses.
12
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THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 MARCH 31
(in thousands) 2003 2002 2003 2002
---------------------------------------------------------------------------------------
OPERATING REVENUES
Investment management $600,787 $617,794 $1,190,082 $1,216,753
Banking/finance 12,348 8,174 28,504 27,422
---------------------------------------------------------------------------------------
Total $613,135 $625,968 $1,218,586 $1,244,175
---------------------------------------------------------------------------------------
INCOME BEFORE TAXES
Investment management $146,777 $156,700 $285,712 $299,381
Banking/finance 5,450 3,293 15,241 18,638
---------------------------------------------------------------------------------------
Total $152,227 $159,993 $300,953 $318,019
---------------------------------------------------------------------------------------
Operating segment assets were as follows:
MARCH 31, SEPTEMBER 30,
(in thousands) 2003 2002
---------------------------------------------------------------------------------------
Investment management $5,451,797 $5,331,515
Banking/finance 1,154,508 1,091,223
---------------------------------------------------------------------------------------
Total $6,606,305 $6,422,738
---------------------------------------------------------------------------------------
Operating revenues of the banking/finance segment included above were
as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 MARCH 31
(in thousands) 2003 2002 2003 2002
------------------------------------------------------------------------------------------
Interest and loan fees $8,101 $6,608 $15,964 $17,923
Interest and dividends on investment securities 5,852 4,112 10,862 9,507
-----------------------------------------------------------------------------------------
Total interest income 13,953 10,720 26,826 27,430
Interest on deposits (1,791) (2,340) (3,380) (5,077)
Interest on short-term debt (110) (57) (198) (275)
Interest expense - inter-segment (605) (1,341) (1,409) (3,486)
-----------------------------------------------------------------------------------------
Total interest expense (2,506) (3,738) (4,987) (8,838)
Net interest income 11,447 6,982 21,839 18,592
Other income 4,234 4,351 13,215 19,162
Provision for loan losses (3,333) (3,159) (6,550) (10,332)
-----------------------------------------------------------------------------------------
Total operating revenues $12,348 $8,174 $28,504 $27,422
-----------------------------------------------------------------------------------------
Inter-segment interest payments from the banking/finance segment to
the investment management segment are based on market rates prevailing
at the inception of each loan. Inter-segment interest income and
expense are not eliminated in our Consolidated Statements of Income.
13
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9. Debt
----
In May 2001, we received approximately $490 million in net proceeds
from the sale of $877 million principal amount at maturity of
zero-coupon convertible senior notes due 2031 (the "Convertible
Notes"). At March 31, 2003, long-term debt included $501.0 million in
principal and $18.0 million of accrued interest related to the
Convertible Notes. The Convertible Notes, which were offered to
qualified institutional buyers only, carry an interest rate of 1.875%
per annum, with an initial conversion premium of 43%. Each of the
$1,000 (principal amount at maturity) Convertible Notes is convertible
into 9.3604 shares of our common stock. We may redeem the Convertible
Notes for cash on or after May 11, 2006 at their accreted value. We
may have to repurchase the Convertible Notes at their accreted value,
at the option of the holders, on May 11 of 2003, 2004, 2006, 2011,
2016, 2021 and 2026. In this event, we may choose to pay the purchase
price in cash or shares of our common stock. The amount of Convertible
Notes that will be redeemed depends on, among other factors, the
performance of our common stock. On April 9, 2003, we notified holders
that we would redeem the Convertible Notes for cash at their accreted
value on May 11, 2003. If we had to repurchase all of the Convertible
Notes on this date, the total payment would be approximately $520.1
million.
We did not have any commercial paper outstanding or medium term notes
issued at March 31, 2003 and at September 30, 2002. See Note 13 for
additional disclosures about subsequent events.
10. Commitments and Contingencies
-----------------------------
GUARANTEES
Under Financial Accounting Standards Board Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others", we are
required, on a prospective basis, to recognize in our financial
statements a liability for the fair value of any guarantees issued or
modified after December 31, 2002 as well as make additional
disclosures about existing guarantees (see Note 14). The following are
guarantees issued as of March 31, 2003. At March 31, 2003, there was
no liability recognized in our consolidated balance sheet for
guaranteed amounts as existing transactions as of this date were
entered into before the effective date of the fair value provision of
the interpretation.
We lease our corporate headquarters in San Mateo, California from a
lessor trust under an operating lease that expires in fiscal 2005,
with additional renewal options for a further period of up to 10
years. In connection with this lease, we are contingently liable for
approximately $145 million in residual guarantees, representing
approximately 85% of the total construction costs of $170 million. We
would become liable under the residual guarantee of $145 million if we
were unable or unwilling to exercise our renewal option to extend the
lease term or buy the corporate headquarter buildings, or if we were
unable to arrange for the sale of the building for more than $145
million.
We are also contingently liable to purchase the corporate headquarter
buildings for an amount equal to the final construction costs of $170
million if an event of default occurs under the agreement. An event of
default includes, but is not limited to, failure to make lease
payments when due and failure to maintain required insurance.
Management considers the possibility of default under the provisions
of the agreement to be remote. The lease is treated as an operating
14
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lease as none of the capitalization criteria under Statement of
Financial Accounting Standards No. 13, "Accounting for Leases" was met
at the inception of the lease.
We provide investment management services to, and have made
investments in, a number of collateralized debt obligation entities
("CDOs") that, using debt financing, invest in debt instruments. These
entities subsequently issue notes and preferred shares to investors.
As of March 31, 2003, in relation to one of these entities, and in the
event that the CDO is terminated prior to the issuance of securities
to investors, we have a contingent obligation in the maximum amount of
approximately $107 million.
In relation to the auto loan securitization transactions that we have
entered into with a number of qualified special purpose entities, we
are obligated to cover shortfalls in amounts due to the holders of the
notes up to certain levels as specified under the related agreements.
As of March 31, 2003, the maximum potential amount of future payments
was $9.6 million.
At March 31, 2003, our banking/finance operating segment had issued
financial standby letters of credit totaling $9.7 million on which
beneficiaries would be able to draw upon in the event of
non-performance by our customers, primarily in relation to lease and
lien obligations of these customers. These standby letters of credit
were secured by marketable securities with a fair value of $20.3
million as of March 31, 2003 and commercial real estate and have
various expiration dates through March 2004.
From time to time, we sell put options giving the purchaser the right
to sell shares of our common stock to us at a specified price upon
exercise of the options on the designated expiration dates if certain
conditions are met. These put options are treated as equity
instruments and the related premium received is recorded in
Stockholders' Equity as Capital in excess of par value. The likelihood
that we will have to purchase our stock and the purchase price is
contingent on the market value of our stock when the put option
contract becomes exercisable. At March 31, 2003, there were 4.4
million put options outstanding with various expiration dates from May
2003 through January 2004.
OTHER COMMITMENTS AND CONTINGENCIES
In February 2001, we signed an agreement to outsource management of
our data center and distributed server operations. Under the
agreement, we may end the agreement any time beginning on March 1,
2004 by incurring a termination charge. The maximum termination charge
payable depends on the termination date, the service levels before our
termination of the agreement, and costs incurred to wind down the
services. Based on March 31, 2003 service levels, the termination fee
payable on March 1, 2004 would approximate $37.2 million and would
decrease on each one-year anniversary for the following three years.
We are involved in various claims and legal proceedings that are
considered normal in our business. While it is not feasible to predict
or determine the final outcome of these proceedings, we do not believe
that they should have a material adverse effect on our financial
position, results of operations or liquidity.
At March 31, 2003, our banking/finance operating segment had
commitments to extend credit aggregating $292.7 million, mainly under
credit card lines. We lease office space and equipment under long-term
operating leases. Future minimum lease payments under non-cancelable
leases are not material.
15
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11. Transactions with Variable Interest Entities
--------------------------------------------
Variable interest entities ("VIEs") consist of corporations, trusts,
partnerships and other entities where the equity investment holders
have not contributed sufficient capital to finance the activities of
the VIEs or the equity investment holders do not have defined rights
and obligations normally associated with equity investments (see Note
14). At March 31, 2003, we were engaged in financial transactions with
the following VIEs.
LESSOR TRUST. We lease our corporate headquarters in San Mateo,
California from a lessor trust under an operating lease as described
in Note 10. Our maximum exposure arising from this arrangement is
approximately $170 million at March 31, 2003. At this time, we believe
that it is probable that we will have to consolidate the lessor trust
in our annual financial statements as of September 30, 2003.
COLLATERALIZED DEBT OBLIGATION ENTITIES. We provide investment
management services to, and have made investments in, a number of CDOs
as described in Note 10. Our equity ownership interest in the CDOs is
currently not sufficient to meet consolidation requirements and they
are reported at fair value. We earn investment management fees,
including subordinated management fees in some cases, for managing the
CDOs, as well as incentive fees that are contingent on certain
performance conditions. At March 31, 2003, the combined market value
of assets in these CDOs was approximately $1.7 billion, and our
maximum exposure to loss as a result of these investments was
approximately $19.6 million. At this time, we believe that it is
reasonably possible that we will have to either make additional
disclosures about or consolidate one or more of these entities in our
annual financial statements as of September 30, 2003.
12. Banking Regulatory Ratios
-------------------------
Following the acquisition of Fiduciary Trust Company International in
April 2001, we became a bank holding company and a financial holding
company subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly
additional, discretionary actions by regulators that, if undertaken,
could have a direct material effect on our financial statements. We
must meet specific capital adequacy guidelines that involve
quantitative measures of our assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting
practices. Our capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require us to maintain a minimum Tier 1 capital and Tier 1
leverage ratio (as defined in the regulations), as well as minimum
Tier 1 and Total risk-based capital ratios (as defined in the
regulations). Based on our calculations as of March 31, 2003, we
exceeded the capital adequacy requirements applicable to us as listed
below.
16
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THREE MONTHS ENDED MINIMUM FOR OUR CAPITAL
(in thousands) MARCH 31, 2003 ADEQUACY PURPOSES
------------------------------------- --------------------- ---------------------------
Tier 1 capital $2,244,324 N/A
Total risk-based capital $2,255,816 N/A
Tier 1 leverage ratio 47% 4%
Tier 1 risk-based capital ratio 65% 4%
Total risk-based capital ratio 66% 8%
------------------------------------- --------------------- ---------------------------
13. Subsequent Events
-----------------
In April 2003, we completed the sale of five-year senior notes due
April 15, 2008 and totaling $420 million. The senior notes, which were
offered to qualified institutional buyers only, carry an interest rate
of 3.7%.
During April 2003, we purchased approximately 2.0 million shares of
our common stock at a cost of approximately $68.6 million.
14. New Accounting Standards
------------------------
In November 2002, Financial Accounting Standards Board Interpretation
No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others"
("FIN 45"), was issued. FIN 45 addresses financial accounting and
reporting for companies that issue certain guarantees. Under FIN 45, a
company must recognize a liability at fair value for all guarantees
entered into or modified after December 31, 2002, even when the
likelihood of making any payments under the guarantee is remote. FIN
45 also requires enhanced disclosures for guarantees existing at
December 31, 2002. The adoption of FIN 45 did not have a material
effect on our consolidated operating results and financial position.
See Note 10 for additional disclosures.
In December 2002, Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation--Transition and Disclosure"
("SFAS 148"), was issued. SFAS 148 amends Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition to the
fair value method of accounting for stock-based compensation when
companies elect to expense stock options at fair value at the time of
grant. SFAS 148 also requires additional interim disclosure for all
companies with stock-based employee compensation. As we adopted the
intrinsic value method described in APB Opinion No. 25, "Accounting
for Stock Issued to Employees", the transition provision of SFAS 148
will not apply to us. The disclosure requirements are effective for
interim periods starting after December 15, 2002. The adoption of SFAS
148 did not have a material effect on our consolidated operating
results and financial position and we have provided the necessary
disclosures in Note 4.
In January 2003, Financial Accounting Standards Board Interpretation
No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), was
issued. FIN 46 addresses reporting and disclosure requirements for
VIEs. It defines a VIE as a corporation, trust, partnership or other
entity where the equity investment holders have not contributed
sufficient capital to finance the activities of
17
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the VIE or the equity investment holders do not have defined rights
and obligations normally associated with an equity investment. FIN 46
requires consolidation of a VIE by the enterprise that has the
majority of the risks and rewards of ownership, referred to as the
primary beneficiary. It also requires additional disclosures for an
enterprise that holds a significant variable interest in a VIE, but is
not the primary beneficiary. The consolidation and disclosure
provisions of FIN 46 are effective immediately for VIEs created after
January 31, 2003, and for interim or annual reporting periods
beginning after June 15, 2003 for VIEs created before February 1,
2003. FIN 46 also requires interim disclosures in all financial
statements issued after January 31, 2003, regardless of the date on
which the VIE was created, if it reasonably possible that an
enterprise will consolidate or disclose information about a VIE when
FIN 46 becomes effective. We are currently evaluating the impact that
the adoption of FIN 46 will have on our results of operations and
financial condition. See Note 11 for interim disclosures under FIN 46.
18
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
In addition to historical information, we also make some statements relating to
the future, which are called "forward-looking" statements. These forward-looking
statements involve a number of risks, uncertainties and other important factors
that could cause our actual results and outcomes to differ materially from any
future results or outcomes expressed or implied by such forward-looking
statements. Forward-looking statements are our best prediction at the time they
are made, and for this reason, you should not rely too heavily on them and
review the "Risk Factors" section set forth below and in our recent filings with
the U.S. Securities and Exchange Commission, which describes these risks,
uncertainties and other important factors in more detail.
GENERAL
We derive the majority of our operating revenues, operating expenses and net
income from providing investment advisory and related services to retail mutual
funds, institutional, high net-worth, private accounts and other investment
products. This is our main business activity and operating segment. The mutual
funds and other products that we advise, collectively called our sponsored
investment products, are distributed to the public globally via five distinct
names:
* Franklin * Templeton * Mutual Series * Fiduciary Trust * Bissett
Our sponsored investment products include a broad range of domestic and
global/international equity, balanced/hybrid, fixed-income and money market
mutual funds, as well as other investment products that meet a wide variety of
specific investment needs of individuals and institutions.
The level of our revenues depends largely on the level and relative mix of
assets under management. To a lesser degree, our revenues also depend on the
level of mutual fund sales and the number of mutual fund shareholder accounts.
The fees charged for our services are based on contracts with our sponsored
investment products or our clients. These arrangements could change in the
future.
Our secondary business and operating segment is banking/finance. Our
banking/finance group offers consumer lending and selected retail-banking
services to high net-worth individuals, foundations and institutions.
19
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RESULTS OF OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
(in millions except per share MARCH 31 PERCENT MARCH 31 PERCENT
amounts) 2003 2002 CHANGE 2003 2002 CHANGE
- -----------------------------------------------------------------------------------------------
NET INCOME $109.6 $120.0 (9%) $219.4 $238.5 (8%)
EARNINGS PER COMMON SHARE
Basic and diluted $0.43 $0.46 (7%) $0.85 $0.91 (7%)
OPERATING MARGIN 23% 24% - 23% 23% -
- -----------------------------------------------------------------------------------------------
Net income decreased 9% and 8% during the three and six months ended March 31,
2003 compared to the same periods last year. These decreases were mainly due to
lower investment management fees consistent with a decline in simple monthly
average assets under management, partially offset by higher shareholder
servicing fees mainly due to an increase in billable shareholder accounts.
ASSETS UNDER MANAGEMENT
March 31 March 31
(in billions) 2003 2002
- -----------------------------------------------------------------------------------------------
Equity:
Global/international $75.7 $93.9
Domestic (U.S.) 42.7 53.2
- -----------------------------------------------------------------------------------------------
Total equity 118.4 147.1
- -----------------------------------------------------------------------------------------------
Balanced/hybrid 37.4 40.8
Fixed-income:
Tax-free 52.3 48.7
Taxable
Domestic 29.4 24.6
Global/international 9.4 7.7
- -----------------------------------------------------------------------------------------------
Total fixed-income 91.1 81.0
- -----------------------------------------------------------------------------------------------
Money market 5.5 5.6
- -----------------------------------------------------------------------------------------------
Total $252.4 $274.5
- -----------------------------------------------------------------------------------------------
Simple monthly average for the three-month period (1) $255.1 $267.9
Simple monthly average for the six-month period (1) $254.6 $261.6
- -----------------------------------------------------------------------------------------------
(1) Investment management fees from approximately 50% of our assets under management at
March 31, 2003 are calculated using a daily average.
Our assets under management at March 31, 2003 were $252.4 billion, 8% lower than
they were a year ago, mainly due to market depreciation in the latter half of
fiscal 2002 and in the quarter ended March 31, 2003. Simple monthly average
assets decreased 5% and 3% during the three and six months ended March 31, 2003
over the same periods a year ago.
The simple monthly average mix of assets under management is shown below.
20
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SIX MONTHS ENDED
MARCH 31
2003 2002
- -----------------------------------------------------------------------------------------------
PERCENTAGE OF TOTAL ASSETS UNDER MANAGEMENT
Equity 48% 52%
Fixed-income 35% 31%
Balanced/hybrid 15% 15%
Money market 2% 2%
- -----------------------------------------------------------------------------------------------
Simple monthly average for the six-month period 100% 100%
- -----------------------------------------------------------------------------------------------
The change in the composition of assets under management resulted from market
depreciation in equity assets in the latter half of fiscal 2002 and in the
quarter ended March 31, 2003. This shift in asset mix led to slight decrease in
our effective investment management fee rate (investment management fees divided
by simple monthly average assets under management). For the six months ended
March 31, 2003, the effective investment management fee rate declined slightly
to 0.549% as compared to 0.552% over the same period last year.
Assets under management by shareholder location were as follows:
AS OF MARCH 31,
(in billions) 2003 2002
- ------------------------------------------------------------------------ ----------- ----------
United States $211.5 $232.1
Canada 16.9 22.0
Europe 10.6 10.8
Asia/Pacific and other 13.4 9.6
- ------------------------------------------------------------------------ ----------- ----------
Total $252.4 $274.5
- ------------------------------------------------------------------------ ----------- ----------
Components of the change in our assets under management were as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 PERCENT MARCH 31 PERCENT
(in billions) 2003 2002 CHANGE 2003 2002 CHANGE
- ----------------------------------------------------------------------------------------------
Beginning assets under management $257.7 $266.3 (3%) $247.8 $246.4 1%
Sales 17.6 18.8 (6%) 34.8 37.7 (8%)
Reinvested distributions 0.6 0.5 20% 2.0 3.1 (35%)
Redemptions (15.1) (14.3) 6% (31.3) (29.8) 5%
Distributions (1.1) (1.1) - (3.2) (4.8) (33%)
(Depreciation)/appreciation (7.3) 4.3 N/A 2.3 21.9 (89%)
- ----------------------------------------------------------------------------------------------
Ending assets under management $252.4 $274.5 (8%) $252.4 $274.5 (8%)
- ----------------------------------------------------------------------------------------------
For the three and six months ended March 31, 2003, sales exceeded redemptions
complex-wide ("net inflows") by $2.5 billion and $3.5 billion, compared to
inflows of $4.5 billion and $7.9 billion in the same periods last year. Market
appreciation of $2.3 billion in the six months ended March 31, 2003 related
mainly to our fixed-income category.
21
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OPERATING REVENUES
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 PERCENT MARCH 31 PERCENT
(in millions) 2003 2002 CHANGE 2003 2002 CHANGE
- ---------------------------------------------------------------------------------------------
Investment management fees $347.8 $365.8 (5%) $699.3 $722.6 (3%)
Underwriting and distribution fees 194.2 197.6 (2%) 380.1 389.5 (2%)
Shareholder servicing fees 55.3 48.0 15% 103.4 95.4 8%
Other, net 15.8 14.6 8% 35.8 36.7 (2%)
- ---------------------------------------------------------------------------------------------
Total operating revenues $613.1 $626.0 (2%) $1,218.6 $1,244.2 (2%)
- ---------------------------------------------------------------------------------------------
SUMMARY
Total operating revenues decreased 2% for both the three and six months ended
March 31, 2003 compared to the same periods last year primarily due to lower
investment management related to a decline in simple monthly average assets
under management, and lower underwriting and distribution fees resulting from
lower sales. The decreases were partly offset by higher shareholder service
fees.
INVESTMENT MANAGEMENT FEES
Investment management fees account for 57% of our operating revenues in the
quarter ended March 31, 2003. These fees are generally calculated under
contractual arrangements with our sponsored investment products as a percentage
of the market value of assets under management. Annual rates vary by investment
objective and type of services provided. In return for these fees, we provide a
combination of investment advisory, administrative and other management
services.
Investment management fees decreased 5% and 3% during the three and six months
ended March 31, 2003 over the same periods last year consistent with the 5% and
3% decrease in simple monthly average assets under management over the same
periods.
UNDERWRITING AND DISTRIBUTION FEES
We earn underwriting fees from the sale of some classes of sponsored investment
products on which investors pay a sales commission at the time of purchase.
Sales at reduced or zero commissions are offered on some classes of shares and
for sales to shareholders or intermediaries that exceed specified minimum
amounts. Therefore, underwriting fees will change with the overall level of
gross sales and the relative mix of sales between different share classes.
Our sponsored investment products pay distribution fees in return for sales,
marketing and distribution efforts on their behalf. While other contractual
arrangements exist in international jurisdictions, in the United States,
distribution fees include 12b-1 fees. These fees are subject to maximum payout
levels based on a percentage of the assets in each fund. We pay a significant
portion of underwriting and distribution fees to the financial advisors and
other intermediaries who sell our sponsored investment products to the public on
our behalf. See the description of underwriting and distribution expenses below.
Underwriting and distribution fees decreased 2% during both the three and six
months ended March 31, 2003 over the same periods last year. During the three
and six months ended March 31, 2003,
22
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commission revenues decreased 7% and 5% over the same periods last year mainly
due to a 6% and 8% decrease in product sales. Distribution fees increased 2%
during the three months ended March 31, 2003 and decreased 1% during the six
months ended March 31, 2003 over same periods last year. The overall decline
during the six months ended March 31, 2003 over the same period in the prior
year was related to a 3% decline in simple monthly average assets under
management over the same period.
SHAREHOLDER SERVICING FEES
Shareholder servicing fees are generally fixed charges per shareholder account
that vary with the particular type of fund and the service being rendered. In
some instances, sponsored investment products are charged these fees based on
the level of assets under management. We receive fees as compensation for
providing transfer agency services, which include providing customer statements,
transaction processing, customer service and tax reporting. In the United
States, transfer agency service agreements provide that accounts closed in a
calendar year remain billable through the second quarter of the following
calendar year at a reduced rate. In Canada, such agreements provide that
accounts closed in the calendar year remain billable for four months after the
end of the calendar year. Accordingly, the level of fees will vary with the
growth in new accounts and the level of closed accounts that remain billable.
Shareholder servicing fees increased 15% and 8% during the three and six months
ended March 31, 2003 over the same periods last year. The increase reflects an
increase in billable shareholder accounts due to revised shareholder service fee
agreements effective on January 1, 2003 and 0.7 million shareholder accounts
added in the acquisition of Pioneer ITI AMC Limited ("Pioneer"), in July 2002.
Prior to January 2003, the U.S. transfer agent did not assess a fee for certain
partially serviced shareholder accounts. As of March 31, 2003, billable accounts
included approximately 3.9 million additional partial service accounts now
billable under the revised U.S. shareholder agreements. This increase in
billable accounts was partially offset by lower rates on closed accounts under
the new agreements.
OTHER, NET
Other, net consists mainly of revenues from the banking/finance operating
segment as well as income from custody services. Revenues from the
banking/finance operating segment include interest income on loans, servicing
income, and investment income on banking/finance investment securities, which
are offset by interest expense and the provision for anticipated loan losses.
Other, net increased 8% during the three months ended March 31, 2003 over the
same period last year. This increase was mainly due higher interest on auto
loans and a decline in interest expense. Other, net decreased 2% during the six
months ended March 31, 2003 from the same period last year consistent with a
decrease in realized gains from auto loan securitizations to $5.5 million in the
six months ended March 31, 2003 from $13.4 million during the same period in the
prior year, partially offset by a decline in interest expense.
23
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OPERATING EXPENSES
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 PERCENT MARCH 31 PERCENT
(in millions) 2003 2002 CHANGE 2003 2002 CHANGE
- ---------------------------------------------------------------------------------------------
Underwriting and distribution $173.1 $177.3 (2%) $341.9 $349.6 (2%)
Compensation and benefits 160.8 159.8 1% 319.9 320.0 -
Information systems, technology
and occupancy 71.4 73.2 (2%) 144.0 147.8 (3%)
Advertising and promotion 24.2 25.5 (5%) 46.9 51.9 (10%)
Amortization of deferred
sales commissions 17.0 17.0 - 33.1 33.8 (2%)
Amortization of intangible assets 4.2 4.2 - 8.5 8.6 (1%)
Other 22.7 20.9 9% 45.1 41.6 8%
- ---------------------------------------------------------------------------------------------
Total operating expenses $473.4 $477.9 (1%) $939.4 $953.3 (1%)
- ---------------------------------------------------------------------------------------------
SUMMARY
Operating expenses decreased 1% during both the three and six months ended March
31, 2003 over the same periods last year. This decrease was primarily due to a
decrease in underwriting and distribution, information systems, technology and
occupancy and advertising and promotion expenses, partially offset by an
increase in other expenses.
UNDERWRITING AND DISTRIBUTION
Underwriting and distribution includes sales commissions and distribution fees
paid to brokers and other third parties for selling, distributing and providing
ongoing services to investors in our sponsored investment products. Underwriting
and distribution expense decreased 2% during both the three and six months ended
March 31, 2003 over the same periods last year consistent with the decrease in
underwriting and distribution revenues.
COMPENSATION AND BENEFITS
Compensation and benefits expense increased 1% during the three months ended
March 31, 2003 and remained constant during the six months ended March 31, 2003
over the same periods last year. Although our compensation structure has
remained relatively constant as compared to the prior year, we have experienced
increases in employee insurance and other benefits costs in the current fiscal
year. We employed approximately 6,600 at March 31, 2003 as compared to about
6,400 at the same time last year. Our acquisition of Pioneer, in July 2002,
added approximately 180 employees. In order to hire and retain key employees, we
are committed to keeping our salaries and benefit packages competitive, which
means that the level of compensation and benefits may increase more quickly or
decrease more slowly than our revenues.
INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY
Information systems, technology and occupancy costs decreased 2% and 3% during
the three and six months ended March 31, 2003 over the same periods last year.
While continuing work on new technology initiatives and investment in our
technology infrastructure, expenditures have declined from
24
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the prior year as we slowed down a number of initiatives and delayed the start
of other technology projects given the current economic slowdown and our focus
on cost control and management.
Details of capitalized information systems and technology costs were as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31 MARCH 31
(in thousands) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------
Net book value at beginning of period $110,045 $151,321 $121,486 $162,857
Additions during period, net of disposals and other
adjustments 8,414 14,906 15,331 22,432
Amortization during period (18,365) (19,361) (36,723) (38,423)
- -----------------------------------------------------------------------------------------------
Net book value at end of period $100,094 $146,866 $100,094 $146,866
- -----------------------------------------------------------------------------------------------
ADVERTISING AND PROMOTION
Advertising and promotion expense decreased 5% and 10% during the three and six
months ended March 31, 2003 over the same periods last year. During the three
and six months ended March 2002, we incurred increased promotion expense to
assist in educating the sales channels and the investing public about the strong
relative investment performance of our sponsored investment products. We are
committed to invest in advertising and promotion in response to changing
business conditions, which means that the level of advertising and promotion
expenditures may increase more rapidly or decrease more slowly than our
revenues.
AMORTIZATION OF DEFERRED SALES COMMISSIONS
Certain fund share classes, including class B, are sold without a front-end
sales charge to shareholders, while at the same time, our distribution
subsidiaries pay a commission on the sale. In the United States, class A shares
are sold without a front-end sales charge to shareholders when minimum
investment criteria are met while our U.S. distribution subsidiary pays a
commission on these sales. Class C shares are sold with a front-end sales charge
that is lower than the commission paid by the U.S. distributor. We defer and
amortize all up-front commissions paid by our distribution subsidiaries.
We have arranged to finance some of these deferred commission assets ("DCA")
arising from our U.S., Canadian and European operations through Lightning
Finance Company Limited ("LFL"), a company in which we have an ownership
interest. In the United States, LFL has entered into a financing agreement with
our U.S. distribution subsidiary and we maintain a continuing interest in the
assets until resold by LFL. As a result, we retain DCA sold to LFL under the
U.S. agreement in our financial statements and amortize them over an 8-year
period or until resold by LFL in a securitization, which generally occurs at
least once annually. LFL did not sell any U.S. DCA in securitization
transactions in either the 6 months ended March 31, 2003 or the 6 months ended
March 31, 2002. In contrast to the U.S. arrangement, LFL has entered into direct
agreements with the Canadian and European sponsored investment products, and, as
a result, we do not record DCA from these sources in our financial statements.
Amortization of deferred sales commissions remained constant and decreased 2%
during the three and six months ended March 31, 2003 over the same periods last
year.
25
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OTHER INCOME (EXPENSE)
Other income (expense) includes investment and other income and interest
expense. Investment and other income is comprised mainly of the following:
* dividends from investments
* interest income from investments in government securities and other
fixed-income investments
* realized gains and losses on investments
* foreign currency exchange gains and losses
* miscellaneous income, including gain or loss on disposal of property.
Other income (expense) increased 5% during the three months ended March 31, 2003
over the same period last year. Other income (expense) decreased 20% during the
six months ended March 31, 2003 over the same period last year due to lower
realized investment gains and interest income, partially offset by higher
foreign exchange gains from our non-U.S. operations.
TAXES ON INCOME
As a multi-national corporation, we provide investment management services to a
wide range of international investment products, often managed from locations
outside the United States. Some of these jurisdictions have lower tax rates than
the United States. The mix of income (mainly investment management fees) subject
to these lower rates, when aggregated with income originating in the United
States, produces a lower overall effective tax rate than existing U.S. Federal
and state tax rates. Our effective income tax rate in the quarter ended March
31, 2003 increased to 28% compared to 25% in the same period last year. The
effective tax rate will continue to reflect the relative contributions of
foreign earnings that are subject to reduced tax rates and that are not
currently included in U.S. taxable income, as well as other factors.
MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2003, we had $824.9 million in cash and cash equivalents, as
compared to $980.6 million at September 30, 2002. Cash and cash equivalents
include cash, U.S. Treasury bills and other debt instruments with original
maturities of three months or less and other highly liquid investments that are
readily convertible into cash, including money market funds. The mix of
short-term instruments and, in particular, the maturity schedules of some debt
instruments, affect the level reported in cash and cash equivalents and in
investment securities, available-for-sale in any given period. Liquid assets,
which consist of cash and cash equivalents, investments available-for-sale and
current receivables increased to $2,872.0 million at March 31, 2003 from
$2,826.0 million at September 30, 2002.
Outstanding debt increased to $640.3 million at March 31, 2003 compared to
$603.0 million at September 30, 2002. As of March 31, 2003, outstanding debt
consists of $519.0 million in principal and accrued interest related to
outstanding convertible notes that we issued in May 2001 and $121.3 million of
other long-term debt. As of September 30, 2002, outstanding debt included $514.2
million related to the convertible notes and $88.8 million of other long-term
debt. Other long-term debt consists mainly of deferred commission liability
recognized in relation to the U.S. DCA financed by LFL that has not yet been
sold by LFL in a securitization transaction. The increase in outstanding debt
from September 30, 2002 is due to U.S. DCA financed by LFL and the accretion of
interest on the convertible notes.
26
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Each of the $1,000 (principal amount at maturity) convertible notes is
convertible into 9.3604 shares of our common stock. We may redeem the
convertible notes for cash on or after May 11, 2006 at their accreted value. We
may have to repurchase the convertible notes at their accreted value, at the
option of the holders, on May 11 of 2003, 2004, 2006, 2011, 2016, 2021 and 2026.
In this event, we may choose to pay the purchase price in cash or shares of our
common stock. The amount of convertible notes that will be redeemed depends on,
among other factors, the performance of our common stock. Redemption of the
convertible notes may require us to obtain alternative financing, which may
increase future interest expense. On April 9, 2003 we notified holders that we
would redeem the convertible notes for cash at their accreted value on May 11,
2003. If we had to repurchase all of the convertible notes on this date, the
total payment would be approximately $520.1 million.
As of March 31, 2003, we had $500 million of commercial paper, $350 million of
medium term notes and $300 million of debt and equity securities available to be
issued under shelf registration statements filed with the Securities and
Exchange Commission. Our committed revolving credit facilities at March 31, 2003
totaled $420 million, of which, $210 million was under a 364-day facility. The
remaining $210 million facility is under a five-year facility that will expire
in June 2007. As of March 31, 2003, our Fiduciary subsidiary had $350 million
available in uncommitted bank lines under the Federal Reserve Funds system.
On April 3, 2003, we amended the $350 million medium term note shelf
registration filed with the Securities and Exchange Commission to permit the
issuance of an additional $70 million in medium term notes. On April 8, 2003, we
completed the sale of $420 million in five-year senior notes due April 15, 2008.
The senior notes, which were offered to qualified institutional buyers only,
carry an interest rate of 3.7%. We expect to use the net proceeds from the
offering for general corporate purposes, which may include repayment of existing
debt.
Our ability to access the capital markets in a timely manner depends on a number
of factors including our credit rating, the condition of the global economy,
investors' willingness to purchase our securities, interest rates, credit
spreads and the valuation levels of equity markets. In extreme circumstances, we
might not be able to access this liquidity readily.
We have arranged with LFL for non-recourse financing of sales commissions
advanced on sales of our B and C shares globally. The sales commissions that we
have financed through LFL during the three and six months ended March 31, 2003
were approximately $36.2 million and $68.3 million compared to $36.0 and $65.4
million over the same periods last year. LFL's ability to access credit
facilities and the securitization market will directly affect our existing
financing arrangements.
Our banking/finance operating segment periodically enters into auto loan
securitization transactions with qualified special purpose entities, which then
issue asset-backed securities to private investors. The outstanding loan
balances held by these special purpose entities were $521.6 million as of March
31, 2003 and $530.9 million as of September 30, 2002. Our ability to access the
securitization market will directly affect our plans to finance the auto loan
portfolio in the future.
At March 31, 2003, the banking/finance operating segment had commitments to
extend credit aggregating $292.7 million, mainly under its credit card lines,
and had issued financial standby letters of credit totaling $9.7 million that
expire through March 2004. The standby letters of credit are secured by
marketable securities and commercial real estate.
During the three and six months ended March 2003, we purchased approximately 2.7
million and 4.3 million shares of our common stock at a cost of $90.5 million
and $136.8 million, including 1 million
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shares repurchased under put option contracts. In January 2003, we increased the
number of shares of our common stock authorized for purchase by 10 million
shares. During April 2003, we purchased 2.0 million shares of our common stock
at a cost of approximately $68.6 million.
During the quarter ended March 2003, we sold put options giving the purchaser
the right to sell 1.4 million shares of our common stock to us at a specified
price upon exercise of the options on the designated expiration dates if certain
conditions are met. At March 31, 2003, there were 4.4 million put options
outstanding with various expiration dates from May 2003 through January 2004.
We expect that the main uses of cash will be to:
* expand our core business
* make strategic acquisitions
* acquire shares of our common stock
* fund property and equipment purchases
* pay operating expenses of the business
* enhance our technology infrastructure
* improve our business processes
* pay shareholder dividends
* repay and service debt.
We believe that we can meet our present and reasonably foreseeable operating
cash needs and future commitments through the following:
* our existing liquid assets
* the continuing cash flow from operations
* our borrowing capacity under current credit facilities
* our ability to issue debt or equity securities
* our mutual fund sales commission financing arrangement.
In particular, we expect to finance future investment in our banking/finance
activities through operating cash flows, debt, increased deposit base, or
through the securitization of a portion of the receivables from consumer lending
activities.
CRITICAL ACCOUNTING POLICIES
Our financial statements and accompanying notes are prepared in accordance with
generally accepted accounting principles in the United States. The preparation
of these financial statements requires us to make estimates and assumptions that
impact our financial position and results of operations. These estimates and
assumptions are affected by our application of accounting policies. Below we
describe certain critical accounting policies that we believe are important to
understanding our results of operations and financial position.
In addition, please refer to Note 1 to the financial statements contained in our
Annual Report on Form 10-K for the fiscal year ended September 30, 2002 for
further discussion of our accounting policies. Estimates, by their nature, are
based on judgment and available information. Differences between actual results
and these estimates could have a material impact on our financial statements.
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INTANGIBLE ASSETS AND GOODWILL
Intangible assets and goodwill as of March 31, 2003 were as follows:
(in thousands) NET CARRYING AMOUNT
- ------------------------------------------------------- ------------------------
Goodwill $1,327,582
Intangible assets - definite-lived 213,768
Intangible assets - indefinite-lived 476,711
- ------------------------------------------------------- ------------------------
Total $2,018,061
- ------------------------------------------------------- ------------------------
Under Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets", we are required to test the fair value of goodwill and
indefinite-lived intangibles for impairment at least once a year. As of March
31, 2003, we completed our annual impairment test of goodwill and
indefinite-lived intangible assets and we determined that there was no
impairment to the goodwill and indefinite-lived assets recorded in our books and
records as of October 1, 2002. While we believe that our testing was
appropriate, it involved the use of estimates and assumptions. We are also
required to consider if any impairment has occurred to definite-lived intangible
assets. Based on our review and evaluation, we do not believe any impairment has
occurred.
INCOME TAXES
As a multinational corporation, we operate in various locations outside the
United States. We have not made a provision for U.S. taxes on the cumulative
undistributed earnings of foreign subsidiaries as those earnings are intended to
be reinvested for an indefinite period of time. These earnings approximated $2.1
billion at March 31, 2003. Changes to our policy of reinvesting foreign earnings
may have a significant effect on our financial condition and results of
operation.
VALUATION OF INVESTMENTS
We record substantially all investments in our financial statements at fair
value or amounts that approximate fair value. Where available, we use prices
from independent sources such as listed market prices or broker or dealer price
quotations. For investments in illiquid and privately held securities that do
not have readily determinable fair values, we estimate the value of the
securities based upon available information. However, even where the value of a
security is derived from an independent market price or broker or dealer quote,
some assumptions may be required to determine the fair value. For example, we
generally assume that the size of positions in securities that we hold would not
be large enough to affect the quoted price of the securities when sold, and that
any such sale would happen in an orderly manner. However, these assumptions may
be incorrect and the actual value realized on sale could differ from the current
carrying value.
We evaluate our investments for other-than-temporary decline in value on a
periodic basis. This may exist when the fair value of an investment security has
been below the current value for an extended period of time. As most of our
investments are carried at fair value, if an other-than-temporary decline in
value is determined to exist, the unrealized investment loss recorded net of tax
in accumulated other comprehensive income is realized as a charge to net income,
in the period in which the other-than-temporary decline in value is determined.
During fiscal 2002, we recognized $60.1 million for an other-than-temporary
decline in the value of certain investments. While we believe that we have
accurately
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estimated the amount of other-than-temporary decline in value in our portfolio,
different assumptions could result in changes to the recorded amounts in our
financial statements.
LOSS CONTINGENCIES
We are involved in various lawsuits and claims encountered in the normal course
of business. When such a matter arises and periodically thereafter, we consult
with our legal counsel and evaluate the merits of the claim based on the facts
available at that time. In management's opinion, an adequate accrual has been
made as of March 31, 2003 to provide for any losses that may arise from these
matters.
VARIABLE INTEREST ENTITIES
In the United States, the Financial Accounting Standards Board ("FASB") has
recently issued Interpretation No. 46 "Consolidation of Variable Interest
Entities" (see Note 14 to the financial statements). This interpretation
requires consolidation of a variable interest entity ("VIE") by the enterprise
that has the majority of the risks and rewards of ownership, referred to as the
primary beneficiary. It also requires additional disclosures for an enterprise
that holds a significant variable interest in a VIE, but is not the primary
beneficiary. We are currently evaluating the impact of this interpretation on
our investments in existence as of January 31, 2003. This evaluation requires us
to make certain assumptions and estimates in calculating the extent of our
interest in such entities, which may impact our treatment of a lessor trust and
certain collateralized debt obligation entities described below.
LESSOR TRUST. We lease our corporate headquarters in San Mateo, California from
a lessor trust under an operating lease that expires in fiscal 2005, with
additional renewal options for a further period of up to 10 years (see Note 11
to the financial statements). At this time, we believe that it is probable that
we will have to consolidate the lessor trust in our annual financial statements
as of September 30, 2003.
COLLATERALIZED DEBT OBLIGATION ENTITIES. We provide investment management
services to, and have made investments in, a number of collateralized debt
obligation entities (see Note 11 to the financial statements). At this time, we
believe that it is reasonably possible that we will have to either make
additional disclosures about or consolidate one or more of these entities in our
annual financial statements as of September 30, 2003.
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RISK FACTORS
WE FACE STRONG COMPETITION FROM NUMEROUS AND SOMETIMES LARGER COMPANIES. We
compete with numerous investment management companies, stock brokerage and
investment banking firms, insurance companies, banks, savings and loan
associations and other financial institutions. Continuing consolidation in the
financial services industry has created stronger competitors with greater
financial resources and broader distribution channels than our own.
Additionally, competing securities dealers whom we rely upon to distribute our
mutual funds also sell their own proprietary funds and investment products,
which could limit the distribution of our investment products. To the extent
that existing or potential customers, including securities dealers, decide to
invest in or distribute the products of our competitors, the sales of our
products as well as our market share, revenues and net income could decline.
CHANGES IN THE DISTRIBUTION CHANNELS ON WHICH WE DEPEND COULD REDUCE OUR
REVENUES AND HINDER OUR GROWTH. We derive nearly all of our fund sales through
broker/dealers and other similar investment advisors. Increasing competition for
these distribution channels has caused our distribution costs to rise and could
cause further increases in the future. Higher distribution costs lower our net
revenues and earnings. Additionally, if one of the major financial advisors who
distribute our products were to cease their operations, it could have a
significant adverse impact on our revenues and earnings. Moreover, our failure
to maintain strong business relationships with these advisors would impair our
ability to distribute and sell our products, which would have a negative effect
on our level of assets under management, related revenues and overall business
and financial condition.
WE HAVE BECOME SUBJECT TO AN INCREASED RISK OF ASSET VOLATILITY FROM CHANGES IN
THE GLOBAL EQUITY MARKETS. We have become subject to an increased risk of asset
volatility from changes in the domestic and global financial and equity markets
due to the continuing threat of terrorism and the recent reports of accounting
irregularities at certain public companies. Declines in these markets have
caused in the past, and would cause in the future, a decline in our revenue and
income.
THE LEVELS OF OUR ASSETS UNDER MANAGEMENT, WHICH IN TURN IMPACT REVENUES, ARE
SUBJECT TO SIGNIFICANT FLUCTUATIONS. Global economic conditions, changes in the
equity market place, interest rates, inflation rates, the yield curve and other
factors that are difficult to predict affect the mix, market values and levels
of our assets under management. Changing market conditions may cause a shift in
our asset mix towards fixed-income products and a related decline in our revenue
and income, since we generally derive higher fee revenues and income from equity
assets than from fixed-income products we manage. Similarly, our securitized
consumer receivables business is subject to marketplace fluctuation.
WE FACE RISKS ASSOCIATED WITH CONDUCTING OPERATIONS IN NUMEROUS FOREIGN
COUNTRIES. We sell mutual funds and offer investment advisory and related
services in many different regulatory jurisdictions around the world, and intend
to continue to expand our operations internationally. Regulators in these
jurisdictions could change their policies or laws in a manner that might
restrict or otherwise impede our ability to distribute or register investment
products in their respective markets.
OUR ABILITY TO SUCCESSFULLY INTEGRATE THE WIDELY VARIED SEGMENTS OF OUR BUSINESS
CAN BE IMPEDED BY SYSTEMS AND OTHER TECHNOLOGICAL LIMITATIONS. Our continued
success in effectively managing and growing our business globally depends on our
ability to integrate the varied accounting, financial and operational systems of
our international business with that of our domestic business.
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OUR INABILITY TO MEET CASH NEEDS COULD HAVE A NEGATIVE EFFECT ON OUR FINANCIAL
CONDITION AND BUSINESS OPERATIONS. Our ability to meet anticipated cash needs
depends upon factors including our asset value, our creditworthiness as
perceived by lenders and the market value of our stock. Similarly, our ability
to securitize and hedge future loan portfolios and credit card receivables, and
to obtain continued financing for Class B and C shares, is also subject to the
market's perception of those assets, finance rates offered by competitors, and
the general market for private debt. If we are unable to obtain these funds and
financing, we may be forced to incur unanticipated costs or revise our business
plans.
OUR EMERGING MARKET PORTFOLIOS AND RELATED REVENUES ARE VULNERABLE TO
MARKET-SPECIFIC POLITICAL AND ECONOMIC RISKS. Our emerging market portfolios and
revenues derived from managing these portfolios are subject to significant risks
of loss from political and diplomatic developments, currency fluctuations,
social instability, changes in governmental polices, expropriation,
nationalization, asset confiscation and changes in legislation related to
foreign ownership. Foreign trading markets, particularly in some emerging market
countries are often smaller, less liquid, less regulated and significantly more
volatile than the U.S. and other established markets.
DIVERSE AND STRONG COMPETITION LIMITS THE INTEREST RATES THAT WE CAN CHARGE ON
CONSUMER LOANS. We compete with many types of institutions for consumer loans,
which can provide loans at significantly below-market interest rates in
connection with automobile sales or in some cases zero interest rates. Our
inability to compete effectively against these companies or to maintain our
relationships with the various automobile dealers through whom we offer consumer
loans could limit the growth of our consumer loan business. Economic and credit
market downturns could reduce the ability of our customers to repay loans, which
could cause our consumer loan portfolio losses to increase.
THE SEPTEMBER 11, 2001 WORLD TRADE CENTER TRAGEDY MAY ADVERSELY AFFECT OUR
ABILITY TO ACHIEVE THE BENEFITS WE EXPECT FROM THE ACQUISITION OF FIDUCIARY
TRUST COMPANY INTERNATIONAL. The September 11, 2001 tragedy at the World Trade
Center resulted in the destruction of our Fiduciary headquarters, loss of 87 of
our employees, additional operating expenses to re-establish and relocate our
operations, and asset write-offs, all of which could adversely affect or delay
our ability to achieve the anticipated benefits from the acquisition. Our
insurance coverage may not cover all losses on claims for property, damage,
extra expenses and business interruptions arising out of the destruction of the
World Trade Center. For the next several years, insurance costs are likely to
increase materially and we may not be able to obtain the same types or amounts
of coverage.
WE ARE SUBJECT TO FEDERAL RESERVE BOARD REGULATION. Upon completion of our
acquisition of Fiduciary in April 2001, we became a bank holding company and a
financial holding company subject to the supervision and regulation of the
Federal Reserve Board. We are subject to the restrictions, limitations, or
prohibitions of the Bank Holding Company Act of 1956 and the Gramm-Leach Bliley
Act. The Federal Reserve Board may impose additional limitations or restrictions
on our activities, including if the Federal Reserve Board believes that we do
not have the appropriate financial and managerial resources to commence or
conduct an activity or make an acquisition. The Federal Reserve Board may also
take actions as appropriate to enforce applicable federal law.
TECHNOLOGY AND OPERATING RISK COULD CONSTRAIN OUR OPERATIONS. We are highly
dependent on the integrity of our technology, operating systems and premises.
Although we have in place certain disaster recovery plans, we may experience
system delays and interruptions as a result of natural disasters, power
failures, acts of war, and third party failures, which could negatively impact
our operations.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, our financial position is subject to market
risk: the potential loss due to changes in the value of investments resulting
from adverse changes in interest rates, foreign exchange and/or equity prices.
Management is responsible for managing this risk. Our Enterprise Risk Management
Committee is responsible for providing a framework to assist management to
identify, assess and manage market and other risks.
We are exposed to changes in interest rates mainly through our debt transactions
and portfolio debt holdings available-for-sale, which are carried at fair value
in our financial statements. As of March 31, 2003, a significant percentage of
our outstanding debt is at fixed interest rates. In our banking/finance
operating segment, we monitor the net interest rate margin and the average
maturity of interest earning assets, as well as funding sources. In addition, as
of March 31, 2003, we have considered the potential impact of the effect on the
banking/finance operating segment, our outstanding debt and portfolio debt
holdings, individually and collectively, of a 100 basis point (1%) movement in
market interest rates. We do not expect this change would have a material impact
on our operating revenues or results of operations in either scenario.
We are also exposed to equity price fluctuations through securities we hold that
are carried at fair value. To mitigate this risk, we maintain a diversified
investment portfolio.
We operate mainly in the United States, but also provide services and earn
revenues in Canada, the Bahamas, Europe, Asia, South America, Africa and
Australia. A significant portion of these revenues and associated expenses,
however, are denominated in U.S. dollars. Therefore, our exposure to foreign
currency fluctuations in our revenues and expenses is not material at this time.
This situation may change in the future as our business continues to grow
outside the United States.
ITEM 4. CONTROLS AND PROCEDURES
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company maintains
disclosure controls and procedures that are designed to ensure that information
required to be disclosed in the Company's filings under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported within the periods
specified in the rules and forms of the Securities and Exchange Commission. Such
information is accumulated and communicated to the Company's management,
including its principal executive officer and principal financial officer, as
appropriate, to allow timely decisions regarding required disclosure. The
Company's management, including the principal executive officer and the
principal financial officer, recognizes that any set of controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives.
Within 90 days prior to the filing date of this Quarterly Report on Form 10-Q,
the Company has carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's principal
executive officer and the Company's principal financial officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based on such evaluation, the Company's principal executive
officer and principal financial officer concluded that the Company's disclosure
controls and procedures are effective.
(b) CHANGES IN INTERNAL CONTROLS. There have been no significant changes in the
Company's internal controls or in other factors that could significantly affect
the internal controls subsequent to the date of their evaluation in connection
with the preparation of this Quarterly Report on Form 10-Q.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no material developments in the litigation previously reported
in our Quarterly Report on Form 10-Q for the period ended December 31, 2002 as
filed with the Securities and Exchange Commission on February 13, 2003. We are
involved from time to time in litigation relating to claims arising in the
normal course of business. Management is of the opinion that the ultimate
resolution of such claims will not materially affect our business or financial
position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Stockholders of Franklin Resources, Inc. was held at
10:00 a.m., Pacific Standard Time, on January 30, 2003 at the principal offices
of the Company located at One Franklin Parkway, San Mateo, California.
The three proposals presented at the meeting were:
1. The election of eleven (11) directors to hold office until the next
Annual Meeting of Stockholders or until their successors are elected
and shall qualify.
2. The ratification of the appointment of PricewaterhouseCoopers LLP as
the Company's independent accountants for the fiscal year ending
September 30, 2003.
3. The approval of the adoption of the 2002 Universal Stock Incentive
Plan.
(b) Each of the eleven nominees for director was elected and received the
number of votes set forth below:
Name Votes For Votes Withheld
---- --------- --------------
Harmon E. Burns 208,811,524 3,179,372
Charles Crocker 208,850,777 3,140,119
Robert D. Joffe 208,799,419 3,191,477
Charles B. Johnson 207,748,540 4,242,356
Rupert H. Johnson, Jr. 208,812,563 3,178,333
Thomas H. Kean 208,773,239 3,217,657
James A. McCarthy 203,680,603 8,310,293
Chutta Ratnathicam 207,831,590 4,159,306
Peter A. Sacerdote 203,522,289 8,468,607
Anne M. Tatlock 208,681,169 3,309,727
Louis E. Woodworth 203,668,229 8,322,667
(c) The ratification of the appointment of PricewaterhouseCoopers LLP as the
Company's independent accountants for the fiscal year ending September 30, 2003,
was approved by a vote of 200,588,811 shares in favor, 9,973,248 shares against,
and 1,428,837 shares abstaining.
(d) The approval of the adoption of the 2002 Universal Stock Incentive Plan was
approved by a vote of 190,683,381 shares in favor, 19,516,716 shares against,
and 1,790,799 shares abstaining.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: see Exhibit Index on page 41 to page 42.
(b) Reports on Form 8-K:
(i) Form 8-K filed on January 23, 2003 reporting under Item 5 "Other
Events" an earnings press release, dated January 23, 2003, and
including said press release as an Exhibit under Item 7 "Financial
Statements and Exhibits"
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SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRANKLIN RESOURCES, INC.
(Registrant)
Date: May 12, 2003 By: /s/ Martin L. Flanagan
----------------------
Martin L. Flanagan
President and Chief Financial Officer
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CERTIFICATIONS
I, Charles B. Johnson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Franklin Resources,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
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6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 12, 2003 /s/ Charles B. Johnson
----------------------
Charles B. Johnson
Chief Executive Officer
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I, Martin L. Flanagan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Franklin Resources,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
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6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 12, 2003 /s/ Martin L. Flanagan
----------------------
Martin L. Flanagan
Chief Financial Officer
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EXHIBIT INDEX
Exhibit 3(i)(a) Registrant's Certificate of Incorporation, as filed November
28, 1969, incorporated by reference to Exhibit (3)(i) to the
Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1994 (the "1994 Annual Report")
Exhibit 3(i)(b) Registrant's Certificate of Amendment of Certificate of
Incorporation, as filed March 1, 1985, incorporated by
reference to Exhibit (3)(ii) to the 1994 Annual Report
Exhibit 3(i)(c) Registrant's Certificate of Amendment of Certificate of
Incorporation, as filed April 1, 1987, incorporated by
reference to Exhibit (3)(iii) to the 1994 Annual Report
Exhibit 3(i)(d) Registrant's Certificate of Amendment of Certificate of
Incorporation, as filed February 2, 1994, incorporated by
reference to Exhibit (3)(iv) to the 1994 Annual Report
Exhibit 3(ii) Registrant's Amended and Restated By-Laws incorporated by
reference to Exhibit 3(ii) to the Company's Annual Report on
Form 10-K for the fiscal year ended September 30, 2002
Exhibit 4.1 Indenture between Franklin Resources, Inc. and The Chase
Manhattan Bank (formerly Chemical Bank), as trustee, dated
as of May 19, 1994, incorporated by reference to the
Company's Registration Statement on Form S-3, filed on April
14, 1994
Exhibit 4.2 Indenture between Franklin Resources, Inc. and The Bank of
New York dated May 11, 2001 incorporated by reference to
Exhibit 4.2 to the Registrant's Registration Statement on
Form S-3, filed on August 6, 2001
Exhibit 4.3 Form of Liquid Yield Option Note due 2031 (Zero Coupon-
Senior) (included in Exhibit 4.2 hereto)
Exhibit 4.4 Registration Rights Agreement between Franklin Resources,
Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") dated May 11, 2001, incorporated by
reference to the Registrant's Registration Statement on Form
S-3, filed on August 6, 2001
Exhibit 4.5 Form of 3.7% Senior Notes due 2008
Exhibit 10.69 Amendment to the Managed Operations Service Agreement dated
February 6, 2001, June 10, 2002 and February 3, 2003 between
Franklin Templeton Companies, LLC and International Business
Machines Corporation
Exhibit 10.70 Representative Form of Franklin Templeton Investor Services,
LLC Transfer Agent and Shareholder Services Agreement
Exhibit 12 Computations of ratios of earnings to fixed charges
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Exhibit 99.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
Exhibit 99.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
42
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