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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 December 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: 249,411,310 shares, common stock, par value $.10 per share at
January 31, 2004.
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED THREE MONTHS ENDED
DECEMBER 31,
(in thousands, except per share data) 2003 2002
- -----------------------------------------------------------------------------------------------------
OPERATING REVENUES:
Investment management fees $454,508 $351,412
Underwriting and distribution fees 272,752 185,937
Shareholder servicing fees 61,338 48,051
Consolidated sponsored investment products income, net 26 --
Other, net 17,545 20,051
- -----------------------------------------------------------------------------------------------------
Total operating revenues 806,169 605,451
- -----------------------------------------------------------------------------------------------------
OPERATING EXPENSES:
Underwriting and distribution 245,879 168,847
Compensation and benefits 189,204 159,118
Information systems, technology and occupancy 69,648 72,595
Advertising and promotion 21,232 22,644
Amortization of deferred sales commissions 22,448 16,045
Amortization of intangible assets 4,402 4,234
Other 30,496 22,513
- -----------------------------------------------------------------------------------------------------
Total operating expenses 583,309 465,996
- -----------------------------------------------------------------------------------------------------
Operating income 222,860 139,455
OTHER INCOME (EXPENSES):
Consolidated sponsored investment products gains, net 4,000 --
Investment and other income 16,191 12,303
Interest expense (7,111) (3,032)
- -----------------------------------------------------------------------------------------------------
Other income, net 13,080 9,271
- -----------------------------------------------------------------------------------------------------
Income before taxes on income and cumulative effect of an accounting change 235,940 148,726
Taxes on income 68,423 38,966
- -----------------------------------------------------------------------------------------------------
Income before cumulative effect of an accounting change 167,517 109,760
Cumulative effect of an accounting change, net of tax 4,779 --
- -----------------------------------------------------------------------------------------------------
NET INCOME $172,296 $109,760
- -----------------------------------------------------------------------------------------------------
Basic earnings per share:
Income before cumulative effect of an accounting change $0.68 $0.43
Cumulative effect of an accounting change 0.02 --
- -----------------------------------------------------------------------------------------------------
NET INCOME $0.70 $0.43
- -----------------------------------------------------------------------------------------------------
Diluted earnings per share:
Income before cumulative effect of an accounting change $0.67 $0.43
Cumulative effect of an accounting change 0.02 --
- -----------------------------------------------------------------------------------------------------
NET INCOME $0.69 $0.43
- -----------------------------------------------------------------------------------------------------
Dividends per share $0.085 $0.075
See accompanying notes to the consolidated financial statements.
2
FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2003 2003
- ------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $1,283,339 $1,017,023
Receivables 369,937 338,292
Investment securities, trading 188,872 41,379
Investment securities, available-for-sale 1,376,901 1,480,554
Prepaid expenses and other 92,821 91,579
- ------------------------------------------------------------------------------------------------------
Total current assets 3,311,870 2,968,827
- ------------------------------------------------------------------------------------------------------
Banking/finance assets:
Cash and cash equivalents 69,437 36,672
Loans held for sale, net 46,145 3,006
Loans receivable, net 339,107 467,666
Investment securities, available-for-sale 347,930 358,387
Other 48,760 52,694
- ------------------------------------------------------------------------------------------------------
Total banking/finance assets 851,379 918,425
- ------------------------------------------------------------------------------------------------------
Non-current assets:
Investments, other 305,271 280,356
Deferred sales commissions 246,254 215,816
Property and equipment, net 504,013 356,772
Goodwill 1,376,675 1,335,517
Other intangible assets, net 684,261 684,281
Receivable from banking/finance group 23,057 102,864
Other 114,622 107,891
- ------------------------------------------------------------------------------------------------------
Total non-current assets 3,254,153 3,083,497
- ------------------------------------------------------------------------------------------------------
TOTAL ASSETS $7,417,402 $6,970,749
- ------------------------------------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
3
FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2003 2003
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Compensation and benefits $154,265 $225,446
Current maturities of long-term debt 164,900 287
Accounts payable and accrued expenses 115,863 112,630
Commissions 109,111 95,560
Income taxes 95,472 43,500
Other 10,235 11,103
- ----------------------------------------------------------------------------------------------------------
Total current liabilities 649,846 488,526
- ----------------------------------------------------------------------------------------------------------
Banking/finance liabilities:
Deposits 633,772 633,983
Payable to parent 23,057 102,864
Other 71,658 65,133
- ----------------------------------------------------------------------------------------------------------
Total banking/finance liabilities 728,487 801,980
- ----------------------------------------------------------------------------------------------------------
Non-current liabilities:
Long-term debt 1,135,789 1,108,881
Deferred taxes 206,521 203,498
Other 35,210 32,412
- ----------------------------------------------------------------------------------------------------------
Total non-current liabilities 1,377,520 1,344,791
- ----------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------
Total liabilities 2,755,853 2,635,297
- ----------------------------------------------------------------------------------------------------------
Minority interest 62,920 25,344
Commitments and contingencies (Note 12)
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;
248,761,096 and 245,931,522 shares issued and outstanding, for
December and September 24,876 24,593
Capital in excess of par value 215,777 108,024
Retained earnings 4,280,246 4,129,644
Accumulated other comprehensive income 77,730 47,847
- ----------------------------------------------------------------------------------------------------------
Total stockholders' equity 4,598,629 4,310,108
- ----------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $7,417,402 $6,970,749
- -----------------------------------------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
4
FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2003 2002
- -----------------------------------------------------------------------------------------------------
NET INCOME $172,296 $109,760
Adjustments to reconcile net income to net cash
provided by operating activities:
(Increase) decrease in receivables, prepaid expenses and other (7,978) 18,565
Net advances of deferred sales commissions (52,886) (31,008)
Decrease in other current liabilities (2,863) (25,465)
Increase in deferred income taxes and taxes payable 35,036 15,905
Increase (decrease) in commissions payable 13,551 (1,409)
Decrease in accrued compensation and benefits (29,302) (47,971)
Originations of loans held for sale, net (69,926) --
Depreciation and amortization 45,014 43,495
Net gains on disposal of assets 1,377 (252)
- -----------------------------------------------------------------------------------------------------
Net cash provided by operating activities 104,319 81,620
- -----------------------------------------------------------------------------------------------------
Purchase of investments (1,220,632) (442,881)
Liquidation of investments 1,218,959 329,095
Purchase of banking/finance investments (614) (72,854)
Liquidation of banking/finance investments 19,657 136,413
Net proceeds from securitization of loans receivable 179,965 124,989
Net origination of loans receivable (25,006) (97,020)
Additions of property and equipment, net (7,747) (15,835)
Acquisition of subsidiaries, net of cash acquired (40,766) --
- -----------------------------------------------------------------------------------------------------
Net cash used in investing activities 123,816 (38,093)
- -----------------------------------------------------------------------------------------------------
(Decrease) increase in bank deposits (210) 73,179
Exercise of common stock options 78,035 548
Net put option premiums and settlements -- 2,293
Dividends paid on common stock (18,485) (18,063)
Purchase of stock (12,524) (46,297)
Increase in debt 30,637 19,955
Payments on debt (6,507) (4,633)
- -----------------------------------------------------------------------------------------------------
Net cash provided by financing activities 70,946 26,982
- -----------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 299,081 70,509
Cash and cash equivalents, beginning of period 1,053,695 980,604
- -----------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $1,352,776 $1,051,113
- -----------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION:
Value of common stock issued, principally restricted stock $42,562 $28,306
Total assets related to consolidation of variable interest entities 212,008 --
Total liabilities related to consolidation of variable interest entities 215,197 --
See accompanying notes to the consolidated financial statements.
5
FRANKLIN RESOURCES, INC.
Notes to Consolidated Financial Statements
December 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 U.S.
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 financial position and 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, 2003. Certain amounts for the comparative prior
year periods have been reclassified to conform to the financial
presentation for and at the periods ended December 31, 2003.
2. NEW ACCOUNTING STANDARDS
------------------------
In December 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 132 (revised
2003), "Employers' Disclosures about Pensions and Other Postretirement
Benefits, an amendment of FASB Statements No. 87, 88, and 106" ("SFAS
132"). SFAS 132 revises employers' disclosures about pension plans and
other post-retirement benefits plans and requires additional disclosures
about the assets, obligations, cash flows, and net periodic benefit cost of
defined benefit pension plans and other defined benefit post-retirement
plans. It does not change the measurement or recognition of those plans
required by SFAS No. 87, "Employers' Accounting for Pensions", SFAS No. 88,
"Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits", and SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions". SFAS 132 is
effective for financial statements relating to fiscal years ending after
December 15, 2003. The interim-period disclosure requirements for SFAS 132
are effective for interim periods beginning after December 15, 2003. We
will adopt the interim-period disclosure requirements for our interim
reporting period ending March 31, 2004.
3. ACQUISITIONS
------------
On October 1, 2003, we completed and recorded the acquisition of the
remaining interest in Darby Overseas Investments, Ltd. and Darby Overseas
Partners, L.P. (collectively "Darby"), in which we formerly held a 12.7%
interest, for an additional investment of approximately $75.9 million in
cash. The excess of the purchase price, including our acquisition costs,
over the fair value of the net assets acquired resulted in goodwill of
approximately $37.4 million. We also recognized definite-lived intangible
assets related to management contracts of approximately $3.4 million. These
definite-lived intangible assets are amortized over the remaining
contractual life of the sponsored investment products, ranging from one to
eight years. At September 30, 2003, Darby had approximately $0.9 billion in
assets under management relating to private equity, mezzanine and emerging
markets fixed-income products.
6
4. COMPREHENSIVE INCOME
--------------------
The following table shows comprehensive income for the three months ended
December 31, 2003 and 2002.
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2003 2002
------------------------------------------------------------------------------------------------
Net income $172,296 $109,760
Net unrealized gain on available-for-sale securities, net of tax 17,777 7,784
Foreign currency translation adjustments 12,789 7,757
------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME $202,862 $125,301
------------------------------------------------------------------------------------------------
5. EARNINGS PER SHARE
------------------
We computed earnings per share as follows:
THREE MONTHS ENDED
DECEMBER 31,
(in thousands except per share data) 2003 2002
-------------------------------------------------------------------------------------------------
Net income $172,296 $109,760
-------------------------------------------------------------------------------------------------
Weighted-average shares outstanding - basic 247,758 257,600
Incremental shares from assumed conversions 2,476 618
-------------------------------------------------------------------------------------------------
Weighted-average shares outstanding - diluted 250,234 258,218
-------------------------------------------------------------------------------------------------
Basic earnings per share:
Income before cumulative effect of an accounting change $0.68 $0.43
Cumulative effect of an accounting change 0.02 --
-------------------------------------------------------------------------------------------------
Net income $0.70 $0.43
-------------------------------------------------------------------------------------------------
Diluted earnings per share:
Income before cumulative effect of an accounting change $0.67 $0.43
Cumulative effect of an accounting change 0.02 --
-------------------------------------------------------------------------------------------------
Net income $0.69 $0.43
-------------------------------------------------------------------------------------------------
6. 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
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2003 2002
------------------------------------------------------------------------------------------------
Net income, as reported $172,296 $109,760
Less: stock-based compensation expense determined under the fair value
method, net of tax (10,806) (16,625)
-------------------------------------------------------------------------------------------------
PRO FORMA NET INCOME $161,490 $93,135
-------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
As reported $0.70 $0.43
Pro forma 0.65 0.36
DILUTED EARNINGS PER SHARE:
As reported $0.69 $0.43
Pro forma 0.65 0.36
-------------------------------------------------------------------------------------------------
7. TRANSACTIONS WITH VARIABLE INTEREST ENTITIES
--------------------------------------------
Under FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities" ("FIN 46"), a variable interest entity ("VIE") is a corporation,
trust, partnership or other entity in which the equity investment holders
have not contributed sufficient capital to finance the activities of 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. The
consolidation and disclosure provisions of FIN 46 are effective immediately
for VIEs created after January 31, 2003. Effective July 1, 2003, six of our
sponsored investment products created after January 31, 2003 were
consolidated in our financial statements.
In December 2003, the FASB published FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities (revised December 2003)" ("FIN
46-R"), clarifying FIN 46 and exempting certain entities from the
provisions of FIN 46. Generally, application of FIN 46-R is required in
financial statements of public entities that have interests in structures
commonly referred to as special-purpose entities for periods ending after
December 15, 2003, and, for other types of VIEs, for periods ending after
March 15, 2004. We early adopted FIN 46-R as of December 31, 2003, and, as
a result, we have recognized a cumulative effect of an accounting change,
net of tax, as of this date to reflect the accumulated retained earnings of
VIEs in which we became an interest holder prior to February 1, 2003.
The following tables present the effect on our consolidated results of
operations and financial position of applying FIN 46-R. These tables
present the effect of consolidating VIEs for which we are the primary
beneficiary and are intended to provide transparency. These tables reflect
the continuing activity of VIEs with inception dates after January 31,
2003, which were consolidated effective July 1, 2003, and they present the
cumulative effect adjustment for sponsored investment products with an
inception date prior to February 1, 2003. These products include funds
registered in Canada and other international locations. At December 31,
2003, the cumulative effect adjustment, net of tax related to the sponsored
investment products was $8.0 million and the impact of consolidation on our
balance sheet was to increase current assets by $44.6 million, current
liabilities by $9.7 million and minority interest by $34.9 million.
Investors in these VIEs have no recourse to us.
In addition to consolidating certain sponsored investment products, we
qualified as the primary beneficiary of a lessor trust, a special purpose
entity that financed the construction of our headquarters campus. At
December 31, 2003, the cumulative effect adjustment, net of tax, related to
this trust was a charge of $3.2 million and the impact of consolidation on
our balance was to increase property and equipment, net, by approximately
$157.6 million, debt by approximately $164.9 million, and minority interest
by approximately $5.1 million. Debt and minority interest, in aggregate,
reflect the maximum contingent liability under agreements related to the
lease of $170.0 million (see Note 12). The debt matures in September 2004,
and will continue to be shown in our consolidated balance sheet as a
current liability until it is refinanced or paid.
8
THREE MONTHS ENDED DECEMBER 31, 2003
BEFORE FIN 46-R FIN 46-R
(in thousands) ADJUSTMENTS ADJUSTMENTS CONSOLIDATED
-------------------------------------------------------------------------------------------------
OPERATING REVENUES:
Investment management fees $454,646 $(138) $454,508
Underwriting and distribution fees 272,754 (2) 272,752
Shareholder servicing fees 61,352 (14) 61,338
Consolidated sponsored investment products income, net -- 26 26
Other, net 17,545 -- 17,545
-------------------------------------------------------------------------------------------------
Total operating revenues 806,297 (128) 806,169
-------------------------------------------------------------------------------------------------
OPERATING EXPENSES 583,309 -- 583,309
-------------------------------------------------------------------------------------------------
Operating income 222,988 (128) 222,860
-------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSES):
Consolidated sponsored investment product gains, net -- 4,000 4,000
Investment and other income 17,742 (1,551) 16,191
Interest expense (7,111) -- (7,111)
-------------------------------------------------------------------------------------------------
Other income, net 10,631 2,449 13,080
-------------------------------------------------------------------------------------------------
Income before taxes on income and cumulative effect of
an accounting change 233,619 2,321 235,940
Taxes on income 67,750 673 68,423
-------------------------------------------------------------------------------------------------
Income before cumulative effect of an accounting change,
net of tax 165,869 1,648 167,517
Cumulative effect of an accounting change, net of tax -- 4,779 4,779
-------------------------------------------------------------------------------------------------
NET INCOME $165,869 $6,427 $172,296
-------------------------------------------------------------------------------------------------
AS OF DECEMBER 31, 2003
BEFORE FIN 46-R FIN 46-R
(in thousands) ADJUSTMENTS ADJUSTMENTS CONSOLIDATED
-------------------------------------------------------------------------------------------------
ASSETS
Current assets $3,257,467 $54,403 $3,311,870
Banking/finance assets 851,379 -- 851,379
Non-current assets 3,096,548 157,605 3,254,153
-------------------------------------------------------------------------------------------------
TOTAL ASSETS $7,205,394 $212,008 $7,417,402
-------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities $471,333 $178,513 $649,846
Banking/finance liabilities 728,487 -- 728,487
Non-current liabilities 1,386,725 (9,205) 1,377,520
-------------------------------------------------------------------------------------------------
Total liabilities 2,586,545 169,308 2,755,853
Minority interest 17,031 45,889 62,920
Total stockholders' equity 4,601,818 (3,189) 4,598,629
-------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $7,205,394 $212,008 $7,417,402
-------------------------------------------------------------------------------------------------
9
In addition, based on our analysis, we have determined that we are a
significant variable interest holder in a number of sponsored investment
products as well as in Lightning Finance Company Limited ("LFL"), a company
incorporated in Ireland whose sole business purpose is to finance our
deferred commission assets. As of December 31, 2003, total assets of these
sponsored investment products were approximately $1,253.7 million and our
exposure to loss as a result of our interest in these products was $166.4
million. LFL had approximately $387.0 million in total assets at December
31, 2003. Our exposure to loss related to our investment in LFL was limited
to the carrying value of our investment in and loans to LFL, and interest
and fees receivable from LFL aggregating approximately $51.3 million. This
amount represents our maximum exposure to loss and does not reflect our
estimate of the actual losses that could result from adverse changes.
8. CASH AND CASH EQUIVALENTS
-------------------------
Cash and cash equivalents at December 31, 2003 and September 30, 2003,
consisted of the following:
(in thousands) DECEMBER 31, SEPTEMBER 30,
2003 2003
-----------------------------------------------------------------------------------------------------
Cash and due from banks $178,331 $260,530
Federal funds sold and securities purchased under agreements to resell 25,167 3,741
Other 1,149,278 789,424
-----------------------------------------------------------------------------------------------------
TOTAL $1,352,776 $1,053,695
-----------------------------------------------------------------------------------------------------
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
$3.0 million at December 31, 2003 and $1.5 million at September 30, 2003.
9. 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 months ended December 31, 2003 and 2002.
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2003 2002
-------------------------------------------------------------------------------------------------
Gross sale proceeds $185,071 $131,620
Less: net carrying amount of loans sold 180,838 126,104
-------------------------------------------------------------------------------------------------
PRE-TAX GAIN $ 4,233 $ 5,516
-------------------------------------------------------------------------------------------------
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 ENDED
DECEMBER 31,
2003 2002
-------------------------------------------------------------------------------------------------
Excess cash flow discount rate (annual rate) 12.0% 12.0%
Cumulative life loss rate 3.4% 4.3%
Pre-payment speed assumption (average monthly rate) 1.8% 1.8%
-------------------------------------------------------------------------------------------------
10
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, as of December 31, 2003 and September 30, 2003, the
carrying value and the sensitivity of the interest-only strip receivable to
hypothetical adverse changes in the key economic assumptions used to
measure fair value:
DECEMBER 31, SEPTEMBER
(in thousands) 2003 30, 2003
-------------------------------------------------------------------------------------------------
CARRYING AMOUNT/FAIR VALUE OF INTEREST-ONLY STRIPS $38,214 $36,010
EXCESS CASH FLOW DISCOUNT RATE (ANNUAL RATE) 12.0% 12.0%
Impact on fair value of 10% adverse change $(540) $(493)
Impact on fair value of 20% adverse change (1,064) (971)
CUMULATIVE LIFE LOSS RATE 3.9% 3.9%
Impact on fair value of 10% adverse change $(2,538) $(2,412)
Impact on fair value of 20% adverse change (5,075) (4,725)
PRE-PAYMENT SPEED ASSUMPTION (AVERAGE MONTHLY RATE) 1.8% 1.8%
Impact on fair value of 10% adverse change $(3,665) $(3,505)
Impact on fair value of 20% adverse change (7,115) (7,051)
-------------------------------------------------------------------------------------------------
Actual future market conditions may differ materially. Accordingly, this
sensitivity analysis should not be considered our projection of future
events or losses.
We receive annual servicing fees ranging from 1% to 2% of the loans
securitized for services we provide to the securitization trusts. 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 for the three months ended December 31, 2003 and
2002.
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2003 2002
-------------------------------------------------------------------------------------------------
Servicing fees received $3,089 $2,372
Other cash flows received 5,465 4,867
Purchase of loans from trusts 378 --
-------------------------------------------------------------------------------------------------
Amounts payable to the trustee related to loan principal and interest
collected on behalf of the trusts of $35.1 million at December 31, 2003,
and $34.4 million at September 30, 2003, are included in other
banking/finance liabilities.
The securitized loan portfolio that we manage and the related delinquencies
as of December 31, 2003 and September 30, 2003, were as follows:
(in thousands) DECEMBER 31, SEPTEMBER 30,
2003 2003
-------------------------------------------------------------------------------------------------
Securitized loans held by securitization trusts $823,082 $680,695
Delinquencies 13,463 12,911
-------------------------------------------------------------------------------------------------
11
Net charge-offs on the securitized loan portfolio were $5.1 million and
$3.0 million during the three months ended December 31, 2003 and 2002.
10. GOODWILL AND OTHER INTANGIBLE ASSETS
------------------------------------
Intangible assets, other than goodwill, at December 31, 2003 and September
30, 2003, were as follows:
GROSS CARRYING ACCUMULATED NET CARRYING
(in thousands) AMOUNT AMORTIZATION AMOUNT
-------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2003
Amortized intangible assets:
Customer base $233,057 $(43,013) $190,044
Other 34,932 (20,172) 14,760
-------------------------------------------------------------------------------------------------
267,989 (63,185) 204,804
Non-amortized intangible assets:
Management contracts 479,457 -- 479,457
-------------------------------------------------------------------------------------------------
TOTAL $747,446 $(63,185) $684,261
-------------------------------------------------------------------------------------------------
GROSS CARRYING ACCUMULATED NET CARRYING
(in thousands) AMOUNT AMORTIZATION AMOUNT
-------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2003
Amortized intangible assets:
Customer base $232,800 $(39,057) $193,743
Other 31,546 (19,653) 11,893
-------------------------------------------------------------------------------------------------
264,346 (58,710) 205,636
Non-amortized intangible assets:
Management contracts 478,645 -- 478,645
-------------------------------------------------------------------------------------------------
TOTAL $742,991 $(58,710) $684,281
-------------------------------------------------------------------------------------------------
Estimated amortization expense for each of the next 5 fiscal years is as
follows:
FOR THE FISCAL YEARS ENDING
(in thousands) SEPTEMBER 30,
---------------------------------------------------------------------------
2004 $17,008
2005 17,008
2006 17,008
2007 17,008
2008 17,008
---------------------------------------------------------------------------
The change in the carrying value of goodwill was as follows:
(in thousands)
---------------------------------------------------------------------------
Goodwill as of September 30, 2003 $1,335,517
Darby acquisition (see Note 3) 37,379
Foreign currency movements 3,779
---------------------------------------------------------------------------
GOODWILL AS OF DECEMBER 31, 2003 $1,376,675
---------------------------------------------------------------------------
12
All of our goodwill and intangible assets, including those arising from the
purchase of Fiduciary Trust Company International ("Fiduciary Trust") in
April 2001, relate to our investment management operating segment.
Indefinite-lived intangible assets represent the value of management
contracts related to our sponsored 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 No.
142, "Goodwill and Other Intangible Assets", and we determined that there
was no impairment in the value of goodwill and indefinite-lived assets as
of October 1, 2002.
11. DEBT
----
Outstanding debt at December 31, 2003 and September 30, 2003, consisted of
the following:
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2003 2003
-------------------------------------------------------------------------------------------------
SHORT-TERM:
Federal Home Loan Bank advances $17,800 $14,500
Current maturities of long-term debt 164,900 287
------------------------------------------------------------ ----------------- ------------------
182,700 14,787
LONG-TERM:
Convertible Notes (including accrued interest) 522,758 520,325
Medium Term Notes 420,000 420,000
Other 193,031 168,556
------------------------------------------------------------ ----------------- ------------------
1,135,789 1,108,881
------------------------------------------------------------ ----------------- ------------------
TOTAL DEBT $1,318,489 $1,123,668
------------------------------------------------------------ ----------------- ------------------
Federal Home Loan Bank advances are included in other liabilities of the
banking/finance operating segment. On December 31, 2003, we recognized a
$164.9 million five-year note facility that was used to finance the
construction of our corporate headquarters campus under the guidance of FIN
46-R (see Note 7). The facility expires in September 2004 and will continue
to be classified as a current liability until it is refinanced or repaid.
In April 2003, we completed the sale of five-year senior notes due April
15, 2008 totaling $420.0 million ("Medium Term Notes"). The Medium Term
Notes, which were offered to qualified institutional buyers only, carry an
interest rate of 3.7% and are not redeemable prior to maturity by either us
or the note holders. Interest payments are due semi-annually.
In May 2001, we received approximately $490.0 million in net proceeds from
the sale of $877.0 million principal amount at maturity of zero-coupon
convertible senior notes due 2031 (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, when the price of our stock reaches certain thresholds. We may
redeem the Convertible Notes for cash on or after May 11, 2006 at their
accreted value. On May 12, 2003, at the option of the holders, we
repurchased Convertible Notes with a face value of $5.9 million principal
amount at maturity, for $3.5 million in cash, the accreted value of the
notes as of May 11, 2003. We may have to make additional repurchases, at
the option of the holders, on May 11 of 2004, 2006, 2011, 2016, 2021 and
2026. In this event, we may choose to repay the accreted value of the
Convertible Notes in cash or shares of our common stock. The amount that we
will be required to redeem by the holders, depends on, among other factors,
the performance of our common stock.
Other long-term debt consists primarily of deferred commission liabilities
recognized in relation to U.S. deferred commission assets financed by LFL
that were not sold by LFL in a securitization transaction as of December
31, 2003 and September 30, 2003.
13
12. 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.
In October 1999, we entered into an agreement for the lease of our
corporate headquarters campus 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 $145.0 million in
residual guarantees, representing approximately 85% of the total
construction costs of $170.0 million. We would become liable under this
residual guarantee if we were unable or unwilling to exercise our renewal
option to extend the lease term or buy the corporate headquarters campus,
or if we were unable to arrange for the sale of the campus for more than
$145.0 million. We are also contingently liable to purchase the corporate
headquarters campus for an amount equal to the final construction costs of
$170.0 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.
On December 31, 2003, we consolidated the lessor trust under the provisions
of FIN 46-R (see Note 7) and recognized, as a current liability, the loan
principal of $164.9 million and minority interest of $5.1 million, which,
in total, represent the amount used to finance the construction of our
corporate headquarters campus and our maximum contingent liability under
the agreements.
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 December
31, 2003, the maximum potential amount of future payments was $19.5 million
relating to guarantees made prior to January 1, 2003. In addition, our
consolidated balance sheet at December 31, 2003 included a $0.4 million
liability to reflect obligations arising from auto securitization
transactions subsequent to December 31, 2002.
At December 31, 2003, our banking/finance operating segment had issued
financial standby letters of credit totaling $4.8 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
banking customers. These standby letters of credit, issued prior to January
1, 2003, were secured by marketable securities with a fair value of $13.7
million as of December 31, 2003 and commercial real estate.
MUTUAL FUND PROCEEDINGS, ACTIONS AND INVESTIGATIONS
MASSACHUSETTS ADMINISTRATIVE PROCEEDING. On February 4, 2004, the
Securities Division of the Office of the Secretary of the Commonwealth of
Massachusetts filed an administrative complaint against Franklin Resources,
Inc. and certain of its subsidiaries (the "Company") alleging violations of
the Massachusetts Uniform Securities Act. The complaint arises from
activity that occurred in 2001 during which time an officer of a Company
subsidiary was negotiating an agreement with an investor relating to
investments in a mutual fund and a hedge fund of funds.
The Company believes that the mutual fund investment at issue, which
involved three round-trip transactions, did not violate the fund's
prospectus, and the Company is confident that no investors in the mutual
fund were harmed by the investment. A communication was sent on behalf of
this officer to the investor that provided, among other things, that the
investor would receive different terms than normal with respect to the
hedge fund of funds investment. This variance of the terms of the hedge
fund of funds investment was unauthorized and was rejected by management of
the Company. This is the same officer who, as the Company disclosed in
December 2003, had been placed on administrative leave and has subsequently
left the Company.
14
GOVERNMENTAL INVESTIGATIONS. As part of ongoing investigations by the U.S.
Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the
Northern District of California, the New York Attorney General, the
California Attorney General, the U.S. Attorney for the District of
Massachusetts, the Florida Department of Financial Services and the
Commissioner of Securities and the Attorney General of the State of West
Virginia, relating to certain practices in the mutual fund industry,
including late trading, market timing and sales compensation arrangements,
the Company and its subsidiaries, as well as certain current or former
executives and employees of the Company, have received requests for
information and/or subpoenas to testify or produce documents. The Company
and its current employees are providing documents and information in
response to these requests and subpoenas. In addition, the Company has
responded to requests for similar kinds of information from regulatory
authorities in some of the foreign countries where the Company conducts its
global asset management business.
The Staff of the SEC has informed the Company that it intends to recommend
that the SEC authorize a civil injunctive action against Franklin Advisers,
Inc., a subsidiary of the Company, and Gregory Johnson, who is President
and Co-Chief Executive Officer of Franklin Resources, Inc. and also serves
as an executive officer or director of most of the Company's subsidiaries.
The Company understands that the SEC's investigation is focused on the
activities that are the subject of the Massachusetts administrative
proceeding described above and other instances of alleged market timing by
a limited number of third parties that ended in 2000. There currently are
discussions underway with the SEC Staff in an effort to resolve the issues
raised in their investigation. Such discussions are preliminary and the
Company cannot predict the likelihood of whether those discussions will
result in a settlement and, if so, the terms of such settlement.
Separately, in connection with the SEC's private investigation that
resulted in a proceeding against Morgan Stanley DW, Inc., the Company has
been asked to furnish documents and testimony relating to its arrangements
to compensate brokers who sell Fund shares. Effective November 28, 2003,
the Company determined not to direct any further brokerage where the
allocation is based, not only on best execution, but in addition on the
sale of Fund shares in order to satisfy preferred list or other shelf space
arrangements, which determination may have a material adverse financial
impact on the Company.
CLASS ACTION LAWSUITS. The Company has been informed that it and other
entities within Franklin Templeton Investments have been named in several
shareholder class actions related to some of the matters described above.
See "Other Legal Proceedings". The Company believes that the claims made in
the lawsuits are without merit and it intends to defend itself vigorously.
It is anticipated that the Company may be named in additional similar civil
actions related to some of the matters described above.
INTERNAL INQUIRIES. The Company also has conducted its own internal
fact-finding inquiry with the assistance of outside counsel to determine
whether any shareholders of the Franklin, Templeton and Mutual Series U.S.
Funds (each a "Fund" and together, "Funds"), including Company employees,
were permitted to engage in late trading or in market timing transactions
contrary to the policies of the affected Fund and, if so, the circumstances
and persons involved. The Company's internal inquiry regarding market
timing and late trading is substantially complete. We have not been able to
identify any late trading problems, but we have identified various
instances of frequent trading. We currently believe that the charges the
Company understands the SEC Staff is contemplating are unwarranted. One
officer of a subsidiary of the Company has been placed on administrative
leave and subsequently resigned from his position with the Company.
To date, the Company also has identified some instances of frequent trading
in shares of certain Funds by a few current or former employees in their
personal 401(k) plan accounts. These individuals include one trader and one
officer of the Funds. These two individuals have been placed on
administrative leave and the officer has resigned from his positions with
the Funds. Although this aspect of our inquiry is not finally complete, to
date we have found no instances of inappropriate mutual fund trading by any
portfolio manager, investment analyst or officer of Franklin Resources,
Inc. The independent directors of the Funds and the Company have retained
independent outside counsel to review these matters, to determine if any
violations of law or policies or inappropriate trading occurred, to conduct
such further inquiries as counsel may deem necessary and to report their
findings and recommendations to the independent directors of the Funds and
the Company's board of directors.
The Company cannot predict with certainty the eventual outcome of the
foregoing Massachusetts administrative proceeding, the governmental
investigations or class action lawsuits, nor whether they will have a
material negative impact on, or cost to, the Company. However, public trust
and confidence are
15
critical to the Company's business and any material loss of investor and/or
client confidence could result in a significant decline in assets under
management by the Company, which would have an adverse effect on future
financial results. If the Company finds that it bears responsibility for
any unlawful or inappropriate conduct that caused losses to our Funds, we
are committed to making the Funds or their shareholders whole, as
appropriate. The Company is also committed to taking action to protect the
interests of our Funds' shareholders, including appropriate action against
any Company personnel found to have knowingly permitted or personally
engaged in improper trading practices.
In addition, pending regulatory and legislative actions and reforms
affecting the mutual fund industry may significantly increase the Company's
costs of doing business and/or negatively impact its revenues, either of
which could have a material negative impact on the Company's financial
results.
OTHER LEGAL PROCEEDINGS
In addition to the Massachusetts Administrative Proceeding referenced under
"Mutual Fund Proceedings, Actions and Investigations" above, we have been
informed during February 2004 that the Company and certain of its
subsidiaries have been named in multiple lawsuits in different federal
courts in Nevada, California and Florida, seeking class action status
alleging violations of various federal securities laws, although the
Company has not yet been served with the complaints in these lawsuits.
Various subsidiaries of the Company have also been named in multiple
lawsuits filed in federal and state courts in Illinois alleging breach of
duty with respect to the valuation of the portfolio securities of certain
Templeton funds managed by such subsidiaries and seeking monetary damages
and costs, as follows:
CULLEN V. TEMPLETON GROWTH FUND, INC. AND TEMPLETON GLOBAL ADVISORS
LIMITED, Case No. 03-859 MJR, was filed on December 16, 2003 in the United
States District Court for the Southern District of Illinois.
KWIATKOWSKI V. TEMPLETON GROWTH FUND, INC. AND TEMPLETON GLOBAL ADVISORS
LIMITED, Case 03 L 785, was filed on December 17, 2003 in the Circuit Court
for the Twentieth Judicial Circuit, St. Clair County, Illinois.
BRADFISCH V. TEMPLETON FUNDS, INC. AND TEMPLETON GLOBAL ADVISORS LIMITED,
Case 2003 L 001361, was filed on October 3, 2003 in the Circuit Court for
the Third Judicial Circuit, Madison County, Illinois.
WOODBURY V. TEMPLETON GLOBAL SMALLER COMPANIES FUND, INC. AND TEMPLETON
INVESTMENT COUNSEL, LLC, Case 2003 L 001362, was filed on October 3, 2003
in the Circuit Court for the Third Judicial Circuit, Madison County,
Illinois.
KENERLEY V. TEMPLETON FUNDS, INC. AND TEMPLETON GLOBAL ADVISORS LIMITED,
Case No. 03-770 GPM, was served on the defendants on November 25, 2003. The
case was filed in the United States District Court for the Southern
District of Illinois. This lawsuit alleges breaches of fiduciary duties
imposed by Section 36(a) of the Investment Company Act of 1940 and pendant
state law claims with respect to the valuation of Templeton World Fund's
portfolio securities.
PARISE V. TEMPLETON FUNDS, INC. AND TEMPLETON GLOBAL ADVISORS LIMITED, Case
No. 2003-L-002049, was filed on December 22, 2003 in the Circuit Court for
the Third Judicial Circuit, Madison County, Illinois and was served on the
defendants on February 13, 2004.
Management strongly believes that the claims made in each of these lawsuits
are without merit and intends vigorously to defend against them.
Except for the matters described above, there have been no material
developments in the litigation previously reported in our Annual Report on
Form 10-K for the period ended September 30, 2003 as filed with the SEC on
December 22, 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.
16
OTHER COMMITMENTS AND CONTINGENCIES
In July 2003, we renegotiated an agreement to outsource management of our
data center and distributed server operations, originally signed in
February 2001. We may terminate the amended agreement any time after July
1, 2006 by incurring a termination charge. The maximum termination charge
payable will depend on the termination date of the amended agreement, the
service levels before our termination of the agreement, costs incurred by
our service provider to wind-down the services and costs associated with
assuming equipment leases. As of December 31, 2003, we estimate that the
termination fee payable in July 2006, not including costs associated with
assuming equipment leases, would approximate $14.0 million and would
decrease each month for the subsequent two years, reaching a payment of
approximately $2.2 million in July 2008.
We lease office space and equipment under long-term operating leases. As of
December 31, 2003, there were no material changes in leasing arrangements
that would have a significant effect on future minimum lease payments
reported in our Annual Report on Form 10-K for the period ended September
30, 2003.
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. 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 December 31, 2003, there were 1.4
million put options outstanding with an average exercise price of $33 and
were treated as short-term liabilities carried at a fair value of $0. They
expired unexercised in January 2004.
At December 31, 2003, our banking/finance operating segment had commitments
to extend credit aggregating $272.7 million, primarily under credit card
lines.
13. COMMON STOCK REPURCHASES
------------------------
During the three months ended December 31, 2003, we purchased and retired
0.3 million shares at a cost of $12.5 million. At December 31, 2003,
approximately 14.3 million shares remained available for repurchase under
board authorizations. During the three months ended December 31, 2002, we
purchased and retired 1.5 million shares at a cost of $46.3 million.
14. 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, Bissett and Fiduciary Trust funds, and institutional, high
net-worth and private accounts and other investment products. The
banking/finance segment offers selected retail-banking services to high
net-worth individuals, foundations and institutions, and consumer lending.
Our consumer lending activities include automotive lending related to the
purchase, securitization, and servicing of retail installment sales
contracts originated by independent automobile dealerships, consumer credit
and debit cards, real estate equity lines, and home equity/mortgage
lending.
17
Financial information for our two operating segments for the three months
ended December 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.
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2003 2002
-------------------------------------------------------------------------------------------------
OPERATING REVENUES
Investment management $791,251 $589,295
Banking/finance 14,918 16,156
-------------------------------------------------------------------------------------------------
TOTAL $806,169 $605,451
-------------------------------------------------------------------------------------------------
INCOME BEFORE TAXES
Investment management $228,061 $138,935
Banking/finance 7,879 9,791
-------------------------------------------------------------------------------------------------
TOTAL $235,940 $148,726
-------------------------------------------------------------------------------------------------
Operating segment assets were as follows:
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2003 2003
-------------------------------------------------------------------------------------------------
Investment management $6,566,023 $6,052,324
Banking/finance 851,379 918,425
-------------------------------------------------------------------------------------------------
TOTAL $7,417,402 $6,970,749
-------------------------------------------------------------------------------------------------
Operating revenues of the banking/finance segment included above were as
follows:
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2003 2002
-------------------------------------------------------------------------------------------------
Interest and fees on loans $7,270 $7,824
Interest and dividends on investment securities 2,964 5,250
-------------------------------------------------------------------------------------------------
Total interest income 10,234 13,074
Interest on deposits (1,193) (1,807)
Interest on short-term debt (61) (35)
Interest expense - inter-segment (489) (804)
-------------------------------------------------------------------------------------------------
Total interest expense (1,743) (2,646)
Net interest income 8,491 10,428
Other income 10,469 8,945
Provision for loan losses (4,042) (3,217)
-------------------------------------------------------------------------------------------------
TOTAL OPERATING REVENUES $14,918 $16,156
-------------------------------------------------------------------------------------------------
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 income statement.
15. BANKING REGULATORY RATIOS
-------------------------
Following the acquisition of Fiduciary Trust 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 result in
certain mandatory, and possibly additional, discretionary actions by
regulators that, if undertaken, could have a direct material
18
adverse 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 December 31, 2003, we exceeded the capital adequacy
requirements applicable to us as listed below.
THREE MONTHS ENDED MINIMUM FOR OUR CAPITAL
(in thousands) DECEMBER 31, 2003 ADEQUACY PURPOSES
-------------------------------------------- ----------------------- ----------------------------
Tier 1 capital $2,346,095 N/A
Total risk-based capital $2,352,786 N/A
Tier 1 leverage ratio 45% 4%
Tier 1 risk-based capital ratio 66% 4%
Total risk-based capital ratio 66% 8%
-------------------------------------------- ----------------------- ----------------------------
16. SUBSEQUENT EVENT
----------------
In January 2004, we received proceeds of $32.5 million from our insurance
carriers for losses incurred as a result of the September 11, 2001
terrorist attacks that destroyed the headquarters of our subsidiary,
Fiduciary Trust. These proceeds represented final recoveries for claims
submitted to our insurance carriers. We will realize a gain of
approximately $30.1 million, before income taxes of approximately $12.0
million, in the reporting period ending March 31, 2004, in accordance with
guidance provided under FASB Statement No. 5 "Accounting for Contingencies"
and Emerging Issues Task Force Abstract "Accounting for the Impact of the
Terrorist Attacks of September 11, 2001", as remaining contingencies
related to our insurance claims have been resolved. See also Note 12.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
In this section we discuss our results of operations and our financial
condition. 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 under five distinct
names:
* Franklin * Templeton * Mutual Series * Bissett * Fiduciary Trust
Our sponsored investment products include a broad range of global/international
equity, U.S. domestic, hybrid/balanced, 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
19
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 selected retail-banking services to high net-worth
and other individuals, foundations and institutions, and consumer lending
services. Our consumer lending activities include automotive lending related to
the purchase, securitization, and servicing of retail installment sales
contracts originated by independent automobile dealerships, consumer credit and
debit cards, real estate equity lines, and home equity/mortgage lending.
RESULTS OF OPERATIONS
THREE MONTHS ENDED
DECEMBER 31, PERCENT
(in millions except per share data) 2003 2002 CHANGE
- -----------------------------------------------------------------------------------------------------
NET INCOME $172.3 $109.8 57%
EARNINGS PER COMMON SHARE
Basic $0.70 $0.43 63%
Diluted 0.69 0.43 60%
OPERATING MARGIN 28% 23% --
- -----------------------------------------------------------------------------------------------------
Net income increased 57% in the three months ended December 31, 2003 compared to
the same period last year. The increase was due to higher investment management,
underwriting and distribution and shareholder servicing fees, partly reduced by
higher underwriting and distribution and compensation and benefits expenses and
a higher effective tax rate.
ASSETS UNDER MANAGEMENT
DECEMBER 31, DECEMBER 31,
(in billions) 2003 2002
- -----------------------------------------------------------------------------------------------------
Equity:
Global/international $118.5 $81.4
Domestic (U.S.) 63.6 43.5
- -----------------------------------------------------------------------------------------------------
Total equity 182.1 124.9
- -----------------------------------------------------------------------------------------------------
Hybrid/balanced 51.1 38.3
Fixed-income:
Tax-free 52.4 52.1
Taxable
Domestic (U.S.) 32.2 27.3
Global/international 13.1 9.1
- -----------------------------------------------------------------------------------------------------
Total fixed-income 97.7 88.5
- -----------------------------------------------------------------------------------------------------
Money market 5.8 6.0
- -----------------------------------------------------------------------------------------------------
TOTAL $336.7 $257.7
- -----------------------------------------------------------------------------------------------------
SIMPLE MONTHLY AVERAGE FOR THE THREE-MONTH PERIOD (1) $318.7 $254.8
- -----------------------------------------------------------------------------------------------------
(1) Investment management fees from approximately 50% of our assets under management at December 31,
2003 were calculated using a daily average.
Our assets under management at December 31, 2003 were $336.7 billion, 31% higher
than they were a year ago, primarily due to excess sales over redemptions of
$20.7 billion and market appreciation of $59.8 billion. Simple monthly average
assets, which are generally more indicative of investment management fee trends
than the year over year change in ending assets under management, were 25%
higher in the three months ended December 31, 2003 than over the same period a
year ago.
20
The simple monthly average mix of assets under management is shown below.
THREE MONTHS ENDED
DECEMBER 31,
2003 2002
- -----------------------------------------------------------------------------------------------------
PERCENTAGE OF SIMPLE MONTHLY AVERAGE ASSETS UNDER MANAGEMENT
Equity 53% 49%
Fixed-income 30% 34%
Hybrid/balanced 15% 15%
Money market 2% 2%
- -----------------------------------------------------------------------------------------------------
TOTAL 100% 100%
- -----------------------------------------------------------------------------------------------------
For the three months ended December 31, 2003, the effective investment
management fee rate increased to 0.570% from 0.552% in the same period last
year. The change in the mix of assets under management, resulting from higher
relative excess sales over redemptions and appreciation for equity as compared
to fixed-income products, led to an increase in our effective investment
management fee rate (investment management fees divided by simple monthly
average assets under management). Generally, equity products carry a higher
management fee rate than fixed-income and hybrid/balanced products.
Assets under management by shareholder location were as follows:
(in billions) AS OF DECEMBER 31, 2003
- ---------------------------------------------------- ---------------------------
United States $248.9
Canada 24.2
Europe 23.6
Global 17.4
Asia/Pacific and other 22.6
- ---------------------------------------------------- ---------------------------
TOTAL $336.7
- ---------------------------------------------------- ---------------------------
Components of the change in our assets under management were as follows:
THREE MONTHS ENDED
DECEMBER 31, PERCENT
(in billions) 2003 2002 CHANGE
- -----------------------------------------------------------------------------------------------------
Beginning assets under management $301.9 $247.8 22%
Sales 23.8 17.1 39%
Reinvested distributions 1.9 1.4 36%
Redemptions (16.4) (16.0) 3%
Distributions (2.7) (2.1) 29%
Acquisitions 0.9 -- N/A
Appreciation 27.3 9.5 187%
- -----------------------------------------------------------------------------------------------------
ENDING ASSETS UNDER MANAGEMENT $336.7 $257.7 31%
- -----------------------------------------------------------------------------------------------------
For the three months ended December 31, 2003, excess sales over redemptions were
$7.4 billion, as compared to $1.1 billion in the same period last year. Market
appreciation of $27.3 billion in the three months ended December 31, 2003
related primarily to our equity and hybrid/balanced products. Our acquisition of
Darby Overseas Investments, Ltd. and Darby Overseas Partners, L.P. (collectively
"Darby"), on October 1, 2003, added $0.9 billion in assets under management
related to private equity, mezzanine and emerging markets fixed-income products
as of the date of this acquisition.
21
OPERATING REVENUES
THREE MONTHS ENDED
DECEMBER 31, PERCENT
(in millions) 2003 2002 CHANGE
- ----------------------------------------------------------------------------------------------------------
Investment management fees $454.5 $351.4 29%
Underwriting and distribution fees 272.8 185.9 47%
Shareholder servicing fees 61.3 48.1 27%
Consolidated sponsored investment products income, net -- -- --
Other, net 17.6 20.1 (12%)
- ----------------------------------------------------------------------------------------------------------
TOTAL OPERATING REVENUES $806.2 $605.5 33%
- ----------------------------------------------------------------------------------------------------------
SUMMARY
Total operating revenues increased 33% during the three months ended December
31, 2003 due to higher investment management, underwriting and distribution and
shareholder servicing fees partly offset by a decline in other revenue.
INVESTMENT MANAGEMENT FEES
Investment management fees, accounting for 56% of our operating revenues in the
quarter ended December 31, 2003, include fees for providing both investment
advisory and administrative services to our sponsored investment products. 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.
Investment management fees increased 29% during the three months ended December
31, 2003 compared to the same period last year consistent with a 25% increase in
simple monthly average assets under management over the same period, and the
increase in our effective fee rate resulting from a shift in asset mix toward
equity products, which generally carry a higher management fee than fixed-income
products.
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 commissions are reduced or eliminated on some classes of shares and for
sales to shareholders or intermediaries that exceed specified minimum amounts.
Therefore, underwriting fees will change with the size of individual
sale transactions and the relative mix of sales between different share classes.
Many of 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 and other
regulatory limitations. 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 increased 47% during the three months ended
December 31, 2003 compared to the same period last year. During the three months
ended December 31, 2003, commission revenues increased 65% from the same period
last year consistent with a 39% increase in gross sales and a change in the
sales mix. Distribution fees increased 35% during the three months ended
December 31, 2003 over the same period last year consistent with a 25% increase
in simple monthly average assets under management and a shift in the asset mix.
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
22
agency services, including 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 27% during the three months ended December
31, 2003 from the same period last year. The increase reflects increases in fee
rates applicable to open accounts, partly reduced by reductions in fee rates
chargeable on accounts closed in the prior calendar year, under revised
shareholder service fee agreements in the United States that became effective on
January 1, 2003, as well as an increase in the overall number of billable
shareholder accounts.
OTHER, NET
Other, net consists primarily 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, and are
reduced by banking interest expense and the provision for probable loan losses.
Other, net decreased 12% during the three months ended December 31, 2003 over
the same period last year consistent with lower realized gains from auto loan
portfolio sales.
OPERATING EXPENSES
THREE MONTHS ENDED
DECEMBER 31, PERCENT
(in millions) 2003 2002 CHANGE
- -----------------------------------------------------------------------------------------------------
Underwriting and distribution $245.9 $168.9 46%
Compensation and benefits 189.2 159.1 19%
Information systems, technology and occupancy 69.7 72.6 (4%)
Advertising and promotion 21.2 22.6 (6%)
Amortization of deferred sales commissions 22.4 16.1 39%
Amortization of intangible assets 4.4 4.2 5%
Other 30.5 22.5 36%
- -----------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES $583.3 $466.0 25%
- -----------------------------------------------------------------------------------------------------
SUMMARY
Operating expenses increased 25% during the three months ended December 31, 2003
compared to the same period last year due to an increase in underwriting and
distribution, compensation and benefits and other expenses.
UNDERWRITING AND DISTRIBUTION
Underwriting and distribution includes amounts payable to brokers and other
third parties for selling, distributing and providing ongoing services to
investors in our sponsored investment products. Underwriting and distribution
expense increased 46% during the three months ended December 31, 2003 over the
same period last year consistent with similar trends in underwriting and
distribution revenue.
COMPENSATION AND BENEFITS
Compensation and benefits expense increased 19% during the three months ended
December 31, 2003 compared to the same period last year. The increase resulted
primarily from an increase in bonus expenses under the Annual Incentive
Compensation Plan, which awards cash and stock bonuses based, in part, on our
performance, merit salary increases effective in October 2003, and additional
compensation and benefit costs related to the acquisition of Darby in October
2003. We also continued to experience higher employee insurance and other
benefit costs. The increase was partly reduced by a decrease in the contractual
retention
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bonus commitments related to the acquisition of Fiduciary Trust Company
International ("Fiduciary Trust") in April 2001. We employed approximately 6,500
people at both December 31, 2003 and December 31, 2002.
INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY
Information systems, technology and occupancy costs decreased 4% during the
three months ended December 31, 2003 from the same period last year primarily
due to lower depreciation levels for equipment and software. The decrease in
depreciation expense is related to a decrease in purchases of information system
and technology equipment as certain of our technology equipment is periodically
replaced with new equipment under our technology outsourcing agreement, as well
as a stabilization in the number and the scope of new technology project
initiatives.
Details of capitalized information systems and technology costs were as follows:
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2003 2002
- -----------------------------------------------------------------------------------------------------
Net book value at beginning of period $79,126 $121,486
Additions during period, net of disposals and other adjustments 7,604 6,917
Amortization during period (12,963) (18,358)
- -----------------------------------------------------------------------------------------------------
NET BOOK VALUE AT END OF PERIOD $73,767 $110,045
- -----------------------------------------------------------------------------------------------------
ADVERTISING AND PROMOTION
Advertising and promotion expense decreased 6% during the three months ended
December 31, 2003 over the same period last year. We experienced costs savings
in a number of discretionary spending areas as a result of continuing cost
control and management efforts. However, direct advertising and promotional
costs were slightly higher in the current period. 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 are sold without a front-end sales charge to
shareholders, although 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. However, 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 over 18 months to 8 years depending on share class or
financing arrangements.
We have arranged to finance our Class B and C 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 a 49% 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
DCA transferred to LFL until resold by LFL. As a result, we reflect DCA sold to
LFL under the U.S. agreement on our balance sheet and amortize them over an
8-year period, or until sold by LFL to third parties. In contrast to the U.S.
arrangement, LFL has entered into direct agreements with our 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 increased 39% during the three months
ended December 31, 2003 over the same period last year primarily due to
increased gross product sales and because LFL has not sold U.S. DCA in a
securitization transaction since June 2002.
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OTHER INCOME (EXPENSE)
Other income (expense) includes investment and other income and interest
expense. Beginning July 1, 2003, realized and unrealized gains (losses), net, of
sponsored investment products that were consolidated in our financial statements
on adoption of the Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities" (see description in Critical
Accounting Policies below), are also included in this classification.
Investment and other income is comprised primarily of the following:
* dividends from investments
* interest income from investments in bonds and government securities
* 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 41% during the three months ended December 31,
2003 from the same period last year. This was primarily due to the inclusion of
realized and unrealized gains (losses), net, related to sponsored investment
products in the current period, and higher net realized investment gains. The
increase was partially reduced by an increase in interest expense related to the
issuance of five-year senior notes in April 2003.
TAXES ON INCOME
As a multi-national corporation, we provide investment management services to a
wide range of international sponsored investment products, often managed from
jurisdictions outside the United States. Some of these jurisdictions have lower
tax rates than the United States. The mix of income (primarily 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 three months ended December 31, 2003 increased to 29% compared to 26% in the
same period last year due to a shift in the mix of pre-tax income earned in
various worldwide jurisdictions. 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 December 31, 2003, we had $1,352.8 million in cash and cash equivalents, as
compared to $1,053.7 million at September 30, 2003. Cash and cash equivalents
include cash, U.S. Treasury bills and other debt instruments with maturities of
three months or less from the purchase date and other highly liquid investments
that are readily convertible into cash, including money market funds. Liquid
assets, which consist of cash and cash equivalents, investments (trading and
available-for-sale) and current receivables increased to $3,636.4 million at
December 31, 2003 from $3,272.3 million at September 30, 2003. Liquid assets
have increased in the current year primarily due to cash provided by operating
activities and proceeds received from auto loan securitizations.
Outstanding debt, including Federal Home Loan Bank advances and current
maturities of long-term debt, increased to $1,318.5 million at December 31, 2003
compared to $1,123.7 million at September 30, 2003. The balance at December 31,
2003 included $522.8 million in principal and accrued interest related to
outstanding convertible notes, $420.0 million in five-year senior notes, a
$164.9 million five-year facility, and $193.0 million of other long-term debt,
consisting primarily of deferred commission liabilities recognized in relation
to U.S. DCA financed by LFL that had not yet been sold by LFL in a
securitization transaction. As of September 30, 2003, outstanding debt included
$520.3 million related to the convertible notes, $420.0 million in five-year
senior notes, and $168.8 million in other long-term debt, including current
maturities.
The increase in outstanding debt from September 30, 2003, is due primarily to
the $164.9 million five-year facility used to finance the construction of our
corporate headquarters campus consolidated in our financial statements as of
December 31, 2003 in accordance with the guidance of FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities (revised December 2003)". The
facility expires in September 2004 and will continue to be classified as a
current liability until it is refinanced or repaid.
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In May 2001, we received approximately $490.0 million in net proceeds from the
sale of $877.0 million principal amount at maturity of zero-coupon convertible
senior notes due 2031 (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, when the price of our stock reaches certain
thresholds. We may redeem the Convertible Notes for cash on or after May 11,
2006 at their accreted value. On May 12, 2003, at the option of the holders, we
repurchased Convertible Notes with a face value of $5.9 million principal amount
at maturity, for $3.5 million in cash, the accreted value of the notes as of May
11, 2003. We may have to make additional repurchases, at the option of the
holders, on May 11 of 2004, 2006, 2011, 2016, 2021 and 2026. In this event, we
may choose to repay the accreted value of the Convertible Notes in cash or
shares of our common stock. The amount that we will be required to redeem by the
holders, depends on, among other factors, the performance of our common stock.
As of December 31, 2003, we had $500.0 million of commercial paper and $300.0
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 December 31, 2003 totaled $420.0
million, of which, $210.0 million was under a 364-day facility expiring in June
2004. The remaining $210.0 million facility is under a five-year facility that
will expire in June 2007. In addition, at December 31, 2003, our banking/finance
operating segment had $566.3 million in available uncommitted short-term bank
lines under the Federal Reserve Funds system, the Federal Reserve Bank discount
window, and Federal Home Loan Bank short-term borrowing capacity. 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.
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. Gross sales proceeds from
these transactions were $185.1 million and $131.6 million during the three
months ended December 31, 2003 and 2002. Our ability to access the
securitization market will directly affect our plans to finance the auto loan
portfolio in the future.
The sales commissions that we have financed globally through LFL during the
three months ended December 31, 2003 were approximately $43.3 million compared
to $32.0 million over the same period last year. LFL's ability to access credit
facilities and the securitization market will directly affect our existing
financing arrangements.
In January 2004, we received proceeds of $32.5 million from our insurance
carriers for losses incurred as a result of the September 11, 2001 terrorist
attacks that destroyed the headquarters of our subsidiary, Fiduciary Trust.
These proceeds represented final recoveries for claims submitted to our
insurance carriers. We will realize a gain of approximately $30.1 million,
before income taxes of approximately $12.0 million, in the reporting period
ending March 31, 2004 (see Note 16 to the financial statements).
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.
26
We believe that we can meet our present and reasonably foreseeable operating
cash needs and future commitments through the following:
* existing liquid assets
* continuing cash flow from operations
* borrowing capacity under current credit facilities
* ability to issue debt or equity securities
* 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.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
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 December 31, 2003, the maximum
potential amount of future payments was $19.5 million relating to guarantees
made prior to January 1, 2003. In addition, our consolidated balance sheet at
December 31, 2003 included a $0.4 million liability to reflect obligations
arising from auto securitization transactions subsequent to December 31, 2002.
At December 31, 2003, the banking/finance operating segment had commitments to
extend credit aggregating $272.7 million, primarily under its credit card lines,
and had issued financial standby letters of credit totaling $4.8 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
banking customers. These standby letters of credit, issued prior to January 1,
2003, were secured by marketable securities with a fair value of $13.7 million
as of December 31, 2003 and commercial real estate.
In July 2003, we renegotiated an agreement to outsource management of our data
center and distributed server operations, originally signed in February 2001. We
may terminate the amended agreement any time after July 1, 2006 by incurring a
termination charge. The maximum termination charge payable will depend on the
termination date of the amended agreement, the service levels before our
termination of the agreement, costs incurred by our service provider to
wind-down the services and costs associated with assuming equipment leases. As
of December 31, 2003, we estimate that the termination fee payable in July 2006,
not including costs associated with assuming equipment leases, would approximate
$14.0 million and would decrease each month for the subsequent two years,
reaching a payment of approximately $2.2 million in July 2008.
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. 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 December 31, 2003, there were 1.4 million put options
outstanding with an average exercise price of $33 and were treated as short-term
liabilities carried at a fair value of $0. They expired unexercised in January
2004.
We lease office space and equipment under long-term operating leases. As of
December 31, 2003, there were no material changes in leasing arrangements that
would have a significant effect on future minimum lease payments reported in our
Annual Report on Form 10-K for the period ended September 30, 2003.
OFF-BALANCE SHEET ARRANGEMENTS
As discussed above, we obtain financing for sales commissions that we pay to
brokers on Class B and C shares through LFL, a company incorporated in Ireland
whose sole business purpose is to finance our DCA. We hold a 49% ownership
interest in LFL and we account for this ownership interest using the equity
method of accounting. In addition, we retain U.S.-originated DCA and related
long-term debt in our financial statements until resold by LFL in a
securitization transaction with third parties. Our exposure to loss related to
our investment in LFL is limited to the carrying value of our investment in and
loans to LFL, and interest and fees receivable from LFL. At December 31, 2003,
those amounts approximated $51.3 million. During the three months ended December
31, 2003, we financed approximately $43.3 million of sales commissions through
LFL and we recognized a pre-tax charge of approximately $3.5 million for our
share of its net loss over this period.
27
As discussed above, 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. Our
main objective in entering in securitization transactions is to obtain financing
for auto loan activities. Securitized loans held by the securitization trusts
totaled $823.1 million as of December 31, 2003 and $680.7 million at September
30, 2003. See also "Contractual Obligations and Commercial Commitments" in this
Item 2.
In October 1999, we entered into an agreement for the lease of our corporate
headquarters campus 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 $145.0 million in residual guarantees
representing about 85% of the total construction costs of $170.0 million. We are
also contingently liable to purchase the corporate headquarters campus for an
amount equal to the final construction costs of $170.0 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.
On December 31, 2003, we consolidated the lessor trust under the provisions of
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities
(revised December 2003)" and recognized, as a current liability, the loan
principal of $164.9 million and minority interest of $5.1 million, which, in
total, represent the amount used to finance the construction of our corporate
headquarters campus and our maximum contingent liability under the agreements.
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. For additional
information about our accounting policies, 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, 2003.
GOODWILL AND OTHER INTANGIBLE ASSETS
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 when there is an indication of impairment, or at
least once a year. As of March 31, 2003, we completed our annual impairment test
of goodwill and indefinite-lived and definite-lived intangible assets and we
determined that there was no impairment to these assets as of October 1, 2002.
The fair value of indefinite-lived intangible assets is determined based on
anticipated discounted cash flows. An indication of goodwill impairment occurs
when the carrying amount of the reporting unit exceeds the implied fair value of
the reporting unit. In estimating the fair value of the reporting unit, we use
valuation techniques based on discounted cash flows similar to models employed
in analyzing the purchase price of an acquisition target. Intangible assets
subject to amortization are reviewed for impairment at each reporting period on
the basis of the expected future undiscounted operating cash flows, without
interest charges, to be derived from these assets.
In performing our analysis, we used certain assumptions and estimates including
those related to discount rates and the expected future period of cash flows to
be derived from the assets, based on, among other factors, historical trends and
the characteristics of the assets. While we believe that our testing was
appropriate, if these estimates and assumptions change in the future, we may be
required to record impairment charges or otherwise increase amortization
expense.
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 $2.2
billion at
28
December 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.
While we believe that we have accurately 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 December 31, 2003 to provide for any probable losses that may arise
from these matters.
VARIABLE INTEREST ENTITIES
Under Financial Accounting Standards Board Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN 46"), a variable interest entity ("VIE") is
a corporation, trust, partnership or other entity in which the equity investment
holders have not contributed sufficient capital to finance the activities of 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. The consolidation and
disclosure provisions of FIN 46 are effective immediately for VIEs created after
January 31, 2003. Effective July 1, 2003, six of our sponsored investment
products created after January 31, 2003 were consolidated in our financial
statements.
In December 2003, the FASB published FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities (revised December 2003)" ("FIN 46-R"), clarifying
FIN 46 and exempting certain entities from the provisions of FIN 46. Generally,
application of FIN 46-R is required in financial statements of public entities
that have interests in structures commonly referred to as special-purpose
entities for periods ending after December 15, 2003, and, for other types of
VIEs, for periods ending after March 15, 2004. We early adopted FIN 46-R as of
December 31, 2003, and, as a result, we have recognized a cumulative effect of
an accounting change, net of tax, as of this date to reflect the accumulated
retained earnings of VIEs in which we became an interest holder prior to
February 1, 2003 (see Note 7 to the financial statements).
Evaluating whether related entities are VIEs and determining whether we qualify
as the primary beneficiary of these VIEs, is highly complex and involves the use
of estimates and assumptions. In general, when we estimate the expected residual
returns of a VIE based on discounted cash flows, we make certain assumptions
about discount rates. In addition, we determine the volatility of the VIE's
expected returns based on available historical information and management's
estimates. While we believe that our testing and approach were appropriate,
future changes in estimates and assumptions may affect our decision to
consolidate one or more VIEs in our financial statements.
29
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. 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, including
economic and credit market downturns.
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 WIDELY VARIED BUSINESS LINES CAN BE
IMPEDED BY SYSTEMS AND OTHER TECHNOLOGICAL LIMITATIONS. Our continued success in
effectively managing and growing our business both domestically and abroad,
depends on our ability to integrate the varied accounting, financial,
information and operational systems of our various businesses on a global basis.
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.
CERTAIN OF THE PORTFOLIOS WE MANAGE INCLUDING OUR EMERGING MARKET PORTFOLIOS AND
RELATED REVENUES ARE VULNERABLE TO MARKET-SPECIFIC POLITICAL OR ECONOMIC RISKS.
Our emerging market portfolios and revenues derived from managing these
portfolios are subject to significant risks of loss from political and
diplomatic
30
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.
WE ARE SUBJECT TO FEDERAL RESERVE BOARD REGULATION. Upon completion of our
acquisition of Fiduciary Trust 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.
VARIOUS ONGOING GOVERNMENTAL INVESTIGATIONS AND REGULATORY ACTIONS AND REFORMS
RELATING TO CERTAIN PRACTICES IN THE MUTUAL FUND INDUSTRY COULD ADVERSELY IMPACT
OUR ASSETS UNDER MANAGEMENT, FUTURE FINANCIAL RESULTS AND INCREASE OUR COSTS OF
DOING BUSINESS.
MASSACHUSETTS ADMINISTRATIVE PROCEEDING. On February 4, 2004, the Securities
Division of the Office of the Secretary of the Commonwealth of Massachusetts
filed an administrative complaint against Franklin Resources, Inc. and certain
of its subsidiaries (the "Company") alleging violations of the Massachusetts
Uniform Securities Act. The complaint arises from activity that occurred in 2001
during which time an officer of a Company subsidiary was negotiating an
agreement with an investor relating to investments in a mutual fund and a hedge
fund of funds.
The Company believes that the mutual fund investment at issue, which involved
three round-trip transactions, did not violate the fund's prospectus, and the
Company is confident that no investors in the mutual fund were harmed by the
investment. A communication was sent on behalf of this officer to the investor
that provided, among other things, that the investor would receive different
terms than normal with respect to the hedge fund of funds investment. This
variance of the terms of the hedge fund of funds investment was unauthorized and
was rejected by management of the Company. This is the same officer who, as the
Company disclosed in December 2003, had been placed on administrative leave and
has subsequently left the Company.
GOVERNMENTAL INVESTIGATIONS. As part of ongoing investigations by the U.S.
Securities and Exchange Commission (the "SEC"), the U.S. Attorney for the
Northern District of California, the New York Attorney General, the California
Attorney General, the U.S. Attorney for the District of Massachusetts, the
Florida Department of Financial Services and the Commissioner of Securities and
the Attorney General of the State of West Virginia, relating to certain
practices in the mutual fund industry, including late trading, market timing and
sales compensation arrangements, the Company and its subsidiaries, as well as
certain current or former executives and employees of the Company, have received
requests for information and/or subpoenas to testify or produce documents. The
Company and its current employees are providing documents and information in
response to these requests and subpoenas. In addition, the Company has responded
to requests for similar kinds of information from regulatory authorities in some
of the foreign countries where the Company conducts its global asset management
business.
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The Staff of the SEC has informed the Company that it intends to recommend that
the SEC authorize a civil injunctive action against Franklin Advisers, Inc., a
subsidiary of the Company, and Gregory Johnson, who is President and Co-Chief
Executive Officer of Franklin Resources, Inc. and also serves as an executive
officer or director of most of the Company's subsidiaries. The Company
understands that the SEC's investigation is focused on the activities that are
the subject of the Massachusetts administrative proceeding described above and
other instances of alleged market timing by a limited number of third parties
that ended in 2000. There currently are discussions underway with the SEC Staff
in an effort to resolve the issues raised in their investigation. Such
discussions are preliminary and the Company cannot predict the likelihood of
whether those discussions will result in a settlement and, if so, the terms of
such settlement.
Separately, in connection with the SEC's private investigation that resulted in
a proceeding against Morgan Stanley DW, Inc., the Company has been asked to
furnish documents and testimony relating to its arrangements to compensate
brokers who sell Fund shares. Effective November 28, 2003, the Company
determined not to direct any further brokerage where the allocation is based,
not only on best execution, but in addition on the sale of Fund shares in order
to satisfy preferred list or other shelf space arrangements, which determination
may have a material adverse financial impact on the Company.
CLASS ACTION LAWSUITS. The Company has been informed that it and other entities
within Franklin Templeton Investments have been named in several shareholder
class actions related to some of the matters described above. See "Legal
Proceedings" included in Part II, Item 1. of this report. The Company believes
that the claims made in the lawsuits are without merit and it intends to defend
itself vigorously. It is anticipated that the Company may be named in additional
similar civil actions related to some of the matters described above.
INTERNAL INQUIRIES. The Company also has conducted its own internal fact-finding
inquiry with the assistance of outside counsel to determine whether any
shareholders of the Franklin, Templeton and Mutual Series U.S. Funds (each a
"Fund" and together, "Funds"), including Company employees, were permitted to
engage in late trading or in market timing transactions contrary to the policies
of the affected Fund and, if so, the circumstances and persons involved. The
Company's internal inquiry regarding market timing and late trading is
substantially complete. We have not been able to identify any late trading
problems, but we have identified various instances of frequent trading. We
currently believe that the charges the Company understands the SEC Staff is
contemplating are unwarranted. One officer of a subsidiary of the Company has
been placed on administrative leave and subsequently resigned from his position
with the Company.
To date, the Company also has identified some instances of frequent trading in
shares of certain Funds by a few current or former employees in their personal
401(k) plan accounts. These individuals include one trader and one officer of
the Funds. These two individuals have been placed on administrative leave and
the officer has resigned from his positions with the Funds. Although this aspect
of our inquiry is not finally complete, to date we have found no instances of
inappropriate mutual fund trading by any portfolio manager, investment analyst
or officer of Franklin Resources, Inc. The independent directors of the Funds
and the Company have retained independent outside counsel to review these
matters, to determine if any violations of law or policies or inappropriate
trading occurred, to conduct such further inquiries as counsel may deem
necessary and to report their findings and recommendations to the independent
directors of the Funds and the Company's board of directors.
The Company cannot predict with certainty the eventual outcome of the foregoing
Massachusetts administrative proceeding, the governmental investigations or
class action lawsuits, nor whether they will have a material negative impact on,
or cost to, the Company. However, public trust and confidence are critical to
the Company's business and any material loss of investor and/or client
confidence could result in a significant decline in assets under management by
the Company, which would have an adverse effect on future financial results. If
the Company finds that it bears responsibility for any unlawful or inappropriate
conduct that caused losses to our Funds, we are committed to making the Funds or
their shareholders whole, as appropriate. The Company is also committed to
taking action to protect the interests of our Funds' shareholders, including
appropriate action against any Company personnel found to have knowingly
permitted or personally engaged in improper trading practices.
In addition, pending regulatory and legislative actions and reforms affecting
the mutual fund industry may significantly increase the Company's costs of doing
business and/or negatively impact its revenues, either of which could have a
material negative impact on the Company's financial results.
32
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 primarily through financing
transactions and portfolio debt holdings available-for-sale, which are carried
at fair value in our financial statements. As of December 31, 2003, a
significant percentage of our outstanding debt was 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 December 31, 2003, we have considered the potential impact of
the effect on the banking/finance operating segment balances, our outstanding
debt and portfolio debt holdings, individually and collectively, of a 100 basis
point (1%) movement in market interest rates. Based on our analysis, we do not
expect that this change would have a material impact on our operating revenues
or results of operations in either scenario.
We operate primarily 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.
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.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management evaluated, with the participation of the Company's
principal executive and principal financial officers, the effectiveness of the
Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) as of December 31, 2003. Based on their evaluation, the Company's
principal executive and principal financial officers concluded that the
Company's disclosure controls and procedures were effective as of December 31,
2003.
There has been no change in the Company's internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
that occurred during the Company's fiscal quarter ended December 31, 2003, that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 4, 2004, the Securities Division of the Office of the Secretary of
the Commonwealth of Massachusetts filed an administrative complaint against
Franklin Resources, Inc. and certain of its subsidiaries (the "Company")
alleging violations of the Massachusetts Uniform Securities Act. The complaint
arises from activity that occurred in 2001 during which time an officer of a
Company subsidiary was negotiating an agreement with an investor relating to
investments in a mutual fund and a hedge fund of funds.
The Company believes that the mutual fund investment at issue, which involved
three round-trip transactions, did not violate the fund's prospectus, and the
Company is confident that no investors in the mutual fund were harmed by the
investment. A communication was sent on behalf of this officer to the investor
that provided, among other things, that the investor would receive different
terms than normal with respect to the hedge fund of funds investment. This
variance of the terms of the hedge fund of funds investment was unauthorized and
was rejected by management of the Company. This is the same officer who, as the
Company disclosed in December 2003, had been placed on administrative leave and
has subsequently left the Company.
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In addition to the Massachusetts Administrative Proceeding referenced under
"Mutual Fund Proceedings, Actions and Investigations" above, we have been
informed during February 2004 that the Company and certain of its subsidiaries
have been named in multiple lawsuits in different federal courts in Nevada,
California and Florida, seeking class action status alleging violations of
various federal securities laws, although the Company has not yet been served
with the complaints in these lawsuits.
Various subsidiaries of the Company have also been named in multiple lawsuits
filed in federal and state courts in Illinois alleging breach of duty with
respect to the valuation of the portfolio securities of certain Templeton funds
managed by such subsidiaries and seeking monetary damages and costs, as follows:
CULLEN V. TEMPLETON GROWTH FUND, INC. AND TEMPLETON GLOBAL ADVISORS LIMITED,
Case No. 03-859 MJR, was filed on December 16, 2003 in the United States
District Court for the Southern District of Illinois.
KWIATKOWSKI V. TEMPLETON GROWTH FUND, INC. AND TEMPLETON GLOBAL ADVISORS
LIMITED, Case 03 L 785, was filed on December 17, 2003 in the Circuit Court for
the Twentieth Judicial Circuit, St. Clair County, Illinois.
BRADFISCH V. TEMPLETON FUNDS, INC. AND TEMPLETON GLOBAL ADVISORS LIMITED, Case
2003 L 001361, was filed on October 3, 2003 in the Circuit Court for the Third
Judicial Circuit, Madison County, Illinois.
WOODBURY V. TEMPLETON GLOBAL SMALLER COMPANIES FUND, INC. AND TEMPLETON
INVESTMENT COUNSEL, LLC, Case 2003 L 001362, was filed on October 3, 2003 in the
Circuit Court for the Third Judicial Circuit, Madison County, Illinois.
KENERLEY V. TEMPLETON FUNDS, INC. AND TEMPLETON GLOBAL ADVISORS LIMITED, Case
No. 03-770 GPM, was served on the defendants on November 25, 2003. The case was
filed in the United States District Court for the Southern District of Illinois.
This lawsuit alleges breaches of fiduciary duties imposed by Section 36(a) of
the Investment Company Act of 1940 and pendant state law claims with respect to
the valuation of Templeton World Fund's portfolio securities.
PARISE V. TEMPLETON FUNDS, INC. AND TEMPLETON GLOBAL ADVISORS LIMITED, Case No.
2003-L-002049, was filed on December 22, 2003 in the Circuit Court for the Third
Judicial Circuit, Madison County, Illinois and was served on the defendants on
February 13, 2004.
Management strongly believes that the claims made in each of these lawsuits are
without merit and intends vigorously to defend against them.
Please also see the discussion of certain governmental proceedings and
investigations in Note 12. "Commitments and Contingencies - Mutual Fund
Proceedings, Actions and Investigations" of Notes to Consolidated Financial
Statements included in Part I, Item 1 of this report.
Except for the matters described above, there have been no material developments
in the litigation previously reported in our Annual Report on Form 10-K for the
period ended September 30, 2003 as filed with the SEC on December 22, 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.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: see Exhibit Index on page 35 to page 36.
(b) Reports on Form 8-K:
(i) Form 8-K filed on October 7, 2003 reporting under Item 5 "Other
Events" and Item 7 "Financial Statements and Exhibits", a press
release issued on October 1, 2003 by Registrant and Darby Overseas
Investments, Ltd.
(ii) Form 8-K furnished on October 23, 2003 reporting under Item 7
"Financial Statements and Exhibits" an earning press release, dated
October 23, 2003, and including said press release as an Exhibit under
Item 12 "Results of Operations and Financial Condition".
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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: February 17, 2004 By: /s/ JAMES R. BAIO
-----------------
James R. Baio
Senior Vice President and
Chief Financial Officer
36
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 incorporated by
reference to Exhibit 4.5 to the Company's Quarterly Report
on Form 10-Q for the period ended March 31, 2003, filed on
May 12, 2003
Exhibit 12 Computations of ratios of earnings to fixed charges
Exhibit 31.1 Certification of Co-Chief Executive Officer
Exhibit 31.2 Certification of Co-Chief Executive Officer
Exhibit 31.3 Certification of Chief Financial Officer
Exhibit 32.1 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 (furnished herewith)
Exhibit 32.2 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 (furnished herewith)
Exhibit 32.3 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 (furnished herewith)
37