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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 June 30, 2004
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
defined 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: 249,384,408 shares, common stock, par value $.10 per share, at July
30, 2004.
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands, except per share data) 2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------
OPERATING REVENUES:
Investment management fees $505,409 $376,553 $1,459,512 $1,075,862
Underwriting and distribution fees 277,790 225,632 844,545 605,727
Shareholder servicing fees 60,582 57,430 183,644 160,796
Consolidated sponsored investment products income, net 1,136 -- 2,645 --
Other, net 17,836 24,292 53,217 60,108
- -------------------------------------------------------------------------------------------------------------
Total operating revenues 862,753 683,907 2,543,563 1,902,493
- -------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES:
Underwriting and distribution 247,930 207,071 758,177 548,986
Compensation and benefits 193,532 163,230 579,875 483,157
Information systems, technology and occupancy 67,464 70,459 205,525 214,458
Advertising and promotion 31,139 22,281 84,306 69,151
Amortization of deferred sales commissions 24,688 19,159 72,133 52,244
Amortization of intangible assets 4,398 4,244 13,201 12,716
Provision for governmental investigations, proceedings
and actions 21,500 -- 81,500 --
September 11, 2001 recovery, net -- -- (30,277) --
Other 31,116 28,088 90,067 73,245
- -------------------------------------------------------------------------------------------------------------
Total operating expenses 621,767 514,532 1,854,507 1,453,957
- -------------------------------------------------------------------------------------------------------------
Operating income 240,986 169,375 689,056 448,536
OTHER INCOME (EXPENSES):
Consolidated sponsored investment products (losses)
gains, net (3,463) -- 6,356 --
Investment and other income 14,300 22,415 59,437 50,276
Interest expense (7,832) (6,736) (22,742) (12,805)
- -------------------------------------------------------------------------------------------------------------
Other income, net 3,005 15,679 43,051 37,471
- -------------------------------------------------------------------------------------------------------------
Income before taxes on income and cumulative effect of an
accounting change 243,991 185,054 732,107 486,007
Taxes on income 70,095 53,666 217,903 135,256
- -------------------------------------------------------------------------------------------------------------
Income before cumulative effect of an accounting change,
net of tax 173,896 131,388 514,204 350,751
Cumulative effect of an accounting change, net of tax -- -- 4,779 --
- -------------------------------------------------------------------------------------------------------------
NET INCOME $173,896 $131,388 $518,983 $350,751
- -------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Income before cumulative effect of an accounting change $0.70 $0.52 $2.06 $1.37
Cumulative effect of an accounting change -- -- 0.02 --
- -------------------------------------------------------------------------------------------------------------
NET INCOME $0.70 $0.52 $2.08 $1.37
- -------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE:
Income before cumulative effect of an accounting change $0.69 $0.52 $2.04 $1.37
Cumulative effect of an accounting change -- -- 0.02 --
- -------------------------------------------------------------------------------------------------------------
NET INCOME $0.69 $0.52 $2.06 $1.37
- -------------------------------------------------------------------------------------------------------------
Dividends per share $0.085 $0.075 $0.255 $0.225
See accompanying notes to the consolidated financial statements.
2
FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
JUNE 30, SEPTEMBER 30,
(in thousands) 2004 2003
- ------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $2,435,268 $1,017,023
Receivables 404,475 338,292
Investment securities, trading 273,254 41,379
Investment securities, available-for-sale 494,765 1,480,554
Prepaid expenses and other 91,739 91,579
- ------------------------------------------------------------------------------------------------------
Total current assets 3,699,501 2,968,827
- ------------------------------------------------------------------------------------------------------
Banking/finance assets:
Cash and cash equivalents 45,148 36,672
Loans held for sale, net 220,188 3,006
Loans receivable, net 340,443 467,666
Investment securities, available-for-sale 304,971 358,387
Other 45,133 52,694
- ------------------------------------------------------------------------------------------------------
Total banking/finance assets 955,883 918,425
- ------------------------------------------------------------------------------------------------------
Non-current assets:
Investments, other 311,128 280,356
Deferred sales commissions 287,260 215,816
Property and equipment, net 475,370 356,772
Goodwill 1,377,279 1,335,517
Other intangible assets, net 674,543 684,281
Receivable from banking/finance group 184,328 102,864
Other 109,294 107,891
- ------------------------------------------------------------------------------------------------------
Total non-current assets 3,419,202 3,083,497
- ------------------------------------------------------------------------------------------------------
TOTAL ASSETS $8,074,586 $6,970,749
- ------------------------------------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
3
FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
JUNE 30, SEPTEMBER 30,
(in thousands, except share data) 2004 2003
- -----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Compensation and benefits $249,568 $225,446
Current maturities of long-term debt 164,935 287
Accounts payable and accrued expenses 243,565 112,630
Commissions 118,329 95,560
Income taxes 69,242 43,500
Other 10,628 11,103
- -----------------------------------------------------------------------------------------------------------
Total current liabilities 856,267 488,526
- -----------------------------------------------------------------------------------------------------------
Banking/finance liabilities:
Deposits 558,989 633,983
Payable to parent 184,328 102,864
Other 59,952 65,133
- -----------------------------------------------------------------------------------------------------------
Total banking/finance liabilities 803,269 801,980
- -----------------------------------------------------------------------------------------------------------
Non-current liabilities:
Long-term debt 1,179,260 1,108,881
Deferred taxes 220,546 203,498
Other 34,195 32,412
- -----------------------------------------------------------------------------------------------------------
Total non-current liabilities 1,434,001 1,344,791
- -----------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------
Total liabilities 3,093,537 2,635,297
- -----------------------------------------------------------------------------------------------------------
Minority interest 75,780 25,344
Commitments and contingencies (Note 13)
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;
249,361,284 and 245,931,522 shares issued and outstanding, for June
30, 2004 and September 30, 2003 24,936 24,593
Capital in excess of par value 230,492 108,024
Retained earnings 4,584,933 4,129,644
Accumulated other comprehensive income 64,908 47,847
- -----------------------------------------------------------------------------------------------------------
Total stockholders' equity 4,905,269 4,310,108
- -----------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $8,074,586 $6,970,749
- -----------------------------------------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
4
FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
NINE MONTHS ENDED
JUNE 30,
(in thousands) 2004 2003
- ------------------------------------------------------------------------------------------------------
NET INCOME $518,983 $350,751
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in receivables, prepaid expenses and other (68,703) (30,084)
Deferred sales commission advances (143,577) (112,065)
Increase in other current liabilities 51,886 106,954
Provision for governmental investigations, proceedings and actions 76,946 --
Increase (decrease) in deferred income taxes and taxes payable 43,169 (45,915)
Increase in commissions payable 22,769 12,064
Increase (decrease) in accrued compensation and benefits 67,991 (14,071)
Originations of loans held for sale, net (217,186) --
Depreciation and amortization 137,455 132,612
Net gains on disposal of assets (18,586) (5,678)
- ------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 471,147 394,568
- ------------------------------------------------------------------------------------------------------
Purchase of investments (1,865,277) (1,644,307)
Liquidation of investments 2,689,393 1,370,323
Purchase of banking/finance investments (2,147) (235,522)
Liquidation of banking/finance investments 57,952 419,114
Net proceeds from securitization of loans receivable 226,527 372,961
Net origination of loans receivable (95,041) (285,267)
Additions of property and equipment, net (11,935) (43,549)
Acquisition of subsidiaries, net of cash acquired (69,904) --
Insurance proceeds related to September 11, 2001 event 32,487 10,643
- ------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 962,055 (35,604)
- ------------------------------------------------------------------------------------------------------
Decrease in bank deposits (74,994) (44,965)
Exercise of common stock options 117,083 4,726
Net put option premiums and settlements -- 1,335
Dividends paid on common stock (60,847) (57,379)
Purchase of stock (50,431) (307,373)
Increase in debt 84,157 493,616
Payments on debt (21,449) (16,113)
- ------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (6,481) 73,847
- ------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 1,426,721 432,811
Cash and cash equivalents, beginning of period 1,053,695 980,604
- ------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $2,480,416 $1,413,415
- ------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION:
Value of common stock issued, principally restricted stock $48,059 $28,373
Total assets related to the consolidation of certain sponsored
investment products and a lessor trust 201,714 --
Total liabilities related to the consolidation of certain sponsored
investment products and a lessor trust 61,834 --
Fair value of subsidiary assets acquired 37,876 --
Fair value of subsidiary liabilities assumed 6,576 --
See accompanying notes to the consolidated financial statements.
5
FRANKLIN RESOURCES, INC.
Notes to Consolidated Financial Statements
June 30, 2004
(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 (the "SEC"). 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 June 30, 2004.
2. NEW ACCOUNTING STANDARDS
------------------------
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN
46"). Under FIN 46, a variable interest entity ("VIE") is an entity in
which the equity investment holders have not contributed sufficient capital
to finance its activities 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
were 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 recognized a cumulative effect of an accounting change, net of
tax, of $4.8 million 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 Notes 7 and 13).
In December 2003, the 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. SFAS 132 is effective for financial
statements relating to fiscal years ending after December 15, 2003. The
interim-period disclosure requirements for SFAS 132 were effective for
interim periods beginning after December 15, 2003 (see Note 12).
3. ACQUISITIONS
------------
On October 1, 2003, we acquired the remaining 87.3% interest in Darby
Overseas Investments, Ltd. and Darby Overseas Partners, L.P. (collectively
"Darby") that we did not own for an additional cash investment of
approximately $75.9 million. The acquisition cost was allocated to tangible
net assets acquired ($31.3 million), definite-lived management contracts
($3.4 million) and goodwill ($41.2 million). These definite-lived
intangible assets are being 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 computes comprehensive income.
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------
Net income $173,896 $131,388 $518,983 $350,751
Net unrealized (loss) gain on available-for-sale
securities, net of tax (8,206) 38,141 10,765 41,296
Foreign currency translation adjustments (9,840) 13,965 6,979 25,186
Minimum pension liability adjustment -- -- (683) --
-------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME $155,850 $183,494 $536,044 $417,233
-------------------------------------------------------------------------------------------------
5. EARNINGS PER SHARE
------------------
We computed earnings per share as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands, except per share data) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------
Net income $173,896 $131,388 $518,983 $350,751
-------------------------------------------------------------------------------------------------
Weighted-average shares outstanding - basic 249,802 252,633 249,032 255,721
Incremental shares from assumed conversions 3,314 621 3,212 622
-------------------------------------------------------------------------------------------------
Weighted-average shares outstanding - diluted 253,116 253,254 252,244 256,343
-------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
Income before cumulative effect of an accounting
change $0.70 $0.52 $2.06 $1.37
Cumulative effect of an accounting change -- -- 0.02 --
-------------------------------------------------------------------------------------------------
Net income $0.70 $0.52 $2.08 $1.37
-------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE:
Income before cumulative effect of an accounting
change $0.69 $0.52 $2.04 $1.37
Cumulative effect of an accounting change -- -- 0.02 --
-------------------------------------------------------------------------------------------------
Net income $0.69 $0.52 $2.06 $1.37
-------------------------------------------------------------------------------------------------
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") allowing eligible participants to buy our common stock at 90%
of its market value on defined dates and to receive a 50% match of the
shares purchased if held for a defined period. 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 purchased at a discount under the ESIP. Matching grants provided
to ESIP participants, however, are recognized as expenses during the
required holding period.
If we had determined compensation costs for our stock option plans and the
discount available on 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
7
estimated fair value of options was calculated using the Black-Scholes
option-pricing model and is amortized over the options' vesting periods.
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands, except per share data) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------
Net income, as reported $173,896 $131,388 $518,983 $350,751
Less: stock-based compensation expense
determined under the fair value
method, net of tax (12,949) (17,325) (35,941) (51,274)
------------------------------------------------------------------------------------------------
PRO FORMA NET INCOME $160,947 $114,063 $483,042 $299,477
------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE:
As reported $0.70 $0.52 $2.08 1.37
Pro forma 0.64 0.45 1.94 1.17
DILUTED EARNINGS PER SHARE:
As reported $0.69 $0.52 $2.06 $1.37
Pro forma 0.64 0.45 1.91 1.17
------------------------------------------------------------------------------------------------
7. CONSOLIDATED SPONSORED INVESTMENT PRODUCTS
The following tables present the effect on our consolidated results of
operations and financial position of consolidating majority-owned sponsored
investment products.
THREE MONTHS ENDED JUNE 30, 2004
-------------------------------------------------
BEFORE CONSOLIDATION SPONSORED
OF SPONSORED INVESTMENT
(in thousands) INVESTMENT PRODUCTS PRODUCTS CONSOLIDATED
------------------------------------------------------------------------------------------------
OPERATING REVENUES:
Investment management fees $505,846 $(437) $505,409
Underwriting and distribution fees 277,875 (85) 277,790
Shareholder servicing fees 60,590 (8) 60,582
Consolidated sponsored investment products income, net -- 1,136 1,136
Other, net 17,836 -- 17,836
------------------------------------------------------------------------------------------------
Total operating revenues 862,147 606 862,753
------------------------------------------------------------------------------------------------
OPERATING EXPENSES 621,767 -- 621,767
------------------------------------------------------------------------------------------------
Operating income 240,380 606 240,986
------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSES):
Consolidated sponsored investment product losses, net -- (3,463) (3,463)
Investment and other income 14,329 (29) 14,300
Interest expense (7,832) -- (7,832)
------------------------------------------------------------------------------------------------
Other income, net 6,497 (3,492) 3,005
------------------------------------------------------------------------------------------------
Income before taxes on income and cumulative effect of
an accounting change 246,877 (2,886) 243,991
Taxes on income 70,903 (808) 70,095
------------------------------------------------------------------------------------------------
Income before cumulative effect of an accounting change,
net of tax 175,974 (2,078) 173,896
Cumulative effect of an accounting change, net of tax -- -- --
------------------------------------------------------------------------------------------------
NET INCOME $175,974 $(2,078) $173,896
------------------------------------------------------------------------------------------------
8
NINE MONTHS ENDED JUNE 30, 2004
-------------------------------------------------
BEFORE CONSOLIDATION SPONSORED
OF SPONSORED INVESTMENT
(in thousands) INVESTMENT PRODUCTS PRODUCTS CONSOLIDATED
------------------------------------------------------------------------------------------------
OPERATING REVENUES:
Investment management fees $1,460,721 $(1,209) $1,459,512
Underwriting and distribution fees 844,632 (87) 844,545
Shareholder servicing fees 183,666 (22) 183,644
Consolidated sponsored investment products income, net -- 2,645 2,645
Other, net 53,217 -- 53,217
------------------------------------------------------------------------------------------------
Total operating revenues 2,542,236 1,327 2,543,563
------------------------------------------------------------------------------------------------
OPERATING EXPENSES 1,854,507 -- 1,854,507
------------------------------------------------------------------------------------------------
Operating income 687,729 1,327 689,056
------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSES):
Consolidated sponsored investment product gains, net -- 6,356 6,356
Investment and other income 62,576 (3,139) 59,437
Interest expense (22,742) -- (22,742)
------------------------------------------------------------------------------------------------
Other income, net 39,834 3,217 43,051
------------------------------------------------------------------------------------------------
Income before taxes on income and cumulative effect of
an accounting change 727,563 4,544 732,107
Taxes on income 216,557 1,346 217,903
------------------------------------------------------------------------------------------------
Income before cumulative effect of an accounting change,
net of tax 511,006 3,198 514,204
Cumulative effect of an accounting change, net of tax (3,189) 7,968 4,779
------------------------------------------------------------------------------------------------
NET INCOME $507,817 $11,166 $518,983
------------------------------------------------------------------------------------------------
AS OF JUNE 30, 2004
-------------------------------------------------
BEFORE CONSOLIDATION SPONSORED
OF SPONSORED INVESTMENT
(in thousands) INVESTMENT PRODUCTS PRODUCTS CONSOLIDATED
------------------------------------------------------------------------------------------------
ASSETS
Current assets $3,578,428 $121,073 $3,699,501
Banking/finance assets 955,883 -- 955,883
Non-current assets 3,419,202 -- 3,419,202
------------------------------------------------------------------------------------------------
TOTAL ASSETS $7,953,513 $121,073 $8,074,586
------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities $783,398 $72,869 $856,267
Banking/finance liabilities 803,269 -- 803,269
Non-current liabilities 1,434,001 -- 1,434,001
------------------------------------------------------------------------------------------------
Total liabilities 3,020,668 72,869 3,093,537
Minority interest 25,157 50,623 75,780
Total stockholders' equity 4,907,688 (2,419) 4,905,269
------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $7,953,513 $121,073 $8,074,586
------------------------------------------------------------------------------------------------
9
8. CASH AND CASH EQUIVALENTS
-------------------------
Cash and cash equivalents consist of the following:
JUNE 30, SEPTEMBER 30,
(in thousands) 2004 2003
---------------------------------------------------------------------- ------------- ---------------
Cash and due from banks $421,673 $260,530
Federal funds sold and securities purchased under agreements to resell 12,887 3,741
Money market funds, time deposits and other 2,045,856 789,424
---------------------------------------------------------------------- --------------- ---------------
TOTAL $2,480,416 $1,053,695
---------------------------------------------------------------------- --------------- ---------------
Federal Reserve Board regulations required reserve balances of $2.7 million
at June 30, 2004 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.
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------
Gross sale proceeds $-- $259,305 $231,786 $390,925
Less: net carrying amount of loans sold -- 249,781 226,068 375,885
-------------------------------------------------------------------------------------------------
PRE-TAX GAIN $-- $9,524 $5,718 $15,040
-------------------------------------------------------------------------------------------------
During the quarter ending September 30, 2004, we realized a pre-tax gain of
approximately $0.6 million on the sale of auto loans with a net carrying
amount of approximately $247.7 million.
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 NINE MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
-------------------------------------------------------------------------------------------------
Excess cash flow discount rate (annual rate) -- 12.0% 12.0% 12.0%
Cumulative life loss rate -- 3.7% 3.4% 3.7 - 4.3%
Pre-payment speed assumption (average monthly rate) -- 1.8% 1.8% 1.8%
-------------------------------------------------------------------------------------------------
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.
10
We generally estimate the fair value of the interest-only strips at each
period-end based on the present value of future expected cash flows,
consistent with the methodology used at the date of securitization. The
following shows the carrying value and the sensitivity of the interest-only
strip receivable to hypothetical adverse changes in the key economic
assumptions used to measure fair value:
JUNE 30, SEPTEMBER
(in thousands) 2004 30, 2003
------------------------------------------------------------------- ------------- ---------------
CARRYING AMOUNT/FAIR VALUE OF INTEREST-ONLY STRIPS $28,706 $36,010
--------------------------------------------------
EXCESS CASH FLOW DISCOUNT RATE (ANNUAL RATE) 12.0% 12.0%
--------------------------------------------
Impact on fair value of 10% adverse change $(398) $(493)
Impact on fair value of 20% adverse change (784) (971)
CUMULATIVE LIFE LOSS RATE 4.0% 3.9%
-------------------------
Impact on fair value of 10% adverse change $(2,102) $(2,412)
Impact on fair value of 20% adverse change (4,203) (4,725)
PRE-PAYMENT SPEED ASSUMPTION (AVERAGE MONTHLY RATE) 1.8% 1.8%
---------------------------------------------------
Impact on fair value of 10% adverse change $(2,948) $(3,505)
Impact on fair value of 20% adverse change (5,697) (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. The
following is a summary of cash flows received from and paid to
securitization trusts.
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands) 2004 2003 2004 2003
-------------------------------------------------------------------------------------------------
Servicing fees received $3,047 $2,375 $9,844 $7,444
Other cash flows received 8,021 4,973 18,726 14,105
Purchase of loans from trusts -- 441 11,837 10,804
-------------------------------------------------------------------------------------------------
Amounts payable to the trustee related to loan principal and interest
collected on behalf of the trusts of $35.9 million at June 30, 2004, 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
were as follows:
JUNE 30, SEPTEMBER
(in thousands) 2004 30, 2003
-------------------------------------------------------------------------------------------------
Securitized loans held by securitization trusts $629,546 $680,695
Delinquencies 12,674 12,911
-------------------------------------------------------------------------------------------------
Net charge-offs on the securitized loan portfolio were $2.8 million and
$11.6 million for the three and nine months ended June 30, 2004 and $3.1
million and $9.1 million for the three and nine months ended June 30, 2003.
11
10. GOODWILL AND OTHER INTANGIBLE ASSETS
------------------------------------
Intangible assets, other than goodwill were as follows:
GROSS CARRYING ACCUMULATED NET CARRYING
(in thousands) AMOUNT AMORTIZATION AMOUNT
-------------------------------------------------------------------------------------------------
BALANCE, JUNE 30, 2004
Amortized intangible assets:
Customer base $232,838 $(50,711) $182,127
Other 34,933 (21,210) 13,723
-------------------------------------------------------------------------------------------------
267,771 (71,921) 195,850
Non-amortized intangible assets:
Management contracts 478,693 -- 478,693
-------------------------------------------------------------------------------------------------
TOTAL $746,464 $(71,921) $674,543
-------------------------------------------------------------------------------------------------
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 $17,219
2005 17,219
2006 17,219
2007 17,219
2008 17,219
---------------------------------------------------------------------------
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) 41,155
Foreign currency movements 607
---------------------------------------------------------------------------
GOODWILL AS OF JUNE 30, 2004 $1,377,279
---------------------------------------------------------------------------
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.
Non-amortized intangible assets represent the value of management contracts
related to certain of our sponsored investment products that are
indefinite-lived. During the quarter ended March 31, 2004, we completed our
annual impairment testing of goodwill and indefinite-lived intangible
assets under the
12
guidance set out in SFAS No. 142, "Goodwill and Other Intangible Assets",
and we determined that there was no impairment in the value of these assets
as of October 1, 2003.
11. DEBT
----
Outstanding debt consisted of the following:
JUNE 30, SEPTEMBER
(in thousands) 2004 30, 2003
-------------------------------------------------------------------------------------------------
SHORT-TERM:
Federal Home Loan Bank advances $13,000 $14,500
Current maturities of long-term debt 164,935 287
----------------------------------------------------------------- --------------- ---------------
177,935 14,787
LONG-TERM:
Convertible Notes (including accrued interest) 527,642 520,325
Medium Term Notes 420,000 420,000
Other 231,618 168,556
----------------------------------------------------------------- --------------- ---------------
1,179,260 1,108,881
----------------------------------------------------------------- --------------- ---------------
TOTAL DEBT $1,357,195 $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. The facility expires in
September 2004 and will continue to be classified as a current liability
until it is refinanced or repaid.
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 their accreted value of $3.5 million in cash. In
addition, on May 12, 2004, we repurchased $11.0 thousand face value of the
Convertible Notes at their accreted value. We may have to make additional
repurchases, at the option of the holders, on May 11 of 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 will be redeemed by the holders, depends on, among other factors, the
performance of our common stock.
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.
Other long-term debt consists primarily of deferred commission liabilities
recognized in relation to U.S. deferred commission assets financed by
Lightning Finance Company Limited ("LFL") that were not sold by LFL in a
securitization transaction as of June 30, 2004 and September 30, 2003.
12. PENSIONS AND OTHER POSTRETIREMENT BENEFITS
------------------------------------------
Fiduciary Trust has a noncontributory retirement plan (the "Retirement
Plan") covering substantially all its employees hired before we acquired
it. Fiduciary Trust also maintains a nonqualified supplementary executive
retirement plan ("SERP") to pay defined benefits in excess of limits
imposed by Federal tax law to participants in the retirement plan who
attain age 55 and ten years of service as of the plan termination date. In
April 2003, the Board of Directors of Fiduciary Trust approved a resolution
to terminate both the Retirement Plan and the SERP as of June 30, 2003. In
December 2003, Fiduciary Trust filed for approval
13
of the Retirement Plan termination with the Internal Revenue Service. Since
Fiduciary Trust has not been notified that the Internal Revenue Service has
approved the Retirement Plan termination, a curtailment gain (loss) has not
yet been recorded in accordance with Statement of Financial Accounting
Standards No. 88, "Employers' Accounting for Settlements and Curtailments
of Defined Benefit Pension Plans and for Termination Benefits".
In addition to these pension plans, Fiduciary Trust sponsors a defined
benefit healthcare plan that provides post-retirement medical benefits to
full-time employees who have worked ten years and attained age 55 while in
the service of Fiduciary Trust, or have met alternate eligibility criteria.
The defined benefit healthcare plan was closed to new entrants in April
2003.
The following table summarizes the components of net periodic benefit cost
for the Retirement Plan and SERP, under pension benefits, and for the
defined healthcare plan, under other benefits.
PENSION BENEFITS OTHER BENEFITS
-------------------------------------------------------
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands) 2004 2003 2004 2003
--------------------------------------------------------------------------------------------------
Service cost $-- $242 $12 $7
Interest cost 391 323 101 80
Expected return on plan assets (226) (193) -- --
Amortization of prior service costs -- (32) 64 --
Amortization of net loss 67 950 17 --
--------------------------------------------------------------------------------------------------
NET PERIODIC BENEFIT COST $232 $1,290 $194 $87
--------------------------------------------------------------------------------------------------
PENSION BENEFITS OTHER BENEFITS
-------------------------------------------------------
NINE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands) 2004 2003 2004 2003
--------------------------------------------------------------------------------------------------
Service cost $-- $726 $36 $21
Interest cost 1,173 969 303 240
Expected return on plan assets (678) (579) -- --
Amortization of prior service costs -- (96) 192 --
Amortization of net loss 201 2,850 51 --
--------------------------------------------------------------------------------------------------
NET PERIODIC BENEFIT COST $696 $3,870 $582 $261
--------------------------------------------------------------------------------------------------
In the nine months ended June 30, 2004, we have not made any contribution
to the Retirement Plan. Based on our most recent valuation, we anticipate
that we will contribute an additional $10.3 million to the Retirement Plan
and an additional $4.2 million to the SERP, when final approval of the
Retirement Plan termination is received from the Internal Revenue Service.
We accrued the benefit liability for this anticipated funding in our
financial statements during the fiscal year ended September 30, 2003.
13. 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 year 2005, with additional
renewal options for a further period of up to 10 years. In connection with
this lease, we are
14
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 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 June 30,
2004, the maximum potential amount of future payments was $16.8 million
relating to guarantees made prior to January 1, 2003. In addition, our
consolidated balance sheet at June 30, 2004 included a $0.4 million
liability to reflect obligations arising from auto securitization
transactions subsequent to December 31, 2002.
At June 30, 2004, our banking/finance operating segment had issued
financial standby letters of credit totaling $2.5 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 $2.7
million as of June 30, 2004 and commercial real estate.
GOVERNMENTAL INVESTIGATIONS, PROCEEDINGS AND ACTIONS
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") claiming violations of
the Massachusetts Uniform Securities Act ("Massachusetts Act") with respect
to an alleged arrangement to permit market timing (the "Mass Proceeding").
On February 17, 2004, the Company filed an Answer denying all violations of
the Massachusetts Act. A hearing on this matter is presently scheduled to
commence on September 20, 2004.
GOVERNMENTAL INVESTIGATIONS. As part of ongoing investigations by 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, the West Virginia Attorney General, the
Vermont Department of Banking, Insurance, Securities, and Health Care
Administration and the National Association of Securities Dealers, relating
to certain practices in the mutual fund industry, including late trading,
market timing and payments to securities dealers who sell fund shares, 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 have been 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.
On August 2, 2004, Franklin Resources, Inc. announced that an agreement has
been reached by its subsidiary, Franklin Advisers, Inc. ("Franklin
Advisers"), with the SEC that resolves the issues resulting from the SEC's
investigation of market timing activity and the SEC issued an "Order
instituting administrative and cease-and-desist proceedings pursuant to
sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and
sections 9(b) and 9(f) of the Investment Company Act of 1940, making
findings and imposing remedial sanctions and a cease and desist order" (the
"Order"). The SEC's Order concerns the activities of a limited number of
third parties that ended in 2000 and those that are the subject of the Mass
Proceeding described above.
15
Under the terms of the SEC's Order, pursuant to which Franklin Advisers
neither admits nor denies any wrongdoing, Franklin Advisers has agreed to
pay $50 million to be distributed to fund shareholders, of which $20
million is a civil penalty. This payment was part of an accrual by the
Company in its fiscal quarter ended March 31, 2004, and will not result in
an additional charge to income.
In the Order, the SEC recognizes that the Company has generally sought to
detect, discourage and prevent market timing in its funds and began to
increase its efforts to control market timing in 1999. The Order also
requires Franklin Advisers to, among other things:
* Enhance and periodically review compliance policies and
procedures, and establish a corporate ombudsman;
* Establish a new internal position whose responsibilities shall
include compliance matters related to conflicts of interests; and
* Retain an Independent Distribution Consultant to develop a plan
to distribute the $50 million settlement to fund shareholders.
The Order further provides that in any related investor actions, Franklin
Advisers will not benefit from any offset or reduction of any investor's
claim by the amount of any distribution from the above-described $50
million to such investor that is proportionately attributable to the civil
penalty paid by Franklin Advisers.
The staff of the SEC has also informed the Company that it is considering
recommending a civil action or proceeding against Franklin Advisers and
Franklin Templeton Distributors, Inc. ("FTDI"), another subsidiary of the
Company, concerning payments to securities dealers who sell fund shares
(commonly referred to as "revenue sharing"). The staff of the California
Attorney General's Office ("CAGO") also has advised us that it is
authorized to bring a civil action against Franklin Resources, Inc. and
FTDI arising from the same events. Even though the Company currently
believes that the charges the SEC staff and CAGO staff are contemplating
are unwarranted, it also believes that it is in the best interest of the
Company's and funds' shareholders to resolve these issues voluntarily, to
the extent the Company can reasonably do so. The Company continues to have
discussions towards resolving these governmental investigations.
The Company's results for the quarter ended June 30, 2004, included a
charge to income of $21.5 million ($17.3 million net of taxes), which
represents the costs that can be currently estimated relating to
anticipated settlement of governmental investigations concerning payments
to securities dealers who sell fund shares. This $21.5 million charge is in
addition to the $60.0 million ($45.6 million, net of taxes) charge to
income taken by the Company in the quarter ended March 31, 2004, primarily
for ongoing governmental investigations, proceedings and actions related to
market timing allegations.
Effective November 28, 2003, the Company determined not to direct any
further brokerage commissions where the allocation is based, not only on
best execution, but also on the sale of shares of the Franklin, Templeton
and Mutual Series U.S. funds (each a "Fund" and together, "Funds"), which
determination may have an adverse impact on the Company.
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 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 found any
late trading, but we have identified various instances of frequent trading.
One officer of a subsidiary of the Company was placed on administrative
leave and subsequently resigned from his position with the Company in
December 2003.
We have found no instances of inappropriate mutual fund trading by any
portfolio manager, investment analyst or officer of Franklin Resources,
Inc. As previously disclosed, the Company 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
included one trader and one officer of the Funds. Pending our further
inquiry, these two individuals were placed on administrative leave and the
officer resigned from his positions with the Funds. The independent
directors of the Funds and the Company also retained independent outside
counsel to review these matters and to report their findings and
16
recommendations. Based on independent counsel's findings and
recommendations, the Company reinstated the trader. The independent counsel
concluded that some instances of the former Fund officer's trading violated
Company policy, and the Company was prepared to institute appropriate
disciplinary action. Subsequently, the former Fund officer resigned from
his employment with the Company. The Company does not believe there were
any losses to the Funds as a result of this trading.
OTHER LEGAL PROCEEDINGS
In addition, the Company and certain of its subsidiaries and current and
former officers, employees, and directors have been named in multiple
lawsuits in different federal courts in Nevada, California, Illinois, New
York, and Florida, alleging violations of various federal securities laws
and seeking, among other things, monetary damages and costs. Specifically,
the lawsuits claim breach of duty with respect to alleged arrangements to
permit market timing and/or late trading activity, or breach of duty with
respect to the valuation of the portfolio securities of certain Templeton
Funds managed by Company subsidiaries, resulting in alleged market timing
activity. The majority of these lawsuits duplicate, in whole or in part,
the allegations asserted in the Mass Proceeding detailed above. The
lawsuits are styled as class actions or derivative actions on behalf of
either the named Funds or the Company.
Management strongly believes that the claims made in each of these
lawsuits, as more specifically described below, are without merit and
intends to vigorously defend against them.
To date, more than 240 similar lawsuits against 18 different mutual fund
companies have been filed in federal district courts throughout the
country. Because these cases involve common questions of fact, the Judicial
Panel on Multidistrict Litigation (the "Judicial Panel") ordered the
creation of a multidistrict litigation, entitled "In re Mutual Funds
Investment Litigation." The Judicial Panel then transferred similar cases
from different districts to the United States District Court for the
District of Maryland for coordinated or consolidated pretrial proceedings
(the "MDL").
As of August 12, 2004, the following lawsuits are pending against the
Company and have been transferred to the MDL:
Kenerley v. Templeton Funds, Inc., et al., Case No. 03-770 GPM, filed on
November 19, 2003 in the United States District Court for the Southern
District of Illinois; Cullen v. Templeton Growth Fund, Inc., et al., Case
No. 03-859 MJR, filed on December 16, 2003 in the United States District
Court for the Southern District of Illinois and transferred to the United
States District Court for the Southern District of Florida on March 29,
2004; Jaffe v. Franklin AGE High Income Fund, et al., Case No.
CV-S-04-0146-PMP-RJJ, filed on February 6, 2004 in the United States
District Court for the District of Nevada; Lum v. Franklin Resources, Inc.,
et al., Case No. C 04 0583 JSW, filed on February 11, 2004 in the United
States District Court for the Northern District of California; Fischbein v.
Franklin AGE High Income Fund, et al., Case No. C 04 0584 JSW, filed on
February 11, 2004 in the United States District Court for the Northern
District of California; Beer v. Franklin AGE High Income Fund, et al., Case
No. 8:04-CV-249-T-26 MAP, filed on February 11, 2004 in the United States
District Court for the Middle District of Florida; Bennett v. Franklin
Resources, Inc., et al., Case No. CV-S-04-0154-HDM-RJJ, filed on February
12, 2004 in the United States District Court for the District of Nevada;
Dukes v. Franklin AGE High Income Fund, et al., Case No. C 04 0598 MJJ,
filed on February 12, 2004, in the United States District Court for the
Northern District of California; McAlvey v. Franklin Resources, Inc., et
al., Case No. C 04 0628 PJH, filed on February 13, 2004 in the United
States District Court for the Northern District of California; Alexander v.
Franklin AGE High Income Fund, et al., Case No. C 04 0639 SC, filed on
February 17, 2004 in the United States District Court for the Northern
District of California; Hugh Sharkey IRA/RO v. Franklin Resources, Inc., et
al., Case No. 04 CV 1330, filed on February 18, 2004 in the United States
District Court for the Southern District of New York; D'Alliessi, et al. v.
Franklin AGE High Income Fund, et al., Case No. C 04 0865 SC, filed on
March 3, 2004 in the United States District Court for the Northern District
of California; Marcus v. Franklin Resources, Inc., et al., Case No. C 04
0901 JL, filed on March 5, 2004 in the United States District Court for the
Northern District of California; Banner v. Franklin Resources, Inc., et
al., Case No. C 04 0902 JL, filed on March 5, 2004 in the United States
District Court for the Northern District of California; Denenberg v.
Franklin Resources, Inc., et al., Case No. C 04 0984 EMC, filed on March
10, 2004 in the United States District Court for the Northern District of
California; Hertz v. Burns, et al., Case No. 04 CV 02489, filed on March
30, 2004 in the United States District Court for the Southern District of
New York.
17
Plaintiffs in the MDL proceeding have until September 29, 2004 to file
their consolidated complaints.
As previously reported, various subsidiaries of the Company have also been
named in multiple lawsuits filed in 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 as follows:
Bradfisch v. Templeton Funds, Inc., et al., Case No. 2003 L 001361, filed
on October 3, 2003 in the Circuit Court of the Third Judicial Circuit,
Madison County, Illinois; Woodbury v. Templeton Global Smaller Companies
Fund, Inc., et al., Case No. 2003 L 001362, filed on October 3, 2003 in the
Circuit Court of the Third Judicial Circuit, Madison County, Illinois;
Kwiatkowski v. Templeton Growth Fund, Inc., et al., Case No. 03 L 785,
filed on December 17, 2003 in the Circuit Court for the Twentieth Judicial
Circuit, St. Clair County, Illinois; Parise v. Templeton Funds, Inc., et
al., Case No. 2003 L 002049, filed on December 22, 2003 in the Circuit
Court of the Third Judicial Circuit, Madison County, Illinois.
These lawsuits are state court actions and are not subject to the MDL.
In addition, the Company and its subsidiaries, as well as certain current
and former officers, employees, and directors, have been named in multiple
lawsuits alleging violations of various securities laws and pendent state
law claims relating to the disclosure of directed brokerage payments and/or
payment of allegedly excessive commissions and advisory fees. These
lawsuits are styled as class actions and derivative actions brought on
behalf of certain Funds, and are as follows:
Stephen Alexander IRA v. Franklin Resources, Inc., et al., Case No. 04-982
(JLL), filed on March 2, 2004 in the United States District Court for the
District of New Jersey; Strigliabotti v. Franklin Resources, Inc., et al.,
Case No. C 04 0883 SI, filed on March 4, 2004 in the United States District
Court for the Northern District of California; Tricarico v. Franklin
Resources, Inc., et al., Case No. CV-04-1052 (JAP), filed on March 4, 2004
in the United States District Court for the District of New Jersey; Miller
v. Franklin Mutual Advisors, LLC, et al., Case No. 04-261 DRH, filed on
April 16, 2004 in the United States District Court for the Southern
District of Illinois; Wilcox v. Franklin Resources, Inc., et al., Case No.
04-2258 (WHW), filed on May 12, 2004 in the United States District Court
for the District of New Jersey; Bahe, Custodian CGM Roth Conversion IRA v.
Franklin/Templeton Distributors, Inc. et al., Case No. 04-11195 PBS, filed
on June 3, 2004 in the United States District Court for the District of
Massachusetts.
The Company cannot predict with certainty the eventual outcome of the
foregoing Mass Proceeding, other governmental investigations or class
actions or other lawsuits, nor whether they will have a material negative
impact on the Company. 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 committed to taking all appropriate actions to protect the
interests of our Funds' shareholders.
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 COMMITMENTS AND CONTINGENCIES
Under FIN 46-R, we have determined that we are a significant variable
interest holder in a number of sponsored investment products as well as in
LFL, a company incorporated in Ireland whose sole business purpose is to
finance our deferred commission assets. As of June 30, 2004, total assets
of sponsored investment products in which we held a significant interest
were approximately $1,231.2 million and our exposure to loss as a result of
our interest in these products was $166.8 million. LFL had approximately
$458.0 million in total assets at June 30, 2004. 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 $53.6 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.
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
18
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 June 30, 2004,
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
June 30, 2004, 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.
At June 30, 2004, our banking/finance operating segment had commitments to
extend credit aggregating $257.0 million, primarily under credit card
lines.
14. COMMON STOCK REPURCHASES
------------------------
During the nine months ended June 30, 2004, we purchased and retired 1.0
million shares at a cost of $50.4 million. At June 30, 2004, approximately
13.6 million shares remained available for repurchase under board
authorizations. During the nine months ended June 30, 2003, we increased
the number of shares authorized for purchase by 20 million shares and we
purchased and retired 9.2 million shares at a cost of $312.3 million. See
also "Part II, Item 2: Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities".
15. 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.
Financial information for our two operating segments 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 NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------
OPERATING REVENUES:
Investment management $848,007 $663,504 $2,499,740 $1,853,586
Banking/finance 14,746 20,403 43,823 48,907
------------------------------------------------------------------------------------------------
TOTAL $862,753 $683,907 $2,543,563 $1,902,493
------------------------------------------------------------------------------------------------
INCOME BEFORE TAXES ON INCOME AND CUMULATIVE EFFECT OF AN ACCOUNTING CHANGE:
Investment management $237,986 $162,329 $710,755 $448,041
Banking/finance 6,005 22,725 21,352 37,966
------------------------------------------------------------------------------------------------
TOTAL $243,991 $185,054 $732,107 $486,007
------------------------------------------------------------------------------------------------
19
Operating segment assets were as follows:
JUNE 30, SEPTEMBER 30,
(in thousands) 2004 2003
---------------------------------------------------------------------------
Investment management $7,118,703 $6,052,324
Banking/finance 955,883 918,425
---------------------------------------------------------------------------
TOTAL $8,074,586 $6,970,749
---------------------------------------------------------------------------
Operating revenues of the banking/finance segment included above were as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------
Interest on loans $8,431 $8,944 $22,199 $24,908
Interest and dividends on investment
securities 2,612 4,241 8,679 15,103
------------------------------------------------------------------------------------------------
Total interest income 11,043 13,185 30,878 40,011
Interest on deposits (969) (1,461) (3,218) (4,841)
Interest on short-term debt (50) (141) (156) (339)
Interest expense - inter-segment (573) (826) (1,286) (2,235)
------------------------------------------------------------------------------------------------
Total interest expense (1,592) (2,428) (4,660) (7,415)
Net interest income 9,451 10,757 26,218 32,596
Other income 5,286 12,595 22,471 25,810
Provision for loan losses 9 (2,949) (4,866) (9,499)
------------------------------------------------------------------------------------------------
TOTAL OPERATING REVENUES $14,746 $20,403 $43,823 $48,907
------------------------------------------------------------------------------------------------
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.
16. 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 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 June 30, 2004, we exceeded the capital adequacy
requirements applicable to us as listed below.
MINIMUM FOR OUR CAPITAL
(in thousands) JUNE 30, 2004 ADEQUACY PURPOSES
-------------------------------------------- ----------------------- ----------------------------
Tier 1 capital $2,933,946 N/A
Total risk-based capital 2,938,237 N/A
Tier 1 leverage ratio 47% 4%
Tier 1 risk-based capital ratio 73% 4%
Total risk-based capital ratio 73% 8%
-------------------------------------------- ----------------------- ----------------------------
20
17. SEPTEMBER 11, 2001 RECOVERY, NET
--------------------------------
In January 2004, we received $32.5 million from our insurance carrier for
claims related to the September 11, 2001 terrorist attacks that destroyed
Fiduciary Trust's headquarters. These proceeds represented final recoveries
for claims submitted to our insurance carrier. We realized a gain of $30.3
million, before income taxes of $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.
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 statements
relating to the future, called "forward-looking" statements. These
forward-looking statements involve a number of risks, uncertainties and other
important factors that could cause the 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 should review the "Risk Factors" section set forth below and in our
recent filings with the U.S. Securities and Exchange Commission (the "SEC"),
which describes these risks, uncertainties and other important factors in more
detail.
GENERAL
We derive substantially all of our operating revenues, operating expenses and
net income from providing investment advisory and related services to retail
mutual funds, institutional, high net-worth, and 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
We sponsor a broad range of investment products including global/international
equity, U.S. equity, hybrid/balanced, fixed-income and money market mutual
funds, and other investment products that meet a wide variety of specific
investment needs of individuals and institutions.
The level of our revenues depends largely on the level and relative mix of
assets under management. To a lesser degree, our revenues also depend on the
level of mutual fund sales and the number of mutual fund shareholder accounts.
The fees charged for our services are based on contracts with our sponsored
investment products. 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 NINE MONTHS ENDED
JUNE 30, PERCENT JUNE 30, PERCENT
(in millions except per share data) 2004 2003 CHANGE 2004 2003 CHANGE
- ----------------------------------------------------------------------------------------------------------
NET INCOME $173.9 $131.4 32% $519.0 $350.8 48%
EARNINGS PER COMMON SHARE
Basic $0.70 $0.52 35% $2.08 $1.37 52%
Diluted 0.69 0.52 33% 2.06 1.37 50%
OPERATING MARGIN 28% 25% -- 27% 24% --
- -----------------------------------------------------------------------------------------------------------
21
Net income increased 32% and 48% in the three and nine months ended June 30,
2004, as compared to the same periods last year, due primarily to higher
investment management and underwriting and distribution fees reflecting a 28%
increase in simple monthly average assets under management in both periods and
an 8% and 30% increase in gross sales over the same periods. The increase was
partly offset by higher operating expenses including underwriting and
distribution and compensation and benefits expenses, and a higher effective tax
rate.
ASSETS UNDER MANAGEMENT
(in billions) JUNE 30, 2004 JUNE 30, 2003
- -----------------------------------------------------------------------------------------------------
Equity:
Global/international $128.6 $91.6
Domestic (U.S.) 66.3 50.7
- -----------------------------------------------------------------------------------------------------
Total equity 194.9 142.3
- -----------------------------------------------------------------------------------------------------
Hybrid/balanced 55.9 42.8
Fixed-income:
Tax-free 49.9 53.6
Taxable
Domestic (U.S.) 30.1 31.4
Global/international 13.6 10.9
- -----------------------------------------------------------------------------------------------------
Total fixed-income 93.6 95.9
- -----------------------------------------------------------------------------------------------------
Money market 6.4 6.0
- -----------------------------------------------------------------------------------------------------
TOTAL $350.8 $287.0
- -----------------------------------------------------------------------------------------------------
SIMPLE MONTHLY AVERAGE FOR THE THREE-MONTH PERIOD (1) $347.8 $272.2
- -----------------------------------------------------------------------------------------------------
SIMPLE MONTHLY AVERAGE FOR THE NINE-MONTH PERIOD (1) $336.1 $261.8
- -----------------------------------------------------------------------------------------------------
(1) Investment management fees from approximately 45% of our assets under management at
June 30, 2004 were calculated using a daily average.
Our assets under management at June 30, 2004 were $350.8 billion, 22% higher
than they were a year ago, primarily due to excess sales over redemptions of
$20.2 billion and market appreciation of $45.0 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, increased 28%
for both the three and nine months ended June 30, 2004 over the same periods a
year ago.
The simple monthly average mix of assets under management is shown below.
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------
Equity 55% 48% 54% 48%
Fixed-income 27% 34% 29% 35%
Hybrid/balanced 16% 16% 15% 15%
Money market 2% 2% 2% 2%
- ----------------------------------------------------------------------------------------------------
TOTAL 100% 100% 100% 100%
- ----------------------------------------------------------------------------------------------------
For the three and nine months ended June 30, 2004, the effective investment
management fee rate (investment management fees divided by simple monthly
average assets under management) was 0.581% and 0.579% as compared to 0.553% and
0.548% in the same periods last year. The change in the mix of assets under
management, resulting from higher relative excess sales over redemptions and
appreciation of equity as compared to fixed-income products, led to an increase
in our effective investment management fee rate. Generally, equity products
carry a higher management fee rate than fixed-income and hybrid/balanced
products.
22
Assets under management by shareholder location were as follows:
JUNE 30, SEPTEMBER
(in billions) 2004 % OF TOTAL 30, 2003 % OF TOTAL
- ------------------------------------------- -------------- ------------- -------------- -------------
United States $257.5 73% $224.0 74%
Canada 25.2 7% 21.5 7%
Europe 26.8 8% 19.9 7%
Asia/Pacific and other 41.3 12% 36.5 12%
- ------------------------------------------- -------------- ------------- -------------- -------------
TOTAL $350.8 100% $301.9 100%
- ------------------------------------------- -------------- ------------- -------------- -------------
Components of the change in our assets under management were as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, PERCENT JUNE 30, PERCENT
(in billions) 2004 2003 CHANGE 2004 2003 CHANGE
- -----------------------------------------------------------------------------------------------------
Beginning assets under management $351.6 $252.4 39% $301.9 $247.8 22%
Sales 23.8 21.9 9% 73.5 56.7 30%
Reinvested distributions 1.2 1.0 20% 4.0 3.0 33%
Redemptions (21.8) (16.0) 36% (57.6) (47.2) 22%
Distributions (1.7) (1.5) 13% (5.8) (4.7) 23%
Acquisitions -- -- -- 0.9 -- N/A
(Depreciation)/appreciation (2.3) 29.2 N/A 33.9 31.4 8%
- -----------------------------------------------------------------------------------------------------
ENDING ASSETS UNDER MANAGEMENT $350.8 $287.0 22% $350.8 $287.0 22%
- -----------------------------------------------------------------------------------------------------
For the three and nine months ended June 30, 2004, excess sales over redemptions
were $2.0 billion and $15.9 billion, as compared to $5.9 billion and $9.5
billion in the same periods last year. Market appreciation of $33.9 billion in
the nine months ended June 30, 2004 related primarily to our equity and
hybrid/balanced products. Darby Overseas Investments, Ltd. and Darby Overseas
Partners, L.P. (collectively "Darby") had $0.9 billion in assets under
management, related to private equity, mezzanine and emerging markets
fixed-income products as of the acquisition date, on October 1, 2003.
OPERATING REVENUES
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, PERCENT JUNE 30, PERCENT
(in millions) 2004 2003 CHANGE 2004 2003 CHANGE
- -----------------------------------------------------------------------------------------------------
Investment management fees $505.4 $376.6 34% $1,459.5 $1,075.9 36%
Underwriting and distribution fees 277.8 225.6 23% 844.6 605.7 39%
Shareholder servicing fees 60.6 57.4 6% 183.7 160.8 14%
Consolidated sponsored investment
products income, net 1.1 -- N/A 2.6 -- N/A
Other, net 17.9 24.3 (26%) 53.2 60.1 (11%)
- -----------------------------------------------------------------------------------------------------
TOTAL OPERATING REVENUES $862.8 $683.9 26% $2,543.6 $1,902.5 34%
- -----------------------------------------------------------------------------------------------------
INVESTMENT MANAGEMENT FEES
Investment management fees, accounting for 59% and 57% of our operating revenues
for the three months and nine months ended June 30, 2004, as compared to 55% and
57% for the same periods last year, 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.
23
Investment management fees increased 34% and 36% for the three and nine months
ended June 30, 2004 compared to the same periods last year consistent with a 28%
increase in simple monthly average assets under management over the same
periods, and an 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 certain 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 23% and 39% for the three and nine
months ended June 30, 2004 compared to the same periods last year. For the three
and nine months ended June 30, 2004, commission revenues increased 7% and 42%
from the same periods last year consistent with a 9% and 30% increase in gross
sales and a change in the sales mix, partially offset by the discontinuation of
front-end sales charges on Class C shares sold in the United States effective
January 1, 2004. Distribution fees increased 35% and 38% for the three and nine
months ended June 30, 2004 over the same periods last year consistent with a 28%
increase in simple monthly average assets under management over the same period
last year 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 shareholder servicing fees for
providing transfer 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 generally 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. In
the coming quarter, we anticipate that approximately 1,325,000 accounts closed
in the United States during calendar 2003 will no longer be billable effective
July 1, 2004.
Shareholder servicing fees increased 6% for the three months ended June 30, 2004
from the same period last year consistent with an increase in billable
shareholder accounts. Fees increased 14% for the nine months ended June 30, 2004
from the same period last year reflecting 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 and 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 26% and 11% during the three and nine months ended June 30,
2004 from the same periods last year due to lower interest income on loans,
lower realized gains on sale of automotive loans and
24
lower custody fees, partially offset by a decrease in interest on deposits, the
decline in provision for probable loan losses related to our consumer lending
portfolio, and an increase in service fees on automobile loans and other banking
fees.
OPERATING EXPENSES
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, PERCENT JUNE 30, PERCENT
(in millions) 2004 2003 CHANGE 2004 2003 CHANGE
- ----------------------------------------------------------------------------------------------------------
Underwriting and distribution $247.9 $207.0 20% $758.2 $549.0 38%
Compensation and benefits 193.6 163.2 19% 579.9 483.2 20%
Information systems, technology and
occupancy 67.5 70.5 (4%) 205.5 214.5 (4%)
Advertising and promotion 31.1 22.3 39% 84.3 69.2 22%
Amortization of deferred sales
commissions 24.7 19.2 29% 72.1 52.2 38%
Amortization of intangible assets 4.4 4.2 5% 13.2 12.7 4%
Provision for governmental
investigations, proceedings and actions 21.5 -- N/A 81.5 -- N/A
September 11, 2001 recovery, net -- -- -- (30.3) -- N/A
Other 31.1 28.1 11% 90.1 73.2 23%
- ----------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES $621.8 $514.5 21% $1,854.5 $1,454.0 28%
- ----------------------------------------------------------------------------------------------------------
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 20% and 38% for the three and nine months ended June 30, 2004
over the same periods last year consistent with higher gross sales and assets
under management and is similar to the trends in underwriting and distribution
revenue.
COMPENSATION AND BENEFITS
Compensation and benefits expense increased 19% and 20% for the three and nine
months ended June 30, 2004 compared to the same periods last year. The increase
resulted primarily from an increase in bonus expense under the Annual Incentive
Compensation Plan, which awards cash and stock bonuses based, in part, on our
performance. In addition, merit salary increases effective in October 2003 and
additional compensation and benefit costs related to the acquisition of Darby in
October 2003 increased costs in fiscal year 2004. The increase was partly
reduced by the decline of contractual commitments related to the acquisition of
Fiduciary Trust Company International ("Fiduciary Trust") in April 2001, as cash
payout obligations under the employee retention and transition compensation
program were fulfilled as required within two years from the acquisition date.
We employed approximately 6,600 people at June 30, 2004 as compared to about
6,500 at June 30, 2003.
INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY
Information systems, technology and occupancy costs decreased 4% during the
three and nine months ended June 30, 2004 from the same periods 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. The decline in information systems and
technology expense was partly offset by an increase in building depreciation
related to the consolidation of our headquarters campus in our results of
operation effective December 31, 2003.
25
Details of capitalized information systems and technology costs were as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands) 2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------
Net book value at beginning of period $64,810 $100,094 $79,126 $121,486
Additions during period, net of disposals and
other adjustments 505 7,486 10,850 22,817
Amortization during period (10,545) (16,645) (35,206) (53,368)
- -----------------------------------------------------------------------------------------------------
NET BOOK VALUE AT END OF PERIOD $54,770 $90,935 $54,770 $90,935
- -----------------------------------------------------------------------------------------------------
ADVERTISING AND PROMOTION
Advertising and promotion expense increased 39% and 22% for the three and nine
months ended June 30, 2004 over the same periods last year due to the
elimination of directed brokerage effective November 28, 2003 and higher
expenditures on direct advertising campaigns and marketing materials. 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.
PROVISION FOR GOVERNMENTAL INVESTIGATIONS, PROCEEDINGS AND ACTIONS
In the three months ended June 30, 2004, we recognized a charge to income of
$21.5 million ($17.3 million, net of taxes), which represents the costs that can
be currently estimated relating to anticipated settlement of governmental
investigations concerning payments to securities dealers who sell fund shares.
The $21.5 million charge is in addition to the $60.0 million charge to income
taken in the quarter ended March 31, 2004 primarily for ongoing governmental
investigations, proceedings and actions related to market timing allegations.
See also "Risk Factors" below.
SEPTEMBER 11, 2001 RECOVERY, NET
In January 2004, we received $32.5 million from our insurance carrier for claims
related to the September 11, 2001 terrorist attacks that destroyed Fiduciary
Trust's headquarters. These proceeds represented final recoveries for claims
submitted to our insurance carrier. We realized a gain of $30.3 million, before
income taxes of $12.0 million, as remaining contingencies related to our
insurance claims have been resolved.
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 B and,
effective January 1, 2004, Class C shares are sold without front-end sales
charges. Prior to this date, Class C shares were sold with a front-end sales
charge that was lower than the commission paid by the U.S. distributor. We
record deferred sales commissions assets for these up-front commissions paid by
our distribution subsidiaries and amortize them over 12 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 agreements directly 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 29% and 38% for the three
and nine months ended June 30, 2004 over the same periods last year consistent
with increased gross product sales and because LFL has not sold U.S. DCA in a
securitization transaction since June 2002.
26
OTHER INCOME (EXPENSES)
Other income (expenses) includes net realized and unrealized investment gains
(losses) of consolidated sponsored investment products, investment and other
income and interest expense. Investment and other income is comprised primarily
of dividends, interest income and realized gains and losses from investments,
income from investments accounted for using the equity method of accounting,
minority interest, and foreign currency exchange gains and losses.
Other income (expenses) decreased 81% during the three months ended June 30,
2004 from the same period last year due to the inclusion of net investment
losses and minority interest expense related to consolidated sponsored
investment products, and lower net realized gains and equity method income from
our investments, lower foreign exchange gains, and higher interest expense
related to the issuance of five-year senior notes in April 2003.
Other income (expenses) increased 15% for the nine months ended June 30, 2004
compared to the same period last year consistent with the inclusion of net
investment gains related to consolidated sponsored investment products, and
higher net realized gains and equity method income from our investments. The
increase was partially reduced by lower foreign currency exchange gains, higher
minority interest expense related to consolidated sponsored investment products
and higher interest expense.
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 tax 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 of 29% for the three months ended June 30, 2004
remained unchanged from the same period last year. Although we experienced a
shift in the mix of pre-tax income to jurisdictions subject to lower taxes, this
shift was offset by the effect on our tax rate of the $21.5 million provision
for governmental investigations, proceedings and actions recognized in the
quarter ended June 30, 2004. The effective tax rate for the nine months ended
June 30, 2004 increased to 30% compared to 28% for the same periods last year.
The increase is due to a shift in the mix of pre-tax income earned in various
worldwide jurisdictions, as well as the effect on our tax rate of the $30.3
million insurance recovery and the $81.5 million provision for governmental
investigations, proceedings and actions that were recognized in the year ended
June 30, 2004. 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
Cash and cash equivalents, which include cash, 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, increased to $2,480.4 million at June 30, 2004 from $1,053.7 million at
September 30, 2003. During the nine months ended June 30, 2004, proceeds from
U.S. Treasury bills with maturities of greater than three months from the
purchase date classified as investment securities were invested in other debt
instruments classified as cash and cash equivalents, primarily term deposits,
with maturities of three months or less from the purchase date, resulting in an
increase in cash and cash equivalents and a decrease in investment securities,
available-for-sale. Liquid assets, which consist of cash and cash equivalents,
investments (trading and available-for-sale) and current receivables increased
to $3,957.9 million at June 30, 2004 from $3,272.3 million at September 30, 2003
primarily due to cash provided by operating activities.
Outstanding debt, including Federal Home Loan Bank advances and current
maturities of long-term debt, increased to $1,357.2 million at June 30, 2004
compared to $1,123.7 million at September 30, 2003. The balance at June 30, 2004
included $527.6 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 $231.6 million of other long-term debt, consisting
primarily of a long-term financing liability 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.
27
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, which was consolidated in our financial
statements in December 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.
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. We may have to make additional repurchases, at the
option of the holders, on May 11 of 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 will be redeemed by the
holders, depends on, among other factors, the performance of our common stock.
As of June 30, 2004, we had $300.0 million of debt and equity securities
available to be issued under shelf registration statements filed with the SEC
and $500.0 million of commercial paper. Our committed revolving credit
facilities at June 30, 2004 totaled $420.0 million, of which, $210.0 million was
under a 364-day facility expiring in June 2005. The remaining $210.0 million
facility is under a five-year facility that will expire in June 2007. In
addition, at June 30, 2004, our banking/finance operating segment had $514.8
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 $0 and $231.8 million for the three and nine months
ended June 30, 2004 and $259.3 million and $390.9 million for the three and nine
months ended June 30, 2003. 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 and nine months ended June 30, 2004 were approximately $38.2 million and
$128.4 million compared to $52.8 million and $121.0 million over the same
periods last year. LFL's ability to access credit facilities and the
securitization market will directly affect our existing financing arrangements.
We expect that the main uses of cash will be to:
* expand our core business
* make strategic acquisitions
* acquire shares of our common stock
* fund property and equipment purchases
* pay operating expenses of the business
* enhance our technology infrastructure
* improve our business processes
* pay shareholder dividends
* repay and service debt.
We believe that we can meet our present and reasonably foreseeable operating
cash needs and future commitments through the following:
* 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 arrangements.
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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 June 30, 2004, the maximum
potential amount of future payments was $16.8 million relating to guarantees
made prior to January 1, 2003. In addition, our consolidated balance sheet at
June 30, 2004 included a $0.4 million liability to reflect obligations arising
from auto securitization transactions subsequent to December 31, 2002.
At June 30, 2004, the banking/finance operating segment had commitments to
extend credit aggregating $257.0 million, primarily under its credit card lines,
and had issued financial standby letters of credit totaling $2.5 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 $2.7 million as
of June 30, 2004 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 June 30, 2004, 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 June
30, 2004, 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 June 30, 2004, those
amounts approximated $53.6 million. During the nine months ended June 30, 2004,
we financed approximately $128.4 million of sales commissions through LFL and we
recognized a pre-tax charge of approximately $1.2 million for our share of its
net loss over this period.
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 $629.5 million as of June 30, 2004 and $680.7 million at September 30,
2003.
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 year 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.
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On December 31, 2003, we consolidated the lessor trust under the provisions of
the Financial Accounting Standards Board ("FASB") Interpretation No. 46,
"Consolidation of Variable Interest Entities (revised December 2003)" ("FIN
46-R") 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. During the quarter ended March 31, 2004, we completed our
annual impairment test of goodwill and indefinite-lived intangible assets and we
determined that there was no impairment to these assets as of October 1, 2003.
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 circumstances that may indicate
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 $2.4
billion at June 30, 2004. 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, 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, available-for-sale for other-than-temporary decline
in value on a periodic basis. This may exist when the fair value of an
investment has been below the current value for an extended period of
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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
would be 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.
Investment securities, trading are carried at fair value with changes in fair
value recognized in our consolidated net income. Trading securities are
comprised of securities held by majority-owned sponsored investment products
that have been consolidated 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 June 30, 2004 to provide for any probable losses that may arise from
these matters. See also "Risk Factors" below.
VARIABLE INTEREST ENTITIES
Under FIN 46-R, a variable interest entity ("VIE") is an entity in which the
equity investment holders have not contributed sufficient capital to finance its
activities or the equity investment holders do not have defined rights and
obligations normally associated with an equity investment. FIN 46-R 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.
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. To determine our interest in the expected losses
or residual returns of each VIE, we performed an expected cash flow analysis
using certain discount rate and volatility assumptions 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.
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.
31
WE HAVE BECOME SUBJECT TO AN INCREASED RISK OF VOLATILITY OF THE ASSETS WE
MANAGE CAUSED BY 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 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.
32
TECHNOLOGY AND OPERATING RISK AND LIMITATIONS 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.
GOVERNMENTAL INVESTIGATIONS, SETTLEMENTS OF SUCH INVESTIGATIONS, ONGOING AND
PROPOSED GOVERNMENTAL ACTIONS, AND REGULATORY EXAMINATIONS OF THE COMPANY AND
ITS BUSINESS ACTIVITIES AS WELL AS CIVIL LITIGATION ARISING OUT OF OR RELATED TO
SUCH MATTERS COULD ADVERSELY IMPACT OUR ASSETS UNDER MANAGEMENT, INCREASE COSTS
AND NEGATIVELY IMPACT THE PROFITABILITY OF THE COMPANY AND FUTURE FINANCIAL
RESULTS.
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") claiming violations of the Massachusetts
Uniform Securities Act ("Massachusetts Act") with respect to an alleged
arrangement to permit market timing (the "Mass Proceeding"). On February 17,
2004, the Company filed an Answer denying all violations of the Massachusetts
Act. A hearing on this matter is presently scheduled to commence on September
20, 2004.
GOVERNMENTAL INVESTIGATIONS. As part of ongoing investigations by 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, the West Virginia Attorney General, the Vermont Department of
Banking, Insurance, Securities, and Health Care Administration and the National
Association of Securities Dealers, relating to certain practices in the mutual
fund industry, including late trading, market timing and payments to securities
dealers who sell fund shares, 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 have been 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.
On August 2, 2004, Franklin Resources, Inc. announced that an agreement has been
reached by its subsidiary, Franklin Advisers, Inc. ("Franklin Advisers"), with
the SEC that resolves the issues resulting from the SEC's investigation of
market timing activity and the SEC issued an "Order instituting administrative
and cease-and-desist proceedings pursuant to sections 203(e) and 203(k) of the
Investment Advisers Act of 1940 and sections 9(b) and 9(f) of the Investment
Company Act of 1940, making findings and imposing remedial sanctions and a cease
and desist order" (the "Order"). The SEC's Order concerns the activities of a
limited number of third parties that ended in 2000 and those that are the
subject of the Mass Proceeding described above.
Under the terms of the SEC's Order, pursuant to which Franklin Advisers neither
admits nor denies any wrongdoing, Franklin Advisers has agreed to pay $50
million to be distributed to fund shareholders, of which $20 million is a civil
penalty. This payment was part of an accrual by the Company in its fiscal
quarter ended March 31, 2004, and will not result in an additional charge to
income.
In the Order, the SEC recognizes that the Company has generally sought to
detect, discourage and prevent market timing in its funds and began to increase
its efforts to control market timing in 1999. The Order also requires Franklin
Advisers to, among other things:
* Enhance and periodically review compliance policies and procedures,
and establish a corporate ombudsman;
* Establish a new internal position whose responsibilities shall include
compliance matters related to conflicts of interests; and
* Retain an Independent Distribution Consultant to develop a plan to
distribute the $50 million settlement to fund shareholders.
The Order further provides that in any related investor actions, Franklin
Advisers will not benefit from any offset or reduction of any investor's claim
by the amount of any distribution from the above-described $50 million to such
investor that is proportionately attributable to the civil penalty paid by
Franklin Advisers.
33
The staff of the SEC has also informed the Company that it is considering
recommending a civil action or proceeding against Franklin Advisers and Franklin
Templeton Distributors, Inc. ("FTDI"), another subsidiary of the Company,
concerning payments to securities dealers who sell fund shares (commonly
referred to as "revenue sharing"). The staff of the California Attorney
General's Office ("CAGO") also has advised us that it is authorized to bring a
civil action against Franklin Resources, Inc. and FTDI arising from the same
events. Even though the Company currently believes that the charges the SEC
staff and CAGO staff are contemplating are unwarranted, it also believes that it
is in the best interest of the Company's and funds' shareholders to resolve
these issues voluntarily, to the extent the Company can reasonably do so. The
Company continues to have discussions towards resolving these governmental
investigations.
The Company's results for the quarter ended June 30, 2004, included a charge to
income of $21.5 million ($17.3 million net of taxes), which represents the costs
that can be currently estimated relating to anticipated settlement of
governmental investigations concerning payments to securities dealers who sell
fund shares. This $21.5 million charge is in addition to the $60.0 million
($45.6 million, net of taxes) charge to income taken by the Company in the
quarter ended March 31, 2004, primarily for ongoing governmental investigations,
proceedings and actions related to market timing allegations.
Effective November 28, 2003, the Company determined not to direct any further
brokerage commissions where the allocation is based, not only on best execution,
but also on the sale of shares of the Franklin, Templeton and Mutual Series U.S.
funds (each a "Fund" and together, "Funds"), which determination may have an
adverse impact on the Company.
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 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 found any late trading, but we have identified various
instances of frequent trading. One officer of a subsidiary of the Company was
placed on administrative leave and subsequently resigned from his position with
the Company in December 2003.
We have found no instances of inappropriate mutual fund trading by any portfolio
manager, investment analyst or officer of Franklin Resources, Inc. As previously
disclosed, the Company 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 included one trader and one officer of the
Funds. Pending our further inquiry, these two individuals were placed on
administrative leave and the officer resigned from his positions with the Funds.
The independent directors of the Funds and the Company also retained independent
outside counsel to review these matters and to report their findings and
recommendations. Based on independent counsel's findings and recommendations,
the Company reinstated the trader. The independent counsel concluded that some
instances of the former Fund officer's trading violated Company policy, and the
Company was prepared to institute appropriate disciplinary action. Subsequently,
the former Fund officer resigned from his employment with the Company. The
Company does not believe there were any losses to the Funds as a result of this
trading.
CLASS ACTION AND OTHER LAWSUITS. The Company has been named in shareholder class
and other actions related to some of the matters described above. See "Legal
Proceedings" included in Part II, Item 1 of this report. Management believes
that the claims made in the lawsuits are without merit and intends to vigorously
defend against them. It is anticipated that the Company may be named in
additional similar civil actions related to some of the matters described above.
REGULATORY OR LEGISLATIVE ACTIONS AND REFORMS, PARTICULARLY THOSE SPECIFICALLY
FOCUSED ON THE MUTUAL FUND INDUSTRY, COULD ADVERSELY IMPACT OUR ASSETS UNDER
MANAGEMENT, INCREASE COSTS AND NEGATIVELY IMPACT THE PROFITABILITY OF THE
COMPANY AND FUTURE FINANCIAL RESULTS. Various compliance and disclosure
requirements and procedures focused on the mutual fund industry have been
adopted, proposed or are being considered by, among others, the SEC and
Congress. These new or anticipated actions or reforms may increase costs and
could have an adverse effect on our future financial results.
34
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 the loan portfolio
held by our banking/finance operating segment and debt securities included in
investment securities, available-for-sale. Our exposure to interest rate changes
related to our debt issuances is not material since a significant percentage of
our outstanding debt is at fixed interest rates. In our banking/finance
operating segment, we monitor the net interest rate margin and the average
maturity of interest earning assets, as well as funding sources. In addition, as
of June 30, 2004, 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 minimize the impact of interest rate
fluctuations related to our investments in debt securities, by managing the
maturities of these securities and diversification.
We are subject to foreign exchange risk through our foreign operations. 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 exposed to equity price fluctuations through securities we hold that are
carried at fair value and through investments held by majority-owned sponsored
investment products that we consolidate. To mitigate this risk, we maintain a
diversified investment portfolio. Our exposure to equity price fluctuations is
also minimized as we sponsor a broad range of investment products in various
global jurisdictions.
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 June 30, 2004. 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 June 30, 2004.
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 June 30, 2004, that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
35
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously reported, 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") claiming violations of the Massachusetts Uniform
Securities Act ("Massachusetts Act") with respect to an alleged arrangement to
permit market timing (the "Mass Proceeding"). On February 17, 2004, the Company
filed an Answer denying all violations of the Massachusetts Act. A hearing on
this matter is presently scheduled to commence on September 20, 2004.
In addition, the Company and certain of its subsidiaries and current and former
officers, employees, and directors have been named in multiple lawsuits in
different federal courts in Nevada, California, Illinois, New York, and Florida,
alleging violations of various federal securities laws and seeking, among other
things, monetary damages and costs. Specifically, the lawsuits claim breach of
duty with respect to alleged arrangements to permit market timing and/or late
trading activity, or breach of duty with respect to the valuation of the
portfolio securities of certain Templeton Funds managed by Company subsidiaries,
resulting in alleged market timing activity. The majority of these lawsuits
duplicate, in whole or in part, the allegations asserted in the Mass Proceeding
detailed above. The lawsuits are styled as class actions or derivative actions
on behalf of either the named Funds or the Company.
Management strongly believes that the claims made in each of these lawsuits, as
more specifically described below, are without merit and intends to vigorously
defend against them.
To date, more than 240 similar lawsuits against 18 different mutual fund
companies have been filed in federal district courts throughout the country.
Because these cases involve common questions of fact, the Judicial Panel on
Multidistrict Litigation (the "Judicial Panel") ordered the creation of a
multidistrict litigation, entitled "In re Mutual Funds Investment Litigation."
The Judicial Panel then transferred similar cases from different districts to
the United States District Court for the District of Maryland for coordinated or
consolidated pretrial proceedings (the "MDL").
As of August 12, 2004, the following lawsuits are pending against the Company
and have been transferred to the MDL:
Kenerley v. Templeton Funds, Inc., et al., Case No. 03-770 GPM, filed on
November 19, 2003 in the United States District Court for the Southern District
of Illinois; Cullen v. Templeton Growth Fund, Inc., et al., Case No. 03-859 MJR,
filed on December 16, 2003 in the United States District Court for the Southern
District of Illinois and transferred to the United States District Court for the
Southern District of Florida on March 29, 2004; Jaffe v. Franklin AGE High
Income Fund, et al., Case No. CV-S-04-0146-PMP-RJJ, filed on February 6, 2004 in
the United States District Court for the District of Nevada; Lum v. Franklin
Resources, Inc., et al., Case No. C 04 0583 JSW, filed on February 11, 2004 in
the United States District Court for the Northern District of California;
Fischbein v. Franklin AGE High Income Fund, et al., Case No. C 04 0584 JSW,
filed on February 11, 2004 in the United States District Court for the Northern
District of California; Beer v. Franklin AGE High Income Fund, et al., Case No.
8:04-CV-249-T-26 MAP, filed on February 11, 2004 in the United States District
Court for the Middle District of Florida; Bennett v. Franklin Resources, Inc.,
et al., Case No. CV-S-04-0154-HDM-RJJ, filed on February 12, 2004 in the United
States District Court for the District of Nevada; Dukes v. Franklin AGE High
Income Fund, et al., Case No. C 04 0598 MJJ, filed on February 12, 2004, in the
United States District Court for the Northern District of California; McAlvey v.
Franklin Resources, Inc., et al., Case No. C 04 0628 PJH, filed on February 13,
2004 in the United States District Court for the Northern District of
California; Alexander v. Franklin AGE High Income Fund, et al., Case No. C 04
0639 SC, filed on February 17, 2004 in the United States District Court for the
Northern District of California; Hugh Sharkey IRA/RO v. Franklin Resources,
Inc., et al., Case No. 04 CV 1330, filed on February 18, 2004 in the United
States District Court for the Southern District of New York; D'Alliessi, et al.
v. Franklin AGE High Income Fund, et al., Case No. C 04 0865 SC, filed on March
3, 2004 in the United States District Court for the Northern District of
California; Marcus v. Franklin Resources, Inc., et al., Case No. C 04 0901 JL,
filed on March 5, 2004 in the United States District Court for the Northern
District of California; Banner v. Franklin Resources, Inc., et al., Case No. C
04 0902 JL, filed on March 5, 2004 in the United States District Court for the
Northern District of California; Denenberg v. Franklin Resources, Inc., et al.,
Case No. C 04 0984 EMC, filed on March 10, 2004 in
36
the United States District Court for the Northern District of California; Hertz
v. Burns, et al., Case No. 04 CV 02489, filed on March 30, 2004 in the United
States District Court for the Southern District of New York.
Plaintiffs in the MDL proceeding have until September 29, 2004 to file their
consolidated complaints.
As previously reported, various subsidiaries of the Company have also been named
in multiple lawsuits filed in 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 as follows:
Bradfisch v. Templeton Funds, Inc., et al., Case No. 2003 L 001361, filed on
October 3, 2003 in the Circuit Court of the Third Judicial Circuit, Madison
County, Illinois; Woodbury v. Templeton Global Smaller Companies Fund, Inc., et
al., Case No. 2003 L 001362, filed on October 3, 2003 in the Circuit Court of
the Third Judicial Circuit, Madison County, Illinois; Kwiatkowski v. Templeton
Growth Fund, Inc., et al., Case No. 03 L 785, filed on December 17, 2003 in the
Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois;
Parise v. Templeton Funds, Inc., et al., Case No. 2003 L 002049, filed on
December 22, 2003 in the Circuit Court of the Third Judicial Circuit, Madison
County, Illinois.
These lawsuits are state court actions and are not subject to the MDL.
In addition, the Company and its subsidiaries, as well as certain current and
former officers, employees, and directors, have been named in multiple lawsuits
alleging violations of various securities laws and pendent state law claims
relating to the disclosure of directed brokerage payments and/or payment of
allegedly excessive commissions and advisory fees. These lawsuits are styled as
class actions and derivative actions brought on behalf of certain Funds, and are
as follows:
Stephen Alexander IRA v. Franklin Resources, Inc., et al., Case No. 04-982
(JLL), filed on March 2, 2004 in the United States District Court for the
District of New Jersey; Strigliabotti v. Franklin Resources, Inc., et al., Case
No. C 04 0883 SI, filed on March 4, 2004 in the United States District Court for
the Northern District of California; Tricarico v. Franklin Resources, Inc., et
al., Case No. CV-04-1052 (JAP), filed on March 4, 2004 in the United States
District Court for the District of New Jersey; Miller v. Franklin Mutual
Advisors, LLC, et al., Case No. 04-261 DRH, filed on April 16, 2004 in the
United States District Court for the Southern District of Illinois; Wilcox v.
Franklin Resources, Inc., et al., Case No. 04-2258 (WHW), filed on May 12, 2004
in the United States District Court for the District of New Jersey; Bahe,
Custodian CGM Roth Conversion IRA v. Franklin/Templeton Distributors, Inc. et
al., Case No. 04-11195 PBS, filed on June 3, 2004 in the United States District
Court for the District of Massachusetts.
Please also see the discussion of certain governmental proceedings and
investigations in Note 13, "Commitments and Contingencies - Governmental
Investigations, Proceedings and Actions", 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 quarterly report on Form 10-Q for
the period ended March 31, 2004, as filed with the SEC on May 14, 2004. 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.
37
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
The following table provides information with respect to the shares of common
stock we repurchased during the three months ended June 30, 2004:
(c) TOTAL NUMBER OF (d) MAXIMUM NUMBER
SHARES PURCHASED AS OF SHARES THAT MAY
(a) TOTAL NUMBER PART OF PUBLICLY YET BE PURCHASED
OF SHARES (b) AVERAGE PRICE ANNOUNCED PLANS OR UNDER THE PLANS OR
PERIOD PURCHASED PAID PER SHARE PROGRAMS PROGRAMS
- ------------------------------- ------------------- -------------------- ---------------------- ----------------------
April 1, 2004 through April -- -- -- 14,263,217
30, 2004
May 1, 2004 through May
31, 2004 216,936 $50.37 216,936 14,046,281
June 1, 2004 through June
30, 2004 493,600 $50.19 493,600 13,552,681
-------------- -------------
TOTAL 710,536 710,536
Under a stock repurchase program authorized by our Board of Directors, we can
repurchase shares of our common stock on the open market and in private
transactions in accordance with applicable securities laws. In August 2002, May
2003, and August 2003, we announced increases in the number of shares available
for repurchase under our stock repurchase program totaling 30 million shares, of
which, 13.6 million shares remain available for repurchase as of June 30, 2004.
Our stock repurchase program is not subject to an expiration date.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: see Exhibit Index on pages 40 to 41.
(b) Reports on Form 8-K:
(i) On April 22, 2004, we furnished a report on Form 8-K under Item 12
with the SEC attaching our press release dated April 22, 2004
announcing our financial results for the quarter ended March 31, 2004.
38
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: August 13, 2004 By: /S/ JAMES R. BAIO
-----------------------
James R. Baio
Senior Vice President and
Chief Financial Officer
39
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 to the Registrant's
Registration Statement on Form S-3, filed on August 6,
2001).
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 10.75 Amended and Restated 364 Day Facility Credit Agreement dated
June 3, 2004 between Franklin Resources, Inc. and The Banks
Parties Thereto, Bank of America, N.A. and The Bank of New
York, as Co-Syndication Agents, Citicorp USA Inc. and BNP
Paribas, as Co-Documentation Agents, and JP Morgan Chase
Bank, as Administrative Agent.
Exhibit 12 Computations of ratios of earnings to fixed charges.
Exhibit 31.1 Certification of Co-Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 Certification of Co-Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.3 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 Certification of Co-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).
40
Exhibit 32.2 Certification of Co-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).
41