FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarterly Period Ended December 31, 2000 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.) 777 MARINERS ISLAND BLVD., SAN MATEO, CA 94404 ---------------------------------------------- (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 ______ ----- APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. YES _____ NO ______ APPLICABLE ONLY TO CORPORATE ISSUERS: Outstanding: 244,128,652 shares, common stock, par value $.10 per share at January 31, 2001.
PART I -FINANCIAL INFORMATION ITEM 1. CONDENSED FINANCIAL STATEMENTS FRANKLIN RESOURCES, INC. CONSOLIDATED STATEMENTS OF INCOME UNAUDITED THREE MONTHS ENDED DECEMBER 31 (In thousands, except per share data) 2000 1999 - -------------------------------------------------------------------------------- OPERATING REVENUES: Investment management fees $345,785 $344,042 Underwriting and distribution fees 164,362 164,243 Shareholder servicing fees 48,222 51,759 Other, net 5,705 5,623 - -------------------------------------------------------------------------------- TOTAL OPERATING REVENUES 564,074 565,667 - -------------------------------------------------------------------------------- OPERATING EXPENSES: Underwriting and distribution 145,684 143,168 Compensation and benefits 141,859 130,849 Information systems, technology and occupancy 57,528 51,631 Advertising and promotion 22,126 22,545 Amortization of deferred sales commissions 18,236 20,631 Amortization of intangible assets 9,909 9,283 Other 19,754 19,925 - -------------------------------------------------------------------------------- TOTAL OPERATING EXPENSES 415,096 398,032 - -------------------------------------------------------------------------------- Operating income 148,978 167,635 OTHER INCOME/(EXPENSES): Investment and other income 49,956 16,679 Interest expense (2,270) (3,364) - -------------------------------------------------------------------------------- Other income, net 47,686 13,315 - -------------------------------------------------------------------------------- Income before taxes on income 196,664 180,950 Taxes on income 47,199 43,428 - -------------------------------------------------------------------------------- NET INCOME $149,465 $137,522 - -------------------------------------------------------------------------------- Earnings per share: Basic and diluted $0.61 $0.55 Dividends per share $0.065 $0.060 The accompanying notes are an integral part of these consolidated financial statements. 2
FRANKLIN RESOURCES, INC. CONSOLIDATED BALANCE SHEETS UNAUDITED DECEMBER 31 SEPTEMBER 30 (In thousands) 2000 2000 - -------------------------------------------------------------------------------- ASSETS: Current assets: Cash and cash equivalents $1,069,217 $734,071 Receivables: Sponsored investment products 237,466 241,282 Other 18,297 27,105 Investment securities, available-for-sale 216,597 635,819 Prepaid expenses and other 26,645 18,017 - -------------------------------------------------------------------------------- Total current assets 1,568,222 1,656,294 - -------------------------------------------------------------------------------- Banking/Finance assets: Cash and cash equivalents 14,528 11,934 Loans receivable, net 288,034 256,416 Investment securities, available-for-sale 29,917 26,851 Other 6,692 4,361 - -------------------------------------------------------------------------------- Total banking/finance assets 339,171 299,562 - -------------------------------------------------------------------------------- Other assets: Deferred sales commissions 88,615 86,754 Property and equipment, net 440,720 444,694 Intangible assets, net 1,248,627 1,169,485 Receivable from banking/finance group 198,778 168,496 Other 208,244 217,158 - -------------------------------------------------------------------------------- Total other assets 2,184,984 2,086,587 - -------------------------------------------------------------------------------- TOTAL ASSETS $4,092,377 $4,042,443 ================================================================================ The accompanying notes are an integral part of these consolidated financial statements. 3
FRANKLIN RESOURCES, INC. CONSOLIDATED BALANCE SHEETS UNAUDITED DECEMBER 31 SEPTEMBER 30 (In thousands except share data) 2000 2000 - -------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY: Current liabilities: Compensation and benefits 72,788 180,743 Current maturities of long-term debt 68,794 68,776 Accounts payable and accrued expenses 83,034 72,646 Commissions 87,671 76,965 Income taxes 71,964 61,661 Other 20,145 28,768 - -------------------------------------------------------------------------------- Total current liabilities 404,396 489,559 - -------------------------------------------------------------------------------- Banking/finance liabilities: Payable to Parent 198,778 168,496 Deposits 55,503 54,846 Other 12,683 15,612 - -------------------------------------------------------------------------------- Total banking/finance liabilities 266,964 238,954 - -------------------------------------------------------------------------------- Other liabilities: Long-term debt 285,760 294,090 Other 56,965 54,347 - -------------------------------------------------------------------------------- Total other liabilities 342,725 348,437 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Total liabilities 1,014,085 1,076,950 - -------------------------------------------------------------------------------- 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;244,128,959 and 243,730,140 shares issued and outstanding,for December and September, respectively 24,413 24,373 Retained earnings 3,084,102 2,932,166 Other (2,810) (3,422) Accumulated other comprehensive income (27,413) 12,376 - -------------------------------------------------------------------------------- Total stockholders' equity 3,078,292 2,965,493 - -------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $4,092,377 $4,042,443 ================================================================================ The accompanying notes are an integral part of these consolidated financial statements. 4
FRANKLIN RESOURCES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS UNAUDITED THREE MONTHS ENDED DECEMBER 31 (In thousands) 2000 1999 - -------------------------------------------------------------------------------- Net income $149,465 $137,522 Adjustments to reconcile net income to net cash provided by operating activities: Decrease in receivables, prepaid expenses and other 19,726 2,097 Advances of deferred sales commissions (20,098) (18,846) Decrease in restructuring liabilities - (1,190) Increase in other current liabilities 12,025 3,160 Increase in income taxes payable 10,303 5,216 Increase in commissions payable 10,705 3,260 Decrease in accrued compensation and benefits (82,809) (46,291) Depreciation and amortization 50,333 48,762 (Gains) losses on disposition of assets (31,572) 455 - -------------------------------------------------------------------------------- Net cash provided by operating activities 118,078 134,145 - -------------------------------------------------------------------------------- Purchase of investments (44,183) (41,597) Liquidation of investments 439,418 197,429 Purchase of banking/finance investments (5,939) (2,744) Liquidation of banking/finance investments 3,269 8,172 Net origination of loans receivable (31,440) (52,196) Acquisition of subsidiary, net of cash acquired (94,483) - Purchase of property and equipment (18,055) (22,496) - -------------------------------------------------------------------------------- Net cash provided by investing activities 248,587 86,568 - -------------------------------------------------------------------------------- Increase (decrease) in bank deposits 658 (2,633) Exercise of common stock options 1,020 266 Dividends paid on common stock (14,623) (13,799) Purchase of stock (7,906) (98,423) Issuance of debt 60,533 190,583 Payments on debt (68,607) (155,634) - -------------------------------------------------------------------------------- Net cash used in financing activities (28,925) (79,640) - -------------------------------------------------------------------------------- Increase in cash and cash equivalents 337,740 141,073 Cash and cash equivalents, beginning of period 746,005 819,244 - -------------------------------------------------------------------------------- Cash and cash equivalents, end of period $1,083,745 $960,317 - -------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION: Value of common stock issued, principally restricted stock $23,811 $28,531 The accompanying notes are an integral part of these consolidated financial statements. 5
FRANKLIN RESOURCES, INC. Notes to Consolidated Financial Statements December 31, 2000 (Unaudited) 1. BASIS OF PRESENTATION We have prepared these unaudited interim financial statements of Franklin Resources, Inc. and its consolidated subsidiaries ("Franklin Templeton Investments") in accordance with the instructions to Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). We have condensed or omitted certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles pursuant to such rules and regulations. In our opinion, all appropriate adjustments necessary to a fair presentation of the results of operations have been made for the periods shown. All adjustments are of a normal recurring nature. You should read these financial statements in conjunction with our audited financial statements for the fiscal year ended September 30, 2000. 2. DEBT At December 31, 2000, our overall weighted average interest rate on outstanding commercial paper and medium-term notes was 6.48%. During the quarter ended December 31, 2000, interest-rate swap agreements with a notional value of $90 million matured and were not renewed. These interest rate swaps had effectively fixed interest rates on $90 million of commercial paper. 3. COMPREHENSIVE INCOME The following table shows comprehensive income for the three months ended December 31, 2000 and 1999. (In thousands) 2000 1999 -------------------------------------------------------------------------- Net income $149,465 $137,522 Change in net unrealized (loss) gain on available-for-sales securities, net of tax (35,730) 13,259 Foreign currency translation adjustment (4,060) 1,958 -------------------------------------------------------------------------- Comprehensive income $109,675 $152,739 ========================================================================== 4. SEGMENT INFORMATION We have two operating segments: investment management and banking/finance. The investment management segment derives substantially all of its revenues and net income from providing investment advisory, fund administration, distribution and related services to our sponsored investment products. The banking/finance segment offers consumer lending and selected retail banking services to individuals. 6
Financial information for our two operating segments for the quarters ended December 31, 2000 and 1999 is presented in the table below. Operating revenues of the banking/finance segment are reported net of interest expense. Assets Income before Operating (In thousands) taxes revenues -------------------------------------------------------------------------- December 2000 Investment management $3,753,206 $195,143 $557,360 Banking/finance 339,171 1,521 6,714 -------------------------------------------------------------------------- Company Totals $4,092,377 $196,664 $564,074 ========================================================================== Assets Income before Operating taxes revenues -------------------------------------------------------------------------- December 1999 Investment management $3,483,884 $180,085 $561,062 Banking/finance 265,408 865 4,605 -------------------------------------------------------------------------- Company Totals $3,749,292 $180,950 $565,667 ========================================================================== 5. EARNINGS PER SHARE Earnings per share were computed as follows: Three months ended December 31 (In thousands except per share amounts) 2000 1999 -------------------------------------------------------------------------- Net income $149,465 $137,522 ========================================================================== Weighted-average shares outstanding - basic 243,708 250,432 Incremental shares from assumed conversions 701 160 -------------------------------------------------------------------------- Weighted-average shares outstanding - diluted 244,409 250,592 ========================================================================== Earnings per share: Basic and diluted $0.61 $0.55 6. SUBSEQUENT EVENT- SECURITIZATION OF LOANS RECEIVABLE In January 2001, we sold auto loans receivable with a net book value of $142.6 million to a securitization trust. The sale proceeds of this securitization were $139.3 million. A gain of $2.9 million has been recorded on the transaction. Significant assumptions used in determining the gain were an excess cash flow discount rate of 12% and a cumulative credit loss rate of 3.06%. 7
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. We also make some statements relating to the future, which are called "forward-looking" statements. Although we do our best to make clear and accurate forward-looking statements, the actual results and outcomes could be significantly different from those that we discuss in this document. For this reason, you should not rely too heavily on these forward-looking statements. We encourage you to look at the "Risk Factors" section below, where we discuss these statements in more detail. GENERAL The majority of our operating revenues, operating expenses and net income are derived from providing investment advisory and related services to retail mutual funds, institutional and private accounts, and other investment products. This is our primary business activity and operating segment. Our sponsored investment products include a broad range of domestic and global/international equity, hybrid, fixed-income and money market mutual funds, as well as other investment products that meet a wide variety of specific investment needs of individuals and institutions. ASSETS UNDER MANAGEMENT December 31 December 31 (In billions) 2000 1999 - -------------------------------------------------------------------------------- Equity: Global/international $96.4 $111.0 Domestic 50.0 44.3 - -------------------------------------------------------------------------------- Total equity 146.4 155.3 - -------------------------------------------------------------------------------- Hybrid Funds 10.1 9.6 Fixed-income: Tax-free 45.0 45.2 Taxable Domestic 16.2 15.4 Global/international 3.7 3.9 - -------------------------------------------------------------------------------- Total fixed-income 64.9 64.5 - -------------------------------------------------------------------------------- Money funds 5.5 5.6 - -------------------------------------------------------------------------------- Total end of period $226.9 $235.0 ================================================================================ Simple monthly average for the three-month period (1) $226.5 $224.1 ================================================================================ (1) Investment management fees from approximately 60% of our assets under management at December 31, 2000 are calculated using a daily average. 8
Our assets under management at December 31, 2000 were $226.9 billion, 3% lower than they were a year ago, but simple monthly average assets increased 1% this quarter over the same period a year ago. Equity assets now comprise 65% of total assets under management as compared to 66% at December 31, 1999. Fixed income assets now comprise 29% of total assets under management as compared to 27% at the same time last year. The change in our assets under management was as follows. ASSETS UNDER MANAGEMENT 3 months ended December 31, PERCENT in billions 2000 1999 CHANGE - -------------------------------------------------------------------------------- Beginning assets under management $229.9 $218.1 5% Sales 12.7 11.0 15% Reinvested Dividends 5.4 4.2 29% Redemptions (15.5) (14.5) 7% (Depreciation)appreciation (5.6) 16.2 n/a - -------------------------------------------------------------------------------- Ending assets under management $226.9 $235.0 (3)% For the three-month period ended December 31, 2000, sales and reinvested dividends exceeded redemptions ("net inflows") complex-wide by $2.6 billion, compared to net inflows of $0.7 billion in the same period last year. Market depreciation of $5.6 billion in the three months ended December 31, 2000 was mostly experienced within the U.S. equity markets, partially offset by appreciation in the fixed income sector. Approximately $3.7 billion of assets under management were added in October 2000 from our acquisition of Bissett & Associates Investment Management Ltd. ("Bissett"), which is reflected in (Depreciation) appreciation in the above table. Domestic equity and fixed income products continued to have strong relative performance to peer groups, while our global equity products' relative performance improved materially compared to peer groups. 9
RESULTS OF OPERATIONS Three months ended December 31 Percent 2000 1999 Change - -------------------------------------------------------------------------------- Net income (in millions) $149.5 $137.5 9% Earnings per share Basic and diluted $0.61 $0.55 11% Operating margin 26% 30% (13)% EBITDA margin (1) 38% 37% 3% - -------------------------------------------------------------------------------- (1) EBITDA margin is earnings before interest, taxes on income, depreciation and the amortization of intangibles (not including amortization of deferred sales commissions) divided by total revenues. Net income during the quarter ended December 31, 2000 increased 9% compared to the same quarter last year, primarily due to increased investment income, partially offset by increased operating expenses. OPERATING REVENUE Three months ended December 31 Percent (In millions) 2000 1999 Change - -------------------------------------------------------------------------------- Investment management fees $345.8 $344.0 1% Underwriting and distribution fees 164.4 164.3 - Shareholder servicing fees 48.2 51.8 (7)% Other, net 5.7 5.6 2% - -------------------------------------------------------------------------------- Total operating revenues $564.1 $565.7 - - -------------------------------------------------------------------------------- SUMMARY Total operating revenues for the quarter ended December 31, 2000 were similar to those recorded for the same period a year ago. This was primarily due to similar levels of simple average assets under management, effective management fee rates and number of shareholder accounts for the two periods under review. INVESTMENT MANAGEMENT FEES Investment management fees, the largest component of our operating revenues, include both investment advisory and business management fees. 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 and generally decline as the average net assets of the portfolios exceed certain threshold levels. In return for these fees, we provide investment advisory, administrative and other management services. Investment management fees increased 1% during the quarter ended December 31, 2000 over the same period last year, consistent with the 1% increase in the simple monthly average assets under management between these periods. 10
Our effective investment management fee rate for the quarter ended December 31, 2000 (investment management fees divided by simple monthly average assets under management) remained constant at 0.61% from the same period last year. UNDERWRITING AND DISTRIBUTION FEES Underwriting commissions are earned from the sale of certain classes of mutual funds that have a sales commission paid at the time of purchase. Distribution fees are paid by our sponsored mutual funds in return for sales and marketing efforts on their behalf. Distribution fees include 12b-1 plan fees, which are subject to maximum pay-out levels, based upon a percentage of the assets in each fund. A significant portion of underwriting commissions and distribution fees are paid to the brokers and other intermediaries who sell our sponsored investment products to the investing public on our behalf. See the description of Underwriting and distribution expenses below. Overall, Underwriting and distribution fees remained constant with the same period last year, despite a 15% increase in product sales. This was mainly caused by a decline in commissionable sales year over year, which led to a reduction in aggregate sales commission revenues. Sales at reduced or zero commissions are offered on certain classes of shares and for sales to shareholders or intermediaries that exceed specified minimum amounts. Thus, as the mix of sales change, so will our commission revenue. The decline in sales commission revenue was offset by an increase in distribution fees during the quarter ended December 31, 2000. This increase was primarily due to the increased simple monthly average assets under management and increased contingent deferred sales commissions. 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, although some funds are charged fees based on the level of assets under management. Fees are received as compensation for providing transfer agency services, which include providing customer statements, transaction processing, customer service and tax reporting. Current agreements with the sponsored investment products provide that closed accounts in a given calendar year remain billable through the second quarter of the following calendar year at a reduced rate. Accordingly, the level of fees will vary with the split of total billable accounts between open and closed accounts. Shareholder servicing fees decreased 7% primarily as a result of a decrease in the total number of billable accounts. OTHER, NET Other, net consists primarily of revenues from the banking/finance operating segment: - -- Operating revenues, consisting primarily of interest and servicing income - -- Interest expense - -- Provision for loan losses Other, net has remained relatively constant during the current year as higher interest and servicing income was offset by higher interest expense. Additionally, revenues from management and advisory activities associated with certain Real Estate Investment Trusts and partnerships have declined during fiscal 2001 as we have reduced our involvement in this business. 11
We have considered the potential impact of the effect on the banking/finance segment of a 100 basis point (1%) movement in market interest rates and we do not expect it would have a material impact on our operating revenues or consolidated results of operations. OPERATING EXPENSES Three months ended December 31 (In millions) 2000 1999 Change - -------------------------------------------------------------------------------- Underwriting and distribution $145.7 $143.2 2% Compensation and benefits 141.9 130.9 8% Information systems, technology and 57.5 51.6 11% occupancy Advertising and promotion 22.1 22.5 (2)% Amortization of deferred sales 18.2 20.6 (12)% commissions Amortization of intangible assets 9.9 9.3 6% Other 19.8 19.9 (1)% - -------------------------------------------------------------------------------- Total operating expenses $415.1 $398.0 4% ================================================================================ SUMMARY Operating expenses increased 4% during the quarter ended December 31, 2000 compared with the same period last year. This was mainly due to increased compensation and technology costs. UNDERWRITING AND DISTRIBUTION Underwriting and distribution includes sales commissions and distribution fees paid to brokers and other third parties for selling, distributing and providing ongoing services to investors in our sponsored investment products. During the quarter ended December 31, 2000, Underwriting and distribution expenses increased 2% compared with the prior year. Total sales increased 15%, but a significant number of those additional sales were at a low or zero commission rate, resulting in a smaller proportional increase in the commissions paid to intermediaries in the current year. COMPENSATION AND BENEFITS Compensation and benefits increased 8% during the quarter ended December 31, 2000 compared to the same period last year, primarily due to annual salary increases partially offset by a 3% decrease in the average employee headcount. Salary awards are given annually in October and are based upon the performance of the individual employee. The number of employees at December 31, 2000 was approximately 6,300 as compared to approximately 6,600 at the same time last year. In order to hire and retain our key employees in the current low unemployment labor market, we are committed to keeping our salaries and benefit packages competitive, which means that the level of compensation and benefits may increase more quickly than our revenues. 12
INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY Information systems, technology and occupancy costs increased 11% over the same period last year. This increase was primarily due to continued expenditure on new technology initiatives and a higher amortization charge resulting from the continuing investment in technology. During the past year, we embarked on a number of hardware upgrades, purchased, developed and installed new software applications, replaced or upgraded older versions of software applications, successfully transitioned to the Year 2000, and developed e-business strategies to improve our service levels, work environment and productivity. We expect that similar activities will continue to impact our overall expenditures through fiscal 2001 and beyond. Details of capitalized information systems and technology costs were as follows: Three months ended December 31 (In millions) 2000 1999 - -------------------------------------------------------------------------------- Cost at September 30 $317,767 $246,857 Net additions during period 14,834 12,474 - -------------------------------------------------------------------------------- Cost at December 31 332,601 259,331 Accumulated amortization at September 30 160,872 108,291 Charge for period 16,503 11,811 - -------------------------------------------------------------------------------- Accumulated amortization at December 31 177,375 120,102 - -------------------------------------------------------------------------------- Net book value at December 31 $155,226 $139,229 ================================================================================ ADVERTISING AND PROMOTION Advertising and promotion expenses during the quarter ended December 31, 2000 remained at a comparable level to the same period last year. AMORTIZATION OF DEFERRED SALES COMMISSIONS Amortization of deferred sales commissions decreased 12% during the quarter ended December 31, 2000 compared to the same period last year, principally as a result of lower sales and the financing arrangements described below. Certain fund classes, namely classes B and C, are sold without a front-end sales charge to shareholders, while, at the same time, our distribution subsidiaries pay a commission to selling brokers and other intermediaries. Similarly, class A shares are sold without a front-end sales charge to shareholders when certain minimum investment criteria are met, yet our U.S. distribution subsidiaries pay a commission on the sale. We have arranged to finance certain deferred commission assets ("DCA") arising from our U.S., Canadian and European operations through Lightning Finance Company Limited ("LFL"). DCA that is recorded on our balance sheet, principally consisting of commissions arising from the sale of class A, B and C shares sold in the U.S., is amortized. As a result of the arrangement with LFL, Canadian and European DCA are no longer recorded in our financial statements. 13
OTHER INCOME (EXPENSE) Investment and other income is comprised primarily of: - -- dividends from investments in our sponsored mutual funds - -- interest income from investments in bonds and government securities - -- realized gains and losses on investments - -- foreign currency exchange gains and losses - -- other miscellaneous income Investment income increased 200% over the same period last year due to greater realized gains, higher average available cash balances to invest and higher interest rates. During the quarter ended December 31, 2000, we recognized net realized gains of approximately $17 million more than the previous quarter from the sale of certain sponsored investment products held by the company for investment. In addition, realized gains of $8.2 million were included in other income related to the $32.9 million gain on the sale of our headquarters building in San Mateo, which is being recognized over 12-month leaseback period through June 2001. Interest expense decreased 33% over the prior year, following a reduction in our average outstanding debt. TAXES ON INCOME Our effective income tax rate for the quarters ended December 31, 2000 and 1999 remained unchanged at 24%. The effective tax rate will continue to be reflective of the relative contributions of foreign earnings that are subject to reduced tax rates and that are not currently included in U.S. taxable income. MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES At December 31, 2000, we had $1,083.7 million in cash and cash equivalents, as compared to $746.0 million at September 30, 2000. Liquid assets, which consist of cash and cash equivalents, investments available-for-sale and current receivables decreased to $1,586.0 million at December 31, 2000 from $1,677.1 million at September 30, 2000. At December 31, 2000, approximately $659.4 million was available to Franklin Templeton Investments under unused commercial paper and medium-term note programs. Revolving credit facilities at December 31, 2000 aggregated $550 million of which $250 million was under a 364-day facility. The remaining $300 million facility will expire in May 2003. Cash provided by operating activities decreased to $118.1 million in the quarter ended December 31, 2000 compared to $134.1 million in the same period last year. This decrease was due mainly to lower operating income resulting from higher operating expenses. During the current quarter we sold $395.2 million of investments, net of purchases; invested net cash of $34.1 million into the banking/finance segment; and used $94.5 million to purchase Bissett, providing a total of $248.6 million in investing activities. Net cash used in financing activities during the current period was $28.9 million. 14
Outstanding debt declined to $354.6 million at December 31, 2000, compared to $362.9 million at September 30, 2000. Debt primarily consisted of commercial paper that carried interest at variable rates and fixed-interest medium-term notes. Our overall weighted average interest rate on outstanding commercial paper and medium-term notes was 6.48% at December 31, 2000. Through our medium-term note program and other fixed rate debt, we have fixed the rates of interest we pay on 24% of our outstanding debt at December 31, 2000. Interest-rate swaps with a notional value of $90 million matured in October 2000. We do not expect to enter into any new interest rate swap agreements in the reasonably foreseeable future. Medium-term notes of $60 million mature in March 2001. Other fixed-rate debt has various maturity dates through October 2003. We have entered into a series of agreements to finance the construction of a new corporate headquarters on a 32-acre site in San Mateo, California. An owner-lessor trust has been set up to finance the construction and lease the completed facility. The construction is substantially on target and we expect to move into our new headquarters in the summer of 2001. The lease agreements are not expected to impact our cash flows or financial condition materially during the initial five-year lease period. We have arranged with LFL for non-recourse financing of sales commissions advanced on sales of our B shares globally. The cumulative sales commissions that we have financed through LFL since inception approximated $230.6 million at December 31, 2000. The acquisition of Bissett for $94.5 million in cash consideration closed on October 2, 2000. The operations of Bissett and its assets under management have been consolidated into our results from the date of closing. We expect that the principal uses of cash will be to increase assets under management through expansion of our business, make strategic acquisitions, fund property and equipment acquisitions, enhance our technology infrastructure, improve our business processes, pay shareholder dividends, repay and service debt, and acquire shares of the company. We expect to finance future increases in investment in our banking/finance activities through operating cash flows, debt, or through the securitization of a portion of the receivables from consumer lending activities. We believe that our existing liquid assets, together with the expected continuing cash flow from operations, our borrowing capacity under current credit facilities, our ability to issue debt or equity securities under shelf registrations, the sales commission financing arrangement and our ability to issue stock will be sufficient to meet our present and reasonably foreseeable operating cash needs. RISK FACTORS WE FACE STRONG COMPETITION FROM NUMEROUS AND SOMETIMES LARGER COMPANIES. We compete with numerous investment management companies, stock brokerage investment banking firms, insurance companies, banks, online and Internet investment sites, savings and loan associations and other financial institutions. These companies also offer financial services and other investment alternatives. Recent consolidation in the financial services industry has created stronger competitors with greater financial resources and broader distribution channels than our own. In addition, the online services that we may offer may fail to compete effectively with other alternatives available to investors. To the extent that existing or potential customers decide to invest with our competitors, our market share, revenues and net income could decline. 15
COMPETING SECURITIES DEALERS AND BANKS COULD RESTRICT SALES OF OUR FUNDS. Many of the securities dealers on whom we rely to sell and distribute Franklin, Templeton and Mutual Series fund shares also have mutual funds under their own names that compete directly with our products. The banking industry also continues to expand its sponsorship of proprietary funds. These firms or banks could decide to limit or restrict the sale of our fund shares, which could lower our future sales and cause our revenues to decline. CHANGES IN THE DISTRIBUTION CHANNELS ON WHICH WE DEPEND COULD REDUCE OUR REVENUES AND HINDER OUR GROWTH. We derive nearly all of our sales through broker/dealers and other similar investment advisors. Increasing competition in 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 distributes our products were to cease operations, even for a few days, 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. NEW SHARE CLASSES THAT WE HAVE INTRODUCED YIELD LOWER REVENUES AND HAVE REDUCED OPERATING MARGINS. Although we receive reduced or no sales charge at the time of initial investments in our class A shares that are related to tax deferred plans and involve sales of more than $1 million, and in our class B shares and C shares, we must nonetheless pay the related dealer commission. In addition, due to industry competition, the dealer commissions that we pay on these types of shares are now higher than in the past and may increase in the future. This could have a negative effect on our liquidity and operating margins. IF OUR ASSET MIX SHIFTS TO PREDOMINANTLY FIXED-INCOME PRODUCTS OUR REVENUES COULD DECLINE. We derive higher fee revenues and income from the equity assets that we manage. Changing market conditions may cause a shift in our asset mix towards fixed-income products and a decline in our income and revenue. WE HAVE BECOME SUBJECT TO AN INCREASED RISK OF ASSET VOLATILITY FROM CHANGES IN THE GLOBAL EQUITY MARKETS. As our asset mix has shifted since 1992 from predominantly fixed-income to a majority of equity assets, we have become subject to an increased risk of asset volatility from changes in global equity markets. Declines in these markets have caused in the past, and would cause in the future, a decline in our income and revenue. THE LEVELS OF OUR ASSETS UNDER MANAGEMENT ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS. Global economic conditions, interest rates, inflation rates and other factors that are difficult to predict affect the mix, market values, and levels of our assets under management. Fluctuations in interest rates and in the yield curve affect the value of fixed-income assets under management as well as the flow of funds to and from fixed-income funds. In turn, this affects our asset management revenues from those assets. Similarly, changes in the equity marketplace may significantly affect the level of our assets under management. The factors above often have opposite effects on equity funds and fixed-income funds, making it difficult for us to predict the net effect of any particular set of conditions on our business and to devise effective strategies to counteract those conditions. 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 16
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, which could force us to revise our business strategy. GENERAL ECONOMIC AND SECURITIES MARKETS FLUCTUATIONS MAY REDUCE OUR SALES AND MARKET SHARE. Adverse general securities market conditions, increased market volatility, currency fluctuations, governmental regulations and recessionary global economic conditions could reduce our mutual fund share sales and other financial services products sales. Increased and unusual market volatility and high valuations in the technology sector and many "new economy" stocks could also reduce our mutual fund share sales to the extent that customers decided to shift to predominately fixed-income products. Similarly, our securitized consumer receivables business is subject to marketplace fluctuation. General 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. 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 portfolios of auto loan and credit card receivables, and to obtain continued financing for class B 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, for any reason, to obtain these funds and financing, we may be forced to incur unanticipated costs or revise our business plan. WE FACE INCREASED COMPETITION IN HIRING AND RETAINING QUALIFIED EMPLOYEES. Our continued success will depend upon our ability to attract and retain qualified personnel. Competition to hire these employees has increased, particularly in certain geographic locations where the majority of our workforce is employed. We may be forced to offer compensation and benefits to these employees at a level that exceeds inflation. With historically low unemployment in the United States, qualified personnel are now moving between firms and starting their own companies with greater frequency. If we are not able to attract and retain qualified employees, our overall business condition and revenues could suffer. OUR EMERGING MARKET PORTFOLIOS AND RELATED REVENUES ARE VULNERABLE TO POLITICAL AND ECONOMIC RISKS ASSOCIATED WITH EMERGING MARKETS. 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, including the finance subsidiaries of large automobile manufacturers. Some of these competitors can provide loans at significantly below-market interest rates in connection with automobile sales. Our inability to compete effectively against these companies or to maintain our relationships with the various automobile dealers through which we offer consumer loans could harm the growth of our consumer loan business. 17
RISK FACTORS RELATING TO THE COMBINATION WITH FIDUCIARY TRUST COMPANY INTERNATIONAL In connection with the proposed acquisition of Fiduciary Trust Company International ("Fiduciary"), which was announced in October 2000, we may be subject to the following risks: THE TRANSACTION IS SUBJECT TO REGULATORY AND SHAREHOLDER APPROVAL. Our Agreement and Plan of Share Acquisition with Fiduciary is subject to the approval of the share exchange by various governmental and regulatory agencies. The share exchange is also subject to the approval of the shareholders of Fiduciary. There is no assurance that all the necessary approvals will be obtained. FLUCTUATING MARKET PRICES COULD CAUSE THE VALUE OF OUR STOCK TO BE RECEIVED BY THE FIDUCIARY SHAREHOLDERS TO BE LESS THAN ITS CURRENT VALUE. The stock market recently has experienced significant price and volume fluctuations. These market fluctuations could have a material adverse effect on the market price of our common stock before completion of the acquisition, and thereby result in Fiduciary shareholders receiving our common stock with a value lower than the average trading price used to determine the exchange ratio in connection with the share exchange. WE MAY BE SUBJECT TO A SUBSTANTIAL TERMINATION FEE IF WE CANCEL THE TRANSACTION. The Agreement and Plan of Acquisition requires us to pay a termination fee of $25 million if, under certain circumstances, the Agreement and Plan of Acquisition is terminated. WE MAY NOT BE ABLE TO ACHIEVE THE BENEFITS WE EXPECT FROM THE ACQUISITION. Achieving the anticipated benefits of the acquisition will depend in part on close collaboration between management and key personnel of the two companies in a timely and efficient manner so as to minimize the risk that the acquisition will result in the loss of clients or employees or the continued diversion of the attention of management. THE ACQUISITION COULD ADVERSELY AFFECT OUR COMBINED FINANCIAL RESULTS OR THE MARKET PRICE OF OUR COMMON STOCK. If the benefits of the acquisition do not exceed the costs associated with the acquisition, including any dilution to our shareholders resulting form the issuance of shares in connection with the acquisition, our financial results, including earnings per share, could be adversely affected. In addition, if we do not achieve the perceived benefits of the acquisition as rapidly as, or to the extent, anticipated by financial or industry analysts, the market price of our common stock may decline. UNCERTAINTIES ASSOCIATED WITH THE ACQUISITION MAY CAUSE FIDUCIARY TO LOSE CLIENTS. Fiduciary's clients may, in response to the announcement of the acquisition, delay or defer decisions concerning their use of Fiduciary products and services following the acquisition. Any delay or deferral could have an adverse effect on our combined businesses. For example, Fiduciary may experience a decrease in expected revenue as a consequence of the uncertainties associated with the acquisition. FOLLOWING THE TRANSACTION, WE WILL BE SUBJECT TO FEDERAL RESERVE BOARD REGULATION. We expect to become a bank holding company and financial holding company that will be subject to Federal Reserve Board regulation under the Bank Holding Company Act of 1956. Following the transaction, we and our subsidiaries will be subject to certain banking regulations, including minimum capital requirements. Additionally, prior approval of the Federal Reserve Board may be required in order to effect a change in control of us. 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the normal course of business, our financial position is subject to a variety of risks, including market risk associated with interest rate movements. We are exposed to changes in interest rates primarily in our debt transactions. Through our medium-term note program and other fixed interest debt, we have effectively fixed the rate of interest we pay on 24% of our debt outstanding at December 31, 2000. We have considered the potential impact of the effect on the banking/finance segment of a 100 basis point (1%) movement in market interest rates and we do not expect it would have a material impact on our operating revenues or results of operations. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS There have been no material developments in the litigation previously reported in our Annual Report on Form 10-K for the period ended September 30, 2000 as filed with the SEC on December 7 , 2000. 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. 19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as part of the report: 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 By-Laws incorporated by reference to Exhibit 3(ii) to the Company's Form 10-K for the fiscal year ended September 30, 1999 Exhibit 10.53 Employment Agreement entered into on December 22, 2000 by and among Anne M. Tatlock, Fiduciary Trust Company International and Franklin Resources, Inc. Exhibit 10.54 Amended and Restated 1998 Universal Stock Incentive Plan as approved by the Board of Directors on October 28, 2000 and the Stockholders at the Annual Meeting held on January 25, 2001. Exhibit 12 Computations of ratios of earnings to fixed charges (b) Reports on Form 8-K: (i) Form 8-K filed on October 25, 2000 reporting under Item 5 "Other Events" the agreement and plan of share acquisition between Fiduciary Trust Company International and Registrant, and including said agreement, an earnings press release and an acquisition press release as Exhibits under Item 7 "Financial Statements and Exhibits" release. (ii) Form 8-K/A (Amendment No. 1) dated October 25, 2000 and filed on October 26, 2000, reporting under Item 5 "Other Events" the agreement and plan of share acquisition between Fiduciary Trust Company International and Registrant and including said agreement, an earnings press release and an acquisition press release as Exhibits under Item 7 "Financial Statements and Exhibits". 20
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FRANKLIN RESOURCES, INC. ------------------------ Registrant. Date: February 14, 2001 /s/ MARTIN L. FLANAGAN ---------------------- MARTIN L. FLANAGAN President, Member-Office of the President, Chief Financial Officer and Chief Operating Officer 21