FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarterly Period Ended March 31, 2001 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: 264,523,885 shares, common stock, par value $.10 per share at April 30, 2001.
PART I -FINANCIAL INFORMATION Item 1. Condensed Financial Statements <TABLE> <CAPTION> FRANKLIN RESOURCES, INC. Consolidated Income Statements Unaudited Three months ended Six months ended March 31 March 31 (In thousands, except per share data) 2001 2000 2001 2000 - -------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> OPERATING REVENUES: Investment management fees $340,136 $356,009 $685,921 $700,051 Underwriting and distribution fees 178,165 200,133 342,527 364,376 Shareholder servicing fees 51,962 53,202 100,184 104,961 Other 7,150 3,182 12,855 8,805 -------------------------------------------- TOTAL OPERATING REVENUES 577,413 612,526 1,141,487 1,178,193 -------------------------------------------- OPERATING EXPENSES: Underwriting and distribution 162,134 176,876 307,818 320,044 Compensation and benefits 140,074 134,581 281,933 265,430 Information systems, technology and 59,002 51,441 116,530 103,072 occupancy Advertising and promotion 24,433 25,895 46,559 48,440 Amortization of deferred sales commissions 17,579 21,600 35,815 42,231 Amortization of intangible assets 10,107 9,283 20,016 18,566 Other 19,611 20,773 39,365 40,698 -------------------------------------------- TOTAL OPERATING EXPENSES 432,940 440,449 848,036 838,481 -------------------------------------------- OPERATING INCOME 144,473 172,077 293,451 339,712 -------------------------------------------- OTHER INCOME (EXPENSE): Investment and other income 32,054 19,752 82,010 36,431 Interest expense (3,259) (3,180) (5,529) (6,544) -------------------------------------------- OTHER INCOME (EXPENSE), NET 28,795 16,572 76,481 29,887 -------------------------------------------- INCOME BEFORE TAXES ON INCOME 173,268 188,649 369,932 369,599 TAXES ON INCOME 41,584 45,275 88,783 88,703 -------------------------------------------- NET INCOME $131,684 $143,374 $281,149 $280,896 ============================================ EARNINGS PER SHARE: BASIC AND DILUTED $0.54 $0.58 $1.15 $1.13 DIVIDENDS PER SHARE $0.065 $0.06 $0.13 $0.12 The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 2
FRANKLIN RESOURCES, INC. Consolidated Balance Sheets Unaudited March 31 September 30 (In thousands) 2001 2000 - -------------------------------------------------------------------------------- ASSETS: Current assets: Cash and cash equivalents $981,823 $734,071 Receivables: Sponsored investment products 218,283 241,282 Other 39,046 27,105 Investment securities, available-for-sale 387,444 635,819 Prepaid expenses and other 33,251 18,017 - ------------------------------------------------------------------------------ Total current assets 1,659,847 1,656,294 - ------------------------------------------------------------------------------ Banking/Finance assets: Cash and cash equivalents 6,832 11,934 Loans receivable, net 197,620 256,416 Investment securities, available-for-sale 25,414 26,851 Other 12,416 4,361 - ------------------------------------------------------------------------------ Total banking/finance assets 242,282 299,562 - ------------------------------------------------------------------------------ Other assets: Deferred sales commissions 100,424 86,754 Property and equipment, net 442,732 444,694 Intangible assets, net 1,238,681 1,169,485 Receivable from banking/finance group 93,461 168,496 Other 178,355 217,158 - ------------------------------------------------------------------------------ Total other assets 2,053,653 2,086,587 - ------------------------------------------------------------------------------ Total assets $3,955,782 $4,042,443 ============================================================================== The accompanying notes are an integral part of these consolidated financial statements. 3
FRANKLIN RESOURCES, INC. Consolidated Balance Sheets Unaudited March 31 September 30 (In thousands except share data) 2001 2000 - ------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY: Current liabilities: Compensation and benefits 90,155 180,743 Current maturities of long-term debt 16,777 68,776 Accounts payable and accrued expenses 86,412 72,646 Commissions 88,382 76,965 Income taxes 24,563 61,661 Other 7,305 28,768 - ------------------------------------------------------------------------------ Total current liabilities 313,594 489,559 - ------------------------------------------------------------------------------ Banking/finance liabilities: Payable to Parent 93,461 168,496 Deposits 47,412 54,846 Other 18,287 15,612 - ------------------------------------------------------------------------------ Total banking/finance liabilities 159,160 238,954 - ------------------------------------------------------------------------------ Other liabilities: Long-term debt 254,579 294,090 Other 46,747 54,347 - ------------------------------------------------------------------------------ Total other liabilities 301,326 348,437 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ Total liabilities 774,080 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; 244,333,822 and 243,730,140 shares issued and outstanding 24,433 24,373 Retained earnings 3,206,303 2,932,166 Other (2,263) (3,422) Accumulated other comprehensive (loss) income (46,771) 12,376 - ------------------------------------------------------------------------------ Total stockholders' equity 3,181,702 2,965,493 - ------------------------------------------------------------------------------ Total liabilities and stockholders' equity $3,955,782 $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 Six months ended March 31 (In thousands) 2001 2000 - -------------------------------------------------------------------------------- Net income $281,149 $280,896 Adjustments to reconcile net income to net cash provided by operating activities: Decrease in receivables, prepaid expenses and other 39,540 5,938 Advances of deferred sales commissions (49,484) (24,491) Decrease in restructuring liabilities - (2,564) (Decrease) increase in other current liabilities (12,064) 2,162 Increase in income taxes payable (37,098) (20,030) Increase in commissions payable 11,416 4,210 Decrease in accrued compensation and benefits (64,293) (16,024) Depreciation and amortization 103,213 99,550 Gains on disposition of assets (42,223) (1,913) - -------------------------------------------------------------------------------- Net cash provided by operating activities 230,156 327,734 - -------------------------------------------------------------------------------- Purchase of investments (194,753) (78,271) Liquidation of investments 440,461 279,295 Purchase of banking/finance investments (11,070) (13,373) Liquidation of banking/finance investments 12,794 12,342 Proceeds from securitization of loans receivable 139,295 123,048 Net origination of loans receivable (80,322) (102,602) Acquisition of subsidiary, net of cash acquired (94,483) - Purchase of property and equipment (44,665) (51,224) - -------------------------------------------------------------------------------- Net cash provided by investing activities 167,257 169,215 - -------------------------------------------------------------------------------- Decrease in bank deposits (7,433) (2,663) Exercise of common stock options 1,592 378 Dividends paid on common stock (30,472) (28,725) Purchase of stock (8,265) (249,395) Issuance of debt 155,646 312,802 Payments on debt (265,831) (271,624) - ------------------------------------------------------------------------------- Net cash used in financing activities (154,763) (239,227) - -------------------------------------------------------------------------------- Increase in cash and cash equivalents 242,650 257,722 Cash and cash equivalents, beginning of period 746,005 819,244 - -------------------------------------------------------------------------------- Cash and cash equivalents, end of period $988,655 $1,076,966 - -------------------------------------------------------------------------------- Supplemental disclosure of non-cash information: Value of common stock issued, principally restricted stock $24,959 $29,229 The accompanying notes are an integral part of these consolidated financial statements. 5
FRANKLIN RESOURCES, INC. Notes to Consolidated Financial Statements March 31, 2001 (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 pursuant to the rules and regulations of the Securities and Exchange Commission. 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 for a fair statement 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 included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2000. 2. Debt At March 31, 2001, our overall weighted average interest rate on outstanding commercial paper was 5.14%. During the quarter ended March 31, 2001, our remaining fixed interest medium term notes, which had a face value of $60 million, were redeemed at maturity. 3. Comprehensive income The following table shows comprehensive income for the three- and six-month periods ended March 31, 2001. Three months ended Six months ended March 31 March 31 (In thousands) 2001 2000 2001 2000 ------------------------------------------------------------------------- Net income $131,684 $143,374 $281,149 $280,896 Net unrealized (loss) gain on available-for-sale (13,952) 5,424 (49,681) 18,683 securities Foreign currency translation adjustments (5,406) (5,696) (9,466) (3,738) ------------------------------------------------------------------------- Comprehensive income $112,326 $143,102 $222,002 $295,841 ========================================================================= 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 three- and six- month periods ended March 31, 2001 and 2000 is presented in the table below. Operating revenues of the banking/finance segment are reported net of interest expense. Three months ended Six months ended March 31 March 31 (In thousands) 2001 2000 2001 2000 -------------------------------------------------------------------------- Operating revenues: Investment management $569,469 $609,357 $1,126,829 $1,170,420 Banking/finance 7,944 3,169 14,658 7,773 -------------------------------------------------------------------------- Company Totals $577,413 $612,526 $1,141,487 $1,178,193 Income before taxes: Investment management $170,873 $189,949 $366,016 $370,034 Banking/finance 2,395 (1,300) 3,916 (435) -------------------------------------------------------------------------- Company Totals $173,268 $188,649 $369,932 $369,599 ========================================================================== Operating segment assets were as follows: (In thousands) March 31, 2001 September 30, 2000 -------------------------------------------------------------------------- Investment management $3,713,500 $3,742,881 Banking/finance 242,282 299,562 -------------------------------------------------------------------------- Company Totals $3,955,782 $4,042,443 ========================================================================== 5. Earnings per share Earnings per share were computed as follows: Three months ended Six months ended March 31 March 31 (In thousands except per share amounts) 2001 2000 2001 2000 -------------------------------------------------------------------------- Net income $131,684 $143,374 $281,149 $280,896 ========================================================================== Weighted-average shares outstanding - basic 244,256 246,826 243,982 248,629 Incremental shares from assumed conversions 871 172 816 163 -------------------------------------------------------------------------- Weighted-average shares outstanding - diluted 245,127 246,998 244,798 248,792 ========================================================================== Earnings per share: Basic and diluted $0.54 $0.58 $1.15 $1.13 7
6. 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 gross sales proceeds of this securitization, including interest and before underwriting discount, 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. New Statement of Financial Accounting Standard In September 2000, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard No. 140 "Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities" ("FAS 140"), which is effective for transfers and servicing of financial assets and extinguishing of liabilities occurring after March 31, 2001. FAS 140 replaces FASB Statement No. 125 and revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. The impact of the adoption of FAS 140 on our reported operating results, financial position and existing financial statement disclosure is not expected to be material. 8. Fiduciary acquisition On April 10, 2001, we acquired Fiduciary Trust Company International, ("Fiduciary"). These financial statements do not include the results of Fiduciary, as it was not a subsidiary at March 31, 2001. Each share of Fiduciary Trust common stock was exchanged for 2.7744 shares of our common stock, resulting in the issuance in the aggregate of approximately 20,187,000 shares of our common stock. The approximate valuation of the shares issued in exchange for Fiduciary was approximately $775 million. We will account for this transaction using the purchase method of accounting. The final valuation for accounting purposes is still in progress. 9. Convertible debt offering On May 11, 2001, we received approximately $490 million in net proceeds upon the closing of the sale of $877 million principal amount at maturity of zero-coupon convertible senior notes due 2031 ("convertible securities"), which were offered to qualified institutional buyers. The total net amount received includes proceeds from the sale of approximately $176 million in convertible securities from the exercise of an over-allotment option by the initial purchaser. We used approximately $129 million of the offering proceeds to repurchase 3 million shares of our common stock. We will use the balance of the proceeds for general corporate purposes. 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS In this section, we discuss the results of our operations and financial condition. We also make some statements relating to the future, which are, or may be considered, "forward-looking" statements. These forward-looking statements are subject to risks, uncertainties, and other important factors. Consequently, actual results and outcomes may vary significantly from those included in or contemplated or implied by our forward-looking statements. For this reason, 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 March 31 March 31 (In billions) 2001 2000 ---------------------------------------------------------------------------- Equity: Global/international $87.6 $106.2 Domestic 45.5 49.3 ----------------------------------------------------------------------------- Total equity 133.1 155.5 ----------------------------------------------------------------------------- Hybrid Funds 9.8 9.0 Fixed-income: Tax-free 45.8 44.6 Taxable: Domestic 17.2 15.0 Global/international 3.9 3.6 ----------------------------------------------------------------------------- Total fixed-income 66.9 63.2 ----------------------------------------------------------------------------- Money funds 5.9 5.7 ----------------------------------------------------------------------------- Total end of period $215.7 $233.4 ============================================================================= Simple monthly average for the three-month period(1) $224.9 $231.0 ----------------------------------------------------------------------------- Simple monthly average for the six-month period(1) $225.6 $226.5 ============================================================================= (1) Investment management fees from approximately 55% of our assets under management at March 31, 2001 are calculated using a daily average. 9
Our assets under management at March 31, 2001 were $215.7 billion, 8% lower than they were a year ago. Simple monthly average assets for the three months ended March 31, 2001 decreased 3% this quarter over the same period a year ago. Equity assets now comprise 62% of total assets under management as compared to 67% at March 31, 2000. Fixed income assets now comprise 31% 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. <TABLE> <CAPTION> ASSETS UNDER MANAGEMENT Three months ended Six months ended March 31 Percent March 31 Percent in billions 2001 2000 Change 2001 2000 Change ------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Beginning assets under management $226.9 $235.0 (3)% $229.9 $218.1 5% Sales 15.6 15.8 (1)% 28.3 26.8 6% Reinvested Dividends 0.8 0.7 14% 6.2 4.9 27% Redemptions (14.7) (18.5) (21)% (30.1) (33.0) (9)% (Depreciation) appreciation (12.9) 0.4 N/A (18.6) 16.6 N/A ------------------------------------------------------------------------------------------------ Ending assets under management $215.7 $233.4 (8)% $215.7 $233.4 (8)% ================================================================================================ </TABLE> For both the three and six months ended March 31, 2001 sales and reinvested dividends exceeded redemptions ("net inflows") complex-wide by $1.7 billion and $4.4 billion, compared to the same periods last year when redemptions exceeded sales and reinvested dividends ("net outflows") complex-wide by $2.0 billion and $1.3 billion. This was principally due to a decrease in redemptions in the current year. Market depreciation of $18.6 billion in the six months ended March 31, 2001 was mostly experienced within the U.S. equity markets, partially offset by appreciation in the fixed income sector. <TABLE> <CAPTION> RESULTS OF OPERATIONS Three months ended Six months ended March 31 Percent March 31 Percent 2001 2000 Change 2001 2000 Change --------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Net income (millions) $131.7 $143.4 (8)% $281.1 $280.9 - Earnings per share Basic and diluted $0.54 $0.58 (7)% $1.15 $1.13 2% Operating margin 25% 28% 26% 29% EBITDA margin(1) As reported 35% 35% 36% 36% -------------------------------------------------------------------------------------------- (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. </TABLE> Net income during the quarter ended March 31, 2001 decreased 8% compared to the same period last year. This was mainly due to lower operating revenues due to a decline in average assets under management. Net income during the six months ended March 31, 2001 was substantially unchanged from the same period last year as lower operating revenues were offset by increased investment income. 10
OPERATING REVENUES Three months ended Six months ended March 31 Percent March 31 Percent (In millions) 2001 2000 Change 2001 2000 Change ----------------------------------------------------------------------------- Investment management fees $340.1 $356.0 (4)% $685.9 $700.0 (2)% Underwriting and distribution fees 178.2 200.1 (11)% 342.5 364.4 (6)% Shareholder servicing fees 51.9 53.2 (2)% 100.2 105.0 (5)% Other, net 7.2 3.2 125% 12.9 8.8 47% ----------------------------------------------------------------------------- Total operating revenues $577.4 $612.5 (6)% $1,141.5 $1,178.2 (3)% ============================================================================= SUMMARY Total operating revenues decreased 6% and 3% for the three and six months ended March 31, 2001 compared to the same periods last year. This was primarily due to decreased investment management and underwriting and distribution fees following reduced average assets under management and a decline in commissionable sales. 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 in certain instances decline as the average net assets of the individual portfolios exceed certain threshold levels. In return for these fees, we provide investment advisory, administrative and other management services. Investment management fees decreased 4% and 2% during the three and six months ended March 31, 2001 over the same periods last year. This decrease was mainly due to the decreases in the simple monthly average assets under management between these periods from $231.0 billion and $226.5 billion a year ago to $224.9 billion and $225.6 billion in the current year, and a shift in our asset mix toward lower fee fixed income products. Equity assets now comprise 62% of total assets under management as compared to 67% at March 31, 2000. Fixed income assets now comprise 31% of total assets under management, as compared to 27% at the same time last year. This shift toward fixed income products led to a decrease in our effective investment management fee rate (investment management fees divided by simple monthly average assets under management) in the quarter ended March 31, 2001 to 0.60% compared to 0.62% in the same period last year. 11
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. Underwriting and distribution fees decreased 11% and 6% during the three and six months ended March 31, 2001 over the same periods last year, despite a 1% decrease and a 6% increase in product sales during these periods. 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. Distribution fee revenues remained substantially unchanged from the same periods last year. 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 2% and 5% during the three and six months ended March 31, 2001 over the same periods last year 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 increased 125% and 47% during the three and six months ended March 31, 2001 over the same periods last year. This increase was principally due to a gain made on the securitization of auto loans in January 2001 of $2.9 million compared to a loss made in our March 2000 securitization of $0.9 million. 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. 12
<TABLE> <CAPTION> OPERATING EXPENSES Three months ended Six months ended March 31 Percent March 31 Percent (In millions) 2001 2000 Change 2001 2000 Change ---------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Underwriting and distribution $162.1 $176.8 (8)% $307.8 $320.0 (4)% Compensation and benefits 140.1 134.6 4% 281.9 265.4 6% Information systems, technology and occupancy 59.0 51.4 15% 116.5 103.1 13% Advertising and promotion 24.4 25.9 (6)% 46.6 48.5 (4)% Amortization of deferred sales commissions 17.6 21.6 (19)% 35.8 42.2 (15)% Amortization of intangible assets 10.1 9.3 9% 20.0 18.6 8% Other 19.6 20.8 (6)% 39.4 40.7 (3)% --------------------------------------------------------------------------------- Total operating expenses $432.9 $440.4 (2)% $848.0 $838.5 1% ================================================================================= </TABLE> SUMMARY Operating expenses decreased 2% and increased 1% during the three and six months ended March 31, 2001 compared to the same periods last year. These changes were primarily caused by reduced underwriting and distribution expenses offset by 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. Underwriting and distribution expenses decreased 8% and 4% during the three and six months ended March 31, 2001 compared to the same periods last year. Total sales decreased 1% and increased 6%, but a significant number of 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 4% and 6% during the three and six months ended March 31, 2001 compared to the same periods last year. This increase was primarily due to annual salary increases partially offset by a 3% and 2% 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 March 31, 2001 was approximately 6,300 as compared to approximately 6,400 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. INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY Information systems, technology and occupancy costs increased 15% and 13% during the three and six months ended March 31, 2001 compared to the same periods 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 13
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 Six months ended March 31 March 31 in millions 2001 2000 2001 2000 ----------------------------------------------------------------------------- Beginning cost $332,601 $259,331 $317,767 $246,857 Net additions during period 20,855 16,039 35,689 28,513 ----------------------------------------------------------------------------- Ending cost 353,456 275,370 353,456 275,370 Beginning Accumulated amortization 177,375 120,102 160,872 108,291 Charge for period 18,550 12,786 35,053 24,597 ----------------------------------------------------------------------------- Ending Accumulated amortization 195,925 132,888 195,925 132,888 ----------------------------------------------------------------------------- Net book value at end of period $157,531 $142,482 $157,531 $142,482 ============================================================================= ADVERTISING AND PROMOTION Advertising and promotion decreased 6% and 4% during the three and six months ended March 31, 2001 compared to the same periods last year. This decrease resulted primarily from reduced printing costs. AMORTIZATION OF DEFERRED SALES COMMISSIONS Amortization of deferred sales commissions decreased 19% and 15% during the three and six months ended March 31, 2001 compared to the same periods last year. This decrease was 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"), a company in which we have an ownership interest. DCA that are 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., including DCA financed through LFL, are amortized. As a result of the arrangement with LFL, all Canadian and European DCA are no longer recorded in our financial statements. Generally, U.S. DCA sold to LFL under the U.S. agreement are retained in the financial statements since they are not considered sold under this agreement until resold by LFL. 14
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 62% and 125% during the three and six months ended March 31, 2001 compared to the same periods last year principally due to higher realized gains in the current year. 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, other realized gains of $8.2 million and $16.4 million were included in other income during the three and six months ended March 31, 2001. These gains 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 16% during the six months ended March 31, 2001 compared to the same periods last year due to a reduction in our average outstanding debt. TAXES ON INCOME Our effective income tax rate for the quarters ended March 31, 2001 and 2000 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 March 31, 2001, we had $988.7 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 $1,658.8 million at March 31, 2001 from $1,677.1 million at September 30, 2000. At March 31, 2001, approximately $644.8 million was available to us under unused commercial paper and medium-term note programs. In addition, revolving credit facilities at March 31, 2001 aggregated to $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 $230.2 million in the six months ended March 31, 2001 compared to $327.7 million in the same period last year. This decrease was due mainly to lower operating income resulting from higher operating expenses and lower operating revenues. During the current year we sold $245.7 million of investments, net of purchases; generated net cash of $60.7 million from the banking/finance segment; and used $94.5 million to purchase Bissett & Associates Investment Management Ltd., providing a total of $167.3 million from investing activities. Net cash used in financing activities during the current year was $154.8 million. Outstanding debt declined to $271.4 million at March 31, 2001 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. During 15
the quarter ended March 31, 2001 our remaining medium term notes, which had a face value of $60 million were redeemed at maturity. Our overall weighted average interest rate on outstanding commercial paper was 5.14% at March 31, 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 $251 million at March 31, 2001. 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 and 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. COMPETING SECURITIES DEALERS AND BANKS COULD RESTRICT SALES OF OUR FUNDS. Many of the securities dealers on which 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 16
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 than from fixed income assets. Changing market conditions may cause a shift in our asset mix towards fixed-income products and a decline in our revenue and income. 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 revenue and income. 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 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 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. 17
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 increases in compensation and benefits to these employees at rates that exceed 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 MARKET-SPECIFIC POLITICAL AND ECONOMIC RISKS. Our emerging market portfolios and revenues derived from managing these portfolios are subject to significant risks of loss from political and diplomatic developments, currency fluctuations, social instability, changes in governmental polices, expropriation, nationalization, asset confiscation and changes in legislation related to foreign ownership. Foreign trading markets, particularly in some emerging market countries are often smaller, less liquid, less regulated and significantly more volatile than the U.S. and other established markets. DIVERSE AND STRONG COMPETITION LIMITS THE INTEREST RATES THAT WE CAN CHARGE ON CONSUMER LOANS. We compete with many types of institutions for consumer loans, 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. RISK FACTORS RELATING TO THE COMBINATION WITH FIDUCIARY TRUST COMPANY INTERNATIONAL In connection with the acquisition of Fiduciary Trust Company International ("Fiduciary"), which was completed on April 10, 2001, we are subject to the following risks: 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. 18
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. WE ARE SUBJECT TO FEDERAL RESERVE BOARD REGULATION. Upon completion of our acquisition of Fiduciary Trust Company International, we became a bank holding company and a financial holding company subject to the supervision and regulation of the Federal Reserve Board under the Bank Holding Company Act of 1956. The Federal Reserve Board may impose limitations, restrictions, or prohibitions on our activities 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, and the Federal Reserve Board may take actions as appropriate to enforce applicable federal law. Additionally, prior approval of the Federal Reserve Board may be required in order to effect a change in control of us. 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. We have effectively fixed the rate of interest we pay on 16% of our debt outstanding at March 31, 2001. 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 Form 10-Q for the period ended December 31, 2000 as filed with the SEC on February 14, 2001. We are involved from time to time in litigation relating to claims arising in the normal course of business. Management is of the opinion that the ultimate resolution of such claims will not materially affect our business or financial position. Item 4. Submission of Matters to a Vote of Security Holders (a) The Annual Meeting of Stockholders of Franklin Resources, Inc. was held at 10:00 a.m., Pacific Standard Time, on January 25, 2001 at the principal offices of the Company located at 777 Mariners Island Boulevard, San Mateo, California. The three proposals presented at the meeting were: 1. The election of nine (9) directors to hold office until the next Annual Meeting of Stockholders or until their successors are elected and shall qualify. 19
2. The ratification of the appointment by the Board of Directors of PricewaterhouseCoopers LLP as the Company's independent accountants for the fiscal year ending September 30, 2001. 3. The ratification and approval of the Amended and Restated 1998 Universal Stock Incentive Plan. (b) Each of the nine nominees for director was elected and received the number of votes set forth below: Name For Against ---------------------- ----------- --------- Harmon E. Burns 219,054,415 4,235,561 Charles B. Johnson 219,036,604 4,253,372 Charles E. Johnson 217,561,115 5,728,861 Rupert H. Johnson, Jr. 217,577,843 5,712,133 Harry O. Kline 218,970,446 4,319,530 James A. McCarthy 219,312,198 3,977,778 Peter M. Sacerdote 217,562,310 5,727,666 Anne M. Tatlock 218,502,606 4,787,370 Louis E. Woodworth 219,312,790 3,977,186 (c) The ratification of the appointment of PricewaterhouseCoopers LLP as the Company's independent accountants for the fiscal year ending September 30, 2001, was approved by a vote of 222,612,356 shares in favor, 61,906 shares against, and 615,714 shares abstaining. (d) The ratification and approval of the Amended and Restated 998 Universal Stock Incentive Plan was approved by a vote of 197,217,219 shares in favor, 25,296,359 shares against, and 776,398 shares abstaining. 20
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 10.55 Representative Sub-Advisory Agreement between FTTrust Company, on behalf of Templeton International Smaller Companies Fund, Templeton Investment Counsel, LLC and Templeton Asset Management Limited, dated January 23, 2001. Exhibit 10.56 Managed Operations Services Agreement between Franklin Templeton Companies, LLC, and International Business Machines Corporation dated February 6, 2001. . Exhibit 10.57 Representative Agency Agreement between FTTrust Company and Franklin/Templeton Investor Services, LLC, dated April 1, 2001. Exhibit 12 Computations of ratios of earnings to fixed charges Exhibit 99 Press Release issued on February 28, 2001 by Registrant and International Business Machines Corporation (b) Reports on Form 8-K: (i) Form 8-K filed on January 22, 2001 reporting under Item 5 "Other Events" Amendment No. 1 to the Agreement and Plan of Share Acquisition between Registrant and Fiduciary Trust Company International dated January 19, 21
2001, and including said agreement and a press release issued jointly on January 19, 2001 by Registrant and Fiduciary Trust Company International as Exhibits under Item 7 "Financial Statements and Exhibits". (ii) Form 8-K filed on January 25, 2001 reporting under Item 5 "Other Events" an earnings press release, dated January 25, 2001, and including said press release as an Exhibit under Item 7 "Financial Statements and Exhibits." (iii) Form 8-K filed on March 15, 2001 reporting under Item 5 "Other Events" a press release issued jointly on March 14, 2001 by Registrant and Fiduciary Trust Company International, and including said press release as an Exhibit under Item 7 "Financial Statements and Exhibits." (iv) Form 8-K filed on March 27, 2001 reporting under Item 5 "Other Events" a press release issued jointly on March 26, 2001 by Registrant and Fiduciary Trust Company International, and including said press release as an Exhibit under Item 7 "Financial Statements and Exhibits." 22
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FRANKLIN RESOURCES, INC. Registrant. Date: May 15, 2001 /s/ Martin L. Flanagan ---------------------- MARTIN L. FLANAGAN President, Member-Office of the President, Chief Financial Officer and Chief Operating Officer 23