FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarterly Period Ended June 30, 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.) One Franklin Parkway, San Mateo, CA 94403 (Address of Principal Executive Offices) (Zip Code) (650) 312-2000 (Registrant's telephone number, including area code) 777 Mariners Island Blvd., San Mateo, CA 94404 (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 CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding: 261,640,925 shares, common stock, par value $.10 per share at July 31, 2001.
PART I - FINANCIAL INFORMATION ITEM 1. CONDENSED FINANCIAL STATEMENTS <TABLE> <CAPTION> FRANKLIN RESOURCES, INC. CONSOLIDATED INCOME STATEMENTS UNAUDITED THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30 JUNE 30 (In thousands, except per share data) 2001 2000 2001 2000 - --------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> OPERATING REVENUES: Investment management fees $362,543 $344,805 $1,048,464 $1,044,856 Underwriting and distribution fees 180,757 165,181 523,284 529,557 Shareholder servicing fees 53,723 54,143 153,907 159,104 Other 12,450 4,768 25,305 13,573 --------------------------------------------------- TOTAL OPERATING REVENUEs 609,473 568,897 1,750,960 1,747,090 --------------------------------------------------- OPERATING EXPENSES: Underwriting and distribution 162,977 142,684 470,795 462,728 Compensation and benefits 167,643 133,125 449,576 398,555 Information systems, technology and 70,576 50,708 187,106 153,780 occupancy Advertising and promotion 27,314 25,279 73,873 73,719 Amortization of deferred sales 16,361 20,980 52,176 63,211 commissions Amortization of intangible assets 16,672 9,283 36,688 27,849 Other 23,234 18,006 62,599 58,704 --------------------------------------------------- TOTAL OPERATING EXPENSES 484,777 400,065 1,332,813 1,238,546 --------------------------------------------------- OPERATING INCOME 124,696 168,832 418,147 508,544 --------------------------------------------------- OTHER INCOME (EXPENSE): Investment and other income 34,698 19,836 116,708 56,267 Interest expense (1,889) (3,998) (7,418) (10,542) --------------------------------------------------- OTHER INCOME (EXPENSE), NET 32,809 15,838 109,290 45,725 --------------------------------------------------- INCOME BEFORE TAXES ON INCOME 157,505 184,670 527,437 554,269 TAXES ON INCOME 37,802 44,300 126,585 133,003 --------------------------------------------------- NET INCOME $119,703 $140,370 $400,852 $421,266 =================================================== EARNINGS PER SHARE: BASIC $0.46 $0.58 $1.61 $1.71 DILUTED $0.46 $0.58 $1.60 $1.70 DIVIDENDS PER SHARE $0.065 $0.06 $0.195 $0.18 The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 2
<TABLE> <CAPTION> FRANKLIN RESOURCES, INC. CONSOLIDATED BALANCE SHEETS UNAUDITED JUNE 30 SEPTEMBER 30 (In thousands) 2001 2000 - ------------------------------------------------------------------------------------------------- <S> <C> <C> ASSETS: Current assets: Cash and cash equivalents $848,138 $734,071 Receivables: Sponsored investment products 249,971 241,282 Other 41,357 27,105 Investment securities, available-for-sale 637,681 635,819 Prepaid expenses and other 38,952 18,017 - --------------------------------------------------------------------------------------------- Total current assets 1,816,099 1,656,294 - --------------------------------------------------------------------------------------------- Banking/Finance assets: Cash and cash equivalents 26,975 11,934 Loans receivable, net 456,864 256,416 Investment securities, available-for-sale 548,589 26,851 Other 8,768 4,361 - --------------------------------------------------------------------------------------------- Total banking/finance assets 1,041,196 299,562 - --------------------------------------------------------------------------------------------- Other assets: Deferred sales commissions 92,269 86,754 Property and equipment, net 472,950 444,694 Intangible assets, net 2,018,236 1,169,485 Receivable from banking/finance group 182,670 168,496 Other 311,443 217,158 - --------------------------------------------------------------------------------------------- Total other assets 3,077,568 2,086,587 - --------------------------------------------------------------------------------------------- TOTAL ASSETS $5,934,863 $4,042,443 ============================================================================================= The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 3
<TABLE> <CAPTION> FRANKLIN RESOURCES, INC. CONSOLIDATED BALANCE SHEETS UNAUDITED JUNE 30 SEPTEMBER 30 (In thousands except share data) 2001 2000 - --------------------------------------------------------------------------------------------------- <S> <C> <C> LIABILITIES AND STOCKHOLDERS' EQUITY: Current liabilities: Compensation and benefits 174,252 180,743 Current maturities of long-term debt 8,703 68,776 Accounts payable and accrued expenses 102,726 72,646 Commissions 90,812 76,965 Income taxes 17,618 61,661 Other 1,828 28,768 - --------------------------------------------------------------------------------------------- Total current liabilities 395,939 489,559 - --------------------------------------------------------------------------------------------- Banking/finance liabilities: Payable to Parent 182,670 168,496 Deposits 697,728 54,846 Other 34,066 15,612 - --------------------------------------------------------------------------------------------- Total banking/finance liabilities 914,464 238,954 - --------------------------------------------------------------------------------------------- Other liabilities: Long-term debt 551,327 294,090 Other 137,997 54,347 - --------------------------------------------------------------------------------------------- Total other liabilities 689,324 348,437 - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- Total liabilities 1,999,727 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; 261,527,312 and 243,730,140 shares issued and outstanding 26,153 24,373 Capital in excess of par value 645,550 - Retained earnings 3,309,080 2,932,166 Other (1,700) (3,422) Accumulated other comprehensive (loss) income (43,947) 12,376 - --------------------------------------------------------------------------------------------- Total stockholders' equity 3,935,136 2,965,493 - --------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $5,934,863 $4,042,443 ============================================================================================= The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 4
<TABLE> <CAPTION> FRANKLIN RESOURCES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS UNAUDITED NINE MONTHS ENDED JUNE 30 (In thousands) 2001 2000 - ------------------------------------------------------------------------------------------- <S> <C> <C> Net income $400,852 $421,266 Adjustments to reconcile net income to net cash provided by operating activities: Decrease (increase) in receivables, prepaid expenses and other 25,953 (11,176) Advances of deferred sales commissions (57,693) (44,220) Decrease in restructuring liabilities - (2,564) (Decrease) increase in other current liabilities (37,986) 3,441 Decrease in income taxes payable (24,047) (8,517) Increase in commissions payable 13,846 4,971 Increase in accrued compensation and benefits 790 19,806 Depreciation and amortization 161,830 148,893 Gains on disposition of assets (52,527) (4,347) - ------------------------------------------------------------------------------------------- Net cash provided by operating activities 431,018 527,553 - ------------------------------------------------------------------------------------------- Purchase of investments (582,574) (136,192) Liquidation of investments 454,230 294,126 Purchase of banking/finance investments (3,411) (18,996) Liquidation of banking/finance investments 361 19,383 Proceeds from securitization of loans receivable 139,295 123,048 Net origination of loans receivable (189,560) (150,134) Acquisition of subsidiaries, net of cash acquired (100,058) - Purchase of property and equipment (81,919) (80,824) - ------------------------------------------------------------------------------------------- Net cash (used in) provided by investing activities (363,636) 50,411 - ------------------------------------------------------------------------------------------- Increase (decrease) in bank deposits 41,416 (1,172) Exercise of common stock options 1,887 390 Dividends paid on common stock (46,366) (43,340) Purchase of stock (137,213) (249,547) Issuance of debt 694,383 394,718 Payments on debt (492,381) (387,568) - ------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities 61,726 (286,519) - ------------------------------------------------------------------------------------------- Increase in cash and cash equivalents 129,108 291,445 Cash and cash equivalents, beginning of period 746,005 819,244 - ------------------------------------------------------------------------------------------- Cash and cash equivalents, end of period $875,113 $1,110,689 - ------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION: Value of common stock issued, principally restricted stock $24,959 $29,833 Value of common stock issued to acquire Fiduciary $775,783 - Fair value of Fiduciary assets acquired $1,539,080 - Fair value of Fiduciary liabilities acquired $757,722 - The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 5
FRANKLIN RESOURCES, INC. Notes to Consolidated Financial Statements June 30, 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 ---- In May 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 (the "Convertible Notes"). The Convertible Notes, which were offered to qualified institutional buyers only, carry a yield to maturity of 1.875% per annum, with an initial conversion premium of 43%. Each of the $1,000 (principal amount at maturity) Convertible Notes is convertible into 9.3604 shares of our common stock. We may redeem the Convertible Notes for cash on or after May 11, 2006 at their accreted value. We may be required to repurchase the Convertible Notes at their accreted value, at the option of the holders, on May 11 of 2003, 2004, 2006, 2011, 2016, 2021 and 2026. In such event, we may choose to pay the purchase price for such repurchases in cash or shares of our common stock. We used approximately $129 million of the offering proceeds to repurchase 3 million shares of our common stock at $43 per share. During the quarter ended June 30, 2001, we allowed the remainder of our commercial paper to mature. We did not have any commercial paper or medium term notes outstanding at June 30, 2001. 6
3. Comprehensive income -------------------- The following table shows comprehensive income for the three and nine months ended June 30, 2001. <TABLE> <CAPTION> Three months ended Nine months ended June 30 June 30 (In thousands) 2001 2000 2001 2000 -------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net income $119,703 $140,370 $400,852 $421,266 Net unrealized gain (loss) on available-for-sale securities 1,929 (2,943) (47,753) 15,739 Foreign currency translation adjustments 896 (1,048) (8,570) (4,785) -------------------------------------------------------------------------------------- Comprehensive income $122,528 $136,379 $344,529 $432,220 ====================================================================================== </TABLE> 4. Segment information ------------------- We have two operating segments: investment management, which accounted for 99% of revenues for the three and nine months ended June 30, 2001 and represented 82% of our assets at June 30, 2001, 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 includes consumer lending and selected retail banking services to individuals. Financial information for our two operating segments for the three and nine months ended June 30, 2001 and 2000 is presented in the table below. Operating revenues of the banking/finance segment are reported net of interest expense and provision for anticipated loan losses. <TABLE> <CAPTION> Three months ended Nine months ended June 30 June 30 (In thousands) 2001 2000 2001 2000 ------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Operating revenues: Investment management $600,715 $564,093 $1,727,544 $1,734,513 Banking/finance 8,758 4,804 23,416 12,577 ------------------------------------------------------------------------------------ Company Totals $609,473 $568,897 $1,750,960 $1,747,090 Income (loss) before taxes: Investment management $155,680 $184,753 $521,697 $554,787 Banking/finance 1,825 (83) 5,740 (518) ------------------------------------------------------------------------------------ Company Totals $157,505 $184,670 $527,437 $554,269 ==================================================================================== </TABLE> 7
Operating segment assets were as follows: <TABLE> <CAPTION> (In thousands) June 30, 2001 September 30, 2000 ------------------------------------------------------------------------------------ <S> <C> <C> Investment management $4,893,667 $3,742,881 Banking/finance 1,041,196 299,562 ------------------------------------------------------------------------------------ Company Totals $5,934,863 $4,042,443 ==================================================================================== </TABLE> 5. Earnings per share ------------------ Earnings per share were computed as follows: <TABLE> <CAPTION> Three months ended Nine months ended June 30 June 30 (In thousands except per share amounts) 2001 2000 2001 2000 -------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net income $119,703 $140,370 $400,852 $421,266 ============================================================================================ Weighted-average shares Outstanding - basic 260,815 243,542 249,591 246,933 Incremental shares from assumed conversions 1,359 199 1,031 188 -------------------------------------------------------------------------------------------- Weighted-average shares outstanding - diluted 262,174 243,741 250,622 247,121 =========================================================================================== Earnings per share: Basic $0.46 $0.58 $1.61 $1.71 Diluted $0.46 $0.58 $1.60 $1.70 We issued approximately 20.2 million shares to purchase Fiduciary Trust Company International on April 10, 2001. </TABLE> 6. New Statement of Financial Accounting Standard ---------------------------------------------- In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard No. 141 "Business Combinations" ("SFAS 141"), and Statement of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting, and prohibits the use of the pooling-of-interests method for such transactions. The new standard also requires identified intangible assets acquired in a business combination to be recognized as an asset apart from goodwill if they meet certain criteria. The impact of the adoption of SFAS 141 on our reported operating results, financial position and existing financial statement disclosure is not expected to be material. SFAS 142 applies to all goodwill and identified intangible assets acquired in a business combination. Under the new standard, all goodwill, including that acquired before initial application of the standard, should not be amortized but should be tested for impairment at least annually. Identified intangible assets should be amortized over their useful lives and reviewed 8
for impairment in accordance with Statement of Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long Lived Assets to be Disposed Of". Within six months of initial application of the new standard, a transitional impairment test must be performed on all goodwill. Any impairment loss recognized as a result of the transitional impairment test should be reported as a change in accounting principle. In addition to the transitional impairment test, the required annual impairment test should be performed in the year of adoption of the standard. The new standard is effective for fiscal years beginning after December 15, 2001, and must be adopted as of the beginning of a fiscal year. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not previously been issued. Retroactive application is not permitted. We expect to early adopt SFAS 142 on October 1, 2001 for our fiscal year 2002 and we are currently evaluating the potential impact of the standard on our financial position and results of operations. 7. Fiduciary acquisition --------------------- On April 10, 2001, we acquired Fiduciary Trust Company International, ("Fiduciary"). These financial statements include the results of Fiduciary from April 10, 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 value of the shares issued in exchange for Fiduciary was approximately $776 million. We accounted for this transaction using the purchase method of accounting. The excess of purchase price, including our relevant costs, over the fair value of the net assets acquired resulted in goodwill of $569 million. Net assets acquired included $227 million of other intangible assets. Until the adoption of SFAS 142, as described in note 6 above, we will amortize goodwill over 40 years and other intangibles over 15 years on a straight-line basis. We have not presented proforma combined results of operations because the results of operations as reported in the accompanying consolidated statements of income would not have been materially different. 9
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 high net worth 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. <TABLE> <CAPTION> ASSETS UNDER MANAGEMENT June 30 June 30 (In billions) 2001 2000 ---------------------------------------------------------------------------------------- <S> <C> <C> Equity: Global/international $93.4 $103.6 Domestic 53.3 49.6 ---------------------------------------------------------------------------------------- Total equity 146.7 153.2 ---------------------------------------------------------------------------------------- Hybrid 38.3 8.9 Fixed-income: Tax-free 46.9 43.8 Taxable: Domestic 23.4 15.3 Global/international 7.2 3.5 ---------------------------------------------------------------------------------------- Total fixed-income 77.5 62.6 ---------------------------------------------------------------------------------------- Money 5.4 5.2 ---------------------------------------------------------------------------------------- Total end of period $267.9 $229.9 ======================================================================================== Simple monthly average for the three-month period (1) $255.9 $228.0 ---------------------------------------------------------------------------------------- Simple monthly average for the nine-month period (1) $238.7 $226.4 ======================================================================================== (1) Investment management fees from approximately 50% of our assets under management at June 30, 2001 are calculated using a daily average. </TABLE> 10
Our assets under management at June 30, 2001 were $267.9 billion, 17% higher than they were a year ago. Simple monthly average assets for the three months ended June 30, 2001 increased 12% this quarter over the same period a year ago, primarily as a result of the inclusion of Fiduciary assets under management. The following table shows the relative composition of assets under management. June 30 June 30 Percentage of total assets under management 2001 2000 - -------------------------------------------------------------------------------- Equity 55% 67% Fixed income 29% 27% Hybrid 14% 4% Money funds 2% 2% - -------------------------------------------------------------------------------- Total 100% 100% The change in the composition of assets under management was largely due to the inclusion of the Fiduciary assets under management in April 2001. Equity assets now comprise 55% of total assets under management as compared to 67% at June 30, 2000. Fixed income assets now comprise 29% of total assets under management, as compared to 27% at the same time last year. Hybrid assets now account for 14% of total assets under management, as compared to 4% at the same time last year. Approximately 64% of Fiduciary's assets under management were classified as hybrid assets at the time of acquisition. The change in our assets under management was as follows. <TABLE> <CAPTION> ASSETS UNDER MANAGEMENT Three months ended Nine months ended June 30 Percent June 30 Percent in billions 2001 2000 Change 2001 2000 Change -------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Beginning assets under management $215.7 $233.4 (8)% $229.9 $218.1 5% Sales 15.4 13.3 16% 43.7 40.1 9% Reinvested Dividends 2.2 3.2 (31)% 8.4 8.1 4% Redemptions (14.9) (15.9) (6)% (45.0) (48.9) (8)% Fiduciary acquisition 45.8 - - 45.8 - - Appreciation (depreciation) 3.7 (4.1) N/A (14.9) 12.5 N/A ------------------------------------------------------------------------------------------------- Ending assets under management $267.9 $229.9 17% $267.9 $229.9 17% ================================================================================================= </TABLE> The acquisition of Fiduciary Trust Company International on April 10, 2001 (the "Fiduciary acquisition") increased our assets under management by $45.8 billion. For both the three and nine months ended June 30, 2001 sales and reinvested dividends exceeded redemptions ("net inflows") complex-wide by $2.7 billion and $7.1 billion, respectively. In the same periods last year, we experienced net inflows of $0.6 billion for the three month period, and net outflows, where redemptions exceeded sales and reinvested dividends ("net outflows") by $0.7 billion for the nine month period. The increase in net inflows in the current periods as compared to the same periods last year, was principally due to increased sales and decreased redemptions resulting from strong relative performance of our sponsored investment products. 11
<TABLE> <CAPTION> RESULTS OF OPERATIONS Three months ended Nine months ended June 30 Percent June 30 Percent 2001 2000 Change 2001 2000 Change ---------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Net income (millions) $119.7 $140.4 (15)% $400.9 $421.3 (5)% Earnings per share Basic $0.46 $0.58 (21)% $1.61 $1.71 (6)% Diluted $0.46 $0.58 (21)% $1.60 $1.70 (6)% Operating margin 20% 30% - 24% 29% - EBITDA margin (1) 32% 37% - 35% 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 three and nine months ended June 30, 2001 decreased 15% and 5% compared to the same periods last year. This was due to higher operating expenses resulting from increases to compensation and technology partially offset by net investment income and the inclusion of the operating results of Fiduciary from April 10, 2001. Earnings per share during the three and nine months ended June 30, 2001 decreased 21% and 6% compared to the same periods last year primarily due to decreased net income and the increase in number of shares outstanding following the Fiduciary acquisition. <TABLE> <CAPTION> OPERATING REVENUES Three months ended Nine months ended June 30 Percent June 30 Percent (In millions) 2001 2000 Change 2001 2000 Change ----------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Investment management fees $362.5 $344.8 5% $1,048.5 $1,044.8 - Underwriting and distribution fees 180.8 165.2 9% 523.3 529.6 (1)% Shareholder servicing Fees 53.7 54.1 (1)% 153.9 159.1 (3)% Other, net 12.5 4.8 160% 25.3 13.6 86% ----------------------------------------------------------------------------------------- Total operating revenues $609.5 $568.9 7% $1,751.0 $1,747.1 - ========================================================================================= </TABLE> SUMMARY Total operating revenues increased 7% for the three months ended June 30, 2001 compared to the same period last year. The increase was primarily attributable to the Fiduciary acquisition, which led to higher investment management fees following higher average assets under management during the quarter. For the nine months ended June 30, 2001, operating revenues were substantially unchanged compared to the same period last year as increases in investment management fees and other revenues related to the banking/finance segment were offset by decreases in underwriting commissions and shareholder servicing fees. 12
INVESTMENT MANAGEMENT FEES Investment management fees, accounting for 60% of our operating revenues in the nine months ended June 30, 2001, 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 increased 5% and remained constant during the three and nine months ended June 30, 2001 over the same periods last year. The increase in this quarter was mainly due to the Fiduciary acquisition which caused increases in the simple monthly average assets under management between the period from $228.0 billion a year ago to $255.9 billion in the current year. This increase was partially offset by a shift in our asset mix toward lower fee fixed income and hybrid investment products. This shift toward fixed income and hybrid investment 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 June 30, 2001. The effective investment management fee rate declined to 0.57% in the current quarter from 0.60% over 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. Underwriting and distribution fees increased 9% and decreased 1% during the three and nine months ended June 30, 2001 over the same periods last year. The increase this quarter was consistent with a 16% increase in product sales and constant distribution fee revenues. The decrease in the nine months ended June 30, 2001 as compared to the prior year was due to a decline in commissionable sales year over year, which led to a reduction in aggregate sales commission revenues despite a 9% increase in product sales. 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 as average assets under management on which these fees are based on remained relatively stable. 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 vary. In the U.S., they provide that closed accounts in a given calendar year remain billable through the second quarter of the following calendar year at a reduced rate. In Canada, the agreements provide that accounts closed in the previous calendar year remain billable for five months after the end of the calendar year. Accordingly, the level of fees will vary with the 13
split of total billable accounts between open and closed accounts, the date on which closed accounts are no longer billable, and the growth in new accounts. Shareholder servicing fees decreased 1% and 3% during the three and nine months ended June 30, 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 and custody services related to Fiduciary. Revenues from the banking/finance operating segment include operating revenues, consisting primarily of interest income on loans, servicing income, and investment income on banking/finance investment securities, which are offset by interest expense and the provision for anticipated loan losses. Other, net increased 160% and 86% during the three and nine months ended June 30, 2001 over the same periods last year. This increase was principally due to the addition of the Fiduciary banking and custody activities from the date of acquisition. 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. <TABLE> <CAPTION> OPERATING EXPENSES Three months ended Nine months ended June 30 Percent June 30 Percent (In millions) 2001 2000 Change 2001 2000 Change ------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> Underwriting and distribution $163.0 $142.7 14% $470.8 $462.7 2% Compensation and benefits 167.6 133.1 26% 449.5 398.6 13% Information systems, technology and occupancy 70.6 50.7 39% 187.1 153.8 22% Advertising and promotion 27.3 25.3 8% 73.9 73.7 - Amortization of deferred sales commissions 16.4 21.0 (22)% 52.2 63.2 (17)% Amortization of intangible assets 16.7 9.3 80% 36.7 27.8 32% Other 23.2 18.0 29% 62.6 58.7 7% ------------------------------------------------------------------------------------------ Total operating expenses $484.8 $400.1 21% $1,332.8 $1,238.5 8% ========================================================================================== </TABLE> SUMMARY Operating expenses increased 21% and 8% during the three and nine months ended June 30, 2001 compared to the same periods last year. These changes were primarily caused by increased compensation and technology costs, the addition of the operating costs of Fiduciary, and increased underwriting and distribution expenses for the three months ended June 30, 2001. 14
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 increased 14% and 2% during the three and nine months ended June 30, 2001 compared to the same periods last year. The increase during the three months ended June 30, 2001 was consistent with a 16% increase in product sales. During the nine months ended June 30, 2001, product sales increased 9%, but a significant number of sales were at low or zero commission rates, resulting in a smaller proportional increase in the commissions paid to intermediaries in the current year. COMPENSATION AND BENEFITS Compensation and benefits increased 26% and 13% during the three and nine months ended June 30, 2001 compared to the same periods last year. This increase was primarily due to the addition of 790 Fiduciary employees, annual salary increases, an increase in employee benefit costs and additional recruiting costs. Salary awards are given annually in October and are based upon the performance of the individual employee. Employee benefits are reviewed annually. The number of employees at June 30, 2001 was approximately 7,100 as compared to approximately 6,500 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 during volatile investment market conditions. INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY Information systems, technology and occupancy costs increased 39% and 22% during the three and nine months ended June 30, 2001 compared to the same periods last year. This increase was primarily due to continued expenditure on new technology initiatives, the charges and costs in connection with IBM's assumption of the management of our data center and distributed server operations and the added costs of the Fiduciary acquisition. 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, 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, including the development of a single global institutional sales and marketing platform. 15
Details of capitalized information systems and technology costs were as follows. <TABLE> <CAPTION> Three months ended Nine months ended June 30 June 30 in thousands 2001 2000 2001 2000 ----------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Beginning cost $353,456 $275,370 $317,767 $246,857 Net assets acquired in Fiduciary acquisition 10,797 - 10,797 - Net additions during period 31,769 22,476 67,458 50,989 ----------------------------------------------------------------------------------------- Ending cost 396,022 297,846 396,022 297,846 Beginning Accumulated amortization 195,925 132,888 160,872 108,291 Charge during period 19,879 13,426 54,932 38,023 ----------------------------------------------------------------------------------------- Ending Accumulated amortization 215,804 146,314 215,804 146,314 ----------------------------------------------------------------------------------------- Net book value at end of period $180,218 $151,532 $180,218 $151,532 ========================================================================================== </TABLE> ADVERTISING AND PROMOTION Advertising and promotion increased 8% and remained constant during the three and nine months ended June 30, 2001 compared to the same periods last year. This increase resulted primarily from increased promotion and advertising activity in the current quarter to assist in educating the sales channels and the investing public about the strong relative investment performance of our sponsored investment products. AMORTIZATION OF DEFERRED SALES COMMISSIONS Amortization of deferred sales commissions decreased 22% and 17% during the three and nine months ended June 30, 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, which occurs at least once annually. OTHER INCOME (EXPENSE) Investment and other income is comprised primarily of: - -- Dividends from investments in our sponsored mutual funds - -- Interest income (except for Banking/Finance segment interest income) 16
- -- Realized gains and losses on investments - -- Foreign currency exchange gains and losses - -- Other miscellaneous income, including gain or loss on disposal of company property Other income increased 75% and 107% during the three and nine months ended June 30, 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 from the sale of certain sponsored investment products held by the company for investment. In addition, other realized gains of $8.2 million and $24.6 million were included in other income during the three and nine months ended June 30, 2001. These gains related to the $32.9 million gain on the sale of our headquarters building in San Mateo, which was recognized over the 12-month leaseback period through June 2001. Interest expense decreased 53% and 30% during the three and nine months ended June 30, 2001 compared to the same periods last year due to the relatively low interest rate of 1.875% on the Convertible Notes issued in May 2001, the redemption of outstanding commercial paper during the three months ended June 30, 2001 and generally lower interest rates in the current year as compared to the same periods last year. TAXES ON INCOME Our effective income tax rate for the quarters ended June 30, 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 June 30, 2001, we had $875.1 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 increased to $2,352.7 million at June 30, 2001 from $1,677.1 million at September 30, 2000. At June 30, 2001, approximately $500 million was available to us under unused commercial paper and medium-term note programs. In addition, revolving credit facilities at June 30, 2001 aggregated to $500 million of which $200 million was under a 364-day facility. The remaining $300 million facility will expire in May 2003. Cash provided by operating activities decreased to $431.0 million in the nine months ended June 30, 2001 compared to $527.6 million in the same period last year. This decrease was due mainly to lower operating income resulting from higher operating expenses offsetting a small increase in operating revenues. During the current year, we used a total of $363.6 million for investing activities, including $128.3 million related to the purchase of investments, net of liquidations; $53.3 million in connection with the banking/finance segment; and $100.1 million primarily related to the purchase of Bissett and Associates Investment Management Ltd. Net cash provided by financing activities during the current year was $61.7 million as net debt issued of approximately $202 million exceeded other uses of cash in financing activities. Outstanding debt increased to $560.0 million at June 30, 2001 compared to $362.9 million at September 30, 2000. As described further in note 2 to the financial statements, after May 2001, debt primarily consists of the Convertible Notes. The Convertible Notes carry a yield to maturity of 1.875% per annum to maturity. We repurchased 3 million shares of common stock at $43 per share on May 20, 2001 17
in conjunction with the issuance of the Convertible Notes. Prior to May 2001, debt primarily consisted of commercial paper that carried interest at variable rates and fixed-interest medium-term notes. During the quarter ended June 30, 2001, our remaining commercial paper was redeemed. Other fixed-rate debt totaling $19 million has various maturity dates through October 2003. We had previously 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 was set up to finance the construction and lease the completed facility. The construction was substantially completed and we moved into our new headquarters in the summer of 2001. The lease agreement is 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 $275 million at June 30, 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 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 for these distribution channels has caused our distribution costs to rise and could cause further increases in the future. Higher distribution costs lower our net revenues and earnings. Additionally, if one of the major financial advisors who distributes our products were to cease their operations, even for a few days, it could have a significant adverse impact on our revenues and earnings. Moreover, 18
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. 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 19
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 is still strong, 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. 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. WE MAY NOT BE ABLE TO ACHIEVE THE BENEFITS WE EXPECT FROM THE RECENT ACQUISITION OF FIDUCIARY TRUST COMPANY INTERNATIONAL ("FIDUCIARY"). 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 FIDUCIARY ACQUISITION COULD ADVERSELY AFFECT OUR COMBINED FINANCIAL RESULTS OR THE MARKET PRICE OF OUR COMMON STOCK. If the benefits of the acquisition over time do not exceed the costs associated with the acquisition, including any dilution to our shareholders resulting from 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. 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. 20
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 98% of our debt outstanding at June 30, 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. 20
PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS An initial complaint captioned Richard Nelson and Dorothy Nelson v. Edward K. Dunn, Jr. was filed on May 7, 2001, Case No. 01-282-DRH, in the United States District Court for the Southern District of Illinois. On June 22, 2001, the Plaintiffs filed a First Amended complaint captioned Richard Nelson, et. al. v. AIM Advisors, Inc. et. al, which added additional plaintiffs and named as defendants advisory and distribution entities from 25 different mutual fund complexes, including Franklin Advisers, Inc. and Franklin Templeton Distributors, Inc., both wholly owned subsidiaries of Franklin Resources, Inc. ("FRI") and Templeton Global Advisors Limited, an indirect wholly owned subsidiary of FRI (collectively, the "Franklin Defendants"). The First Amended complaint alleges, among other things, violations of the Investment Company Act of 1940 with respect to distribution and advisory contracts of funds advised or distributed by the defendants, including the Franklin Defendants. The plaintiffs are seeking actual and punitive damages, as well as equitable and other relief. We previously reported that three individual plaintiffs filed a consolidated complaint in the U.S. District Court for the Southern District of Florida, against Templeton Vietnam Opportunities Fund, Inc. (now known as Templeton Vietnam and Southeast Asia Fund, Inc.); Templeton Asset Management, Ltd., an indirect wholly-owned subsidiary of FRI and the investment manager of the closed-end investment company; certain of the fund's officers and directors; FRI; and Templeton Worldwide, Inc., an FRI subsidiary. The plaintiffs in that action, captioned In Re: Templeton Securities Litigation (Civil Action No. 98-6059) moved to certify a class with respect to certain claims raised in the consolidated complaint. The district court recently denied the plaintiffs' motion to certify a class with respect to their claims. Management believes that these lawsuits are without merit and intends to vigorously defend such actions. In addition to the above-described lawsuits, 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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (c) On May 11, 2001, we completed a private offering of $877,000,000 principal amount at maturity of zero-coupon convertible senior notes due 2031 (the "Convertible Notes") for aggregate net proceeds of approximately $490,000,000. Each $1,000 principal amount at maturity security was issued 21
at 57.128% of principal amount at maturity, accretes at a rate of 1.875% per annum and is convertible into 9.3604 shares of our common stock. We may be required to repurchase the securities at the accreted value at the option of the holders on May 11 of 2003, 2004, 2006, 2011, 2016, 2021 and 2026. In such event, we may choose to pay the purchase price for such repurchases in cash or shares of our common stock. We may redeem the Convertible Notes for cash on or after May 11, 2006. We used approximately $129 million of the net offering proceeds to repurchase 3 million shares of our common stock. We will use the balance of the proceeds for general corporate purposes. This transaction was completed without registration in reliance upon section 4(2) of the Securities Act. The securities were initially sold to Merrill Lynch, Pierce, Fenner & Smith Incorporated for resale to qualified institutional buyers pursuant to Rule 144A under the Securities Act. 22
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 4.1 Indenture between Franklin Resources, Inc. and The Bank of New York dated May 11, 2001 incorporated by reference to Exhibit 4.2 to the Registrant's Registration Statement on Form S-3, filed on August 6, 2001 Exhibit 4.2 Registration Rights Agreement between Franklin Resources, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") dated May 11, 2001 incorporated by reference to Exhibit 4.4 to the Registrant's Registration Statement on Form S-3, filed on August 6, 2001 Exhibit 12 Computations of ratios of earnings to fixed charges (b) Reports on Form 8-K: (i) Form 8-K filed on April 10, 2001 reporting under Item 2 "Acquisition or Disposition of Assets" the completion of the share acquisition of Fiduciary Trust Company International ("Fiduciary"), and including a press release issued jointly on April 10, 2001 by Registrant and Fiduciary as an Exhibit under Item 7 "Financial Statements and Exhibits". (ii) Form 8-K filed on April 26, 2001 reporting under Item 5 "Other Events" an earnings press release, dated April 26, 2001, and including said press release as an Exhibit under Item 7 "Financial Statements and Exhibits." 23
(iii) Form 8-K filed on May 7, 2001 reporting under Item 5 "Other Events" the filing of a press release dated, May 7, 2001, by Registrant announcing the offering of debt securities convertible into shares of the Registrant's common stock, and including said press release as an Exhibit under Item 7 "Financial Statements and Exhibits." (iv) Form 8-K filed on May 8, 2001 reporting under Item 5 "Other Events" the filing of a press release dated, May 8, 2001, by Registrant announcing that Registrant had entered into a purchase agreement for the sale of zero-coupon convertible senior notes, and including said press release as an Exhibit under Item 7 "Financial Statements and Exhibits." (v) Form 8-K filed on May 14, 2001 reporting under Item 5 "Other Events" the filing of a press release dated, May 11, 2001, by Registrant announcing the completion of the zero-coupon convertible note offering and the Registrant's repurchase of shares of common stock, and including said press release as an Exhibit under Item 7 "Financial Statements and Exhibits." (vi) Form 8-K/A filed on June 19, 2001 amending Form 8-K filed on April 10, 2001 and reporting under Item 7 "Financial Statements and Exhibits" Registrant's determination that the financial statements and the pro forma financial statements relating to the acquisition of Fiduciary need not be filed on Form 8-K. 24
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FRANKLIN RESOURCES, INC. ------------------------ Registrant. Date: August 13, 2001 /s/ Martin L. Flanagan ---------------------- MARTIN L. FLANAGAN President, Member-Office of the President, Chief Financial Officer and Chief Operating Officer 25