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, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to______________ Commission File No. 1-9318 FRANKLIN RESOURCES, INC. (Exact name of registrant as specified in its charter) Delaware 13-2670991 (State or other jurisdiction (IRS Employer of incorporation or organization) Identification No.) One Franklin Parkway, San Mateo, CA 94403 (Address of Principal Executive Offices) (Zip Code) (650) 312-2000 (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ______ ----- 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: 261,895,951 shares, common stock, par value $.10 per share at April 30, 2002. - --------------------------------------------------------------------------------
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) 2002 2001 2002 2001 - --------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> OPERATING REVENUES: Investment management fees $365,778 $340,136 $722,576 $685,921 Underwriting and distribution fees 197,537 178,165 389,544 342,527 Shareholder servicing fees 48,024 51,962 95,365 100,184 Other, net 14,629 7,150 36,690 12,855 --------------------------------------------------- TOTAL OPERATING REVENUES 625,968 577,413 1,244,175 1,141,487 --------------------------------------------------- OPERATING EXPENSES: Underwriting and distribution 177,327 162,134 349,594 307,818 Compensation and benefits 159,764 140,074 319,907 281,933 Information systems, technology and 73,197 59,002 147,791 116,530 occupancy Advertising and promotion 25,481 24,433 51,906 46,559 Amortization of deferred sales commissions 17,047 17,579 33,790 35,815 Amortization of intangible assets 4,258 10,107 8,633 20,016 Other 20,875 19,611 41,670 39,365 --------------------------------------------------- TOTAL OPERATING EXPENSES 477,949 432,940 953,291 848,036 --------------------------------------------------- OPERATING INCOME 148,019 144,473 290,884 293,451 --------------------------------------------------- OTHER INCOME (EXPENSE): Investment and other income 14,782 32,054 33,111 82,010 Interest expense (2,808) (3,259) (5,976) (5,529) --------------------------------------------------- OTHER INCOME (EXPENSE), NET 11,974 28,795 27,135 76,481 --------------------------------------------------- INCOME BEFORE TAXES ON INCOME 159,993 173,268 318,019 369,932 TAXES ON INCOME 39,997 41,584 79,504 88,783 --------------------------------------------------- NET INCOME $119,996 $131,684 $238,515 $281,149 =================================================== EARNINGS PER SHARE: BASIC $0.46 $0.54 $0.91 $1.15 DILUTED $0.46 $0.54 $0.91 $1.15 DIVIDENDS PER SHARE $0.070 $0.065 $0.14 $0.13 The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 2 - --------------------------------------------------------------------------------
<TABLE> <CAPTION> FRANKLIN RESOURCES, INC. CONSOLIDATED BALANCE SHEETS UNAUDITED MARCH 31 SEPTEMBER 30 (in thousands) 2002 2001 - --------------------------------------------------------------------------------------------- <S> <C> <C> ASSETS: Current assets: Cash and cash equivalents $1,046,897 $497,241 Receivables: Sponsored investment products 210,420 233,086 Other 58,030 63,079 Investment securities, available-for-sale 813,456 1,027,975 Prepaid expenses and other 100,123 108,895 - --------------------------------------------------------------------------------------------- Total current assets 2,228,926 1,930,276 - --------------------------------------------------------------------------------------------- Banking/finance assets: Cash and cash equivalents 42,929 71,736 Loans receivable, net 491,848 555,314 Investment securities, available-for-sale 661,263 484,280 Other 49,892 117,914 - --------------------------------------------------------------------------------------------- Total banking/finance assets 1,245,932 1,229,244 - --------------------------------------------------------------------------------------------- Other assets: Deferred sales commissions 142,105 104,082 Property and equipment, net 418,561 449,626 Intangible assets, net 693,555 702,198 Goodwill 1,287,005 1,286,622 Receivable from banking/finance group 193,045 307,214 Other 285,451 256,388 - --------------------------------------------------------------------------------------------- Total other assets 3,019,722 3,106,130 - --------------------------------------------------------------------------------------------- Total assets $6,494,580 $6,265,650 ============================================================================================= The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 3 - --------------------------------------------------------------------------------
<TABLE> <CAPTION> FRANKLIN RESOURCES, INC. CONSOLIDATED BALANCE SHEETS UNAUDITED MARCH 31 SEPTEMBER 30 (in thousands except share data) 2002 2001 - --------------------------------------------------------------------------------------------- <S> <C> <C> LIABILITIES AND STOCKHOLDERS' EQUITY: Current liabilities: Compensation and benefits 158,118 221,672 Current maturities of long-term debt 8,279 8,361 Accounts payable and accrued expenses 135,378 127,918 Commissions 85,767 83,518 Income taxes 19,394 11,925 Other 4,002 4,039 - --------------------------------------------------------------------------------------------- Total current liabilities 410,938 457,433 - --------------------------------------------------------------------------------------------- Banking/finance liabilities: Payable to Parent 193,045 307,214 Deposits 795,970 723,608 Other 83,992 39,839 - --------------------------------------------------------------------------------------------- Total banking/finance liabilities 1,073,007 1,070,661 - --------------------------------------------------------------------------------------------- Other liabilities: Long-term debt 605,267 566,013 Other 190,915 193,647 - --------------------------------------------------------------------------------------------- Total other liabilities 796,182 759,660 - --------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------- Total liabilities 2,280,127 2,287,754 - --------------------------------------------------------------------------------------------- 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; 261,860,066 and 260,797,545 shares issued and outstanding, for March and September, respectively 26,186 26,080 Capital in excess of par value 695,113 657,878 Retained earnings 3,544,866 3,342,979 Accumulated other comprehensive loss (51,712) (49,041) - --------------------------------------------------------------------------------------------- Total stockholders' equity 4,214,453 3,977,896 - --------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $6,494,580 $6,265,650 ============================================================================================= 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 SIX MONTHS ENDED MARCH 31 (in thousands) 2002 2001 - ------------------------------------------------------------------------------------------- <S> <C> <C> Net income $238,515 $281,149 Adjustments to reconcile net income to net cash Provided by operating activities: Decrease in receivables, prepaid expenses and other 133,644 39,540 Advances of deferred sales commissions (76,118) (49,484) Increase/ (decrease) in other current liabilities 64,925 (12,064) Increase/ (decrease) in income taxes payable 7,468 (37,098) Increase in commissions payable 2,249 11,416 Decrease in accrued compensation and benefits (38,756) (64,293) Depreciation and amortization 91,134 103,213 Gains on disposition of assets (5,433) (42,223) - ------------------------------------------------------------------------------------------- Net cash provided by operating activities 417,628 230,156 - ------------------------------------------------------------------------------------------- Purchase of investments (1,115,645) (194,753) Liquidation of investments 1,103,370 440,461 Purchase of banking/finance investments (30,319) (11,070) Liquidation of banking/finance investments 21,719 12,794 Net proceeds from securitization of loans receivable 299,980 139,295 Net origination of loans receivable (239,147) (80,322) Addition of property and equipment (18,458) (44,665) Acquisition of subsidiaries, net of cash acquired - (94,483) - ------------------------------------------------------------------------------------------- Net cash provided by investing activities 21,500 167,257 - ------------------------------------------------------------------------------------------- Increase/ (decrease) in bank deposits 72,362 (7,433) Exercise of common stock options 12,905 1,592 Dividends paid on common stock (35,129) (30,472) Purchase of stock (8,070) (8,265) Issuance of debt 43,799 155,646 Payments on debt (4,146) (265,831) - ------------------------------------------------------------------------------------------- Net cash provided by/ (used in) financing activities 81,721 (154,763) - ------------------------------------------------------------------------------------------- Increase in cash and cash equivalents 520,849 242,650 Cash and cash equivalents, beginning of period 568,977 746,005 - ------------------------------------------------------------------------------------------- Cash and cash equivalents, end of period $1,089,826 $988,655 - ------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION: Value of common stock issued, principally restricted stock $28,151 $24,959 The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 5 - --------------------------------------------------------------------------------
FRANKLIN RESOURCES, INC. Notes to Consolidated Financial Statements March 31, 2002 (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, 2001. 2. Comprehensive Income -------------------- The following table shows comprehensive income for the three- and six-month periods ended March 31, 2002. <TABLE> Three months ended Six months ended March 31 March 31 (in thousands) 2002 2001 2002 2001 -------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net income $119,996 $131,684 $238,515 $281,149 Net unrealized gain/(loss) on available-for-sale securities, net of tax 3,610 (13,952) 6,181 (49,681) Foreign currency translation adjustments (2,217) (5,406) (8,852) (9,466) -------------------------------------------------------------------------------------- Comprehensive income $121,389 $112,326 $235,844 $222,002 ====================================================================================== </TABLE> 6 - --------------------------------------------------------------------------------
3. Earnings per Share ------------------ Earnings per share were computed as follows: <TABLE> Three months ended Six months ended March 31 March 31 (in thousands except per share amounts) 2002 2001 2002 2001 ---------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net income $119,996 $131,684 $238,515 $281,149 ======================================================================================== Weighted-average shares outstanding - basic 261,596 244,256 261,284 243,982 Incremental shares from assumed conversions 515 871 697 816 ---------------------------------------------------------------------------------------- Weighted-average shares outstanding - diluted 262,111 245,127 261,981 244,798 ======================================================================================== Earnings per share: Basic and diluted $0.46 $0.54 $0.91 $1.15 </TABLE> 4. Securitization of Loans Receivable ---------------------------------- The following table shows details of auto loan securitization transactions for the three- and six-month periods ended March 31, 2002. <TABLE> Three months ended Six months ended March 31 March 31 (in millions) 2002 2001 2002 2001 -------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net carrying amount of loans sold $- $142.6 $306.3 $142.6 Gross sale proceeds $- $145.5 $319.7 $145.5 Pre-tax gain $- $2.9 $13.4 $2.9 </TABLE> When we sell auto loans in a securitization transaction, we retain interest-only strips and servicing rights. The gross sales proceeds include the fair value of the interest-only strips. 7 - --------------------------------------------------------------------------------
We generally estimate fair value based on the present value of future expected cash flows. The key assumptions used in the present value calculations of our securitization transactions are as follows: <TABLE> Three months ended Six months ended March 31 March 31 2002 2001 2002 2001 -------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Excess cash flow discount rate (annual rate) N/A 12% 12% 12% Cumulative credit loss rate (annual rate) N/A 3.06% 3.76% 3.06% Pre-payment speed assumption (annual rate) N/A 1.5% 1.5% 1.5% </TABLE> These assumptions are determined using data from comparable transactions, historical information and derived from management's estimate. Interest-only strip receivables are generally restricted assets and subject to limited recourse provisions. The carrying value of the interest-only strips as of March 31, 2002 and September 30, 2001 was $30.3 million and $10.8 million, respectively. Included in banking/finance liabilities-other are amounts payable to trustees for servicing income collected of $22.2 million and $10.9 million as of March 31, 2002 and September 30, 2001, respectively. With respect to retained servicing responsibilities, we receive annual servicing fees ranging from 1.25% to 2.0% of the loans securitized. Additionally, we receive the rights to future cash flows, if any, arising after the investors in the securitization trust have received their contracted return. The following is a summary of revenues received in the three and six months ended March 31, 2002 relating to securitized loans: <TABLE> Three months ended Six months ended March 31 March 31 (in thousands) 2002 2001 2002 2001 -------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Servicing fees $2,092 $1,369 $3,397 $2,336 Other cash flows received on retained interests $958 $513 $1,258 $743 </TABLE> 5. Goodwill and Intangible Assets ------------------------------ Effective October 1, 2001, we adopted Statement of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 142 addresses the initial recognition and measurement of intangible assets acquired outside a business combination and the recognition and measurement of goodwill and other intangible assets subsequent to acquisition. Under the new standard, all goodwill and indefinite-lived intangible assets, including those acquired before initial application of the standard, will not be amortized but will be tested for impairment at least annually. Accordingly, effective October 1, 2001, we ceased amortization on goodwill and indefinite-lived assets. This resulted in an amortization expense reduction of approximately $12.5 million ($9.4 million net of tax) and a $0.04 increase in basic and diluted 8 - --------------------------------------------------------------------------------
earnings per share for the quarter ended March 31, 2002 and an expense reduction of approximately $25 million ($18.8 million net of tax) and a $0.08 increase in basic and diluted earnings per share for the six months ended March 31, 2002. Our goodwill and intangible assets are attributable to our investment management operating segment. Indefinite-lived intangible assets represent the value of management contracts related to our mutual funds and other investment products. The following table reflects our results adjusted as though we had adopted SFAS 142 on October 1, 2000. <TABLE> Three months ended Six months ended March 31 March 31 (in thousands except per share amounts) 2002 2001 2002 2001 --------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net income as reported $119,996 $131,684 $238,515 $281,149 Goodwill amortization - 5,732 - 11,464 Indefinite-lived intangibles amortization - 3,288 - 6,576 Tax effect at effective tax rate - (2,165) - (4,330) --------------------------------------------------------------------------------------- Net income as adjusted $119,996 $138,539 $238,515 $294,859 Basic and diluted earnings per share as $0.46 $0.54 $0.91 $1.15 reported Basic earnings per share as adjusted $0.46 $0.57 $0.91 $1.21 Diluted earnings per share as adjusted $0.46 $0.57 $0.91 $1.20 </TABLE> Intangible assets at March 31, 2002 were as follows: <TABLE> Gross carrying Accumulated Net carrying (in thousands) amount amortization amount -------------------------------------------------------------------------------------- <S> <C> <C> <C> Amortized intangible assets: Customer base $232,191 $(15,652) $216,539 Other 31,545 (17,456) 14,089 -------------------------------------------------------------------------------------- 263,736 (33,108) 230,628 Non-amortized intangible assets: Management contracts 462,927 - 462,927 -------------------------------------------------------------------------------------- Intangible assets, net $726,663 $(33,108) $693,555 </TABLE> 9 - --------------------------------------------------------------------------------
Estimated amortization expense for each of the 5 succeeding fiscal years is as follows: Fiscal years ended (in thousands) September 30, --------------------------------------------------------------------------- 2002 $17,109 2003 16,951 2004 16,951 2005 16,951 2006 16,951 As of March 31, 2002, we have completed the impairment testing of goodwill and indefinite-lived intangible assets as of the beginning of our current fiscal year under the guidance set out in SFAS 142. We have determined that there is no impairment to the goodwill and indefinite-lived assets recorded in our books and records as of October 1, 2001. 6. 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, trustee services and selected retail-banking services to the general public, high net-worth individuals and corporations. Financial information for our two operating segments for the three- and six- month periods ended March 31, 2002 and 2001 is presented in the table below. Operating revenues of the banking/finance segment are reported net of interest expense and any provision for loan losses. <TABLE> Three months ended Six months ended March 31 March 31 (in thousands) 2002 2001 2002 2001 ------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Operating revenues: Investment management $617,794 $569,469 $1,216,753 $1,126,829 Banking/finance 8,174 7,944 27,422 14,658 ------------------------------------------------------------------------------------ Total $625,968 $577,413 $1,244,175 $1,141,487 Income before taxes: Investment management $156,700 $170,873 $299,381 $366,016 Banking/finance 3,293 2,395 18,638 3,916 ------------------------------------------------------------------------------------ Total $159,993 $173,268 $318,019 $369,932 ==================================================================================== </TABLE> Operating segment assets were as follows: <TABLE> (in thousands) March 31, 2002 September 30, 2001 ------------------------------------------------------------------------------------ <S> <C> <C> Investment management $5,248,648 $5,036,406 Banking/finance 1,245,932 1,229,244 ------------------------------------------------------------------------------------ Total $6,494,580 $6,265,650 ==================================================================================== </TABLE> 10 - --------------------------------------------------------------------------------
7. 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"). At March 31, 2002, the amount included in long-term debt in respect of the Convertible Notes was $501 million in principal and $8.4 million of accrued interest. 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 this event, we may choose to pay the purchase price for such repurchases in cash or shares of our common stock. We did not have any commercial paper outstanding or medium term notes issued at March 31, 2002. 8. Commitments and Contingencies ----------------------------- Under an operating lease for our global corporate headquarters in San Mateo, California, we are contingently liable for approximately $145 million in residual guarantees, representing approximately 85% of the total construction costs of $170 million. The lease is classified as an operating lease as the net present value of the minimum lease payments, including the residual guarantee estimate, was less than 90% of the fair value of the leased property at the inception of the lease. In February 2001, we signed an agreement with IBM under which IBM assumed management of our data center and distributed server operations. Under the terms of the agreement, we may terminate the agreement any time after March 2004. If we were to terminate the agreement, we would incur a termination charge. The maximum termination charge payable depends on service levels prior to our termination of the agreement, and the amount of costs IBM would incur in winding down the services. Based on March 31, 2002 service levels, this termination fee would approximate $37.4 million. We do not consider it likely that we will incur this cost. Under the terms of the original agreement, we also must pay IBM an additional transition charge of approximately $2.7 million in March 2003. We lease office space and equipment under long-term operating leases. Future minimum lease payments under non-cancelable leases are not material to our reported operating results and financial position. At March 31, 2002, the banking/finance operating segment had commitments to extend credit aggregating $309.6 million, principally under its credit card lines. It also held standby letters of credit totaling $10.2 million, which were secured by marketable securities. We are involved in various claims and legal proceedings that are considered normal in our business. While it is not feasible to predict or determine the final outcome of these proceedings, we do not believe that they should have a material adverse effect on our financial position, results of operations or liquidity. 11 - --------------------------------------------------------------------------------
9. Banking Regulatory Ratios ------------------------- Following the acquisition of Fiduciary Trust Company International ("Fiduciary") in April 2001, we became a bank holding company and a financial holding company subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum amounts and ratios of Tier 1 capital to average assets (as defined in the regulations) and Tier 1 and total capital to risk-weighted assets (as defined in the regulations). We believe that, as of March 31, 2002, we exceed the capital adequacy requirements currently applicable to us as listed below. <TABLE> Three months ended Minimum for our March 31, 2002 capital adequacy purposes (in thousands) ------------------------------------------------ -------------------- ----------------- <S> <C> <C> Total risk-based capital $2,179,778 N/A Tier 1 capital $2,170,449 N/A Tier 1 leverage ratio 51% 4% Tier 1 risk-based capital ratio 83% 4% Total risk-based capital ratio 84% 8% </TABLE> 12 - --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS In this section, we discuss our results of operations and our financial condition. We also make some statements relating to the future, which are called "forward-looking" statements. Although we do our best to make clear and accurate forward-looking statements, the actual results and outcomes could be significantly different from those that we discuss in this document. For this reason, you should not rely too heavily on these forward-looking statements. You should review 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 management and related services to retail mutual funds, institutional, high net-worth, separate 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, sector and money market mutual funds, as well as other investment products that meet a wide variety of specific investment needs of individuals and institutions. The level of our revenues is largely dependent upon the level and relative composition of assets under management. To a lesser degree, our revenues are also dependent on the level of mutual fund sales and the number of mutual fund shareholder accounts. The fees charged for our services are based on contracts between our subsidiary entities and our sponsored investment products or our clients. These arrangements could change in the future. Our secondary business activity and operating segment is banking/finance. Our banking/finance group offers selected retail-banking services to high net-worth individuals and corporations and consumer lending. 13 - --------------------------------------------------------------------------------
<TABLE> <CAPTION> ASSETS UNDER MANAGEMENT March 31 March 31 (in billions) 2002 2001 ------------------------------------------------------------------------------------------ <S> <C> <C> Equity: Global/international $93.9 $87.6 Domestic (U.S.) 53.2 45.5 ------------------------------------------------------------------------------------------ Total equity 147.1 133.1 ------------------------------------------------------------------------------------------ Hybrid 40.8 9.8 Fixed-income: Tax-free 48.7 45.8 Taxable: Domestic 24.6 17.2 Global/international 7.7 3.9 ------------------------------------------------------------------------------------------ Total fixed-income 81.0 66.9 ------------------------------------------------------------------------------------------ Money 5.6 5.9 ------------------------------------------------------------------------------------------ Total $274.5 $215.7 ========================================================================================== Simple monthly average for the three-month period (1) $267.9 $224.9 ------------------------------------------------------------------------------------------ Simple monthly average for the six-month period (1) $261.6 $225.6 ========================================================================================== (1) Investment management fees from approximately 45% of our assets under management at March 31, 2002 are calculated using a daily average. </TABLE> Our assets under management at March 31, 2002 were $274.5 billion, 27% higher than they were a year ago. Simple monthly average assets during the quarter ended March 31, 2002 increased 19% over the same period a year ago. The change in the absolute level and simple monthly average assets under management for the quarter ended March 31, 2002 versus the prior year, is mainly due to the addition of the assets under management of Fiduciary Trust Company International ("Fiduciary") acquired in April 2001, net sales of our sponsored investment products and market appreciation. The following table shows the relative composition of assets under management. <TABLE> <CAPTION> As of March 31, 2002 2001 ------------------------------------------------------------------------------------------- <S> <C> <C> Percentage of total assets under management: Equity 54% 61% Fixed-income 29% 31% Hybrid 15% 5% Money 2% 3% ------------------------------------------------------------------------------------------- Total 100% 100% =========================================================================================== </TABLE> 14 - --------------------------------------------------------------------------------
The change in the composition of assets under management resulted primarily from the inclusion of the Fiduciary assets under management. Approximately 64% of Fiduciary's assets under management were classified as hybrid assets at the time of acquisition in April 2001. The change in our assets under management was as follows. <TABLE> Three months ended Six months ended March 31 Percent March 31 Percent (in billions) 2002 2001 Change 2002 2001 Change ------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Beginning assets under management $266.3 $226.9 17% $246.4 $229.9 7% Sales 18.8 15.6 21% 37.7 28.3 33% Reinvested dividends 0.5 0.8 (38)% 3.1 6.2 (50)% Redemptions (14.3) (14.7) (3)% (29.8) (30.1) (1)% Acquisitions - - - - 3.7 (100)% Appreciation/ (depreciation) 3.2 (12.9) N/A 17.1 (22.3) N/A -------------------------------------------------------------------------------------------------------- Ending assets under management $274.5 $215.7 27% $274.5 $215.7 27% ======================================================================================================== </TABLE> The acquisitions of Bissett and Associates Investment Management Ltd. in October 2000 and Fiduciary in April 2001 increased our assets under management by $3.7 and $45.8 billion, respectively. For both the three and six months ended March 31, 2002 sales and reinvested dividends exceeded redemptions ("net inflows") complex-wide by $5.0 billion and $11.0 billion, respectively, compared to the same periods last year when net inflows complex-wide were $1.7 billion and $4.4 billion, respectively. Substantially all of the $17.1 billion in market appreciation that occurred in the six months ended March 31, 2002 resulted from increases in the global/international, domestic equity and hybrid investment categories. The chart below summarizes changes in our assets under management by product class. 15 - --------------------------------------------------------------------------------
<TABLE> Three months ended Percent Six months ended Percent March 31 change March 31 change (in billions) 2002 2001 2002 2001 ----------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> GLOBAL/INTERNATIONAL EQUITY Beginning assets under management $89.4 $96.4 (7)% 80.2 97.6 (18)% Sales 6.9 5.1 35% 14.1 8.8 60% Reinvested dividends - 0.2 (100)% 0.8 3.1 (74)% Redemptions (5.1) (6.4) (20%) (12.0) (13.0) (8)% Acquisitions - - - - 2.2 (100)% Appreciation/ (depreciation) 2.7 (7.7) N/A 10.8 (11.1) N/A ----------------------------------------------------------------------------------------------------------- Ending assets under management 93.9 87.6 7% 93.9 87.6 7% DOMESTIC EQUITY Beginning assets under management 51.7 50.0 3% 44.5 53.9 (17)% Sales 3.8 3.7 3% 7.2 7.1 1% Reinvested dividends - - - 1.1 1.7 (35)% Redemptions (2.2) (2.6) (15)% (4.4) (4.9) (10)% Acquisitions - - - - - - (Depreciation)/ appreciation (0.1) (5.6) (98)% 4.8 (12.3) N/A ----------------------------------------------------------------------------------------------------------- Ending assets under management 53.2 45.5 17% 53.2 45.5 17% HYBRID Beginning assets under management 38.6 10.1 282% 36.1 9.3 288% Sales 1.6 0.4 300% 2.8 0.6 367% Reinvested dividends 0.1 - 100% 0.2 0.2 - Redemptions (0.4) (0.3) 33% (0.9) (0.7) 29% Acquisitions - - - - 1.1 (100)% Appreciation/ (depreciation) 0.9 (0.4) N/A 2.6 (0.7) N/A ----------------------------------------------------------------------------------------------------------- Ending assets under management 40.8 9.8 316% 40.8 9.8 316% TAX-FREE INCOME Beginning assets under management 48.3 45.0 7% 48.4 44.0 10% Sales 1.7 1.3 31% 3.3 2.2 50% Reinvested dividends 0.3 0.3 - 0.6 0.6 - Redemptions (1.2) (1.0) 20% (2.4) (2.2) 9% Acquisitions - - - - - - (Depreciation)/ appreciation (0.4) 0.2 N/A (1.2) 1.2 N/A ----------------------------------------------------------------------------------------------------------- Ending assets under management 48.7 45.8 6% 48.7 45.8 6% TAXABLE FIXED-INCOME Beginning assets under management 32.5 19.9 63% 31.6 19.8 60% Sales 2.4 2.0 20% 5.0 3.5 43% Reinvested dividends 0.1 0.2 (50)% 0.3 0.4 (25)% Redemptions (2.7) (1.2) 125% (4.7) (2.5) 88% Acquisitions - - - - 0.4 (100)% Appreciation/ (depreciation) - 0.2 (100)% 0.1 (0.5) N/A ----------------------------------------------------------------------------------------------------------- Ending assets under management 32.3 21.1 53% 32.3 21.1 53% MONEY Beginning assets under management 5.8 5.5 5% 5.6 5.3 6% Sales 2.4 3.1 (23)% 5.3 6.1 (13)% Reinvested dividends - 0.1 (100)% 0.1 0.2 (50)% Redemptions (2.7) (3.2) (16)% (5.4) (6.8) (21)% Acquisitions - - - - - - Appreciation 0.1 0.4 (75)% - 1.1 (100)% ----------------------------------------------------------------------------------------------------------- Ending assets under management 5.6 5.9 (5)% 5.6 5.9 (5)% ----------------------------------------------------------------------------------------------------------- TOTAL ENDING ASSETS UNDER MANAGEMENT $274.5 $215.7 27% $274.5 $215.7 27% ----------------------------------------------------------------------------------------------------------- </TABLE> 16 - --------------------------------------------------------------------------------
<TABLE> <CAPTION> RESULTS OF OPERATIONS Three months ended Six months ended March 31 Percent March 31 Percent 2002 2001 Change 2002 2001 Change ---------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Net income (in millions) $120.0 $131.7 (9)% $238.5 $281.1 (15)% Earnings per share Basic and diluted $0.46 $0.54 (15)% $0.91 $1.15 (21)% Operating margin 24% 25% - 23% 26% - EBITDA margin(1) 30% 35% - 30% 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 six months ended March 31, 2002 decreased 9% and 15% compared to the same periods last year primarily due to a decline in investment and other income. <TABLE> <CAPTION> OPERATING REVENUES Three months ended Six months ended March 31 Percent March 31 Percent (in millions) 2002 2001 Change 2002 2001 Change ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Investment management fees $365.8 $340.1 8% $722.6 $685.9 5% Underwriting and distribution fees 197.6 178.2 11% 389.5 342.5 14% Shareholder servicing Fees 48.0 51.9 (8)% 95.4 100.2 (5)% Other, net 14.6 7.2 103% 36.7 12.9 184% ----------------------------------------------------------------------------------------------- Total operating revenues $626.0 $577.4 8% $1,244.2 $1,141.5 9% =============================================================================================== </TABLE> SUMMARY Total operating revenues increased 8% and 9%, respectively, for the three and six months ended March 31, 2002 compared to the same periods last year. The acquisition of Fiduciary in April 2001 provided higher investment management fees from higher average assets under management, despite a lower effective fee rate resulting from the change in the mix of assets under management. In addition, investment management and underwriting and distribution fees increased following an overall improvement in sales performance and market appreciation. We also benefited from increased banking/finance segment revenues included in other, net, resulting from the net gain related to the auto loan securitization completed in December 2001. INVESTMENT MANAGEMENT FEES Investment management fees, accounting for 58% of our operating revenues in the quarter ended March 31, 2002, include both investment advisory and business management fees. These fees are generally calculated under contractual arrangements with our sponsored investment products, institutional, high net-worth, and separate account clients as a percentage of the market value of 17 - --------------------------------------------------------------------------------
assets under management. Annual rates vary by investment objective and type of services provided. In return for these fees, we provide a combination of investment advisory, administrative and other management services based on the needs of our clients. Investment management fees increased 8% and 5% during the three and six months ended March 31, 2002 over the same periods last year. This increase was primarily due to the Fiduciary acquisition, net sales (including dividend re-investments) and market appreciation, which increased simple monthly average assets under management. This increase was partially offset by a shift in our asset mix toward fixed-income and hybrid investment products. The shift in asset mix led to a decrease in our effective investment management fee rate (investment management fees divided by simple monthly average assets under management). The effective investment management fee rate in the quarter ended March 31, 2002 declined to 0.55% compared to 0.60% in the same period last year. UNDERWRITING AND DISTRIBUTION FEES Underwriting commissions are earned from the sale of certain classes of sponsored investment products that have a sales commission paid at the time of purchase. 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 changes, so will our commission revenue. Our sponsored investment products pay distribution fees in return for sales, marketing and distribution efforts on their behalf. While other contractual arrangements exist in other locations, in the United States, distribution fees include 12b-1 plan fees, which are subject to maximum payout 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. See the description of underwriting and distribution expenses below. Underwriting and distribution fees increased 11% and 14% during the three and six months ended March 31, 2002 over the same periods last year. Commission revenues increased 21% and 31% over the same periods last year primarily due to a 20% and 33% increase in product sales. Distribution fees increased 5% over each of the same periods last year resulting from higher assets under management, partially offset by the change in asset mix resulting from the addition of Fiduciary's assets under management. SHAREHOLDER SERVICING FEES Shareholder servicing fees are generally fixed charges per shareholder account that vary with the particular type of fund and the service being rendered. In certain instances, sponsored investment products are charged these 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. In the U.S., transfer agency service agreements 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, such agreements provide that accounts closed in the previous calendar year remain billable for four months after the end of the calendar year. Accordingly, the level of fees will vary with the split of total billable accounts between open and closed accounts, the period in which closed accounts are no longer billable, and the growth in new accounts. In the coming quarter, we anticipate that approximately 365,000 accounts closed in Canada during calendar 2001 will no longer be billable effective May 1, 2002. 18 - --------------------------------------------------------------------------------
Shareholder servicing fees decreased 8% and 5% during the three and six months ended March 31, 2002 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 103% in the three months ended March 31, 2002. This increase was principally due to the increase resulting from the addition of the Fiduciary banking and custody activities from the date of acquisition. Other, net increased 184% in the six months ended March 31, 2002. This increase was principally due to the net impact of the recognition of a gain of $13.4 million resulting from the sale of a portion of our auto loan portfolio in December 2001 and the increase resulting from the addition of the Fiduciary banking and custody activities from the date of acquisition. <TABLE> <CAPTION> OPERATING EXPENSES Three months ended Six months ended March 31 Percent March 31 Percent (in millions) 2002 2001 Change 2002 2001 Change ------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Underwriting and distribution $177.3 $162.1 9% $349.6 $307.8 14% Compensation and benefits 159.8 140.1 14% 320.0 281.9 14% Information systems, technology and and occupancy 73.2 59.0 24% 147.8 116.5 27% Advertising and promotion 25.5 24.4 5% 51.9 46.6 11% Amortization of deferred sales commissions 17.0 17.6 (3)% 33.8 35.8 (6)% Amortization of intangible assets 4.2 10.1 (58)% 8.6 20.0 (57)% Other 20.9 19.6 7% 41.6 39.4 6% ------------------------------------------------------------------------------------------------ Total operating expenses $477.9 $432.9 10% $953.3 $848.0 12% ================================================================================================ </TABLE> SUMMARY Operating expenses increased 10% and 12% during the three and six months ended March 31, 2002 over the same periods last year. This increase was primarily caused by the addition of the operating costs and other expenses arising from the Fiduciary acquisition (including a retention bonus pool established to retain certain key employees), increased information systems, technology and occupancy, and underwriting and distribution expenses, offset by decreased amortization of intangible assets. 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 expense increased 9% and 14% during 19 - --------------------------------------------------------------------------------
the three and six months ended March 31, 2002 over the same periods last year consistent with the increase in underwriting and distribution revenues. COMPENSATION AND BENEFITS Compensation and benefit expense increased 14% during the three and six months ended March 31, 2002 over each of the same periods last year. This increase was primarily due to the addition of Fiduciary employees and related retention bonuses committed to the Fiduciary staff. The increase was partially offset by the decision made by management during the quarter ended December 2001 to reduce employee salaries by 5% or 10%, depending on specific salary categories. In May 2002, we reinstated salaries for employees whose salaries were reduced by 5%. We will review employee salaries in the 10% reduction category in July 2002. As a result of the reinstatements, compensation and benefit expense is expected to increase in future months. In addition, our bonus pool is calculated based on operating profits and specific investment performance drivers. As the prospects for the company continue to improve, we expect compensation costs to increase. Merit salary awards are normally given annually in October and are based upon the performance of the individual employee, market conditions and position description. We decided not to provide merit increases to employees in October 2001. The number of employees at March 31, 2002 was approximately 6,400 as compared to approximately 6,300 at the same time last year. Without the addition of Fiduciary staff, the employee headcount at March 31, 2002 would have decreased from the prior year by approximately 400. In order to hire and retain our key employees, we are committed to keeping our salaries and benefit packages competitive, which means that the level of compensation and benefits may increase more quickly or decrease more slowly than our revenues at certain points in our growth cycle. In addition, if leading indicators continue to point to an economic recovery and our growth in assets under management continues, we may need to hire additional staff, which will also place upward pressure on compensation. INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY Information systems, technology and occupancy costs increased 24% and 27% during the three and six months ended March 31, 2002 over the same periods last year. This increase was primarily due to the charges and costs in connection with IBM's assumption of the management of our data center and distributed server operations, the added technology and occupancy costs of the Fiduciary acquisition, and the increase in amortization expense related to our capitalized expenditures on technology initiatives. During the past year, we embarked on a number of hardware upgrades, purchased, developed and installed new software applications, re-engineered our technology infrastructure and global network architecture, replaced or upgraded older versions of software applications, and developed and implemented e-business strategies to improve our service levels, work environment and productivity. The extent of this work has declined from the quarter ended December 31, 2001 as we slowed down a number of initiatives and delayed the start of other technology projects given the current economic slowdown and our focus on cost control and management. 20 - --------------------------------------------------------------------------------
Details of capitalized information systems and technology costs were as follows: <TABLE> Three months ended Six months ended March 31 March 31 (in thousands) 2002 2001 2002 2001 ------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net book value at beginning of period $151,321 $155,226 $162,857 $156,895 Additions during period, net of disposals and other adjustments 14,906 20,855 22,432 34,907 Net assets acquired through acquisitions - - - 782 Amortization during period (19,361) (18,550) (38,423) (35,053) ------------------------------------------------------------------------------------------- Net book value at end of period $146,866 $157,531 $146,866 $157,531 =========================================================================================== </TABLE> ADVERTISING AND PROMOTION Advertising and promotion increased 5% and 11% during the three and six months ended March 31, 2002 over the same periods last year. This increase resulted primarily from increased promotion and advertising activity to assist in educating the sales channels and the investing public about the strong relative investment performance of our sponsored investment products over the relevant periods. AMORTIZATION OF DEFERRED SALES COMMISSIONS Amortization of deferred sales commissions decreased 3% and 6% during the three and six months ended March 31, 2002 over the same periods last year. This decrease was principally a result of the change in sales mix and our current financing arrangements. Certain fund classes, namely class 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 defer and amortize this up front commission over a 1 to 8 year period. Thus, as the balance of the deferred sales commission asset changes on our balance sheet, so does the amortization expense. We have also 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. As a result of the arrangement with LFL, Canadian and European DCA are no longer recorded in our financial statements. U.S. DCA sold to LFL under the U.S. agreement are retained in our financial statements until resold by LFL, which generally occurs at least once annually. AMORTIZATION OF INTANGIBLE ASSETS Amortization of intangible assets decreased 58% and 57% during the three and six months ended March 31, 2002 over the same periods last year. This decrease was due to the adoption of Statement of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") on October 1, 2001. Under the new accounting standard we ceased to amortize goodwill and indefinite-lived intangible assets. This resulted in a reduction in amortization expense of approximately $9 million and $18 million for the three and six months ended March 31, 2002, as compared to the same periods last year. We completed our impairment testing of goodwill and indefinite-lived intangible assets as specified in SFAS 142 and have determined that there is no impairment to the goodwill and indefinite-lived assets recorded in our books and records as of October 1, 2001. 21 - --------------------------------------------------------------------------------
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, and other miscellaneous income including the gain or loss on disposal of property. Other income (expense) decreased 58% and 65% during the three and six months ended March 31, 2002 over the same periods last year. During the quarter ended December 31, 2000, we recognized additional net realized gains of approximately $19.6 million from the sale of certain sponsored investment products held for investment. In addition, 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 was recognized over 12-month leaseback period through June 2001. TAXES ON INCOME Our effective income tax rate for the quarter ended March 31, 2002 increased to 25% compared to 24% in the same period last year consistent with increased revenues generated in the U.S. 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, 2002, we had $1,089.8 million in cash and cash equivalents, as compared to $569.0 million at September 30, 2001. Cash and cash equivalents include U.S. Treasury bills and other debt instruments with original maturities of three months or less, money market funds and other highly liquid investments that are readily convertible into cash. The mix of short-term instruments and, in particular, the maturity schedules of certain debt instruments affect the levels reported in cash and cash equivalents and in investments available-for-sale in any given quarter. Liquid assets, which consist of cash and cash equivalents, investments available-for-sale and current receivables increased to $2,833.0 million at March 31, 2002 from $2,377.4 million at September 30, 2001, primarily due to net income generated in the six months ended March 31, 2002 of $238.5 million, proceeds received from the securitization of auto loans net of new loan originations, and an increase in deposits in our banking/finance operating segment. Outstanding debt increased to $613.5 million at March 31, 2002 compared to $574.4 million at September 30, 2001. Outstanding debt consists primarily of $509.4 million in principal and accrued interest related to outstanding Convertible Notes that we issued in May 2001. 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 this event, we may choose to pay the purchase price for such repurchases in cash or shares of our common stock. The overall increase in outstanding debt is primarily related to additional financing activity of our mutual fund Class B and C shares sales, which increased other long-term debt to $104.1 million as of March 31, 2002, from $69.7 million as of September 30, 2001. This debt has various maturity dates through fiscal 2006 and thereafter. 22 - --------------------------------------------------------------------------------
At March 31, 2002, approximately $850 million was available to us under unused commercial paper and medium-term note programs. In addition, in fiscal 2001 we filed a shelf registration statement with the Securities and Exchange Commission permitting the issuance of debt and equity securities of up to $300 million. Our ability to access the capital markets in a timely manner is dependant on a number of factors including our credit rating, the condition of the global economy, investors' willingness to purchase our securities, interest rates, credit spreads and the equity market valuation levels. In extreme circumstances, we might not be able to access this liquidity readily. Our committed revolving credit facilities at March 31, 2002 totaled $500 million, of which, $200 million was under a 364-day facility. The remaining $300 million facility was under a five year facility and will expire in May 2003. We also have $350 million available in uncommitted bank lines under the Federal Reserve Funds system through Fiduciary. We have arranged with LFL for non-recourse financing of sales commissions advanced on sales of our B and C shares globally. The sales commissions that we have financed through LFL during the three and six months ended March 31, 2002 approximated $36.0 million and $65.4 million respectively versus $20.5 million and $35.5 million over the same periods in the prior year. Since September 1998, our banking/finance operating segment has entered into a number of securitization transactions with special purpose entities, which then issue asset-backed securities to private investors. The outstanding loan balances held by these special purpose entities were $415.1 million as of March 31, 2002 and $211.4 million as of September 30, 2001. Our ability to access the securitization market will directly affect our plans to finance the auto loan portfolio in the future. 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 purchases, pay operating expenses of the business, enhance our technology infrastructure, improve our business processes, pay shareholder dividends, repay and service debt, and acquire our common stock. We expect to finance future increases in investment in our banking/finance activities through operating cash flows, debt, increased deposit base, or through the securitization of a portion of the receivables from consumer lending activities. We believe that our existing liquid assets, together with the continuing cash flow from operations, our borrowing capacity under current credit facilities, our ability to issue debt or equity securities and our mutual fund sales commission financing arrangement will be sufficient to meet our present and reasonably foreseeable operating cash needs and future commitments. 23 - --------------------------------------------------------------------------------
RISK FACTORS WE FACE STRONG COMPETITION FROM NUMEROUS AND SOMETIMES LARGER COMPANIES. We compete with numerous investment management companies, stock brokerage and investment banking firms, insurance companies, banks, savings and loan associations and other financial institutions. Continuing consolidation in the financial services industry has created stronger competitors with greater financial resources and broader distribution channels than our own. Additionally, competing securities dealers whom we rely upon to distribute our mutual funds also sell their own proprietary funds and investment products, which could limit the distribution of our investment products. To the extent that existing or potential customers, including securities dealers, decide to invest in or distribute the products of our competitors, the sales of our products as well as our market share, revenues and net income could decline. CHANGES IN THE DISTRIBUTION CHANNELS ON WHICH WE DEPEND COULD REDUCE OUR REVENUES AND HINDER OUR GROWTH. We derive nearly all of our fund sales through broker/dealers and other similar investment advisors. Increasing competition for these distribution channels has caused our distribution costs to rise and could cause further increases in the future. Higher distribution costs lower our net revenues and earnings. Additionally, if one of the major financial advisors who distribute our products were to cease their operations, it could have a significant adverse impact on our revenues and earnings. Moreover, our failure to maintain strong business relationships with these advisors would impair our ability to distribute and sell our products, which would have a negative effect on our level of assets under management, related revenues and overall business and financial condition. WE HAVE BECOME SUBJECT TO AN INCREASED RISK OF ASSET VOLATILITY FROM CHANGES IN THE GLOBAL EQUITY MARKETS. We have become subject to an increased risk of asset volatility from changes in the domestic and global equity markets due to the recent terrorist attacks. Declines in these markets have caused in the past, and would cause in the future, a decline in our revenue and income. THE LEVELS OF OUR ASSETS UNDER MANAGEMENT, WHICH IN TURN IMPACT REVENUES, ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS. Global economic conditions, changes in the equity market place, interest rates, inflation rates, the yield curve and other factors that are difficult to predict affect the mix, market values and levels of our assets under management. Changing market conditions may cause a shift in our asset mix towards fixed-income products and a related decline in our revenue and income, since we derive higher fee revenues and income from equity assets than from fixed-income products we manage. Similarly, our securitized consumer receivables business is subject to marketplace fluctuation. WE FACE RISKS ASSOCIATED WITH CONDUCTING OPERATIONS IN NUMEROUS FOREIGN COUNTRIES. We sell mutual funds and offer investment advisory and related services in many different regulatory jurisdictions around the world, and intend to continue to expand our operations internationally. Regulators in these jurisdictions could change their policies or laws in a manner that might restrict or otherwise impede our ability to distribute or register investment products in their respective markets. OUR INABILITY TO MEET CASH NEEDS COULD HAVE A NEGATIVE EFFECT ON OUR FINANCIAL CONDITION AND BUSINESS OPERATIONS. Our ability to meet anticipated cash needs depends upon factors including our asset value, our creditworthiness as perceived by lenders and the market value of our stock. Similarly, our ability to securitize and hedge future loan portfolios and credit card receivables, and to obtain continued financing for class B shares, is also subject to the market's perception of those assets, finance rates offered by competitors, and the general market for private debt. If we are unable to obtain these funds and financing, we may be forced to incur unanticipated costs or revise our business plans. 24 - --------------------------------------------------------------------------------
WE FACE COMPETITION IN HIRING AND RETAINING QUALIFIED EMPLOYEES. Our continued success will depend upon our ability to attract and retain qualified personnel. 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, which 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 whom we offer consumer loans could limit the growth of our consumer loan business. Economic and credit market downturns could reduce the ability of our customers to repay loans, which could cause our consumer loan portfolio losses to increase. THE SEPTEMBER 11, 2001 WORLD TRADE CENTER TRAGEDY MAY ADVERSELY AFFECT OUR ABILITY TO ACHIEVE THE BENEFITS WE EXPECT FROM THE RECENT ACQUISITION OF FIDUCIARY. The September 11, 2001 tragedy at the World Trade Center resulted in the destruction of our Fiduciary headquarters, loss of 87 of our employees, additional operating expenses to re-establish and relocate our operations, and asset write-offs, all of which could adversely affect or delay our ability to achieve the anticipated benefits from the acquisition. Overcoming this tragedy and achieving the anticipated benefits of the acquisition will depend on close collaboration between management and key personnel of the two companies in a timely and efficient manner. 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. WE ARE SUBJECT TO FEDERAL RESERVE BOARD REGULATION. Upon completion of our acquisition of Fiduciary, 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. TECHNOLOGY AND OPERATING RISK COULD CONSTRAIN OUR OPERATIONS. We are highly dependent on the integrity of our technology, operating systems and premises. Although we have in place certain disaster recovery plans, we may experience system delays and interruptions as a result of natural disasters, power failures, acts of war, and third party failures, which could negatively impact our operations. 25 - --------------------------------------------------------------------------------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the normal course of business, our financial position is subject to market risk: the potential loss due to changes in the value of investments resulting from fluctuations in interest rates, foreign exchange and/or equity prices. Management is responsible for managing this risk. We have also established a Risk Management Committee to provide a framework to assist management to identify, assess and manage market and other risks. We are exposed to changes in interest rates primarily in our debt transactions and portfolio debt holdings available for sale, which are carried at fair value. As of March 31, 2002, a significant percentage of our outstanding debt is at fixed interest rates. In our banking/finance segment, we monitor the net interest rate margin and the average maturity of interest earning assets and funding sources. In addition, we have considered the potential impact of the effect on the banking/finance segment, our outstanding debt and portfolio debt holdings, individually and collectively, of a 100 basis point (1%) movement in market interest rates. We do not expect this change would have a material impact on our operating revenues or results of operations in either scenario. We operate primarily in the United States, but also provide services and earn revenues in Canada, the Bahamas, Europe, Asia, South America, Africa and Australia. The majority of these revenues and associated expenses, however, are denominated in U.S. dollars. Therefore, our exposure to foreign currency fluctuations in our revenues and expenses is not material at this time. This situation may change in the future as our business continues to grow outside the United States. We are exposed to equity price fluctuations as investments available for sale are carried at fair value. To mitigate this risk, we maintain a diversified investment portfolio. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We previously reported that three individual plaintiffs filed a consolidated class action and derivative complaint, captioned In re: Templeton Securities Litigation (Civil Action No. 98-6059), 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.) (hereafter, the "Fund"); Templeton Asset Management, Ltd., an indirect wholly-owned subsidiary of Franklin Resources, Inc. ("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. On April 3, 2002, the Court provided final approval of a settlement agreement entered into among the parties, which had been preliminarily approved by the Court on November 15, 2001. Under the terms of the settlement agreement, the plaintiffs and defendants agreed to resolve all claims for $6.5 million, including plaintiffs' attorneys fees and the costs of administering the settlement; it is expected that the Fund will receive a minimum of $2 million, which has been reflected in the Fund's net asset value as of April 3, 2002. The defendants have agreed to the settlement to avoid the expense and inconvenience of further proceedings. The settlement does not contain, and specifically denies, any admission of wrongdoing or violation of law by any of the defendants. We also previously reported that on June 22, 2001 plaintiffs Richard Nelson and Dorothy Nelson filed a First Amended complaint, captioned Richard Nelson, et. al. v. AIM Advisors, Inc. et. al. (Case No. 01-282-DRH), in the United States District Court of the Southern District of Illinois, which added additional plaintiffs and named as defendants advisory and distribution entities from 25 different mutual fund 26 - --------------------------------------------------------------------------------
complexes, including Franklin Advisers, Inc. and Franklin/Templeton Distributors, Inc., both wholly-owned subsidiaries of FRI and Templeton Global Advisors Limited, an indirect wholly-owned subsidiary of FRI (collectively, the "Franklin Defendants"). On September 17, 2001, the plaintiffs filed a Second Amended Complaint, which dropped certain claims included in the First Amended Complaint and deleted certain previously named defendants. The Second Amended Complaint had alleged, 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. On March 29, 2002, based on the stipulation of all parties in the action, the Court entered an order of dismissal of the entire action as to all defendants, including the Franklin Defendants, without prejudice. 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, 2002 at the principal offices of the Company located at One Franklin Parkway, San Mateo, California. The two 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. 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, 2002. (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 195,356,360 4,021,770 Charles B. Johnson 195,388,245 3,989,885 Charles E. Johnson 195,335,827 4,042,303 Rupert H. Johnson, Jr. 195,394,594 3,983,536 Harry O. Kline 195,377,600 4,000,530 James A. McCarthy 195,950,759 3,427,371 Peter A. Sacerdote 195,429,271 3,948,859 Anne M. Tatlock 195,147,502 4,230,628 Louis E. Woodworth 195,962,621 3,415,509 (c) The ratification of the appointment of PricewaterhouseCoopers LLP as the Company's independent accountants for the fiscal year ending September 30, 2002, was approved by a vote of 197,913,819 shares in favor, 650,892 shares against, and 813,419 shares abstaining. 27 - --------------------------------------------------------------------------------
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 10.62 Deferred Compensation Agreement For Director's Fees, as amended on April 15, 2002. Exhibit 12 Computations of ratios of earnings to fixed charges (b) Reports on Form 8-K: (i) Form 8-K filed on January 24, 2002 reporting under Item 5 "Other Events" an earnings press release, dated January 24, 2002, and including said press release as an Exhibit under Item 7 "Financial Statements and Exhibits." 28 - --------------------------------------------------------------------------------
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 14, 2002 /s/ Martin L. Flanagan ---------------------- MARTIN L. FLANAGAN President, Member-Office of the President, Chief Financial Officer and Chief Operating Officer 29 - --------------------------------------------------------------------------------