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, 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: 259,915,179 shares, common stock, par value $.10 per share at
July 31, 2002.
1
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS
FRANKLIN RESOURCES, INC.
CONSOLIDATED INCOME STATEMENTS
UNAUDITED
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30 JUNE 30
(in thousands, except per share data) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------
OPERATING REVENUES:
Investment management fees $384,840 $362,543 $1,107,416 $1,048,464
Underwriting and distribution fees 213,300 180,757 602,844 523,284
Shareholder servicing fees 48,832 53,723 144,197 153,907
Other, net 19,078 12,450 55,768 25,305
---------------------------------------------------
TOTAL OPERATING REVENUES 666,050 609,473 1,910,225 1,750,960
---------------------------------------------------
OPERATING EXPENSES:
Underwriting and distribution 191,586 162,977 541,180 470,795
Compensation and benefits 167,570 167,643 487,477 449,576
Information systems, technology and
occupancy 75,573 70,576 223,364 187,106
Advertising and promotion 29,268 27,314 81,174 73,873
Amortization of deferred sales commissions 17,677 16,361 51,467 52,176
Amortization of intangible assets 4,238 16,672 12,871 36,688
Other 26,286 23,234 67,956 62,599
---------------------------------------------------
TOTAL OPERATING EXPENSES 512,198 484,777 1,465,489 1,332,813
---------------------------------------------------
OPERATING INCOME 153,852 124,696 444,736 418,147
---------------------------------------------------
OTHER INCOME (EXPENSE):
Investment and other income 18,017 34,698 51,128 116,708
Interest expense (3,158) (1,889) (9,134) (7,418)
---------------------------------------------------
OTHER INCOME (EXPENSE), NET 14,859 32,809 41,994 109,290
---------------------------------------------------
INCOME BEFORE TAXES ON INCOME 168,711 157,505 486,730 527,437
TAXES ON INCOME 43,021 37,802 122,525 126,585
---------------------------------------------------
NET INCOME $125,690 $119,703 $364,205 $400,852
===================================================
EARNINGS PER SHARE:
BASIC $0.48 $0.46 $1.39 $1.61
DILUTED $0.48 $0.46 $1.39 $1.60
DIVIDENDS PER SHARE $0.07 $0.065 $0.21 $0.195
See notes to the consolidated financial statements.
2
FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
JUNE 30 SEPTEMBER 30
(in thousands) 2002 2001
- ---------------------------------------------------------------------------------------------
ASSETS:
Current assets:
Cash and cash equivalents $897,814 $497,241
Receivables:
Sponsored investment products 256,581 233,086
Other 46,755 63,079
Investment securities, available-for-sale 1,231,190 1,027,975
Prepaid expenses and other 101,205 108,895
- ---------------------------------------------------------------------------------------------
Total current assets 2,533,545 1,930,276
- ---------------------------------------------------------------------------------------------
Banking/finance assets:
Cash and cash equivalents 25,724 71,736
Loans receivable, net 419,148 555,314
Investment securities, available-for-sale 555,221 484,280
Other 77,949 117,914
- ---------------------------------------------------------------------------------------------
Total banking/finance assets 1,078,042 1,229,244
- ---------------------------------------------------------------------------------------------
Other assets:
Deferred sales commissions 113,529 104,082
Property and equipment, net 401,080 449,626
Intangible assets, net 689,318 702,198
Goodwill 1,287,005 1,286,622
Receivable from banking/finance group 65,545 307,214
Other 280,700 256,388
- ---------------------------------------------------------------------------------------------
Total other assets 2,837,177 3,106,130
- ---------------------------------------------------------------------------------------------
TOTAL ASSETS $6,448,764 $6,265,650
=============================================================================================
See notes to the consolidated financial statements.
3
FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
JUNE 30 SEPTEMBER 30
(in thousands except share data) 2002 2001
- ---------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Current liabilities:
Compensation and benefits 199,747 221,672
Current maturities of long-term debt 8,685 8,361
Accounts payable and accrued expenses 127,963 127,918
Commissions 87,186 83,518
Income taxes 48,517 11,925
Other 8,114 4,039
- ---------------------------------------------------------------------------------------------
Total current liabilities 480,212 457,433
- ---------------------------------------------------------------------------------------------
Banking/finance liabilities:
Deposits 758,017 723,608
Payable to parent 65,545 307,214
Other 56,756 39,839
- ---------------------------------------------------------------------------------------------
Total banking/finance liabilities 880,318 1,070,661
- ---------------------------------------------------------------------------------------------
Other liabilities:
Long-term debt 575,434 566,013
Other 196,519 193,647
- ---------------------------------------------------------------------------------------------
Total other liabilities 771,953 759,660
- ---------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------
Total liabilities 2,132,483 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; 262,000,694 and
260,797,545 shares issued and outstanding for 26,200 26,080
June and September
Capital in excess of par value 700,063 657,878
Retained earnings 3,652,217 3,342,979
Accumulated other comprehensive loss (62,199) (49,041)
- ---------------------------------------------------------------------------------------------
Total stockholders' equity 4,316,281 3,977,896
- ---------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $6,448,764 $6,265,650
=============================================================================================
See notes to the consolidated financial statements.
4
FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED NINE MONTHS ENDED
JUNE 30
(in thousands) 2002 2001
- -------------------------------------------------------------------------------------------
Net income $364,205 $400,852
Adjustments to reconcile net income to net cash
Provided by operating activities:
Decrease in receivables, prepaid expenses and other 56,059 25,953
Net advances of deferred sales commissions (67,200) (57,693)
Increase (decrease) in other current liabilities 33,217 (37,986)
Increase (decrease) in income taxes payable 36,591 (24,047)
Increase in commissions payable 3,668 13,846
Increase in accrued compensation and benefits 1,897 790
Depreciation and amortization 138,505 161,830
Gains on disposition of assets (4,342) (52,527)
- -------------------------------------------------------------------------------------------
Net cash provided by operating activities 562,600 431,018
- -------------------------------------------------------------------------------------------
Purchase of investments (1,225,692) (582,574)
Liquidation of investments 880,973 454,230
Purchase of banking/finance investments (62,873) (3,411)
Liquidation of banking/finance investments 62,662 361
Net proceeds from securitization of loans receivable 499,332 139,295
Net origination of loans receivable (342,124) (189,560)
Net addition of property and equipment (25,074) (81,919)
Acquisition of subsidiaries, net of cash acquired - (100,058)
- -------------------------------------------------------------------------------------------
Net cash used in investing activities (212,796) (363,636)
- -------------------------------------------------------------------------------------------
Increase in bank deposits 34,408 41,416
Exercise of common stock options 17,829 1,887
Dividends paid on common stock (53,250) (46,366)
Purchase of stock (8,146) (137,213)
Issuance of debt 82,583 694,383
Payments on debt (68,667) (492,381)
- -------------------------------------------------------------------------------------------
Net cash provided by financing activities 4,757 61,726
- -------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 354,561 129,108
Cash and cash equivalents, beginning of period 568,977 746,005
- -------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $923,538 $875,113
- -------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION:
Value of common stock issued, principally restricted stock $28,009 $24,959
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
See notes to the consolidated financial statements.
5
FRANKLIN RESOURCES, INC.
Notes to Consolidated Financial Statements
June 30, 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 the rules and regulations of the
Securities and Exchange Commission. Under these rules and regulations,
we have shortened or omitted some information and footnote disclosures
normally included in financial statements prepared under generally
accepted accounting principles. We believe that we have made all
adjustments necessary for a fair statement of the results of operations
for the periods shown. All adjustments are normal and recurring. You
should read these financial statements together with our audited
financial statements included in our Annual Report on Form 10-K for the
year ended September 30, 2001.
2. Comprehensive Income
--------------------
The following table shows comprehensive income for the three and nine
months ended June 30, 2002.
Three months ended Nine months ended
June 30 June 30
(in thousands) 2002 2001 2002 2001
--------------------------------------------------------------------------------------
Net income $125,690 $119,703 364,205 $400,852
Net unrealized (loss) gain on
available-for-sale
securities, net of tax (22,059) 1,929 (15,878) (47,753)
Foreign currency translation
adjustments 11,572 896 2,720 (8,570)
--------------------------------------------------------------------------------------
Comprehensive income $115,203 $122,528 $351,047 $344,529
======================================================================================
6
3. Earnings per Share
------------------
We computed earnings per share as follows:
Three months ended Nine months ended
June 30 June 30
(in thousands except per share
amounts) 2002 2001 2002 2001
----------------------------------------------------------------------------------------
Net income $125,690 $119,703 $364,205 $400,852
========================================================================================
Weighted-average shares
outstanding - basic 261,952 260,815 261,507 249,591
Incremental shares from assumed
conversions 1,135 1,359 894 1,031
----------------------------------------------------------------------------------------
Weighted-average shares
outstanding - diluted 263,087 262,174 262,401 250,622
========================================================================================
Earnings per share:
Basic $0.48 $0.46 $1.39 $1.61
Diluted $0.48 $0.46 $1.39 $1.60
4. Securitization of Loans Receivable
----------------------------------
The following table shows details of auto loan securitization
transactions for the three and nine months ended June 30, 2002.
Three months ended Nine months ended
June 30 June 30
(in millions) 2002 2001 2002 2001
--------------------------------------------------------------------------------------
Net carrying amount of loans
sold $178.9 $ - $485.2 $142.6
Gross sale proceeds $183.8 $ - $503.5 $145.5
Pre-tax gain $4.9 $ - $18.3 $2.9
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.
We generally estimate fair value based on the present value of future
expected cash flows. The key assumptions used in the present value
calculations of our securitization transactions at the date of
securitization were as follows:
7
Three months ended Nine months ended
June 30 June 30
2002 2001 2002 2001
--------------------------------------------------------------------------------------
Excess cash flow discount rate
(annual rate) 12% N/A 12% 12%
3.30%,
Cumulative life loss rate 3.30% N/A 3.76% 3.06%
Pre-payment speed
assumption (average
monthly rate) 1.5% N/A 1.5% 1.5%
We determined these assumptions using data from comparable transactions,
historical information and management's estimate. Interest-only strip
receivables are generally restricted assets and subject to limited
recourse provisions. The carrying value of the interest-only strips was
$29.7 million as of June 30, 2002 and $10.8 million as of September 30,
2001. Amounts payable to the trustee for servicing income collected on
behalf of the trusts of $25.1 million as of June 30, 2002 and $10.9
million as of September 30, 2001 are included in other banking/finance
liabilities.
With respect to retained servicing responsibilities relating to the
securitization trusts, we receive annual servicing fees ranging from
1.25% to 2.0% of the loans securitized. We also 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 cash flows received in the three and nine
months ended June 30, 2002 from all the securitization trusts during
these periods:
Three months ended Nine months ended
June 30 June 30
(in thousands) 2002 2001 2002 2001
--------------------------------------------------------------------------------------
Servicing fees received $1,952 $1,249 $5,349 $3,585
Total cash flows received on
retained interests other
than servicing fees $6,064 $2,543 $11,985 $5,323
5. Goodwill and Intangible Assets
------------------------------
On 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 after 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, on October 1, 2001, we ceased amortization
on goodwill and indefinite-lived assets. This resulted in the following
amortization expense reduction:
8
(in thousands except per share Three months ended Nine months ended
amounts) June 30, 2002 June 30, 2002
--------------------------------------------------------------------------------------
Amortization expense reduction $12,517 $37,551
Amortization expense reduction - net
of tax $9,325 $28,098
Increase in basic and diluted earnings
per share $0.04 $0.11
All of our goodwill and intangible assets, including those arising from
the purchase of Fiduciary Trust Company International ("Fiduciary") in
April 2001, relate to our investment management operating segment.
Indefinite-lived intangible assets represent the value of management
contracts with our mutual funds and other investment products. The
following table reflects our results as though we had adopted SFAS 142
on October 1, 2000.
Three months ended Nine months ended
June 30 June 30
(in thousands except per share
amounts) 2002 2001 2002 2001
---------------------------------------------------------------------------------------
Net income as reported $125,690 $119,703 $364,205 $400,852
Goodwill amortization - 8,798 - 20,262
Indefinite-lived intangibles amortization - 3,288 - 9,864
Tax effect at effective tax rate - (2,901) - (7,230)
---------------------------------------------------------------------------------------
Net income as adjusted $125,690 $128,888 $364,205 $423,748
Basic earnings per share as reported $0.48 $0.46 $1.39 $1.61
Diluted earnings per share as reported $0.48 $0.46 $1.39 $1.60
Basic earnings per share as adjusted $0.48 $0.49 $1.39 $1.70
Diluted earnings per share as adjusted $0.48 $0.49 $1.39 $1.69
9
Intangible assets at June 30, 2002 and September 30, 2001 were as
follows:
Gross
carrying Accumulated Net carrying
(in thousands) amount amortization amount
--------------------------------------------------------------------------------------
<c>
As at June 30, 2002
-------------------
Amortized intangible assets:
Customer base $232,191 $(19,532) $212,659
Other 31,545 (17,813) 13,732
--------------------------------------------------------------------------------------
263,736 (37,345) 226,391
Non-amortized intangible assets:
Management contracts 462,927 - 462,927
--------------------------------------------------------------------------------------
Total $726,663 $(37,345) $689,318
======================================================================================
As at September 30, 2001
------------------------
Amortized intangible assets:
Customer base $232,191 $(7,913) $224,278
Other 31,545 (16,552) 14,993
--------------------------------------------------------------------------------------
263,736 (24,465) 239,271
Non-amortized intangible assets:
Management contracts 462,927 - 462,927
--------------------------------------------------------------------------------------
Total $726,663 $(24,465) $702,198
======================================================================================
Estimated amortization expense for each of the next 5 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 completed the impairment testing of goodwill
and indefinite-lived intangible assets under the guidance set out in
SFAS 142 and we 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 almost all of
its revenues and net income from providing investment advisory,
investment administration, distribution and related services to our
sponsored investment products. The banking/finance segment offers
consumer lending, certain trustee services and selected retail-banking
services to the general public, high net-worth individuals, foundations
and institutions.
10
We show financial information for our two operating segments for the
three and nine months ended June 30, 2002 and 2001 in the table below.
Three months ended Nine months ended
June 30 June 30
(in thousands) 2002 2001 2002 2001
------------------------------------------------------------------------------------
Operating revenues:
Investment management $650,465 $600,715 $1,867,218 $1,727,544
Banking/finance-gross revenues 20,907 18,486 67,499 43,277
Banking/finance-interest expense
and loan loss provision (5,322) (9,728) (24,492) (19,861)
------------------------------------------------------------------------------------
Total $666,050 $609,473 $1,910,225 $1,750,960
Income before taxes:
Investment management $160,111 $155,680 $459,492 $521,697
Banking/finance 8,600 1,825 27,238 5,740
------------------------------------------------------------------------------------
Total $168,711 $157,505 $486,730 $527,437
====================================================================================
Operating segment assets were as follows:
(in thousands) June 30, 2002 September 30, 2001
------------------------------------------------------------------------------------
Investment management $5,370,722 $5,036,406
Banking/finance 1,078,042 1,229,244
------------------------------------------------------------------------------------
Total $6,448,764 $6,265,650
====================================================================================
7. Debt
----
In May 2001, we received approximately $490 million in net proceeds from
the sale of $877 million principal amount at maturity of zero-coupon
convertible senior notes due 2031 (the "Convertible Notes"). At June 30,
2002, long-term debt included $501 million in principal and $10.8
million of accrued interest related to the Convertible Notes. The
Convertible Notes, which were offered to qualified institutional buyers
only, carry an interest rate of 1.875% per annum, with an initial
conversion premium of 43%. Each of the $1,000 (principal amount at
maturity) Convertible Notes is convertible into 9.3604 shares of our
common stock. We may redeem the Convertible Notes for cash on or after
May 11, 2006 at their accreted value. We may have 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 in cash or shares of our common
stock.
We did not have any commercial paper outstanding or medium term notes
issued at June 30, 2002.
11
8. Commitments and Contingencies
-----------------------------
We are contingently liable for approximately $145 million in residual
guarantees under an operating lease for our global corporate
headquarters in San Mateo, California. This represents about 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 start 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 agreement, we may end the agreement any time after March 2004
by incurring a termination charge. The maximum termination charge
payable depends on the termination date, the service levels prior to our
termination of the agreement, and costs IBM would incur in winding down
the services. Based on June 30, 2002 service levels, this termination
fee would approximate $37.2 million. We do not consider it likely that
we will incur this cost. Under the terms of the agreement, we must also
pay IBM an additional transition charge of about $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 June 30, 2002, our banking/finance operating segment had commitments
to extend credit aggregating $286.0 million, mainly under credit card
lines, and held standby letters of credit totaling $6.9 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.
9. Banking Regulatory Ratios
-------------------------
Following the acquisition of 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 cause some
mandatory and possibly additional discretionary actions by regulators
that, if undertaken, could have a direct material effect on our
financial statements. We must meet specific capital guidelines that
involve quantitative measures of our assets and liabilities 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).
Based on our calculations, as of June 30, 2002, we exceed the capital
adequacy requirements currently applicable to us as listed below.
12
Three months ended Minimum for our
(in thousands) June 30, 2002 capital adequacy
purposes
------------------------------------------------ -------------------- -----------------
Tier 1 capital $2,282,803 N/A
Total risk-based capital $2,290,074 N/A
Tier 1 leverage ratio 51% 4%
Tier 1 risk-based capital ratio 85% 4%
Total risk-based capital ratio 86% 8%
10. Subsequent Events
-----------------
On July 26, 2002, our 75% owned subsidiary, Templeton Asset Management
(India) Private Limited, acquired all of the issued and outstanding
shares of Pioneer ITI AMC Limited, an Indian investment management
company with approximately $0.8 billion in assets under management as of
the purchase date. The aggregate value of this all-cash transaction was
approximately $55.4 million.
In July 2002, we purchased approximately 2.1 million shares of our
common stock at a cost of $64.4 million. In August 2002, we increased
the number of shares of our common stock authorized for purchase by us
by 10 million to 11.4 million shares. Also, in July 2002, we completed
the sale of put options that give the purchaser the right to sell 2.5
million shares of our common stock to us at a specified price upon
exercise of the options on the designated expiration dates in January,
June and July of 2003 if certain conditions are met.
13
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 differ
significantly from those that we discuss in this document. For this reason, you
should not place too much emphasis on these forward-looking statements and
should review the "Risk Factors" section below, where we discuss these
statements in more detail.
GENERAL
We derive the majority of our operating revenues, operating expenses and net
income from providing investment management and related services to retail
mutual funds, institutional, high net-worth, separate accounts and other
investment products. This is our main 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.
The level of our revenues depends largely on the level and relative mix of
assets under management. To a lesser degree, our revenues also depend on the
level of mutual fund sales and the number of mutual fund shareholder accounts.
The fees charged for our services are based on our contracts with our sponsored
investment products or our clients. These arrangements could change in the
future.
Our secondary business and operating segment is banking/finance. Our
banking/finance group offers selected retail-banking services to high net-worth
individuals, foundations and institutions and consumer lending.
14
ASSETS UNDER MANAGEMENT
June 30 June 30
(in billions) 2002 2001
------------------------------------------------------------------------------------------
Equity:
Global/international $93.6 $93.4
Domestic (U.S.) 48.5 53.3
------------------------------------------------------------------------------------------
Total equity 142.1 146.7
------------------------------------------------------------------------------------------
Hybrid 39.6 38.3
Fixed-income:
Tax-free 50.2 46.9
Taxable:
Domestic (U.S.) 24.7 23.4
Global/international 8.4 7.2
------------------------------------------------------------------------------------------
Total fixed-income 83.3 77.5
------------------------------------------------------------------------------------------
Money 5.4 5.4
------------------------------------------------------------------------------------------
Total $270.4 $267.9
==========================================================================================
Simple monthly average for the three-month period (1) $274.8 $255.9
------------------------------------------------------------------------------------------
Simple monthly average for the nine-month period (1) $265.6 $238.7
==========================================================================================
(1) We calculate investment management fees using a daily average for about
45% of our assets under management at June 30, 2002. The remaining
investment management fees are mainly calculated based on month-end and
quarter-end assets under management.
Our assets under management at June 30, 2002 were $270.4 billion, 1% higher
than they were a year ago. Simple monthly average assets during the quarter
ended June 30, 2002 increased 7% over the same period a year ago. The
increase in the absolute level and simple monthly average assets under
management for the quarter ended June 30, 2002 from the prior year is mainly
due to increased net sales, partially offset by market depreciation.
The following table shows the mix of assets under management by investment
type.
As of June 30, 2002 2001
-------------------------------------------------------------------------------------------
Percentage of total assets under management:
Equity 52% 55%
Fixed-income 31% 29%
Hybrid 15% 14%
Money 2% 2%
-------------------------------------------------------------------------------------------
Total 100% 100%
===========================================================================================
The change in the mix of assets under management resulted mainly from the
decline in equity markets during the quarters ended June 30, 2002 and
September 30, 2001.
15
The change in our assets under management was as follows:
Three months ended Nine months ended
June 30 Percent June 30 Percent
(in billions) 2002 2001 Change 2002 2001 Change
---------------------------------------------------------------------------------------------------------------------------
Beginning assets under management $274.5 $215.7 27% $246.4 $229.9 7%
Sales 18.6 15.4 21% 56.3 43.7 29%
Reinvested dividends 1.1 2.2 (50)% 4.2 8.4 (50)%
Redemptions (14.1) (14.9) (5)% (43.9) (45.0) (2)%
Acquisitions - 45.8 (100)% - 49.5 (100)%
(Depreciation)/appreciation (9.7) 3.7 N/A 7.4 (18.6) N/A
---------------------------------------------------------------------------------------------------------------------------
Ending assets under management $270.4 $267.9 1% $270.4 $267.9 1%
===========================================================================================================================
The acquisition of Bissett and Associates Investment Management Ltd.
("Bissett") in October 2000 increased our assets under management by $3.7
billion, and the Fiduciary Trust Company International ("Fiduciary")
acquisition in April 2001 increased our assets under management by $45.8
billion, as of the dates of these acquisitions. For both the three and nine
months ended June 30, 2002 sales and reinvested dividends exceeded
redemptions ("net inflows") complex-wide by $5.6 billion and $16.6 billion,
compared to the same periods last year when net inflows were $2.7 billion
and $7.1 billion. Market appreciation of $7.4 billion in the nine months
ended June 30, 2002 resulted from increases in the global/international
equity, hybrid, and taxable fixed-income products partially offset by
depreciation in the other investment products.
The chart below summarizes changes in our assets under management by product
class.
16
Three months ended Percent Nine months ended Percent
June 30 change June 30 change
(in billions) 2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------------
GLOBAL/INTERNATIONAL EQUITY
Beginning assets under management $93.9 $87.6 7% $80.2 $97.6 (18)%
Sales 7.0 5.3 32% 21.1 14.1 50%
Reinvested dividends 0.1 0.7 (86)% 0.9 3.8 (76)%
Redemptions (4.7) (5.8) (19)% (16.7) (18.8) (11)%
Acquisitions - 3.2 (100)% - 5.4 (100%)
(Depreciation)/ appreciation (2.7) 2.4 N/A 8.1 (8.7) N/A
----------------------------------------------------------------------------------------------------------------
Ending assets under management 93.6 93.4 - 93.6 93.4 -
DOMESTIC (U.S.) EQUITY
Beginning assets under management 53.2 45.5 17% 44.5 53.9 (17)%
Sales 3.6 3.1 16% 10.8 10.2 6%
Reinvested dividends 0.3 0.7 (57)% 1.4 2.4 (42)%
Redemptions (2.6) (2.2) 18% (7.0) (7.1) (1)%
Acquisitions - 3.7 (100)% - 3.7 (100)%
(Depreciation)/ appreciation (6.0) 2.5 N/A (1.2) (9.8) (88)%
----------------------------------------------------------------------------------------------------------------
Ending assets under management 48.5 53.3 (9)% 48.5 53.3 (9)%
HYBRID
Beginning assets under management 40.8 9.8 316% 36.1 9.3 288%
Sales 1.2 0.6 100% 4.0 1.2 233%
Reinvested dividends 0.2 0.2 - 0.4 0.4 -
Redemptions (0.6) (0.5) 20% (1.5) (1.2) 25%
Acquisitions - 29.1 (100)% - 30.2 (100)%
(Depreciation)/ appreciation (2.0) (0.9) 122% 0.6 (1.6) N/A
----------------------------------------------------------------------------------------------------------------
Ending assets under management 39.6 38.3 3% 39.6 38.3 3%
TAX-FREE INCOME
Beginning assets under management 48.7 45.8 6% 48.4 44.0 10%
Sales 1.8 1.6 13% 5.1 3.8 34%
Reinvested dividends 0.3 0.3 - 0.9 0.9 -
Redemptions (1.4) (1.2) 17% (3.8) (3.4) 12%
Acquisitions - 0.1 (100)% - 0.1 (100)%
Appreciation/ (depreciation) 0.8 0.3 167% (0.4) 1.5 N/A
----------------------------------------------------------------------------------------------------------------
Ending assets under management 50.2 46.9 7% 50.2 46.9 7%
TAXABLE FIXED-INCOME
Beginning assets under management 32.3 21.1 53% 31.6 19.8 60%
Sales 2.7 1.9 42% 7.7 5.4 43%
Reinvested dividends 0.2 0.2 - 0.5 0.6 (17)%
Redemptions (2.3) (1.8) 28% (7.0) (4.3) 63%
Acquisitions - 9.7 (100)% - 10.1 (100)%
Appreciation/ (depreciation) 0.2 (0.5) N/A 0.3 (1.0) N/A
----------------------------------------------------------------------------------------------------------------
Ending assets under management 33.1 30.6 8% 33.1 30.6 8%
MONEY
Beginning assets under management 5.6 5.9 (5)% 5.6 5.3 6%
Sales 2.3 2.9 (21)% 7.6 9.0 (16)%
Reinvested dividends - 0.1 (100)% 0.1 0.3 (67)%
Redemptions (2.5) (3.4) (26)% (7.9) (10.2) (23)%
Acquisitions - - - - - -
(Depreciation)/ appreciation - (0.1) (100)% - 1.0 (100)%
----------------------------------------------------------------------------------------------------------------
Ending assets under management 5.4 5.4 - 5.4 5.4 -
----------------------------------------------------------------------------------------------------------------
TOTAL ENDING ASSETS UNDER
MANAGEMENT $270.4 $267.9 1% $270.4 $267.9 1%
----------------------------------------------------------------------------------------------------------------
17
RESULTS OF OPERATIONS
Three months ended Nine months ended
June 30 Percent June 30 Percent
2002 2001 Change 2002 2001 Change
----------------------------------------------------------------------------------------------
Net income (in millions) $125.7 $119.7 5% $364.2 $400.9 (9)%
Earnings per share
Basic $0.48 $0.46 4% $1.39 $1.61 (14)%
Diluted $0.48 $0.46 4% $1.39 $1.60 (13)%
Operating margin 23% 20% 23% 24%
EBITDA margin (1) 30% 32% 30% 35%
-----------------------------------------------------------------------------------------------
(1) EBITDA margin is earnings before interest, taxes on income, depreciation
and the amortization of intangibles (not including amortization of deferred
sales commissions) divided by total revenues.
Net income during the three months ended June 30, 2002 increased 5% compared
to the same period last year mainly due to higher operating revenues offset
by increased operating expenses and lower investment and other income. Net
income during the nine months ended June 30, 2002 decreased 9% compared to
the same period last year due to increased operating expenses and lower
investment and other income, partially offset by higher operating revenues.
OPERATING REVENUES
Three months ended Nine months ended
June 30 Percent June 30 Percent
(in millions) 2002 2001 Change 2002 2001 Change
---------------------------------------------------------------------------------------------
Investment
management fees $384.9 $362.5 6% $1,107.4 $1,048.5 6%
Underwriting and
distribution fees 213.3 180.8 18% 602.8 523.3 15%
Shareholder servicing
Fees 48.8 53.7 (9)% 144.2 153.9 (6)%
Other, net 19.1 12.5 53% 55.8 25.3 121%
------------------------------------------------------------------------------------------
Total operating revenues $666.1 $609.5 9% $1,910.2 $1,751.0 9%
=========================================================================================
SUMMARY
Total operating revenues for the three and nine months ended June 30, 2002
increased 9% 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 higher
average assets under management. We also benefited from increased
banking/finance operating segment revenues included in other, net, resulting
from higher net gains related to auto loan securitizations in the current
fiscal year.
18
INVESTMENT MANAGEMENT FEES
Investment management fees, accounting for 58% of our operating revenues in
the quarter ended June 30, 2002, include both investment advisory and
business management fees. These fees are generally calculated under
contractual arrangements with our sponsored investment products, and
institutional, high net-worth, and separate account clients as a percentage
of the market value of 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 6% during the three months ended June
30, 2002 over the same period last year consistent with increased simple
average assets under management. Investment management fees increased 6%
during the nine months ended June 30, 2002 over the same period last year.
This increase was mainly 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 June 30, 2002 declined to 0.56%
compared to 0.57% in the same period last year.
UNDERWRITING AND DISTRIBUTION FEES
We earn underwriting commissions from the sale of some 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 some 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 international
jurisdictions, in the United States, distribution fees include 12b-1 plan
fees, which are subject to maximum payout levels based on a percentage of
the assets in each fund. We pay a significant portion of underwriting
commissions and distribution fees to the financial advisors and other
intermediaries who sell our sponsored investment products to the public on
our behalf. See the description of underwriting and distribution expenses
below.
Underwriting and distribution fees increased 18% and 15% during the three
and nine months ended June 30, 2002 over the same periods last year.
Commission revenues increased 24% over the same periods last year mainly due
to a 21% and 29% increase in product sales. Distribution fees increased 14%
and 10% during the three and nine months ended June 30, 2002 over the same
periods last year consistent with higher simple average 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 some instances, sponsored investment products are charged these
fees based on the level of assets under management. We receive fees 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 calendar year remain billable through the second
quarter of the following calendar year at a reduced rate. In Canada, such
19
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 mix 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 1,207,000 accounts closed in the U.S. during
calendar year 2001 will no longer be billable effective July 1, 2002.
Shareholder servicing fees decreased 9% and 6% during the three and nine
months ended June 30, 2002, as a result of a decrease in the total number of
billable accounts.
OTHER, NET
Other, net consists mainly 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
mainly 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 53% in the three months ended June 30, 2002 mainly due
to a gain of $4.9 million from the sale of a portion of our auto loan
portfolio in June 2002. Other, net increased 121% in the nine months ended
June 30, 2002. This increase was primarily due to the addition of the
Fiduciary banking and custody activities from the date of acquisition and
increased gains recognized on auto loan portfolio sales.
OPERATING EXPENSES
Three months ended Nine months ended
June 30 Percent June 30 Percent
(in millions) 2002 2001 Change 2002 2001 Change
---------------------------------------------------------------------------------------------------------------
Underwriting and distribution $191.6 $163.0 18% $541.2 $470.8 15%
Compensation and benefits 167.5 167.6 - 487.5 449.5 8%
Information systems, technology
and occupancy 75.6 70.6 7% 223.4 187.1 19%
Advertising and promotion 29.3 27.3 7% 81.2 73.9 10%
Amortization of deferred sales
commissions 17.7 16.4 8% 51.5 52.2 (1)%
Amortization of intangible assets 4.2 16.7 (75)% 12.8 36.7 (65)%
Other 26.3 23.2 13% 67.9 62.6 8%
---------------------------------------------------------------------------------------------------------------
Total operating expenses $512.2 $484.8 6% $1,465.5 $1,332.8 10%
===============================================================================================================
SUMMARY
Operating expenses increased 6% during the three months ended June 30, 2002
over the same period last year. This increase was mainly due to higher
underwriting and distribution expenses, consistent with increased
underwriting and distribution revenues, partially offset by a reduction in
the amortization of intangible assets.
20
Operating expenses increased 10% during the nine months ended June 30, 2002
over the same period last year. This increase was mainly 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 18% and 15% during
the three and nine months ended June 30, 2002 over the same periods last
year consistent with the increase in underwriting and distribution revenues.
COMPENSATION AND BENEFITS
Compensation and benefits expense remained constant during the three months
ended June 30, 2002 compared to the same period last year. Compensation and
benefits expense increased 8% during the nine months ended June 30, 2002
over the same period last year. This increase was mainly due to the addition
of Fiduciary employees and related retention bonuses committed to the
Fiduciary staff. The increase was partially offset by an overall decline in
employees as well as 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 reinstated employee salaries
in the 10% reduction category in July 2002. In addition, our bonus pool is
calculated based on operating profits and specific investment performance
drivers. We employed approximately 6,500 people at June 30, 2002 compared to
about 7,100 at the same time last year.
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.
INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY
Information systems, technology and occupancy costs increased 7% during the
three months ended June 30, 2002 over the same period last year. This
increase was mainly due to a contractual increase in service charges related
to IBM's assumption of the management of our data center and distributed
server operations.
Information systems, technology and occupancy costs increased 19% during the
nine months ended June 30, 2002 over the same period last year. This
increase was mainly due to costs related to IBM's assumption of the
management of our data center and distributed server operations and added
technology and occupancy costs of the Fiduciary acquisition.
21
During the past year, we performed technology work including:
* upgrading hardware
* purchasing, developing and installing new software
* re-engineering our technology infrastructure and global network
architecture
* replacing or upgrading older versions of software applications
* developing and implementing e-business strategies to improve our
service levels, work environment and productivity.
The extent of this work has declined during both the three and nine months
ended June 30, 2002 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.
Details of capitalized information systems and technology costs were as
follows:
Three months ended Nine months ended
June 30 June 30
(in thousands) 2002 2001 2002 2001
-------------------------------------------------------------------------------------------
Net book value at beginning of period $146,866 $157,531 $162,857 $156,895
Additions during period, net of disposals and
other adjustments 5,865 31,769 28,297 66,989
Net assets acquired through acquisitions - 10,797 - 11,266
Amortization during period (18,390) (19,879) (56,813) (54,932)
-------------------------------------------------------------------------------------------
Net book value at end of period $134,341 $180,218 $134,341 $180,218
===========================================================================================
ADVERTISING AND PROMOTION
Advertising and promotion increased 7% and 10% during the three and nine
months ended June 30, 2002 over the same periods last year. This increase
resulted mainly from increased promotion and advertising activity to educate
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 increased 8% and decreased 1%
during the three and nine months ended June 30, 2002 over the same periods
last year. These changes were mainly a result of changes in sales mix and
our current financing arrangements. In the U.S., we sell class A shares
without a front-end sales charge to shareholders when minimum investment
criteria are met, yet our U.S. distribution subsidiary pays a commission on
the sale. We defer and amortize this up-front commission over a 12 to 18
month period. Thus, as the balance of the deferred sales commission asset on
our balance sheet changes, so does the amortization expense.
We also 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. We retain U.S. DCA sold to LFL under
the U.S. agreement in our financial statements and amortize it over an 8
year period, until resold by LFL in a securitization, which generally occurs
at least once annually. In June
22
2002, LFL sold approximately $61.5 million U.S DCA and we reflected this
transaction in our financial statements.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets decreased 75% and 65% during the three and
nine months ended June 30, 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 about $9 million and $28 million for
the three and nine months ended June 30, 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 in March 2002
and have determined that there is no impairment to the goodwill and
indefinite-lived assets recorded in our financial statements as of October
1, 2001.
OTHER INCOME (EXPENSE)
Investment and other income is primarily comprised of the following:
* dividends from investments in our sponsored mutual funds
* interest income from investments in bonds and government securities
* realized gains and losses on investments
* foreign currency exchange gains and losses
* other miscellaneous income including the gain or loss on disposal of
property.
Other income (expense) decreased 55% and 62% during the three and nine
months ended June 30, 2002 over the same periods last year. The decrease in
the nine months ended June 30, 2002 is related mainly to a realized gain of
approximately $19.6 million from the sale of sponsored investment products
held for investment and a $24.6 million gain on the sale of our headquarters
building in San Mateo in the prior year, as well as a decline in interest
income on investments in the current year. The gain on the sale of our
headquarters building was recognized over a 12-month leaseback period
through June 2001.
TAXES ON INCOME
Our effective income tax rate for the three months and nine months
ended June 30, 2002 increased to 25.5% and 25.2%, compared to 24% in the
same periods last year consistent with increased revenues generated in the
U.S.. The effective tax rate will continue to reflect the relative
contributions of foreign earnings that are subject to reduced tax rates and
that are currently excluded from U.S. taxable income.
MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2002, we had $923.5 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
23
instruments and, in particular, the maturity schedules of some 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 $3,013.3 million at June 30, 2002 from
$2,377.4 million at September 30, 2001. This increase was mainly due to net
income generated in the nine months ended June 30, 2002 of $364.2 million
and proceeds received from the securitization of auto loans net of new loan
originations.
Outstanding debt increased to $584.1 million at June 30, 2002 compared to
$574.4 million at September 30, 2001. Outstanding debt consists mainly of
$511.8 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 have 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 in cash or shares of our common stock. The
overall increase in outstanding debt is due mainly to additional financing
activity of our mutual fund Class B and C shares sales, partially offset by
the sale of certain U.S. deferred commission assets by LFL in June 2002.
This resulted in a slight increase in other long-term debt to $72.3 million
at June 30, 2002, from $69.7 million as of September 30, 2001. Other debt
has various maturity dates through fiscal 2006 and thereafter.
At June 30, 2002, about $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
depends on a number of factors including our credit rating, the condition of
the global economy, investors' willingness to purchase our securities,
interest rates, credit spreads and the equity market valuation levels. In
extreme circumstances, we might not be able to access this liquidity
readily.
Our committed revolving credit facilities at June 30, 2002 totaled $420
million, of which, $210 million was under a 364-day facility. The remaining
$210 million facility was under a five year facility and will expire in June
2007. 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 nine months ended June 30,
2002 approximated $38.4 million and $103.9 million compared to $23.6 million
and $59.2 million in the same periods in the prior year.
Since September 1998, our banking/finance operating segment has entered into
a number of auto loan 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 $537.6
million as of June 30, 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.
24
We expect that the main uses of cash will be as follows:
* 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
* acquire shares of 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 we can meet our present and reasonably foreseeable operating
cash needs and future commitments through the following:
* our existing liquid assets
* the continuing cash flow from operations
* our borrowing capacity under current credit facilities
* our ability to issue debt or equity securities
* our mutual fund sales commission financing arrangement.
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.
25
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 and the recent reports of accounting
irregularities at certain public companies. Declines in these markets have
caused in the past, and would cause in the future, a decline in our revenue
and income.
THE LEVELS OF OUR ASSETS UNDER MANAGEMENT, WHICH IN TURN IMPACT REVENUES,
ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS. Global economic conditions, changes
in the equity market place, interest rates, inflation rates, the yield curve
and other factors that are difficult to predict affect the mix, market
values and levels of our assets under management. Changing market conditions
may cause a shift in our asset mix towards fixed-income products and a
related decline in our revenue and income, since we generally derive higher
fee revenues and income from equity assets than from fixed-income products
we manage. Similarly, our securitized consumer receivables business is
subject to marketplace fluctuation.
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 and C
shares, is also subject to the market's perception of those assets, finance
rates offered by competitors, and the general market for private debt. If we
are unable to obtain these funds and financing, we may be forced to incur
unanticipated costs or revise our business plans.
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
26
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 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.
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.
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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 mainly in our debt transactions and
portfolio debt holdings available-for-sale, which are carried at fair value. As
of June 30, 2002, a significant percentage of our outstanding debt is at fixed
interest rates. In our banking/finance operating segment, we monitor the net
interest rate margin and the average maturity of interest earning assets and
funding sources. In addition, we have considered the potential impact of the
effect on the banking/finance operating 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 mainly in the United States, but also provide services and earn
revenues in Canada, the Bahamas, Europe, Asia, South America, Africa and
Australia. Most 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
There have been no material developments in the litigation previously reported
in our Form 10-Q for the period ended March 31, 2002 as filed with the
Securities and Exchange Commission on May 14, 2002. 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 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
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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 26, 2002 reporting under Item 5
"Other Events" an earnings press release, dated April 25,
2002, and including said press release as an Exhibit under
Item 7 "Financial Statements and Exhibits."
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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 12, 2002 /s/ Martin L. Flanagan
----------------------
MARTIN L. FLANAGAN
President, Member - Office of the President,
Chief Financial Officer and Chief Operating
Officer
30
CERTIFICATION OF PERIODIC REPORT
I, Charles B. Johnson, Chief Executive Officer, of Franklin Resources, Inc. (the
"Company"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350, that to my knowledge:
1. the Quarterly Report on Form 10-Q of the Company for the quarterly
period ended June 30, 2002 (the "Report") fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 (15 U.S.C. 78m or 78o(d)); and
2. the information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
Dated: August 12, 2002 /s/ Charles B. Johnson
----------------------
Charles B. Johnson
Chief Executive Officer
31
CERTIFICATION OF PERIODIC REPORT
I, Martin L. Flanagan, Chief Financial Officer of Franklin Resources, Inc. (the
"Company"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350, that to my knowledge:
1. the Quarterly Report on Form 10-Q of the Company for the quarterly
period ended June 30, 2002 (the "Report") fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 (15 U.S.C. 78m or 78o(d)); and
2. the information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
Dated: August 12, 2002 /s/ Martin L. Flanagan
----------------------
Martin L. Flanagan
Chief Financial Officer
32