FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Quarterly Period Ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to______________
Commission File No. 1-9318
FRANKLIN RESOURCES, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-2670991
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
777 Mariners Island Blvd., San Mateo, CA 94404
(Address of Principal Executive Offices)
(Zip Code)
(650) 312-2000
(Registrant's telephone number, including area code)
---------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO ______
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. YES _____ NO ______
APPLICABLE ONLY TO CORPORATE ISSUERS:
Outstanding: 252,652,244 shares, common stock, par value $.10 per share at
January 31, 1999.
PART I -FINANCIAL INFORMATION
Item 1. Condensed Financial Statements
FRANKLIN RESOURCES, INC.
Consolidated Statements of Income
Unaudited
Three months ended
December 31
(In thousands, except per share data) 1998 1997
- --------------------------------------------------------------------------------
Operating revenues:
Investment management fees $330,370 $348,562
Underwriting and distribution fees 188,604 243,188
Shareholder servicing fees 45,734 37,606
Other, net 2,971 3,043
- --------------------------------------------------------------------------------
Total operating revenues 567,679 632,399
- --------------------------------------------------------------------------------
Operating expenses:
Underwriting and distribution 163,046 205,312
Compensation and benefits 133,814 133,291
Information systems, technology and occupancy 48,479 46,596
Advertising and promotion 28,238 27,362
Amortization of deferred sales commissions 25,019 23,896
Amortization of intangible assets 9,373 8,995
Other 22,805 19,505
Restructuring charge 46,140 -
- --------------------------------------------------------------------------------
Total operating expenses 476,914 464,957
- --------------------------------------------------------------------------------
Operating income 90,765 167,442
Other income/(expenses):
Investment and other income 10,536 14,975
Interest expense (6,173) (6,152)
- --------------------------------------------------------------------------------
Other income, net 4,363 8,823
- --------------------------------------------------------------------------------
Income before taxes on income 95,128 176,265
Taxes on income 26,636 45,750
- --------------------------------------------------------------------------------
Net income $68,492 $130,515
- --------------------------------------------------------------------------------
Earnings per share:
Basic $0.27 $0.52
Diluted $0.27 $0.52
Dividends per share $0.055 $0.05
The accompanying notes are an integral part of these consolidated financial
statements.
FRANKLIN RESOURCES, INC.
Consolidated Balance Sheets
Unaudited
As of As of
December 31 September 30
(In thousands) 1998 1998
- --------------------------------------------------------------------------------
ASSETS:
Current assets:
Cash and cash equivalents $634,178 $537,188
Receivables:
Fees from Franklin Templeton funds 212,094 204,826
Other 38,628 25,773
Investment securities,
available-for-sale 271,815 470,065
Prepaid expenses and other 20,353 22,137
- -----------------------------------------------------------------------------
Total current assets 1,177,068 1,259,989
- -----------------------------------------------------------------------------
Banking/Finance assets:
Cash and cash equivalents 16,992 18,855
Loans receivable, net 192,730 165,074
Investment securities,
available-for-sale 22,122 21,847
Other 3,794 4,991
- -----------------------------------------------------------------------------
Total banking/finance assets 235,638 210,767
- -----------------------------------------------------------------------------
Other assets:
Deferred sales commissions 108,327 123,508
Property and equipment, net 365,093 349,229
Intangible assets, net 1,244,340 1,253,713
Receivable from banking/finance group 112,989 87,282
Other 154,698 195,561
- -----------------------------------------------------------------------------
Total other assets 1,985,447 2,009,923
- -----------------------------------------------------------------------------
Total assets $3,398,153 $3,480,049
=============================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
FRANKLIN RESOURCES, INC.
Consolidated Balance Sheets
Unaudited As of As of
December 31 September 30
(In thousands except share data) 1998 1998
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Compensation and benefits $73,059 $156,253
Commissions 56,170 53,174
Income taxes 37,386 67,319
Short-term debt 58,516 117,956
Other 134,589 82,691
- -----------------------------------------------------------------------------
Total current liabilities 359,720 477,393
- -----------------------------------------------------------------------------
Banking/finance liabilities:
Deposits:
Interest bearing 74,569 81,615
Non-interest bearing 5,647 6,166
Payable to parent 112,989 87,282
Other 8,225 3,018
- -----------------------------------------------------------------------------
Total banking/finance liabilities 201,430 178,081
- -----------------------------------------------------------------------------
Other Liabilities:
Long-term debt 413,233 494,459
Other 56,953 49,349
- -----------------------------------------------------------------------------
Total other liabilities 470,186 543,808
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
Total liabilities 1,031,336 1,199,282
- -----------------------------------------------------------------------------
Stockholders' equity:
Preferred stock, $1.00 par value,
1,000,000 shares authorized; none
issued - -
Common stock, $.10 par value,
500,000,000 shares
authorized; 252,441,498 and
252,715,488 shares
issued and outstanding, respectively 25,244 25,174
Capital in excess of par value 115,038 93,033
Retained earnings 2,249,443 2,194,835
Other (3,517) (4,230)
Accumulated other comprehensive income (19,391) (28,045)
- -----------------------------------------------------------------------------
Total stockholders' equity 2,366,817 2,280,767
- -----------------------------------------------------------------------------
Total liabilities and
stockholders' equity $3,398,153 $3,480,049
=============================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
FRANKLIN RESOURCES, INC.
Consolidated Statements of Cash Flows
Unaudited Three months ended
December 31
(In thousands) 1998 1997
- ---------------------------------------------------------------------------
Net income $68,492 $130,515
Adjustments to reconcile net income to net cash provided by operating
activities:
(Increase) decrease in receivables,
prepaid expenses and other current assets (39,970) 21,889
Increase in deferred sales commissions (9,838) (51,223)
Increase in restructuring liabilities 46,140 -
Increase in other current liabilities 18,998 32
(Decrease) increase in income taxes payable (29,933) 28,214
Increase in commissions payable 2,996 3,023
Decrease in compensation and benefits (55,425) (40,536)
Depreciation and amortization 51,553 42,448
Losses (gains) on disposition of assets 2,546 (4,036)
- ---------------------------------------------------------------------------
Net cash provided by operating activities 55,559 130,326
- ---------------------------------------------------------------------------
Purchase of investments (61,671) (74,599)
Liquidation of investments 325,479 21,799
Purchase of banking/finance investments (8,319) (214)
Liquidation of banking/finance investments 7,986 -
Net (origination) collections of loans
receivable (27,792) 8,203
Purchase of property and equipment (31,658) (58,058)
Proceeds from sale of property 176 14,517
Other - (1,424)
- ----------------------------------------------------------------------------
Net cash provided by (used in) investing
activities 204,201 (89,776)
- ----------------------------------------------------------------------------
Increase (decrease) in bank deposits (7,566) 1,662
Exercise of common stock options 476 1,039
Dividends paid on common stock (12,587) (11,345)
Purchase of common/treasury stock (7,113) (2,942)
Issuance of debt 40,000 22,986
Payments on debt (177,843) (41,898)
- ----------------------------------------------------------------------------
Net cash used in financing activities (164,633) (30,498)
- ----------------------------------------------------------------------------
Increase in cash and cash equivalents 95,127 10,052
Cash and cash equivalents, beginning of
period 556,043 442,741
- ---------------------------------------------------------------------------
Cash and cash equivalents, end of period $651,170 $452,793
- ---------------------------------------------------------------------------
Supplemental disclosure of non-cash information:
Value of common stock issued in other
transactions, principally for the
Company's incentive plans $27,769 $30,595
The accompanying notes are an integral part of these consolidated financial
statements.
FRANKLIN RESOURCES, INC.
Notes to Consolidated Financial Statements
December 31, 1998
(Unaudited)
1. Basis of Presentation
The unaudited interim financial statements of Franklin Resources, Inc. and
its consolidated subsidiaries (the "Company") included herein have been
prepared in accordance with the instructions to Form 10-Q pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, all appropriate adjustments
necessary to a fair presentation of the results of operations have been made
for the periods shown. All adjustments are of a normal recurring nature.
Certain prior year amounts have been reclassified to conform to current year
presentation. These financial statements should be read in conjunction with
the Company's audited financial statements for the fiscal year ended
September 30, 1998.
2. Restructuring
During the first fiscal quarter of 1999, the Company announced a total
estimated restructuring charge of $58 million and recorded a pretax
restructuring charge of $46.1 million. Of the $46.1 million, approximately
$10.8 million is expected to be paid in cash. The Company expects to record
an additional $12.3 million pretax restructuring charge during the second
quarter of fiscal 1999 relating to employee severance and termination
benefits.
The restructuring charges reflect the estimated future costs of achieving the
benefits outlined in a restructuring plan developed and approved by
management during the first quarter of fiscal 1999 and subsequently approved
by the Company's Board of Directors. The plan is aimed at improving service
levels and profitability, reducing costs and reprioritizing the Company's
business activities.
The components of the restructuring charge are as follows:
(In millions) As of December 31, 1998
------------------------------------------------------------
Asset write-down $31.9
Lease termination charges 5.8
Other 8.4
====================================================
$46.1
====================================================
Asset write-down includes a discontinued investment management contract and
other assets related to certain other discontinued products.
3. Debt
During the first quarter of fiscal 1999, interest rate swap agreements which
fixed interest rates on $40 million of commercial paper, expired. The
remaining interest rate swap agreements, maturing through October 2000,
effectively fix interest rates on $255 million of commercial paper. The fixed
rates of interest range from 6.24% to 6.645%. At quarter end, the weighted
average effective interest rate, including the effect of interest-rate swap
agreements, was 6.17% on approximately $431.6 million of outstanding
commercial paper and medium-term notes.
4. Adoption of Statement of Financial Accounting Standards Board
During this quarter the Company adopted Statement of Financial Accounting
Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income." SFAS 130
establishes the disclosure requirements for reporting Comprehensive income in
an entity's financial statements. Total Comprehensive income includes net
income, unrealized gains and losses on investments and foreign currency
translation adjustments. Accumulated other comprehensive income, a component
of stockholders' equity, was formerly reported as "Other", and consists of
total net unrealized losses on available-for-sale securities and foreign
currency adjustments. There was no impact on previously reported net income
arising from the adoption of SFAS 130.
The following table shows comprehensive income for the three months ended
December 31, 1998 and 1997.
(In thousands) 1998 1997
----------------------------------------------------------------------------
Net income $68,492 $130,515
Net unrealized gain (loss) on
available-for-sale securities 5,529 (6,785)
Foreign currency translation adjustment 3,125 (9,380)
============================================================================
Comprehensive income $77,146 $ 114,350
============================================================================
5. Subsequent events
On January 4, 1999, the Company's principal distribution subsidiary began
selling a new class of mutual fund shares, B shares, to the public. These
shares are sold without an upfront sales charge to the shareholder. The
distribution subsidiary will pay eligible third-party intermediaries a sales
commission of between 3% and 4%. Shareholder redemptions will be subject to a
contingent deferred sales charge of 4%, declining to 0% over a six-year
period. The shares will be subject to 12b-1 fees similar to other Company
products. The Company expects to finance the sales commissions through
existing cash flows and other financing arrangements.
On January 28, 1999, the Company's shareholders approved the 1998 Universal
Stock Incentive Plan (the "New Plan"); similar in most respects to the
Universal Stock Plan approved in 1994. The New Plan allows for stock grants
to participating employees of up to a total of 10,000,000 shares.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
FORWARD-LOOKING STATEMENTS
The following discussion contains "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995 which include
phrases with the type of wording further described in Part II Item 5.
"Forward-Looking Statements and Risk Factors," which could cause actual
results to differ materially from historical results and those presently
anticipated or projected. The Company cautions readers not to place undue
reliance on any such forward-looking statements, which speak only as of the
date made.
GENERAL
Franklin Resources, Inc. and its consolidated subsidiaries (the "Company")
derive substantially all of their revenues and net income from providing
investment management, administration, distribution and related services to
the Franklin, Templeton and Mutual Series funds, institutional accounts and
other investment products (collectively, the "Franklin Templeton Group"). The
Company has a diversified base of assets under management and a full range of
investment products and services to meet the needs of most individuals and
institutions.
ASSETS UNDER MANAGEMENT
As of
December 31 September 30 December 31
(In billions) 1998 1998 1997
- -----------------------------------------------------------------------------
Franklin Templeton Group:
Equity:
Global/international $92.8 $84.8 $98.3
Domestic (U.S.) 37.4 34.8 37.6
- -----------------------------------------------------------------------------
Total equity 130.2 119.6 135.9
- -----------------------------------------------------------------------------
Hybrid Funds <F1> 14.5 14.0 14.9
Fixed-income:
Tax-free 50.9 50.5 47.0
Taxable
Domestic (primarily U.S. Gov't.) 16.0 16.0 15.5
Global/international 4.0 3.7 3.8
- -----------------------------------------------------------------------------
Total fixed-income 70.9 70.2 66.3
- -----------------------------------------------------------------------------
Money funds 4.6 4.8 3.9
=============================================================================
Total end of period $220.2 $208.6 $221.0
=============================================================================
Monthly average for the three-month
period $217.0 $221.6 $220.6
=============================================================================
<F1> Hybrid funds include asset allocation, balanced, flexible and
income-mixed funds as defined by the Investment Company Institute. Previously
these funds had been included primarily in the equity category.
Since September 30, 1998, although redemptions have exceeded purchases in the
equity funds managed by the Company, market appreciation has resulted in an
increase in these assets to $130.2 billion as of December 31, 1998 and an
overall increase in the Company's assets under management to $220.2 billion.
Compared to December 31, 1997, the Company's assets under management at
December 31, 1998 have declined slightly. As a result of turmoil in global
equity markets in the preceding eighteen months, and associated market
depreciation, the Company's assets under management in equity funds declined
to $119.6 billion at September 30, 1998, resulting in a decline in total
assets under management to $208.6 billion as of September 30, 1998.
Equity assets now comprise 59% of total assets under management compared to
57% in September 1998 and 61% in December 1997. Fixed income funds now
comprise 32% of total assets under management, as compared to 34% and 30% in
September 1998 and December 1997, respectively. The shift in the Company's
managed asset mix toward lower fee fixed-income products and lower average
assets in the first quarter of 1999 when compared to the same quarter a year
ago, has resulted in lower investment management fee revenues for the three
months ended December 31, 1998, as compared to the same period a year ago.
RESULTS OF OPERATIONS
Three months ended
December 31 Percent
1998 1997 Change
- --------------------------------------------------------------------------------
Net income (millions) $68.5 $130.5 (48)%
Earnings per share
Basic $0.27 $0.52 (48)%
Diluted $0.27 $0.52 (48)%
Operating margin 16% 26%
Operating margin before restructuring
change 24% -
- --------------------------------------------------------------------------------
Net income during the quarter ended December 31, 1998 decreased compared to
the same quarter last year, as a result of a restructuring charge taken in
the quarter as well as decreased investment management fees from reduced
average assets under management. Operating margins decreased to 16% due
primarily to the restructuring charge. Operating margins before the
restructuring charge declined to 24% due to reduction in operating revenues
associated with decreased assets under management and the changing
composition of those assets.
Operating revenue
Three months ended
December 31 Percent
(In millions) 1998 1997 Change
- --------------------------------------------------------------------------------
Investment management fees $330.4 $348.6 (5)%
Underwriting and distribution fees 188.6 243.2 (22)%
Shareholder servicing fees 45.7 37.6 22%
Other, net 3.0 3.0 -
- --------------------------------------------------------------------------------
Total operating revenues $567.7 $632.4 (10)%
- --------------------------------------------------------------------------------
Investment management fees, the largest component of the Company's operating
revenues, are generally calculated under fixed fee arrangements, as a
percentage of the value of assets under management. The Company's investment
management fee revenues are generally affected by market appreciation or
depreciation in assets under management as well as the flow of funds into or
out of these portfolios. There have been no significant changes in the
investment management fee structures for the Franklin Templeton Group in the
periods under review.
The Company's effective investment management fee rate (investment management
fees divided by average assets under management) decreased slightly in the
quarter ended December 1998 to 0.61% compared to 0.63% in the same quarter
last year, primarily due to the relative increase in lower fee fixed-income
assets under management. Future changes in the composition of assets under
management may affect the effective investment management fee rates earned by
the Company.
During fiscal 1998, the Company reclassified revenues relating to the
distribution component of Canadian revenues from Investment management fees
to Underwriting and distribution fees. The Company believes this change more
closely matches revenue generated from distribution services with the
expenses incurred. The quarter ended December 31, 1997 has been reclassified
accordingly. Investment management fees for the quarter ended December 1998
decreased 5% over the same period last year, due to the 2% decrease in
average assets under management between these periods, and to the shift to
relatively lower fee fixed-income products.
Certain subsidiaries of the Company act as distributors for its sponsored
funds and receive commissions and distribution fees. Underwriting commissions
are earned primarily from fund sales. Distribution fees are generally based
on the level of assets under management. Underwriting and distribution fees
decreased 22% over the same period last year primarily as a result of
decreased mutual fund sales and average assets under management.
Shareholder servicing fees are generally fixed charges per account that vary
with the particular type of fund and the service being rendered. Shareholder
servicing fees increased 22% as a result of a 28% increase in billable
shareholder accounts to 10.2 million from 8.0 million a year ago and an
increase in the average per account charge.
Other, net
Three months ended
December 31
(In millions) 1998 1997 Change
- --------------------------------------------------------------------------------
Revenues $7.1 $9.7 (27)%
Provision for loan losses (1.5) (2.1) (29)%
Interest expense (2.6) (4.6) (43)%
================================================================================
Total other, net $3.0 $3.0 -
================================================================================
Other, net consists primarily of revenues from the Company's banking and
finance subsidiaries, net of interest expense and the provision for loan
losses. Other, net remained relatively stable in the quarter ended December
1998 compared with the same quarter last year, although each of the component
parts decreased. Revenues and the provision for loan losses decreased as a
result of securitization of auto loans in September 1998. Banking/finance
interest expense decreased in the current quarter due to a reduction in the
average borrowing requirements of the banking/finance group combined with a
reduction in effective interest rates.
Operating expenses
Three months ended
December 31
(In millions) 1998 1997 Change
- --------------------------------------------------------------------------------
Underwriting and distribution $163.1 $205.3 (21)%
Compensation and benefits 133.8 133.3 -
Information systems, technology and
occupancy 48.5 46.6 4%
Advertising and promotion 28.2 27.4 3%
Amortization of deferred sales commissions 25.0 23.9 5%
Amortization of intangible assets 9.4 9.0 4%
Other 22.8 19.5 17%
Restructuring charge 46.1 - 100%
================================================================================
Total operating expenses $476.9 $465.0 3%
================================================================================
Underwriting and distribution includes sales commissions and distribution
fees paid to brokers and other third party intermediaries. The decrease in
underwriting and distribution expenses was consistent with the decrease in
mutual fund sales and average assets under management.
Compensation and benefits for the quarter ended December 1998 remained at the
previous year's levels. Despite an increase of 20% in the Company's workforce
since this time last year, attempts at reducing temporary labor costs and
overtime in the current fiscal year have been successful. The Company
continues to experience upward pressure on compensation and benefits due to
the effects of a very competitive labor market.
Information systems, technology and occupancy costs increased 4% over the
same period last year. During the past two years, the Company has experienced
a significant increase in its workforce and has embarked upon major systems
implementations, Year 2000 corrections and European Monetary Unit
preparations, and has upgraded its network, desktop and Internet
environments. The Company anticipates that such major systems undertakings
will continue to have an impact on the Company's operating results through
the year 2000 and beyond. See "Year 2000 Readiness Disclosure" below.
Advertising and promotion expenses increased 3% over the same period last
year, mainly due to increased promotional activity and new marketing
campaigns.
Amortization of deferred sales commissions increased 5% over the same period
last year as cumulative sales of these products increased. Sales commissions
on certain Franklin Templeton Group products sold without a front-end sales
charge are capitalized and amortized over periods not exceeding four years --
the period in which management estimates that they will be recovered from
distribution plan payments and from contingent deferred sales charges. Sales
commissions on B shares, which were introduced in January, 1999, will be
capitalized and amortized over a period not exceeding eight years. As a
result of the capitalization and amortization of these charges, any decrease
in sales levels will not immediately be reflected in decreased expenses.
Restructuring charges of $46.1 million ($35.5 million, or $0.14 per diluted
share after tax) were recorded with respect to a plan initiated by management
during the first quarter aimed at improving service levels and profitability
and reducing costs. The plan details the reprioritization of global business
activities, discontinuing certain products and writing off investments and
other assets related to those products. In connection with this plan, the
value of one management contract, recorded as an intangible asset, was
written off. The plan also recognizes efficiencies from the recent conversion
of all U.S. funds onto a single shareholder record-keeping system by
eliminating approximately 560 positions principally in the United States.
Severance costs of approximately $12.3 million related to this element of the
plan are expected in the second fiscal quarter of 1999. At the completion of
these restructuring efforts, the Company's annual operating expenses are
expected to decrease approximately $100 million from peak levels at the end
of fiscal 1998, assuming a continuation of the current business environment.
Other income/(expenses):
Three months ended
December 31
(In millions) 1998 1997 Change
- --------------------------------------------------------------------------------
Investment and other income $10.5 $15.0 (30)%
Interest expense (6.2) (6.2) -
================================================================================
Other income, net 4.3 8.8 (51)%
================================================================================
Investment and other income for the quarter ended December 1998 decreased 30%
from the same period last year. Interest income for the current quarter
exceeded that earned in the prior year, due to higher average levels of
investment in fiscal 1999, but this increase was offset by realized losses
from the sale of investments in the current quarter, compared to realized
gains in the prior year. Interest expense remained stable over the same
period last year, despite a reduction in total debt in the first fiscal
quarter of 1999. The reduction in expense following the paydown of debt
resulting from the securitization of auto loans in September 1998 was
attributed to the banking/finance group (see Other, net revenues above).
Taxes on income
The Company's effective income tax rate for the quarter ended December 1998
has increased to 28%, compared to 26% for the same period last year. This
increase reflects the decrease in the relative contributions of foreign
earnings that are subject to reduced tax rates and that are not currently
included in U.S. taxable income.
MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL
RESOURCES
At December 31, 1998, the Company's assets aggregated $3.4 billion, down from
$3.5 billion at September 30, 1998. Stockholders' equity approximated $2.4
billion compared to approximately $2.3 billion at September 30, 1998. The
increase in stockholders' equity was primarily a result of increased net
income. Outstanding debt (long-term and short-term) decreased by $140.7
million (23%) at December 31, 1998, from $612.4 million at September 30,
1998.
Cash provided by operating activities for the quarter ended December 1998
decreased 57% from $130.3 million in the same quarter last year. This decline
was due mainly to lower net income in the current quarter. The decrease in
net income was due to lower operating revenues and the restructuring plan,
which required little incremental cash expenditure in the first quarter. The
decrease in income taxes payable was due to lower taxable income in the
current year. The Company sold $325.5 million of its investments in the
period and used $31.7 million to purchase property and equipment, providing
$204.2 million from its investing activities in the quarter. $177.8 million
of these funds were used to pay down and service debt, resulting in cash used
in financing activities of $164.6 million. During the quarter ended December
1998, the Company paid $12.6 million in cash dividends to stockholders.
As of December 31, 1998, the Company had fixed interest rates on
approximately $415 million of its debt through its interest-rate swap
agreements and its medium-term note program.
Management expects that the principal needs for cash will be to advance sales
commissions, fund property and equipment acquisitions, pay shareholder
dividends and service debt. Any future increases in the Company's investment
in its consumer lending activities are expected to be financed through
existing debt facilities, operating cash flows, or through the securitization
of a portion of the receivables from such consumer lending activities.
Management believes that the Company's existing liquid assets, together with
the expected continuing cash flow from operations, its borrowing capacity
under current credit facilities and its ability to issue stock will be
sufficient to meet its present and reasonably foreseeable cash needs.
Year 2000 Readiness Disclosure
In connection with the Company's preparation for the Year 2000, the Company's
mission-critical securities trading systems, portfolio accounting systems and
general ledger systems have now been certified as Year 2000 compliant and are
currently operating in production. In addition, the Company has completed the
prerequisite point-to-point and extended point-to-point testing and
certification of mission-critical and non mission-critical systems necessary
to participate in the Securities Industry Association ("SIA") "Streetwide
Testing" to be held over five weekends beginning in March 1999.
The Company's Year 2000 plan prioritizes the Year 2000 certification of core
mission-critical information technology ("IT") systems over other IT systems
and further prioritizes IT systems in general over non-IT systems. Because
the Year 2000 project is an ongoing Company-wide endeavor, the state of the
Company's progress changes daily. The information provided in this Form 10-Q
about our Year 2000 progress is provided as of February 11, 1999.
The Company's Year 2000 compliance plan is comprised of four phases:
Assessment, Remediation, Testing and Implementation. The Company currently
plans to complete all phases of its Year 2000 plan with respect to
mission-critical IT systems by September 1999 and with respect to other
important systems as soon as possible thereafter, but in any event by
December 31, 1999. During the quarter ended December 31, 1998, the Company
completed the inventory of its end user computing systems. A number of end
user computer systems were identified as mission-critical systems and the
Company re-evaluated which systems it considered to be mission critical. As a
result of this re-evaluation, certain systems which the Company had
previously considered to be mission-critical, and which were close to
certification, were removed from the pool of mission-critical systems. In
addition, certain end user computing systems that had not yet been assessed
were added to the pool of mission-critical systems. Together, these changes
caused the completion percentage of mission-critical systems in the
categories of Testing and Implementation to remain at the same level as was
reported for the quarter ended September 30, 1998.
Phase of % of Mission
Project Critical Complete
-----------------------------------
Assessment 95%
Remediation 79%
Testing 30%
Implementation 30%
The non mission-critical systems of the Company are either maintained by the
Company's Information Systems & Technology ("IS&T") department or are end user
systems. These systems are prioritized with "high", "medium" or "low" in the
Company's Year 2000 plan. The IS&T systems have been given high priority,
while the end user systems have been given lower priorities. The percentages
below include only the IS&T-managed systems, which represent approximately 95
systems.
Phase of % of Non Mission Critical
Project IS&T Systems Complete
-------------------------------------------
Assessment 100%
Remediation 99%
Testing 82%
Implementation 74%
During the past quarter, the Company's Canadian subsidiary, Templeton
Management Limited, was asked by the Ontario Securities Commission to
participate in industry-wide testing in Canada. In order to complete work to
allow participation in this testing, the Company delayed planned Year 2000
certification of a key mission critical system in Canada, the shareholder
management system. However, the Company believes that this system is Year
2000 compliant and currently plans to complete certification of this system
in March 1999.
The Company experienced some delays in its Year 2000 plan during the quarter
because of the need to devote employee and system resources to the successful
implementation of the Euro on January 1, 1999 and the Company's first
offering of B shares, which began on January 4, 1999. The Company is
currently in the process of testing one of its most mission-critical systems,
the domestic transfer agency system. This system and related subsystems make
up approximately 17% of the Company's mission critical systems. Although the
Company is behind its original schedule in this testing due to various
delays, the Year 2000 certification of this system is progressing, including
testing of related sub-systems. No material problems have been encountered to
date.
Non-IT Systems. Other than third-party long distance telephone and data lines
and public utility electrical power, the Company's business operations are
not heavily dependent on non-IT components or systems, and none of the
Company's mission-critical systems is a non-IT system. The Company estimates
that it has completed assessment of approximately 90% of the Company-owned or
-managed non-IT components, and approximately 50% to 75% of third-party owned
components, including building, mechanical, air conditioning, electrical and
security systems. Based on the Company's assessment to date and information
received from third parties, the majority of the Company's non-IT systems
will not require remediation. With the exception of potential general public
utility problems, the Company does not expect to experience any material
effects related to the Year 2000 compliance of non-IT systems.
Third Parties and Year 2000. The Company's business operations are heavily
dependent upon a complex worldwide network of IT systems that are owned and
managed by third parties; including data feeds, trading systems, securities
transfer agent operations and stock market links. The Company has contacted
all of its major external suppliers of goods, services and data (other than
suppliers of electricity or long distance data and voicelines) to assess
their compliance efforts and the Company's exposure in the event of a failure
of third-party compliance efforts. The Company is in the process of
validating and reviewing the responses received to date from these suppliers
of mission-critical systems and in some cases is seeking additional
information, written assurances of certification, or test scripts. As of
February 11, 1999, no mission-critical third-party supplier had informed the
Company that it would not be Year 2000 compliant by the millenium date.
Cost Estimates. The total estimated costs associated with the required
modifications to become Year 2000 compliant range from $50 million to $60
million, not all of which is incremental to the Company's operations. The
estimated costs consist mainly of internal and third-party labor costs which
are expensed as incurred. The total amount expended on the project through
December 31, 1998 was approximately $20.6 million. The Company's estimates of
the total costs to complete the Year 2000 project will continue to be refined
in future periods. As is indicated in the analysis above, approximately 60%
to 66% of the expected costs of the Year 2000 project have not yet been
incurred. The Company believes that its existing liquid assets, together with
expected cash flow from operations, combined with its borrowing capacity
under existing credit facilities will be sufficient to fund anticipated
expenditures.
Contingency Planning. The Company is beginning to develop a contingency plan,
including identification of those mission-critical systems for which it is
practical to develop a contingency plan. The Company currently plans to
complete its contingency plan in September 1999. However, in an operation as
complex and geographically distributed as the Company's business there are
limited alternatives to certain of its mission-critical systems or public
utilities. If certain public utilities or mission-critical systems are not
made Year 2000 compliant or fail, there would be a material adverse impact
upon the Company's business, financial condition and results of operations.
Although the Company is investigating alternative solutions, it is unlikely
that any adequate contingency plan can be developed for such failures.
European Monetary Unit (the "Euro")
In December 1998, the Company successfully converted its international
computer applications software and its business operations to enable
transaction processing and record keeping using the Euro, and has experienced
no material adverse impact as a result. Many of the Company's managed funds
and financial products have substantial investments in countries whose
currencies eventually will be completely replaced by the Euro. All aspects of
the Company's investment process, including trading, foreign exchange,
payments, settlements, cash accounts, custodial accounts and accounting have
been affected by the implementation of the Euro (the "Euro Issue").
Because the use of the Euro will be phased-in over several years, the Company
is not presently able to assess the cost impact of the Euro Issue on the
Company, but does not presently anticipate that it will have a material
adverse effect on the Company's cash flows, operations or operating results.
The Company is generally expensing costs incurred relating to the Euro Issue
during the period in which they are incurred.
Specific Risks Associated with the Year 2000 and the Euro.
The Company's ability to manage the Year 2000 Problem and the Euro Issue are
subject to uncertainties beyond its control that could cause actual results
to differ materially from what has been discussed above. The Company could
become subject to legal claims in the event of any Year 2000 or Euro problem
in the Company's business operations. In addition, the Company and its
subsidiaries are subject to regulation by various governmental authorities
which could impose sanctions or fines or cause the Company to cease certain
operations in the event its systems are not Year 2000 compliant. Also,
investors concerned about the Year 2000 Problem or the Euro Issue could
withdraw monies from the Company's funds resulting in a decline in assets
under management which could have a material adverse effect upon the
Company's business, financial condition and results of operations.
Factors that could influence the effect of the Year 2000 Problem include the
success of the Company in identifying systems and programs that are affected
by the Year 2000 Problem (for example, it is possible that the SIA testing
may reveal connectivity problems between the Company's systems and those of
third parties). Other facts include the nature and amount of testing,
remediation, programming, installation and systems work required to upgrade
or to replace each of the affected programs or systems; the rate, magnitude
and availability of related labor and consulting costs; the success of the
Company in correcting its internal systems and the success of the Company's
external partners and suppliers in addressing their respective Year 2000
Problems.
The failure of organizations such as those mentioned above under "Third
Parties and Year 2000" to resolve their own issues with respect to the Year
2000 Problem could have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition, the establishment of the Euro may result in market volatility,
expose investments to currency risk due to fluctuations in multiple
currencies, change the economic environment and behavior of investors, or
change the competitive environment for the Company's business in Europe.
Similarly, companies operating in more than one country, such as the Company,
may gain or lose competitive advantages because of the Euro in ways that are
not predictable. It is not currently possible to predict the impact of the
Euro on the business or financial condition of European issuers which
Company-sponsored funds may hold in their portfolios or the impact on the
value of fund shares.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
During the last fiscal year the balance of loans receivable for the Company's
banking and finance subsidiaries constituted less than 10% of corporate
assets. The Company considered the potential impact on consolidated results
from a reasonably possible near-term movement in interest rates and judged
that this impact would not be material.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company has previously reported a complaint filed in September 1998 in
the U.S. District Court for the Southern District of Florida, against
Templeton Asset Management, Ltd., an indirect wholly-owned subsidiary of the
Company and the investment manager of the closed-end investment company,
Templeton Vietnam Opportunities Fund, Inc. (now known as Templeton Vietnam
and Southeast Asia Fund, Inc.); certain of the fund's officers and directors;
the Company; and Templeton Worldwide, Inc., a Company subsidiary.
On January 8, 1999 the Company and the other defendants moved to dismiss the
complaint, captioned Richard Waksman, plaintiff on behalf of himself and all
others similarly situated v. Templeton Asset Management Ltd., et al., (Civil
Action No.98-7059) on various legal grounds, including the fact that the
lawsuit mischaracterizes the "fundamental policies" of the Fund and fails to
acknowledge the basic investment objective of the Fund to pursue long-term
capital appreciation. Management believes that this lawsuit is without merit
and intends to defend this action vigorously.
Other than as stated above, there have been no material developments in the
litigation previously reported in the Form 10-K/A of the Company filed with
the SEC on December 29, 1998.
In addition, the Company is 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 the Company's business or financial position.
Item 5. Other Information
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
When used in this Form 10-Q and in future filings by the Company with the
SEC, in the Company's press releases and in oral statements made with the
approval of an authorized executive officer, the words or phrases "will
likely result", "are expected to", "will continue", "is anticipated",
"estimate", "project" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. All assumptions, anticipations, expectations
and forecasts contained herein are forward-looking statements that involve
risks and uncertainties. Discussions in "MD&A" about the anticipated effects
of the Company's restructuring initiative, estimated completion dates for
phases of the Company's Year 2000 plan, related cost estimates, statements
about possible effects of the Year 2000 Problem and the Euro Issue, and
possible contingency plans are also "forward-looking statements." Such
statements are subject to certain risks and uncertainties, including those
discussed below, that could cause actual results to differ materially from
historical earnings and those presently anticipated or projected. The Company
wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and should
be read in conjunction with the risk disclosure below. The Company wishes to
advise readers that the factors listed below could affect the Company's
financial performance and could cause the Company's actual results for future
periods to differ materially from any opinions or statements expressed with
respect to future periods in any current statements.
The Company will not undertake and specifically declines any obligation to
release publicly the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or
unanticipated events.
General Factors
The ability of the Company to achieve the expected benefits of the
restructuring plan, including improved service levels and profitability and
cost reductions, is not certain and depends in part upon the Company's
ability to make certain internal operational changes and also upon world
economic and market conditions.
The Company's revenues and income are derived primarily from the management
of a variety of financial services products. As discussed above, the
financial services industry is highly competitive. Such competition could
negatively impact the Company's market share, which could impact assets under
management, from which the bulk of the Company's revenues and income arise.
The Company is in competition with the financial services and other
investment alternatives offered by stock brokerage and investment banking
firms, insurance companies, banks, savings and loan associations and other
financial institutions. Such competition could negatively impact the
Company's market share, revenues and net income. Sales of mutual fund shares
and other financial services products can also be negatively affected by
adverse general securities market conditions, currency fluctuations,
governmental regulations and recessionary global economic conditions.
Securities dealers, whose large retail distribution systems play an important
role in the sale of shares of the Franklin, Templeton and Mutual Series
funds, also sponsor competing proprietary mutual funds. To the extent that
these firms limit or restrict the sale of Franklin, Templeton or Mutual
Series funds shares through their brokerage systems in favor of their
proprietary mutual funds, future sales may be negatively impacted and the
Company's revenues might be adversely affected. In addition, as the number of
competitors in the investment management industry increases, greater demands
are placed on existing distribution channels, which has caused distribution
costs to increase.
The inability of the Company to compete and to distribute and sell its
products effectively would have a negative effect on the Company's level of
assets under management, related revenues and overall business and financial
condition.
Many of the Company's competitors have substantially greater resources than
the Company. In addition, there has been a trend of consolidation in the
mutual fund industry which has resulted in stronger competitors. The banking
industry also continues to expand its sponsorship of proprietary funds
distributed through third party distributors. To the extent that banks limit
or restrict the sale of Franklin, Templeton or Mutual Series shares through
their distribution systems in favor of their proprietary mutual funds, assets
under management might decline and the Company's revenues might be adversely
affected.
Certain portions of the Company's managed portfolios are invested in various
securities of corporations located or doing business in developing regions of
the world commonly known as emerging markets. These portfolios and the
Company's revenues derived from the management of such portfolios are subject
to significant risks of loss from unfavorable political and diplomatic
developments, currency fluctuations, social instability, changes in
governmental policies, expropriation, nationalization, confiscation of assets
and changes in legislation relating to foreign ownership. Foreign trading
markets, particularly in some emerging market countries are often smaller,
less liquid, less regulated and significantly more volatile.
The Company's assets under management include a significant number of global
equities, which increase the volatility of the Company's managed portfolios
and its revenue and income streams. From 1992 until mid-1998, equity
investments increased as a percentage of the Company's assets under
management. The shift in the Company's asset mix from primarily fixed-income
to a combination of fixed-income and global equities has increased the
possibility of volatility in the Company's managed portfolios due to the
increased percentage of equity investments managed. Declines in global
securities markets that affect the value of these equities, recently have
caused and in the future will cause, revenue declines and may have a material
adverse impact on the Company's business, financial condition and results of
operations. In addition, the Company derives higher revenues and income from
its equity assets and therefore shifts in assets from equity to fixed-income
would have an adverse impact on the Company's income and revenues.
The Company's ability to meet anticipated cash needs is dependent upon
factors including the value of the Company's assets, the creditworthiness of
the Company as perceived by lenders and the market value of the Company's
stock. Similarly, the Company's ability to securitize future portfolios of
auto loan and credit card receivables would also be affected by the market's
perception of those portfolios, finance rates offered by competitors, and the
general market for private debt. The Company's inability to meet cash needs
for various reasons as and when required could have a negative affect on the
Company's financial condition and business operations.
Market values are affected by many things, including the general condition of
national and world economics and the direction and volume of changes in
interest rates and/or inflation rates. A significant portion of the Company's
assets under management are fixed-income securities. Fluctuations in interest
rates and in the yield curve will have an effect on fixed-income assets under
management as well as on the flow of monies to and from fixed-income funds
and, therefore, on the Company's revenues from such funds. In addition, the
impact of changes in the equity marketplace may significantly affect assets
under management. The effects of the foregoing factors on equity funds and
fixed-income funds often operate inversely and it is, therefore, difficult to
predict the net effect of any particular set of conditions on the level of
assets under management.
A number of mutual fund sponsors presently market their funds without sales
charges. As investor interest in the mutual fund industry has increased,
competitive pressures have increased on sales charges of broker-dealer
distributed funds. In response to such competitive pressures, the Company
might be forced to lower or further adjust sales charges, substantially all
of which are currently paid to broker-dealers and other financial
intermediaries. The reduction in such sales charges could make the sale of
shares of the Franklin, Templeton and Mutual Series funds less attractive to
the broker-dealer community, which could in turn have a material adverse
effect on the Company's revenues. In the alternative, the Company might be
required to pay additional fees, commissions or charges in connection with
the distribution of its shares which could have a negative effect on the
Company's earnings.
As a result of increased competitive pressures, in January 1999 the Company
implemented a new share structure using Class A, B and C shares in many of
its funds. Class B shares have not previously been offered by the Company,
and shares previously sold as "Class II shares" are now termed Class C
shares. Both Class B and C shares require certain charges to be paid by the
Company or a subsidiary of the Company to third-party intermediaries, which
creates a significant cash requirement. Past sales of Class C shares, which
were first introduced in 1995, have caused distribution expenses to exceed
distribution revenues for certain products and put increasing pressure on
the Company's profit margins. In addition, sales of Class C shares have
increased relative to the Company's overall sales, resulting in higher
distribution expenses. The Company anticipates that it will be able to
finance these charges from its existing cash flows and other financing
arrangements. If the Company is unable to fund commissions on Class B or C
shares using existing cash flow and debt facilities, the Company's
liquidity could be negatively impacted and additional funding will be
necessary. Past sales of Class C shares are not necessarily indicative of
future sales volume, and future sales of Class B or C shares may be lower
or higher than sales of other types of share classes as a result of changes
in investor demand or lessened or unsuccessful sales efforts by the
Company.
The Company's auto loan receivables business and credit card receivable
activities are subject to significant fluctuations in those consumer market
places as well as to significant competition from companies with much
larger receivable portfolios. In addition, certain of the Company's
competitors are engaged in the financing of auto loans in connection with a
much larger automobile manufacturing businesses and may at times provide
loans at significantly below market interest rates in order to further the
sale of automobiles.
The consumer loan market is highly competitive. The Company competes with
many types of institutions including banks, finance companies, credit unions
and the finance subsidiaries of large automobile manufacturers. Interest
rates the Company can charge and, therefore, its yields vary based on this
competitive environment. The Company is reliant on its relationships with
various automobile dealers and this relationship is highly dependent on the
rates and service that the Company provides. There is no guarantee that in
this competitive environment the Company can maintain its relationships with
these dealers. Auto loan and credit card portfolio losses can also be
influenced significantly by trends in the economy and credit markets which
negatively impact borrowers' ability to repay loans.
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(v) to the Company's Form 10-Q for the Quarterly
Period ended December 31, 1994
Exhibit 10.1 Representative Variable Insurance Fund Fund
Participation Agreement among Templeton Variable
Products Series Fund or Franklin Valuemark Fund,
Franklin Templeton Distributors, Inc. and an insurance
company
Exhibit 11 Computations of per share earnings
Exhibit 12 Computations of ratios of earnings to fixed charges
Exhibit 27 Financial Data Schedule. (Filed with the Securities and
Exchange Commission only)
(b) Reports on Form 8-K:
(i) Form 8-K dated October 23, 1998 reporting under Item 5 "Other
Events" the filing of an earnings press release by the
Registrant on October 23, 1998 and including said press release
as an Exhibit under Item 7 "Financial Statements and Exhibits".
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRANKLIN RESOURCES, INC.
Registrant
Date: February 11, 1999 /S/ Martin L. Flanagan
MARTIN L. FLANAGAN
Senior Vice President,
Chief Financial Officer