FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Quarterly Period Ended March 31, 1999
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: 252,115,025 shares, common stock, par value $.10 per share at
April 30, 1999.
1
PART I -FINANCIAL INFORMATION
Item 1. Condensed Financial Statements
FRANKLIN RESOURCES, INC.
Consolidated Statements of Income
Unaudited
Three months ended Six months ended
(In thousands except per share March 31 March 31
data)
- ------------------------------------------------------------------------------
1999 1998 1999 1998
Operating revenues:
Investment management fees $322,419 $351,240 $652,789 $699,802
Underwriting and distribution
fees 178,406 278,622 367,010 521,810
Shareholder servicing fees 47,762 39,399 93,496 77,005
Other 5,484 4,430 8,455 7,473
- ------------------------------------------------------------------------------
Total operating revenues 554,071 673,691 1,121,750 1,306,090
- ------------------------------------------------------------------------------
Operating expenses:
Underwriting and distribution 153,300 242,406 316,346 447,718
Compensation and benefits 128,816 132,744 262,630 266,035
Information systems, technology
and occupancy 52,111 45,862 100,590 92,458
Advertising and promotion 25,393 31,243 53,631 58,605
Amortization of deferred sales 22,963 26,525 47,982 50,421
commissions
Amortization of intangible assets 9,283 8,949 18,656 17,944
Other 18,770 22,538 41,575 42,043
Restructuring charges 12,315 - 58,455 -
- ------------------------------------------------------------------------------
Total operating expenses 422,951 510,267 899,865 975,224
- ------------------------------------------------------------------------------
Operating income 131,120 163,424 221,885 330,866
- ------------------------------------------------------------------------------
Other income (expense):
Investment and other income 14,490 11,596 25,026 26,571
Interest expense (4,776) (3,826) (10,949) (9,978)
- ------------------------------------------------------------------------------
Other income (expense), net 9,714 7,770 14,077 16,593
- ------------------------------------------------------------------------------
Income before taxes on income 140,834 171,194 235,962 347,459
Taxes on income 38,363 44,525 64,999 90,275
- ------------------------------------------------------------------------------
Net income $102,471 $126,669 $170,963 $257,184
==============================================================================
Earnings per share:
Basic $0.41 $0.50 $0.68 $1.02
Diluted $0.41 $0.50 $0.68 $1.02
Dividends per share $0.055 $0.05 $0.11 $0.10
The accompanying notes are an integral part of these consolidated financial
statements.
2
FRANKLIN RESOURCES, INC.
Consolidated Balance Sheets
Unaudited September
March 31 30
(In thousands) 1999 1998
- ------------------------------------------------------------------------
ASSETS:
Current assets:
Cash and cash equivalents $620,146 $537,188
Receivables:
Fees from Franklin Templeton funds 209,626 204,826
Other 24,646 25,773
Investment securities,
available-for-sale 379,854 470,065
Prepaid expenses and other 22,393 22,137
- -------------------------------------------------------------------------
Total current assets 1,256,665 1,259,989
- -------------------------------------------------------------------------
Banking/Finance assets:
Cash and cash equivalents 11,174 18,855
Loans receivable, net 216,807 165,074
Investment securities,
available-for-sale 16,845 21,847
Other 3,714 4,991
- -------------------------------------------------------------------------
Total banking/finance assets 248,540 210,767
- -------------------------------------------------------------------------
Other assets:
Deferred sales commissions 104,461 123,508
Property and equipment, net 363,934 349,229
Intangible assets, net 1,221,342 1,253,713
Receivable from banking/finance group 137,774 87,282
Other 126,091 195,561
- -------------------------------------------------------------------------
Total other assets 1,953,602 2,009,293
- -------------------------------------------------------------------------
Total assets $3,458,807 $3,480,049
=========================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
3
FRANKLIN RESOURCES, INC.
Consolidated Balance Sheets
Unaudited
March 31 September 30
(In thousands except share data) 1999 1998
- -----------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Compensation and benefits $99,640 $156,253
Commissions 55,845 53,174
Income taxes 33,317 67,319
Short-term debt 58,730 117,956
Other 118,251 82,691
- -----------------------------------------------------------------------------
Total current liabilities 365,783 477,393
- -----------------------------------------------------------------------------
Banking/finance liabilities:
Deposits:
Interest bearing 56,750 81,615
Non-interest bearing 8,762 6,166
Payable to parent 137,774 87,282
Other 9,087 3,018
- -----------------------------------------------------------------------------
Total banking/finance liabilities 212,373 178,081
- -----------------------------------------------------------------------------
Other Liabilities:
Long-term debt 391,268 494,459
Other 43,440 49,349
- -----------------------------------------------------------------------------
Total other liabilities 443,708 543,808
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
Total liabilities 1,012,864 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;
252,129,204 and 251,741,578 shares
issued and outstanding, respectively 25,213 25,174
Capital in excess of par value 103,822 93,033
Retained earnings 2,338,044 2,194,835
Other (4,509) (4,230)
Accumulated other comprehensive
income (16,627) (28,045)
- -----------------------------------------------------------------------------
Total stockholders' equity 2,445,943 2,280,767
- -----------------------------------------------------------------------------
Total liabilities and
stockholders' equity $3,458,807 $3,480,049
=============================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
4
FRANKLIN RESOURCES, INC.
Consolidated Statements of Cash Flows Six months ended
Unaudited March 31
(In thousands) 1999 1998
- ------------------------------------------------------------------------------
Net income $170,963 $257,184
Adjustments to reconcile net income to net
cash provided by operating activities:
Increase in receivables,
prepaid expenses and other current assets (32,448) (30,786)
Increase in deferred sales commissions (28,935) (75,994)
Increase in other current liabilities 12,038 12,336
Increase in restructuring liability 24,703 -
(Decrease) increase in income taxes payable (34,002) 2,014
Increase in commissions payable 2,671 9,805
Decrease in compensation and benefits (25,305) (15,500)
Depreciation and amortization 114,074 88,890
Losses (gains) on disposition of assets 1,171 (5,530)
- ------------------------------------------------------------------------------
Net cash provided by operating activities 204,930 242,419
- ------------------------------------------------------------------------------
Purchase of investments (289,507) (91,955)
Liquidation of investments 482,007 36,525
Purchase of banking/finance investments (16,222) (215)
Liquidation of banking/finance investments 21,146 -
Net (origination) collection of
banking/finance loans receivable (51,726) 6,361
Purchase of property and equipment (47,839) (80,353)
Proceeds from sale of property 2,635 14,517
Other - (1,424)
- ------------------------------------------------------------------------------
Net cash provided by (used in) investing
activities 100,494 (116,545)
- ------------------------------------------------------------------------------
Decrease in bank deposits (22,270) (7,098)
Exercise of common stock options 476 2,791
Dividends paid on common stock (26,473) (23,979)
Purchase of Company stock (23,459) (2,942)
Issuance of debt 40,030 55,597
Payments on debt (198,451) (47,502)
- ------------------------------------------------------------------------------
Net cash used in financing activities (230,147) (23,133)
- ------------------------------------------------------------------------------
Increase in cash and cash equivalents 75,277 102,741
Cash and cash equivalents, beginning of
period 556,043 442,741
- ------------------------------------------------------------------------------
Cash and cash equivalents, end of period $631,320 $545,482
==============================================================================
Supplemental disclosure of non-cash information:
Value of common stock issued, principally
for the Company's incentive plans $33,014 $36,988
The accompanying notes are an integral part of these consolidated financial
statements.
5
FRANKLIN RESOURCES, INC.
Notes to Consolidated Financial Statements
March 31, 1999
(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 quarter ended December 31, 1998, the Company adopted a
restructuring plan estimated to cost approximately $58 million and designed
to reduce costs, improve service levels and reprioritize the Company's
business activities. During that quarter, the Company recorded a pretax
charge of $46.1 million in connection with the plan. Additionally, during the
quarter ended March 31, 1999, the Company recorded a second and final
restructuring pretax charge of $12.3 million, also in connection with the
plan. Approximately 80% of the total estimated charges are expected to be
utilized during the current fiscal year. As of March 31, 1999, the Company
has utilized $33.7 million of the total estimated charges. Approximately $9.5
million of the amounts utilized represented cash payments. The remaining
balance of $24.7 million is included in other current liabilities. See the
table below.
Balance at Additional Restructuring Balance
December restructuring liability March
(In millions) 31, 1998 liability utilized 31, 1999
---------------------------------------------------------------------------
Asset write-down $31.9 - $(25.5) $6.4
Employee severance and
termination benefits - $12.3 (7.0) 5.3
Lease termination charges
and other 14.2 - (1.2) 13.0
---------------------------------------------------------------------------
Total $46.1 $12.3 $(33.7) $24.7
===========================================================================
6
The material portion, $31.9 million, of the anticipated total restructuring
charges of approximately $58.4 million was for asset write-downs related to
discontinued products. More specifically, these charges were primarily for
the write-off of intangible and other assets with respect to the termination
of investment management agreements related to several off-shore investment
products and several domestic retail products. The products in question have
either been terminated or are in the process of termination. The largest
single write-down was for $13.7 million of intangible assets related to an
offshore non-retail product.
The other significant component, $12.3 million, of the estimated total
restructuring charges was for severance and termination benefits with respect
to efficiencies made possible by the Company's conversion to one shareholder
servicing system. Approximately 560 positions, or 7% of the Company's
workforce at December 31, 1998, will be eliminated. Although the reductions
were announced during first quarter, the charge was not recognized until
second quarter when the affected employees were notified. The majority of
affected employees had left the Company at March 31, 1999.
3. Debt
----
At March 31, 1999 the Company had interest rate swap agreements, maturing
through October 2000, which effectively fix interest rates on $250.6 million
of commercial paper. The fixed rates of interest range from 6.24% to 6.65%.
At March 31, 1999, the weighted-average effective interest rate, including
the effect of interest-rate swap agreements, was 6.30% on approximately
$450.0 million of outstanding debt.
4. Earnings per share
------------------
Earnings per share were computed as follows:
Three months ended Six months ended
March 31 March 31
(In thousands except per
share amounts) 1999 1998 1999 1998
----------------------------------------------------------------------------
Net income $102,471 $126,669 $170,963 $257,184
============================================================================
Weighted-average shares
outstanding - basic 252,189 252,860 252,025 252,682
Incremental shares from
assumed conversions 390 198 779 499
============================================================================
Weighted-average shares
outstanding-diluted 252,579 253,058 252,804 253,181
============================================================================
Earnings per share:
Basic $0.41 $0.50 $0.68 $1.02
Diluted $0.41 $0.50 $0.68 $1.02
----------------------------------------------------------------------------
5. Adoption of Statement of Financial Accounting Standards Board
-------------------------------------------------------------
During the quarter ended December 31, 1998, 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 available-for-sale
securities and foreign currency translation adjustments.
7
These amounts were formerly reported as "Other" within Stockholders' equity
and are now reported under "Accumulated other comprehensive income." Items
relating to movements in the Company's stock, such as deferred compensation
in the form of restricted stock, remain in "Other" within Stockholders'
equity. There was no impact on previously reported net income arising from
the adoption of SFAS 130.
Comprehensive income for the three- and six-month periods ended March 31,
1999 was as follows:
Three months ended Six months ended
March 31 March 31
(In thousands) 1999 1998 1999 1998
----------------------------------------------------------------------------
Net income $102,471 $126,669 $170,963 $257,184
Net unrealized gain (loss)
on available-for-sale
securities 4,863 6,191 10,392 (594)
Foreign currency translation
adjustments (2,099) 1,515 1,026 (7,865)
----------------------------------------------------------------------------
Comprehensive income $105,235 $134,375 $182,381 $248,725
============================================================================
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.
8
ASSETS UNDER MANAGEMENT
March 31 March 31
(In billions) 1999 1998
----------------------------------------------------------------
Franklin Templeton Group:
Equity:
Global/international $91.4 $111.7
Domestic (U.S.) 37.4 45.9
----------------------------------------------------------------
Total equity 128.8 157.6
----------------------------------------------------------------
Hybrid funds <F1> 10.7 12.5
Fixed-income:
Tax-free 51.6 48.1
Taxable
Domestic (primarily
U.S. Gov't.) 16.1 15.7
Global/international 4.0 4.1
----------------------------------------------------------------
Total fixed-income 71.7 67.9
----------------------------------------------------------------
Money funds 4.8 4.0
----------------------------------------------------------------
Total end of period $216.0 $242.0
================================================================
Monthly average for
the three-month period $216.4 $229.4
----------------------------------------------------------------
Monthly average for
the six-month period $216.2 $225.6
================================================================
<F1> Hybrid funds include asset allocation, balanced, flexible and
income-mixed funds as defined by the Investment Company Institute.
Periods prior to March 31, 1999 have been restated to reflect the
reclassification of certain funds to Domestic Equity from the Hybrid
category.
Assets under the Company's management at March 31, 1999 decreased by $26.0
billion (11%) from March 31, 1998. During the three- and six-month periods
ended March 31, 1999, redemptions have exceeded purchases in the equity funds
managed by the Company. Market appreciation for these assets has partially
offset this trend during the most recent three- and six-month periods.
Equity assets now comprise 60% of total assets under management compared to
65% at March 31, 1998. Fixed income funds now comprise 33% of total assets
under management, as compared to 28% at March 31, 1998. The shift in the
Company's managed asset mix toward lower fee fixed-income products and lower
average assets has resulted in lower investment management fee revenues for
the three- and six-month periods ended March 31, 1999, as compared to the same
periods a year ago.
9
RESULTS OF OPERATIONS
Results of operations
(In millions Three months ended Six months ended
except per share March 31 March 31
amounts) 1999 1998 Change 1999 1998 Change
----------------------------------------------------------------------------
Net income $102.5 $126.7 (19)% $171.0 $257.2 (34)%
Earnings per share
Basic $0.41 $0.50 (18)% $0.68 $1.02 (18)%
Diluted $0.41 $0.50 (18)% $0.68 $1.02 (33)%
Operating margin 24% 24% 20% 25%
Operating margin
before restructuring
charges 26% - 25% -
----------------------------------------------------------------------------
Net income during the three- and six-month periods ended March 1999 decreased
compared to the same periods last year, as a result of the restructuring
charge as well as decreased investment management fees from reduced average
assets under management. Operating margins before the restructuring charges
for the three-months ended March 31, 1999 increased primarily due to the
Company's successful efforts to reduce operating expenses following the
implementation of the restructuring plan described below.
Operating revenues
Three months ended Six months ended
March 31 March 31
(In millions) 1999 1998 Change 1999 1998 Change
------------------------------------------------------------------------------
Investment
management fees $322.4 $351.3 (8)% $652.8 $699.8 (7)%
Underwriting and
distribution fees 178.4 278.6 (36)% 367.0 521.8 (30)%
Shareholder
servicing fees 47.8 39.4 21% 93.5 77.0 21%
Other, net 5.5 4.4 25% 8.5 7.5 13%
------------------------------------------------------------------------------
Total operating
revenues $554.1 $673.7 (18)% $1,121.8 $1,306.1 (14)%
==============================================================================
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.
10
The Company's effective investment management fee rate (investment management
fees divided by average assets under management) decreased slightly in the
quarter ended March 1999 to 0.60% compared to 0.61% 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.
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 36% and 30% over the same three- and six-month periods 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. During the
periods under review, shareholder servicing fees increased as a result of an
increase in billable shareholder accounts to 10.7 million from 8.2 million a
year ago and an increase in the average per account charge. In accordance with
agreements with the majority of funds in the Franklin Templeton Group, closed
accounts remain billable through the third quarter of each fiscal year at a
reduced fee level. At March 31, 1999, therewere 2.2 million of such accounts.
Other, net
Three months ended Six months ended
March 31 March 31
(In millions) 1999 1998 Change 1999 1998 Change
------------------------------------------------------------------------------
Revenues $9.2 $10.4 (12)% $16.2 $20.1 (19)%
Provision for
loan losses (1.0) (1.6) (38)% (2.6) (3.6) (28)%
Interest expense (2.7) (4.4) (39)% (5.1) (9.0) (43)%
------------------------------------------------------------------------------
Total other, net $5.5 $4.4 25% $8.5 $7.5 13%
==============================================================================
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 increased slightly in the periods ended March 31, 1999
compared with the same periods last year, although each of the component parts
decreased. The revenues and the provision for loan losses of the banking and
finance subsidiaries have decreased in the current three- and six-month
periods as a result of the securitization of $134.3 million of consumer auto
loans that took place during September 1998. The Company excludes securitized
loans and the related allowance for loan losses from its balance sheet, and
excludes the associated interest revenues and provision for loan losses from
its results of operations. Banking/finance interest expense decreased in the
current periods due to a reduction in the average borrowing requirements of
the banking/finance group combined with a reduction in effective interest
rates.
11
Operating expenses
Three months ended Six months ended
March 31 March 31
(In millions) 1999 1998 Change 1999 1998 Change
------------------------------------------------------------------------------
Underwriting and
distribution $153.3 $242.4 (37)% $316.3 $447.7 (29)%
Compensation and
benefits 128.8 132.8 (3)% 262.6 266.0 (1)%
Information systems,
technology and
occupancy 52.1 45.9 14% 100.6 92.5 9%
Advertising and
promotion 25.4 31.3 (19)% 53.6 58.6 (9)%
Amortization of
deferred sales
commissions 23.0 26.5 (13)% 48.0 50.4 (5)%
Amortization of
intangible assets 9.3 8.9 4% 18.7 18.0 4%
Other 18.8 22.5 (16)% 41.6 42.0 (1)%
Restructuring
charges 12.3 - 100% 58.5 - 100%
------------------------------------------------------------------------------
Total operating
expenses $423.0 $510.3 (17)% $899.9 $975.2 (8)%
==============================================================================
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 net
mutual fund sales and average assets under management. Net mutual fund sales
declined 36% and 33% in the three- and six-month periods ended March 31, 1999
compared to the same periods a year ago.
Compensation and benefits decreased 3% and 1%, respectively, from the same
three- and six-month periods in 1998. The decreases were due to the
preliminary effects of the reduction in the Company's workforce in accordance
with the restructuring plan described below. Affected employees were notified
on January 14, 1999, and the majority had left the Company by March 31, 1999,
although some will remain through June 1999. 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 14% and 9%,
respectively, from the same three- and six-month periods in 1998. These
increases were due to expenditures on major systems implementations, Year 2000
corrections and European Monetary Unit conversions. 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 decreased over the same periods last year,
mainly due to reduced promotional activity.
Amortization of deferred sales commissions decreased 13% and 5% over the same
three- and six-month periods in 1998. Sales commissions on certain Franklin
Templeton Group products sold without a front-end sales charge are capitalized
and amortized over periods not exceeding eight years-the period in which
management estimates that they will be recovered from distribution plan
payments and from contingent deferred sales charges. Reduced sales in fiscal
1999 have led to some reductions in deferred sales commissions and their
related amortization.
12
During the three- and six-month periods ended March 31, 1999, the Company
recognized pretax restructuring charges of $12.3 million and $58.4 million (or
$0.03 and $0.17 per diluted share after tax), respectively. These charges were
related to a plan announced and initiated by management in the first quarter
of fiscal 1999. See Note 2 to the financial statements. The Company does not
expect to incur any additional charges with respect to the plan during fiscal
1999.
Of the $58.4 million estimated total restructuring charges, approximately 80%
are expected to be utilized during the current fiscal year. The anticipated
lost revenues associated with discontinued products are not expected to have a
material impact on ongoing results of operations. The net impact of the
restructuring plan is also not expected to have a material impact on the
results of operations for the current fiscal year or the results of any one
geographic region or product line.
The $12.3 million charge recognized during the quarter ended March 31, 1999
was for severance and termination benefits related to the elimination of
approximately 560 positions or 7% of the Company's workforce. Although the
reductions were announced during first quarter, the charge was not recognized
until second quarter when the affected employees were notified. The
elimination of these positions was made possible primarily by the Company's
conversion to one shareholder servicing system in the United States.
At the completion of these restructuring efforts, the Company's annual
operating expenses are expected to decrease approximately $100 million from
peak levels in fiscal 1998, assuming a continuation of the business
environment at the time of the restructuring. The operating expense savings in
future periods are based on an analysis of current business activities and a
variety of cost-savings measures. A substantial portion of these anticipated
savings are expected to come from decreased employee and occupancy costs as a
result of the reduction in the workforce discussed above. In the three months
ended March 31, 1999 the Company had begun to see some reduction in operating
expenses as a result of the restructuring.
Other income/(expenses):
Three months ended Six months ended
March 31 March 31
(In millions) 1999 1998 Change 1999 1998 Change
------------------------------------------------------------------------------
Investment and $14.5 $11.6 25% $25.0 $26.6 (6)%
other income
Interest expense (4.8) (3.8) 26% (10.9) (10.0) 9%
------------------------------------------------------------------------------
Other
income/(expenses) $9.7 $7.8 24% $14.1 $16.6 (15)%
==============================================================================
Interest income exceeded that earned in the prior year, due to higher average
levels of investment securities in fiscal 1999. Interest expense increased
over the same periods a year ago due to an increase in the weighted-average
cost of borrowing and a decrease in capitalized construction period interest.
The increases were partially offset by a reduction in debt used to finance
operations. During the same periods, debt used to finance consumer auto loans
also decreased resulting in lower interest expense for the banking/finance
group. (See Other, net revenues above).
13
Taxes on income
The Company's effective income tax rate for the six months ended March 1999
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 not currently included in
U.S. taxable income.
MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL
RESOURCES
At March 31, 1999 and September 30, 1998 the Company's assets aggregated $3.5
billion. Stockholders' equity approximated $2.5 billion at March 31, 1999
compared to approximately $2.3 billion at September 30, 1998. The increase in
stockholders' equity was primarily a result of net income. Outstanding debt
(long-term and short-term) decreased by $162.4 million (27%) at March 31,
1999, from $612.4 million at September 30, 1998 as the result of the
utilization of cash from operations.
Cash provided by operating activities for the six months ended March 1999
decreased to $209.7 million from $242.4 million in the same period last year.
This decline was due mainly to lower net income in the current fiscal year.
The decrease in net income was due to lower operating revenues and the
restructuring plan. The Company sold $187.7 million of investment securities,
net of its purchases and used $47.8 million to purchase property and
equipment, providing $95.7 million from its investing activities in the
six-month period ended March 1999. Of these funds $198.4 million were used to
pay down and service debt and $23.5 million were used to purchase Company
stock, resulting in cash used in financing activities of $230.1 million.
During the six months ended March 31,1999, the Company paid $26.5 million in
cash dividends to stockholders.
As of March 31, 1999, the Company had fixed interest rates on approximately
$410.6 million or 91% of its outstanding 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 stockholder
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.
14
Year 2000 Readiness Disclosure
Information contained in this section regarding the Company's Year 2000
preparations is provided as of April 20, 1999, unless otherwise stated.
Because the Year 2000 project is an ongoing Company-wide endeavor, the state
of the Company's progress changes daily.
The Company's mission-critical securities trading systems, portfolio
accounting systems, customer service systems, general ledger systems, and
several of its international and domestic transfer agency systems, have been
certified as Year 2000 compliant and are operating in production. The Company
intends to have all but one of its remaining mission-critical systems, a
replacement sales and marketing system, certified by June 1, 1999.
The Company participated in the Securities Industry Association "Streetwide
Testing" which ended on April 17, 1999. This testing was successful and
revealed no significant problems in the Company's systems. Due to the use of
its domestic transfer agency system during such Streetwide Testing, the
Company delayed completion of some of its Year 2000 certification efforts on
such system.
The Company has now resumed certification testing of its domestic transfer
agency system and expects such testing will be finished in the near future.
Successful tests have been completed on certain primary processes such as the
establishment of new accounts and transactions which cross the century line.
No material problems have been encountered to date in the remediation and
testing of the domestic transfer agency system.
The Company's Year 2000 compliance plan is comprised of four phases:
Assessment, Remediation, Testing and Implementation. The Company considers a
system to be Year 2000 compliant when it has passed a number of prescribed
tests established by the Company, viewed as the industry-standard or suggested
by regulators. However, no testing can guarantee that a system which has been
certified as Year 2000 compliant will not have difficulties associated with
the Year 2000.
Assessment: systems are inventoried, budgets and strategies are
created to address identified problems.
Remediation: software corrections, upgrades and other fixes are
made; questionnaires requesting Year 2000 compliance
assurances are sent to vendors and, in some cases, test
scripts are requested.
Testing: internal systems are tested on a stand-alone basis;
point-to-point testing is conducted for some systems,
and the system is certified as Year 2000 compliant.
Implementation: systems that have been identified as being Year
2000 compliant are put into normal business operation;
end-user training is conducted.
15
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. The
following percentages refer only to mission-critical IT systems.
Phase of % of Mission
Project Critical Complete
------------------------------------
Assessment 100%
Remediation 97%
Testing 85%
Implementation 85%
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
maintained systems. These systems are prioritized as "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. Additional systems
were added to the pool of non-mission critical systems during the quarter
ended March 31, 1999, causing the Remediation completion percentage to drop by
1% from previously reported figures.
Phase of % of Non Mission Critical
Project IS&T Systems Complete
---------------------------------------
Assessment 100%
Remediation 98%
Testing 84%
Implementation 79%
Non-IT Systems. Non-IT systems include such items as building environment
controls and elevators, electrical and security systems, public utility power
supplies, phone company systems, and embedded computer chips in devices such
as fax machines and copiers. 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. Based upon the
Company's ongoing assessment and information received from third parties, very
few of the Company's non-IT systems will require remediation. The only such
system identified as of April 20, 1999 as not being Year 2000 compliant is the
internal building security system that the Company uses in certain of its
leased properties. The Company has ordered a Year 2000 software upgrade from
the vendor of this system. The Company does not expect to experience any
material effects related to the Year 2000 compliance of non-IT systems unless
there are general public utility problems beyond the Company's control.
16
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 and services 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. To date, no
mission-critical third-party supplier has informed the Company that it would
not be Year 2000 compliant by the millenium date.
Cost Estimates. The total estimated costs through March 2000 associated with
the Year 2000 project range from $50 million to $60 million, including an
unallocated reserve. 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 March 31, 1999 was approximately $26 million.
The Company's estimates of the total costs to complete the Year 2000 project
will continue to be refined in future periods. 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 developing comprehensive worldwide
contingency plans, including identification of those mission-critical systems
for which it is practical to develop a contingency plan. The Company currently
expects to have its contingency plans complete and in place by September 1999.
However, in an operation as complex and geographically dispersed as the
Company's business there are, in certain cases, limited alternatives to some
of its mission-critical systems or public utilities. While redundant systems
and back-up power supplies are in place to address communication or power
interruptions, if certain public utilities fail in multiple locations or
mission-critical systems are not made Year 2000 compliant or fail, there could
be a material adverse impact upon the Company's business, financial condition
and results of operations. This is especially true if such outages were to
extend for a period of many days.
The Company's contingency plans are based on critical processes required to
support the Company's worldwide business units, linking these processes to
systems, and providing work-arounds to mitigate the loss of such systems. A
software planning tool has been employed to facilitate the creation of
contingency plans. Business Continuity planning specialists are assisting in
the contingency planning process in each of the Company's global business
areas.
17
The Company has formed a Year 2000 cross-over team with representatives from
each major business function around the globe, including IS&T. The cross-over
team will identify what the Company must do before, during and after the Year
2000 cross-over. The Company's computer systems, including customer
information records, are already routinely backed-up and the cross-over team
is preparing processes to address any unusual occurrences related to the Year
2000 cross-over.
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. 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.
18
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
In the normal course of business, the financial position of the Company is
subjected to a variety of risks, including market risk associated with
interest rate movements. The Company is exposed to changes in interest rates
primarily in its debt transactions. Through its interest-rate swap agreements
and its medium-term notes program the Company has effectively fixed the rate
of interest it pays on 91% of its debt outstanding at March 31, 1999. As a
result, the Company does not believe that the effect of reasonably possible
near-term changes in interest rates on the Company's financial position,
results of operations or cash flow would be material.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material developments in the litigation previously reported
in the Form 10-Q of the Company for the period ended December 31, 1998 filed
with the SEC on February 12, 1999.
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.
19
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.
20
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.
21
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.
22
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.
23
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 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 January 14, 1999 reporting under Item 5 "Other
Events" the filing of a press release by the
Registrant on January 14, 1999 and including said press release
as an Exhibit under Item 7 "Financial Statements and Exhibits".
(ii) Form 8-K dated January 21, 1999 reporting under Item 5 "Other
Events" the filing of an earnings press release by the
Registrant on January 21, 1999 and including said press release
as an Exhibit under Item 7 "Financial Statements and Exhibits".
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRANKLIN RESOURCES, INC.
------------------------
Registrant
Date: May 12, 1999 /S/ Martin L. Flanagan
----------------------
MARTIN L. FLANAGAN
Senior Vice President
25